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Why BEE deals fail in SMMEs

08 Oct 2014

Jaco OdendaalMuch has been written about BEE deals in the corporate sector, but very few authors have looked at the reasons for the failure of so many BEE deals in small, medium and micro-sized enterprises (SMMEs).

In 2003, when the Broad-based Economic Empowerment (B-BBEE) Act was promulgated in South Africa, little was known about the requirements for BEE compliancy. The fact that the B-BBEE Codes of Good Practice only came into operation in February 2007, further contributed to the uncertainty, with the result that many companies concluded BEE deals while the industry was still in limbo.

Black ownership alone does not mean that a company is BEE compliant, neither is black ownership a prerequisite for compliance. Black ownership (25%+) contributes between 20 to 25 points, depending on whether the company is a qualifying small enterprise or a generic enterprise. However, 20 to 25 points do not suffice to even obtain Level 8 status, therefore a company with black ownership can still be non-compliant.

Since BEE compliance counts quite substantially toward economic participation in South Africa, having an acceptable contribution status as determined by the Codes of Good Practice, is of the utmost importance. Whether this was the original intention, one can only speculate but the author is of the opinion that this might not have been the case. Indeed, the Amended Codes of Good Practice seem to place more emphasis on black ownership.

So why do many BEE deals in the SMME sector fail? A study of one particular deal has identified the main contributors to failure:

The lack of understanding that black ownership alone is not sufficient.
As discussed above, more than mere black ownership is required to become a truly empowered entity. In the case study the deal was brokered and everybody was happy that it would be enough. However, eight years later there was still no real economic benefit for the ultimate beneficiaries. This was due to the fact that no real substance had been created in the company and no plans had been implemented to ensure that the remaining six elements, as prescribed by the Codes, also received attention.

Retention of control by the original white owner.
Even though it might never have been the intention, the original white owner often retains control of the empowerment entity under the guise of guidance and skills transfer. In this particular case study, the guidance and skills transfer had been going on for eight years. This begs the question: when will the black management staff be allowed to be true managers? The natural result is that they may feel marginalised. This does not contribute to a feeling of empowerment!

Black empowered shareholders vs so-called black new entrants.
It is common for affluent blacks, or consortiums of blacks, to become shareholders of empowerment entities. This is often done in conjunction with black new entrants who also become shareholders. In most cases the black new entrants are employees of the empowerment entity. It is quite obvious that the views and expectations of the two groups will differ substantially. Generally speaking, the "already empowered" shareholders will be mere shareholders who require good return on investment and little more; while the employees, who have not yet experienced the fruits of empowerment, will be looking to become more involved in the day-to-day operation of the company.

Contrasting views may lead to conflict, and where shareholders are conflicted, SMME businesses suffer. New entrants will often be dominated by the other group merely as a result of the lack of experience.

Directors of the empowerment entity do not act in the best interests of the entity, but represent the interests of the shareholder(s) they represent.
The business in the case study had three shareholders, all of them juristic persons. Each shareholder nominated a representative to be appointed on the board of the empowerment entity. As a result, each representative on the board acted on behalf of his/her shareholder instead of acting solely in the interests of the company. Board meetings became very unproductive and were characterized by conflict.

Inefficient governance structures.
A true empowerment entity should have proper governance structures in place. These structures should allow for a distinction between executive and non-executive directors. Executive directors should be given a full mandate by the board to operate the company on a day-to-day basis, while the non-executive directors should provide oversight and strategic guidance. The original white owner should typically be a non-executive director. Further to this, executive directors should be held accountable for their operational decisions. There is no sense in mollycoddling black executives, as it will not do them any favours.

The lack of application of general commercial principles.
A concerning phenomenon of BEE deals in the SMME sector is that they sometimes lack commercial substance. Some arrangements are artificial at best. Although some of these arrangements can be seen as fronting, it may not necessarily be the intention of the parties involved. In the case study, the parties entered into an arrangement where the empowerment entity merely received a portion of the income generated by the group (of which the empowerment company forms part). The intention seems to have been to provide shareholders with value in the company while protecting it from general commercial risks. Although some value was created, the arrangement was not sustainable and nobody was truly empowered. Only when the empowerment entity is operated on commercial terms, which entails dealing with business risks, will it benefit the people it seeks to empower.

Ignorance of legislation impacts on the business of the empowered entity.
A significant challenge is the lack of knowledge regarding legislation that applies to the general business environment. Small businesses find it increasingly difficult to keep up with all the laws being passed by government. Even though an empowerment entity may have a good operational business, non-compliance with applicable legislation will put the entity at risk.

The above-mentioned points are not an exhaustive list of things that can go wrong, but have contributed substantially to the failure of initiatives that seemed like ‘a good idea at the time’.

BEE should be supported by all businesses in South Africa because it will contribute to sustainability, and simply because it’s the right thing to do. However, every BEE deal should be carefully planned and executed. Failing this, a lot of effort will go to waste without value or benefit accruing to anybody.

Jaco Odendaal is the Managing Director of Exceed Tax and Advisory (Pty) Ltd and specialises in B-BBEE, corporate advisory and corporate tax services. For more information, contact him on tel 021 882 8140 or 010 125 0230

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