Companies Act, 71 of 2008 Series

Part 1: Setting up your company

If you are considering setting up a company, the two options that are available to you are to either incorporate a new company which is registered with the correct details from inception, or you can acquire a shelf company, transfer the shares held by the incorporator to the new shareholder(s) and then change the various company details. This article focusses on incorporating a new company from scratch.

While the process of incorporating a company may be relatively simple, there are very important considerations to take note of regarding the way in which your company should be structured – this will largely depend on your needs.

The basics

  • Every company is incorporated in terms of and subject to the provisions of the Companies Act, 71 of 2008 (as amended) (“the Companies Act“).
  • Every company must have a memorandum of incorporation (“MOI“) which is lodged with the Companies and Intellectual Property Commission (“CIPC“).
  • Every company must be incorporated with at least 1 (one) director and at least 1 (one) share in the company must be issued to at least 1 (one) shareholder (bearing in mind that no shareholder may hold fractional shares in the company).
  • All share transactions must be recorded in the securities register of the company.

What substantive documentation is required to set up a company?

  • MOI
  • Previously known as the memorandum and articles of association, this is the founding document of the company and sets out, among various other things, the share capital of the company, the shareholders’ rights in relation to share issues, restrictions on transfers of shares, voting rights of directors and shareholders, information rights and importantly, any limitations on the board of directors’ powers to deal with certain matters, for example, by being reserved for shareholder approval.
  • The standard MOI in terms of the Companies Act, available from the CIPC, is perfectly suitable for sole shareholder companies. However, for any company intending to have two or more shareholders, a bespoke MOI drafted according to the specific needs of the parties involved is highly advisable.
  • Shareholders’ agreement
  • A written shareholders’ agreement is also recommended for any company intending to have two or more shareholders. This agreement regulates the relationship between the shareholders and their rights and obligations towards each other and/or the company. It is a recordal of a certain position in time and contains provisions relating to, for example, the appointment of directors, shareholders’ funding obligations and circumstances in which shareholders may be forced to sell their shares. New shareholders can either sign a deed of adherence to an existing shareholders’ agreement, the shareholders’ agreement can be amended to include a new shareholder, or a new shareholders’ agreement can be concluded.
  • While a shareholders’ agreement is not a legal requirement for the incorporation of a company, it is certainly advisable to have such an agreement in instances where there are confidential matters that the shareholders wish to record in writing that would otherwise be contained in the MOI. The MOI is a public document (any person can apply to the CIPC to obtain a copy of a company’s MOI), so parties should carefully consider whether there are any matters that they would like to preserve the confidentiality of.
  • Other supporting documentation
  • For the purposes of issuing shares, simple subscription agreements may also be prepared to record the terms on which such shares are issued to the new shareholders.
  • In terms of the Companies Act, any issue of shares must be authorised by the board of directors, such shares must be evidenced by share certificates which are issued by the directors and must be recorded in the securities register of the company.

What is the process involved in registering a company?

Most recently, the CIPC have managed to drastically improve their online company registration systems and on average, it now takes between one and three weeks for your new company to be incorporated. Dommisse Attorneys’ company secretarial unit can assist you with an application to the CIPC to incorporate a company. The following documentation must be submitted for this purpose, namely:

  • various CoR forms;
  • a MOI;
  • certified copies of the identity documents of all initial directors / incorporators; and
  • a mandate letter for Dommisse Attorneys to make the application to the CIPC on your behalf.

Your company is registered, now what?

  • The CIPC will issue a certificate of incorporation which evidences the registration of the company. The next step will be to issue shares to the first shareholders of the company.
  • SARS should automatically register the company for the purposes of Income Tax and you will be able to open a bank account for the business, if required.
  • There are various on-going company secretarial tasks, such as creating and maintaining the securities and directors’ register of the company (a requirement in terms of the Companies Act), preparing board and shareholders’ resolutions, MOI amendments, attending to the filing of annual returns and the processing of any company changes, for example, change of registered office or financial year end.
  • Dommisse Attorneys’ company secretarial unit offers these services, not only to newly incorporated companies, but also to mature companies seeking our assistance for the purposes of a due diligence or general compliance. Having your company secretarial house in order is very important when considering attracting outside investment and/or for exits of existing shareholders.

Attention credit providers: affordability assessment regulations suspended

The Department of Trade and Industry published a notice on 21 August 2015 (GG 39127) confirming the suspension of the affordability assessment regulations under the National Credit Act 34 of 2005 for a period of six calendar months effective from 13 March 2015. The notice further indicates that until the suspension is lifted on 13 September 2015, the affordability assessment guidelines that were published by the National Credit Regulator in September 2013 will be enforceable.

The affordability assessment regulations came into effect on 13 March 2015 which makes it mandatory for credit providers to “take practicable steps” to assess the consumer’s discretionary income in order to determine whether the consumer has the financial means and prospects to pay the proposed credit instalments. The National Credit Act prohibits credit providers from granting “reckless credit”. A credit provider must not enter into a credit agreement without first taking reasonable steps to assess the proposed consumer’s existing financial means, prospects and obligations (amongst other things). If this is not done, the credit agreement could be declared as reckless which gives a court or tribunal the power to either set aside the consumer’s rights and obligations under that agreement or suspend the force and effect of that agreement.

The affordability assessment regulations in essence require credit providers to consider the following before granting credit:

  • three months bank statements or payslips;
  • a consumer’s credit profile as contained at a credit bureau;
  • calculation of consumer’s necessary expenses such as accommodation, transport, medical, education, food, water and electricity (table provided in the regulations to ensure that consumers are not understating their expenses);

The publication of the notice seems to be somewhat superfluous. There is only a little over 3 weeks left for credit providers to implement the necessary “system changes” since the date of publication of the suspension notice was on 21 August 2015 and the date upon which the suspension will be lifted will be on 13 September 2015. After the suspension is lifted the affordability assessments will become compulsory and enforceable by the National Credit Regulator. This probably does not give credit providers the necessary time to comply which was their original grievance with the regulations. Safe to say, credit providers should finalise their system changes at this stage in order to ensure compliance with the regulations before the suspension is lifted.

 

Q&A with the co-founders of WooThemes, Mark Forrester and Magnus Jepson

Following on from the “featured client” insert which appeared in our May newsletter, we managed to pin down the co-founders of WooThemes to hear what they had to say about their experience working with our law firm, especially in light of the “WooMattic” transaction, as it has affectionately come to be known among the transaction team.

Why is it important for a law firm to build up a sound knowledge base about their client’s products and industry?

WooThemes is surrounded by an interesting tech ecosystem – the open source software world. Selling commercial software products for an open source platform comes with its fair share of niche license legalities and grey areas, especially around the GNU General Public License.

This, coupled with a good grasp of our intellectual property, where it is being generated, and an understanding of our international business is hugely important context for our legal team to make well informed recommendations.

What core skills should a law firm have?

Beyond an understanding of our ecosystem, it’s important for a law firm to have a genuine interest in the open source philosophy and legalities and to further believe in the values we operate with and carve out commercial protection around them. At WooThemes we always gravitate towards start-ups and more specialist companies with a hunger for catering for our niche requirements and providing customised solutions. Relationships matter to us, so it’s been great having a personal connection with Dommisse Attorneys and the specific attorneys dedicated to us. Two skills that are crucial are diplomacy when dealing with different parties and to be honest and upfront when navigating an area they are not particularly well versed in and willing to connect you with a network that is.

Communication is always a potential pitfall; so how can attorneys ensure that they communicate in a way that fits with your company’s style?

We’re a distributed company of remote workers, with co-founders on different continents. We thrive on communication systems like Slack, Google Hangouts and Skype to connect with our team of 55 people spanning 18 countries (and a lot of different time zones). Working with lawyers who understand how we communicate and are willing to adopt our processes has been refreshing. It’s also encouraging to see legal firms willing to adapt and embrace the change that the Internet brings.

What is the most valuable role that a law firm can play in a significant transaction, like the sale of WooThemes to Automattic?

Given that we were ill equipped in the areas of investments, mergers and acquisitions and due diligences, a significant role for our attorneys to fulfil was to facilitate and provide expert guidance to us, as well as maintaining an objective view of the deal and being able to help guide the negotiations. A role all start-ups’ attorneys’ should be able to fulfil is to humanise legal jargon and take the pain out of digesting lengthy contracts, highlighting the important items, whilst being willing to make judgements on other more minor points based on their understanding of the client (reading the client’s workloads and stress levels).

Just as important as the acquisition, is to ensure a healthy pace through a nerve wracking due diligence, whilst ensuring no areas are left uncovered. In a transaction of this nature, ensuring over-communication, especially when dealing with so many different attorneys on the other side of the transaction, was vital.

What is the worst way a law firm could behave in the course of a deal like this?

When it comes to dealing with a company like WooThemes, a crucial failure would be making assumptions that the client has read all the legal contracts in the same detail that the law firm has! Also, not being willing to adapt to the communication needs of the client or the acquirer can put the transaction at risk. Trying too hard to impress the wrong client by losing focus of your client’s needs, as well as taking a long time to communicate, both to the client and to the acquirer, could have equally severe consequences.

One of the most important things to remember is that when it’s crunch time, don’t rush through the all-important last terms and amended agreements, and worry about missing a deadline rather than ensuring the client has all the information they need to make the best decision.

Employee share ownership plans: Some whys & hows

INTRODUCTION

In the past few months, we have seen a noticeable increase in the number of clients making enquiries about Employee Share Ownership Schemes/Plans (we will ‘affectionately’ refer to them as “ESOPs” for the purpose of this article). Setting up an ESOP is almost invariably a fairly expensive and time-consuming process, so we recommend that any company looking to set up such an employee incentive plan should carefully consider some of the ‘why’s’ and ‘how’s’ from the outset to ensure that the end result is firmly based on the initial aims and intentions, and that all parties understand the benefits and pitfalls. On the positive side, it is encouraging see so many companies (particularly start-ups) considering and making enquiries about their ESOP options at such an early stage, demonstrating a healthy acknowledgment of the importance of employees to business success, and a curiosity to explore a variety of corporate structuring options.

THE ‘WHYS’ AND ‘HOWS’

In an effort to bring some structure to the questions of why, whether and how to set up an employee incentive plan of some kind in a South African company law environment, we recommend being guided by the below initial considerations:

Why an ESOP?

All too often companies lose sight of the ‘why’ at some point on the road to taking a corporate structuring step. The reasons and intentions behind your ESOP should guide and inform most aspects of the way in which it is structured and implemented – if this is done, a more coherent plan results from the process. By way of a few examples:

  • If your intention is to attract top talent, then ensuring that there are real ownership benefits and that the tax consequences have been carefully considered, may be more likely to attract these individuals to your business.
  • If your intention is to retain top talent, consider whether the vesting or restriction provisions in your ESOP should be structured such that your employees see more benefit the longer they stay.
  • If your intention is to benefit your BEE status by setting up an ESOP, consult with your rating agency as a first step in determining the best way to structure your ESOP.
  • If your intention is to provide your employees with a real ‘cash-in-hand’ benefit, make sure that the ESOP benefit they receive is one which is capable of giving regular cash benefits (such as dividends).
  • If your intention is to benefit every level of employee in your business, ensure that your ESOP is not overly complex, is well communicated, and does not force employees to pay for the benefit (bearing in mind that employees who live on a month-to-month basis most likely won’t want to ‘buy’ something with only a possible future cash realisation).

Finally, once you have identified the intention/s behind your ESOP, it is important to consider whether these intentions can be better served in another way, for example, through a company bonus pool or issuing options to acquire shares directly to certain employees without having these form part of an ESOP. You do not want to look back on the cost and effort in setting up your ESOP as being ultimately avoidable in favour of an alternative employee benefit structure.

What ESOP structure is best for you?

We are most commonly approached with requests for two different types of employee incentive plans, namely an ESOP which grants employees of a company the right to acquire actual shares in such company (either directly or through ‘options’), and, a phantom/notional share scheme administered by a trust (with the trust holding shares in the company concerned, and with the employees as beneficiaries of the trust, receiving benefits attaching to such shares).

The best structure for your ESOP should first and foremost be guided by its intentions, however there are some broad-sweeping generalisations which we sometimes apply in advising our clients on the best structure for their incentive scheme:

  • Phantom/Notional Share Plan/Scheme: These have a great capacity for flexibility and can be geared towards giving your employees a ‘cash’ benefit without the employees having any control over shares or company decision-making, or ownership of the actual shares. These schemes are most appropriate for dividend-declaring companies with a large number of possible ESOP beneficiaries, with no need to have any ‘real’ ownership of shares in these companies.

 

  • Employee Share Ownership Plan/Scheme: These are most appropriate for smaller beneficiary pools, where a company’s aim is to provide employees with the opportunity to acquire an actual share in the company. These do create the potential for a large number of shareholders (having the downside of creating a ‘rats and mice’ share register and attracting some administrative hassle in approving shareholder resolutions), however there are also a few structuring choices that can be made to minimise the downsides (for example by having a separate ESOP share class).

Nothing is certain but death and taxes?

It’s best to accept early on that granting your employees an ESOP benefit is bound to have a tax repercussion. We recommend arming yourself with the best tax advice in relation to the income tax and capital gains tax that might be payable on ESOP benefits, to ensure that your employees obtain the best possible benefit from their ESOP participation (bearing in mind the intentions of the ESOP), and to ensure that your company does not fall foul of tax laws by (for example) failing to withhold and pay PAYE when it becomes due.

How will you implement?

Implementation is an oft-overlooked factor of an ESOP. By way of a few examples, you might need to consider:

  • The terms of your ESOP in relation to vesting and restrictions.
  • The provisions of section 97 of the Companies Act, 71 of 2008 in relation to a compliance officer for the ESOP (so that the scheme does not fall within the meaning of a public offer of securities).
  • Whether or not your employees will need to be bound by the provisions of an existing shareholders’ agreement for the company once they acquire shares in that company.
  • If you will be running your employee incentive scheme through a trust, what are the costs and implications of registering and administering that trust.
  • How will employees be allowed to exercise options to acquire shares?
  • How will you communicate the ESOP benefit appropriately to your employees – not creating unrealistic expectations, but being sure to communicate honestly and effectively and providing training where necessary.

CONCLUSION

While we don’t wish to oversimplify the process of setting up and implementing an ESOP, we believe that a basic understanding of the above will be a good foundation from which to proceed. We would also recommend, as some final points, that you avoid complexity wherever possible, be guided by your intentions at all times, and don’t be afraid to ask your legal or tax advisor what might seem like stupid questions – the better understanding you have of your own ESOP, the more likely it is to be an effective business and corporate structuring tool.