Deemed BEE ownership

In this article we discuss several ways to legitimately achieve BEE ownership points, without having actual BEE owners. This is called ‘deemed ownership’.

A recap on why achieving actual BEE ownership is so *damn* hard

Ownership is the trickiest part of the BEE Scorecard.  Consider that sometimes, the owners are not committed to BEE with good reason E.g. multinationals based outside of South Africa in markets which reprioritize their own citizens’ wellbeing over South Africans.  International players look at the whole world as their playing field.  South Africa is one market of many, and it is assessed against others.  Ease of doing business is a factor, and BEE (or other) shareholders make it harder.  This is further complicated when the rules are in flux or unclear.  It is well documented that BEE in of itself does not attract investment and often deters it.  Sometimes this further sets back the objectives of the BEE Act (see our forthcoming article on the competition commission and Burger King for more).

Just the same as multinationals prefer to control their own destinies, smaller businesses such as entrepreneurial startups or family businesses, are setup by the type of business owners whose strength often lies in them being in control.  Their commitment to the business and not having to answer to others, gives them the agility to grow this part of the economy in a way no other companies can.  Furthermore, these owners commit so much more than just funds to a business which they would not be properly rewarded for by pure financial investors. Indeed, one of the most frequent frustrations we come across is business owners who have done a BEE ownership deal only to find that their new shareholders are not active in the business operationally (or at least, not with the same passion as the founding shareholders).

Then there are those who would love to do a BEE deal but cannot because they cannot find suitable black partners.  Sometimes it’s because they are unrealistic in the amount they want from them or expect them to contribute more than their fair share or to contribute unethically (yes corruption…) but sometimes it is because astute black investors do not believe there is a good investment thesis to their involvement.

In the end, the founders and shareholders of family businesses are so invested in them, with their identities and success so entwined with their business, that they also cannot be unemotional in assessing their businesses.  This is made worse still when they contemplate being minority shareholders in their own businesses.  And, to be fair, in smaller organizations, these are personal relationships.  Finding partners with the same values, ethos and culture (and funds) is key to success but does cut the investor pool significantly. A small investor pool always puts downward pressure on valuations, further hampering the deals.

Then there is the financing of the deal itself: one of the one of the most common misconceptions is that one is forced to give shares in a company away.  This is often linked to a shortage of suitable black business partners, with adequate funds.  Ironically this is precisely what BEE aims to rectify.  But for now, this has been recognized with the rules around vendor finance.  This means that black investor, even if they do not have funds, can be assisted to pay for their shares by the seller.  This is done through dividend flows or through the movement in the share’s valuation (especially in listed shares).  But neither of these is guaranteed and are risky.

These and other reasons make ownership the hardest part of the BEE Scorecard to address.

Deemed ownership:

What many do not often appreciate, is that the BEE Codes allow for entities to be treated as black owned, even if they are not.

Of course, there are clear terms and conditions to this.  But there are many ways to be treated as black, without giving up actual shareholding.  These deemed ownership structures can if done properly meet the letter and spirit of the BEE Act without running the risk of fronting.  So, there are more options than simply selling shares available for BEE ownership points.

This article briefly explores some of these.

FLOW THROUGH OWNERSHIP

The most common form of non-black BEE ownership is provided for 3.4.3.1 of Code 100 which provides “where in the chain of Ownership, Black people have a flow-through level of participation of at least 51%, and then only once in the entire ownership structure of the Measured Entity, such Black participation may be treated as if it were 100% Black.”

A simple reading of this means that one could have 49% non-Black ownership and that it can be treated as Black owned.  Even though this can only be done once in an ownership it is possible for an entity to be treated as 51% Black owned, even if effectively only 26% (51% of 51%).

B-BBEE FACILITATOR

In terms of 3.6 of Code 100 the Minister of Trade and Industry may designate certain organs of state or public entities as B-BBEE facilitators and they will then be treated 100% Black owned.

Controversially, facilitator status was granted to Telkom in 2019, which is only partially (40%) state owned.  This allowed Telkom to be deemed to be 100% Black owned despite only 42% of its free float being South African owned, let alone Black owned.  This distorted competition in the telecoms sector and was challenged in court.  In the Altron v Minister of DTI this was set aside as fatally flawed.

As this section is only available to organs of state and public entities, this is unlikely to feature in many ownership structures.

BROAD BASED OWNERSHIP, ESOPS AND TRUSTS

3.9 of Code 100 addresses broad based ownership schemes and employee share ownership programms (ESOPs).  Similar provisions are contained in 3.12 for non-discretionary trusts.  In terms of this it is possible to look through these schemes to get the effective Black ownership.  So Black employees, for example, who are not registered shareholders of their employer may contribute its Black ownership if they are beneficiaries of a qualifying scheme.

There are limits and conditions on such structures in Annexures 100(B) ,100(C) and 100(D) of Code 100, but it is possible to have one shareholder treated as Black, instead of thousands of individuals (who are not actual shareholders).  This is administratively simpler at the very least.

As only 85% of the value of benefits allocated by the scheme must be allocated to Black people, it is possible for up to 15% of the benefits to be allocated to others.

However, the B-BBEE Commission has cracked down on abuse in these structures, especially with regards to the requirement that participants must take part in “managing the scheme at a level similar to the management role of shareholders in a company having shareholding.”

This has been an area is an area in regulatory flux and uncertainty and, despite the recent gazette by Minister Patel clarifying this section of the codes, it should be approached with caution.

BUSINESS AND ASSET SALES

Statement 102 allows an entity to sell part of its business or assets to a black-owned company and to claim a pro-rata ownership as if it had sold its shares, even if it has not.  Let’s say a business were to sell a division that represents say 40% of its business to a 100% black-owned company, it can claim that it is 40% Black owned, even though it has not sold any shares at all.

There are some valuation challenges (as set out in detail in our article on Statement 102) but if properly managed this ownership can be claimed in perpetuity after the third anniversary, and may be particularly attractive from a control point of you.

OPTIONS

3.13 of Code 100 allows for option holders to be treated as shareholders, before they exercise their options (and before they are really shareholders) as long as they have the economic interests and voting rights that they would have had had they been shareholders and provided that this irrevocable for the option period.

As option holders enjoy the benefits of shareholding (for free or a fraction of the share value) there is no reason to exercise an option before its expiry.  But expiry this has to be seriously assessed.  At this time the Black shareholder is better informed and, ideally, better financed to exercise the option.  But until exercising, the ownership is deemed to be Black even if the grantor of the option (the real shareholder) is not.

EQUITY EQUIVALENTS

Many foreign listed groups do not want to deal with minority shareholders and are particularly challenged by the BEE ownership criteria.

Statement 103 was put in place to allow multi-nationals to support BEE without diluting the ownership in their South African subsidiary, as long as they commit to invest in Black businesses an equivalent amount to what such a minority interest would have been worth.  So, if, for example, a South African subsidiary is valued at R1 billion and the foreign holding company commits to investing R340 million it can claim to be 34% Black owned, while remaining 100% owned by the foreign company.

This is not only not available to South African owned entities, it comes with its own challenges (see the article on this). This ownership is structure is only open to multinationals and does require specific ministerial approval but does allow ownership to be protected.

PRIVATE EQUITY FUNDS

3.10 of Code 100 allows a private equity shareholder to be considered as Black as long as the Manager and the Fund meet certain criteria.  There’s no criteria applicable to the investors in the Fund itself, and they need not be Black.  The private equity rules took cognizance of the reality that private equity investment is often sourced from international (i.e. not Black) markets.

Essentially the Black private equity manager’s BEE credentials are given to the Fund, for as long as it and the Fund is compliant.  The Fund must after eight years have the majority of its investments in Black businesses.

These rules are used by Tusker in an innovative way that allows for deemed ownership without actual ownership but does require a commitment to the BEE Act.  We are confident that this can a cost benefit analysis will show the merits of BEE ownership, and it’s far faster and more economically attractive position than equity equivalents for foreign multi-nationals.

WHICH APPROACH IS BEST FOR YOU?

When considering BEE ownership for your business, you should make sure to address the following:

  • Does BEE ownership add value (or reduce value destruction) in your business? The acid test for this is whether you will be able to compete for more work by having the appropriate level of BEE ownership.
  • Does the structure/solution you’re considering meet letter and spirit of the BEE Act?
  • Is the structure/solution financially affordable? Are the magnitude and timing of cash flows known with certainty in advance?
  • What degree of control do you retain over the decision-making in your business?
  • Can the structure/solution be unwound if needed?
  • Are the vendors of the proposed solution/structure well established and trustworthy?
  • Has the proposed structure/solution been successfully scrutinized by the B-BBEE commission?

If you have any questions, feel free to contact us info@tusker.co.za