Why PEP-owned Businesses Need An Exit Plan

Businesses rarely fail because a risk was unforeseeable. More often, they fail because everyone assumed they would have time to respond.

A shareholder is appointed to public office. A bank flags the company during a routine compliance review. A regulator requests information. Media scrutiny intensifies. Within days, banking facilities are restricted, key customers start asking questions, and one shareholder's continued involvement becomes a material business risk.

By then, it is too late to start negotiating an exit strategy.

Waiting until a problem arises is rarely an effective strategy, especially for companies with politically exposed shareholders. By the time banks, regulators or counterparties start asking questions, the window for calm decision-making has often closed.

A buy-and-sell agreement gives shareholders a framework for making difficult decisions before those decisions need to be made under pressure.

The risk most companies overlook

Throughout my practice, advising on commercial transactions and resolving complex disputes, I have seen the same pattern emerge repeatedly. The most difficult matters are rarely those involving the most complicated legal issues. They are the situations where parties failed to agree on the rules before a problem arose.

When relationships deteriorate or external pressure mounts, even sophisticated shareholders can struggle to reach agreement on valuation, timing and process.

Without a pre-agreed mechanism, the departure of a shareholder can trigger:

• deadlock between shareholders;
• disputes with estates or family members;
• uncertainty around management control;
• liquidity pressure on the business;
• disruption to key commercial relationships; and
• costly litigation over valuation or transfer terms.

These risks are amplified when one shareholder's profile creates regulatory or reputational concerns for the company itself.

A buy-and-sell agreement removes uncertainty by determining in advance who may acquire an interest, when they may do so, how the interest will be valued and how the acquisition will be funded.

When drafted correctly, it takes negotiation out of the moment of crisis.

A buy-and-sell agreement is only as good as its drafting

A buy-and-sell agreement does not exist in a vacuum. Under South African law, it must align with the broader corporate governance framework and the company's existing constitutional documents.

The Companies Act 71 of 2008 regulates share transfers, directors' duties and company-funded buyouts. Equally important is ensuring that the agreement works alongside the company's Memorandum of Incorporation and any shareholders' agreement.

One of the most common drafting failures is inconsistency between these documents. A carefully negotiated buy-and-sell agreement offers little protection if its provisions conflict with the company's constitutional framework.

Two provisions of the Companies Act are particularly important:

• section 4, which requires a company to satisfy the solvency and liquidity test before repurchasing shares; and
• section 48, which governs share repurchases and sets out the approval requirements for these transactions.

Funding mechanisms, valuation provisions and transfer restrictions should all be tested against these requirements at the drafting stage, not when a trigger event occurs.

Effective governance should also align with the principles of King IV, particularly those relating to ethical leadership, accountability and stakeholder-inclusive decision-making.

Why PEP ownership changes the equation

South Africa's anti-money laundering framework requires accountable institutions to apply enhanced due diligence measures to domestic prominent influential persons and foreign prominent public officials, collectively known as politically exposed persons, or PEPs.

PEP status is not a finding of wrongdoing.

It is a risk classification that recognises the increased exposure associated with individuals who hold, or are connected to, positions of public influence.

The challenge for businesses is that the risk does not remain confined to the individual shareholder. It extends to the company.

In practice, businesses with PEP shareholders may face:

• increased scrutiny from banks, lenders and investors;
• enhanced source-of-funds and source-of-wealth enquiries;
• reputational damage arising from adverse media coverage;
• concerns relating to procurement processes or conflicts of interest;
• additional compliance obligations; and
• the potential loss of contracts, licences or banking facilities.

These developments often happen quickly.

A bank's decision to de-risk a relationship or a regulator's request for information can create immediate operational consequences.

Businesses without a pre-agreed exit mechanism are then forced to negotiate under pressure, often with limited time and diminished leverage.

When the bank starts asking questions

Consider a company with three equal shareholders.

Two years after incorporation, one shareholder is appointed to a senior public office. Eighteen months later, the company's bank identifies the shareholder during a routine compliance review and advises that the shareholding structure must be reconsidered.

The remaining shareholders agree that an exit is necessary, but fundamental questions remain unanswered.

Who will buy the shares?

How will they be valued?

How quickly must the transaction occur?

How will it be funded?

Without agreed answers, the business faces uncertainty at precisely the moment when stability matters most.

A well-drafted buy-and-sell agreement would have addressed each of these issues in advance, enabling an orderly transition at a fair value within a defined timeframe.

What a PEP-specific agreement should cover

Traditional buy-and-sell agreements typically focus on death, disability, retirement or insolvency.

For businesses with PEP shareholders, that approach is no longer sufficient.

Additional trigger events and protections should include:

• mandatory disclosure of changes in PEP status;
• beneficial ownership transparency obligations;
• compliance warranties linked to anti-money laundering legislation;
• anti-bribery and corruption undertakings;
• source-of-funds and source-of-wealth cooperation obligations;
• sanctions screening and adverse media monitoring triggers;
• regulatory cooperation requirements; and
• lender, investor or counterparty triggers where continued involvement threatens banking facilities, licences or key contracts.

These provisions must be carefully balanced.

Companies have a legitimate interest in protecting themselves against regulatory and reputational risk. Equally, shareholders are entitled to due process, fair treatment and an independent valuation mechanism.

Agreements that allow shareholders to force an exit without objective safeguards are unlikely to withstand scrutiny when challenged.

The objective is not to create an unfair advantage. It is to establish a clear, transparent process that protects all parties.

Plan before the pressure starts

A buy-and-sell agreement should not be viewed as a contingency document that sits in a drawer.

It is part of the governance framework that protects a business when shareholder risk becomes a commercial reality.

The best time to address these issues is before they arise, while relationships remain strong and commercial objectives are aligned.

Waiting until a bank, regulator or headline forces the conversation is invariably the most expensive option.

If your shareholders' agreement and Memorandum of Incorporation do not adequately address PEP-related risks, now is the time to review them.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.