Archive for year: 2020

Catastrophes like floods and fires do occur and there is insurance to cater for these types of events. There are two different types of insurance cover for these events – one to repair or replace the assets damaged (your normal insurance policy) and one to compensate you for the losses incurred during the time it takes to get the business going again. This latter one is known as ‘Business Interruption’ or ‘Loss of Profits’ insurance.

Statistics show that nearly three out of four businesses never recover from a catastrophic event and it is therefore important to ensure that your Business Interruption insurance has been carefully thought through.

What to insure for

You need to have a good grasp of your costs and expected sales and gross profit. You don’t want to underinsure so if your business is growing reflect that fact – for example if you expect 10% growth (and trends in your business justify this) show this to insurers or you won’t get paid out this additional amount.

It is important to make sure that all your projections are well grounded and can be defended as they will be closely scrutinised by loss adjustors in the event of a claim. Thus, the better you understand your costs, the less chance of having a claim either rejected or adjusted downwards.

Another critical factor is the indemnity period. This is the time you will be covered for whilst out of business. For example, if you put a six-month indemnity period in your policy, you will only get paid out for six months even if it takes twelve months to get the business back on its feet again.

Let’s look at an example… 

Bernie has a cosmetics factory and his year end is 31 December.

	Bernie’s Cosmetics Factory
	Budget for Year	R
	Sales	120,000
	Cost of Sales	(45,000)
	Purchases	(10,000)	**
	Wages	(35,000)
	= GROSS PROFIT	75,000
	COSTS	(46,000)
	Salaries	(20,000)
	Distribution	(6,000)	**
	Maintenance	(5,000)	**
	Rent	(15,000)
	= PROFIT	29,000

On January 2, the factory burns down. It will take 12 months to get the factory up and running again.

	Business Interruption Claim	R
	ADJUSTED GROSS PROFIT	65,000
	Gross Profit	75,000
	Less Purchases	(10,000)
	COSTS INCURRED	40,000
	Salaries	20,000
	Rent	15,000
	Preparation Cost	5,000	***
	= CLAIM	105,000	*
	*Adjusted gross profit plus your incurred costs.
	**Variable costs which will not be incurred in the 12-month period of re-establishing the factory.
	***Putting together claims is a time-consuming task, so include it in your policy.
	NB! Include VAT in the assured amount as insurance pay outs include VAT.

You can see from this simple example that this is a very complex process – spend time with your accountant getting to grips with your revenues and costs. Also use a reliable insurance broker.

Remember that 43% of businesses that suffer a catastrophe never trade again and a further 29% go out of business within two years.

The Companies Act 2008 places onerous duties on directors and if you do not meet these obligations, you risk personal liability for any damages flowing from these actions.

“Knowing” in the company law context

A director gets “knowing” (actual knowledge) of the company by remaining apprised of the conditions of the relevant industry, what is revealed by the media of the business or its competitors and from the “pack” of data received before a directors’ meeting.

The Companies Act goes further and says a director “reasonably ought” to know important matters in the company. In other words, a director should look beyond what is presented to him and be on the lookout for any other issues that could impact the company.

To gain “reasonably ought” to know information, a director should investigate pertinent matters or may take “other measures” which would result in gaining valuable data – for example, the director may contact an executive director to clarify a matter.

An example to clarify – how to protect yourself from personal liability

• Let’s take “Bill”, a non-executive director of a company which has a subsidiary that imports equipment from China. Bill knows that the subsidiary has purchased a building and owes a R20 million bond on it. The company has guaranteed the R20 million liability.
• Bill has a board meeting in a week’s time and finds that there is no mention of the subsidiary’s bond in his management pack.
• He has read about the new COVID-19 coronavirus and realises that the factory that supplies the equipment to the subsidiary has been temporarily closed and it will take more than a month to get the factory back in production when it reopens. It will then take one month for it to build up stock. Shipping time to South Africa is six weeks. Bill finds out that the subsidiary has only one month’s stock and thus faces potentially about three months of trading without stock. The subsidiary is highly geared, and Bill is concerned that it could stop trading which would mean the R20 million guarantee will be called up and this could affect the company’s solvency.
• Naturally, Bill carefully documents all of this and raises his concerns at the board meeting.
• A majority of the board are reassured by the executive directors that Bill’s concerns are not valid. Four months later, the subsidiary ceases trading, and it and the company end up in liquidation.
• An investigation is carried out and one of its findings is that the company “reasonably ought” to have anticipated that the coronavirus would create solvency problems for the subsidiary and their failure to act has caused both companies substantial losses. Consequently, the directors are personally liable for these losses.
• Not all directors of course, as Bill shows the investigators the work he did and how he was outvoted at the board meeting. He avoids being held liable for the losses.

Directors be wary of this – don’t just rely on management packs etc but also look for the matters you “ought to know” about. This applies also to alternate directors and senior managers who are deemed by the Companies Act to effectively have the powers of directors.

Small and medium-sized enterprises (SMEs) have limited access to capital markets. As SMEs are considered to be the cheapest and most cost-effective sector in creating jobs, the Revenue authorities sought to address this by creating an attractive allowance for Venture Capital Companies (VCC) in 2009.

The VCC allowance gave a massive boost to venture capital in South Africa, and also to SMEs who have received R6 billion in investment since 2009. Venture capital now accounts for 2% of GDP (in the USA this is 4%).

For you the taxpayer it offers an attractive way to reduce your tax as you are allowed to deduct R2.5 million from your taxable income if you invest in a VCC. This is in your own capacity or via a trust; if you use a company to make the investment, it can deduct R5 million.

How it works initially

 

Note: The examples below relate to an investment in your own personal name, and different tax rates and net returns will apply if you invest through a trust or company.

 

Assume you have R2.5 million in taxable income. It is 20 February, you have little more than a week before you will have to pay provisional tax and you want to reduce your tax liability and make a good investment.

You have researched the VCCs and decide to invest R2.5 million in a VCC which invests in solar power.

You have saved yourself R1.125 million in tax.

To avoid having this tax deduction of R1.125 million reversed, you will need to be invested with the VCC for five years.

How it works in subsequent years

The VCC onward invests the R2.5 million in a qualifying SME (the SMEs need to be registered with SARS) which then installs solar power in, say, a block of flats. Of interest here is that the SME also gets a 100% deduction on the R2.5 million.

If you cash in on the investment after 5 years, this will be the position:

In summary, you received a tax deduction of R1.125 million and 5 years later paid R450 000 in capital gains tax. Your investment of R2.5 million has been refunded to you. If you discount these cash flows, this equates to an after-tax return of just over 10% over five years which is pretty good as inflation is currently just below 4%, i.e. a real return of 6%. As a comparative the stock market delivered a return of just below 6% in the last decade.

This excludes any costs you may be charged.

Beware of costs

There are many VCCs out there and they charge varying fees, so be very careful of these costs as they come in many guises such as performance fees, administration costs, annual charge etc.

It is worth getting your accountant to check these costs.

Look for the gems

As we saw above, the qualifying SME (the entity that installs the solar power), gets a 100% upfront write-off of the investment (R2.5 million in this example for a tax saving of R700 000). Some creative VCCs have used this tax saving to return income to you the investor. Take the example of a residential complex where the qualifying company installs solar power in the complex and then charges the owners of the complex for the electricity they consume using solar power (this charge is at a substantial discount to Eskom’s rate). The qualifying company returns this charge to the VCC which then pays these amounts as dividends to you, the investor.

Thus, everybody scores:

• Residents of the complex don’t pay for the installation of the solar power and get cheap electricity,
• The qualifying company takes its profit out of the R2 500 000 investment and tax saving of R700 000,
• The VCC makes money from charging you fees, and
• You, the investor, get a return (after-tax and net of all costs) of over 20% over the 5 year period, which is excellent.

Don’t delay, the clock is ticking!

The only downside to this is that the allowances will fall away in June 2021. VCC companies are lobbying government to extend this program past June 2021, but even if they are unsuccessful, you have just under 18 months to take advantage of this scheme.

Of course this sort of investment isn’t for everyone; ask your accountant whether it might suit you.

Recent research by the University of the Western Cape on the rate of failure of small businesses makes for interesting reading and provides insights that we all really need to take on board, particularly in these hard economic times.

SMMEs, their importance and their failure rates

Globally 60 to 70% of jobs are found in SMMEs (Small, Medium and Micro-Enterprises) but in South Africa this figure is only just over 28% despite more than 95% of businesses in South Africa being SMMEs.

South Africa has a higher failure rate of SMMEs than elsewhere in the world (70% – 80% of our small businesses fail within 5 years). In previously disadvantaged communities only 1% of businesses progress from employing less than 5 people to having staff of 10 or more.

6 factors that can make or break an SMME business

The research indicates that in terms of success factors, 40% can be attributed to the entrepreneur. The characteristics of this person are crucial and they need to show:

1. Persistence, being proactive and being a self-starter,
2. That they do not react to events but are continually planning (good planning is an important success indicator), innovating, having an ability to learn and apply this learning and having a culture of achievement.

The factors contributing to failure are ones we are aware of:

3. Lack of skills – government and large corporates snap up almost all of South Africa’s limited skills,
4. Difficulty in accessing finance – lending institutions require a track record before providing funding to businesses,
5. Poor accounting records and limited information systems,
6. Late payment by state institutions and large corporates (Kenya is considering passing legislation that compels paying SMMEs on time).

There are others too like corruption crowding out legitimate SMMEs and low bargaining power.

Entrepreneurs – what can you do?

Have a look at the 6 factors listed above. Maximise the positives, and do something about the problem areas. Remember, your accountant is there to help you succeed so don’t be shy to ask for advice.

What can government do?

Clearly the country is missing a sizeable opportunity to grow the economy and to reduce our 27% unemployment rate.

One way to get this going is through mentoring and training. Government programs are having a limited impact and there is space for business to also play its part. Why not interview some SMME owners and determine if they have the characteristics as shown above? Those that have the attributes can be successfully mentored to get good accounting records and systems, skills can be addressed as well as access to finance.