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BEE ownership via Private Equity

Overview

This method involves a B-BBEE-compliant private equity (PE) fund investing in a company. The company can then treat the ownership held by the PE fund as if it were held by Black people, contributing to its B-BBEE ownership score. This can be an attractive option for companies seeking growth capital and a strategic B-BBEE partner. However, the PE structure (i.e. the fund itself, it’s investments, and the fund manager) must meet strict B-BBEE criteria.

How does it work normally?

In a typical (non-B-BBEE) private equity transaction:

Fundraising: A PE fund raises capital from investors (limited partners).
Investment: The fund identifies and invests in target companies, typically acquiring a significant minority or majority stake.
Value Creation: The fund works with the company’s management to improve operations, grow the business, and increase its value.
Exit: After a period (typically 3-7 years), the fund exits its investment, usually through a sale to another company, an initial public offering (IPO), or a recapitalization. The fund distributes profits to its investors.

What are the BEE rules?

The B-BBEE Codes (Code Series 100, Statement 100, paragraph 3.10) set out specific requirements for recognizing ownership through PE funds:

Fund Manager Compliance: The fund manager (the entity that manages the fund) must be a B-BBEE owned company, meeting the following criteria:
- Voting Rights: At least 51% of the fund manager’s exercisable voting rights associated with the equity instruments through which the fund holds ownership in the measured entity must be held by Black people.
- Executive/Senior Management: At least 51% of the fund manager’s executive and senior management must be Black people.
- Profit Share: At least 51% of the profits made by the fund manager (including carried interest – the fund manager’s share of profits from investments) must accrue to Black people.
Investment in Black-Owned Companies: The PE fund must invest at least 51% of the value of funds under management (at cost) in companies that have at least 25% direct Black shareholding (using the Flow-Through Principle). This 51% target is phased in over time, starting at 5% within one year of the fund’s commencement date and gradually increasing to 51% from the beginning of the ninth year.
Facilitation of Ownership: The PE Fund manager can facilitate direct Black shareholding in the investee company.
Measurement Date: The fund’s compliance is determined at each measurement date, and the status is applicable for 12 months.
Funds pre-dating the Codes: For funds that were fully invested before 11 October 2014, the focus is on the B-BBEE compliance of the fund manager (voting rights, profit share, and being a B-BBEE owned company).

What’s the spirit?

The spirit is to encourage private equity funds to become agents of transformation by:

Investing in Black-owned businesses: Promoting the growth of Black-owned companies.
Being Black-owned themselves: Increasing Black participation in the private equity industry.
Creating sustainable value: Generating returns for Black investors and contributing to economic growth.
Facilitating ownership: Helping companies to achieve direct Black shareholding.

The deal process:

Identify a B-BBEE Compliant Fund: The company seeking investment must find a PE fund that meets the B-BBEE criteria.
Due Diligence: Both the company and the fund conduct due diligence on each other.
Negotiation: The parties negotiate the terms of the investment, including the amount of equity, the valuation, the shareholder agreement, and the fund’s role in the company.
Legal Documentation: An investment agreement and a shareholder agreement are signed.
Investment: The fund invests in the company.
Value Creation: The fund works with the company’s management to grow the business.
Exit: The fund eventually exits its investment.
Ongoing B-BBEE Reporting: The company reports on its B-BBEE ownership, including the ownership held through the PE fund.

Pros & cons of this method

Pros:

Access to Capital: Provides access to growth capital.
Expertise: PE funds often bring operational and strategic expertise.
B-BBEE Compliance: Can significantly contribute to the company’s B-BBEE ownership score.
Strategic Partnership: The fund can be a valuable strategic partner.
Facilitated Ownership: The fund can assist in finding and structuring direct Black shareholding.

Cons:

Cost: PE funds typically charge management fees and a share of profits (“carry”), which can be substantial.
Loss of Control: The fund may require significant influence or control over the company.
Fund Manager Compliance: Ensuring the fund manager’s ongoing B-BBEE compliance is crucial.
Finding a Suitable Fund: Identifying a B-BBEE compliant fund that is a good fit for the company can be challenging.
Exit Pressure: PE funds have a defined investment horizon and will eventually seek to exit, which can create pressure on the company.
Portfolio effects: Since 51% of the funds’ investments must be made into black companies, if this isn’t achieved then at that point in time none of the investments made would count as black. i.e. there is significant risk to investee companies of another portfolio company’s corporate actions risking their BEE status achieved by the fund. This is tricky to manage.

Costs

Setup Costs:
- Legal fees (investment agreement, shareholder agreement).
- Due diligence costs.
- Negotiation costs.
Ongoing Costs:
- Fund management fees (typically a percentage of assets under management).
- Carried interest (a share of profits).
- Reporting to the fund.

Gotchas

Fund Manager Fronting: Ensuring the fund manager is genuinely B-BBEE compliant, not just creating a facade.
Investment Targets: The fund’s requirement to invest in companies with direct Black shareholding can be challenging to meet.
Exit Alignment: The company and the fund need to be aligned on the exit strategy.
Control Issues: The level of control the fund requires can be a point of contention.

Grey Areas

Defining “Profits”: The Codes refer to “profits” accruing to Black people, but the precise definition of profits (especially in complex fund structures) can be debated.
Valuation: As always, valuing the company’s shares can be subjective. Fund managers are rewarded on ‘carried interest’, so they are encouraged to buy as cheaply as possible and sell for the maximum possible.
Phased-In Investment Targets: The phased-in targets for investing in Black-owned companies can be complex to track.

Alternatives

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

Tusker has over 10 years experience in crafting unique BEE ownership solutions for each our clients’ unique needs, especially using the private equity rules very effectively. We’d love to help you too! Please contact us to learn more.