Statement 102: BEE ownership through the sale of assets:
Businesses want the same things from BEE – ownership dilution at a fair price, with simplicity and trustworthy partners without giving up effective control of the business. Minority deals are relatively easy, but given the advantages of 51% BEE ownership, the control issue becomes very important – both from the ‘achieve genuine transformation’ and ‘don’t give up anything you don’t have to’ points of view.
While at Tusker.co.za we have a proven ability to effectively address these issues through our private-equity structure, another way to do so is through the sale of assets – covered by Statement 102 of the BEE codes.
This article discusses the principles and highlights some of the danger areas. As with all things BEE, it’s not as simple as it seems…
What’s the core idea?
A white company (the ‘measured entity’) can sell off a division to black owners (the “spin off business”) and claim the relative value as ownership in the measured entity. A deal must use standard, independent valuation method(s) and the final ownership percentage claimed is based on the relative valuation of the measured entity and spin-off businesses as measured for the first three years after the deal. There are also caveats as to what kind of spin-off is valid for these deals.
For now, a simple example:
E.g 1: A measured entity (worth R100M) includes a stand-alone division (worth R51M) that is sold to a consortium of black investors. If both the measured entity and the spin off business grow at the same rate after three years their relative valuation will remains 49:51. The measured entity would then be treated as 51% black-owned in perpetuity, even though there is no actual black ownership or black control in the measured entity.This is the main attraction of s102 deals.
However, if the spin off business sold is less than 51% of the value of the original measured entity then the proportion of ownership achieved is proportionally less. Similarly, if the buyer are less than 100% Black (or if the BEE ownership of the buyer changes during the 3-year review time).
E.g. 2: The same measured entity spins off a stand-alone division (worth R25M) to a 60%-black owned company. Both businesses grow at the same rate as above and after three years the measured entity would be deemed to be 15% black owned: (25*60%)/100=15%.
What can be sold or spun off?
The measured entity can sell an asset, equity instrument (i.e. shares in a company) or a separately identifiable relating business i.e. a business that is related to the seller by virtue of being a subsidiary, joint venture, associate, business unit/division, or any other similar related arrangements within the ownership structure of the Seller.
What happens if my business doesn’t have a division we can spin-off?
By nature, Statement 102 deals exclude the vast majority of South African businesses who do not have divisions/units that would meet all the criteria to be spun off. That’s why they’re typical the domain of bigger conglomerates only. But, there is an opportunity for smaller businesses in that the spin-off doesn’t have to be old – it’s entirely possible to create a business unit that’s sufficiently valuable pre-deal, then spin that off (if this is your situation then chat to us as this can be a minefield).
What are the other criteria?
For ownership points to be recognised:
- The transaction should be subject to an independent verification value by an independent expert. We’ve written before about valuation abuses in BEE deals and this is no different – care must be taken here, especially as for a Statement 102 transaction the valuation is done at the time of the deal and at the end of each year for three years after. There is always a chance that the year three valuer doesn’t agree with the prior methods and this can totally wreck the deal. So, fudge the valuation at your risk!
- The sale of asset, equity Instrument and/or business must involve a separately identifiable related business which has:
- No unreasonable limitations or conditions with regards to its clients or customers;
- Clients, customers or suppliers other than the seller; and
- Any operational outsourcing arrangements between the seller and the separately identifiable related Business must be negotiated at arms-length on a fair and reasonable basis.
- B-BBEE shareholders, or their successors if the B-BBEE shareholding is the same or improved, holding the asset for a minimum of three years.
- The transaction must result in:
- the creation of viable and sustainable businesses or business opportunities in the hands of Black people; and
- the transfer of critical and specialised skills, managerial skills, and productive capacity to Black people.
i.e. there are a lot of requirements/tests and given the nature of these transactions they can already be complex (e.g. what division is sold off, what capital equipment goes with it, how are costs shared, which staff move with the business etc). Every legal clause requires oversight and there a many ways in which a deal of this nature could fall foul of scrutiny by a Verification Agent or the B-BBEE Commission. This legal complexity is a major factor against these deals, but it’s not the only one.
What can’t you do:
The following transactions do not constitute “qualifying transactions”:
- transfers of business rights by way of license, lease or other similar legal arrangements not conferring unrestricted ownership; and
- sales of franchises by franchisors to franchisees (but a “qualifying transaction” will include sales of franchises from franchisees to other franchisees or to new franchisees do not qualify for recognition).
- We have seen some ‘sale and leaseback’ transactions i.e. a productive asset is sold to black people who then lease it back to the ‘white’ company, however, the codes clearly state that the business transferred must have clients, customers and suppliers other than the seller.
What other restrictions/tests apply?
- No repurchase agreement: the seller cannot have the right to repurchase the asset/shares/business in any way during the 3-year period. A deal made to during this period to defer the repurchase to year 4 would also render the scheme invalid.
- No jobs must be lost unnecessarily as a result of the transaction.
- No double-dipping: Where a seller has claimed benefits in terms of Statement 102 under its ownership scorecard it may not claim under the enterprise and supplier development element.
How are ownership points measured?
Importantly, Net Value points apply: the calculation of these points under Statement 102 must be based on (i) the total value of the transaction; (ii) the value of Equity Instruments held by Black people in the separately identifiable related business; and (ii) the carrying value of the Acquisition Debt of Black people in the separate identifiable related business. The measured entity must use a Standard Valuation method when calculating the aforesaid values.
i.e. if the black buyers of the business unit finance their purchase with debt, then the amount of remaining debt will affect the calculation of the ownership points.
The seller, when applying Statement 102, will need to comply with the sub-minimum requirement for ownership, being 40% of the Net Value points only to the extent of the transaction involving the separately identifiable related business and will only have to comply with all other priority elements as required by the Generic Codes.
What about voting rights?
Voting Rights and Economic Interest are calculated using the formula set out in Annexure 102(A); the seller can achieve equivalency percentages in its ownership scorecard as if those percentages arose from a sale of equity Instruments in the seller to black people.
Where calculating the ownership score, recognition of the value of the sale transaction occurs on the basis that:
- The separately identifiable related business must form part of the same chain of ownership and be owned by the seller. i.e. you can’t sell black people a division that is unrelated to the seller/measured entity to start with.
- The recognisable Economic Interest will be the percentage of the value of the separately identifiable related business to the total value of the seller.
- The percentage of Exercisable Voting Rights held by the new owners of the separately identifiable related business represents the recognisable right to Exercisable Voting Rights held by Black people. This is easy for 100% black owned buyers, but far more complex to determine where the BEE owners voting rights are not straightforward to determine (.e.g. share classes or other arangements).
- The rights of ownership granted to Black people in the separately identifiable related business are comparable to rights that would have accrued had the sale/transaction taken place at seller level.
The final ownership score takes three years to measure:
One of the biggest risks in S102 transactions is that the final ownership score achieved takes three years to determine – as this is based on how the relative fortunes of the original measured entity and the spin-off business compare three years into the future.
For the first three years after the transaction, the seller will recognise the ownership points on the date of measurement in accordance with the (i) value of the seller and (ii) the value of the separately identifiable related business. On each measurement date after the third year, the seller can recognise ownership points based on the ownership indicator percentages achieved in the third year after the transaction.
While the transaction value is required to be reviewed by an independent expert, who is required to provide an opinion on the fairness of the transaction value. Continued recognition is subject to the opinion of the independent expert supporting the transaction value.
One of the most beneficial aspects for a seller in concluding a Statement 102 sale transaction is that it radically reduces the seller’s Net Value points requirement, an element that is a priority element and can result in the entity being discounted by a BBBEE status level if it fails to meet the 40% sub-minimum level of compliance.
Areas of confusion:
- Not all asset sales qualify: the sale of an asset that isn’t an independent business would seldom qualify for recognition under this statement, which requires that the transfer of a viable, sustainable business, plus productive capacity and specialized skills. So, you can sell off a building, equipment, etc. but it will only receive recognition if all the qualifying criteria are met.
- Calculation of Net Value, economic interest and voting rights: these have been described as “an interpretative lottery”. The formula included as a schedule to Statement 102 only applies to the calculation of economic interest and voting rights and not Net Value points, which requires another calculation method. This offers opportunity but also carries risk. Please ensure that any Statement 102 deal you are considering is carefully checked by your verification agent before you commit to it.
- Cross-ownership: what happens if the measured enity sells an asset to a ‘black company’ in which the measured entity is also a shareholder’? Here, the requirement for a “separately identifiable related business” has also led to confusion regarding the nature of the purchaser; particularly whether it must be unrelated to the seller and whether it must be at least 51% black-owned. Compounding that, the advice on the B-BBEE Commssion’s website seems to conflict with the position stated in the codes: the answer to the question “Can a measured entity recognize points for assets sold to a company it has shares in, for the purpose of Statement 102?” is “Points can be recognized where assets are sold to a company in which the seller has no relationship with the purchaser, which means it has to be a separately identifiable business”.
What’s the Tusker position on Statement 102 deals?
Complexity is nothing new to BEE deals, but Statement 102 deals are especially complex with many criteria to be met, different measurements for net value, voting rights and economic interest, and confusion as to whether the selling business can have any interest in the buying business. Each of these items is a possible obstacle, and every single deal will by nature be bespoke – pushing up legal costs etc.
But the main thing that concerns us is that one won’t have any certainty about the actual ownership score achieved until three years after the deal – this is because it’s only the relative valuation of the seller and spin-off at that time that determines the points achieved. We commonly hear that businesses are suffering because they’re not black owned, and our clients use this to justifiably reduce their valuations pre-deal. But say one sells a division worth 51% of the original measured entity’s value to black people: the measured entity being deemed 51% black owned should grow faster and be far more competitive. If this is the case, then by the end of year three the measured entity’s value is likely to have grown much faster than the value of the spin off business. Just a 0.1% difference in growth rates over 3 years is enough to screw up your deal! When revalued, the ownership would then be diluted to less than 51% envisaged – not the desired outcome. This risk is really hard to protect against while meeting all the other criteria.
What’s the why?
Moreover, there is one other point that we very rarely see discussed: what’s the strategic rationale for selling off a business unit in the first place? Although we conclude this article with this point, if you’re considering this approach to ownership then the first question should be ‘why’ the deal makes strategic sense. So many of the deals we’ve seen fail at this first hurdle. However, perhaps there is a division that no longer makes strategic sense – an adjacency to exit, or perhaps something lower growth or capital intensive (i.e. a ‘dog’) that can be dumped. But then watch out for relative valuations at the end of year three. Either way, the strategic rationale must be interrogated and understood before a Statement 102 transaction is considered- there is no point selling off the crown-jewels to achieve BEE, and there are other, far less risky or complex ways to achieve the same result.