NOT ALL SHARES ARE CREATED EQUAL: WHY YOUR NEXT DEAL NEEDS A SECOND LOOK
In the great corporate barnyard of capital raising, not all eggs are laid equal.
Some investors want the golden egg – a predictable slice of profit, warm and regular. Others want to own the hen – feathers, feed, risk and all. And for businesses, the real question is: do we reward performance, or give away power?
This isn’t just an academic riddle. Whether you opt to issue equity shares or enter into a profit-sharing arrangement will fundamentally affect your company’s governance, tax exposure, strategic direction, and future valuation.
Below, we unpack this critical choice in South African law and commercial strategy – not just in what the terms mean, but in how they behave, what rights they carry, and how a wise business should approach the investor courtship ritual.
Equity Shares: A Seat at the Table, and a Slice of the Pie
An equity share represents formal ownership in a company. Shareholders enjoy the privileges and responsibilities that come with legal title, including voting rights, dividend entitlement (when declared), access to key financial records, and – crucially – participation in capital appreciation and exit events.
Under the Companies Act 71 of 2008, these rights are regulated by a combination of the Act (notably sections 35 – 40, including section 36 on share classifications, and sections 50 – 65), the company’s Memorandum of Incorporation (MOI), and any shareholder agreements. Shareholders are listed in the securities register (section 50), have access to financial records (section 26), and can vote on key transactions (section 65), including sales of major assets or issuing of further shares (section 41).
This legal structure means that shareholders do not merely “earn”; they influence, participate, and persist.
To use a business analogy: equity is like buying into a chain of hotels. You don’t just get revenue from guests; you get a say in expansion plans, brand positioning, and if the hotel chain is sold to an international group, you share in the windfall.
Profit Sharing: A Cut of the Action, Without the Keys to the Office
Profit-sharing, by contrast, is a purely contractual right to receive a portion of the profits generated by the company or project, without receiving any ownership interest.
There are no shares issued, no voting rights conferred, and no access to financial decision-making. The investor is, legally speaking, an income-entitled creditor – not a member of the corporate body.
While this structure can be commercially useful in incentivising introducers, channel partners, or non-controlling investors, it offers limited long-term security. The recipient of profit shares has no claim to value on sale, no say in governance, and no cushion if profits drop. Their only real recourse is breach of contract.
This model is popular in South African B-BBEE structuring, project finance, or founder-retained ownership scenarios – but it must be handled carefully.
Picture it like this: profit sharing is akin to leasing a corner of a profitable logistics warehouse – you receive rent tied to delivery volumes, but you don’t get to change the fleet, paint the trucks, or claim proceeds if the warehouse is sold.
The Governance Gap: Ownership vs Obligation
While both mechanisms provide returns, only equity provides governance muscle.
- Equity holders can call meetings (section 61), vote on resolutions (section 65), and challenge directors for breach of duties (section 76).
- Profit share recipients, on the other hand, may be locked into long-term contracts with no say in key strategic decisions – including the sale of assets, dilution of returns, or shifts in financial policy.
This imbalance becomes particularly acute when things go wrong – such as insolvency, management disputes, or underperformance.
In the words of Cassim et al. in Contemporary Company Law (Juta, 2021), “the rights conferred by shareholding are not merely economic; they are participatory, enforceable, and structural.” By contrast, profit-sharing rights, being personal and enforceable only in contract, may collapse if the company faces liquidity issues or restructuring.
The Tax Trap: Structure Now, Regret Later
Equity returns (dividends) are taxed under the Dividends Tax regime (currently 20%), while profit-sharing payments are typically taxed as income at the recipient’s marginal rate, which may be higher.
This distinction is not merely academic.
If you structure something that looks, smells, and functions like a dividend – but call it profit-sharing – you may trigger unexpected tax, regulatory, or B-BBEE consequences.
The Jet Charter Analogy: Equity Investors vs Profit Sharers
Let’s say your company launches a luxury jet charter operation.
- Equity investors own 25% of the company. They help decide on routes, aircraft purchases, and marketing strategies. If the company is sold, they receive 25% of the proceeds. If it crashes and burns (figuratively), they take the hit.
- Profit share partners, on the other hand, receive 10% of net profits – if there are profits. They don’t get to vote, don’t attend board meetings, and don’t see a cent if the company is sold to Emirates.
It’s not that one model is better – it’s that they serve different purposes. But companies that fail to understand this often find themselves accidentally giving away the jet instead of the charter income.
Due Diligence: The Radar Before Takeoff
No matter which model you offer investors, a thorough legal due diligence is critical – and not just for the buyer.
For companies, due diligence provides the legal audit of readiness. It ensures:
- That your share register is clean and compliant (section 50);
- That your MOI aligns with the intended structure (section 15);
- That profit-sharing arrangements aren’t inadvertently triggering shareholder approval requirements under Section 41 (3) of the Companies Act of more than 30% of company assets or voting rights;
- That your governance framework can withstand scrutiny in future funding rounds or exit events.
For investors, due diligence is a means to test whether the returns match the rights, and whether they are entering into a robust legal framework or an entrepreneurial daydream.
Think of it like this: due diligence is your flight simulator. Before you take off – whether with an equity co-pilot or a profit-share passenger – you need to know if the instruments work, the doors are secure, and the manual isn’t just aspirational.
Final Boarding Call: Ownership, Obligation, and Opportunity
At the intersection of law and investment lies a simple, elegant truth: not all money is equal.
Some partners want a voice. Others want a return. Your job as a founder, director, or investor is to understand the weight of each, and to structure accordingly.
Whether you are structuring a shareholder entry, revisiting your MOI, or negotiating a complex B-BBEE transaction – ask yourself:
Are you giving away the hen, or just a few eggs?
Author: Zahra Abdul
The above is intended for informational and educational purposes only. Please consult with our team for further advice.
