01 - Business Entities

Question 1

What are the factors to take into account when choosing a business entity?

Answer 1

The number of persons involved The extent of these persons’ involvement The required capital at commencement of business The sources of capital Relevant tax considerations The necessity to limit liability The expected duration of the business venture

Question 2

What are the general characteristics of a sole proprietor?

Answer 2

Not a separate legal entity (Business assets and liabilities form part of personal estate – no distinction). Profits from business is added to person’s other income. Interest earned on business bank account is added to the other interest earned by person (e.g. only R23 800 exempt if under 65). If business makes loss it can normally be set off against other sources. It does not qualify as a “small business corporation” but can qualify as a micro business

Question 3

What are the advantages of a sole proprietorship?

Answer 3

-No formalities required to start the business -No partners or board to report to – self-employed -No formalities to stop doing business, other than settling liabilities Income from business accrues straight to proprietor Income tax and CGT relatively simple The proprietor can insure own life to cover liabilities in order to ensure smooth transfer of all business assets to heirs after death

Question 4

What are the disadvantages of a sole proprietorship?

Answer 4

All the proprietor’s assets are at risk -All licences, agreements and goodwill ceases at death of the proprietor -Business will cease on death of proprietor -All business assets will be subject to CGT on death of the proprietor due to deemed disposal of all a natural person’s assets to estate on death Sole proprietor cannot be employee of the business and therefore not belong to pension fund A sole proprietorship is more difficult to sell than a separate entity

Question 5

What are the general characteristics of a partnership?

Answer 5

A partnership is an agreement between natural or juristic persons, under which each partner agrees to contribute to the partnership. The partnership’s object is the making of a profit. The partnership’s business is conducted for the joint benefit of the partners. Partnerships can be: -universal partnerships or specific partnerships. -ordinary partnerships or extraordinary partnerships.

Question 6

What is the difference between a universal and a specific partnership?

Answer 6

A universal partnership occurs when -partners contribute all their property or all their profits to the partnership, -usually for an open-ended period -and for wide-ranging purposes, -with a commensurate sharing of the profits of their enterprises. Example - Marriage in community of property is (or a similar relationship can be) a universal partnership, but universal partnerships also occur in commercial undertakings. A specific partnership will usually be a -more temporary and focused arrangement, -in terms of which partners contribute their resources for a particular defined purpose only -and share only in profits from that particular project together, e.g. a professional partnership like architects or engineers.

Question 7

What are the types of partnership?

Answer 7

In an ordinary partnership, partners are jointly and severally liable for all of the debts of the partnership. The liability of partners in an extraordinary partnership is limited in some way. There are different forms of extraordinary partnership: -An anonymous partnership has at least one partner whose name is not disclosed to the public and who is not liable to third parties for the debts of the partnership, but is liable to the other partners to the extent agreed between the partners. -A partnership en commandite has undisclosed partners who make a fixed contribution and whose liability to other parties is limited to that fixed commitment.

Question 8

What are the essentials of a partnership?

Answer 8

Each party must make an appreciable contribution to the partnership; The business is carried on for the joint benefit of the partners; The objective should be to make a profit; and The agreement between the parties should be legitimate and made with the intention to establish a partnership.

Question 9

What are the rights of a partner in a partnership?

Answer 9

Financial -Share in the profits of the partnership; -Compensation for services rendered to the partnership; -A share of the assets when distributed on dissolution of the partnership. Non-Financial -Participate in the management of the business; -Inspection of the partnership books;

Question 10

What are the duties of a partner in a partnership?

Answer 10

Financial -Make a contribution towards the partnership; -Share in losses of the partnership; Intent -Accept and fulfil the obligations of the partnership agreement; -Procure benefits for the partnership; Competence and Information -Exercise care and skill in all actions in connection with the business of the partnership; -Make full disclosures of information relevant to the partnership; -Guard against conflicts of interest.

Question 11

Is a partnership a separate juristic person?

Answer 11

No. A partnership does not have separate legal personality from its members. The partners own the partnership property as co-owners and the rights and liabilities of the partnership are also the individual partners’ rights and liabilities. Therefore, the death of a partner brings the partnership to an end. This can be dealt with in the partnership agreement by immediately creating a new partnership between the remaining partners. Two exceptions to this rule are: -The sequestration of a partnership estate is, to an extent, treated as separate from the estates of the individual members of the partnership. -A partnership may sue and be sued in its own name.

Question 12

How is a partnership terminated?

Answer 12

-Expiring of the term for which the agreement was entered into; -The end of the business undertaking or reason for existence; -Mutual agreement between all the partners; -A notice of dissolution given by one of the partners in terms of the agreement; -An order of court granted upon application of one or more of the partners for good cause. -A change in the membership of the partnership (a new partnership may be agreed to); -The insolvency of the partnership or any of its members; -Partners becoming alien enemies on or after the outbreak of war;

Question 13

What are the advantages of a partnership?

Answer 13

-Uncomplicated to form -No registration requirements, except for a specific trade or profession Partners can conduct any business and are only limited in this by any relevant provisions of the partnership agreement. A partnership en commandite can be very useful for certain investment schemes, e.g. property development.

Question 14

What are the disadvantages of a partnership?

Answer 14

No perpetual succession. Upon the death of each partner, or if a partner gives a notice of dissolution, the partnership comes to an end. Partners are jointly and severally liable for the liabilities of the partnership, with the exception of extraordinary and en commandite partners.

Question 15

What are the general characteristics of close corporations?

Answer 15

-Close corporations (CC’s) were created under the Close Corporations Act, 69 of 1984. -The new Companies Act, 71 of 2008, put and end to this. -Existing CC’s continue to operate under the 1984 Act, but no new corporations can be formed. CC’s are separate juristic persons with perpetual succession and do not die with the member(s). Members hold a member’s interest, expressed as a percentage. Members can enter into an association agreement and buy-and-sell agreements.

Question 16

What is the nature and the number of members allowed within a CC?

Answer 16

A CC can have anything from 1 to 10 members. Members can be: Natural persons; The executor or administrator in the deceased estate of a member; The trustee or curator of the insolvent estate of a member; A trustee of a testamentary trust if - beneficiary of the trust is a natural person and - if the trustee is a juristic person it is not controlled by a trust beneficiary; A trustee of an inter vivos trust, subject to certain conditions - beneficiary of the trust is a natural person; - The total number of beneficiaries, together with the total number of members of the CC may not exceed ten. -If it does, the trustee ceases to be a member and that membership can never be reinstated.

Question 17

What are the rules of Association Agreement that may not be altered?

Answer 17

Disposing of an insolvent member’s interest (see sec 34); The members who are disqualified from taking part in the management of the CC (see sec 47); The right of a member to call a meeting.

Question 18

What are the standard rules of the Association Agreement that may be altered?

Answer 18

Financial -Every member is indemnified with respect to expenses incurred in connection with the business. -Payments to members (profits) will be in proportion to their membership interest. Non-financial -Every member is entitled to participate in the business of the CC. -Every member has an equal right to take part in the management of the CC. -Decisions must be by majority vote, in accordance with the percentage membership interest.

Question 19

When would the separate legal status of a CC be pierced?

Answer 19

-Abuse of the existence of the CC; -Making of certain loans without the consent of all members; -Acting with gross negligence, intent to defraud, etc. -Members who do not qualify to be members; -Taking part in the management while being disqualified; -Failure to appoint an accounting officer; -Failure to act with the necessary skill;

Question 20

What are the advantages of a CC?

Answer 20

• Very flexible, and can be converted into a company if need be. • Can act quickly and easily due to simple structure. • Less complex legislation than company legislation • No directors, and hence no complex rules to protect members against abuses of power by directors. • Perpetual succession and limited liability (to an extent). • Can purchase member’s interest. • The turnover is unlimited, only the number and nature of members are limited. • There is a measure of protection in that certain decisions can only be taken by a majority vote.

Question 21

What are the disadvantages of a CC?

Answer 21

The CC Act can be too simplistic with inadequate protection for minorities. Many parts of the 2008 Companies Act are now incorporated by reference. The corporate veil can be pierced or lifted more easily because of the informality of the structure. -The absence of an association agreement can cause serious problems. -In the absence of an association agreement, any member of the CC can incur liabilities on behalf of the CC. -An association agreement binds a new member although that member did not participate in the drafting of the agreement.

Question 22

What are the general characteristics of companies?

Answer 22

The Companies Act, 71 of 2008, came into effect on 1 May 2011, replacing Act 61 of 1973. -The new Act encourages business activity by providing a more flexible regulatory environment. -The focus is now to make a company and its office bearers accountable to relevant stakeholders. -The new act focusses on an enlightened approach to shareholder value. -Shareholders must promote the success of the company in their collective best interest -Shareholders must foster positive relationships with employees, customers and suppliers. The company is allowed to regulate itself through its Memorandum of Incorporation (MOI), which can vary significantly from company to company. The act prohibits - reckless trading and trading in a negligent or fraudulent manner. Under the new act existing close corporations can continue, but no new close corporations may be formed.

Question 23

What are the types of company that can be set up?

Answer 23

Profit company – incorporated for the purpose of financial gain for its shareholders. The maximum number of shareholders are not restricted in any way. Non-profit company – replacing the previous so-called sec. 21 company. Charitable or professional organisations, e.g. the FPI.

Question 24

What are the types of for profit companies that can be created?

Answer 24

Personal liability company (Inc) - It is a (private, profit) company used mainly by professional practices. Directors are jointly and severally liable together with the company for all contractual debts and liabilities incurred during their term of office. Private company ((Pty) Ltd) – It is a profit company whose MOI prohibits the offering of shares to the public and restricts the transferability of its shares. Public company (Ltd) – Any company that is not a state-owned enterprise, a private company or a personal liability company. Shares may be offered to the public and are fully transferable (irrespective of whether it is listed on an exchange or unlisted). State-owned company (SOC) – National government business enterprise.

Question 25

What does it mean for a company to be a separate legal entity?

Answer 25

A company is a separate legal entity with separate juristic personality. It exists separately from its shareholders and does not come to an end upon the death or insolvency of any shareholder or group of shareholders. It can sue and be sued in own right and has its own rights, duties, assets and liabilities. A shareholder’s liability is limited to the value of his/her shareholding, unless s/he has signed surety for company debts. Directors of a personal limited liability company are jointly and severally liable with the company for contractual debts and liabilities incurred during their term of office.

Question 26

Under what conditions can the separate legal status of a company be pierced?

Answer 26

Common law – Courts have power to “lift corporate veil” and hold shareholders and directors personally liable for company debts if: -The company is used to disguise fraudulent and illegal conduct -A director/shareholder treats company assets as his/her own - A statute empowers the court to do so. Companies Act - Section 20(9) of the Act gives the courts the power “to lift the corporate veil” ignore the separate legal personality of the company and treat shareholders/directors as if they owned the assets and conducted the business in their personal capacities.

Question 27

What is the MOI?

Answer 27

-Under the 1973 Act, two documents were needed, i.e. the Memorandum and the Articles of Association. -Now one document, the Memorandum of Incorporation (MOI). The MOI sets out the rights, duties and responsibilities of shareholders, directors and other stakeholders. It determines the type of the company, and the rights, powers and duties of all stakeholders. The 2008 Act prescribes that the MOI includes: -unalterable provisions -alterable provisions -default provisions (this applies automatically if the MOI does not deal with that matter). The MOI can be amended by special resolution or by order of court. Shareholders of a company may enter into an agreement concerning any matter relating to the company, provided it is consistent with the Act and with the MOI. Examples are: -Association or shareholders’ agreement; -Buy-and-sell agreement.

Question 28

Describe the nature of share capital in a company structure?

Answer 28

Under 2008 Act a public or private company must have two types of share capital: - authorised shares capital: maximum number authorised by MOI -issued share capital: the amount of share capital raised by company in return for the number of shares issued by it. Authorised share capital is not static. It can be increased or decreased by special resolution by board of directors, except if MOI provides that it cannot. No minimum share capital is required.

Question 29

What are par value and not par value shares?

Answer 29

Under the 1973 Act, companies could authorise and issue shares either with a par value, or without it. Par value shares have been abolished by the 2008 Act. Shares issued before 1973 Act was repealed will continue to have all the rights associated with par value shares. Par value shares will continue until the Minister has made regulations for their conversion to no par value shares.

Question 30

What rights do shareholders have?

Answer 30

Financial -Share in profits of the company that has been duly distributed by the company, e.g. by the declaration and payment of a dividend -Share in the net surplus capital of a company upon its winding-up. Non-Financial -Vote at general meetings of members; -Information about the affairs of the company;

Question 31

What are types of shares that a company can create?

Answer 31

Preference shares - Shareholders enjoy preference over any other class of shares i.r.o. payment of dividends and in some case i.r.o. return of capital on winding-up. Cumulative preference shares - Arrear dividend to accumulate and be added to a dividend declared in a subsequent financial year (preference shares are presumed to be cumulative unless there is a contrary provision in the MOI or terms of issue). Participating preference shares - Which (contrary to the general rule) entitle preference shareholders to share in distributions of surplus profits after the payment of their dividends. Shares with preferential rights to a refund of capital on winding-up (generally, preference shares share pro rata with ordinary shares in the repayment of capital). Convertible preference shares - which give shareholders the right to convert them into shares of another class. Ordinary shares (the residual class of shares and constituting the equity share capital of the company) - which are not entitled to a fixed dividend, but are generally entitled to vote at general meetings of shareholders and - are generally entitled to share in any surplus profits on winding-up. Redeemable shares - which a company may redeem in much the same way that it would repurchase its own shares. Deferred shares (also known as founder’s shares) - which qualify for a dividend after a prescribed minimum dividend has been paid to ordinary shareholders. Capitalisation shares - which are shares that have been created out of distributable profits in place of paying out dividends.

Question 32

How are shares issued in a company?

Answer 32

Board has right to issue shares (no longer the shareholders in general meeting). Board can only issue new shares to the extent the MOI allows it to do so. Board can also increase the authorised share capital of the company (subject to limitations in MOI). Adequate consideration – Board to issue shares only for adequate consideration (cash or non- cash).