Why convert to a private company
As you may know, it is no longer possible to register a new Close Corporation (“CC”).
Do you have a CC and require assistance to determine the following:
1. Can I keep trading as a CC?
You can keep trading as a CC that existed before 1 May 2011. CCs will phase out in the next couple of years, and all CCs will be compelled to convert to a private company.
As explained below, our current laws are unfavourable to continue trading as a CC.
The members of a CC have the following options:
- Convert to a private company with a new Memorandum of Incorporation (“MOI“). The MOI sets out unalterable provisions of the Companies Act and the alterable clauses according to your business needs;
- Remain a CC (until a deadline for conversion is announced) and comply with the Companies Act, which creates an amended CC. You will need a new Association Agreement customised to suit your business.
2. What is the difference between a private company and CC?
The CC was created to be a vehicle for a single entrepreneur or a group of members who require limited liability (protecting against personal liability by creating a corporate entity). The CC was also created for perpetual succession (continuation of a corporation’s existence despite the death, bankruptcy, change in membership or an exit from the business of any owner or member) that was easy to run and not burdensome. Only natural persons could be members of a CC.
CCs do not separate the rights of owners and managers in a business if they are both members and have the same risks and liabilities. They have only one agreement, the Association Agreement, which combines all parties’ roles, responsibilities and relationships.
The Companies Act distinguishes between shareholders and directors and their duties, rights and responsibilities. A company must have an MOI, which sets out the company’s governance standards and shareholders’ rights and roles as a distinction from directors. It is supplemented with the Shareholders Agreement, which deals with rights and responsibilities and exit strategies for Shareholders.
Now many provisions of the Companies Act apply to CCs, creating an unwieldy hybrid system. If you choose not to convert, a new Articles of Association must be implemented to be tailored to the new legal system. These are not merely documents to tick off a compliance list. They are the roadmap for conducting your business and protecting your personal liability!
Here is some information to allow you to make an informed decision:
3. Advantages of a private company
- The small private company has the same (and more) advantages as the CC, namely:
- Reduced annual return fee;
- No audit;
- No compulsory annual general meeting;
- Credibility in tender applications;
- Credibility with international companies as the CC was a uniquely South African vehicle;
- Credibility in general: a Proprietary Limited is a better brand for a growing business;
- Corporates can own shares in a company, not like a CC. Therefore, you are palatable to equity investors;
- Revenue stream can be extended to shareholders;
- Electronic administration;
- Good corporate governance through compulsory clauses in Memorandum of Incorporation (“MOI”);
- Regulate business relationships and avoid disputes with Shareholders Agreement;
- There is better protection against personal liability as the Business Judgment Rule applies to directors of companies. For example, when the director acted in good faith and took a decision in the company’s best interest with advice from an auditor, attorneys, or other professional advisors, it resulted in an error of judgment, which meant a financial loss to the company director will be protected.
- You can appoint managers as directors and give them profit share without giving up equity or control;
- A private company means a more dynamic business model and better risk management
4. Disadvantages of trading as a CC
The amendments to the Close Corporations Act and application of provisions of the new Companies Act altered this simplified legal vehicle, and the disadvantages are:
- Onerous administrative duties and arrangements;
- Public interest score calculation (PIS-score);
- Obliged to deliver annual financial statements in conjunction with the International Financial Reporting Standards;
- Compulsory audit of the financial statements of specific CCs dependent on their PIS score;
- Unlike with companies, third parties are entitled to assume each member can act and bind the CC. The Association Agreement should be altered so that the CC is only bound to transactions with third parties if the member has expressly or implied obtained authority from the CC;
- Members of a CC are now compelled to purchase the interest of another member, whether he wants to or not;
- To fund the purchase of the interest of another, the courts can order the sale of a corporate asset. It would be best to determine the value of the interest in the Agreement of Association;
- All CCs are now subject to a stricter Solvency and Liquidity Test than that applied to companies, in particular, if the CC wants to make a payment to a member;
- When a CC makes a payment to a member contrary to the provisions of the Close Corporations Act, the member will be liable to the CC for any such payment received;
- Easier disqualifications of members regulations;
- Strict winding-up and liquidation requirements.
5. Required information and documentation for conversion from Close Corporation to Company
- Notice of Conversion
- Filing fee
- Written consent signed by members holding at least 75% of the members’ interest;
- MOI
- Initial directors;
- Certified copies of the identity documents of all the incorporators and the directors.
6. Should you wish to remain a CC?
You must obtain advice on what is best for your corporation. You will need a new Association Agreement tailored for your needs to avoid the pitfalls of the legislation, which is now a Frankenstein’s monster of legal principles.
We encourage you to connect with Yolandi Erasmus on email yolandi@novatelegal.co.za to BOOK a Free in-person or remote 30-Minute consultation to assess your business legal requirements.