THE DEPARTMENT of Trade and Industry (dti) issued a general notice last week, dealing with recognition of the Broad-Based Black Economic Empowerment (BBBEE) recognition schemes.
The notice was criticised by big business, verification agencies, law firms, as well as the National Union of Mineworkers (NUM).
The dti should be applauded for the bold steps taken to implement the law to the letter as an opportunity for radical economic transformation. This brave step is a catalyst for a meaningful participation of black people in the economy.
The purpose of the new codes is to promote the achievement of the constitutional right to equality and higher economic growth rate, among others.
On the other hand, according to a report by a prominent black law firm, there are common trends that tend to have more of a disempowering effect and are potentially hazardous to the economy as a whole in the long run. Some of these include complex transactions, refusal to recognise BEE contribution, contracting arrangements, asset loading, lock-in clauses and board control and lack of adequate minority protections.
Unnecessary complex transactions
These are transactions where the empowerment shareholders hold their shareholding indirectly at an insignificant level in the “food chain”, at which level the dividends that trickle through are perpetually insufficient.
A BEE shareholder may directly hold shares in a company that holds a licence, in maritime for example, but not in the agent that does the actual operations. Thus, the agent can inflate its costs to an extent that there is very little profit left to declare a meaningful dividend to the licensee.
The licensee then has to pay for its administration costs before declaring dividends to the ultimate shareholders.
Through such excessive layering, money is diluted and value eroded at each level such that by the time the BEE shareholder receives anything, it is too little to build it into any significant participant in the operation. Further, the BEE party is usually paying off debt anyway, at a rate that will leave them perpetually indebted.
Refusal to recognise BEE contribution
Most BEE transactions are structured on the basis that, in mining for example, the mining rights, which most BEE persons and entities own, are of no real value. In other words, the prospecting rights that BEE shareholders hold are never afforded any value or afforded drastically discounted token value.
On the other hand, the established companies inject funds in the form of loans into the mining companies, which loans usually come at a minimum cost of prime interest rates on repayment, usually ensuring that the company is indebted for a significant portion of its future, with all profits being allocated to servicing such debt.
Management contracting arrangements
This transaction structure involves the outsourcing of services of some nature, such as sub-contract arrangements with management, where they do not owe a fiduciary obligation to the company (since they are merely contractors) and as such don’t have to manage costs. Usually such sub-contracts go to a related party (such as a related company in which the BEE shareholder has no interest or a director or a relative of a director) and at inflated pricing structures or otherwise arbitrarily determined prices.
Asset renting/liability loading
Asset renting and liability loading generally involves companies that prefer to have virtually no physical assets on their books, but comparatively huge liabilities that are never extinguished towards which their income is endlessly directed. This structure is much harder to detect as it does not have to be declared at the outset of the participation of the BEE company.
However, its effects are the same, if not more detrimental, as the local company is continually laden with costs such that there is very little profit to declare dividends, and in the event of any financial stress, the company has no assets to rely on.
Transfer pricing arrangements
Transfer pricing generally involves a foreign company selling its local subsidiary goods or services at a price that is not arms-length. The effect of such arrangements is that the company has very high cost-structures and generally in a net-loss position, meaning that there are no dividends to be declared. Thus, where the empowerment partners acquired their shares with debt, they usually remain perpetually in debt.
Encumbered equity, especially where vendor finance is concerned, usually leaves the empowerment partner in perpetual debt as they usually buy-in to the structure with very little rights to influence the strategic direction of the company.
Funding and dilution clauses
Funding and dilution clauses involve provisions in shareholder agreements to the effect that where the company, in the normal course requires funding, should the company fail to obtain such funding in the normal course from banks and other funders, all shareholders are obliged to contribute towards such required funding in proportion to their shareholding.
Should any shareholder fail to contribute and any other shareholder is able to contribute such shortfall, the company shall issue shares to the contributing shareholder to the value of the contributed amount, and thus the non-contributing shareholder shall be diluted in their shareholding.
Traditionally, the empowerment shareholder is usually the one with the least access to and/or ability to raise such necessary extra-funding when the company calls for capital contributions, which means the empowerment partner ends up diluted to an insignificant shareholding that is usually laden with debt.
BEE shareholders are locked-in for the sense of security of the non-BEE shareholders. These clauses allow the companies to benefit from perpetual claims to empowerment credentials but in most cases, leave the “empowered” parties trapped in an “abusive relationship” with no benefits.
The new codes are the result of years of relentless struggle for radical economic transformation and the beginning of an era.
In March 1998, the BEE Commission sent a letter to a number of black individuals and organisations inviting them to participate in the National Black Economic Empowerment Commission (BEEC). The letter explained the establishment of the BEEC in a terse, forceful, passionate and uncompromising manner:
“The motivation for the establishment of the commission is that the notion of true empowerment as defined by black people does not exist, nor does a common definition or benchmark which serves as minimum requirements...”
The new codes give hope to those on the periphery of the economy for a meaningful radical economic transformation. The bold steps taken by our government illustrate that the nation is very serious about economic transformation.
Last week, the dti announced that a technical task team would be set up to “explore the appropriate balance between active (direct) and passive (broad-based schemes) ownership”.
The task team would deliver its recommendations within 30 days. We hope that our government shall not succumb to concerted and co-ordinated pressure demonstrated by big business in the past few days.
President Jacob Zuma’s desire to see the Nedbank and Standard Bank being joined by Mofokeng Bank shall be realised. The government’s wish to see black JSE ownership jump to double digits shall see the light of day.
Radical economic transformation cannot happen unless government departments and state-owned enterprises play ball such as has been illustrated by Minister Thulas Nxesi during the budget vote of Public Works when he said:
“With a sustainable register of state immovable assets in place, we will have at our disposal the tools to leverage this massive property portfolio for economic development. This will also assist us to drive the transformation of the property sector in South Africa.
The NUM has joined Business Leadership South Africa and other big business in their criticism of the new codes. The Black Business Council should engage the NUM on the new codes because we have so much in common.
In conclusion, it is our firm belief that the general notice on the recognition of broad-based schemes should be supported because this will ensure that BBBEE transactions offer real voting and economic benefits of participation by the empowerment participants.
Sello Mashao Rasethaba and Danisa Baloyi are stalwarts in the Black Business Council. They are also members of the National Black Business Council and they write in their personal capacities.