A Guide for South African Entrepreneurs on Selling Equity and Transferring Shares

Introduction

Selling equity and transferring shares are critical decisions for any business owner. These actions can bring in necessary capital, facilitate growth, and provide an exit strategy. However, entrepreneurs in South Africa must navigate a complex legal and regulatory landscape to ensure compliance and optimize their financial outcomes. This article outlines the key steps and considerations for South African entrepreneurs when selling equity and transferring shares in their businesses, with a focus on potential tax implications and the importance of seeking professional advice.

Understanding Equity and Shares

Equity represents ownership in a company, typically in the form of shares. Selling equity means offering part of this ownership to external investors in exchange for capital. This can dilute the original owner's stake but can also provide funds necessary for expansion, debt reduction, or other business needs. Shares can be ordinary or preference shares, each with distinct rights and obligations.

The Process of Selling Equity

1. Valuation of the Business

Before selling equity, it is crucial to determine the value of the business. This involves a comprehensive assessment of the company's assets, liabilities, market position, and future earning potential. Entrepreneurs can engage professional valuers or investment bankers to ensure an accurate valuation.

2. Preparing Legal Documents

Key legal documents required include:

- Sale of Shares Agreement: Outlines the terms and conditions under which shares of a company are sold and transferred from one party to another.

- Shareholders’ Agreement: Outlines the rights and responsibilities of shareholders.

- Subscription Agreement: Specifies the terms under which new shares will be issued.

- Memorandum of Incorporation (MOI): Governs the relationship between shareholders and directors.

3. Due Diligence

Potential investors will conduct due diligence to assess the viability and potential risks associated with the business. Entrepreneurs should be prepared to provide detailed financial records, business plans, and legal documents.

4. Negotiating Terms

Negotiations will cover the price per share, the amount of equity to be sold, and any additional conditions, such as board representation for investors or performance milestones.

5. Compliance and Regulatory Approvals

The sale of shares must comply with the Companies Act, 2008, and the Financial Markets Act, 2012. Entrepreneurs may need to seek approval from the South African Reserve Bank (SARB) if foreign investors are involved.

Transferring Shares

1. Review the MOI

The MOI will outline the procedure for transferring shares, including any preemptive rights of existing shareholders, which means existing shareholders have the first right to purchase shares before they are offered to external parties.

2. Obtain Necessary Approvals

Board approval may be required for the transfer of shares. In some cases, shareholders may also need to approve the transfer.

3. Prepare and Execute Transfer Documents

Essential documents include:

- Share Transfer Form (CM42): Formalizes the transfer of shares.

- Share Certificates: Must be updated to reflect the new ownership.

- Securities Transfer Tax (STT) Form: Required for tax purposes.

4. Register the Transfer

The company’s share register must be updated to reflect the new shareholder. This is a crucial step to ensure the transfer is legally binding.

Tax Implications

1. Capital Gains Tax (CGT)

Selling shares can trigger CGT on the profit made from the sale. The CGT rate for individuals is currently 18%, while for companies it is 21.6%. Entrepreneurs should maintain detailed records of the purchase price and sale price of shares to calculate the capital gain accurately.

2. Securities Transfer Tax (STT)

An STT of 0.25% is levied on the transfer of shares. This tax is applicable to both listed and unlisted shares and must be paid within two months of the transfer.

3. Dividend Tax

If equity is sold in the form of dividends (e.g., preference shares with cumulative dividends), a 20% dividend tax may be applicable.

Seeking Professional Advice

Given the complexity of the legal and tax issues involved in selling equity and transferring shares, entrepreneurs should seek advice from:

- Legal Advisors: To ensure compliance with the Companies Act and to draft and review all necessary legal documents.

- Tax Advisors: To optimize tax liabilities and ensure compliance with SARS regulations.

- Financial Advisors: To assess the financial implications of the sale or transfer and to provide valuation services.

Conclusion

Selling equity and transferring shares can be a strategic move for South African entrepreneurs seeking to grow their businesses or realize some of their investments. By understanding the legal requirements, tax implications, and the importance of professional advice, entrepreneurs can navigate this process successfully and achieve their business objectives.

The StartUp Legal is here to help make your compliance journey seamless. Book a complimentary consultation with us using the following link: https://calendar.app.google/1U7xpawDJd2ARe1Y8