The ownership element remains one of the most significant contributors to a company’s broad- based black economic empowerment (BEE) scorecard. Under the generic Codes of Good Practice on Broad-Based Black Economic Empowerment (BEE Codes), ownership covers three main sub-components:

  • exercisable voting rights;
  • economic interest (being a right akin to dividends); and
  • net value (i.e. the value of shares net of liabilities used to acquire them).  

Given this underlying regime, structuring ownership transactions calls for careful attention where preference shares are used, because their legal form may affect how they are treated for BEE purposes.

The general rule for preference shares

Preference shares are a class of share capital which typically carry rights different from ordinary equity, for example a priority right to dividends, priority in liquidation, possibly limited or no voting rights, and sometimes redemption or convertibility features.  As a general rule, preference shares are not taken into account when determining BEE ownership credentials because they are considered debt instruments. The Companies Act does not refer to “preference shares”.  It refers to classes of shares having “preferences, rights, limitations and other terms” so there is no closed list of what can be done.

However, this is only a general rule. 

The exception as the rule

Increasingly we are seeing shares called “preference shares” purporting to be excluded from BEE ownership calculations on the basis of that name alone. But, when the actual terms of the shares are interrogated more closely, the core characteristics of the shares are not that of debt but that of equity.

The draft amended BEE verification manual of 2015 states at paragraph 6.4.3 that before the verification agent continues with procedures to verify occurrence, accuracy, classification and validity of the entity’s score, the verification agent must confirm “if or not the equity held by Black People has the characteristic of debt or whether or not debt has been presented in the form of preference shares, debentures or other ownership derivatives”.  Paragraph 6.5 further states that the verification agent “needs to identify all rights of ownership that may have an impact on the value attributable to black participants. These may include various types or classes of equity instruments, e.g. ordinary shares, preference shares, options and/or other derivatives”.

Accordingly, despite the name given to a class of shares being “preference shares”:

  • if the shares have characteristics like a fixed return akin to interest, limited or no voting rights, a mandatory redemption date, or have been issued in return for funds provided, the shares would have characteristics of debt and would likely be excluded from a BEE ownership calculation; whereas
  • if the shares have characteristics like participating in dividends beyond a fixed return, carry significant voting rights (or conversion rights into ordinary shares), and are not mandatorily redeemable, or are not in return for funding provided, the shares would have characteristics of equity and would likely be included into a BEE ownership calculation.

The better rule would be that so-called preference shares do not automatically count as ordinary equity for BEE ownership calculation; each instrument needs to be assessed on its rights and risk profile relative to the ordinary shares.

Structuring and practical considerations

The following considerations should be kept in mind when considering the use of preference shares rights by any name in a BEE ownership structure:

  1. Is it intended that the preference shares will be counted towards or excluded from the BEE ownership calculations?
  2. Carefully design and consider the rights of the preference shares to align with the intended calculation outcome.
  3. Assess whether preference shares would be considered as part of the debt incurred by the BEE partner in the acquisition of their shares.
  4. Record and support the “equity-like” or “debt-like” nature of the preference shares (for example a legal opinion or competent persons report).
  5. Maintain evidence of the rights and risk of loss associated with the preference shares, and the exercise of those rights and risks.
  6. Be aware of the risks of a misrepresentation of the correct nature of preference shares – specifically claiming that it is debt and should be excluded from BEE ownership calculations.
  7. Have the proposed preference share terms reviewed for confirmation that they would or would not be included from a BEE ownership calculation, and if they would be considered as part of the debt incurred by the BEE partner in the acquisition of their shares.