Buying an Existing Business

This month we read in the news about the historical planned acquisition of Activision Blizzard Inc. by Microsoft Corp..  The deal is said to be approximately $68.7 billion which will be the largest merger in the history of the video game industry. This has sparked up conversation at Legalese regarding the benefits for such an acquisition as well as the legal consequences of such sales.

Why purchase an existing business?

There are many reasons why you may be interested in purchasing an existing company. In certain circumstances and industries, it may be necessary to purchase your competitors to grow your business. The company may have assets including intellectual property that may be beneficial to the growth of your business. There could be a sector of customers that the company has already established a relationship with that your company has not. These among other factors could be the attractive reasons for considering the purchase of an existing business.

How should you structure the sale?

There are two primary ways in which you could structure the sale. You could purchase the entire shareholding through the sale of shares, or you could purchase the business as a going concern.

Sale of Share Structure

In this structure you will be purchasing the shares from the shareholder(s) in the company. The result of this sale would be that you become the shareholder. The company’s legal entity will remain intact and will continue operating as is. The valuation of the shares may be expressly set out in the Shareholder Agreement of the company. It is important to ensure that, if you structure the sale in this manner, the foundational documents of the company have been reviewed (i.e., Memorandum of Incorporation and Shareholder Agreement).

Business as a Going Concern Structure

Alternatively, you may purchase the business as a going concern and avoid any transfer of shares. This sale involves the business’ assets, clients, brand name, intellectual property, and good will. The result of this type of sale is that a new legal entity takes on the business. It will no longer be housed in the previous legal entity. It is important to note that every aspect of the business need not be subject to the sale for it to legally be considered a sale of a business as a going concern. This term does not have a definition set in stone but rather a test which is applied. It will amount to a sale of a business as a going concern when the business largely remains the same after the sale as it was prior to the sale. This test will be applied on a case-by-case basis.

What if there are existing employees?

The first structure (the sale of shares) would not result in any change in the relationship with existing employees. The entity remains intact and therefore the employer does not change and neither do the terms of the employment. The second structure (sale of a business as a going concern) results in the business transferring in whole or in part to a new entity. Therefore, the legal identity of the employer no longer operates the business. The Labour Relations Act has expressly set out what occurs in this instance. Generally speaking, the existing employees shall have their contracts transferred to the new employer on the same conditions as the contract with the previous employer if the sale is a going concern. Deviations from the terms of the existing employment agreements could amount to a renegotiation of the terms in terms of South African Labour laws.

What are the tax consequences of the sale?

The sale of shares is not simply a transaction that amounts to revenue in accordance with South African Revenue Services (“SARS”). There are certain factors which must be considered to conclude whether the sale of shares will be treated as revenue or as capital in nature. We recommend seeking professional guidance on the circumstances of your transaction if you intend to sell your shares.

The sale of a business as a going concern will provide the seller with certain tax benefits. However, as always, there are certain requirements. Both the seller and buyer must be VAT vendors for the transaction to be “zero-rated”. This is very important because it will permit the purchase to not pay VAT on the purchase of the business. If it is not expressly stated that the business is a going concern and the parties to the sale are not VAT vendors, then this benefit falls away. The purchaser will then be required to pay the associated VAT and may claim it back at a later stage.

Conclusion

Unfortunately, we are not privy to the details of the sale of Activision Blizzard Inc. to Microsoft Corp., but we are reminded of the multitude of benefits of growing your business by purchasing an existing business. If you are considering purchasing an existing business or you have been approached to sell your business, then contact us at Legalese. We will assist you with distilling the complexities involved in such a transaction and ensure that the sale is tailored to best suit your needs.

– Christian Tabor-Raeside

Have any questions? Drop us a message below and we’ll be in touch!

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