The economic implications of the 2019 novel coronavirus disease (COVID-19) pandemic in South Africa and globally, coupled with the pre-existing lack of growth in the South African economy, have significantly slowed deal making and fundraising. Much of the capital invested is in follow-on transactions, restructuring and recapitalisations. South African general partners (GPs) usually look to raise and deploy funds with a wider African mandate to access growth markets outside South Africa with a South African base, however, the lockdowns and travel restrictions triggered by the pandemic have presented both financial and practical obstacles for GPs looking to raise and deploy funds.

The economic cycle has created opportunities for private equity (PE) players to pursue public to private transactions and to acquire businesses or divisions of listed groups needing to rationalise and pay down debt, and we have seen a number of these transactions in recent times. The telecommunications infrastructure space has been a bright spot with significant deal activity.

The pandemic and its economic impact has had a substantial effect on PE portfolio companies, with knock on effects to PE funds and the industry that will play out over some time.

Fundraising efforts have been inhibited by the liquidity constraints caused by the pandemic and the negative economic outlook in South Africa, coupled with the robust returns achieved by PE funds in developed markets in recent years. However, funds have continued to be raised, including a number of specialist or sector-focused funds, for example in renewables, technology, Broad-Based Black Economic Empowerment (B-BBEE) and others.

Based on the value invested, the bulk of PE investments are made into established businesses in buyout and similar transactions, however significant growth and expansion capital has been invested in the telecommunications infrastructure sector. Significant funds have been raised and invested in renewable energy projects, including projects within the South African Government's independent power producer programme.

However, the funding available to be invested in early stage companies, as well as small, medium and micro enterprises (SMMEs) (including through venture capital (VC) and impact funds), has continued to grow, not least through the allocations by the SA SME Fund (that is, a fund of funds that allocates capital to fund managers, focusing on VC and growth oriented funds).

PE and VC funds have played a role in funding infrastructure and businesses in the COVID-19 environment, where lenders have become more stringent in their lending requirements.

Initially, the COVID-19 crisis caused a significant halt in deal activity as PE funds focused on managing liquidity issues across portfolios, and this has continued to lead to restructuring and refinancing activity in distressed portfolio companies. Since then, the South African market has experienced a steady increase in PE transactions, however in general activity levels have remained somewhat depressed. There have been a number of "take privates" of Johannesburg Stock Exchange (JSE)-listed companies by PE funds over the past three years, and this trend may well continue in 2023 and beyond.

The renewable energy field continues to see significant activity, including secondary sales of existing project assets. Much of the deal flow that would typically have been generated by the maturing of current fund vintages, has been deferred given economic conditions, and these transactions will likely come back to the table in the next two to three years.

There is a well-established market practice of exits by managed auction processes, culminating in sales to trade or financial buyers (including secondary transactions to other PE funds). Exits by way of listing/initial public offering (IPO) have been rare. Exit activity in 2020 was largely put on hold given the pandemic and economic conditions, however we expect to see activity come back, particularly in sectors or portfolio companies that were able to perform in 2020, which resilience may attract a premium. Businesses are now also strengthened by management teams who are more experienced now than they were last year in managing the effects of the COVID-19 pandemic. There have also been several good practices, for example around liquidity management, that will be entrenched and stand companies in good stead going forward.

Limited partnerships are often used for private equity investments (see Question 6 for the applicable tax principles). Venture capital investments are commonly through companies (see Question 7 for the applicable tax principles, and Question 4 for incentives).

The key difference between PE and VC is the form of investment and stage/type of company in which the investment takes place. PE investments are typically made in mature or well established businesses with established profit and cash flow profiles. VC investments target start-up or young businesses with high growth potential, and usually provide growth capital. The tech sector is a particular focus for VC funds given low capital requirements and high scalability.

The typical investors in PE funds are (figures based on the 2020 Private Equity Report published by the Southern African Venture Capital and Private Equity Association (SAVCA) showing figures for 2019):

The total funds raised increased by 69% in 2019 (ZAR21.7 billion), compared to the ZAR12.8 billion raised in 2018, broken down as follows:

Of these investments, and based on the same figures, 64.7% of funding was raised from a non-South African source, and the balance of 35.3% locally.

To improve the country’s competitiveness, reduce the appeal of base erosion and profit shifting, encourage investment and promote economic growth, in the 2020 Budget Review the then Minister of Finance announced the government’s intention to restructure the corporate income tax system over the medium term by broadening the base and reducing the corporate income tax rate in a revenue neutral manner.

The overarching policy goal for reforming corporate income tax is to create a tax policy environment that is conducive to broad‐based economic growth and that avoids complicated incentives for specific sectors or groups of taxpayers. The corporate income tax rate will, therefore, be reduced from 28% to 27% for companies with tax assessment years commencing on or after 1 April 2022.

One of the incentives for specific sectors or groups of taxpayers aimed at investments in unlisted companies is the Venture Capital Company (VCC) tax incentive regime which encourages equity funding to SMMEs. The regime (set out in section 12J of the Income Tax Act) allows a taxpayer to benefit from a tax deduction in respect of 100% of any expenditure actually incurred by a taxpayer in acquiring shares issued to that taxpayer by a VCC. The VCC would then apply the funding raised to make investments in companies meeting certain criteria.

The VCC tax incentive ceased to apply after 30 June 2021. The discontinuation of the VCC tax incentive does not affect qualifying investments made before the sunset date. Further, VCC shares acquired before 30 June 2021 by qualifying investors will not have a recoupment of their upfront investment if such VCC shares are held for at least five years since their acquisition.

Private equity funds are usually structured as fiscally transparent vehicles (that is, there is no taxation at entity level) to avoid the increased taxes associated with investing through companies. This is in the form of en commandite partnerships, vesting trusts or bewind trusts:

For funds that have a cross-jurisdictional investment mandate, the funds are frequently structured as partnerships or collective investment scheme structures in Mauritius. Where there are South African investors in such a fund, a dual structure is usually used, involving two parallel legal structures that co-invest, one based in South Africa for the South African investors and one based in Mauritius for the non-South African investors. This is typically driven by exchange control limitations.

Partnerships are fiscally transparent and, accordingly, the individual partners are taxed separately on their partnership profits. In addition, another attractive feature of a partnership is that the definition of "permanent establishment" in the Income Tax Act includes a carve out for "qualifying investors" who invest passively through South African and foreign partnerships as limited partners without being actively involved in managing the partnership.

In a vesting trust, provided that income or capital gains are vested in the beneficiaries, theythe beneficiarie will be taxed in their own hands.

The beneficiaries of a bewind trust are owners of the assets held by the trust and are taxed as such. That is, income and capital gains received by the trust are deemed to be received by or accrued by the beneficiaries, and expenditure is allocated in the same manner.

South African companies are generally not favoured as traditional PE vehicles, because they are subject to income tax at a rate of 28% (reducing to 27% for companies with years of assessment commencing on or after 1 April 2022) and capital gains tax at an effective rate of 22.4% (reducing to an effective rate of 21.6% for companies with years of assessment commencing on or after 1 April 2022). In addition, dividends to shareholders would attract dividends withholding tax at a rate of 20% (unless exempt or reduced under a double taxation treaty). Accordingly, en commandite partnership structures (see Question 5) are generally preferred.

The average lifespan of a fund is usually between seven to ten years. The lifespan of funds that invest in infrastructure, energy and related sectors tends to be longer.

The investment objectives of PE funds are to give long term unlimited equity positions for investors where portfolio companies can be guided to growth, as well as to return attractive yields to investors over the fund's lifecycle. Each fund has differentiated investment objectives, depending on the geographical focus, industry preference, asset limitations, and general environmental and social governance requirements.

Private equity funds are not regulated, but service providers such as PE fund managers are subject to South Africa legislation. Fund management services are subject to regulation under:

Due to the FAIS Act's broad definition of "intermediary services", fund administrators must obtain authorisation from the FSCA to provide non-discretionary intermediary services (Category I licence) or use aggregated investment and disinvestment orders (Category III licence) (FAIS Act).

A PE fund manager requires a Category I licence or a Category II licence (to provide discretionary investment management services with regards to financial products), depending on whether it formally acts as an adviser to a PE fund or is responsible for the exercise of investment discretion on behalf of the PE fund. However, if the licensing requirements of the foreign regulator where the foreign PE fund manager is domiciled are at a standard that the FSCA in South Africa regards as sufficiently high, the foreign financial services providers and their compliance officers may be able to obtain exemptions from compliance with certain South African requirements. There are detailed restrictions and disclosure requirements relating to fees and remuneration in the conflict of interest and other provisions of the General Code of Conduct for Authorised Financial Services Providers under the FAIS Act.

The Conduct of Financial Institutions Bill (COFI Bill), once enacted, will require that, among other things, PE funds be licensed. The COFI Bill aims to improve the regulation of the South African financial sector and streamline the conduct requirements for financial institutions. It is unclear when the COFI Bill will come into effect but estimates suggest it could be about two years.

The Collective Investment Schemes Control Act (CISCA) regulates retail funds. It regulates and controls the administration of collective investment schemes and the promotion of the business or the solicitation of investments in a collective investment scheme in South Africa.

If the fund is structured as a company, the promoters must comply with the applicable provisions of the Companies Act, including the provisions regulating offers to the public. If investments in these companies are to be offered to the public, then a prospectus is required. However, it is generally possible to avoid an offer to the public by marketing to specific investors or to rely on an exemption, for example by applying a minimum investment requirement of ZAR1 million.

Other forms of PE funds themselves are not regulated. However, the marketing of financial products to the South African public can only be performed by persons holding the required licence under the FAIS Act. The FSCA must approve foreign collective investment schemes that market to the South African public, and a South African collective investment scheme must register under CISCA to enable it to market to the South African public.

The FSCA has exempted PE funds that are members of the SAVCA from regulation under CISCA, provided that SAVCA members do not market their funds to members of the public.

South African pension funds are permitted to invest up to 10% of their assets into unlisted alternative assets, including PE funds (Regulation 28, Pensions Funds Act).

Private equity funds are unregulated and any limits on maximum or minimum investment periods, amounts or transfers of investments are therefore regulated under the fund's constitutional documents.

A PE fund is governed by its constitutional document (that is, a partnership agreement or a trust deed).

Investors typically seek to negotiate the following protections:

Typically, the equity capital structure in a PE transaction consists of a combination of shareholder loans, preference shares and ordinary share capital, often with a relatively small pure equity (ordinary share) component. Convertible and debt structures are not common in PE transactions in South Africa.

All layers of shareholder capital are likely to be subordinated to bank debt and seen as shareholder equity to that extent, and the capital structure is generally designed with tax efficiency in mind (that is, to obtain interest deductibility on funding used to acquire productive assets or expenditure in the production of income, and minimise withholding taxes when capital is returned to investors). Fixed return instruments (loans or preference shares) can also be used to subsidise management or a management vehicle.

Although convertible instruments are not commonly used by PE funds in South Africa, they can be used and would take the form of debt that is convertible into shares in the company after a period of time or based on particular events. Advantages of convertible instruments include:

Pure debt instruments are not typical for PE transactions in South Africa and mezzanine instruments have not been a common feature of PE transactions in recent years but are seen in African transactions.

A private company cannot offer its securities to the public and must restrict their transferability (Companies Act).

All shareholders in a private company have a statutory pre-emptive right (which may be negated, limited or restricted in the company's memorandum of incorporation) to be offered and subscribe for a pro rata portion of any shares to be issued by the company, before they are issued to third parties. This statutory right is customarily excluded and replaced with a contractually agreed pre-emptive right on the issue of shares.

In addition, a private company's shareholders' agreement and/or memorandum of incorporation (the primary constitutional document) will customarily provide a right of first refusal or right of first offer in favour of the other shareholders (pro rata to their current shareholding in the company), which would satisfy the Companies Act requirement to restrict transferability.

South African residents are (subject to certain exemptions) taxed on their worldwide income, while non-residents are only taxed on South African-sourced income (subject to the provisions of any relevant double taxation agreements (tax treaties)).

Income tax: South African companies are subject to an income tax rate of 28% (27% for companies with years of assessment commencing on or after 1 April 2022), trusts an income tax rate of 45% and South African individuals a marginal tax rate of up to 45%. A summary of the individual tax rates for the period 1 March 2022 to 28 February 2023 is set out below:

Companies and trusts must include 80% of their capital gains in their taxable income, whereas individuals must include 40% of their capital gains in their taxable income. This results in the maximum effective CGT tax rate of:

Non-South African residents are only subject to South African CGT on any disposal of immovable property, or an interest or right in immovable property, situated in South Africa or if the assets disposed of are attributable to a permanent establishment of the non-resident in South Africa.

Certain exemptions may apply to the disposal of foreign equity shares where the shareholding is more than 10%. There are also "dividend stripping" provisions which may recharacterise otherwise exempt income as capital gains proceeds.

Withholding taxes. South Africa levies dividends withholding tax at a rate of 20%, unless exempt (dividends to South African corporates are exempt) or reduced under a double taxation treaty. Interest withholding tax and royalties withholding tax are levied on payments of interest and royalties to non-residents at a rate 15% in the absence of any tax relief under a tax treaty.

Tax treaties. South Africa has a large treaty network, particularly with many African countries including Botswana, Democratic Republic of Congo, Egypt, Ghana, Kenya, Nigeria, Tanzania, Mauritius, Mozambique, Namibia, Rwanda, and Zambia. Other tax treaties include Australia, the United States of America, the United Kingdom, the Netherlands, Switzerland, the United Arab Emirates, China, Singapore, and Hong Kong.

Securities transfer tax. This is levied on the transfer of shares, at a rate of 0.25% of the higher of the market value of the shares or the consideration paid.

It is common for PE exits to take place by auction, and companies can also conduct auctions to dispose of particular businesses or divisions. No specific legislation governs auction processes, but as with any M&A transaction, the resultant transaction is subject to:

Public-to-private transactions are common in South Africa, and a number have taken place in recent years. Generally, public-to-private transactions are implemented by way of a scheme of arrangement proposed by the target's board of directors between the shareholders of the target (section 114, Companies Act). In addition, Chapter 5 of the Companies Act and the Takeover Regulations apply to the approach and offer process, and for companies listed on the JSE, the provisions of the JSE Listings Requirements must be complied with.

The principal documents are:

There will likely also be a shareholders' agreement regulating the shareholding in the target (or the acquiring entity), and particularly the arrangements between the acquirer and management, post-acquisition.

The principal documents are:

The sellers provide contractual protections such as warranties and indemnities to the PE acquirer. However, the warranties and indemnities are provided for a limited:

In South Africa it is customary for PE sellers to provide warranties, and sellers are increasingly requiring warranty and indemnity insurance to be part of the sale package, allowing the purchaser to claim against an insurer for any breach under an insured warranty and/or indemnity, and not the fund, limiting the fund's contingent liabilities.

In addition, PE acquirers can require that:

In a public-to-private transaction, warranties are generally not obtained as the acquirer is acquiring its shares from public shareholders.

The key portfolio company managers generally serve on the board of the portfolio company and accordingly are subject to common law and statutory duties including a duty of care, skill and diligence, and fiduciary duties. The duties are owed to the company (that is, the body of shareholders as a whole).

Under South African employment law, an employee cannot be forced to continue their employment after an MBO. Therefore, key protections sought in an MBO are:

The right financial incentives and alignment are therefore key.

The governance arrangements in respect of a portfolio company are contained in its shareholders' agreement and memorandum of incorporation. While the shareholders' agreement is a private contract between the shareholders, and between the shareholders and the portfolio company, any inconsistency between the shareholders' agreement and the memorandum of incorporation results in the memorandum of incorporation superseding the shareholders' agreement. The memorandum of incorporation must therefore be aligned with the shareholders' agreement. The memorandum of incorporation must be lodged with the Companies and Intellectual Property Commission and is a public document.

The shareholders' agreement and memorandum of incorporation set out, at a minimum:

The board (over which a PE investor will usually have control) controls the company, but the day-to-day management of the portfolio company is delegated to the chief executive officer or senior executives. Where the PE investor only acquired a minority stake and does not control the board, it would expect to have veto rights in respect of specially protected matters at a shareholder level.

A majority of PE transactions require debt financing, usually by way of senior secured facilities of an estimated 30% to 40% of the acquisition price of the relevant transaction.

Debt finance for PE transactions is most commonly sourced in the form of secured term loans from the major South African banks. Bridge financing and the refinancing of fund investments are also typically seen in PE transactions. Mezzanine financing may be used in smaller transactions involving growth businesses, while bonds, notes and so on are not commonly used to finance PE transactions.

In leveraged buyout transactions, a "debt push down structure" is used to enable the introduction of acquisition debt. A two-stage transaction is followed, under which:

The proceeds of the business acquisition are then distributed to the purchaser who applies the proceeds to settle the bridge loan.

The interest incurred on senior debt raised as part of a debt push-down is subject to local South African interest limitation rules. The amount of interest expenditure, under the interest limitation rules, that is deductible in a year of assessment is currently broadly equal to the interest received/accrued, plus about 41% of "adjusted taxable income" (this percentage is determined with reference to the average repo rate, which has decreased significantly over the last year), minus other interest incurred that is not subject to limitations.

However, as noted in Question 14, the amount of interest expenditure that is deductible in a year of assessment in respect of debts owed specifically to persons not subject to tax, or subject to tax at a reduced rate, will no longer be determined with reference to the average repo rate. Instead, a fixed rate of 30% will apply to debt owed to such creditors for years of assessment commencing on or after 1 April 2022.

In secured financings, lenders generally take comprehensive security over the assets of the target and its subsidiaries, including pledges of shares.

Typical features of senior term debt include:

In addition, lenders require that, from a company or group structure point of view, they are not structurally subordinated, and that any shareholder debt in the capital structure is fully subordinated.

A company cannot provide financial assistance for the purposes of, or in connection with, the purchase of shares in the company unless both:

There are no exemptions.

The order of priority on insolvent liquidation is:

If a company is in financial distress and the board wishes to and believes that the company can be rehabilitated, the business rescue procedure in the Companies Act can be used. Once a business rescue plan has been approved (by a certain percentage of shareholders and creditors) and implemented by the business rescue practitioner, the plan is binding on every creditor and every shareholder, irrespective of the creditor's ranking. Further, the secured creditor cannot realise its security, regardless of whether the creditor was present at the meeting where approval of the business rescue plan was put to a vote.

It is possible for a debt holder to obtain conversion rights or options allowing it to participate in equity returns.

In addition to employment remuneration and short-term key performance indicator (KPI)-based incentives, managers are usually incentivised by way of equity ownership or participation, often on a subsidised or facilitated basis. This may be coupled with a ratchet or other exit-based scheme to drive alignment, typically structured through preference shares, the participation rights of which depend on the return to the PE fund at exit.

There are no specific tax reliefs or incentives available to portfolio company managers.

There are specific tax rules that regulate the taxation of employees. These seek to include in an employee's income the gain (or loss) arising on the vesting of an equity instrument, where that equity instrument was acquired by that taxpayer by virtue of his/her employment or from any person by arrangement with that person's employer.

The date of vesting depends on whether the equity instrument is subject to a restriction, such as bad leaver provisions that prevent the taxpayer from freely disposing of that equity instrument at market value ("restricted equity instrument") or not ("unrestricted equity instrument"):

The tax cost for a manager is substantially greater if the gains are caught by these rules and therefore subject to employees' tax (maximum marginal rate of 45%) as opposed to the gains being subject to CGT (at a rate of 18%).

Before a company can declare and pay any distributions (including dividends), the board of directors must apply the solvency and liquidity test set out in sections 4 and 46 of the Companies Act. The solvency and liquidity test requires the board to assess whether, following the distribution, considering all reasonably foreseeable financial circumstances of the company at that time, both:

Loan repayments, payments of interest and other payments such as monitoring or management fees are not subject to these rules.

Warranties are often included in the investment documents confirming that the target and its representatives have complied with relevant anti-corruption and anti-bribery legislation, including foreign legislation and sanctions restrictions where applicable.

The Prevention and Combatting of Corrupt Activities Act (PCCAA) is the principal piece of anti-corruption legislation in South Africa and provides for, among other things, the strengthening of measures to prevent and combat corruption and corrupt activities, and investigative measures in respect of corruption and related corrupt activities.

Apart from the primary offence of corruption, a person may:

In addition, a company or legal entity can be convicted of an offence.

A person convicted of these offences may be liable to a fine or imprisonment, confiscation or forfeiture of proceeds or assets instrumental to the commission of the offence. Where related to government procurement and tenders, companies or individuals may also be entered into a register allowing termination of any relevant agreement and preventing them from doing business with the government for ten years.

Typically, exits are achieved by way of a trade sale or sale to a financial investor (including secondary buyouts by other PE funds). For suitable portfolio companies, an exit by way of a listing or initial public offering (IPO) on the JSE or other relevant stock exchange may be a route to exit.

Sale to a trade buyer. The primary advantage of exiting by way of a sale to a trade buyer is that there may be operational synergies or efficiencies or strategic factors allowing a trade buyer to pay a higher price than would be paid by a financial buyer.

The disadvantages include:

Sale to a financial investor. The advantage of exiting through a sale to a financial investor is that the characteristics that made the portfolio company attractive to a PE acquisition in the first place should lend themselves to future PE ownership, and would similarly accommodate typical PE structuring. There should also be no competition or similar competitive concerns or dynamics, and PE ownership generally facilitates continued manager ownership and participation in a manner that may not be possible under corporate or trade ownership.

Disadvantages may include the lack of synergies or efficiencies to drive pricing, and transaction conditions (particularly debt conditions).

Listing or IPO. The key advantage of a listing or IPO is the possibility of achieving a listed valuation multiple, which would typically be higher than the multiple attributed to an unlisted investment or paid in a private sale. In addition, there may be valuation and other advantages through increased visibility and public profile with customers, suppliers, investors and the media, which also assists in attracting institutional and professional investors.

The disadvantages of a listing or IPO include that:

Assuming that there is no ability or appetite to recapitalise or sell (even at a distressed valuation), the company's lenders can exercise their security and take over the equity, or a portion of the equity, of a distressed portfolio company. Similarly, where there is no or little residual equity value, it may be possible to facilitate a sale to management.

In VC transactions, it is less likely that there will be lenders with security, and there are likely to be fewer, or no, realisable assets. Accordingly a winding up or sale back to management at nominal value are the only likely outcomes if new capital cannot be raised.

In circumstances where there is no or little value to be realised, and no opportunity to recapitalise, restructure or otherwise save the company, the only real advantage to any of these options is limiting any further downside, obligations or exposure to the PE fund. Where it is possible to retain some equity, this allows the PE fund to retain some upside should the company turn around but does prevent a clean exit.

The COFI Bill, once enacted, is expected to have a significant impact on the PE and VC industry. For the first time in South African financial regulation, the legislation will include a definition of an "alternative asset". Although the COFI Bill is not yet finalised, it clearly indicates the regulators' intentions regarding all alternative assets and the explanatory policy paper accompanying the COFI Bill clarifies that both pooled funds currently regulated under CISCA, private equity funds and real estate trusts will be licensed under the COFI Bill.