Corne van Dyk, founder of Pretoria based financial services firm, Accountants on Site, sheds some light on the revised Broad Based Black Economic Empowerment codes, the most common way to implement black ownership into businesses and the considerations to be taken into account once the black ownership transaction has been effected.
If you are a business owner in South Africa, you are probably fully aware of the Broad Based Black Economic Empowerment (B-BBEE) Act and the implications for your business if you do not achieve an appropriate level. The reality of the revised B-BBEE codes is that unless your company is exempt or turns over below R10 million annually, you need to have black ownership in order to achieve an appropriate B-BBEE level.
Before explaining the ways in which black ownership can be integrated into a business, van Dyk goes over a few basic B-BBEE principles. Firstly, if your company has an annual turnover below R10 million, you are exempt from B-BBEE and you will achieve an automatic level 4. The only thing that is required to prove this is the completion of a B-BBEE affidavit in the presence of a Commissioner of Oath confirming your turnover and percentage of black ownership. You do not need to go through a verification process.
If your company has black ownership of 51% or more, you can obtain an automatic level 2 by completing the same B-BBEE affidavit mentioned above. “All other companies have to be verified by a SANAS verification agency and need to achieve points on all the different required elements – these include; ownership, management control, skills development, preferential procurement, enterprise- and supplier development and socio-economic development,” says van Dyk. “Achieving points on each of these elements is also regulated and would need to be covered in detail another time.”
Taking the above basic principles into consideration, how can a company implement black ownership? Van Dyk says that the first step is determining a selling price for the portion of the company that you want to sell. He explains that a selling price is the price that two parties agree upon for an underlying asset. To assist in this determination of the selling price, a valuation needs to be done on the business.
“What the current owner needs to understand about this selling price is that this price is compensation for all the value that was created up to that point. To explain this, I would compare two similar companies with the same profit and risk profile,” van Dyk elaborates. “In the one company (A) the owner/director took a large monthly salary and regular dividends while in the other company (B) the owner/director only took a minimal salary. Even if both companies created the same value, company A reduced their value with salaries and dividends, while company B accumulated their value. When it comes to a valuation, company A will be valued far less than company B because the owner of company A has already extracted his/her compensation. What needs to be made clear here is that the selling price is the ‘equaliser’ of compensation.”
Once the selling price is determined, the company needs to find a buyer for these shares. This buyer needs to be considered ‘black’ as defined by the B-BBEE Act for the company to earn the B-BBEE points.
According to the Act, the definition of ‘black’ is as follows: “Black people” means African, Coloured or Indian persons who are natural persons and; are citizens of the Republic of South Africa by birth or descent; or are citizens of the Republic of South Africa by naturalisation before 27 April 1994 on or after 27 April 1994 and who were entitled to acquire citizenship prior to naturalisation.
It is imperative, says van Dyk that the current owner considers whether a working relationship can be developed with the new partner on a board and/or shareholder level but that this need not be the only consideration. “Buying a share in your business, does not necessarily mean that this individual needs to work in or for the company. These individuals are shareholders and need to participate on that level,” he says. “The rules regarding shareholder participation is governed by the Companies Act of South Africa; your company’s Memorandum of Incorporation and lastly by your shareholder agreement. In these documents you can determine if the shareholder can appoint a director to represent them on board level in an executive or a non-executive position. Any participation of a black director in the company will be measured under Management control.”
Once the buyer(s) have been identified, the purchase price needs to paid. In most cases the buyer(s) do not have these funds available or do not want to put their funds on the table as a means of mitigating their risk. It is possible for the company to finance this purchase price. What this entails is that the company will pay the seller the purchase price by providing a loan to the new buyer. The terms of this loan could be set for this loan to be repaid within a number of years, accruing interest at a market related rate, with the companies own dividends. This means that every time the company declares a dividend, the portion attributable to the new shareholder will be utilised to settle the acquisition loan. Once this loan is settled the new shareholder will own unencumbered shares and will receive any dividends declared thereafter.
This is a fairly straightforward process and is standard practice however van Dyk cautions that the B-BBEE codes have determined certain parameters regarding finance structures like this one. “To qualify for black ownership and earn all the net value points, the value of these shares – a.k.a. the company – needs to increase by a minimum of 10% per annum. Alternatively the loan needs to reduce by 10% annually.”
Once this ownership structure has been put in place, there are a few things that the current owner needs to consider. “Now that a portion of your company is owned by a third party, more formal procedures need to be followed regarding meetings, disclosure of financial information and the authorisation of significant transactions and these procedures should be stipulated in your shareholder agreement,” points out van Dyk.
He says that once this structure has been put in place, a clear line has also been drawn defining the difference between an owner and an employee. This means that if you are involved in running the business, you should be remunerated with a market related salary for someone in your position. “If you were the owner of company B in our example above, you would now need to adjust your remuneration to a market related level while always keeping in mind the fact that salaries of directors come under scrutiny of the shareholders.”
Van Dyk concludes by saying that although there are various ways to implement an ownership structure to enhance B-BBEE performance, this is the most basic method. “Using this simpler method will help you to avoid any claims that fronting has taken place. Hopefully business owners can now see the ways in which B-BBEE partnerships can strengthen a business and that they now have some hope in a very though economic environment.”