BEE deals and "once empowered, always empowered"
I wrote this on the back of the recently announced BEE deal that we ran valuations for for one of our clients, although I originally wrote it in June, during/ after our report was sent out.
Due to the country’s past, government’s main instruction has largely been to facilitate economic inclusivity to those who were previously disadvantaged by pre-democracy laws, this means that Broad-Based Black Economic Empowerment (BBBEE) regulations will always be not only a talking point but a directive for doing business in South Africa.
Core mandates of BBBEE is to accelerate the de-racialisation of the South African economy through, though not limited to, facilitating ownership and management of enterprises and productive assets by collective enterprises, achieving equitable representation in all occupations and levels of the workforce, preferential procurement and investment in enterprises that are owned or managed by Black people.
While no amendments were proposed for broad-based schemes, the most recent proposed Codes of Good Practice focus largely on ownership with a stricter emphasis on enhancing youth skills.
One of the major changes introduced by the proposed guidelines is the readjustment of thresholds and targets for enterprises on priority elements namely equity ownership, skills development, enterprise development and preferential procurement.
The proposal includes,
Reviewing the BEE rating of Exempt Micro Enterprises (EMEs) –firms with an annual turnover of less than R10million- and Qualifying Small Enterprises (QSEs) -enterprises with a turnover more than R10million but less than R50million. Previously, these firms would have been classed as a Level 1 contributor for 100% BEE ownership and as Level 2 contributors for 51% BEE ownership.
Thus it is proposed that determination of 100% or 51% ownership can only be met through the flow-through principle.
Continuing Consequence -the “once empowered, always empowered principle”
States that companies with a BEE shareholding can continue accounting for no more than 40% of the BEE shareholding after the BEE partners have surrendered their shares in the ownership scorecard.
In the event of a dilution in the actual percentage of black ownership in a Measured Entity, such dilution having occurred on or after 1 January 2011 as a result of all other sales of shares, other than the sale of shares a portion of the percentage may be recognisable subject to the following criteria:
The black participant has held those shares for a minimum period of three years;
Net value must have been created in the hands of Black People. (i.e. a portion of the debt acquired to purchase the equity must have been repaid or the selling price of the shares must be higher than the purchase price);
Transformation has taken place within the measured enterprise.
In the case of a loss of shares by the black investor, the following additional rules apply:
A written tripartite agreement between the Measured Enterprise, the black participant and a lender must record the loan or security arrangement, unless the Measured Entity is the lender; and
The period over which the points were allocated or recognisable will not exceed the period over which the shares were held.
In the context of BEE share schemes, point two above is important for a firm wishing to maintain or promote its BEE rating, meaning that the structure of the BEE transaction would ultimately have to end in the money in order to ensure that the newly acquired BEE rating is maintained or in the event of the shares being surrendered, that the enterprise is able to account 40% of the BEE shareholding.
This begs the question, how does the vendor company ensure that the BEE deal will end in the money?
Industry suggests that the over-valuing of the company’s equity is the dominant reason why most BEE deals fail, the likelihood of failure is compounded if the deal involves financing from third parties as the cost of borrowing and other transaction related costs are added to the bill.
If the vendor company is financing the deal, zero interest payments should be an option, this, along with using all dividends to repay the loan, this would also result in a lower IFRS 2 charge.
