Direct BEE Ownership

Overview

Direct Ownership is the simplest and most straightforward form of B-BBEE ownership. It involves Black individuals directly holding shares (ordinary shares, typically) in a company, giving them voting rights and economic interest (dividends and capital growth) proportionate to their shareholding.

How does it work normally?

In a typical (non-B-BBEE) direct ownership scenario:

1. Share Issuance or Transfer: A company either issues new shares to the investor or an existing shareholder transfers some of their shares to the investor.
2. Shareholder Agreement: The shareholders enter into a shareholder agreement that governs their relationship, including voting rights, dividend policies, share transfer restrictions, and dispute resolution mechanisms.
3. Funding: The investor pays for the shares, either with their own funds or through a loan (from a bank, the company itself, or another source).
4. Shareholder Rights: The investor becomes a shareholder with all the rights and responsibilities that entails, including voting at shareholder meetings, receiving dividends, and participating in the growth of the company.

What are the BEE rules?

The B-BBEE Codes of Good Practice (specifically Code Series 100, Statement 100) govern how direct ownership is measured for B-BBEE purposes:

• Flow-Through Principle: Ownership is traced through any intervening entities to the ultimate Black natural person holding the shares. If a Black-owned company holds shares, the ownership is attributed to the Black individuals who own that company.
• Modified Flow-Through Principle: Once Black ownership reaches 51% or more at any point in the ownership chain, it is treated as 100% Black ownership for the purposes of calculating Exercisable Voting Rights and Economic Interest.
• Exclusion Principle: Ownership by Organs of State, Public Entities, and (optionally) Mandated Investments can be excluded from the calculation.
• Voting Rights: Measured as the percentage of exercisable voting rights held by Black people (and Black women) compared to the total voting rights.
• Economic Interest: Measured as the percentage of economic interest (dividends, capital growth) to which Black people (and Black women, and designated groups) are entitled, compared to the total economic interest.
• Net Value: This is crucial. It measures the real economic value held by Black shareholders, after deducting any acquisition debt used to acquire the shares. The formula is: (Value of Black-held shares - Acquisition Debt) / (Total Value of the Company). The result is then multiplied by the Time-Based Graduation Factor.
• Time-Based Graduation Factor: This factor increases the recognized Net Value over time, rewarding long-term ownership. It starts at 10% in year one and reaches 100% from year nine onwards.
• Recognition after Sale: If a Black shareholder exits after at least three years, a portion of their ownership can still be recognized, provided value was created and transformation took place.
• Subminimum: A company must achieve at least 40% of the Net Value points (8 points, adjusted by the time-based graduation factor) to avoid being discounted by one B-BBEE level.

What’s the spirit?

The spirit of B-BBEE ownership is to achieve genuine and sustainable economic empowerment for Black South Africans. It’s not about ticking boxes or creating artificial structures. It’s about:

• Meaningful Participation: Black shareholders should have real influence and control, not just be passive recipients of benefits.
• Value Creation: The ownership structure should create real economic value for Black shareholders.
• Long-Term Transformation: The goal is lasting change, not short-term gains.
• Substance over Form: The Codes emphasize that substance (the real economic reality) takes precedence over legal form.

The deal process:

1. Identify Potential Black Shareholders: This could be strategic partners, management, employees, or other investors.
2. Due Diligence: Both the company and the potential investors conduct due diligence on each other.
3. Valuation: The company’s shares are valued using a Standard Valuation Method (DCF, NAV, Market Multiples).
4. Negotiate Terms: The parties negotiate the number of shares, the price, the funding arrangements, and the terms of the shareholder agreement.
5. Funding: The Black shareholders secure funding (own funds, loans).
6. Legal Documentation: A share subscription agreement (for new shares) or a share sale agreement (for existing shares) is signed, along with a shareholder agreement.
7. Implementation: The shares are issued or transferred, and the Black shareholders are registered.
8. Ongoing Compliance: The company monitors and reports on its B-BBEE ownership, ensuring Net Value compliance.

Pros & cons of this method

Pros:

• Simplicity: Relatively easy to understand and implement.
• Direct Control: Black shareholders have direct control and benefit.
• Strategic Partnerships: Can bring in valuable skills, networks, and market access.
• Alignment of Interests: Shareholders are directly incentivized to grow the company’s value.

Cons:

• Capital Requirements: Black shareholders need access to capital, which can be a barrier.
• Dilution: Existing shareholders’ stakes are diluted.
• Finding Suitable Partners: Identifying and attracting suitable Black shareholders can be challenging.
• Risk of Exit: Black shareholders might sell their shares, potentially impacting the company’s B-BBEE rating.
• Net Value Challenges: Meeting the Net Value requirements can be difficult, especially in the early years.

Costs

• Setup Costs:
  • Legal fees (shareholder agreement, share subscription/sale agreement).
  • Valuation fees.
  • Due diligence costs.
• Ongoing Costs:
  • Shareholder administration.
  • Compliance reporting.
  • Potential dividend payments.

Gotchas

• Fronting: Creating artificial structures to give the appearance of Black ownership without genuine benefit or control is illegal and carries severe penalties.
• Net Value: Failing to meet the Net Value subminimum will result in a one-level drop in the overall B-BBEE rating.
• Acquisition Debt: High levels of acquisition debt can significantly reduce Net Value.
• Shareholder Disputes: Disagreements among shareholders can be disruptive and costly.
• Exit Strategies: Planning for the potential exit of Black shareholders is important.

Grey Areas

• Valuation: Determining the fair market value of the shares can be subjective and lead to disagreements.
• Funding Structures: Complex funding arrangements can raise questions about whether the Black shareholders have genuine economic interest.
• Continued Recognition: The rules around continued recognition after a Black shareholder exits can be complex.

Alternatives

• Broad-Based Ownership Schemes (BBOS)
• Employee Share Ownership Programmes (ESOPs)
• Trusts
• Private Equity Funds
• Sale of Assets
• Equity Equivalents (for multinationals)

Tusker has over 10 years experience in crafting bespoke ownership solutions for our clients’ unique needs. Please contact us for a confidential discussion regarding your BEE ownership needs.