STRUCTURING THE EMPOWERMENT TRANSACTION September 2006

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STRUCTURING THE EMPOWERMENT TRANSACTIONSeptember
2006
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The overriding factor in executing an
empowerment transaction is sustainability, both
from a relationship and a financial perspective.
It is not desirable to have to repeat the entire
exercise.
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THE EMPOWERMENT PROCESS
IDENTIFYING THE BEE PARTNER
SETTING THE RELATIONSHIP
PARAMETERS
STRUCTURING THE
TRANSACTION
HOUSEKEEPING
THE CODES OF GOOD PRACTICE
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CODES OF GOOD PRACTICE
The Department of Trade and Industrys Codes of
Good Practice are the building blocks upon which
a sound empowerment transaction is built and
measured.
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CODES OF GOOD PRACTICE

• Binding on the public sector
• Used as the basis on which BBBEE credentials are
  measured
• 7 Elements
• Ownership 20
• Management Control 10
• Enterprise Development 10
• Procurement 20
• Skills Development 20
• Employment Equity 10
• Residual 10

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FLOW THROUGH PRINCIPLE
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MODIFIED FLOW-THROUGH PRINCIPLE

• The measured enterprise is entitled to treat one
  black majority owned company in the chain of
  ownership as if it were 100 owned by black
  people

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CONTROL PRINCIPLE

• The measured enterprise is entitled to treat each
  majority controlled company in the chain of
  ownership as if it were 100 owned by black people

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OWNERSHIP SCORECARD
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ILLUSTRATIVE EXAMPLE

• Assumptions
• ABC (Pty) Ltd is valued at R100 million
• Finance Co loan to Broad-Based BEE Trust R2
  million
• Finance Co loan to BEE Co R18 million
• Black People Co ? Black New Entrant
• Year 1

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ILLUSTRATIVE EXAMPLE

• Therefore, ABC (Pty) Ltd qualifies for the
  following ownership points
• Voting Rights
• Black people 3
• Black women 2 (50 x 22.5 11.25)
• Economic Interest
• Black people 4
• Black women 2 (50 x 22.5 11.25)
• Black participants in broad-based 1
• ownership schemes
• Realisation Points
• Ownership fulfillment 0 (Not unencumbered)
• Net Equity Interest 7 (Black equity is 80
  geared,
• therefore full points earned in Year 1)
• Bonus Points 0.5 (0 x 22.5) 2.5
  15 x 3
• 19.5

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IDENTIFYING THE BEE PARTNER
IDENTIFYING THE BEE PARTNER
SETTING THE RELATIONSHIP
PARAMETERS
STRUCTURING THE
TRANSACTION
HOUSEKEEPING

• The recent trend is overwhelmingly towards
  broad-based empowerment groups real empowerment
  at the grass roots level.

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IDENTIFYING THE BEE PARTNER

• Qualitative considerations
• Chemistry
• Mutual respect
• Shared vision
• Industry focus
• Industry expertise
• Level of commitment
• Staff
• Quantitative considerations
• Ownership points women, new entrants,
  broad-based
• Maximum points composition
• Women 10
• Broad-based 15

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SETTING THE RELATIONSHIP PARAMETERS
IDENTIFYING THE BEE PARTNER
SETTING THE RELATIONSHIP
PARAMETERS
STRUCTURING THE
TRANSACTION
HOUSEKEEPING

• A common failure in BEE transactions is the
  breakdown in the relationship due to
  geometrically opposed expectations of value-add
  between the BEE investor and the business owner.

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CLOSING THE EXPECTATION GAP

• Discuss and document expectations upfront
• Incorporate key value propositions into the
  transaction
• Service level agreement
• Marketing and assistance agreement
• Separate return on investment and reward for
  effort
• Incentivise successful efforts in cash (cash is
  king - particularly for BEE investors!!)
• Management fees
• Sales incentives
• Consider incorporating put/call provisions in the
  event of an irreconcilable breakdown in the
  relationship

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STRUCTURING THE TRANSACTION
IDENTIFYING THE BEE PARTNER
SETTING THE RELATIONSHIP
PARAMETERS
STRUCTURING THE
TRANSACTION
HOUSEKEEPING
The transaction should be value-maintaining at
the very least, but preferably value-enhancing.
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STRUCTURING OPTIONS

• There are 3 primary methods of structuring the
  transaction
• Sale of shares
• Fresh issue of new shares
• Sale of business to a Newco
• The variations on, and combinations of, the 3
  primary methods are infinite
• Cash vs. vendor finance vs. third party finance
• Ordinary shares vs. preference shares
• Different classes of shares carrying varying
  rights as to dividends, voting, conversion etc.
• The financial instruments available are more than
  sufficient to achieve the respective parties
  desired results
• An experienced corporate advisor may be required
  in order to conceptualise and implement an
  optimal transaction structure

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STRUCTURING OPTIONS
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SALE OF BUSINESS TO NEWCO

• Explanatory notes
• The business of ABC (Pty) Ltd is valued at R100
  million
• ABC (Pty) Ltd establishes Newco (Pty) Ltd as a
  75 held subsidiary
• BEE Consortium subscribes for 25 in Newco (Pty)
  Ltd for a nominal consideration
• ABC (Pty) Ltd sells the business to Newco (Pty)
  Ltd on loan account as a going concern for R100
  million

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SALE OF BUSINESS TO NEWCO

• Explanatory notes (continued)
• ABC (Pty) Ltd elects the intra-group rollover
  relief provisions of section 45, thereby
  exempting it from CGT and Income Tax recoupments
• The loan account is stratified into risk layers

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SALE OF BUSINESS TO NEWCO

• Explanatory notes (continued)
• The BEE Consortium shares in the excess of the
  growth in the value of the business above
• The original purchase consideration (i.e. R100
  million) plus
• The weighted average cost of the stratified loan
  accounts
• ABC (Pty) Ltd has the right to secure third party
  finance in respect of any risk layer (in which
  case it receives immediate payment of that
  portion of the purchase price)
• The BEE Consortium has the right to secure third
  party finance in respect of its pro rata portion
  of Layer 3 (i.e. the Equity loan)
• The advantages of this structure to the
  transacting parties are as follows
• ABC (Pty) Ltd
• Tax-efficient
• Value-enhancing
• Capable of rapid implementation
• BEE Consortium
• Limited cash requirement
• Highly leveraged returns

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HOUSEKEEPING
IDENTIFYING THE BEE PARTNER
SETTING THE RELATIONSHIP
PARAMETERS
STRUCTURING THE
TRANSACTION
HOUSEKEEPING
It takes a significant commitment in time and
effort to execute the transaction. The
housekeeping is the last function in the
process dont allow this relatively easy task
to negatively impact the transactions success.
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HOUSEKEEPING

• Draft, negotiate and sign legal documents
• Shareholders agreement
• Purchase and sale/share subscription agreement
• Service level/marketing and assistance agreement
• Update statutory registers
• Issue share certificates
• Pay stamp duty
• Apply for accreditation

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QUESTIONS