BEE Gets a New Buzz with Change in Laws
by Andile Ntingi
THE reforms to South Africa’s corporate laws have given black investors an opportunity to restructure more than 70% of black economic empowerment (BEE) deals.
The restructuring mainly of the funding instruments will make it easier for them to service their debt.
Before the new laws were implemented in December, BEE investors paid exorbitant interest rates to lenders. They, in turn, had no alternative but to charge for the higher risk and uncertainty associated with funding the purchase of empowerment stakes.
The uncertainty was compounded by Section 38 of the Companies Act, which made it impossible for lenders to fund BEE transactions at lower cost. The section prohibited a company from providing financial assistance to buy its own shares or its parent company.
This posed a dilemma for lenders because many BEE deals are usually concluded at a holding company level and not at a subsidiary level, where cashflows are generated.
The holding company, which sells a stake to black investors, then commits itself to paying the loan on behalf of its BEE shareholders if they fail to meet their debt commitments.
This arrangement irked banks because the parent company relied on the subsidiary delivering regular dividends to help pay them to BEE investors. They, in turn, used the dividends to pay for the empowerment shares.
Prince Ngcobo, the head of corporate finance at banking group Citi, says Section 38 means that lenders cannot knock on the doors of the subsidiaries if BEE investors or parent companies default.
The banks did not like this. The fact that you could not force a board of directors of a subsidiary to declare dividends caused great uncertainty and, as a result, the cost of BEE funding was higher.
The new legislation now allows the company to provide financial assistance to buy its own shares or that of its holding company.
In other words, banks will be able to lend at subsidiary level, where the assets of the holding company are present and where cash is being generated. This will reduce the cost of BEE funding as lenders can pursue subsidiaries if black investors or parent firms fail to meet their loan obligations.
But certain conditions must be met before financial assistance is provided.
These conditions -require that:
- About 75% of shareholders must approve the terms of the financial assistance;
- The company’s board must satisfy itself that after assistance has been provided, the assets of the company, fairly valued, must exceed its liabilities; and
- The board must review the transaction every year to ascertain if the company can pay its debts ?after granting the financial aid.
The concept of the target company granting financial assistance to black investors buying its shares is not new. It has been done before, but at a parent level. This is called vendor financing.
In vendor-financed deals, funding is not provided by third party financiers like banks. Instead the firm that is being acquired gives a loan to the empowerment partner.
Sometimes, the company provides guarantees to a bank that it will be liable for the loan if the BEE partner defaults.
Ngcobo expects the new laws to cut the cost of BEE funding from between 20% and 30% to a level between the prime rate and 20%. The prime rate stands at 14.5%.
The new pricing reflects that the lenders to BEE players still face a risk, albeit a lower one than before.
For example, if a company is being liquidated, lenders to BEE ?¼investors will be paid what they are owed after senior creditors have been paid.
Ngcobo says the reforms to the Companies Act present black investors with a golden opportunity to restructure transactions in a cheaper and more sustainable way.
Most BEE deals that were conducted a long time ago can be restructured by enabling lenders to allow direct recourse to the target company, he says.
Black investors have welcomed the changes but are wary of the challenges they pose.
Litha Nyhonyha, the executive chairperson of Regiments Capital, says there is a risk that companies can use the financial aid as a leverage to impose onerous terms on BEE investors.
My experience with vendor financing is that it is more expensive or comes with onerous terms. This puts a person in a weaker position as a BEE investor because the seller will dictate the terms of the transaction, says Nyhonyha.
He says the absence of third parties like banks in vendor-financed transactions makes it difficult to negotiate better terms.
BEE players need to be vigilant. They must not do deals for the sake of doing them, they must do deals that make sense,says Nyhonyha.
His company has empowerment stakes in listed firms such as Capitec Bank and telecoms group Vox Telecom.