All businesses operating in South Africa must decide what strategy they will follow with regards to Black Economic Empowerment (BEE) – a set of laws that aim to ensure political stability through meaningful participation by black people in the economy.
Although unpopular, BEE isn’t going away soon – the transformational need is still very much there, and none of the major political parties in our recent elections has called for its’ abolition. Instead, we expect the BEE landscape to become more onerous and increasingly militant. Our prior predictions about the increasing emphasis on 51% flow-through ownership have been proven accurate with the changes gazetted on 31 May 2019.
While compliance with the BEE Act is entirely voluntary, in reality, the government uses its’ immense spending power to push BEE compliance down to the big companies that deal with the government, who in turn push BEE requirements onto their suppliers. BEE is effectively unavoidable unless your business is almost entirely offshore-focused or has an offering so unique that customers have no choice but to buy from you.
Every company must choose
Every company must choose how to achieve a BEE level that will make them competitive, as measured against a scorecard which depends on both company size and industry sector. BEE requirements become increasingly onerous as a company grows.
The different parts of the scorecard lead to a strategic choice as to how a competitive BEE score is achieved:
- Is it better to spend 3% of turnover on Skills Development? or
- Spend 3% of NPAT on Supplier Development/Enterprise Development/Socio-Economic Development? or
- Employ black people in executive and senior management? or
- Transfer a substantial ownership stake (25,1% to 51%) to black people?
The correct answer requires detailed financial analysis, with the starting point being that the benefits of the chosen BEE strategy must outweigh the costs and risks, or it’s better to do nothing.
The tool to use in understanding this is a Discounted Cash Flow valuation model of the business – it allows understanding as to how changes in sales (downwards due BEE non-compliance or upwards at different rates depending on the BEE strategy chosen – see below), changes in costs (there is always a cost to BEE compliance), and changes to the discount rate (due to the increase/decrease in risk resulting from the chosen BEE strategy) affect both cash flows and the value of the firm. By using this approach, you can understand the true tradeoffs between spend on different scorecard elements and/or the impact of different levels of BEE ownership, allowing you to make an investment decision.
Using this approach, it quickly becomes apparent that not all BEE is equal, and that BEE ownership has special value because of these factors:
- Ownership is a priority element. Minimum scores must be obtained or else a businesses’ overall scores are discounted a level.
- Big companies must procure from 51% BEE-owned suppliers to get the most points on their scorecards
- For companies under R50m sales, achieving 51% BEE ownership achieves an automatic level 2 meaning that spend on the rest of the scorecard can be saved.
- Companies above R50m struggle to get higher than a level 7 unless they’ve complied with the BEE ownership requirement.
The end result is BEE ownership drives more sales, better payment terms and value creation than all the other scorecard elements combined. We invite you to plug your numbers into our model and see for yourself.
In a low-growth economic environment (which we expect to continue for the foreseeable future) BEE ownership is one of the few levers one can pull to achieve sustainable competitive advantage.
Doing a legitimate BEE ownership deal isn’t easy:
99.9% Of South African companies operate in private-capital markets where transferring ownership is incredibly difficult, to begin with. The starting point of any deal is a solid relationship with the existing shareholders (often the founders) of the business – whose expectations are far more ‘partnership’ than ‘shareholder only’. The separatist legacy of Apartheid now makes it very hard for black and white businesspeople to find one another – trust takes time, always. On top of this, information about the company is hard to come by, each transaction must be negotiated with point-in-time valuations and negotiated payment terms. Legal agreements are complex, and shares must be held for a long time. All of these factors increase risk and drive down valuations.
BEE deals add further layers of complexity: ideological and partner-search issues aside, the biggest problems are fears around giving up control and that most potential black partners simply do not have the cash available to buy the shares on offer. The result is that over 50% of BEE-deals are vendor-financed. Risk is increased too because neither the buyers nor sellers typically have much experience in these types of transactions; advice from BEE experts, attorneys, accountants and tax experts is recommended.
However, BEE ownership offers strategic advantage; a variety of structures can be used to achieve BEE ownership, including:
- Broad-Based and Employee Share Option Schemes
- Private equity funds
- Options and share warrants
- Preference shares
Each must be considered in terms of compliance with letter and spirit of the BEE Act, resulting control of the business, desired impact (broad/narrow), likely impact on sales, costs and time to conclude the deal and what’s required to manage it going forward. Tax consequences have to be very carefully considered as there must always be enough cash available to pay taxes triggered as a result of capital gains or income. Tax has tripped up many BEE deals, often years after the conclusion.
While BEE deals can be complex, the truth remains that BEE ownership offers the highest ROI compared to spend on the other scorecard elements. The trick then, is how to reduce the complexities of a BEE deal to the point where it’s a no-brainer. This is where Tusker comes in.
Tusker’s BEE solution
Tusker is a BEE private equity fund. We have taken great care to develop a unique structure that offers 20%-100% legitimate BEE ownership for any business with sales >R2.5M. A Tusker deal can be concluded in <3 months and does not mean giving up day to day control of your business. In some cases, Sec 12J tax incentives also apply. The Tusker structure offers the highest ROI of any BEE investment your business can make. It will give you the 51% BEE ownership (or more) you need to out-compete your peers and create sustainable competitive advantage in the SA market, all while fully complying with letter and spirit of the act and increasing your shareholder value.
The bottom line is that if achieving your desired level of BEE ownership would increase the value of the business by more than 10% then Tusker is a no-brainer.
We’d love you to join our herd.
Continue to read Part 2 – The need for BEE.
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