BEE shareholders often do not have the balance sheet required to fund the acquisition of their equity stake in a Measured Entity. If shares are not paid for in cash, there are a number of other ways in which the acquisition price can be settled. Although the shares can be donated, in our experience this rarely happens. As a result, most BEE ownership transactions are financed either by existing shareholder/s or the Measured Entity itself.
We have found that in practice many people remain unsure of or misunderstand the manner in which a BEE shareholder’s equity stake can be financed and the options available. This article seeks to simplify and clarify this.
For the purposes of this article we will compare and contrast two funding arrangements: firstly, a conventional loan structure; and secondly, a notional vendor finance (NVF) structure.
With a conventional loan structure, the BEE shareholder settles the acquisition price for its shares through a loan raised with either a third party or the Measured Entity itself. Over the course of the transaction, when the BEE shareholder receives dividends, all or part of such dividends is used to pay down the loan. While this is a very simple funding arrangement, it is not often used in practice as it is tax inefficient.
A NVF structure achieves the same economic outcome as a conventional loan. With a NVF structure, when the BEE shareholder acquires its shares usually only a small portion or the acquisition price is paid upfront (or sometimes none at all) with the balance being credited to the BEE shareholder as a notional loan. This notional loan is then repaid over time through the upfront waiver by the BEE shareholder of the right to receive dividends from the Measured Entity (usually 60-80% of such dividends). Alternatively, the BEE shareholder can subscribe for a class of shares which limit the holder’s right to receive dividends until the acquisition funding has been repaid. The loan is “notional” since there is no actual flow of funds between the funder and the BEE shareholder. This structure is far more tax efficient. Variations of this funding structure are used by listed and unlisted companies alike.
The success and sustainability of BEE transactions often hinge on the design of the underlying funding arrangement. It is therefore imperative that this part of the transaction be thought through carefully and that proper advice be sought. If you’re curious to discuss the funding arrangement of a BEE transaction you’re involved in or are contemplating, please do get in touch.