Black economic empowerment ownership initiatives: a Johannesburg Stock Exchange perspective

Abstract

The success of black economic empowerment (BEE) is still not clear. The objective of this paper is to assess the results of BEE equity transfers and contribute to the development of a framework to assess the cost/benefit of transferring equity in this fashion. BEE data from 62 companies listed on the Johannesburg Stock Exchange were analysed using a qualitative methodology and descriptive analysis. The results indicate that respondent companies have transferred less than 25 per cent equity to BEE partners, that a majority of firms appear to support the social objectives of BEE, that external partners appear to best promote shareholder wealth, and that the primary source of funding for BEE equity transactions is third-party funding or the respondent companies themselves. Finally, the Malaysian experience of affirmative action offers some useful lessons for South Africa's BEE programme, as well as some valuable insights into the economics of wealth redistribution.

1. INTRODUCTION

One of the first mandates of the African National Congress after the 1994 election was to redress the inequalities created by apartheid in the political, social and economic sphere (Department of Trade and Industry [DTI], 2003). A number of initiatives began with the repeal of discriminatory laws and the voluntary transfer of equity to black individuals or groups (Engdahl & Hauki, 2001). However, it was only after the 1998 stock market crash that a comprehensive black economic empowerment (BEE) framework was set up (DTI, 2003). From its inception, the success of BEE has been questioned. On the one hand, the black middle class has grown steadily since 1994 (Burger & Van den Berg, 2004), and black ownership of capital on the Johannesburg Stock Exchange (JSE) has increased to 4 per cent as a result of a number of industry charters (Southall, 2004; Thompson, 2004). On the other, there is growing criticism of BEE, and many critics suggest it is a ‘sham’ – that has only benefited the politically connected elite (Engdahl & Hauki, 2001; Boshoff & Mazibuko, 2003; National Public Radio, 2004; Southall, 2004, 2005; Jackson et al., 2005; Freund, 2006). There are also suggestions that BEE could retard foreign investment (Southall, 2004, 2005; Thompson, 2004; Butler, 2006) and that the transfer of ownership to BEE partners could tie up R450 billion (Cargill, 2004).

From the outset BEE has lacked a coherent definition, and it has been questioned whether it is convergent with globalisation (Engdahl & Hauki, 2001; Dlamini, 2004). Furthermore, a number of BEE initiatives have contradicted government objectives and there is no guarantee that BEE ownership initiatives will be successful (South African Chamber of Business, 2003; Ritchken, 2004). White-owned firms have also been accused of manipulating BEE (Business Report, 2005a, 2005b), and widely differing perceptions of BEE and share ownership schemes persist (BusinessMap, 2003; Boshoff & Mazibuko, 2003). South Africa's experience with its BEE initiative is not unique: similar programmes in the USA and Malaysia have produced a range of different outcomes. In the USA, the economic position of blacks and whites remains unequal 30 years after the initiation of its BEE programmes. Conversely, Malaysia's experience is far more positive, and poverty has been drastically reduced during a 20-year period despite some claims that transfer of ownership to the indigenous population remains low (BusinessMap, 2000; FW de Klerk Foundation, 2005).

The majority of JSE-listed companies now articulate a corporate social responsibility strategy, and spending on these programmes ranges between 0.5 per cent and 1.5 per cent of after-tax and pre-tax profit, respectively (Mail & Guardian, 2007). With the introduction of the Broad Based Black Economic Empowerment Act in 2003, however, the emphasis on equity transfers in BEE compliance has been reduced, but equity transfer remains a significant component at 20 per cent of the overall BEE Balanced Scorecard rating. According to the Financial Mail's Top 185 Empowerment Companies 2005, only 38 companies listed on the JSE met the 25 per cent BEE equity target to be classified as a black empowered firm (Financial Mail, 2005).

The objective of this study is to contribute to a better understanding of the variables that influence a successful BEE equity ownership transaction. More specifically, the study will contribute to the development of a framework for structuring and funding equity ownership transactions and selecting a suitable BEE partner. It does not address the other components of the BEE Balanced Scorecard (see Section 2.1, below). It investigates five research questions: the percentage of equity that has actually been transferred to BEE partners, the reasons for implementing a BEE ownership initiative, the reasons for selecting various types of BEE partner, the sources of funding that have been employed for BEE ownership initiatives and, finally, whether the Malaysian affirmative action programme offers any useful lessons for South Africa's BEE programme.

The present study is important in a South African context because of the urgent need to transform the demographics of the economy. It will contribute to a better understanding of the complexities of BEE ownership programmes from a financial management perspective.

The rest of the paper is structured as follows. Section 2 discusses a number of key variables that influence the structuring of BEE ownership initiatives. Section 3 outlines the study's methodology and data. Section 4 analyses and discusses the results in relation to the five research questions. Section 5 develops a series of recommendations for developing a framework to analyse a prospective BEE ownership transaction. Finally, Section 6 summarises the findings of the study and concludes by making some suggestions for future research.

2. THE BLACK ECONOMIC EMPOWERMENT ENVIRONMENT

BEE has been described as:

an integrated and coherent socio-economic process that directly contributes to the economic transformation of South Africa and brings about significant increases in the number of black people that manage, own and control the country's economy, as well as significant decreases in income equalities. (DTI, 2003)

A core component of BEE is the creation and nurturing of new enterprises that produce value-adding goods and services, as well as the attraction of new investment and employment opportunities (DTI, 2003). A central objective of BEE is to promote the redistribution of wealth in South Africa by attempting to transform the ownership of companies within the constraints of a free market system (BusinessMap, 2004a; Ritchken, 2004). Early BEE deals focused on empowering a single BEE party (National Public Radio, 2004), but more recently these ownership initiatives have started to include a broader base of beneficiaries (Cargill, 2004). In order to demonstrate compliancy, moreover, companies have found that it is increasingly important to have their BEE status verified by an accredited BEE rating agency (DTI, 2005).

2.1 The BEE Scorecard

BEE consists of seven elements of company transformation: ownership, management control, employment equity, skills development, preferential procurement, enterprise development, and a residual element (DTI, 2005). In order to calculate a company's BEE status, a ‘scorecard’ has been developed to quantify these seven elements. Each one is allocated a weighting out of 100. Ownership counts 20 points, management control 10 points, employment equity 10 points, skills development 20 points, preferential procurement 20 points, enterprise development 10 points and the residual elements 10 points.

The score for the ownership element, the element this paper deals with, is influenced by the voting rights of blacks in a company and their degree of economic interest. Further points are awarded for voting rights and economic interest in the hands of black women. The total score for the BEE ownership element is calculated by adding up all the ownership weighting points and cannot exceed 20 points.

2.2 Reasons for implementing a BEE ownership initiative

Implementing a BEE programme has become an unavoidable imperative for many South African companies if they wish to maintain long-term profitability (BusinessMap, 2005). Initially, the main driver of BEE compliance was to ensure compliance with government procurement requirements or to qualify for government contracts, licences or concessions (BusinessMap, 2000; Koolen, 2004). However, companies that are not directly dependent on government procurement are also being forced to implement BEE requirements in their companies in order to retain their customers, particularly if their customers are linked to government procurement programmes (Koolen, 2004; BusinessMap, 2005).

The empirical evidence of corporate social responsibility programmes and their links with shareholder wealth has yielded mixed results. Some researchers indicate a positive relationship with wealth creation (Boutin-Dufresne & Savaria, 2004:64) whilst others claim no relationship exists or, alternatively, that many other variables act as intermediaries (McWilliams & Siegel, 2000; Barnett & Salomon, 2003; Campbell, 2007). In this regard, BEE has been cited as a strategic opportunity to grow market share (Koolen, 2004; Woolley, 2005). The new BEE partner can increase business for a company, as well as provide strategic advice on political and economic trends at board level (Business Report 2004, 2005b). However, the new BEE party should have an intimate knowledge of the industry if value is to be extracted from the transaction (Business Report, 2005b). Finally, directors might breach their fiduciary duties if their company does not comply with BEE requirements and, because of this, some form of opportunity cost is incurred. Even though the BEE Act does not require compliance, directors could be liable if the opportunity cost is linked to non-fulfilment of their fiduciary duties. However, in order to claim damages from the directors, the company would have to prove that it was the lack of BEE compliance that led to lost revenue, and proving this connection would be problematic (Business Report, 2005c).

2.3 Reasons for selecting various types of BEE partner

The selection of the right BEE partner is critical for the long-term sustainability and success of a BEE ownership initiative (Raphula, 2004; Woolley, 2005), so the ability of this partner to deliver on empowerment-related opportunities should be the key to selecting the partner (Ritchken, 2004). A potential BEE partner could be an internal or an external candidate. Possible internal candidates would be black employees, managers or directors. Internal candidates understand how the company operates, its internal political landscape and its values and culture (Raphula, 2004). Advantages of choosing internal candidates are that they are more suited for operational involvement and the deal is therefore implemented much faster (Raphula, 2004; Woolley, 2005). Funding for the transaction is easier because Section 38 of the Companies Act does not prohibit the company from funding BEE share incentive schemes for employees. Furthermore, empirical evidence suggests that an internal party can be used to align the interests of the employees, managers and directors with the interests of the shareholders (Raphula, 2004). Share ownership by employees can also lead to a host of benefits, including higher worker motivation, fewer worker complaints, lower absenteeism and lower labour turnover (Boshoff & Mazibuko, 2003). Negative aspects of an internally selected BEE partner could include a lower public profile than certain external candidates and a lack of high-level management skills (Raphula, 2004).

Potential external candidates can be divided into operational, broad-based and influential partners (Business Report, 2004). Operational partners are BEE partners who have been involved in and running their own operations, and include BEE suppliers, BEE business associates and BEE competitors (Business Report, 2004; Raphula, 2004). Broad-based partners include management companies for development trusts, trade union funds and business association funds (Business Report, 2004). Influential partners are investment holding companies headed by individuals with political connections. These companies often have investments in a diverse range of industries (Business Report, 2004). External BEE partners are more likely to increase market share, introduce new ideas and give the BEE ownership initiative a public profile. However, external BEE partners may come from a different organisational culture and could be relatively unfocused on the transaction because of their involvement in multiple transactions (Raphula, 2004). Implementing a BEE ownership initiative with external partners takes longer than with internal partners because of the requirements of third-party financing, due diligence investigations and the conclusion of a shareholder's agreement (Raphula, 2004). Internal candidates, however, who require external funding, would also be subject to a longer time frame.

2.4 Funding BEE ownership initiatives

The main sources of financing of BEE ownership initiatives include third-party funding, vendor (or company) finance, and funding from BEE partners. Third-party finance can be obtained from private equity, banks, the Industrial Development Corporation, Public Investment Commissioners, the National Empowerment Fund and a variety of other public and private institutions (BusinessMap, 2004b; Business Report, 2004; Koolen, 2004). Private equity companies might also provide finance for a BEE ownership transaction but they often require high returns and an equity portion of the target company. The BEE party will thus only start sharing in the benefits of the deal above these high hurdle rates (Business Report, 2004). Banks appear to be the logical institution for financing BEE ownership initiatives, and it has been suggested that banks should be required to finance BEE ownership initiatives without insisting on the traditional security. However, banks should not be forced to fund risky BEE ownership initiatives (BusinessMap, 2003; Business Report, 2004). Other forms of third-party financing, such as the National Empowerment Fund, were relaunched in 2004 with funding of R2 billion. The National Empowerment Fund appears to be willing to invest in more risky BEE ownership initiatives up R50 million, offers debt, quasi-equity and equity financing, and requires ownership to be an economic interest and not just voting rights. Rather than investing at holding company level, the fund prefers to invest at asset level to ensure that BEE partners will obtain an operational involvement in the target company (BusinessMap, 2004b).

The availability of third-party finance for BEE ownership initiatives has been substantially increased by the Financial Services Charter, which has allocated R75 billion for financing various aspects of BEE. However, prospective BEE partners should expect to pay an appropriate rate for the investment funds borrowed (BusinessMap, 2005). Furthermore, financiers are being increasingly selective with respect to funding higher risk initiatives, and security remains a problem for third-party funding (BusinessMap, 2005; Mongalo, 2005). In this regard, financiers are increasingly unwilling to accept shares as security unless they are acquired at a substantial discount, or they prefer to issue convertible instruments that ensure, when the outstanding amount owed to the financiers is repaid, that the new BEE party will retain the residual shares (Mbetse, 2004).

The second major form of funding, namely vendor finance, has emerged as a new financing structure that has the best interests of both the company and the BEE party in mind (Mbetse, 2004; Mongalo, 2005). The company wishing to engage in a BEE ownership initiative facilitates the financing of the transaction. The facilitation could be a combination of direct financing to the BEE party in the form of a low-interest loan for preference shares, a guarantee to a third-party funder, a discount to the BEE party, a deferred equity sale or an innovative funding structure such as a notional loan. Vendor finance can be restructured if there is a change in market conditions that adversely affects the BEE ownership initiative. The downside to these loans is that they often meet with shareholder resistance (Mbetse, 2004) and companies should be aware that vendor finance might not comply with Section 38 of the Companies Act (Hale, 2004).

Most BEE ownership initiatives require the BEE party to acquire shares in the target company (Meister & Van der Merwe, 2004). In many cases, the BEE party will require assistance in raising finance. Section 38 of the Companies Act of 1973 prohibits a company from providing financial assistance for the purpose of purchasing its own shares (Meister & Van der Merwe, 2004), and also protects companies from potential partners using the company's assets to fund their acquisition (Hale, 2004). In terms of Section 38, however, companies are allowed to provide financial assistance to employees to buy shares in the company (DTI, 2004). Finally, the Companies Act is likely to be reformed to allow companies to provide financial assistance, subject to certain requirements, to the purchasers of their shares (Mongalo, 2005).

3. RESEARCH METHODOLOGY

A survey of JSE-listed companies was used to collect the data to test the five research questions. Because of the wide range of responses, a qualitative methodology was used to assemble and analyse the data. More specifically, a content analysis was performed on the data, because this is an effective method for identifying patterns and themes in open ended data (Breakwell et al., 2000). This methodology allowed the study to explore a wide range of variables that influence the successes and failures of BEE ownership initiatives.

The data used in the analysis were compiled from JSE Stock Exchange News Service announcements that were made after 1 January 1999. The data therefore include BEE ownership initiatives from 1 January 1999 to 31 November 2005. The sample size of 72 companies included only entities that had not been suspended by 31 November 2005. The data are limited to companies listed on the main boards of the JSE and the study focuses only on BEE equity ownership initiatives implemented at holding company level or South African multinational companies that have sold a stake in all subsidiaries in a single BEE ownership initiative.

The analysis was limited to holding company BEE ownership initiatives and South African multinational companies that have implemented a single BEE ownership initiative for all their local subsidiaries. The reason for this limit was that the information about various BEE ownership initiatives in multiple subsidiaries is not properly disclosed.

4. RESULTS AND DISCUSSION

4.1 Percentage of total equity transferred

Table 1 presents the percentage of total equity transferred to BEE partners by a sample of 72 South African companies. The results indicate that 27 companies (just under 40 per cent of the sample) have transferred 10 per cent or less of total equity, 28 companies have transferred between 10 and 25 per cent, and only 17 have transferred 25 per cent or more.

Table 1: Percentage of total equity transferred to a BEE partner

Percentage of total equity transferred	Total
Up to 5 per cent	1
Between 5 per cent and 10 per cent	26
Between 10 per cent and 15 per cent	11
Between 15 per cent and 20 per cent	8
Between 20 per cent and 25 per cent	9
Between 25 per cent and 30 per cent	14
Above 30 per cent	3
Total	72

Of the 27 companies that have transferred 10 per cent or less of total equity, 10 are financial institutions. The financial services charter only requires companies to transfer 10 per cent of equity by 2009 and 25 per cent by 2014. We can therefore expect a flood of empowerment deals before 2014 in this sector. The one deal below 5 per cent was an employee share scheme where the company concerned indicated that their BEE ownership initiative was the first part of a phased strategy to achieve the required BEE targets.

No definitive reason was identified for companies transferring between 10 per cent and 25 per cent in their BEE ownership initiatives. These companies did not indicate whether this was their first or only BEE ownership initiative. They might have decided to pursue a BEE rating on the basis of a limited equity ownership scheme complemented by the other six elements of the BEE Scorecard. Only 26 companies in the sample currently meet the BEE requirements of 25 per cent. The three deals above 30 per cent were ones that involved major shareholders who identified the need for their companies to become BEE compliant and were willing to sell a part of their stake in the company to assist with BEE ownership requirements.

In the study sample, less than 25 per cent of equity has been transferred in a BEE ownership transaction. This level of equity transfer concurs with a report in the Financial Mail (2005) that said fewer than 25 per cent of the top 185 empowerment companies had transferred 25 per cent of equity. It can therefore be hypothesised that a second round of BEE ownership initiatives will have to be implemented in the future if companies wish to earn maximum points from the ownership weighting on the BEE Scorecard. Alternatively, it has been suggested that the structure of equity deals needs to be overhauled (Business Report, 2004).

4.2 Reasons for implementing a BEE ownership initiative

Table 2 presents the reasons given by the 72 respondent companies for implementing their BEE ownership initiatives. The highest ranking reason for BEE ownership initiatives, chosen by 37 companies (just over one-half the sample), was that BEE is essential for South Africa to sustain its economic and democratic structures. This social realisation was further supported by 29 companies who (understandably) indicated a commitment to the principles of BEE. This reason agrees with the findings of BusinessMap (2005), whose survey concluded that BEE was an unavoidable imperative. However, a considerable number of economic reasons appear to have precipitated BEE ownership transactions. For example, 32 companies (a little less than one-half of the sample) believed that implementing BEE ownership initiatives would grow their business and market share, and 17 of the companies (about one-quarter) confirmed that BEE was a core component of their growth strategy. This reason is supported by the findings of various surveys that suggest BEE is a strategic opportunity to grow market share (Business Report, 2004, 2005b; Koolen, 2004; Woolley, 2005). Conversely, 23 of the companies (about one-third) believed they would lose the market share if they did not become BEE compliant, thus supporting the surveys of BusinessMap (2005) and Koolen (2004) – who suggest that the relative competitive position of the company could be threatened if its customers demand BEE credentials. Fifteen of the companies, about one-fifth, said attracting and retaining black staff was a key reason for increasing black ownership in their companies. This was also one of the key reasons found by other researchers for selecting an internal BEE partner (Boshoff & Mazibuko, 2003; Raphula, 2004; Woolley, 2005). Other reasons included being a first mover in their industry sector (Koolen, 2004), as an opportunity to raise finance and as one of the requirements to tender for government contracts. Only five of the surveyed companies, a small minority, said government procurement contracts were a central reason for BEE initiatives. This finding somewhat contradicts BusinessMap's (2000) finding that affirmative government procurement programmes were a main driver of BEE compliance. Nineteen of the surveyed companies, about one-quarter, indicated that their BEE ownership initiatives were driven by sector charters, which agrees with the findings of other surveys. These sectors were identified as mining, financial, health, agriculture, tourism, and the information, communication and technology sector.

Table 2: Reasons for implementing BEE ownership initiatives

Reason	Total
BEE is essential for South Africa to sustain its economic and democratic structures	37
Companies see BEE as an opportunity to grow their business and market share	32
Companies are committed to the principles of BEE	29
Companies realise that BEE is a business imperative and that they will lose market share if BEE is not implemented	23
Companies wish to comply with requirements of their respective industry charter/legislative reasons/licences	19
A BEE ownership initiative is part of a broader BEE strategy	17
Companies hope to attract and retain black staff by implementing a BEE ownership initiative	15
Companies see an advantage in being the first mover or leading BEE company in their industry	7
The companies customers require the company to have BEE credentials	7
Companies use a BEE ownership initiative as an opportunity to raise finance	7
Companies are required by government procurement to comply with BEE requirements	5

In certain instances, the government has used licences to compel companies to implement BEE. For example, the broadcasting and mining sectors require a licence and rights to operate. In the gambling industry, the North West Province legislature required Sun International to implement a BEE ownership initiative as part of their gambling licence requirements (Koolen, 2004; BusinessMap, 2005). Finally, contrary to the assumptions of Business Report (2000c), companies did not indicate directors' compliance with fiduciary duties as a reason for BEE compliance.

4.3. Reasons for selecting a BEE partner

Table 3 presents the reasons for selecting a BEE partner. Firstly, black company employees are the prime source of internal partners. Eleven of the 72 respondent companies indicated that selecting employees as a BEE partner would address the problem of attracting and retaining competent black employees. To this end, the employees are often offered a share scheme with a lock-in period.

Table 3: Reasons for selecting specific BEE partners

Reason	Total
Investment holding company
The investment holding company will add value to the company and help the company to grow its  market share and customers	42
The economic benefits from the BEE ownership initiative will flow to a broad range of beneficiaries	37
The investment holding company has developed a focus on the particular industry	30
The investment holding company has market credibility and a good track record	22
The investment holding company will assist the company with transformation initiatives	21
The investment holding company has connections with government or within the industry	19
A current business relationship exists between the company and the investment holding company	19
The investment holding company will become involved in the management and operations  of the company	19
The investment holding company has investments in multiple industries	13
The company will gain a black director from the investment holding company	13
A current director of the company is a director in the investment holding company	12
The investment holding company is wholly owned by women	9
Social responsibility fund
The economic benefits from the BEE ownership initiative will flow to a broad range of beneficiaries	14
Complements existing corporate social responsibility	6
The social responsibility fund is wholly for the benefit of women	2
Business partners
A current business relationship exists between the company and the business partner	4
The business partner has market credibility and a good track record	3
The business partner will become involved in management and operations of the company	3
The business partner will add value to the company and help the company to grow its market share  and customers	2
The business partner has connections with government or within the industry	2
A current director of the company is a director in the business partner	2
The company will gain a black director from the partner	2
Employees
Attracting and retaining employees by providing employees with an ownership stake in the company	11
Companies plan to align the interests of the partner with those of shareholders	7
The economic benefits from the BEE ownership initiative will flow to a broad range of beneficiaries	6

Boshoff and Mazibuko (2003) agree with this motive and suggest that an internal party as the BEE partner reduces labour turnover and increases productivity. The companies did not specifically indicate that employees were selected as a partner because of their knowledge of the company or that the implementation process would be faster, as suggested by other surveys (Raphula, 2004; Woolley, 2005).

Seven of the companies said a BEE share scheme would align the financial interests of the employees with those of the shareholders, which agrees with the conclusions of Raphula (2004), and six of them said employee share schemes were consistent with the goals of broadening the distribution of the BEE ownership transactions that have been so strongly emphasised by the South African government and senior public figures (DTI, 2003; National Public Radio, 2004).

Three types of external BEE partner were evaluated by the respondents: an investment holding company, a social responsibility fund and a current business partner. With regard to an investment holding company as a prospective BEE partner, 42 of the companies (well over one-half of the sample) believed the new relationship would add economic value to the company, while the other 30 said the BEE partner already had a focus in their particular industry. Other reasons were that the new partner had credibility (22 companies), had connections with government or the particular industry (19 companies), that a current business relationship existed (19 companies), that the new partner would contribute to the management of the company (19 companies), and that it had significant investments in other industries (13 companies). These reasons are broadly supported by the contentions of Raphula (2004) and Business Report (2004) that an external BEE partner can add value because they are influential, they have political connections and they often have investments in a diverse range of industries. Other benefits of an investment holding company as a BEE partner that were mentioned by the respondents are that the transaction would benefit a broad range of beneficiaries (37 companies), that the new partner could assist the company with its transformation initiatives (21 companies), that there was the possibility of acquiring a black director (13 companies), and that the investment holding fund was owned by women (nine companies).

A few respondents offered similar reasons for selecting two other types of external BEE partner: a social responsibility fund and a current business partner. Fourteen companies said a social responsibility fund can promote broad-based ownership transactions. Reasons given for believing current business partners would add value to the business were: their business relationship (four respondents), their credibility (three respondents), their management inputs (three respondents), their connections (two respondents) and that the company could gain a black partner (two respondents).

4.4 Funding BEE ownership initiatives

Table 4 presents who funds BEE ownership initiatives. Nearly one-third of the respondent companies (22 companies) indicated that their BEE ownership transaction had been funded by some form of third-party finance. This response supports the conclusion of other surveys that third-party finance from private equity, banks and institutions such as the Industrial Development Corporation and the National Empowerment Fund is a primary source of finance for BEE ownership transactions (BusinessMap, 2004b; Business Report, 2004; Koolen, 2004). The second largest source of funding for these transactions is the respondent company itself (mentioned by 10 respondents) or its holding company (mentioned by six respondents). It has been suggested that company funding is a relatively new financing structure that is more flexible than third-party finance, but there are some concerns about the potential for shareholder reluctance (Mbetse, 2004; Mongalo, 2005), and companies using this source of funding should ensure they do not contravene Section 38 of the Companies Act (Hale, 2004; DTI, 2004; Mongalo, 2005).

Table 4: Sources of finance for BEE ownership initiatives

Funding	Total
Third-party finance	22
Own funds of BEE partner	11
Company provides funding	10
Undisclosed	10
Deferred shares^a	8
Holding company provides funding for BEE ownership initiative in subsidiaries	6
Share exchange^b	4
Loans between shareholders	2
Donation	1
Preference shares	1
Total^c	75
^aDeferred shares are a way of funding the purchase of shares. ^bThe share exchange occurs when the company merges with a BEE partner. ^cThe total is more than 72 because three initiatives mentioned two equally important sources of finance.

The third largest source of funding equity transactions was the prospective BEE partner themselves – 11 companies said their new partner had access to their own funds. These partners were typically an investment holding company, a social responsibility fund or a current business partner (Business Report, 2004; Raphula, 2004). Disappointingly, 10 of the respondents did not divulge their source of funding. Other sources of funding that were mentioned included deferred shares (mentioned by eight companies), and a share exchange of some sort, a loan between shareholders, a donation, and preference shares.

4.5 Does the Malaysian experience provide any lessons for BEE?

Malaysia's implementation of its New Economic Plan (NEP) in 1970 is perhaps a closer representation of the South African situation (BusinessMap, 2000). The Malays (or Bumiputra) constituted 57.6 per cent of the population, of which 65 per cent lived in poverty (BusinessMap, 2000). The NEP aimed to eliminate poverty and promote greater economic equality between the Malays and non-Malays within a period of 20 years (BusinessMap, 2000; FW de Klerk Foundation, 2005). The NEP included measures such as expanded educational opportunities, employment quotas and incentives for companies selling their stock, at a discount, to Malays. In order to bid for government contracts and to list shares on the stock exchange, companies were required to have Malays as 30 per cent equity shareholders (BusinessMap, 2000). The Malaysian government further used the allocation of government contracts, quotas and licences to promote the growth of Malay companies (BusinessMap, 2000).

The positive effects of the NEP have been remarkable, in that the Malays' share of corporate equity ownership rose from 2.4 per cent in 1970 to 27.2 per cent in 1988 (FW de Klerk Foundation, 2005). The employment of Malays in the manufacturing sector rose from 30.8 per cent to 48 per cent and in the services sector rose from 37.9 to 51 per cent (BusinessMap, 2000). The overall incidence of poverty fell from 49.3 per cent in 1970 to 22.4 per cent in 1987 (FW de Klerk Foundation, 2005). The NEP was not without problems, however, nor did it go uncriticised. According to the Gini coefficient, the wealth gap within the Malay population rose from 0.4 in 1968 to 0.4495 in 1997 (FW de Klerk Foundation, 2005). A perception exists that the Malay elite have benefited more than the rest of the Malays from the NEP and they have benefited from government favouritism. Economically successful ethnic minorities felt that the playing field was unreasonably stacked against them. Most Malaysians, however, acknowledge that the NEP has helped Malaysia to avoid racial turmoil (BusinessMap, 2000).

The NEP differed in two ways from BEE. Firstly, from the beginning the NEP was a comprehensive programme led by the Malaysian Government. BEE, on the other hand, was a set of initiatives separately developed by various branches of government and the private sector (BusinessMap, 2000). With the introduction of the Broad Based Black Economic Empowerment Act of 2003, the government has now introduced a comprehensive BEE programme. Secondly, the Malaysian Government realised that the NEP focus on the redistribution of wealth from non-Malays to Malays would be socially unsustainable in a slow growth economy (BusinessMap, 2000). The success of the NEP was largely supported by Malaysia's high Gross Domestic Product growth rate (6.7 per cent) during the life of the NEP (FW de Klerk Foundation, 2005; South African Chamber of Business, 2003). The high growth rate was due to a high domestic savings rate and a growth in exports (BusinessMap, 2000). Whether a policy similar to the NEP would be successful given the current South African growth environment is uncertain (South African Chamber of Business, 2003).

A number of lessons can be learnt from this empowerment initiative by Malaysia:

•	Empowerment initiatives take at least two decades to deliver their effects (FW de Klerk Foundation, 2005).
•	The education of previously disadvantaged individuals is crucial for the initiative's success.
•	Empowerment should focus on developing skills and not only on redistributing assets.
•	Social support for empowerment should be elicited among all racial groups by ensuring that empowerment transactions are conducted according to well-defined, socially acceptable rules and that the truly deprived are benefiting.
•	Economic growth is a key element for empowerment initiatives to succeed (BusinessMap, 2000).

5. RECOMMENDATIONS

The primary emphasis for a BEE equity ownership transaction should be on creating value and offering broad-based benefits (Cargill, 2004; Business Report, 2005d). There are a number of steps a company aiming to ensure a successful BEE ownership equity transaction can take. Table 5 presents a checklist for evaluating the extent of equity transferred, the reason the company is involved in the BEE transaction, the suitability of the potential partner, and the source of funding. The company should also document the advantages and disadvantages of each of the variables, ensure compliance with company strategy, and perform the necessary cost/benefit calculations to quantify the economic outcomes of the transaction.

Table 5: Checklist for evaluating the suitability of a BEE partner

Checklist	Variable	Advantages/disadvantages	Cost/benefit
1. Extent of equity	Industry charter, competitors, compliance with other BEE factors
2. Reason for BEE transaction	Social responsibility, political connections, increase market share
3. Suitability of BEE partner	Internal versus external, management skills, finances, political connections
4. Source of funding	Third-party finance, loans, own finance

The first step is to evaluate the extent of equity to be transferred to the prospective BEE partner. Firstly, the company could determine the extent of compliance with the other six elements of the BEE Scorecard. The company could also consider the relative size of its operations and the level of BEE ownership compliance achieved by their competitors and could establish whether an industry charter provides any guidelines with respect to the transfer of equity. Furthermore, the company could evaluate the share price reaction with respect to BEE transactions within the same industry sector. Secondly, if the company plans to transfer equity in a number of steps, a timetable of these transactions can be projected. Finally, it must be borne in mind that the current equity transferred might not equal the eventual BEE equity holding by all BEE partners in a few years' time, mainly because of the financing costs of ordinary shares and the internal funding mechanisms in deferred shares.

The second step is to ensure the reason for the BEE equity ownership transaction is clearly documented. Here, the full range of social responsibility and economic reasons should be documented. These reasons could be configured with the industry charter, as well as with the company strategy. It is suggested the advantages and disadvantages of the reasons be examined and quantified using some form of cost/benefit analysis. If the new partner can add market share to the company, then this should be quantified.

The third step is to select an appropriate BEE partner. The lifecycle of the company could influence this selection: growing businesses need a BEE partner who can provide operational and management inputs, while more mature businesses might need have less need of these (Raphula, 2004; Woolley, 2005). To select an appropriate BEE partner, Raphula (2004) lists the qualities the target company should identify. The BEE partner should:

•	operate in same industry;
•	understand the industry in which the company operates;
•	know what challenges and opportunities the industry faces;
•	bring synergies and possible diversification opportunities;
•	have a potential to grow the business;
•	have a close cultural match;
•	possess the necessary qualifications or industry experience;
•	have business acumen;
•	be able to add long-term value and bring other competitive advantages;
•	be able to help transform the organisation;
•	be able to identify new growth areas and strategies; and
•	contribute at management and operational level.

The fourth and final step is to investigate all the advantages and disadvantages of the various forms of funding. These could be quantified and compared from a company perspective, and a funding timetable could be created to indicate a time line of cash flows with respect to the transfer.

6. SUMMARY AND CONCLUSION

The success or failure of BEE in South Africa has been hotly debated, and the current economic climate of rising inflation and interest rates could threaten the future of BEE. Nevertheless, South African companies are faced with the challenge of implementing BEE ownership initiatives because of the social and economic imbalances created by apartheid. The findings of the first research question suggest that a majority of companies surveyed do not comply with the 25 per cent equity transfer requirement of the BEE ownership element. These findings support a survey by the Financial Mail (2005) that indicated only 21 per cent of the top 185 empowerment companies had transferred 25 per cent of their equity to a BEE partner. This would suggest that further rounds of BEE ownership initiatives could take place in the future, as expected in the financial services sector, or confirm that companies prefer to focus more on the other six elements of the scorecard.

The findings of the second research question suggest that most companies have invested in BEE because of a perceived need for social responsibility programmes allied to profit-making. The usefulness of these findings is that companies intending to invest in similar programmes can investigate and compare their real with their stated reasons for complying with BEE requirements. The empirical evidence for the links between corporate social responsibility programmes and wealth creation is ambivalent, and companies are advised to think carefully about integrating their BEE programmes with the balance of their strategic plans. Furthermore, the findings indicate that an investment holding company is the most appropriate new BEE partner because it can deliver on a wide range of social responsibility and economic objectives. The usefulness of these findings is that these objectives can be used to develop a checklist a company can use to evaluate the suitability of a BEE candidate (see Table 5).

Third-party finance and own funding appeared to be the most attractive form of finance for a BEE equity ownership transaction. In this regard, few black companies or individuals have had the resources to purchase equity outright, and the latest amendments to Section 38 of the Companies Act could further promote company funding as a primary source of BEE equity transactions. The checklist of sources of funds can be usefully employed to evaluate the cost/benefit of alternate forms of finance.

The Malaysian NEP offers some interesting insights into variables that could influence the success of South Africa's BEE programme. Even though the NEP experienced problems transferring ownership and did not reduce the wealth disparities within the Malay population over its 25-year period, it did reduce the wealth disparities between the various racial groups. One of the reasons why the Malaysian NEP worked was that the Malaysian economy grew substantially during the period of the NEP. It should therefore be remembered that BEE only results in a redistribution of wealth when the growth rate of the company exceeds the interest cost on the money borrowed to purchase the stake in the BEE ownership initiative.

Further areas for research should include an evaluation of share price reactions to BEE announcements on the JSE. In addition, there is a need to investigate exactly how redistributive the BEE transactions have actually been and to collect empirical evidence as to the value that is added because of a BEE transaction. Furthermore, it is important to establish how many BEE transactions have failed before being formally announced, and what variables made BEE transactions succeed. These variables could be macro-economic factors, access to funding, company attitudes and the availability of suitable BEE partners. It would also be useful to investigate the reasons why certain companies have not adopted BEE ownership initiatives. Finally, further research could attempt to establish whether the Balanced Scorecard weightings as they stand are ideally applicable to all industry sectors.