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STRUCTURING THE EMPOWERMENT TRANSACTION September 2006

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

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STRUCTURING THE EMPOWERMENT TRANSACTION September 2006

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  1. STRUCTURING THE EMPOWERMENT TRANSACTIONSeptember 2006

  2. “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.”

  3. THE EMPOWERMENT PROCESS IDENTIFYING THE BEE PARTNER SETTING THE RELATIONSHIP PARAMETERS STRUCTURING THE TRANSACTION HOUSEKEEPING THE CODES OF GOOD PRACTICE

  4. 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.”

  5. 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

  6. FLOW THROUGH PRINCIPLE

  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

  8. 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

  9. OWNERSHIP SCORECARD

  10. 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

  11. 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

  12. 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.”

  13. 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%

  14. 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.”

  15. 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

  16. 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.”

  17. 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

  18. STRUCTURING OPTIONS

  19. 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

  20. 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”:

  21. 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

  22. 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 – don’t allow this relatively easy task to negatively impact the transaction’s success.”

  23. 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

  24. QUESTIONS

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