THE EVOLUTION OF BEE EQUITY PARTICIPATION
While ownership and control is only one of the components of broad-based empowerment, it is the most visible aspect and as a result is receiving a lot of attention. It is however, not always the easiest element to address to ensure long term sustainability. The low level of access to finance and capital resources by black investors has been and still is the main challenge relating to the transfer of ownership and control to black investors. This lack of access to funds has been instrumental in shaping the manner in which BEE transactions are structured.
The Early Structures
The typical structure that was used to transfer equity to BEE investors during the first wave of BEE transactions in the late 1990’s, was the ‘special purpose vehicle’ (SPV). The structure would generally be established as follows:
• a company would be registered (i.e. the SPV) and the BEE investor would be issued with 100% of its ordinary shares at nominal value;• the SPV would then be capitalised by a financial institution through the issue of preference shares to the financier (generally redeemable at the end of three to five years);• the capital was then used by the SPV to acquire shares in the operating company seeking to transfer equity to the BEE investor;• dividend income received from the equity investment in the operating company would be used by the SPV to pay the preference dividends and to redeem the preference shares at the end of their term.
Very few of the BEE transactions undertaken during this period have been successful and sustainable. This was due partly to market conditions and partly to the nature of the structure described above. Volatile markets, the 1998 market crash and the high interest rate environment in South Africa at the time meant that dividend receipts on the equity investment were not sufficient to service the funding obligations in accordance with the terms of the preference shares. As a result, many of the underlying equity investments reverted to the financial institutions when repayment obligations could not be met.
In general, there was also a lack of real commitment to BEE and often the BEE investor was a passive, indirect shareholder having no influence on the day-to-day operations of the company. In many cases, the financial institution actually controlled the underlying equity investment through the onerous terms of the preference shares. This was of course compounded by a general failure to address the other aspects of empowerment such as skills development, procurement and management participation.
The New Structures
The structures that are currently being used to transfer equity to BEE investors are generally more sophisticated than the first generation models. In addition, the transfer of equity tends to be vendor financed, rather than being financed by institutional funding. The obviously reduces transaction and funding costs. The new structures also differ from the older structures in that:
• equity transfers are linked to other components of empowerment, such as skills development, management participation and board representation; • there is often a transfer of equity to a broad-based pool of black investors, including transfers to employee share incentive schemes, community trusts and institutions such as the Public Investment Commission (PIC), which is the institution responsible for the investment of public sector pension and provident funds.
Many of the new structures facilitate the transfer of equity to BEE investors through the creation of a class of shares generally described as “deferred shares”. This class of shares typically gives the BEE investor the same voting rights as an ordinary shareholder on date of issue (thereby meeting the control requirements of the BEE scorecards), but the right to receive dividends in respect of the shares is deferred until the company has achieved a level of growth in earnings that can be attributed to the contribution of the BEE investor.
Another example of a new structure is the one recently announced by ABSA Bank. ABSA intends to transfer approximately 10% of its shares to black shareholders. This will be achieved by ABSA issuing a number of redeemable preference shares to a BEE company at par value. The redeemable preference shares each have an option attached to them entitling the holder to subscribe for one ABSA ordinary share at a strike price linked to the market value of the ordinary shares on the date the options are exercised. The options will be exercisable during a two-year period, three years after the date of issue of the redeemable preference shares. When and if the options are exercised, the redeemable preference shares will be redeemed at their par value.
The newer structures are preferable to the earlier structures in that:
• they accommodate broad-based BEE ownership;• they incentivise the BEE investor to make a meaningful contribution by linking the economic benefits that can be derived by the BEE investor from its investment, to the growth of the company;• the transaction and funding costs are significantly lower; • in general, the structures can be easily unwound at a minimal cost, should the parties so require.
The new structures are however, neither perfect nor without their challenges. The complexity of the new vendor financed structures has meant that the parties involved are often at risk of contravening Section 38 of the Companies Act, which prohibits a company from giving any type of financial assistance for the purpose of or in connection with the purchase of or subscription for its shares, or shares in its holding company. The parties are also at risk of incurring substantial upfront and future tax costs. These issues are dealt with in more detail in later chapters of this Guide.
In addition, there is growing criticism of the deferred benefit structures. The argument is that by deferring the economic benefits attaching to the shares acquired by BEE investors to an indeterminable future date, these structures do not transfer true ownership to the BEE investor from day one.
It seems that no amount of financial or legal engineering can overcome the fundamental challenge facing BEE, which is a lack access to finance and capital resources by BEE investors.
ASHLEIGH HALE / KWANELE RADEBE29 APRIL 2004