The Global Entrepreneurship Monitor South Africa reported in 2016-2017 that the established business ownership rate in South Africa was only 2.5%. This means that, of the population aged between 18 -64 years old, only 2.5% own or manage their own business that has been in operation for at least 42 months.
Although concerning, considering the role these entrepreneurs play in creating jobs and wealth in the economy, there has been a recent movement in the employment market towards independence. In such cases, one will either opt for starting their own business from scratch, a challenge in itself, or choose to buy an existing business or franchise.
But what does ‘buying a business’ really entail in South Africa? The most important first step in buying a business is that you feel prepared and comfortable in your ability to manage it.
There are several value drivers of a business that you should consider in your brainstorming process:
- Trained employees
- Customer base
- Existing cash flow
- Financial records and representations by seller
- Your plans for the business
While the option of acquiring an already established business may be less risky than starting from scratch, buying a business is no guarantee that it will continue to be successful and careful evaluation and research should be undertaken to assist your final decision.
We highlight some key factors to consider when purchasing a business in South Africa.
- How do you plan on Buying the Business?
Will you be buying the entire business including assets, liabilities, staff and contracts or are you going to take over the assets and the clients too? There are numerous places that offer information on businesses for sale in South Africa and a brokerage is a good place to start as they are aware of the legal requirements. When it comes to negotiating the sale agreement, get to know if there will be a hand over period, whether the seller has any personal relationships with influential stakeholders and if there is going to be a restraint of trade agreement.
- Analyse Financial Records
It is advised that you analyse the financial records including balance sheets, profits and loss statements, tax returns, purchases and sales records and bank statements for the past 3 years. These documents are important for determining the viability and profitability of the business. The price you eventually pay for the business is usually a multiple of the net profit before interest income and tax which is why it is important to acquire financial statements as these help to determine possible future income as well as any contractual obligations. You also want to know if the business you are buying is going to be profitable so constantly monitor financial activity.
- Assess any Tax Implications
Whether you buy the entire business or only own the assets of the business, you are now liable for any taxes owed or to be paid. It’s wise to find out how the existing employees were paying tax, i.e. using the payroll service and if they were on employment payment tax and then get a tax authority to issue a ‘clearance letter’. Should you wish to sell your business in future, it’s also in your interest to know about relevant provisions of capital gains tax law and Securities Transfer Tax (STT) implications.
- Evaluate the Business Model and Competition
It is wise to find out why the seller is selling their business and what model or strategy they were employing to maximise profit. Get to know the key decision makers in the business, such as the CEO or management team, and decide if the business can function efficiently without them if they are leaving the company. Also evaluate whether you will have a competitive advantage, be it through your products, branding, technology or operating efficiency.
- Draft a “Letter of Intent”
This consists of the terms and conditions of purchase between the buyer and seller and includes things like the purchase price, how and when the amount should be paid, the assets of the business that will be sold to the buyer, the terms of the seller’s noncompeting agreement and so on. This term sheet assists the lawyers when it comes to drafting the legal contracts for the sale.
It is vital that you do extensive research before purchasing a business as it is a lengthy and sometimes tricky process. Don’t be afraid to ask for help and get professional advisors involved.