Continuing consequences

Here we discuss the concept of “Continuing Consequences,” also known as “Continued Recognition of Black Ownership after the Sale or Loss of Shares,” within the B-BBEE Ownership framework. This is a crucial provision that addresses the potential for “churning” of Black ownership and aims to incentivize long-term, sustainable empowerment.

The Problem: “Churning” and Short-Termism

Without a mechanism to recognize ownership after a sale, there’s a risk of what’s often called “churning” or “recycling” of Black ownership. This is where:

1. A company achieves a certain level of Black ownership (e.g., 25.1%).
2. It receives B-BBEE points and recognition for that ownership.
3. The Black shareholders then sell their shares (often back to the original shareholders or to another non-Black entity).
4. The company loses its Black ownership and associated B-BBEE points.
5. The company then enters into another Black ownership transaction to regain points, repeating the cycle.

This cycle doesn’t lead to lasting empowerment. The same pool of Black capital might be used repeatedly, moving from one company to another, without significantly increasing the overall level of Black economic participation in the economy. It also disincentivizes long-term commitment from both the company and the Black shareholders.

The Solution: Continuing Consequences (Statement 100, Paragraph 3.8)

The “Continuing Consequences” provision (found in Statement 100, paragraph 3.8 of the Amended Codes of Good Practice) addresses this issue. It allows a measured entity to continue to recognize a portion of Black ownership after a Black participant has exited through the sale or loss of shares, provided certain strict conditions are met. This creates an incentive for genuine, long-term empowerment and reduces the temptation to “churn” ownership for short-term B-BBEE points.

Conditions for Continued Recognition:

For a company to benefit from Continuing Consequences, all of the following conditions must be met:

1. Minimum Holding Period: The Black participant must have held the shares for a minimum period of three years. This is the most fundamental requirement, demonstrating a commitment to sustained ownership.
2. Net Value Creation: Net value must have been created in the hands of the Black participant during their holding period. This means that the value of their shares, after deducting any acquisition debt, must have increased. This is calculated using the Time-Based Graduation Factor (the same factor used in the regular Net Value calculation). This ensures that the Black participant genuinely benefited economically from the ownership.
3. Transformation within the Measured Entity: The measured entity must have maintained or improved its overall B-BBEE status (excluding Ownership) during the period the Black participant held the shares. This is measured by comparing the company’s B-BBEE Recognition Level (e.g., Level Four, Level Two) at the time the Black participant entered and exited. This prevents companies from letting their overall transformation efforts slide while relying solely on the initial Black ownership transaction.
4. 40% Limit: The continued recognition of Black ownership from all instances of sale or loss of shares cannot contribute more than 40% of the total points on the Ownership scorecard. This prevents companies from relying solely on past ownership transactions and encourages ongoing efforts to maintain or increase direct Black ownership.
5. Written Agreement (for loans): If the Black participant’s share acquisition was financed by a loan (from the company or a third party), there must be a written tripartite agreement between the measured entity, the Black participant, and the lender, recording the loan or security arrangement. This provides transparency and helps prevent disputes. This is not required if the measured entity is the lender.
6. Time Limit: The period that the company can continue to recognise the points after the sale will not exceed the period for which the shares were held.

Calculating the Continued Recognition Points:

If all the conditions are met, the points attributable to the measured entity are calculated using the following formula:

A = B * C * D

Where:

• A: The percentage of Ownership points that survive the sale or loss (i.e., the points the company can continue to recognize).
• B: The percentage of Ownership points that were attributable to the Black participant immediately before the sale or loss (calculated using the regular Ownership scorecard formulas). This captures the level of ownership the company had before the exit.
• C: The Net Value percentage achieved by the Black participant at the date of sale or loss, using the Time-Based Graduation Factor. This reflects the real economic value created.
• D: The B-BBEE Recognition Level of the measured entity (e.g., 100% for Level Four, 125% for Level Two) at the date of measurement, based on its performance on all elements other than Ownership. This links the continued recognition to the company’s overall transformation progress.

Example:

• A Black participant held shares representing 20% of the voting rights and economic interest in Company X for 5 years.
• At the time of sale, the Net Value calculation (using the Time-Based Graduation Factor) showed that 60% of the target Net Value had been achieved.
• Company X’s B-BBEE Recognition Level (excluding Ownership) at the time of measurement is Level Four (100%).

Continued Recognition Calculation:

• B = Points attributable before sale. Let’s assume this was 10 points across the various indicators.
• C = Net Value Percentage at Sale = 60%
• D = B-BBEE Recognition Level = 100%

A = 10 * 0.60 * 1.00 = 6 points

Company X can continue to recognize 6 Ownership points attributable to the exited Black participant. If this, combined with any points from any other previous sales, is more than 40% of the total ownership points (i.e. more than 10 points), then only 10 points can be recognised.

Strategic Implications:

• Long-Term Partnerships: Continuing Consequences encourages companies to build long-term partnerships with Black shareholders, as the benefits of ownership recognition extend even after an exit.
• Genuine Empowerment: The Net Value requirement ensures that the provision is not abused. Black participants must genuinely benefit economically from the ownership.
• Due Diligence: Companies must carefully track the holding periods, Net Value creation, and their own B-BBEE performance to ensure they qualify for continued recognition.
• Structuring Exits: The provision influences how exits are structured. It may be beneficial to structure exits in a way that maximizes Net Value creation for the exiting Black participant.
• Not a Replacement for Current Ownership: While valuable, Continuing Consequences is not a substitute for maintaining current Black ownership. The 40% limit and the requirement for ongoing transformation efforts ensure this.

Conclusion:

The “Continuing Consequences” provision is a sophisticated mechanism within the B-BBEE Ownership framework. It aims to balance the need for recognizing past Black ownership with the imperative for ongoing transformation and genuine, long-term empowerment. By meeting the strict conditions, companies can benefit from continued recognition of ownership, incentivizing sustainable partnerships and preventing the unproductive “churning” of Black ownership. This provision, when understood and applied correctly, contributes to a more stable and meaningful B-BBEE landscape.

Please contact us for a confidential discussion around your unique BEE ownership requirements.