Broad-Based Ownership Schemes, ESOPs, and Trusts

Overview

This section covers three related B-BBEE ownership methods that involve holding shares indirectly through an intermediary entity:

• Broad-Based Ownership Schemes (BBOS): Schemes designed to benefit a wide group of Black people, such as community trusts, stokvels, and co-operatives.
• Employee Share Ownership Programmes (ESOPs): Schemes that give employees (including Black employees) a stake in the company they work for.
• Trusts: Legal entities that hold assets (in this case, shares) on behalf of beneficiaries. Trusts can be used for various B-BBEE ownership purposes, including holding shares for BBOS, ESOPs, or specific Black individuals.

These methods are often used when direct ownership is not feasible or desirable, or when the goal is to achieve broader-based empowerment.

How does it work normally?

• BBOS:
  1. A legal entity (e.g., a trust, a non-profit company) is established with a constitution or trust deed that defines its objectives, beneficiaries (or class of beneficiaries), and rules of operation.
  2. The company issues or transfers shares to the BBOS.
  3. The BBOS manages the shares and distributes benefits (dividends, capital growth) to its beneficiaries according to its rules.
• ESOPs:
  1. A legal entity (often a trust) is established with rules that define eligible employees, participation criteria, allocation of shares, vesting periods, and exit mechanisms.
  2. The company issues or transfers shares to the ESOP.
  3. Employees become participants in the ESOP and are allocated shares (often gradually over time).
  4. Employees receive benefits (dividends, share value growth) according to the ESOP’s rules.
• Trusts (General):
  1. A trust deed is created, specifying the trustees, beneficiaries, and the terms of the trust (how assets are managed and distributed).
  2. The company transfers shares to the trust.
  3. The trustees manage the shares and distribute benefits to the beneficiaries according to the trust deed.

What are the BEE rules?

The B-BBEE Codes (Code Series 100, Statement 100, and Annexes 100(B), 100(C), and 100(D)) set out specific rules for these methods:

• General Principles:
  • Flow-Through Principle: Ownership is traced through the intermediary entity to the ultimate Black natural person beneficiaries.
  • Substance over Form: The real economic benefits and control must flow to Black people.
• BBOS:
  • Defined Beneficiaries: The beneficiaries (or a clearly defined class of beneficiaries) must be identified.
  • Independent Trustees: At least 50% of the fiduciaries (trustees or similar) must be independent, 50% must be Black, and 25% must be Black women.
  • Benefit Allocation: At least 85% of the value of benefits must accrue to Black people.
  • No Discretion: The fiduciaries must have no discretion on the key terms (beneficiaries, proportion of benefits).
  • Winding Up: On winding up, accumulated economic interest must go to the beneficiaries or an entity with similar objectives.
  • Management Fees: For commercially operated schemes, management fees should not exceed 15%
• ESOPs:
  • Defined Participants: Eligible employees and their participation criteria must be clearly defined.
  • Employee Participation: Employees must have a say in managing the scheme (e.g., appointing trustees).
  • Financial Reporting: Financial reports must be presented to participants yearly.
  • Vesting: Shares may vest over time (employees earn the right to them gradually).
  • Exit Mechanisms: Rules for what happens when employees leave the company.
  • Accumulated Economic Interest: Payable to participants.
• Trusts:
  • Defined Beneficiaries: The trust deed must clearly define the beneficiaries and their entitlements.
  • No Discretion (Generally): Trustees generally have no discretion on key terms (beneficiaries, entitlements).
  • Family Trusts – Exception: Family trusts can allow trustee discretion, but this limits their recognition under the Codes.
  • Legitimacy Certificate: For a trust to contribute maximum points, a competent person must certify that it was created for a legitimate commercial reason and doesn’t circumvent the Codes.
• Contribution Limits: Generally, BBOS, ESOPs, and Trusts can contribute a maximum of 40% of the total ownership points. However, if they meet additional criteria (demonstrating operational capacity, track record, etc.), they can contribute up to 100% of the ownership points.

What’s the spirit?

The spirit is to achieve broad-based empowerment, benefiting a wider group of Black people (communities, employees) rather than just a few individuals. It’s about:

• Inclusivity: Reaching a larger number of beneficiaries.
• Sustainable Empowerment: Creating long-term benefits for the beneficiaries.
• Good Governance: Ensuring that the schemes are managed responsibly and transparently.
• Avoiding Circumvention: Preventing the use of these structures to create artificial B-BBEE compliance without genuine benefit.

The deal process:

1. Choose the Structure: Decide whether a BBOS, ESOP, or a different type of trust is most appropriate.
2. Design the Scheme: Define the beneficiaries/participants, eligibility criteria, allocation rules, vesting periods (for ESOPs), and governance structures.
3. Legal Documentation: Draft the trust deed, constitution (for BBOS), or scheme rules (for ESOPs).
4. Trustee/Fiduciary Appointment: Appoint trustees or other fiduciaries who meet the B-BBEE requirements (independence, demographics).
5. Valuation: Value the company’s shares.
6. Share Transfer: Transfer shares from the company to the BBOS, ESOP, or trust.
7. Communication: Inform beneficiaries/participants about the scheme.
8. Ongoing Management: Manage the scheme, distribute benefits, and ensure compliance.

Pros & cons of this method

Pros:

• Broad-Based Impact: Can benefit a larger number of Black people.
• Employee Motivation (ESOPs): Can improve employee morale, productivity, and retention.
• Community Development (BBOS): Can contribute to community upliftment.
• Flexibility: Trusts can be tailored to specific needs.
• Professional Management: Trustees or scheme managers can handle the complexities.
• Potential for 100% Contribution: If additional criteria are met, these schemes can contribute significantly to the ownership score.

Cons:

• Complexity: Setting up and managing these structures can be complex and require legal expertise.
• Administrative Burden: Ongoing administration, reporting, and compliance can be significant.
• Governance Challenges: Ensuring good governance and preventing abuse can be challenging.
• Dilution: Existing shareholders’ stakes are diluted.
• Potential for Disputes: Disputes among beneficiaries, participants, or trustees can arise.
• Cost: Setup and ongoing costs can be substantial.

Costs

• Setup Costs:
  • Legal fees (trust deed, constitution, scheme rules).
  • Valuation fees.
  • Trustee/fiduciary appointment.
  • Scheme registration (if applicable).
  • Communication costs.
• Ongoing Costs:
  • Trustee/fiduciary fees.
  • Administration costs.
  • Compliance reporting.
  • Auditing.
  • Distribution of benefits.

Gotchas

• Fronting: Using these structures to create a false impression of Black ownership is illegal.
• Lack of Independence: Trustees/fiduciaries must be genuinely independent.
• Discretionary Powers: Excessive trustee discretion can limit B-BBEE recognition.
• Beneficiary Definition: Beneficiaries must be clearly defined (or a defined class).
• Benefit Allocation: The rules for allocating benefits must be clear and comply with the Codes.
• Operational Capacity: Schemes must demonstrate the capacity to operate effectively.

Grey Areas

• Defining “Operational Capacity”: The Codes require schemes to demonstrate operational capacity, but the specific requirements can be open to interpretation.
• Legitimacy of Trusts: Determining whether a trust was created for a “legitimate commercial reason” can be subjective.
• Valuation: As with direct ownership, valuing the shares can be a point of contention.

Alternatives

• Direct Ownership
• Private Equity Funds
• Sale of Assets
• Equity Equivalents (for multinationals)

Tusker has 10 years experience crafting bespoke solutions to our client’s unique BEE ownership needs. Please contact us for a confidential discussion around your situation/requirements.