Opinionista Dirk De Vos 20 August 2014

My guide to fixing B-BBEE

The recent comments by Deputy Minister of Trade and Industry (DTI) Mzwandile Masina at a Black Industrialists Stakeholder Engagement session that his department intends to make sweeping changes to Black Economic Empowerment should be welcomed. The current BEE rules are a tangled mess and the new Codes of Good Practice are even worse. It is hard to think that any fresh ideas could do more.

The aim of the DTI is to create a minimum of 100 black industrialist-led firms active in the productive sectors within the next three years. This presents us with a specific target and BEE can then be shaped in a way that is more likely to achieve the stated target. Whether the target is a worthwhile or suitable one is another worthy debate and one that should occur. Unfortunately, this type of focused debate does not take place much.

Instead, we avoid this as the Deputy Minister did when he reverted to the type of language that most of us have grown quite weary of: One over-used word in particular, “transformation” comes to mind. This word has become a catch-all with very little shared idea about what it actually means. Everyone can insert their own ideas. Our policy makers, realising this, and in an effort to communicate their serious intent, have taken to adding an adjective – “radical” – so now we have “radical transformation” which, note the passive sentence construction, is “to be accelerated”.

The problem with BEE is that it tries to do too many things: The current Codes, still in force, have seven different elements which different companies, depending on their size, apply in different ways to get a score or BEE contribution level. It brings to mind Apple’s iPhone ad: want to get black people involved in the equity structure of existing companies? There’s an app for that. Increase the number of black managers? There’s an app for that. Improve employment representivity, or skills development, procure more from black owned companies, get companies to invest in start-ups or get companies to run corporate social investment programmes? There are apps for all of those too.

The new codes, published last year and due to come into force early next year, move these apps around a bit, push once-separate elements into one – management control is now combined with employment equity and Preferential Procurement and Enterprise Development. Score weighting also changes and there is less opportunity to avoid losing points on matters that a measured firm would score poorly on. In response to criticism that the old codes did nothing for local manufacturing, a new concept is introduced with the definition of an “Empowering Supplier”: If one is able to get one’s mind around the very poor grammar and mishmash of concepts contained in this definition, it seems to be about procuring more stuff locally.

The one somewhat surprising thing in the new codes is the emphasis placed on passive or minority ownership. The new codes keep the target to 25% but now require that an effective 10% be owned outright or not be subject to being financed. Ownership, the particular rules and scoring takes up about a third of the new code’s 112-odd pages. It is surprising because building up minority black shareholdings does not work.

A typical BEE transaction involves the sale of a defined shareholding (the BEE stake) to a black grouping or structure established for this purpose. The BEE stake is then financed using debt. This debt could be provided by the sellers of the shares (subject to restrictions in the Companies Act) or by a bank using commercially based interest rates. The net result of this across the economy is that capital, once invested in productive assets, leaves the productive economy. The other side of the problem is increased levels of debt: While in general terms, interest payments on debt can be deducted before taxable income is determined, this does not apply to money borrowed to finance share purchases.

It would make sense if it all worked out in the end but it mostly doesn’t: Dividends from shares rarely pay more than the interest charged to pay for them. So the only hope is that the share value increases, but it is not a sound working assumption. The result is that BEE funding schemes find themselves “out of the money” and if they do work, equity purchased ends up with a far lower BEE ownership level when the funding structures are unwound. The funders, banks and BEE advisors, however, have made real money along the way. Tragically, the best prospects for future industrialists are sucked into the financial sector, earning good salaries and not building businesses.

More debt in the productive side of the economy means creeping “financialisation” of the economy. With more debt, even at a shareholder level, companies are more wary of taking the risks inherent in growing their business or undertaking new ventures. The other problem with BEE shares is that companies have a direct interest in retaining whatever black share ownership they have. Black shareholders can only sell to other blacks. White shareholders can exercise their all rights as shareholders (dividend and voting rights) and sell them if they are unhappy, but black shareholders get only dividends and voting rights and selling them is restricted, compounding the passive nature of this type of shareholding. Minority or passive broad based black shareholding has an important place in low-risk, long-term Public Private Partnerships in, say, infrastructure, but it is no way to build a black capitalist class.

One positive element about the new codes, though, is the dumping of BEE verification agencies. BEE verification agencies represent an entirely new and unproductive industry that adds another layer of costs to BEE compliance. Further, the complexity of the BEE rules means that there is no consistency in the scores that two different agencies might confer to the same company. There are other absurdities that emerge, encapsulated by this tweet: “So, I had to hire a white company to prove that my company is black. Gotta love this country”. The new codes allow all but the biggest companies to score themselves on pain of penalties for misrepresenting their scores, but Deputy Minister says that he intends to take this function in-house at the DTI. This is another bad idea: the DTI certainly does not remotely have the capability to monitor BEE compliance across the whole economy.

What, then, might work instead? The advice of any industrialist, black or otherwise, would be to do just one thing, do it well, and not get distracted. Many of the elements of the codes are already covered in other legislation, regulations or incentives. Management and employment equity issues are already dealt with in the Employment Equity Act, Skills Development and its funding in the Skills Development Act; socio-economic development in the Income Tax Act and in mining licences. If these pieces of legislation are seen to be insufficient, they can be amended. Procurement allows black business to get a chunk of the action before the interest and tax payable line.

This is a good place to start. To do this, we need to define a qualifying black business in simplest terms: One definition that could work is “a company in which 51% of the issued securities (equity) is owned directly by black South Africans; at least 51% of the equity must be owned by people serving on the board of the company; and at least 51% of the board (calculated by the number of votes in the total) is in the hands of black South Africans”. This definition would encourage (but not prescribe) the direct involvement of the black owners in operations, management and in taking business risks. It would discourage holdings in multiple entities but still allow some flexibility to attract other capital via loans or new share issues and non-black or foreign skills at the highest level. It would also serve to encourage successful black businesspeople to use their wealth to plough back into these qualifying black businesses. Most of all, it is relatively easy to monitor and makes fronting much harder to do.

The rest of the country could then be subject to the same type of legislation that governs the state, namely the Preferential Procurement Policy Framework Act (which gives a weighting of 90/10 to price/BEE in large contracts and 80/20 in smaller ones). One could introduce a tax benefit for those who procure from these companies and perhaps introduce a minimum threshold for procurement from these businesses which, if not met, will attract a surcharge. The surcharge could be ring-fenced to provide capital for a specialist fund providing start-up and expansion capital for these qualifying black businesses.

The above construction also deals with another problem – the question of a sunset clause on BEE. As these qualifying black companies grow, expand, operate in other countries or look to an IPO/listing, the capital structure for remaining a qualifying black company will become a constraint. But that is a good thing – by that time, any company that has any hope of being competitive and sustainable in the longer term has to be weaned off policy support. Experience would have been earned; skills honed; brands established; networks, formal and informal, would have been established. These corporates would be ready to take their place in the broader corporate sector, do so as equals and be celebrated for doing so. Our efforts should, by then, be focused on the next generation of black business.

We should also listen to the Deputy Minister’s ideas on how to tweak the Preferential Procurement Policy Framework Act. It can’t go too far. Procurement is governed by section 217 of the Constitution and requires that state organs contract for goods and services on the basis of fairness, equitability, transparency, competiveness and cost-effectiveness. The Public Finance Management Act and the Local Government: Municipal Systems Act and the Municipal Finance Management Act require more or less the same thing. South Africa is also a founding member of the WTO and a signatory to the WTO Agreement on Government Procurement. Treasury is different from the DTI. It is responsible for the collection of taxes that fund a Trillion Rand annual government budget that funds a growing public servant wage bill, an expensive education system, an expanding health system and a burgeoning social grants system. It also funds the servicing of existing government indebtedness. The expenditure on education, health and social grants benefits our people who do not have access to the formal economy and for whom BEE means very little.

The recent IMF report on the South African economy painted a bleak picture of our slow growth economy. While much comment has centred on our labour relations regime, the report also puts business, particularly big business, in the dock. Costly regulation, including BEE compliance, makes it harder for small businesses to grow. The creation of sustainable new firms is amongst the lowest in the world.

Let’s go with the Deputy Minister and make the creation of a black capitalist class the target of BEE. Increasing competition from them could improve the rest of our under-performing economy. It will take a long time and will be hard to do, and there will be a lot of failures along the way, but if this is the aim, we should clear away all the other stuff that makes this objective even harder to achieve. DM

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