BUSINESS LIVE / 03 DECEMBER 2020 - 14:49 / ASHLEIGH HALE AND NTOKOZO NZIMA
Transactions now include several empowerment structures, such as assets sales and equity equivalent investment programmes
Certain trends are becoming apparent in relation to broad-based black economic empowerment (B-BBEE) transactions in SA, driven in part by market conditions and the increasing role of the B-BBEE Commission in assessing BEE transactions.
For the past five years or so BEE ownership transactions have been predominantly implemented through trusts, including employee and broad-based ownership schemes. This limited range of options is expanding to include several more empowerment structures, such as the sale of assets to black-owned companies and equity equivalent investment programmes (EEIPs).
We are also seeing transactions with black private equity funds, which if they meet certain criteria — including being managed by majority black-owned fund managers — are deemed to be 100% black-owned. Companies are also looking to capitalise on programmes such as the Youth Employment Service (Yes) initiative, which seeks to increase the level of youth employment in SA. If certain targets in this initiative are met it can improve a company’s BEE status by one or two levels. Trusts had become the default choice as they are quick and straightforward to set up, but the B-BBEE Commission has been questioning how effective they are in achieving economic transformation. Hence the renewed interest in ownership structures. Asset sales can be an attractive empowerment option for companies, especially if they involve the sale of a business component/division that the acquirer can run as a stand-alone operation or in a joint venture with the seller, with the seller earning BEE ownership points as a result. EEIPs, on the other hand, are intended for multinationals with global policies that restrict their ability to sell shares or assets in local operations. EEIPs have historically been perceived as challenging because they require ministerial approval and capital investment. EEIPs enable multinationals to claim ownership points by making contributions to socioeconomic development initiatives in lieu of an ownership transaction. With socioeconomic development now a matter of urgency, the government appears to be displaying greater willingness to engage on EEIPs. More EEIPs are almost certainly on the cards. Another emerging trend is for companies in certain sectors to go above and beyond the standard ownership target, which in most sectors is 25% plus one vote. Even though there are no additional ownership points to be scored for exceeding the standard target, we are seeing 51% black-owned and 30% black female-owned structures being implemented as a result of competitive pressures in some sectors, most notably in the information & communications technologies (ICT) and marketing, advertising & communication sectors. This trend is being driven by the enterprise and supplier development element of the B-BBEE codes: companies can receive a number of empowerment points for procuring goods and services from suppliers that are 51% black-owned or 30% black female-owned, so to remain competitive suppliers have a real incentive to exceed the standard ownership target.
Access to capital has been a stumbling block for many black investors, who have historically had to resort to traditional third-party loans to finance empowerment transactions. This is shifting towards more flexible, efficient and affordable funding structures, including notional vendor funding (NVF), which aims to achieve the same economic effect as a traditional loan structure but without any actual flow of funds. In an NVF structure the starting point is to agree on the fair market value of the shares to be acquired and the amount the investor must pay for the shares. The difference between these amounts constitutes the “notional loan”. The terms of the shares and the notional loan are structured in a manner that facilitates settlement of the notional loan through dividends from the company, in terms of an agreed formula. Other forms of BEE funding include equity funding in the form of preference shares, which are usually issued by the BEE investor to the company, with the subscription proceeds being used by the BEE investor to purchase shares in the company. A minority discount is typically applied to equity purchases, which also assists in achieving the necessary net value points on the ownership scorecard from the outset.
These forms of funding are more sustainable than traditional loans, which typically place empowerment investors under considerable pressure during market downturns. They allow both buyer and seller more space to negotiate their terms, and also to more easily respond to market conditions. Shareholder arrangements in BEE transactions have been an area of focus for the B-BBEE Commission. Practices that it considers unduly restrictive to BEE shareholders include lockup provisions, change of control restrictions and restraints of trade, and these have been under increased scrutiny. One of the reasons sellers have insisted on lockups, which restrict the investor from transferring the shares for a fixed period, is the desire to maintain an empowered level of ownership for as long as possible. This contrasts with the desire of investors to monetise their investments. In the future it is going to be important to strike a balance with arrangements that are fair to both sides. Restrictions on dealing with shares will have to be carefully considered.
The same goes for board appointment rights and minority protections. These provisions should be commensurate with BEE shareholders’ shareholding level in the company. Typically, the holder of a 25% share would have veto rights in respect of certain important decisions, and director appointment rights, for instance. The B-BBEE Commission wants to see empowerment that encourages BEE shareholders to be involved in the business, rather than just passive holders of shares. At the end of the day it is important for the parties to strike a balance between the commercial arrangements that usually apply in respect of minority shareholding arrangements and the need to meet the requirements of the ownership scorecard in the B-BBEE codes.
Hale is partner and Nzima senior associate at Bowmans.
Disclaimer - The views expressed here are not necessarily those of the BEE CHAMBER