Lack of transformation is as big a threat as Covid-19
MONEYWEB / 13 MAY 2020 - 12.01 / ZODWA NTULI
Economic transformation is on a perpetual go-slow and the coronavirus may bring it to a screeching halt, warns B-BBEE Commissioner.
At the best of times economic participation of black people hinges on the whims of a resistant business class.
The latest National Status and Trends on Broad-Based Black Economic Empowerment (B-BBEE) report produced by the B-BBEE Commission again illustrates this transformation apathy. The report indicates that black ownership regressed from 32% in 2016 to 25% in 2018, that only 2% of the JSE is 100% black owned, and black management control of enterprises is stagnant at around 38%.
Now Covid-19 threatens to heap further destruction upon our fragile transformation environment. There is a need for urgent and sustainable interventions to mitigate the potential of Covid-19 to wipe out the nominal gains made over the last 26 years.
The aim of this article is to shed light on the worst-case scenarios for black business during this pandemic and more importantly spur us into action.
Black businesses shrink in size as turnover falls
The B-BBEE Codes of Good Practice categorise enterprises based on annual turnover for purposes of measurement for B-BBEE, with Exempted Micro Enterprises (EME) being those at R10 million and below and qualifying small enterprises (QSEs) being those at above R10 million and up to R50 million.
Some of these enterprises will not survive Covid-19, while some will shed jobs. The expected decrease in turnover for many enterprises would see a decrease in the number of large enterprises (above R50 million) who will become QSEs and the knock-on effect for some QSEs being reduced to EMEs.
Consequently, as EMEs exit, so the biggest contributor to black business participation in the economy diminishes and subsequently the potential to grow and be competitive.
Overall, the number of measured entities reduce, which also impacts available contributions towards B-BBEE.
Enterprise and supplier development (ESD) tanks
The advent of Covid-19 and slowed economic activity is expected to affect revenue and profit and, with constrained financial resources, enterprises will reprioritise their budgets.
For those enterprises that have reduced B-BBEE to a box-ticking exercise, spending on B-BBEE will likely to be sacrificed where deemed non-strategic or non-essential.
Supply contracts with black EMEs and QSEs stand to be cancelled, which is a threat to the sustainability of these enterprises that rely on supplier development from large enterprises. The black-owned suppliers may be forced to exit the market, leaving monopolies to thrive in already concentrated markets.
The same principle holds for enterprise development (ED) which requires enterprises to provide key and needed financial and non-financial support to black entrepreneurs who have business ideas, but need support to develop their ideas and operate a sustainable business.
The economic pinch also means the opportunity for new ED arrangements and support for black entrepreneurs is likely to diminish in 2020 and beyond.
Skills development funds cut and more unemployment
The recent unemployment statistics by Statistics SA showed a more-than 28% unemployment rate, with the majority being black people, and youth accounting for more than 50%. If 90% of the jobs are expected to come from small, medium and micro enterprises (SMMEs) as envisaged in the National Development Plan, this will be affected, as more jobs are expected to be shed.
Part of the challenges about employment has been a shortage of skills for the economy. The skills development element of the B-BBEE codes requires enterprises to spend 6% of payroll on skilling their employees and those outside their employ. This includes contributions towards bursaries and the YES initiative introduced last year.
Again, the percentage and actual rand value of spend towards skills development may be affected due to lower profits, insufficient revenue to stay afloat, and having to reprioritise spend. The effect would be no or less training for unemployed graduates, youth and black people in general, as wage bills get reduced.
Company B-BBEE contribution levels plummet
The 2019 national status and trends report showed about 60% of enterprises achieved a B-BBEE level of 1-4, an increase from the 40% in the 2018 report. If contributions and initiatives are reduced, enterprises face a lower B-BBEE performance rating and some would be downgraded a level in respect of each priority element they fail to achieve. This may also occur if enterprises decide not to proceed with some of the ownership transactions they were implementing this year.
With less ESD activity, skills development and ownership, downgrading is more than likely, resulting in enterprises losing their licences or contracts with organs of state if they lose their compliance status.
Section 10 of the B-BBEE Act makes it mandatory for all organs of state and public entities to consider the Codes for qualification criteria for procurement, licences, incentives and grants, among others.
A non-compliant status may trigger withdrawal or cancellation processes or disqualify enterprises for new applications.
Increase in defaults on B-BBEE loans
The Major B-BBEE Analysis Report 2017 – 2018 showed the grand total value of the 272 registered major B-BBEE transactions under the period of the report (June 2017 to 31 March 2018) was R188,745 billion. Of these transactions, about 35% were vendor financed, 19% financed by banks and 1.5% financed by government. Only about 21% of the transactions are said to be cash-based, but that does not mean unencumbered, as there is no requirement to disclose the source of the cash.
This funding model means that most equity acquisitions by black people are financed by the private sector itself on its terms, with black people being indebted to the private sector sellers.
Typically, the structure of the B-BBEE deals includes provision that dividends will be used to repay the loan advanced for the acquisition of shares, more often notional loans. Some enterprises will not be able to declare any dividends under the current conditions. The lack of dividend flow will affect the repayment of the loans account and lead to compounded interest and or extended repayment terms, which will affect net value realisation. This means black shareholders will continue to be over-indebted with no hope of settling the loan in the agreed term, thus threatening the ability to ultimately own the shares.
Most financing agreements include a default provision that the shares will revert to the seller if there is a default in loan repayment; provisions may be invoked to the detriment of black shareholders. We expect that some deals will hold while others would require restructuring or refinancing, which may impact black shareholders even further by increasing capital and or interest owed.
Major B-BBEE transactions put on ice or cancelled
In 2017-2018, 272 major B-BBEE transactions were filed, and 95 in 2018-2019, and over 100 expected in 2019-2020. With Covid-19, not only are transactions delayed due to the lockdown period, but the conclusion of some intended for 2020 will be halted or affected negatively, reducing the opportunity of acquisitions by black people.
With the economic slow-down, there is a possibility for reduced numbers of B-BBEE transactions and consolidations and mergers. The dilution of black shareholding will lead to a regression in ownership by black people. The pace of economic transformation would be retarded, which will further prolong disparities and inequality.
The way forward
There needs to be a careful consideration on the size, nature and duration of the financial interventions made available to support black businesses in this period – this means all black businesses, not only black SMMEs. The interventions required include grants, incentives, and other non-financial support necessary to sustain these businesses.
Preferential procurement should be enhanced in this period to continue to advance adherence to B-BBEE. Relaxing these rules will leave the majority of black suppliers and entrepreneurs out of the value chains.
This is also the time to encourage strategic empowerment partnerships between [black-owned] and [white-owned] enterprises for available support to benefit an inclusive economy. Bona fide discussions, re-negotiations and collective strategic decision-making between or among partners is advisable.
An increase in government funding made available to black business and entrepreneurs will also go a long way, given that only 1.5% of the B-BBEE deals filed in 2017/2018 were funded by government or government entities. To increase the impact, partnerships between public and private sector funding institutions may be more beneficial seeing, that more than 50% of the B-BBEE deals are either bank-funded or vendor financed. The funding in this case should extend to start-up capital and basic support required by new entrants and black entrepreneurs currently making use of ESD support.
Covid-19 should not be seen as an opportunity to create a “no rule” dispensation but rather an opportunity to encourage better coordination between public and private sector to transform the economy to be inclusive.
Zodwa Ntuli is the B-BBEE Commissioner
Disclaimer - The views expressed here are not necessarily those of the BEE CHAMBER