Transcript Document

STRUCTURING THE EMPOWERMENT
TRANSACTION
September 2006
“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.”
THE EMPOWERMENT PROCESS
IDENTIFYING
THE BEE
PARTNER
SETTING THE
RELATIONSHIP
PARAMETERS
STRUCTURING
THE
TRANSACTION
THE CODES OF
GOOD PRACTICE
HOUSEKEEPING
CODES OF GOOD PRACTICE
“The Department of Trade and Industry’s Codes of
Good Practice are the building blocks upon which a
sound empowerment transaction is built and
measured.”
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
Enterprise Development
Procurement
Skills Development
Employment Equity
Residual
10
10
20
20
10
10
FLOW THROUGH PRINCIPLE
BLACK
PERSON
NON-BLACK
PERSONS
10%
90%
TRUST
10%
90%
COMPANY A
35%
65%
COMPANY B
74%
26%
EFFECTIVE BLACK
OWNERSHIP
= 90%
x
90%
x
65%
x
26%
MEASURED
COMPANY
= 13.7%
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
BLACK
PERSON
NON-BLACK
PERSONS
10%
90%
TRUST
10%
90%
COMPANY A
35%
65%
COMPANY B
74%
26%
EFFECTIVE BLACK
OWNERSHIP
= 90%
x
90%
x
100%
x
26%
MEASURED
COMPANY
= 21.1%
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
BLACK
PERSON
NON-BLACK
PERSONS
10%
90%
TRUST
10%
90%
COMPANY A
35%
65%
COMPANY B
74%
26%
EFFECTIVE BLACK
OWNERSHIP
= 90%
x
100%
x
100%
x
26%
MEASURED
COMPANY
= 23.4%
OWNERSHIP SCORECARD
Voting Rights
Economic Interest
Realisation Points
Points
Target
Black people (Flow-Through or Control Principle)
3
25% +1 share
Black women (Flow-Through Principle only)
2
10%
Black people (Flow-Through or Modified Flow-Through Principle)
4
25%
Black women (Flow-Through Principle only)
2
10%
Black designated groups/black participants in broad-based
ownership schemes (Flow-Through Principle only)
1
2.5%
Ownership fulfillment (Flow-Through Principle only)
1
Unencumbered
title
Net equity interest (Flow-Through Principle only)
7
10 years (i.e.
10% per year)
20
Bonus Points
Black new entrants / Black participants in broad-based
ownership schemes (Flow-Through Principle only)
3
15%
ILLUSTRATIVE EXAMPLE
BLACK WOMENS
TRUST
HOLD
CO
75%
22.5%
ABC
(PTY) LTD
50%
50%
BLACK PEOPLE
CO
BEE
CO
FINANCE
CO
2.5%
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
BROAD-BASED
BEE TRUST
ILLUSTRATIVE EXAMPLE
Therefore, ABC (Pty) Ltd qualifies for the following ownership points:
Voting Rights
 Black people
 Black women
3
2
(50% x 22.5% = 11.25%)
Economic Interest
 Black people
 Black women
 Black participants in broad-based
ownership schemes
4
2
1
(50% x 22.5% = 11.25%)
Realisation Points
 Ownership fulfillment
 Net Equity Interest
Bonus Points
0
7
(Not unencumbered)
(Black equity is 80% geared,
therefore full points earned in Year 1)
0.5
[(0% x 22.5%) + 2.5%] ÷ 15% x 3
19.5
IDENTIFYING
THE BEE
PARTNER
SETTING THE
RELATIONSHIP
PARAMETERS
STRUCTURING
THE
TRANSACTION
HOUSEKEEPING
IDENTIFYING THE BEE PARTNER
“The recent trend is overwhelmingly towards
broad-based empowerment groups – real
empowerment at the grass roots level.”
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
Broad-based
10%
15%
IDENTIFYING
THE BEE
PARTNER
SETTING THE
RELATIONSHIP
PARAMETERS
STRUCTURING
THE
TRANSACTION
HOUSEKEEPING
SETTING THE RELATIONSHIP
PARAMETERS
“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.”
CLOSING THE EXPECTATION GAP
•
•
Discuss and document expectations upfront
Incorporate key value propositions into the transaction


•
•
Separate return on investment and reward for effort
Incentivise successful efforts in cash (cash is king particularly for BEE investors!!)


•
Service level agreement
Marketing and assistance agreement
Management fees
Sales incentives
Consider incorporating put/call provisions in the event of an
irreconcilable breakdown in the relationship
IDENTIFYING
THE BEE
PARTNER
SETTING THE
RELATIONSHIP
PARAMETERS
STRUCTURING
THE
TRANSACTION
HOUSEKEEPING
STRUCTURING THE
TRANSACTION
“The transaction should be value-maintaining at the
very least, but preferably value-enhancing.”
STRUCTURING OPTIONS
•
There are 3 primary methods of structuring the transaction:



•
The variations on, and combinations of, the 3 primary methods are infinite:



•
•
Sale of shares
Fresh issue of new shares
Sale of business to a Newco
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
STRUCTURING OPTIONS
Codes of Good Practice
Tax on Initial
Transaction
Voting Rights
Economic
Interest
Realisation
Points
Capital
Gains
Tax
STC
Access
to
Finance
Sale of shares for cash*


?
Yes
No
Limited
Sale of shares on loan account


?
Deferred
No
N/A
Sale of business to Newco in terms of
section 45



No
No
Yes
Fresh issue of new class of convertible
ordinary/preference shares


?
No
No
Limited
Transaction Structure
* Assumes BEE investor finances the purchase of the shares through a third party
? Depends on the value at which the sale takes place and the rate at which the finance is settled
SALE OF BUSINESS TO NEWCO
SHAREHOLDER
1
35%
65%
SHAREHOLDER
2
ABC
(PTY) LTD
SALE OF
BUSINESS TO
NEWCO
75%
NEWCO
(PTY) LTD
25%
BEE
CONSORTIUM
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
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”:
Description
Interest Rate
Layer 1
Senior debt
Prime
Layer 2
Mezzanine debt
Prime plus 3% to 5%
Layer 3
Equity loan
20% to 25% (after tax)
Repayment
Terms
5 years
5 to 7 years
Indefinite
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
IDENTIFYING
THE BEE
PARTNER
SETTING THE
RELATIONSHIP
PARAMETERS
STRUCTURING
THE
TRANSACTION
HOUSEKEEPING
HOUSEKEEPING
“It takes a significant commitment in time and effort to
execute the transaction. The “housekeeping” is the
last function in the process – don’t allow this
relatively easy task to negatively impact the
transaction’s success.”
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
QUESTIONS