Black economic empowerment is often identified as a hold-all reason for the multiple challenges facing small businesses, and is blamed for everything from the inability to access capital and government tenders, to the problems of hiring staff.
But smart entrepreneurs, having realised that BEE can provide their business with a real competitive edge, are using it to great effect. In an increasingly competitive business environment, entrepreneurs should be on the look-out for anything that can provide them with even the smallest degree of differentiation, and those that get BEE right know it can be made to work for their businesses.
Understanding the codes
The government’s stated purpose in implementing broad-based black economic empowerment is to ensure that a more representative portion of the population can reap the benefits of involvement in the economy, thereby addressing the past economic imbalances brought about during Apartheid.
While BEE has in some instances developed a poor reputation for benefiting a few privileged individuals, there is an increased focus on ensuring that it impacts a broader cross-section of the historically disadvantaged community – hence the shift from Black Economic Empowerment (BEE) to Broad-Based Black Economic Empowerment (B-BBEE). (For the purposes of this article, BEE can be taken to imply B-BBEE).
There are seven elements of the Department of Trade and Industry’s Broad-Based Black Economic Empowerment Codes of Good Practice (commonly known as the codes). Companies are scored on their performance in implementing each element, or a combination of elements.
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The seven elements of the codes
1. Ownership: measures the equity that black people hold in the business according to their voting rights, economic interest (including entitlement to dividends, capital gains and other rights of shareholders) and realisation points (the accumulation of net economic interest in the hands of black shareholders).
2. Management Control: measures the extent to which black employees participate at the Board level and are employed in senior management positions.
3. Employment Equity: measures the percentage of black staff employed in the business. On the QSE scorecard a distinction is made between black managers and black employees, while on the Generic Scorecard only black senior, middle and junior management employees count.
4. Skills Development: measures the extent to which the company has invested in the development of skills among black employees. It is split between skills and training, and learnerships.
5. Preferential Procurement: this element measures the extent to which a company uses the services of black-owned or BEE compliant businesses, and is based on the empowerment level of a business’s suppliers.
6. Enterprise Development: this element is aimed at developed small, black-owned enterprises. Beneficiaries must meet certain black-owned or size criteria.
7. Socio Economic Development: measures the investment that a company makes in uplifting black individuals, communities or groups, mostly through charitable means.
Contrary to a commonly-held belief, BEE is not only relevant to big corporates or black-owned businesses. In fact, the codes take cognizance of the role that small to medium enterprises play in the economy and make provisions for their needs.
The codes differentiate between businesses of different sizes and there are different scorecards for Exempt Micro Enterprises (EMEs), Qualifying Small Enterprises (QSEs) and Generic Enterprises.
- Exempt Micro Enterprises (EMEs)
Businesses with a turnover of less than R5 million a year are automatically exempt from BEE requirements. They are automatically deemed to be a Level 4 Contributor if they are less than 50% black-owned or a Level 3 contributor if they are more than 50% black-owned. Start-up businesses are treated as EMEs for the first year following their formation, regardless of their expected total revenue. (EMEs that wish to tender for government contracts of between R5 million and R35 million will, however, need to use the QSE or Generic scorecard.)
- Qualifying Small Enterprises (QSEs)
QSEs are organisations whose annual turnover is between R5 million and R35 million. The dti has developed a BEE scorecard specifically for QSEs whereby each of the seven codes is weighted equally at 25 points. QSEs are then given the option of selecting any four of the seven codes on which to comply in order to achieve their requisite 100 points.
This addresses one of the most common BEE concerns that entrepreneurs have, namely the (incorrect) perception that you have to ‘give away’ shares in a company in which you’ve invested everything. It makes BEE more accessible and manageable for SMEs, and because all codes are given equal weighting, gives you maximum recognition for any investment your company might make. For instance, QSEs can earn a full 25 points for their investment in socio-economic development (commonly known as corporate social investment or CSI) projects, whereas larger companies that are scored using the Generic Scorecard can earn a maximum of five points for such activities.
- Generic Enterprises
Generic Enterprises are those with an annual turnover in excess of R35 million. Their scorecard differs significantly from the QSE scorecard as they have to report on all seven codes in order to assess their BEE status, and codes are weighted differently according to their perceived importance in furthering broad-based black economic empowerment in the country.
The weighting of the various dti code elements for each group of enterprises is detailed in the table that follows:
Contribution levels and BEE verification
A verification certificate provides other businesses with assurance of your BEE status, and is imperative if they want to claim BEE points for having conducted business with your company.
EMEs can be assessed by a BEE verification agency, an auditor or an accounting officer but auditing firms need to be accredited by the Independent Regulatory Body for Auditors (IRBA) to conduct BEE verifications and issue BEE certificates. For QSEs and Generic Enterprises BEE verification should be done by a recognised BEE verification agency. They will conduct an independent BEE audit on your company. Strict rules govern the conduct of these agencies and it’s best to select one that has achieved accreditation with the South African National Standards (SANAS).
The number of points you score for each element will determine your BEE contribution level. The lower the contributer level, the more compliant the business – in other words a Level 1 contributor is the most BEE compliant with a Level 8 contributor being close to non-compliant.
Thinking differently – how BEE can benefit your business
When entrepreneurs understand that BEE can actually deliver benefits to their business, or that they can earn BEE points for investments that they are already making, it often brings about a shift in their negative perceptions of black economic empowerment.
So instead of feeling resentful about ‘yet another hindrance that government has placed in the way of small business’, consider how you can use the legislation to your advantage. There are many benefits to be derived from a strong BEE status, in addition to the obvious one of putting your company in line to win tenders and contracts.
For example small businesses can use the Enterprise Development (ED) code to access mentorship and investment from big business. Becoming BEE compliant and making your business an attractive ED investment can open up doors to immensely beneficial partnerships with big businesses. A number of savvy would-be start-ups featured in various issues of Entrepreneur magazine have accessed capital, equipment, mentorship and business deals from large organisations looking to earn ED points.
Similarly, the Preferential Procurement code can enable your small business to join the procurement database of a range of large corporates, something that’s considerably more difficult to achieve without the leverage of BEE.
An investment in skills development will provide your business with multiple long-term benefits while earning you BEE points, and involvement in community and social upliftment projects can boost your brand and build morale and loyalty among staff. Programmes that fast-track the development of black employees into management positions can widen your network of business contacts and provide you with access to a broader market.
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The ins and outs of ESOPs
Thinking of implementing an Employee Share Ownership Programme? Here are some important points to consider.
Barnstone Corporate Services provides consulting services and advice to large corporate organisations and has been instrumental in helping some of the country’s biggest blue-chip companies to implement Employee Share Ownership Programmes (ESOPs) worth billions of rands. The company also has valuable advice to offer small businesses that are considering ESOPs as part of their BEE principles. “The following principles may be useful for any organisation considering implementing an ESOP,” says James Steere, manager in the company’s Executive Advisory Services unit.
He offers the following insight on some important considerations when implementing an ESOP:
1. Understand why
You need to understand why you are implementing an ESOP. If it is for BEE purposes, you need to understand how your business is classified by the BEE codes (as an EME, QSE or Generic Enterprise).
Consult with a BEE rating agency to establish what the scheme would have to achieve in order to improve your rating. You need to know what percentage of the company would have to be owned through an ESOP structure and whether the employee demographic is suitable. If your company is made up entirely of white males, an ESOP obviously won’t benefit you on the BEE front but you might still want to consider it as a tool for aligning employee and shareholder interests. Similarly, if you are a QSE an ESOP would only give you a maximum of 40% of the available score on the ownership element, so just doing an ESOP may not be enough if you fall short on the other elements.
Another important consideration is whether you want different employees to benefit in different ways. For example, will length of service in the company or job grade form part of the evaluation in determining how employees will benefit.
Understanding why you are implementing the ESOP is an essential first step as it guides the choice you make about the preferred structure and how best to implement it.
Your second step is to select a suitable legal structure in which to house the ESOP. Remember that however well intentioned an ESOP may be, employees face the same financial pressures as we all do, and they might simply sell any shares that they are given in the company. This would render the ESOP fairly meaningless.
To get around this, the preferred ESOP structure is a trust, with employees as the beneficiaries. This allows for benefits from share ownership to accrue to employees over a period of time whilst limiting the ultimate control that employees have over the shares. It also allows for new joiners to the company to be included as beneficiaries and for people who leave the company to forfeit part or all of their benefits under the ESOP.
Typically, the company provides a low-interest loan to the trust with which it acquires a block of shares in the company. This loan is then paid back over time from the dividends accruing to those shares now owned by the trust. The balance of the dividend stream due to the trust after each loan payment is then paid out to trust beneficiaries and/or reinvested in the trust. After a defined period of time (usually a ten-year lock-in period) – provided the loan has been settled – the shares are allocated to the employees who can then sell them or keep them.
In this way, the interests of employees are aligned to those of the shareholders and managers because if the company is more profitable, everyone benefits.
It’s extremely important that you take the time to actively communicate to employees and other key stakeholders so that their expectations are managed and they understand and support the transaction. Some important communcation considerations:
- Don’t assume that people understand the basic concepts such as share ownership, trust structures and dividends. You will need to invest in an accessible education campaign that helps them understand all aspects of the ESOP. Create a forum for discussion and debate. It doesn’t have to be a masterpiece of communication – but the worst thing to do is rely on informal discussion of these concepts and structures outside of work. This typically creates unrealistic expectation about the benefits. If possible, conduct two or more engagement sessions with your employees at different times. People will often listen through a presentation and only later come up with a question. Repeated discussions help to build trust in the process.
- Don’t shy away from the difficult conversations. If you need to allocate different beneficiary rights or values to different employees, explain why this is necessary and take it on the chin if people are angry. The only mistake you can make here is to ignore a problem – get stuck in and let people vent if they need to. Provided your reasons for setting up the ESOP as you are are fair, employees will generally understand even if they don’t agree.
- If you are in a unionised industry, proactively engage with unions but ideally create the understanding that the ESOP is not up for negotiation. Rather it is a structure to be presented and discussed. Ultimately the company shareholders will decide if and how it is established. If the structure is patently unfair, the Union representatives are likely to object so make sure that it works.
- Get a good tax consultant/auditor/lawyer – this is not a conventional commercial transaction so you need to be careful about how it’s accounted. There are tax implications and legal documents that need to be carefully drafted. If it’s a big transaction you’ll probably need support from a banking team to guide you on the best financing options.
- When selecting trustees, the first priority has to be that they function as a group. Don’t elect trustees simply because they are prominent individuals or well liked. The role of the trustee is critical in ensuring the proper functioning of the trust over a long period of time.
- Make sure that the structure is well supported and that there’s someone in the company whose job it is to oversee the ESOP. These things go on for a long time and need internal day-to-day processes to make sure that as employees leave or join, ESOP records are appropriately maintained.