OWNERSHIP

TRANSACTIONS MUST WITHSTAND SCRUTINY

Options and Share Warrants’

There are many vehicles organisations use to meet the Ownership Scorecard

requirements; however, critical to an organisation’s overall score is that an Ownership

transaction must benefit the Beneficiary and not the vehicle driving the process. There

are two givens when entering into an Ownership transaction for B-BBEE purposes.

Firstly, it must make good business sense. Then it must withstand the scrutiny of a

B-BBEE Verification and an investigation by the B-BBEE Commission, if necessary.

The Codes of Good Practice (Codes) in four paragraphs provide for ‘Options and

Share Warrants’, a lesser-known Ownership vehicle. The structure affords future

shareholding by allowing both an organisation and a buyer, in B-BBEE terms

a ‘Black’ Participant, the opportunity to assess a partnership’s feasibility and

success before officially entering into a share transaction. Start-up Enterprises

commonly use the ‘Options and Share Warrants’ avenue during their investor

rounds or in the case of acquiring a Large Enterprise.

In this article, I will unpack the requirements for claiming Ownership Points

under ‘Options and Share Warrants’, beginning with the applicable definitions

from Schedule 1.

Anelda Grau is a Verification Manager and Technical

Signatory at MSCT BEE Services (Pty) Ltd, a

SANAS accredited B-BBEE Rating Agency.

She obtained her BCom in Marketing

Management through Milpark Education

and her MDP in B-BBEE through

Unisa. She has in-depth technical

knowledge of the Codes of

Good Practice, providing

B-BBEE Verification services

to organisations of all sizes

across all sectors.

Voting Rights means voting right attaching to an Equity Instrument owned by or held for a participant measured using the

Flow-through Principle or the Control Principle;

Exercisable Voting Rights means a voting right of a Participant that is not subject to any limit;

Economic Interest means a claim against an Entity representing a return on Ownership of the Entity similar in nature to a dividend

right, measured using the Flow-Through and, where applicable, the Modified Flow-Through Principles;

Equity Instrument means the instrument by which a Participant holds rights of Ownership in an entity;

Standard Valuation means a standard valuation method for an asset, an Economic Interest, or any other instrument or right

relevant to measurement under statement 100, undertaken using normal valuation methods that represent

standard market practice;

Current Equity Interest Date means the later occurring of the date of commencement of statement 100 and the date upon which the

transaction undertaken by the Measured Entity in order to achieve 'Black' Rights of Ownership became

effective and unconditional;

Acquisition debt means the debts of:

a) ‘Black’ Participants incurred in financing the purchase of an ‘Equity Instrument’ in the organisation; and

b) Juristic persons or trusts in the chain of Ownership between the eventual ‘Black’ Participants and the

organisation for the same purpose as those in (a);

51% 'Black'-owned means an Entity in which:

a) ‘Black’ People hold at least 51% of the ‘Exercisable Voting Rights’ as determined under Code

series 100;

b) ‘Black’ People hold at least 51% of the economic interest as determined under Code series 100; and

c) Have earned all the points for ‘Net Value’ under statement 100;

Net Value means the percentage resulting from the formula in Annexe 100(C) of statement 100, which links to the

Deemed Value, which is:

‘Options and Share Warrants’

There are many vehicles organisations use to meet the Ownership Scorecard

requirements; however, critical to an organisation’s overall score is that an Ownership

transaction must benefit the Beneficiary and not the vehicle driving the process. There

are two givens when entering into an Ownership transaction for B-BBEE purposes.

Firstly, it must make good business sense. Then it must withstand the scrutiny of a

B-BBEE Verification and an investigation by the B-BBEE Commission, if necessary.

The Codes of Good Practice (Codes) in four paragraphs provide for ‘Options and

Share Warrants’, a lesser-known Ownership vehicle. The structure affords future

shareholding by allowing both an organisation and a buyer, in B-BBEE terms

a ‘Black’ Participant, the opportunity to assess a partnership’s feasibility and

success before officially entering into a share transaction. Start-up Enterprises

commonly use the ‘Options and Share Warrants’ avenue during their investor

rounds or in the case of acquiring a Large Enterprise.

In this article, I will unpack the requirements for claiming Ownership Points

under ‘Options and Share Warrants’, beginning with the applicable definitions

from Schedule 1.

Deemed Value is a crucial component of the ‘Net Value’ Transfer Calculation. Formula A and Formula B determine the difference between

‘Net Value’, and ‘Economic Interest’ calculate as follows:

Formula A

A = B x (1/(25% x C)) x

It incorporates the graduation factor, which evaluates the debt

settlement over no more than ten years.

Where:

A = ‘Net Value’ in the hands of ‘Black’ Participants;

B = The Deemed Value for all ‘Black’ Participants in the

Measured Entity (refer to Formula 3 in Statement 000);

C = The Time-based Graduation Factor of the Economic

Interest compliance target.

Formula B

A = B/C x 8

Determines the percentage of ‘Economic Interest’ of ‘Black’

Participants as a percentage of the Ownership target.

Where:

A = is the result of ‘Net Value’ Transfer Calculation;

B = is the percentage ‘Economic Interest’ in an organisation

consisting of ‘Black’ Participants;

C = is the target for the Ownership indicator for ‘Net Value’

Transfer Calculation (currently at 25%)

To demonstrate how the Codes provide for ‘Options and Share Warrants’, the process will be

illustrated through scenarios using:

ABC Traders, a Large Enterprise with a Status Level 3 and 110% Preferential Procurement Recognition. In 2017 it was valued using a

‘Standard Valuation’ method at R10m. In 2022, a re-evaluation using the same methodology set the value at R15m.

What are the rules that apply to ‘Options and Share Warrants’?

The rules applicable for claiming points are under Statement 100, paragraph 3.13:

> The Ownership Scorecard recognises ‘Exercisable Voting Rights’ and ‘Economic Interest’ if a ‘Black’ Participant holds an ‘Equity

Instrument’ or partly until a future date but within a specific time frame. However, it is on the provision that a ‘Black’ Participant has the

first right to the agreed shareholding or a portion thereof at that future date, taking into account the agreed option period.

In 2017, ABC Traders identified a ‘Black’ Participant to acquire a 51% stake in the business with a five-year option period. All parties

agreed that during, or at the end of the option period, the ‘Black’ Participant had the first right of acquisition to the said 51% stake.

From the transaction date and throughout that period, the ‘Black’ Participant will hold 51% of the ‘Exercisable Voting Rights’ and gain

‘Economic Interest’ until the option period expires.

ABC Traders applies the ‘Standard’ Valuation’ methodology using the Discounted Cash Flow (DCF) method to determine that a 100%

stake in the business is R10m. ABC Traders secures the transaction through an agreement with the ‘Black’ Participant for a 51% stake

in the business for R5.1m over five years.

Following the agreement, the ‘Black’ Participant is entitled to dividend payments and/or associated wealth once ABC Traders declares

them. Furthermore, the ‘Black’ Participant has the right to vote at the same level as all shareholders.

Note

> ‘Exercisable Voting Rights’ are not ‘Voting Rights’. The

difference between the definitions is that ‘Exercisable Voting

Rights’ refer to ‘Voting Rights’ that are not subject to any limit,

meaning a ‘Black’ Participant has no restrictions or limitations

when voting.

> The ‘Voting Rights’ associated with an ‘Equity Instrument’

must transfer to a ‘Black’ Participant for the duration of the

option period.

> The ‘Equity Instrument’ must irrevocably transfer the value

of ‘Economic Interest’ to a ‘Black’ Participant for the option

period. They must receive the 'Economic Interest' linked to

‘Economic Interest’ due to them, like any other shareholder.

> ‘Economic Interest’ can be in the form of dividends or

associated wealth for five years, even if the period extends

over the share option period.

> The ‘Equity Instrument’ value must be determined using a

‘Standard Valuation’ method that calculates ‘Net Value’.

Annually, on the date of measurement, a B-BBEE Rating Agency

must ascertain whether an organisation met the objectives outlined

in paragraph 3.13, statement 100 in the Codes:

“3.13.1 ‘Exercisable Voting Rights’ and Economic Interest will

be recognised where a Participant holds an instrument

granting the holder the right to acquire an ‘Equity

Instrument’ or part thereof at a future date, providing the

following requirements are met:

3.13.2 The Exercisable Voting Rights attached to that instrument

are irrevocably transferred to the holder for the option

period and are exercisable by the holder before acquiring

the Equity Instrument;

3.13.3 The value of ‘Economic Interest’ is irrevocably transferred for

the option period and paid to the holder of that instrument

before the exercise of that right;

3.13.4 The value of an instrument must be determined by using a

‘Standard Valuation’ method for calculating the ‘Net Value’.”

How is the value of an ‘Equity Instrument’

determined?

A vital part of any ownership transaction is the ‘Equity Instrument’

valuation before entering into a transaction. The ‘Standard

Valuation’ methodology determines a fair market value that will

establish the acquisition price. A valuation is necessary year on-year from the transaction date, determining the outstanding

‘Acquisition Debt’ of the ‘Black’ Participant. The ‘Equity

Instruments’ value determination must reflect whether it is more

or less than the option price presented to the ‘Black’ Participant.

The value of an ‘Equity Instrument’ must be re-established on a

year-on-year basis. Therefore, the value of a transaction on the

transaction date forms the basis for the transaction. However,

although the share price increases, it is subject to the ‘Net Value’

calculation.

There are other methods for establishing the value of an ‘Equity

Instrument’ on the transaction date. However, annual valuations

determine the effective economic growth or value of the ‘Equity

Instrument’ over the total option period. As the base cost

pinpoints the transaction date, with annual reviews, the ‘Black’

Participant can track economic activity from the transaction date,

year on year, to transparently reveal the ‘Economic Interest’ due

to them.

What does it mean to exercise a share

option?

At the end of five years, or at the point where the share option

is exercised, a company re-evaluation will determine the value

of the ‘Equity Instrument’ at that time, again applying the same

‘Standard Valuation’.

The outcome of the year-on-year evaluation of ABC Traders revealed that in 2017 it was valued at R10m. Five years later, applying the

same ‘Standard Valuation’ methodology, its value had increased to R15m, indicating a R5m increase over the five years.

Valuation over five years Initial valuation March 2017 | R10m. Revaluation March 2022 | R15m.

‘Black’ Participant’s 51% stake

in ABC Traders R5.1m R7.65m

Over five years, the value of the 51% stake in ABC Traders increased by R2.55m. However, the 'Black' Participant is entitled to and

receives a return on ownership similar in nature to a dividend right based on the additional R2.55m based on the 2022 valuation.

Following the five-year share option, the ‘Black’ Participant has three choices:

Option 1

Take the R2.55 growth as entitled.

Option 2

Carry the R2.55m against the ‘Acquisition

Debt’.

Option 3

Opts to exit the share option, whereby the

growth of ABC Traders would be payable

If an organisation experiences a decrease in value over the five

years, the inverse will apply. Therefore, a drop in value is essential for

‘Black’ Participants to consider before entering such an agreement.

There are various other ways to determine the value of a business.

Yet, the share options’ commercial requirements must align with the

provisions of paragraph 3.13 of statement 100.

Importantly, the ‘Equity Instrument’, or vehicle an organisation uses

to drive its ownership structures, must be relevant, thus stand the

scrutiny of a B-BBEE Verification in line with the rules set out in

statement 100.

How do Share options relate to different kinds

of structures?

When using different types of legal entities or forms of Ownership as

Option Holders, the relevant structures need to be verified according

to the requirements and rules set out in Code Series 100.

When an Ownership structure includes a Trust, a non-profit

organisation (NPO) and a Pty Ltd that further includes preference

shares or options and share warrants, an organisation must ensure

the relevant legal structures follow the guidelines laid out in

the Codes.

Where a Trust is utilised as a vehicle for an NPO, an Employee Share

Ownership Scheme (ESOP) or a Broad-Based Ownership Scheme

(BBOS), a different set of rules applies in each case as per the

definitions in Schedule 1 of statement 100, which are:

BBOS ESOP NPO

means an

ownership scheme

which meets the

rules set out in

Annexe 100B;

means a worker or

employee scheme

which meets the

rules set out in

Annexe 100C;

means a non-profit

organisation registered

under the Non-Profit

Organisation Act of

1997

In line with statement 100, ABC Traders sets up the following

Ownership vehicles:

‘Across-the board’ a BBOS

‘Workforce’

an ESOP

‘Trustworthy’

an NPO

> If a Trust takes the form of a

BBOS, the measurement will

be against the rules in Annexe

100B and its additional

criteria.

> If a Trust takes the form of an

ESOP, the measurement must

be against the rules in Annexe

100C and its additional

criteria. Additionally, a trust

must meet the rules as per

Annexe 100D.

> NPOs cannot issue

shares, therefore, have no

shareholders. In such a

case, an NPO is measured

according to the rules and the

additional criteria applicable

to an ESOP or BBOS. The

relevant rules are determined

by establishing the mandate

of the NPO.

Step 1

‘Trustworthy’ meets

the definition of 51%

‘Black’-owned.

Step 2

‘Trustworthy’ abides

by the rules governing

Trusts and achieves the

additional applicable

criteria as per Annexe

100(D).

In the instance where the vehicle takes the form of a Pty Limited,

both the ‘Exercisable Voting Rights’ and the ‘Economic Interest’

percentages must accurately reflect and ensure that the definition

‘51% ‘Black’-owned’ is achieved. It is not a given that the

percentage ‘Exercisable Voting Rights’ will equal the percentage

of ‘Economic Interest’. Therefore, ensuring both criteria meet

the percentage requirement is essential. Overlooking this vital

ingredient at the time of a B-BBEE Verification will impact the

overall Ownership calculation.

Organisations entering into Ownership transactions for B-BBEE

purposes must do due diligence and get not only a legal opinion,

but one from a B-BBEE Professional. All parties must ensure

that the transaction aligns with the B-BBEE Act and Codes of

Good Practice.

What are the risks attached to facilitating

an Ownership transaction?

All parties involved in an Ownership transaction for B-BBEE

purposes must familiarise themselves with section 13O(2) and

section 12N(3) of the B-BBEE Act. They set out the offence and

penalty relating to ‘Knowing People’. ‘Knowing People’ are at risk

of imprisonment for up to 12 months. The term means that such

a person knowingly turned a blind eye or should have known that

a claim or initiative did not align with the Code they are measured

on or The B-BBEE Act, which has outlined a ‘Knowing Person’

as follows: a had actual knowledge of that matter; or b was in a position in which the person reasonably ought

to have – i had actual knowledge;

ii investigated the matter to the extent that would have

provided the person with practical knowledge; or

iii taken other measures which, if taken, would reasonably

be expected to have equipped the person with actual

knowledge of the matter.

Who is a ‘Knowing Person’ as outlined in

The B-BBEE Act?

To reiterate, a ‘Knowing Person’ is anyone who knows or should

have known about Fronting Practices, an offence in the B-BBEE

Act. A ‘Knowing Person’ would be at risk of prosecution if they: > Hinder, obstruct or attempt to influence the B-BBEE

Commission in performing its duties;

> Provide false information to the B-BBEE Commission; > Misrepresent or attempt to distort the B-BBEE status of an

organisation;

> Provide false or misrepresented information during a

B-BBEE Audit;

> Are involved in and consented to the implementation of

strategies or initiatives that are a Fronting Practice; and

> Failed to report awareness of suspected offences to the

B-BEE Commission, in the case of a Verification Professional

or other individual.

Who is a ‘Knowing Person’?

A ‘Knowing Person’ is any person who feeds into an

organisation’s B-BBEE Strategy at any level. Moreover, a Board of

Directors is responsible for the management of an organisation.

Their role is to lead an organisation in making strategic and

operational decisions; subsequently, they are liable to ensure

that an organisation meets its statutory obligations, knowingly

or unknowingly, and are ‘Knowing People’. The rationale behind

this is the expectation that Directors have sufficient knowledge

of The B-BBEE Act and Codes applicable to their organisations

to identify and halt the implementation of Fronting Practices by

employees or consultants.

Often organisations are advised against implementing an

initiative suspected of being a Fronting Practice by their B-BBEE

Consultant, Advisor or B-BBEE Rating Agency, but ignore such

advice. It is important to note that any person operating in the

B-BBEE space is legally obligated to report Fronting Practices to

the B-BBEE Commission. Should a B-BBEE Consultant, Advisor

or B-BBEE Rating Agency not report Fronting Practices, they

would be guilty of an offence.

The accountability of a ‘Knowing Person’ remains intact,

irrespective of whether a Director or Employee who is a ‘Knowing

Person’ breaks ties with the organisation in question.

Many Directors, employees and ‘Black’ Participants who feed

an organisation’s B-BBEE Strategy are oblivious of the liability

or the penalties attached to Fronting Practices. The most

common reason is an over-reliance on consultants to drive an

organisation’s B-BBEE Strategy without internal competence.

Organisations have, in the past, generally opted to lean on the

knowledge and ethics of third parties.

Taking poor advice from a third party is not a defence against

Fronting Practice. When it comes down to it, it will not only be

the third party who will be penalised; it will be those directly

involved and all other ‘Knowing Persons’ acting on behalf of an

organisation. To mitigate the risk of taking third-party advice, an

organisation should have at least one ‘Knowing Person’ within

the organisation who is competent in identifying Fronting Practice

risks and adequately questions or investigates them.

Organisations must ensure that ‘Knowing People’ feeding their

B-BBEE Strategy are fully versed in not only The B-BBEE Act,

but The Codes or the relevant Sector Code on which they are

measured, along with all related practice notes and statements

of clarity.