Private Companies in South Africa: Practical and Legal Considerations Concerning Acquisitions and Disposals

• South Africa
• Africa

• Mergers and acquisitions

29-11-2019

Mergers and acquisitions (“M&As”) involving privately held companies in South Africa entail various legal, financial and other issues. Advanced preparation and an understanding of the fundamental practical and legal issues concerned can significantly impact the outcome of such acquisitions and disposals.

Illustrated hereunder are select essential factors to consider when embarking upon an M&A transaction entailing the sale or purchase of a private company/business in South Africa.

1. Timing

Most M&As take a considerable period from inception to consummation. Accordingly, it is imperative to initiate and maintain a realistic timetable which will act as a driving force to closure. Additionally, it is beneficial for the seller and purchaser to maintain a dedicated and focussed team to maintain momentum throughout the transaction.

Legislative and regulatory factors which can affect the timing of private M&As in South Africa include South Africa’s unique competition law (anti-trust law), exchange control legislation, employment law, Black Economic Empowerment (“BEE”) polices, financial regulatory system and the takeover provisions contained in the Companies Act No7 of 2008 (“Companies Act”) pertaining to takeovers and mergers.

As a result of the lengthy path to finalisation, financial projections may deviate during the M&A process. During the negotiation phase of the M&A, it is difficult (partly as a result of the inevitable distraction by the M&A process) but imperative that the management of the target company ensures continued conduct of the business in the same manner in which it has been conducted in the past in order to ensure that the financial performance of a company or business is not significantly reduced. Any significant reduction in the financial forecasts of the company or business can result in the failure of the transaction or significant warranty and indemnity claims by the purchaser.

2. Due Diligence Investigation and Preparation

M&A transactions typically involve a substantial due diligence on the part of the purchaser. Private companies and businesses are “private” and unsurprisingly, there are limited resources to obtain information relating thereto. Purchasers rely heavily on the target company itself to provide such information. Prior to obligating itself to the transaction, the purchaser is likely to require detailed information on a number of matters pertaining to the target company in order to fully appreciate its business affairs and operations, including its history, state of affairs, financial, operational, legal and strategic position, assets and liabilities, contracts, litigation risk and intellectual property issues. It should be noted that a purchaser will employ additional highly specialised due diligence activities when investigating companies in regulated industries, such as banking, insurance or finance. Accordingly, the selling company will need to ensure that its books, records, and contracts can withstand a purchaser’s robust due diligence investigation.

Through thoughtful planning for the due diligence investigation, the seller will be in a position to identify and pre-empt potential risks which will prove advantageous for negotiating mitigation measures to successfully negotiate and consummate a sale of the target company. Certain legal deficiencies such as missing or unsigned agreements which are commonly uncovered during the due diligence investigation can be remedied as a condition to closing.

Other significant information for the purchaser which may be gleaned from the due diligence investigation and which may be remedied as conditions to closing include-

• consents required from counterparties to contracts in connection with the acquisition. The parties should attempt to limit or eliminate any consent requirements that could delay or jeopardise the transaction. In addition, the purchaser is likely to be concerned regarding change in control provisions in the selling company’s agreements. For example, if a key license terminates upon a change in control, the purchaser may seek a substantial purchase price reduction or exit the deal altogether. A prudent seller will review such documents early in the deal process in order to identify these provisions and work with its advisors to develop a strategy for addressing any identified risks.
• employment terms and conditions relating to key employees and/or management of the target company. The seller may wish to negotiate restraint of trade provisions for key management;
• legislative and regulatory consents and requirements for the continued conduct of the business of the company and in order to implement the transaction;
• shareholder approvals required to implement the transaction and consideration of dissenters’ or appraisal rights issues as well as specific Board approvals required to give effect to the transaction.

Naturally, there is a careful balancing act between disclosures to a potential purchaser early in the process (to avoid misunderstandings later) and limiting disclosure of important trade secrets or other confidential information until definitive agreements have been concluded between the parties in question. Sellers should be judicious regarding a potential purchaser being armed with important knowledge which could be used to compete with the seller’s business, particularly if the potential purchaser is a competitor. Hence, the need for a carefully constructed non-disclosure agreement.

3. Non-Disclosure Agreement

As indicated above, due diligence disclosures can be precarious if the potential acquirer is a direct competitor of the seller. It is therefore imperative for a selling company to ensure that a comprehensive non-disclosure agreement is in place with interested purchasers. Such agreements should strictly define limitations on the use by the purchaser of the seller’s confidential information disclosed during the negotiation process.

4. Letter of Intent

Notwithstanding that a letter of intent is strictly not required as a precursor to an M&A transaction, it is common for parties to enter into a detailed letter of intent once a favourable purchaser has been identified. These documents, although non-binding with respect to business terms, are extremely important for ensuring exclusivity for the purchaser during the negotiations of a definitive acquisition agreement. Similarly, a seller should negotiate the terms of the letter of intent or term sheet with the assistance of its legal advisors as if it were a binding document in order to optimise a favourable deal for the seller.

5. Legislative and Regulatory Considerations

The regulatory and legislative context surrounding M&As in South Africa encompasses common law and statute. However, the legalities surrounding M&A transactions involving privately held companies is largely governed by agreement between the parties. The foremost statutory considerations which are applicable in the private M&A arena are briefly outlined below.

5.1. The Companies Act

The Companies Act governs South African registered companies and prescribes the following actions on the part of such companies-

• Shareholder approval for the disposal of a whole or the greater part of the assets of a company or business;
• The acquisition of minority shareholdings in circumstances where a purchaser intends acquiring 90% or more of the shares in a target company;
• Appraisal rights for dissenting minority shareholders (if all or a major part of a business is sold);
• A statutory procedure relating to the amalgamation of two corporate entities into one;

• Specific regulations (the Takeover Regulations), in instances where more than 10% of the shares in a private company have been transferred within the previous 24 months (other than between related parties) and in respect of “Affected Transactions” which include the sale of all or a majority of the business of a private company, a scheme of arrangement, a merger or any transaction in which a person acquires 35% or more of the voting rights of a company.

5.2. The Competitions Act No 89. of 1998 (“the Competitions Act”)

The prior approval by the South African Competition Authorities of M&As which involve a change in control and have an economic effect within South Africa are mandatory under the Competitions Act, provided that the applicable monetary thresholds based on the gross turnover and gross asset values of the target company and the purchaser, are satisfied. Several factors are considered during the merger approval process, including whether the transaction will prevent or lessen competition and the impact of the proposed transaction.

5.3. Exchange Control Considerations

In terms of the Exchange Control Regulations of 1961, the South African Reserve Bank is specifically authorised to control the flow of capital in and out of South Africa. Although these controls have been gradually relaxed over the years, foreign sellers and purchasers may require exchange control approval prior to implementation of an M&A involving a South African registered company or South African owned or held assets.

5.4. BEE Considerations

BEE is a policy of the South African government intended to ensure the economic empowerment and increased economic participation of previously disadvantaged black South Africans. Areas on which the government has focused its BEE policies concerning South African companies and business are, ownership, management control, employment equity, skills development, preferential procurement, enterprise development and socio-economic development (social responsibility). Accordingly, there has been an increase in companies in South Africa placing empowerment obligations on their service providers and suppliers thus giving preference to suppliers and service providers who have satisfactory BEE credentials.

6. Definitive M&A Agreement

The definitive acquisition agreement is of paramount importance to both the seller and the purchaser and is central to a successful M&A transaction. Some of the more important issues which will arise in negotiating the definitive acquisition agreement include:

• Transaction structure (share purchase, asset purchase, or merger);
• Purchase price and related financial terms such as, possible adjustments to the purchase price and the milestones or other triggers for earnouts or contingent purchase price payments, including retention amounts for warranty and indemnification claims by the purchaser and the period of the retention;
• The mechanisms for termination of the agreement prior to closing and the financial consequences thereof;
• The conditions to consummation of the transaction (parties should ideally limit these to ensure that the transaction can close quickly and without risk of failure of such conditions). Regulatory requirements must be satisfied before closing and the parties should consider the issues that may arise in this regard particularly relating to competition (anti-trust) approvals, exchange control legislation, financial regulatory compliance and the take-over provisions contained in the Companies Act (if applicable);
• The nature, extent and scope of the representations and warranties to be furnished by the seller and whether any qualifications will apply. For example, “knowledge” and “materiality” caveats, alternatively, the parties may consider use of M&A representations and warranties insurance;
• The allocation of risk, particularly concerning unidentified liabilities;
• In circumstances where closing of the transaction does not occur immediately following signing (which is often the case), the nature of the business covenants applicable between signing and closing;
• The treatment of employees, having specific regard to the Labour Relations Act no.66 of 1995 (if applicable);
• Provisions for termination of the acquisition agreement;
• The responsibility and cost for obtaining any consents and governmental approvals; and
• The preparation of a disclosure schedule (the schedule attached to an acquisition agreement that lists contracts, capitalisation, intellectual property, litigation, etc., and exceptions to representations and warranties that would otherwise not be accurate). Formulating this schedule is time-consuming, may require many drafts and often delays signing and/or closing of the transaction. Accordingly, sellers and/or the target companies are cautioned to commence preparing this schedule without delay. A carefully constructed disclosure schedule can operate as formidable protection against post-closing indemnification claims by the purchaser.

Evidently, there are multifaceted and challenging legal issues which are required to be negotiated and documented in the definitive acquisition agreement and sophisticated M&A advisors who are intimately familiar with the business realities of the transaction, the overall structure and mechanics of the acquisition agreement and who possess a comprehensive command of the substantive South African legal landscape are essential for the seller and the purchaser to ensure that their respective interests are adequately protected and that the acquisition or disposal can be finalised and implemented in the most cost effective and timely manner.