New BEE rules make 51% flow-through ownership even more important:

Early last year the DTI put out several proposed changes to the BEE Act for public comment. We submitted our comments/concerns within the dates and subsequently met with the DTI to discuss them. Others did the same.

Speculation as to which changes would come and which of the proposals would be discarded has ended: on 9 April 2019 Minister Davies signed four amendments to the B-BBEE codes that were gazetted on 31 May 2019 and come into effect on 30 November 2019. These amendments affect code 000 (general principles), code 300 (skills development), code 400 (Enterprise and supplier development, including preferential procurement), and changes to some definitions in section 1 of the codes.

Aside from a large list of proposed changes that didn’t make it into law, what’s significant is the timing of these changes: while they are the last amendments the outgoing DTI Minister Rob Davies would sign off on BEE; they could easily have been stopped by the new government if they saw fit but instead they were gazetted. In some ways, this is policy stability – it certainly sets a clear direction for the foreseeable future.

Since Tusker is BEE-ownership focused, this article discusses impact of the changes in the codes from an ownership perspective. There are some far-reaching and important changes, which support our earlier prediction that ownership will become more important and that the nature of the ownership (flow through) is also increasingly emphasised. The bottom line is that 51% flow-through ownership is more important than ever, for you and your big corporate customers.

Here are some of the specific changes:

Amendments to Schedule 1 (interpretation and definitions):

“Designated Group Supplier”, has been introduced. This is a supplier who is not only 51% Black owned but these owners are also unemployed black people, black youth, black people with disabilities; black people living in rural and underdeveloped areas and/or black military veterans. This term was not previously defined. This provides clarity on how to earn the 2 points on the preferential procurement scorecard for procurement from a “Designated Group Supplier”.

Net value calculations get clarification through the definition of “Current Equity Interest Date”. This helps provide some clarification around calculations involving the ‘time-based graduation factor’ which is often used in vendor-financed structures.

Amendments to Amended Codes Series 000: General Principles

The ‘automatic’ level 2 status for 51% black-owned EMEs or QSEs is only available if they’re 51%-99% owned on a flow-through basis. Similarly, 100% flow-through ownership gets to an ‘automatic’ level 1. Only an affidavit is required for companies this size. The most NB point here is that modified flow through (MFT) structures cannot achieve Automatic level 1 or 2 – they will instead have to go through a full audit on the QSE codes, adding a significant hassle factor (and the costs of a full BEE audit) to the use of MFT.

Tusker commentary: the recognition of ownership via the modified flow through principle is forcibly being squeezed out (as predicted). We’d suggest any business change to a direct (i.e. flow-through) 51% ownership. Contact us to learn how to do this at the highest possible ROI.

Amendments to Amended Code Series 400: Enterprise and Supplier Development (including Preferential Procurement)

Procurement is the way that BEE codes trickle down through the economy, and here the ‘big companies’ now have a target to procure 50% of total procurement (up from 40%) from 51% black-owned companies, AND the points awarded for this go from 9 to 11 AND spend on 51% black owned companies as measured on the flow-through principle can be multiplied by a factor of 1.2 i.e. the target and the available scorecard points and procurement recognition have shifted – again placing increased emphasis on 51% black-owned businesses as measured on a flow-through basis.

Another very NB change is that large entities (i.e. those in the Generic threshold) can also be included as beneficiaries of enterprise development or supplier development initiatives as long as they are 51% black owned on a flow-through basis and provided that when the entity first received assistance from the measured entity, the Beneficiary was an EME or QSE. Recognition for assistance to 51% Black owned large entities will be limited to five years from the time when the beneficiary first received assistance from the measured entity. This change is designed to not penalise either the QSE who becomes Generic because it wins business from a large customer, or the large customer who buys from the QSE that then becomes Generic. i.e. it provides a much-needed smoothing of the BEE effects as businesses grow from QSE to Generic. Again, modified flow through structures clearly do not meet the grade.

The amendments also make it clear that a supplier development beneficiary is a part of the Measured Entity’s supply chain, whereas an enterprise development beneficiary is not. This is a simple and clear test for companies and verification agencies alike. Contact us to learn how our ownership solutions can accommodate either in an optimal way.

Guarantees receive a far higher status too: whereas previously only 3% of the amount of any guarantee provided could be recognised as supplier or enterprise development contributions, this is now 50%. The idea is that companies can provide guarantees rather than spend money, but this of course will need to be balanced by far more reliable credit-worthiness and financial diligence by the parties providing the guarantee. It may also affect liquidity/solvency requirements. While it sounds attractive it may significantly change risk exposure.

What was left out?

While the emphasis on 51%+ flow-through black ownership is expected, last years’ proposed amendments included a lot of other tweaks. It’s beyond the scope of this article to revisit all of them, but as an illustration of the process/thinking involved here are three examples:

  • Proposed: that 51% flow through black owned businesses could get an automatic level 2 even in the generic category. Many argued against this, with the logic that all big companies should be measured against all of the scorecard elements. Net result: companies that are QSE/EMEs and grow into generic get a period (5 years) of continued recognition on their customers ESD scorecards, but still have to do all the BEE scorecards on their own business.
  • Proposed: restrictions into how flow-through ownership could be achieved. For example, a proposal that could have affected us was that private-equity ownership would not count as flow-through ownership if a company moved from QSE into Generic. (The same was proposed for broad-based trusts and some other common structures). We argued that this made no sense as private-equity by nature targets high growth companies that would be expected to grow from QSE to generic very quickly. Thankfully, the changes place an increasing emphasis on 51% flow-through black ownership without being increasingly restrictive as to how that is achieved. We think this is sensible.
  • There were no changes to the turnover amounts relative to the scorecard levels. E.g. QSEs are businesses with turnover higher than R10M and lower than R50M. EMEs are lower than R10M and Generic above R50M. This hasn’t changed. Many people expected these brackets to be moved upwards, but the DTI has learned a lesson from SARS and will let BEE requirements become increasingly stringent for more companies as inflationary growth pushes them into higher brackets.

What are the summary implications?

51% flow-through black ownership is the trump card – the new regulations place increasing emphasis on this, from the ‘automatic level 2’ available to EME/QSEs, to the continued recognition of them as they grow through the generic level, to the points available on ESD scorecards, and the enhanced recognition of procurement spend for 51% flow-through black owned companies. There really is no other choice.

Please contact us to learn how Tusker can help you achieve 51% flow-through black ownership in a way that keeps you in operational control and increases the value of your investment in your business.