Learn how to use BEE as a strategic advantage:

Want to learn how to make BEE into a strategic advantage?

You’re not alone: we’ve been asked many times if we’d share our experience in finance and BEE to help business owners and their advisors better understand how to make BEE into a strategic advantage.

So we’re planning a series of 1-day workshops in the major cities of SA, for Oct/Nov this year.

It will be a super experience-transfer workshop, where we’ll really unpack things for you.

You’ll learn:

  • Why BEE exists and why it’s not going away anytime soon
  • How the low-growth economy increases the importance of BEE
  • What the different scorecard elements really cost, vs the returns you can expect.
  • The advantages of an ownership-first BEE strategy
  • How to survey your customers and understand the ROI from BEE
  • Why buying/selling shares in private companies is tricky, and why BEE makes this harder still.
  • Common issues in BEE deals, including financing, tax and control…frustrations and fronting
  • What the ideal BEE looks like
  • The different ownership types allowed in the codes
  • The pros and cons of common ownership structures
  • How to finance BEE deals
  • How tax trips up many deals, sometimes years down the line.
  • How to get out of a BEE deal
  • Dealing with the BEE commission: what to expect.
  • Verification: common pitfalls & how to prepare
  • Sector specific issues
    …and much more.

If you’d be interested in this, simply email us and we’ll stay in touch. More formal communications to follow…

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.

How to get out of a BEE deal

Relationships end with death or divorce. Legal fees and taxes are certain:

Many relationships sour, once the excitement of the courting is over and the realization of the limitations of the partnership sets in.  Sometimes this turns ugly (or the partner does?) and ends in litigation, often highly emotionally charged and sometimes just plain vengeant.  A solid pre-nup can mitigate the damage and set out the rules, but even so the process of divorce often leaves both parties feeling cheated.  Legal and other advice means that neither side really wins, and the pie that remains to be shared is smaller than the pie before the divorce. The destruction of value is worth the ability to chart a course independently of the other party going forward.

Even when the other party is not even contesting the separation, divorces are never simple.  This applies to dissolving a marriage, a customs union or a commercial arrangement.  Look at the Bezos divorce, Brexit or the Growthpoint BEE dispute as examples.

BEE contracts, like any commercial union, often go the same way:

The reasons for a BEE relationship no longer working are the same as in a marriage – a party disappears; the enthusiasm goes; better prospects beckon; expectations are not being met or consummated; trust breaks down; or it is simply a waste of time.  This happens even when there isn’t a guilty party.  Sometimes it’s not working.

Undoing a BEE deal is very different to a divorce:

We’ve recently seen a number of cases where the aggrieved party in a BEE deal decides to get rid of the annoying partners, mistakenly thinking that the decision to do so is all that is necessary. Not so much.

There is one huge difference between a matrimonial relationship and a shareholder relationship: if one party wants a marriage to end, the other can’t save it.  The mere fact that someone wants to leave a marriage is evidence that the marriage has irretrievably broken down – a recognized ground for divorce.  So, staying married is as much of a choice as marrying.  Married people chose to stay married, even if its unhappily ever after.

In shareholding relationships there is often no such choice, especially when the shareholders don’t agree.  The unhappy partner in the BEE arrangement cannot simply chant “Go Away” three times or hope on a wing and a prayer that the other side will just slip into the sunset.

Firstly, for the BEE ownership points to be claimed the Black Person has to be the shareholder in the register (yes, this discussion ignores options and the BEE rules around them).  There may be contracts between the parties, but no matter what, a shareholder gets rights from a company’s Memorandum of Incorporation, Company Rules and the Companies Act.  Some of these rights, especially those in the Act cannot be taken away.

So, to be clear, if a shareholder hasn’t paid a seller for some shares, the seller may sue for payment, but he cannot simply take the shares back.  The registered shareholder is entitled to some rights and can claim these from the company, directors and other shareholders just because he is a shareholder.  It does not matter how one seduced and enticed one’s spouse into marriage, the spouse has special legal status just because they are the spouse!

How to get out of a BEE ownership deal:

In undoing any shareholder relationship, the basic objective must be to get the shareholder’s name out of the register.  This must follow the correct process or it will simply be put back (and other claims may still follow in respect of, say, lost dividends or legal fees).  It’s important to seek advice to ensure that this is done properly.

Simply put, the exiting shareholder needs to be part of the process and will be paid to leave in one of the following ways:

  1. Willing seller: If the BEExiter agrees to sell his shares, buy them.  The shares could be bought by the other shareholders, by a third party or even by the company itself (subject to additional Companies Act requirements).  In any case the buyer and seller must agree the price.  The fact is that there is a logical price at which a rational seller will say that it is a good deal and take his money and run.  This price may be one that the seller has named, or it may be one that the buyer made too good to turn down.  The seller may sell because the shareholder divorce is destroying value and it is better to jump ship and salvage what one can.  This price exists.  The challenge is that if the emotions have gotten too hot, if the expectations are too far from reality, then all it takes is for one party to act unreasonably or irrationally and then “expropriation with compensation” will fail. This is too often the case – both sides need to engage with independent advisors early in any process that’s likely to be acrimonious (and removing a shareholder quickly gets that way).

Either way, the exiting shareholder needs to agree to this and needs to be paid.

  1. Forced sales: A properly written shareholders’ agreement/company rules or MOI sets out what happens in the event of a forced sale. If one has secured agreement in advance that one party can buyout shareholders on the occurrence of some event then one can force the sale.  But, there are two requirements: (i) there should be this advance agreement (normally included in shareholders’ agreement) and (ii) the event must have happened.  The type of events that could trigger a forced sale include certain misconduct (such as prohibited competition, or solicitation of clients or staff) or a change in circumstances (such as liquidation).  Importantly this could be the majority shareholder too who is forced to sell.  As this is a contractual provision it may be that the forced seller simply does not exit on the agreed terms, and one has to enforce a contract (while he remains a shareholder).  This is addressed by making the company a party to the shareholders’ agreement too so that it can be compelled to register a forced sale.

The exiting shareholder needs to pre-agree to this and needs to be paid.

  1. Optional sales: A sale can also be forced by giving someone an option to buy the shares at some time in the future at a pre-determined price.  This is a call option and if a party who has such an option calls on the shares and pays the agreed price, then the selling shareholder has to deliver the shares.  Unlike a forced sale, the option holder does not have to buy the shares, but should he elect to, then the shareholder has to sell the shares.

The exiting shareholder needs to pre-agree to this and needs to be paid.

  1. Donations: The BEExiter cannot simply resign as a shareholder, as say an employee could.  Even if he ceases to exist (because he dies or is sequestrated), his shares just pass to his successor in title (his executor, heirs or liquidator).  However, if a shareholder is not interested in conveniently dying (and the other remedies mentioned here are not available) then he can only cease to be a shareholder if he gives them away.  Donors are liable for donations tax, so even in this scenario the exiting shareholder does have cash flow consequences, albeit negative ones.

The exiting shareholder needs to agree to this and needs to pay.

  1. Other forced sales: The Companies Act does give aggrieved shareholders certain rights to address being wronged and they can approach the Companies Tribunal or the Courts to seek redress.  The most important rights are the so-called appraisal rights in section 164 which can force a company to buy out a shareholder at fair value in certain circumstances.  It doesn’t matter if neither the seller or the company agree to the value.  They have to, however this is obviously a long process and can be very expensive in terms of legal fees etc.

The exiting shareholder agrees to this (as he initiates the process) and needs to be paid.

What about trying to make it work?

As we’ve shown above, one party cannot simply remove another because they don’t like them.  Parties need to negotiate their coexistence and how they will exit from the relationship. Obviously, this is better done long before things fall apart.

Sometimes working on the relationship will yield the best results and this often starts with listening to and talking with one another.  We are no counsellors but why doesn’t the existing relationship work?

  • Are the intentions of the parties honourable at the outset? Do parties trust each other?
  • Are expectations and deal-terms reasonable and fair? Often in BEE transactions there’s unreasonable expectations for super returns – expecting business to flow just because of shareholding (yet without anything untoward) or for dividends simply to flow despite no real value added. Many entrepreneurs want a business partner – someone to get stuck in and run the business – rather than just a shareholder and when they get the latter face real disappointment.
  • Are the expectations of the after-life just a fantasy or is it better to stay where you are (not only because you committed to, but because you actually want to)?
  • What’s the vision? Can the parties still offer each other the promise of a future together?
  • Should stay in this less than perfect arrangement because the alternative is too costly to contemplate and isn’t great for future generations?

The Tusker approach:

As highly experienced experts in BEE and other shareholder transactions, we’ve taken extensive care to make sure that our agreements include very clear clauses that determine the rights of parties and the process to be followed in a potential divorce. These are standard in every deal we do and are agreed up front. The most NB thing however, is the setting of expectations as to what happens after we invest in a business, as its against these expectations that reality is always measured. Both parties are far more likely to be happy if people do what they say they’re going to do.

How the NCA sinks vendor-financed deals

This may be one of the more NB articles we’ve written. No kidding. The most common method used to finance BEE might just become spectacularly unstuck thanks to the NCA (National Credit Act) and a whole bunch of money owed to ‘white’ sellers of shares may be unenforceable. Read on, and expect a flurry of legal activity. 

Understanding Vendor finance:

Vendor finance is, very simply, the financing of the buyer by the seller.

You want a BEE partner but they don’t have money (usually the case), so you sell them the shares in the business but lend them the money (i.e. you become a credit provider) to buy the shares. They repay this debt and the interest thereon through dividends over time. You get your money and the BEE points you need; they get the shares and the economic value. As a credit provider, the credit risk is yours but once the shares (or portions thereof) have been transferred they belong to the new (presumably BEE) owners.

Almost half of BEE deals involved Vendor financing: the B-BBEE Commission reported that 39% of all BEE ownership transactions were vendor-financed and that a further 5% involved some combination of funding which included vendor financing.

A real world example: 

To fully understand vendor finance let’s look at what it is with a simple example (in this case, unrelated to BEE but the same principles apply):

Mr. Du Bruyn set up a business in 1984 sealing industrial leaks.  He and his wife knew a young man, Mr. Karsten, who they treated as their son.  Karsten was a law graduate, a university lecturer and a municipal councilor and the Du Bruyns involved him in the business in the early 2000s. They mentored him so that, by 2008, he was the technical director and he became a shareholder.

Eventually, in 2012, they agreed to part ways (the best way to get rid of a shareholder, as we discussed previously, is to buy them out) and they agreed that Karsten would buy out the Du Bruyns for R2.5 million.  They gave Karsten until 31 March 2013 to find the money.  When he couldn’t, they very kindly gave him another six months and when the finance still couldn’t be found, the Du Bruyns offered to buy Karsten out instead – for R1.5 million cash.

Karsten wanted R2 million which the elderly couple didn’t have, so the vendor (Mr. Karsten) agreed to vendor finance – the Du Bruyns would buy Karsten’s shares for R2 million with R500 000 to be paid in cash and the balance payable over five years with interest.

So far so good. The vendor gets the price he wants but to do this has to finance the buyer. Fairly typical. The difference is what happens when the buyer can’t come up with the money.

Enter the Supreme Court:

These (above) are the facts of a recent Supreme Court of Appeal court case Du Bruyn NO and Others v Karsten.

What went wrong: the business started underperforming and the Du Bruyns tried what they could to help it, even selling some personal assets.  Ultimately it made no difference and in the end they stopped paying Karsten and he started legal proceedings to recover the R1.1 million that they still owed him.

However, the Du Bruyns argued that they did not have to pay Karsten back in terms of their loan agreement and the highest court in the land agreed with them.  The court said that the loan agreement was void and unenforceable, which means that all its terms like interest rate, security and the like were not worth the paper they were written on.

The long arms of the National Credit Act:

The court reached its conclusion based on the National Credit Act 34 of 2005 which basically says that a lender needs to be licensed in terms of this Act to be able to enforce a loan agreement.

What is more, the vendor needs to have the licence at the time he makes the loan and it does not matter if he gets it later.  The court said that section 40 was clear and that if one makes any loan (even if it’s a once off or even if one is not in the business of making loans) then one needs a licence.

Implications for vendor-financed deals:

Before 2016 the lender had to be owed over R500 000 on his loans before falling under the NCA, since then the law states that a licence is needed for any loan is where there is an amount in excess of R0.01 that has to be repaid. i.e. every loan is now regulated.

In any vendor-financed situation where the buyer cannot come up with the cash – either because he doesn’t have it, can’t get it, or simply doesn’t want to pay – this is a very important judgment.

Yes, if I owe you any amount and you do not have a licence, you can forget about trying to enforce our loan agreement in any court – until parliament changes that section.  This won’t change fast – we do not have a sitting parliament at the moment (April 2019) and since a parliament seldom changes a law quickly and even less frequently backdates a law, we can expect a few years for this problem to be resolved.

Until then the BEE shareholders to whom you extended the credit to buy shares simply don’t have to worry about the contract, and the shares issued so far are theirs to keep.

Get legal advice:

Some of the reported B-BBEE ownership structures may have been vendor financed by licensed credit providers but there are (per the National Credit Regulator’s latest 2017/8 Report) only 6 191 credit providers. Chances are most of the vendors are at risk here.

All other vendor financiers should seek legal opinion on how they will get their money.

Their lawyers will no doubt point them to rules of unjust enrichment, but whatever without a valid contract no lender will get any interest, will not have their loan secured and can’t withhold instalments from dividends or remuneration.

There may have been far more economic empowerment in these deals than anyone realised…

How the Government shoots BEE in the foot

Tusker is a BEE private-equity fund and our articles inevitably illicit quite a lot of reaction – much of it’s against BEE, and especially the perceived link between BEE and corruption (the extent of which understandably draws angry responses from fed up South Africans, especially in the business community).

To be clear, Tusker believes in the need for transformation and has built its business around making BEE ownership financially sensible and strategically advantageous for our clients.  However, this does not mean that Tusker is blind to the challenges that BEE presents.  Some challenges are ideological.  Other challenges relate to practicalities such as bad implementation or regulatory uncertainty.  But, the biggest single problem is that Government has given BEE a bad name as we explore further below.

On many levels, BEE has been a real success:

Credit must be given where credit is due:  Government brought us BEE and it has not all been bad. Despite the common perception, it is just not true that only a handful have benefitted from BEE. There is no doubt that the South African economy’s racial composition has changed significantly in the decade and a half that we have had BEE: many BEE schemes have generated wealth for black people in shares; many black managers and youth were trained and recruited for BEE purposes; and multiple suppliers and communities have benefitted from BEE.

In the BEE Act’s lifespan the spending power of black people and the size of the middle class of black people has also ballooned, changing forever the racial makeup of the economy.  Whether this could have been achieved more efficiently is a rearward-looking policy question, but economic statistics show that Black people now have the majority of jobs in the economy, own the most houses, make up up most of the membership of pension funds.

However, black people also remain the majority of the unemployed, homeless and poor.

To say that too few have seen the benefit of BEE is impossible to argue with. To say that the corrupt have used BEE as a vector is also impossible to argue with (but it’s not true that BEE causes corruption either).

Where’s the blame?

The limited success of BEE cannot however be blamed entirely on Government, especially since Government has not made BEE compulsory.  The fact that many businesses have effectively ignored BEE is a choice they have been allowed to make.

What then has Government done wrong?

Government isn’t leading by example: 

We analysed the B-BBEE Commissions’ report here and compared it to the analysis of our own database. Probably the most telling fact is this:

“…even that is not as surprising of the state’s coverage – remembering that the state is the champion of champions for BEE.  The report states that only 4 out of 299 State-Owned Entities and Organs of State Entities submitted their annual Compliance Reports.

Yes, you read that correctly. The government doesn’t care enough about BEE to get verified.”

Simply put, Government is not in compliance with its reporting obligations in terms of the BEE Act.  They have not been leading by example, making it more difficult for the B-BBEE Commission to take other serial offenders to task.

Maybe this could be overlooked if Government championed BEE in other ways, but have they?

In theory, the BEE Act aims to encourage procurement from black providers of an equivalent service at an equivalent price, but in practice it appears that the government pays a heavy premium to procure from black companies even though the price and quality would be worse than otherwise. This is obviously wasteful expenditure and an inefficient use of taxpayer money, but does it circumvent the purposes of the BEE Act? Since the Act’s purpose is to transform, the answer is no.

Government is not good at juggling all of South Africa’s needs: 

Government has an unenviable task. The theory behind the BEE Act was that Government would use its enormous purchasing power and annual expenditure budget of nearly R1 trillion on promoting black businesses and participation in the economy by black people.  This would be hard enough if this were Government’s only objective, but Government has to also consider the existing economy (read tax collections), international investor sentiment (read investor capital flows) and consumer and business confidence (read economic activity) to promote economic growth.

Such imperatives promote economic growth (which would also be radical, given the state of the economy at the moment), but might not change the racial composition of the economy.  Even though it’s unclear what the target or ideal racial composition of the economy is, more should definitely benefit from being active participants in the South African economy.

Luckily, Government is also tasked with growing the economy and this, of necessity, means it cannot be solely obsessed with BEE.  So, the second Government BEE problem is that it has been bad at its impossible task of juggling BEE and other competing objectives.

No definition of success:

Some policies are easy to understand. E.g. reduce unemployment to an acceptable level of say 5%.

The BEE-Act not so much. When has enough transformation happened? When has enough BEE been done? Should BEE be stopped when black people are the majority of the economy?  If this were Government’s sole objective it could achieve it by chasing away citizens (like Zimbabwe) or by discouraging foreign investors (like Venezuela).

The lack of sunset clauses is probably deliberate. The argument is probably that “we’ll know when when we know” that sufficient transformation has occurred, and in the meantime it’s a useful political tool.

Government removes the incentive to do BEE:

The most common criticism of BEE (read the comments on our facebook page) is that it has fostered cadre deployment, bribery and corruption and resultant poor service delivery.

These are completely separate problems that are global phenomenon and have existed long before and independently from BEE, but one should critically consider whether the way Government has transacted has advanced B-BBEE or if it has in some way frustrated the objectives of the BEE Act.

There are many good corporate citizens that have organized their BEE affairs (which involve giving up money, control or both) by doing the right things, only to lose a tender to someone who won it in because they are better at stuffing cash in Louis Vuitton handbags, offering real estate in Dubai or by bribing a verification agent to falsify a certificate.

Inevitably the question is asked: why bother with BEE? Every corrupt deal removes the incentive to do BEE.

BEE trumps all other commercial considerations for Government:

BEE as we know it is not the first time in history that one group has tried to dominate a market place by giving itself preferable terms.

Stereotypical examples abound of how Jewish businessmen, freemasons and local business chapters have promoted their members’ business interests.  The Broederbond and the Proudly South African campaigns are local examples, which are similar to BEE in that they want to encourage business with one group (to the exclusion of others).

Obviously, they are different in that these are not legislated, but as BEE is voluntary (for everyone in the private sector), they also seek to give preference to one group.  So, the theory is that when all else is equal (cost, quality, ability to deliver) then preference should be given to black businesses. This is how BEE is supposed to work and this form of BEE is really hard to argue against.

In reality though BEE trumps all other commercial considerations and contracts are awarded to black businesses sometimes at the expense of quality or cost.  Awarding a contract to construct a road to a black business may look cheap until someone pays with his or her life, which could be the result of shoddy workmanship not being considered in awarding the contract.  Quality should always be considered.  So should price.  Why pay more than the market price?  The Jewish, Broederbond and masonic business deals were always done at a special price “for my friends” but Government’s special price is sometimes above the market cost, because a middle man takes a cut or simply because a black person is offering the service.

In a free market one would not pay more than one should for anything – unless there is corruption, bribery or some other form of rent seeking or because it is somebody else’s money and there is no regard to that. When BEE trumps commercial considerations of quality and price then taxpayer money is wasted and frustrations build, making it harder to encourage others to comply.

Government is not always a great client to have: 

No matter how much business one wins from any contract, it is worth nothing until actually banked.  Despite ongoing assurances, Government is a notorious late payer. Every time Government is late in paying, it affects the working capital of the black business.  Only businesses with much more other business or with sufficient cash reserves can survive.  Unfortunately, many businesses are not in such a position and either go out of business (waiting for the cheque from Government) or decide to do business with everyone except Government, not bothering to tender for its business.  This cuts Government efficiencies and fails to promote BEE.

So what should Government do?  They should support B-BBEE fully – by doing good clean business on the best terms it can, and rewarding those that have legitimately transformed with contracts that pay them as promised.

Is BEE a farce?

Is BEE really a farce, or is that just ego speaking?

Dr. Iqbal Surve (chairman and shareholder of Sekunjalo which in turn owns Independent Media) has been appearing before the Mpati Commission of Inquiry which is looking to the affairs of the Public Investment Corporation or PIC.

In his testimony before the Commission Dr. Surve is quoted as saying “BEE is a Farce” – this was the front-page headline of The Star, a paper in his stable of (not-so) independent publications.

He was also quoted as stating that BEE is fundamentally flawed and needs to be reviewed.  In support of this he cites well known examples of BEE companies that imploded after their share prices failed to perform: Nail, REAL, Thebe, Mvelaphanda and his own Sekunjalo.

Really?

As believers in free markets and the power of stock markets, we do not believe that a failed share price can ever be used to argue that BEE has failed.

If this were the case, we could point to Steinhoff to argue that “WMC” is no more or to the likes of Anglo, Barloworld, Edcon and other giants of the markets during apartheid to show that white economic disempowerment has been reached.  Really?  What is the link between any share price and the race of its shareholders?

BEE can be useful to blame but it alone has little bearing on any share price.  It may be relevant, indirectly, in helping a company land business or secure funding, but analysts valuing companies only care that the business or finance has been won.  Analysts don’t care how these are won, let alone whether it was because of BEE, especially if they are foreign analysts and don’t really care about or understand BEE.

Stock markets reward relative investment performance:

As with any stock market, South African markets punish the share prices of badly run companies and inflate those that are well run, irrespective of who owns their shares.  Badly run could be from fraud (Steinhoff), excessive risk (Aspen) or poor execution (Group 5).  No ordinary share has traded at a discount or a premium because of the race of its shareholders.  Besides being irrelevant, nobody knows the race of the shareholders at any point –in good liquid companies these are changing every minute of the trading day.

In simple terms share prices go down because shareholders “dump” them.  Sellers choose to sell for a number of reasons.   Some have nothing to do with the company e.g. the seller needs the money to pay off a personal loan or income tax.  Most are directly related to the company, where the seller believes that the share price will drop and wants to cash out while he still can.  When there are lots of sellers, it’s more likely that shareholders are selling because they think the company will be worth less in future than it is now. Why sell if you think it will go up?

We all want the same thing: a better ROI:

Black and white investors (including the foreigners who own ±70% of the JSE ) all look to make good investments.  On this, at least, all races are fully united.

If shareholders are united in their assessment of the company and have no immediate need to sell shares to raise cash for other reasons, then it’s a share price cannot drop – everyone is holding, and no trades happen so the price doesn’t move. This applies in every company, including BEE companies.

Therefore, every black-owned listed company (including those cited by Dr. Surve), that has seen its’ share price fall has done so because its black shareholders have decided to sell – en masse.  There may have been some white sellers too, but a BEE Company had to be mostly black sellers by definition. While there are myriad reasons for selling, almost all are because there is a better use (risk/return basis) for the money.  Such a decision is not a BEE-related decision.  When a shareholder wants to get out, he is voting with his money – in effect saying that he can deploy the capital better elsewhere than the companys’ management can.

Therefore, we question whether a company with a declining share price is a sign of BEE being a farce, or whether its future prospects and investment value are simply looking worse than before.

Perhaps the “good” doctor has underestimated not only the power of the markets to price correctly, but also the intelligence of the investors themselves.

What’s the role of the PIC in this?

One of the biggest investors on the JSE is the PIC, which although only Level 2 represents millions of black peoples’ savings and (where investment principals were followed, was often a seller of shares in BEE businesses too).

The PIC was formed by Parliament in 2004 and, at over R2 trillion in size, is one of the world’s largest fund managers (and definitely the biggest in Africa).  Given the size of the PIC it cannot simply concern itself with its members’ needs.  The PIC has a key role to play in not only South Africa’s capital markets but also in the development of the country as a whole…it has a major transformation role and as it states in its latest report:

The objective of transformation within PIC investee companies is to give effect to the country’s transformation agenda and the PIC’s transformation objectives are to, among others:

  • Promote and incubate the growth of broad-based empowerment;
  • Achieve wide-reaching social transformation;
  • Stimulate economic growth and transformation in South African investee companies; and
  • Integrate all the B-BBEE elements into business processes.

However, the PIC is a licenced financial service provider (like all fund managers, including Tusker) and like them it looks to give its clients a superior investment return.  Even its BEE transformation objectives are secondary to a client mandate, and if it buys or sells shares it is not (or should not be) because of BEE…

Where’s the real farce?

As reported in the Daily Maverick: “At the end of September 2018, after interest was added, Sekunjalo owed R1.35-billion to the PIC for Independent Media. The company has not been servicing its debt and, with a penalty interest fee added, Sekunjalo may owe as much as R1.5-billion, said commissioner Gill Marcus.”

Amongst other deals, the PIC has funded the doctor too, and he’s in front of the commission because it looks like the deal was far from correctly priced. Did he get the money because of real investment potential or because he was BEE or for some other reason?

Time will tell.

BEE fronting – what it is, the risks, and what to do about it:

There has been a lot of recent publicity around BEE fronting and the B-BBEE Commission devoted much of its recent annual conference on BEE ownership to this very important topic. Fronting and BEE ownership can easily overlap.

At the 2019 B-BBEE Ownership conference the Minister of Trade and Industry (under whose ministry the B-BBEE Commission falls) categorically stated that fronting is hampering economic transformation.

However, some issues are often overlooked and so in this article we seek to clarify some of the issues around fronting.

What is “fronting”?

Fronting was not mentioned in the original BEE Act (2003), but it did not mean that people did not abuse the Act and put all sorts of structures in place which met the letter of the law but actually did nothing to further the objectives of the Act.

In response, a decade after the Act was passed a definition was included for what constitutes a “fronting practice”.  In essence it was defined as “any act that undermines or frustrates the objectives of the Act or its implementation”.  This can obviously be broad and can be open to interpretation.

The definition does list some examples, but this is not an exhaustive list.  In other words, there are other forms of fronting, but the following are definitely fronting (in simpler English than in the Act.  Please read section 1 of the B-BBEE Act for the proper definitions):

  • Where a Black Person is given a title (such as director or shareholder) but does not get the powers associated with it;
  • Where the economic flows from a BEE transaction differ between what the legal documents say and what actually happens;
  • Where the contracts are not commercially reasonable. This could be because the contract has significant (and unfair) limitations, is not likely in reality or was not arm’s length on a fair and reasonable basis.

While the list is not exhaustive (and more examples exist), it is clear if one contracts or appoints fairly and then abides by the contract there is no clear-cut fronting, and some proof will be required that the objectives and implementation of the Act are knowingly being frustrated.

What are the consequences of fronting?

Just inserting a definition of fronting into the Act doesn’t really change how people behave.  So, it’s important that all the other 2013 amendments also be considered.

The most significant were in section 13, which not only established the B-BBEE Commission but also criminalized certain contraventions of the Act, including fronting (section 13 O(1)(d)).

Anyone found guilty of fronting can be sent to prison and/or be fined.  These penalties can be summarized as follows:

  • For people involved in fronting: prison can be for up to ten years and there is no limit to the fine.  People can be sentenced to both prison and a fine.
  • For companies involved in fronting: the fine can be up to 10% of annual turnover (there cannot be any imprisonment).
  • For verification agents, procurement officers and public servants who are aware of any fronting or attempted fronting who fail to report the fronting: prison can be for up to one year and there is no limit to the fine.  These parties can also be sentenced to both prison and a fine.

Clearly these are very serious offences.  To be clear, there are other offences in the BEE Act, which carry the same penalties.  But this article will be confined to the offence of fronting.

Section 13P adds another consequence to a fronting conviction: once convicted the guilty party also cannot for the next ten years deal with government and organs of state.  Given that such contracts were presumably the motivation for the fronting, this could be the worst punishment for many businesses (and could be 100% of turnover for the next decade).  This is  theoretical, as such a company clearly would not be around after conviction.

The section goes on to provide for all shareholders and directors of a company convicted of fronting (even if they themselves were not) to be restricted in a similar way.  This is so that they do not simply try and front again through another entity.  Importantly, there is no time limit for such a restriction and individual shareholders and directors could find that they are banned from ever doing public sector work.

But, as the B-BBEE Commission points out, this is not all…a conviction also comes with significant reputational damage.  For example, if payments have been made to a business on the back of BEE Scores that were wrongfully obtained because of fronting, litigation may be instituted to recover these amounts.

In other words, fronting carries some really serious penalties including reputational risk, fines, imprisonment and removal of access to markets (government spend).

Who can be guilty of fronting?

As can be seen from the above it is clear there are two types of fronting offenders:  those who front and those who know of fronting and who should report it.

To be guilty of fronting one has to knowingly engage in fronting.

While this sounds like the normal requirement in criminal law that someone should have the intention to commit the crime, the BEE Act goes further to also cover those crimes that are as a result of negligence too.

This is because there was also a definition added in 2013 for “knowing” which covers more than actual knowledge of fronting.  Those who actually know that they are engaged in fronting are liable to being charged, but so are those who ought to have known.  In this latter category are people who ought to have investigated a matter to such an extent that they have actual knowledge and those who should have taken reasonable steps to have actual knowledge.

Let’s unpack what this means, using a common front arrangement:  a black person signs up to be a shareholder in a business and gives it BEE points. However, that person is not really a shareholder because he signs contracts that leave the economic rights and votes in that company in effect unchanged.  This is a typical sham transaction and the company would have engaged in fronting practice because it would have actual knowledge that nothing has changed (and in all likelihood not demonstrable audit/paper trail of records of participation in meetings, dividends, resolutions, etc).

But, just like with bribery and corruption, fronting practices have to always involve two or more parties.  Simply put this boils down to a white party (which wants to get BEE credentials) and a black party (who gives those credentials) at least.  So, the black party in this example has also engaged in a fronting practice.

However, he might escape criminal liability if he did not “know” he was fronting.  If he conspires with the white party and knows full well that there is a front, he is equally guilty as the white party.  But what if he genuinely did not know?  Well, this is where the definition is important, and one would need to consider whether he should have investigated or taken steps to understand.  The test is whether “reasonable” steps were taken to get the knowledge.

What is reasonable?

Consider whether it is reasonable for a black person to say he did not know he was fronting when he is well educated and experienced in commercial matters and has signed contracts with fronting in?  Getting an attorney or accountant as a BEE partner therefore, for example, gives certain protection to a white party because the BEE partner has to think carefully before reporting fronting that he himself knows about and is involved in.  Such partners should investigate or are reasonably expected to find out and whether they do or not is not relevant to whether they know or not that they are fronting.

But, if even the most uneducated BEE partner becomes aware of his involvement in a fronting practice and allows it to continue, he is fronting too!

It is important that all verification agents, officers and state officials understand that the B-BBEE Commission has effectively got them as its eyes and ears and if they become aware of any fronting or attempted fronting, they have to report it, in much the same way one has to report a car crash that one is involved in.  Not reporting something like this is an offence for such people.

How does someone get convicted of fronting?

As with any crime only a court can convict someone of fronting.

For this to happen, someone would need to lay a complaint and the B-BBEE Commission would need to investigate the matter and decide to refer the matter to the NPA for prosecution.

The NPA would then need assess itself whether it agrees with the B-BBEE Commission and decide whether it believes that it can successfully prosecute.  Then of course a judge would need to agree with the NPA and B-BBEE Commission that fronting has taken place (and if there is an appeal, maybe more judges would need to agree too).  But, what is clear is that the B-BBEE Commission does not have the powers to convict anyone of fronting – that is handled through ‘normal’ legal challenges.

What’s very important however, is that the B-BBEE Commission does have significant powers to investigate fronting, and this can open up a can of worms for guilty parties.

Section 13K gives powers to summon witnesses and evidence, for example.  People have to cooperate with the Commission, but they do not if it will incriminate themselves, and if they do and it is self-incriminatory the evidence is not admissible in the criminal court case.  But, to be clear, the B-BBEE Commission can make a finding of whether fronting has occurred (section 13J(3) makes this crystal clear) but this is not a criminal conviction.

More likely, what happens here is that the BEE commission could refer you to court to enforce the terms of the ‘fronting’ agreement. For example – a black person (the gardener or the tea lady) is told they become the owner of 51% of the share in a company but never see a share certificate, dividend or board meeting (fronting 101) – the courts could enforce the agreement leaving the black person the legitimate owner of the shares, and the company no longer fronting…as we’ve said before – the risks are high.

The B-BBEE Commission can also refer the matter to the NPA or SAPS (s13J(4) and (5)) or (and here’s another real risk) SARS (s13J(6).  So, to put it in another way, the B-BBEE Commission has access to significant information which they can share with parties with serious teeth.

How to report fronting:

Verification agencies and procurement officers have an obligation in terms of the Act to report fronting, but anyone can lay a complaint or report something suspect here: https://www.bbbeecommission.co.za/lodge-a-complaint-process/

What is the state of fronting?

A lot of fronting is alleged but before turning to the statistics around fronting it is important to contextualize fronting as follows:

Firstly, fronting only became illegal in October 2014.  So, while BEE was introduced in 2003, for the first decade there was no fronting in a legal sense.

Secondly, even though in the first five years of fronting there have not been fronting convictions, it does not mean that fronting does not occur.  This may be more a reflection of our law enforcement agencies or our court backlogs, which are not BEE issues.

Thirdly, one needs to consider whether like so many other crimes, there are reasons for underreporting.  We have already alluded to the risks of reporting a fronting offence where one is also a guilty party, but some parties will not report a crime which does not affect them, because they do not want to become involved in investigations and trials.  And, of course, many people are simply unaware that fronting occurs.  All this does not mean that fronting is not a real problem.

At the B-BBEE Commission’s 4th Annual Conference earlier this month it was reported that 484 complaints were received up to the end of 2018 and of these three had been referred to criminal prosecution and two to court.  Details were not provided as to what they were referred for, but even if it assumed that all referrals relate to fronting, one will see that the numbers are not as alarming as the popular press would lead one to believe.

Problems with fronting:

The Minister of Trade and Industry did say at the 4th Annual BEE Conference that while fronting needs to “ruthlessly eradicated”, it is equally important “to identify, support and value those who are doing the right thing”.  So, it is important not to throw the baby out with the bath water. The B-BBEE Commission also repeatedly stressed that they urge companies to approach them to review structures or other arrangements they are considering so that they can give guidance/opinions as to how to make them compliant before they are implemented. (Tusker has taken this approach with our structures and continue to engage with the B-BBEE Commission and DTI as we innovate further).

Given our history, there is too much distrust in our society and fronting is immediately suspected to be behind many BEE transactions.  This is often unfair, even though it may sometimes be the case.  The vast majority of South Africans are not criminals and we should not lose sight that we must target the wrongdoers and not go for the innocent.  The B-BBEE Commission is obligated to operate impartially and without fear or prejudice, which means that the B-BBEE Commission respects the principles of our legal system, including of criminal law.

So, if one acts wrongfully one should worry.  If not, do not.

We recommend everyone to keep solid records of decisions made, resolutions, meeting attendance, participation in management, dividends, AGMs etc (standard governance stuff, but essential proof if ever you face a fronting allegation).

Please contact us if you’re looking for a B-BBEE investor/shareholder that’s 100% legitimate and can grow the value of your investment in your business.

 

 

Is B-BBEE going away?

We’re frequently asked if B-BBEE is going away. The reality is that it’s here to stay – but likely to be changed/modified along the way. This article is an NB read for those who’d like to believe they can put off BEE until some magical future date – we think (for all the reasons listed below) that this is an unsafe bet. Please read and share. We’d be very interested, as always in constructive comments and suggestions. 

The foreign investment imperative:

Zimbabwe recently abolished indigenisation ownership requirements in its mining sector, allowing for 100% foreign ownership.  This follows a similar move in Namibia at the end of 2018 – where BEE was scrapped because it wasn’t benefitting the majority. Both countries found that foreign investment had dropped off and attributed this to their laws comparable to our BBBEE laws.  Envoys of President Ramaphosa on his drive to drum up investments in South Africa, have been told that investment is less appealing because of, amongst other factors, the BEE Act.

Foreigners are not alone in questioning this Act, which is central to South Africa’s transformation agenda.  South Africans also question the future of this Act.  The questioners range from those waiting for economic transformation and losing faith in the Act’s ability to deliver this, to those who consider the Act racist legislation to blame for corruption and economic decline.  They believe, for completely different reasons, that the Act should be scrapped, following the Namibian and Zimbabwean examples.

Policy uncertainty breeds risk:

Many investments have structured around BEE and were the Act to be scrapped, some of these investments would be relooked at.  Resentment may be created where the investment is then considered a waste.  But, even if it’s not, it’s certain that the investors would see more policy uncertainty.  Investors only need to know what the rules of the game are to be able to plan their affairs.  The rules themselves are less important than knowing that they are what they are.  The negative investor sentiment around BEE stems from the fact that rules appear to be changed often.  Consider the uncertainty around the Mining Charter and the impact on investment, for example.  The B-BBEE Commission does not help by making rulings/directives that are non-binding – compared to those by SARS which set clear guidelines for everyone on tax matters. This means that the Commission never introduces certainty, even when issuing practice notes or interpretation guidelines.  Nobody can therefore every be fully certain that the BEE rules are whatever one thinks them to be.

Change in inevitable:

We have to expect that the Act (and Codes) will change.  This is partially an admission of some of the failings in the Act, but it also reflects what a radical idea BEE is.  This is a social experiment, never attempted anywhere else in the world.  An idea to redress the past without reparations.  Normally, the idea is for the “victor” (the side on the right side of history) to make the other side pay.  This happened throughout history and after each war the loser was made to pay.  This was meant to hurt.  Germany, for example, made its final instalment ($94 million) on its WWI debt in 2010, almost a century after the Armistice.

The problem with reparations is that the “loser” often feels they are unfair and often this causes significant resentment.  The WWI reparations led the economic hardship of the Weimar Republic and the rise of the Nazis.  We all know how that worked out. Beware the shallow victory.

South Africa is a massive compromise (AKA negotiated settlement) with a powerful Bill of Rights:

Our Rainbow Nation chose not to exact revenge and reparations in this way.  But did demand the restoration of some equity and justice.  This included many compromises, which were intended to be just, without being unjust.  This was to balance the competing interest groups’ needs, without destroying value for everyone.  As with any compromise, this meant that nobody is entirely satisfied with what they got.

The compromises included the establishment of a Government of National Unity, the Truth and Reconciliation Committee, our anthem and most significantly the Constitution of the Republic.

Chapter 2 of the Constitution introduces a Bill of Rights, which is the complete antithesis of what existed under apartheid.  The Bill of Rights includes the right to equality, as the very first right, prohibiting unfair discrimination on the basis of, amongst other things, race.  Clearly, this marked a complete break with South Africa’s past, and echoed what Mandela referred to in his inauguration when he said this beautiful land would never again experience the oppression of one group by another.  It’s the same section many refer to when criticizing the BEE Act.

The right to equality is a basic human right.  Basic human rights are often called first generation rights, which are political and civil rights such as the right to be freedom of religion, speech and movement and rights to fair trials and votes and so on.  First generation rights protect citizens from the state, and, although basic were missing for most of South Africa’s history.  After the second world war, second generation human rights developed.  These are economic, social and cultural such as the rights to education, housing, health and food.  These are more progressive and also sorely needed in South Africa.  But there is a third generation of human rights such as the rights to a healthy environment, group rights and intergenerational rights.  These are much more aspirational and largely unofficial.  But, South Africa, sought to compensate for previous lack of human rights and included these too its constitution.  This is what makes our constitution so different.  One third generation right is the right to economic and social development.

B-BBEE and the constitution:

So how BEE fits into South Africa’s constitutional framework is an important consideration:  Clearly if it does not, it would not be allowed and the Constitutional Court would strike the statute down.  This has not happened and should give those who say the BEE Act should be scrapped pause, because in one way it would be easier to scrap through the Courts than through parliament.

So, we need to consider how an Act such as the BEE Act which clearly is discriminatory and does not treat everyone equally can be upheld when it immediately looks like a contravention of the first human right.

Well, let’s first consider that nothing in the Constitution prohibits discrimination.  There is plenty discrimination around that we accept.  Pensions, maternity leave, disability parking bays are examples of discrimination, where not everyone is treated equally but which nobody has challenged constitutionally.  The simple reason is that the Constitution prohibits unfair discrimination (and not any fair discrimination).  So, the first consideration is whether BEE is fair in the context of South Africa.  If it is, the Act will not be scrapped in this way.

Most people who think this is unfair have not read the Right to Equality clause in the Bill of Rights which goes to state “to promote the achievement of equality, legislative and other measures designed to protect or advance persons, or categories of persons, disadvantaged by unfair discrimination may be taken.”  Therefore, if the BEE Act is intended to promote equality it’s specifically allowed.

The BEE Act has specific objectives in section 2 which include economic transformation for more meaningful participation of black people in the economy.  There is no debate that this is designed to advance a category of persons disadvantaged by unfair discrimination.  And therefore it’s hard to argue that the BEE Act is unconstitutional by being racist.  (This is not intended to be a legal treatise on the Act vis a vis the whole of the Constitution.  Rather simply to explain why even though based on racial identity it’s not unconstitutional).

Can B-BBEE be scrapped by a political process?

The only other way for the Act to be scrapped is through the democratic process by the National Assembly repealing it.  This could be because the Act has achieved its objectives (and is therefore no longer necessary).  The Act’s objectives are not clear – in that it’s unclear what meaningful participation by black people in the economy means or what substantial change in racial composition of ownership and management is, for example.  There is quantitative measure of “meaningful” or “substantial”, but it would be hard to argue that the economy is fairly distributed while we have the Gini coefficient of inequality that we do.  We do not believe the objectives have been met, and importantly, no political party would dare to suggest this.

To overturn the Act parliament would have to change policy entirely, coming up with new objectives to better achieve equality.  This is quite a specific question and is not to be confused with some of the other perceived problems of the Act, such as corruption which are actually to be dealt with in terms of completely different laws (beyond this scope of this article).

This is a policy decision of the members of parliament to debate and it does not matter whether South Africa has a head of state who is a beneficiary of the Act or not.  What do the parties in parliament say?  Our parliament is coming to an end and will not look at changing any laws including the BEE Act and will leave this to the next parliament.

What are the positions of the major political parties?

None of the election polls suggest any party winning the super majority needed to change the Constitution and so the right to equality will remain as is.  But the winning party will be able to change the BEE Act.  When one looks at the main contenders’ election manifestos one gets an inclination of what the new parliament’s view on BEE will be.

A third of the 66 page ANC Election Manifesto deals with economic transformation and is the first policy addressed.  Nothing suggests that the party is considering scrapping the policy.

The 81 page manifesto of the current opposition also dedicates a third to the economy, and after public debate the DA agreed that “the approach to Black Economic Empowerment (BEE) as carried out by the ANC, which has only served to enrich a politically connected elite and to dampen economic growth, at the cost of job creation”.  So, should they be in a position to scrap the Act, what would they replace it with?  Their manifesto states “Empowerment approaches to provide meaningful redress which eventually realises socioeconomic justice. This approach must codify specific metrics which will signify successful redress (these could include measurables in terms of broader ownership, improved education and skills outcomes, improved entrepreneurial support etc.).  As these goals are achieved the need for this approach will fall away.”  This does not sound too dissimilar to the BEE Act other than it that states that the need should fall away.  We agree that should be the whole purpose of the Act.  But the DA goes on to state “Social protection measures which provide for all currently disadvantaged South Africans regardless of their, or their families’, exposure to past injustice.”  This will need to be assessed by the electorate, but in that disadvantages that translate to inequalities are still in the Constitution, how much would really change?

At 166 pages the EFF has the most to say in its manifesto.  The EFF seem in this respect to agree with the DA when they state “The few black people who participate in the economy, do so, subject to white approval through a black economic empowerment model that is ostensibly designed to benefit a small number of individuals without ever changing the structural exclusion of the majority.”  Theirs is a more aspirational document than the others and seeks the ideal of economic transformation which is more BEE if anything.

Why B-BBEE is here to stay:

Not one of these parties is calling for the BEE Act to be scrapped.  But there is an acceptance that BEE has problems.  This article is not to explore those.  We merely state that the Act is central to our objective of transforming South Africa.  Nobody has ever thought this could be achieved without some compromise and cost.  BEE is sometimes seen as the cost of transformation (we don’t believe it has to be a cost, contact us to learn how we do things) and even if this is true South Africa should focus on what it’s getting.  This goal was spelt in our world leading Constitution and its third generation rights.  This alone separates us from Namibia and Zimbabwe and for as long as it’s the Supreme Law of our land, it will be difficult to completely scrap BEE, but changes should be expected and they might well push harder for BEE rather than make it go away…As for foreign companies looking to invest here – we have a great solution for you too – please contact us.

How to calculate the return on investment from BEE

Is BEE about transformation? compliance? or could it be an investment that sets up a sustainable competitive for your business?

The lens you use to frame the problem is paramount to choosing the appropriate outcome and deciding if it’s worth the effort.

When it comes to transformation, most business owners we speak to understand the need to look after their black staff, suppliers and customers in some form. They understand the need to help transform our country. Many are happy with the transfer of a minority stake in the business (over time) to achieve this. There is a strong sense of looking after the stakeholders in the business as the ‘circle of influence’ and it’s a contribution that many are prepared to make, but it’s a minority stake and closely aligned to normal (i.e. non-BEE) employee shareholder scheme levels of ownership.

Those with a ‘compliance’ lens tend to spend just enough money on the scorecard to remain compliant. If they do any ownership, it’s a reluctant 25.1% deal, often using modified flow through. They’re compliant, but not aspirational nor strategic about BEE. They want the cheapest deal that gets them compliant and never give up control.

Those looking at BEE strategically – as an investment decision that can bring competitive advantage – quickly realise:

  • BEE is driven by your customers, not the government. Chances are your customers want their suppliers to be 51% owned to get the most points on their scorecard.
  • BEE is zero sum: either you do it or your competitors do. It’s a choice that creates winners and losers from within the same pot of money. It’s redistributive by design.
  • Ownership is the cheapest form of BEE – it enables EME/QSEs to get level 1 or 2 without spending on the rest of the scorecard, and for Generic companies (who must spend on all elements) ownership is the only way to get to the higher BEE levels.
  • It’s an investment decision: it’s much easier to transfer 51% or more of the business if you know you’ll make more money as a result.
  • It’s a control decision: astute business owners understand that control of investment decisions and the board is different to managerial control. Effective day to control can be maintained while transferring majority ownership, and negative control can be maintained on major board-level decisions.
  • There are variety of options/structures that can achieve this in different ways – they carry different costs and different risks. They must be assessed in terms of BEE compliance (letter and spirit of the Act), tax consequences (now and down the line), control, ROI etc. It’s a marriage, after all.

The most fundamental analysis, indeed the starting point, should always be working out what value BEE brings: 

So how do you do it?

Business valuation is about future earnings, discounted to today by the expected risk.

Doing a BEE deal should ideally increase earnings potential and reduce risk. Not doing a BEE deal may reduce earnings potential and increase risk (as is the situation many of our potential customers find themselves in). Remember than in business valuation terms,  even a small change in sales growth rates or a small reduction in risk (cost of capital) can make a major change to your valuation.

So how do we analyse the future earnings side?

Here is guide as to how to do it so that you can make more confident decisions:

  • Draw up a list of all your existing clients and prospective clients.
  • For each of them, make a column for existing and potential future products/services that you could sell to them.
  • For each of these, estimate how much you will sell to them if you do nothing, and how more you could sell to them at 25,1%, 51% or even 100% BEE ownership.
  • Do this for year 1, year 2, and all the way out to year 5. It gets fuzzy out there but force your mind to interrogate what is realistic.
  • Put a confidence level against each number – how certain are you to achieve these numbers
  • Sum the (totals*confidence) for each year. You now have a rough idea across 4 different ownership scenarios.
  • That’s the internal analysis. It’s a guess at best but forces you to think.

You now need to do the hard part: speaking to your customers.

Repeat the same exercise as above, but actually meet with your customers.

  • Have a confidential discussion with them.
  • Explain how you want to solve their problem (BEE procurement from quality customers they trust).
  • Ask them, if you got 25,1%, 51%, 100% BEE ownership levels then how much more business you would get?
  • Ask them to put a confidence level against their statement above i.e. force them to really think
  • Ask them what else (i.e. factors aside from BEE) you need to do to get more business. This is really important – it may be that you actually suck on service/price/quality but you think you’re not getting the work because of BEE. Or it may be you’re really good and it’s only BEE holding you back. Either way you learn and can improve.
  • Ask what happens if you do nothing about BEE – would your business really suffer?
  • by when?
  • Ask who else supplies them and what BEE level they have (they may not tell you exactly, but you’ll get a sense of how competitive it would make your business).
  • Maybe you can’t get much more business but they’ll offer you much more attractive payment terms? You need to push them and understand the difference here too. An extra 30 days cash can make a major difference to a business, and it’s often a concession they’re willing to make to BEE suppliers.
  • See how much you can get at different levels of BEE.
  • You also need to understand if their contracts with have any clauses relating to a change of ownership in your business. Many large, “strategic” contracts do have provisions for change of ownership – normally to do with takeover provisions – and you’ll want to understand if BEE ownership triggers any of this. It’s a potential business risk that your customers may not even be aware they’re forcing on you.
  • Repeat this with each customer. Maybe even different people from each customer, it depends how complex their business is, and how important they are to you. These conversations are great for building relationships, demonstrating intent, and growing your business so it’s never time wasted.
  • Add it all up as before.

Now you’ve got their guesses and somewhere between theirs and yours is the answer as to how much more your business could grow sales at different levels of BEE; from doing nothing to going 100% in. You’ll also know what other levers you can pull to grow your business.

You are now in a position to strategically choose the right level of BEE.

Lastly, remember that a small increase in sales or reduction in risk can make a massive difference to your valuation. You may find that a 51% deal is way more affordable than you think.

We have a very elegant solution to this complex problem where we can demonstrate how much your value can be expected to grow while you legitimately contribute to the future of SA. For help on how best to achieve that level, speak to us.

 

Is ownership the cheapest form of BEE?

Companies with sales under R50M that achieve 51% BEE ownership automatically qualify as level 2 BEE and don’t need to spend on any other scorecard points, those with 100% BEE ownership are automatic level 1. Is it better to go with ownership or spend on the rest of the scorecard? Our analysis shows that ownership leaves far more value in the hands of the existing shareholders than compliance with the rest of the scorecard: in the example below doing nothing about BEE leads to a value of R16.4M – all to existing shareholders. Doing BEE by the other scorecard points leads to a value of R23.7M – all to existing shareholders. Doing BEE via a 51% ownership deal leads to a value of R37.3M for the whole company of which the existing shareholders get R26.5M – by far the best deal overall.

Is ownership the cheapest form of BEE?

One of the most highly experienced BEE consultants we work with said recently that in her opinion ‘BEE ownership is the cheapest form of BEE and makes more sense than anything else on the scorecard’.

How true is that statement?

As a recap, transformation is measured across a variety of scorecards, each of which have different high-level targets:

  • Ownership (25.1%)
  • Skills development (3% of turnover)
  • Supplier development (1% NPAT)
  • Enterprise development (1% NPAT)
  • Socio-economic development (1% NPAT)

Note that we’re illustrating this discussion using the generic scorecard and ignoring the sub-components of each (e.g. how much of ownership goes to black females). These details don’t impact the calculations. We’re also only working with EMEs and QSEs here, as Generic companies need to comply with all elements of the scorecard.

Let’s illustrate our example with the story of ‘White Co’:

WhiteCo is a family business that manufactures special widgets – the business makes R5M PAT from a turnover of R30M (i.e. it’s a QSE). While the widgets are used across industry most of the buyers in turn supply large SOEs or SOCs and so there is a lot of pressure for WhiteCo to transform. Against all of this, there are 3 other players in the market, all of whom make slightly different but practically interchangeable widgets. One is already level 3 BEE, one is level 5 (same as WhiteCo) and the other doesn’t support BEE and will never do so (WhiteCo knows this because the company is struggling to get new work and staff have been sending their CVs…).

WhiteCo wants to use BEE to increase its competitiveness, but they are uncertain if the investment in BEE is worthwhile. So, here’s the high-level analysis they run:

Can they ignore BEE?

The first question is what happens if they do nothing? Firstly, with the overall SA economy not growing and with likely export markets already dominated by China, WhiteCo’s profitability depends almost entirely on their local market share. Based on discussions with customers, management determine that unless they get to at least level 3, the business will lose 15% of sales per year as customers shift spend to the level 3 BEE Co. This trend would be expected to continue, with the result that WhiteCo would be almost worthless 5 years from now.

How much would BEE help them grow?

The second question is what would the impact of getting the right level of BEE be? Based on discussions with customers, management realise that if they can get to Level 2, they’d have a real competitive advantage. Customers promise an extra 10%-20% of sales if they get to level 2, depending on how Level 2 is reached.

Ownership is a priority element for your customers, so they reward it more highly:

WhiteCo are told by a number of their customers that ownership is rated more highly than the rest of the scorecard, and that the target is 51%. They work out that they can grow by 20% if they achieve 51% ownership, but only 10% if they get to level 2 by non-ownership means. (The reason for this is that ownership of suppliers is important in how it counts towards to big company’s own scorecard).

To determine which path is better, the WhiteCo Financial Director runs a DCF (discounted cash flow) valuation analysis of WhiteCo, comparing the costs of complying with the different scorecard elements. Of particular interest is ownership – because they know that as a QSE they can get an automatic level 2 by getting 51% black ownership and don’t have to spend on any other scorecard element until they reach the Generic category. Getting this right would free up cash for expansion, or would it?

These are the key growth and discount rate assumptions in the model:

The business will contract at 15% per year if it does nothing about BEE, whereas it will grow 10% by getting to level 2 without ownership and 20% if it achieves 51% ownership. This numbers could be a lot more extreme – our survey respondents suggested that no getting to 51% ownership or level 2 would hit their business by up to 50%, and that growth of more than 50% would be possible in some circumstances. YMMV. Lastly, from a valuation perspective we discount cashflows at a rate of 25% pa (implying a 4X PE ratio, a bit generous but using this number doesn’t affect the relative difference between scenarios).

The value of WhiteCo if it does nothing:

If the business does nothing about BEE, it declines in value and is currently worth R16.4M to shareholders.

Note that a valuation of R16.4M is lower than R20M (PE of 4*PAT of R5) – because the business isn’t growing. (We will address the zero-sum nature of BEE in another article, and manipulation of valuations in yet another).

Getting to Level 2 without ownership:

If the business can get to level 2 using the non-ownership scorecards, then the business grows in value to R23.7M, all of which is owned by the existing ‘white’ shareholders. Note that this means the value of the business has gone up by about 50% due to BEE. This of course has come from the decline in value of the other market players. In a zero-growth economy, BEE is zero-sum by definition…

Getting to level 2 via ownership only:

If the business can get to level 2 using ownership only, then it avoids all the operational costs of the rest of the scorecard and the business grows to R37.3M in value, so this looks like the best option for the value of the business as a whole, but the question is how much of this value goes to the existing shareholders and how much to the BEE owners.

Now we get to the interesting ‘who gets what’ discussion. The truth is ownership deals are complicated.

The simplest example: a cash deal:

Assume for a moment the BEE shareholders bought 51% at the pre-BEE valuation of R16.4M, so they paid R8.2M in cash (this very rarely happens) and those shares are now worth R18.6M and they’ve made a profit of R10.45M on an 8.2M investment. Not bad work if you can get it.

The ‘white’ shareholders have received R8.2m in cash (again, this is highly unusual) and have 49% of the business which together is worth R26.5M. A big jump over the R16.4M the business was worth in total before the deal, and more than the R23.7M their shares would have been worth by doing the ‘non-ownership’ BEE stuffs.

Some caveats:

Whereas complying with the non-ownership elements of the scorecard is really about where you spend money and which service providers you choose to spend your money on, which you can change if you’re unhappy, ownership is more emotive.

Many entrepreneurs/business owners worry about a loss of control. They inherently object to someone else having a majority stake in the business (ideology aside) and in most cases have an unwarranted view of what this means. Sometimes it’s just easier to do the non-ownership things, or ignore BEE altogether, than face up the real nuts and bolts of transformation.

Importantly, we’ve ignored tax in these scenarios. The non-ownership scorecard spend/points is either calculated on turnover or NPAT (i.e. tax effects are built-in already and comparison between scenarios is valid). On the dividend side, we compare all scenarios in the same way (i.e. ignoring tax) and the comparison is valid. In real-life your tax structuring will determine your effective tax rate, but the relative difference between scenarios would be the same as we present here.

The conclusion:

Our analysis would suggest that ownership is a better way to achieve level 2 BEE points than compliance with the rest of the scorecard.

But that’s not all….we can do an even better deal through Tusker:

We have developed a better way of doing ownership deals, which complies with letter and spirit of the BEE act and using the same numbers above would:

  • Leave the original shareholders with R23.3M of shares in their business, and an investment of R8.1M in a business that is 25.1% BEE owned (i.e. R31.4M in total). This is nearly twice the value of the entire business before BEE, and 50% better than the ‘non-ownership’ deal.
  • Keep you in effective control of the business.
  • Let you achieve 51% or 100% ownership for the same cost (there are many benefits to being 100% BEE owned in this way).
  • Can be unwound if the BEE act magically disappears (not expected but our clients ask about this).
  • Includes a built-in option to exit partially/entirely down the line.

Please contact us if you’d like to know more.