There has been quite a lot of media coverage recently around a business by the name of “KleuterZone”, which operates a chain of creches and kindergartens around South Africa. In particular, according to the reports, there appears to be some controversy around the recruitment of investors by the business, with some investors claiming to have been issued shares in companies other than those they were led to believe they were investing in, or in non-existent companies. Other investors have complained that the returns they have received on their investments do not nearly approach the levels promised by the business owners. More recently, coverage has emerged in which investors have reported not being paid dividends declared to investors for the month of March, with the founder of the business apparently overseas and uncontactable. On 18 March, the Pretoria High Court ordered the provisional liquidation of KleuterZone Operations (Pty) Ltd, one of the group companies.

Having regard to the various and available information, the model by which the business attracts investors is not clear. A link on KleuterZone’s website (www.KleuterZonegroep.co.za) advertises “franchise opportunities”. In broad terms, a franchised business is an independent entity, trading under a name, and using intellectual property, belonging to the franchisor.  In the vast majority of cases, the business owner is actively involved in running it.  

However, a closer examination of the site indicates that the business is offering investors shares in existing businesses owned, not by independent entrepreneurs, but by the “group”. The website also speaks of there being over 1300 investors, spread amongst 83 separate schools operated by the company. It appears that investors are invited to subscribe for shares in one or other of the group companies, and remain invested as silent partners, with the expectation of receiving dividends when the company becomes profitable. This is confirmed by the affidavit filed in support of the provisional liquidation application, in which the applicant states that she purchased shares in KleuterZone Operations (Pty) Ltd, after receiving a “promotional offer”.

Whether a business is inviting investments in the form of acquiring independently owned and managed franchises, or by subscribing for shares in and existing companies managed by the founders, South African law is deeply concerned to protect investors from being misled into investing in a “too good to be true” concept, which turns out be just that.

In the case of a franchise, this protection is provided by the Consumer Protection Act (CPA) and the regulations enacted under it. This legislation provides that every franchisor must give every prospective franchisee a disclosure document containing, amongst other information, information relating to the franchisor’s financial status, the number of franchisees it has and the management support structure in place to assist franchisees. This information is intended to assist the prospective franchisee in evaluating the business opportunity presented to them. The prospective franchisee must be given at least 14 days to consider and verify the information provided, before the franchisor may ask them to sign a franchise agreement.

The regulations provide a lengthy list of terms and information the franchise agreement itself must contain, ranging from details of the business concept and intellectual property the franchisee will be licensed to use, the financial and operational obligations they will be taking on and the capital investment required of them.

Finally, section 7(2) of the CPA provides that, after signing the agreement, the franchisee will have a 10-business day “cooling off period” to consider the terms of the agreement and the business proposition and may then cancel the agreement, should they choose, “without cost or penalty”. The franchisee’s attention must be drawn to this right by printing the wording of the section prominently on the front page of the agreement.

In the case of a company that wishes to offer its shares for sale to the public, it must comply with the requirements of the Companies Act, and particularly Chapter 4, which, like the CPA and regulations, is intended to promote transparency and ensure that potential investors have access to all the information they reasonably require to make an informed decision.

Section 99 of the Companies Act states that, when shares of a company that are not listed on a stock exchange (as is the case with KleuterZone) are offered to the public, the offer must be accompanied by a prospectus, which has been filed with the Companies and Intellectual Property Commission. Section 98 provides that, as an alternative, shares may be offered by way of an advertisement, but the advertisement must either fulfil the requirements of a prospectus or indicate where and how the full prospectus can be obtained.

Section 100 sets out the requirements of a prospectus. It states that every prospectus must contain all the information that an investor may reasonably require to assess –

• the assets and liabilities, financial position, profits and losses, cash flow and prospect of the company in which a right or interest is to be acquired; and
• the securities being offered and rights attached to them.

It must also comply with the specification prescribed in terms of the Companies Act. Regulations 72 to 79 of the regulations in terms of the Companies Act set out in detailed information that must appear in a prospectus, for the assistance of potential investors.  

Section 104 of the Companies Act shows how seriously the Legislature takes the requirements of disclosure and transparency when companies offer shares for sale. The directors of the company, the person responsible for the preparation of the prospectus or who authorised it to be issued, and any person who offered shares on the basis of the prospectus, are all liable to compensate anyone who suffers a loss as a result of an untrue statement in a prospectus, or where information is omitted and investors are likely to be misled.

The applicant in the provisional liquidation application does not state whether she received any documentation other than the “promotional offer”. Having regard to the “promotional offer”, which is attached to the applicant’s affidavit, it appears to fall far short of the Companies Act requirements for a prospectus.

Potential investors, whether as owners of a franchised business or subscribers for shares in a company should be aware, and make use, of the rights to disclosure and transparency from promoters of investments, by making sure they obtain all information to which they are entitled. In so doing, they can avoid the risk of being caught out by those “too good to be true” propositions.  

Written by Ian Jacobsberg, Fluxmans Attorneys