Private equity in South Africa: market and regulatory overview

A Q&A guide to private equity law in South Africa.

This Q&A is part of the multi-jurisdictional guide to private equity. It gives a structured overview of the key practical issues including, the level of activity and recent trends in the market; investment incentives for institutional and private investors; the mechanics involved in establishing a private equity fund; equity and debt finance issues in a private equity transaction; issues surrounding buyouts and the relationship between the portfolio company's managers and the private equity funds; management incentives; and exit routes from investments. Details on national private equity and venture capital associations are also included.

To compare answers across multiple jurisdictions, visit the Private Equity Country Q&A tool. For a full list of jurisdictional Q&As visit www.practicallaw.com/privateequity-mjg.

Contents

Market overview

1. How do private equity funds typically obtain their funding?

The market continues to be dominated by pension and endowment funds. Of the total ZAR27.3 billion raised in 2013:

  • 85.2% was from pension and endowment funds (2012: 48.6%).

  • 5.1% was from private equity funds of funds (2012: 12%).

  • 3.3% was from insurance companies (2012: 11.5%).

Cumulatively, of the funds raised but not yet returned to investors, South Africa is the main source of fund raising (58.9%), ahead of the UK (15.6%) and North America (12.9%).

The industry statistics stated in this Q&A are sourced from the KPMG and Southern African Venture Capital and Private Equity Association (SAVCA) Industry Performance Survey of South Africa covering the 2013 calendar year and published in June 2014.

 
2. What are the current major trends in the private equity market?

Nearly half of 2013 investments were channelled into infrastructure. This continuing theme shows the ongoing developmental opportunities available in energy, transport, telecommunications and social infrastructure, both in South Africa and into the continent.

 
3. What has been the level of private equity activity in recent years?

Fundraising

Growth in fundraising remains strong. Third party funds raised increased from ZAR18.8 billion during 2012 to ZAR27.3 billion during 2013 (45.2%).

There was a marked decrease in foreign sourced funding, which was down from 31.4% of all third party funds raised in 2012 to 20.05% in 2013.

The majority of reported fund raising activity during:

  • 2012 was by independents (47.9%).

  • 2013 was by captives (government) (72%).

Investment

The reported value of private equity investments increased from ZAR9.9 billion during 2012 to ZAR17.5 billion during 2013 (76.8%).The total number of investments increased from 510 to 580 during 2013 (70%).

The overall average investment deal size increased from ZAR19.4 million in 2012 to ZAR30.2 million in 2013.

Of the investments made during 2013:

  • 48.4% were in the infrastructure sector.

  • 13.1% in the manufacturing sector.

  • 11.4% in the media sector.

Transactions

In 2013, as a proportion of investments made by cost:

  • 12% comprised investment in seed, and start-up/early stage entities.

  • 35% comprised investments in buy-outs.

  • 42% comprised investments in expansion capital.

  • 12% comprised replacement capital.

Exits

Funds returned to investors increased from ZAR7 billion during 2012 to ZAR10.2 billion during 2013. The value of disposal proceeds increased from ZAR3.1 billion in 2012 to ZAR5.4 billion during 2013.

In 2013, disposal to other private equity firms or financial institutions was the most popular method of exit in value terms. The next most popular forms of exit were sale to management (buyback) and share buyback by the portfolio company.

 

Reform

4. What recent reforms or proposals for reform affect private equity in your jurisdiction?

Exchange control

It is becoming easier to establish African private equity funds domestically. There has been a recent concession to African private equity funds established in South Africa under South Africa's Exchange Control Rulings (issued by the Financial Surveillance Department of the South African Reserve Bank). Previously, South African private equity funds were required to seek approval on an investment-by-investment basis for investments outside of South Africa. However, they can now seek approval on an upfront basis for all investments into Africa.

Tax efficiency for foreign investors

There was previously a risk of certain domestic funds inadvertently creating a permanent establishment for foreign investors. Recent amendments to the South African Income Tax Act have eliminated this risk for certain qualifying funds (see Question 5, Tax efficiency for foreign investors).

Pension fund prudential rules

There is increasing participation by South African pension funds in private equity funds following revisions to Regulation 28 of the South African Pension Funds Act. Regulation 28 sets out prudential rules for pension funds and now has a specific category for alternative funds. As such, pension funds can now invest up to 15% of their assets in hedge funds and private equity funds.

Regulation of domestic hedge funds

At present, domestic hedge funds are unregulated. Following consultation with industry representatives, the Financial Services Board (FSB) (the South African financial services regulator) has produced proposals for a regulated regime for hedge funds established in South Africa.

Tax residency of foreign investment funds

The Treasury recently introduced an amendment to the South African Income Tax Act that makes it easier for South African managers to be appointed to manage offshore investment funds (whose investment portfolios in essence comprise listed securities and money market instruments) without those investment funds being deemed to be tax resident in South Africa. The new dispensation does not extend to offshore funds investing in unlisted private assets and is therefore not available to domestic managers of foreign private equity funds. The reason for the categorisation of funds by reference to their investment mandates is unclear. Also, no more than 10% of the foreign fund can be held by South African residents. (See also Question 5, Tax residency of foreign investment funds.)

Regulation of private equity managers/advisers

Managers/advisers of South African private equity funds are required to be regulated as financial services providers (FSPs) (Financial Advisory and Intermediary Services Act (FAIS)). Ordinarily, they are entitled to be licenced as "category I" FSPs, which is a less onerous regulatory regime for non-discretionary managers. However, any managers managing or advising private equity funds, whether domestic or foreign, with South African pension fund investors must hold a "category II" FSP licence. The category II FSP licence is for discretionary asset managers and its more onerous requirements can be problematic for private equity managers. The FSB is currently engaging with industry representatives with a view to introducing a category of FSP specifically tailored for private equity managers. It is unclear when draft regulations will be published.

AIFM Directive

The FSB has entered into co-operation agreements with a number of EU member states under the auspices of Directive 2011/61/EU on alternative investment fund managers (AIFM Directive).

Takeover regulations

The Companies Act and the Takeover Regulations apply to "affected transactions" involving "regulated" companies. An "affected transaction" may include the acquisition of a business as a going concern or the purchase of the assets of a business, a scheme of arrangement and an amalgamation or merger. It also includes a traditional offer to purchase shares. Both the Companies Act and the Takeover Regulations prescribe formalities that must be followed when undertaking an "affected transaction". For example, certain procedures must be followed and specific information must be disclosed. The Takeover Regulation Panel (Panel) has responsibility for overall supervision of affected transactions. Amendments to the existing Takeover Regulations have been mooted, and it is anticipated that an Amendment Bill to the legislation should be out for comment during 2015. It is unclear what those amendments would entail, and how they would affect the market.

The Panel has suggested that a "put up or shut up" rule be introduced. Under this rule, a target company could ask the Panel to impose a deadline to clarify a potential bidder's intentions where both:

  • The potential buyer is thinking of making an offer but is not yet in a position to make a firm bid.

  • The approach is unwelcome to the target company.

If the potential bidder "puts up", it makes a firm offer. If it "shuts up", it must say that it has no intention to bid, and that would bar it from making an offer for the target for a specified time period.

 

Tax incentive schemes

5. What tax incentive or other schemes exist to encourage investment in unlisted companies? At whom are the incentives or schemes directed? What conditions must be met?

Tax residence of foreign investment funds

The definition of "resident" in the Income Tax Act 1962 (ITA) has been amended to introduce a carve-out from the tax residency test for certain foreign funds. Management of a fund from South Africa will no longer necessarily make that fund tax resident in South Africa.

To be eligible for the carve-out from the residence test, the foreign investment fund must be an entity (other than an individual) that satisfies all of the following:

  • It is not incorporated, established or formed in South Africa.

  • Its interest is primarily in liquid assets, which consist solely of one or more of the following:

    • amounts in cash or that constitute cash equivalents;

    • financial instruments issued by a listed company or by the government;

    • if not a listed financial instrument or government bond, an instrument which is traded by the general public on a market;

    • rights to receive any of the above assets;

    • derivative of the above instruments.

  • No more than 10% of the shares or other form of participatory interest in that entity is directly or indirectly held by South African residents.

  • It has no employees and no directors or trustees that are engaged full time in the management of that company or trust.

If these requirements are met, when determining tax residence of the foreign investment fund, the place of effective management test does not take into account certain services provided by a South African investment manager that is licensed as a "financial services provider" under FAIS. Activities that are disregarded include the provision of financial product advice and intermediary services (and activities incidental to those).

Venture capital companies (VCCs)

The government provides tax incentives to investors wishing to invest in VCCs (section 12J, ITA). Any taxpayer qualifies to be an investor in a VCC.

For an entity to qualify as a VCC, on application for VCC status to the South African Revenue Service (SARS), the following preliminary requirements must be met:

  • The entity must be a resident.

  • The sole object of the entity must be the management of investments in qualifying companies (investees).

  • The entity's tax affairs must be in order.

  • The company, together with any connected person, must not control any qualifying investee company (that is, small business or junior mining company) in which it holds shares.

  • The company must be licensed (section 7, FAIS).

Additional requirements must be met within the 36-month period after VCC status is awarded, regulating assets acquired by the company and the types of expenditure incurred by it.

An entity that fails to comply with the requirements outlined above will have its VCC status withdrawn.

The VCC regime results in the following tax consequences for qualifying investors:

  • They are entitled to claim tax deductions in respect of their investment expenditure in an approved VCC.

  • Where any loan or credit is used to finance the expenditure in acquiring shares in a VCC and remains owing at the end of the year of assessment, the deduction is limited to the amount for which the investor is deemed to be at risk.

  • No tax deduction is allowed where the investor is a connected person to the VCC at or immediately after the acquisition of any venture capital share in that VCC.

  • Dividends on VCC shares are subject to the 15% dividends tax unless the investor qualifies for an existing dividend tax exemption.

  • The deduction already claimed is recouped (recovered) if the investor disposes of the VCC shares to the extent of the initial VCC investment.

  • The normal income tax and capital gains tax (CGT) rules apply in respect of VCC shares.

The tax incentive provided under the VCC regime does not extend to investee companies that the VCC invests in. These entities are subject to the standard income tax and CGT rules.

These tax incentives are available until 30 June 2021.

During the 2014 National Budget Speech, the Minister of Finance made the following proposals (which are yet to be made law):

  • Deductions will be permanent if investments are held for a certain period of time.

  • Investors will be entitled to transfer of tax benefits when investors dispose of their investments.

  • The total asset limit for qualifying investee companies will be increased from ZAR20 million to ZAR50 million, and from ZAR300 million to ZAR500 million in the case of junior mining companies.

  • Capital gains tax on the disposal of assets will be waived.

  • The permitted business forms will be expanded.

Tax efficiency for foreign investors

Generally, non-resident investors are subject to tax in South Africa on income earned from a source within South Africa. Where the non-resident is from a country that has a double tax agreement (DTA) with South Africa, South Africa cannot usually tax that non-resident unless it has a permanent establishment (PE) in South Africa.

There is a safe harbour under the PE rules (see below) for foreign "qualifying investors" (as defined in the ITA) that invest in South African private funds. A qualifying investor means a partner or trust beneficiary of an entity that satisfies the following requirements (in respect of the year of assessment at issue):

  • There is limited liability towards third parties in proportion with the amount contributed.

  • The partner (or trust beneficiary) does not participate in the effective management of the business of the partnership (or trust).

  • The partner (or trust beneficiary) does not have the authority to act on behalf of the partnership (or trust).

  • The partner (or trust beneficiary) does not receive any receipts or accruals in respect of services performed for the benefit of the partnership (or trust).

In these circumstances, the foreign qualifying investors will not be treated as having a PE in South Africa solely due to their investments in the South African fund. In terms of the definition of a PE, the relevant investment fund (partnership or trust) is an independent agent in regard to the qualifying investor's investment's (ITA). This means that the activities of a general partner (or trustee) within South Africa will not create a PE in South Africa for foreign qualifying investors that invest in the relevant fund in respect of receipts and accruals derived from the relevant fund's investments.

 

Fund structuring

6. What legal structure(s) are most commonly used as a vehicle for private equity funds in your jurisdiction?

The most commonly used structure is the en commandite partnership (ECP), a form of partnership under common law. An ECP is akin to the limited partnerships one encounters in other jurisdictions. It does not have legal personality and has two categories of partner:

  • Those with unlimited liability as regards third parties (usually a private equity fund's general partner).

  • Those with limited liability (usually a private equity fund's investors or limited partners).

The principles for ensuring that a limited partner's liability remains limited are simple but relatively unsophisticated. Unfortunately, there is no list of permitted limited partner activities as there is in some other jurisdictions, and consequently most investors adopt a conservative and entirely passive approach to fund participation.

Some private equity funds are structured as bewind trusts, a form of trust under common law. However, these trusts do not appear to be in favour with the South African Treasury. The latest relaxed Exchange Control dispensation for private equity funds investing into Africa, for example, is only available to funds that are formed as ECPs.

 
7. Are these structures subject to entity level taxation, tax exempt or tax transparent (flow through structures) for domestic and foreign investors?

Private equity entities are generally incorporated as one of the following vehicles:

  • En commandite partnerships. This entity is tax transparent and partners are deemed to be carrying on the trade or business of the partnership. The income received by the partnership is deemed to be received by or accrued by the partners in ratio of their partnership interests. The expenditure is allocated in the same manner. Therefore, the partners will be subject to tax in respect of the partnership income.

  • Bewind trusts. Beneficiaries of a bewind trust are owners of the assets held by the trust and are taxed as such.

 
8. What (if any) structures commonly used for private equity funds in other jurisdictions are regarded in your jurisdiction as being tax inefficient (whether by not being recognised as tax transparent or otherwise)? What alternative structures are typically used in these circumstances?

South African companies are not tax transparent and this can increase the tax burden for investors whether pension funds, individuals or non-resident investors. For that reason, the corporate vehicle is not favoured by South African private equity funds.

 

Investment objectives

9. What are the most common investment objectives of private equity funds?

Nearly half of 2013's private equity fund investments were channelled into infrastructure. Other sectors with significant investment were manufacturing, media and banks, financial services and insurance.

 

Fund regulation and licensing

10. Do a private equity fund's promoter, principals and manager require licences?

Managers or advisers of private equity funds must be licensed as financial services providers (FSP) under the Financial Advisory and Intermediary Services Act. Principals must be approved as representatives of the licensed FSP.

 
11. Are private equity funds regulated as investment companies or otherwise and, if so, what are the consequences? Are there any exemptions?

Regulation

The Collective Investment Schemes Control Act (CISCA) regulates retail funds. It regulates and controls the:

  • Administration of collective investment schemes.

  • Promotion of the business of or the solicitation of investments in a collective investment scheme in South Africa.

Private equity funds are unregulated but the provisions of CISCA are broad and in some respects ambiguous. It is imperative to ensure that a private equity fund does not inadvertently fall under CISCA's provisions. Private equity funds cannot, for example, avail themselves of the relaxed financial promotion regime applicable to regulated retail funds. The circumstances in which investments in a private equity fund can be sought from South African investors are extremely limited. South African law does not currently distinguish between categories of investor and the restrictions are the same whether the target audience is retail investors, institutions, high net worth individuals, sophisticated investors or otherwise.

Exemptions

There are no specific statutory exemptions available to promoters of private equity funds. However, the regulator considers reverse solicitation as not comprising financial promotion.

 
12. Are there any restrictions on investors in private equity funds?

Private equity funds are unregulated and therefore there are no restrictions as to which categories of investor can participate. As a general principle of contractual law, minors must be assisted. Investor requirements are usually included as self-imposed restrictions (for example, minimum general partner commitment amounts).

 
13. Are there any statutory or other limits on maximum or minimum investment periods, amounts or transfers of investments in private equity funds?

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

 

Investor protection

14. How is the relationship between the investor and the fund governed? What protections do investors in the fund typically seek?

A private equity fund structured as an en commandite partnership (ECP) or a trust is governed by a partnership agreement or a trust deed respectively. The fund vehicle is usually advised by an adviser that contracts directly with the fund (in the case of a fund formed as an ECP, acting through its general partner). Individual investors may also negotiate side letter terms with the fund and its adviser.

Examples of protections that investors typically seek to negotiate include:

  • Investment restrictions, including restrictions on geographic and sector exposure and on borrowing and hedging.

  • Key persons' time commitment.

  • The appointment of an investors' advisory board, which usually regulates conflicts of interest.

  • Restrictions on raising competing/successor funds.

  • General partner removal clauses (for cause and without cause).

  • Clawbacks of carried interest that have been paid in excess of the general partner's entitlement.

  • Reserved matters that require limited partner approval.

 

Interests in portfolio companies

15. What forms of equity and debt interest are commonly taken by a private equity fund in a portfolio company? Are there any restrictions on the issue or transfer of shares by law? Do any withholding taxes or capital gains taxes apply?

Most common form

Private equity funds commonly invest through a combination of equity (in the form of ordinary and preference shares) and debt instruments.

Restrictions

If a private company proposes to issue any shares, each existing shareholder has a right (before any other person who is not a shareholder) to be offered such a number of shares as are equal to the voting power of that shareholders' general voting rights immediately before the offer was made. However, that pre-emptive right may be limited by the private company's Memorandum of Incorporation.

No other general restrictions exist under the Companies Act in regard to the issue or transfer of shares. However, shareholders commonly regulate their relationship in a shareholders' agreement, and that agreement often provides for restrictions on the issue or transfer of shares.

Taxes

Disposal by local funds of assets will generally be subject to capital gains tax in South Africa, which is applied to corporates at an effective rate 18.6%.

South Africa also has a dividend withholding tax at a rate of 15% which, broadly speaking, applies to dividends paid to non-South African corporates.

With effect 1 March 2015, South Africa will also impose a withholding tax on interest paid to non-residents, also at a rate of 15%.

There are also withholding taxes applicable to royalty and service fees paid offshore (the latter with effect from 1 January 2017).

 

Buyouts

16. Is it common for buyouts of private companies to take place by auction? If so, which legislation and rules apply?

Buyouts by way of public auction are not common and no legislation governs sales by public auction. Although a statutory merger regime was introduced into the Companies Act, which became effective on 1 May 2011, it is unclear whether that regime would be used extensively in practice. The regime facilitates a merger in the true sense (that is, two companies joining together and becoming one). Many permutations of this type of transaction are possible and this new process promises to open interesting new avenues for undertaking merger transactions.

 
17. Are buyouts of listed companies (public-to-private transactions) common? If so, which legislation and rules apply?

Buyouts of listed companies are not common. In the case of listed companies, the requirements of the Johannesburg Stock Exchange (JSE) or any other exchange on which they are listed must also be complied with. To a large extent, the JSE relies on the Takeover Regulation Panel to oversee and regulate takeovers relating to listed companies, and the provisions of the Companies Act and the Takeover Regulations prevail. The tax consequences of transactions of that nature also require careful analysis and understanding.

 

Principal documentation

18. What are the principal documents produced in a buyout?

The principal documents produced in a buyout are usually driven by local requirements. Those documents typically include a sale agreement, together with resolutions authorising the parties to enter into the transaction. In the context of any statutory merger, the Companies Act requires that a written agreement be concluded between the parties, setting out the required details.

 

Buyer protection

19. What forms of contractual buyer protection do private equity funds commonly request from sellers and/or management? Are these contractual protections different for buyouts of listed companies (public-to-private transactions)?

A private equity buyer commonly seeks warranties and indemnities from the sellers. Supporting warranties are also typically sought from the existing management team. Appropriate provisions relating to the deferral of payment of part of the purchase price (or appropriate earn out provisions) are also typically included.

 
20. What non-contractual duties do the portfolio company managers owe and to whom?

Directors' duties arise in a number of ways and can be found in separate contractual undertakings given by a director, the common law or statutes. The common law duties have, in part, been codified in the Companies Act. The Companies Act contains substantive standards of directors' conduct that require a director to exercise his powers and perform his functions:

  • In good faith and for a proper purpose.

  • In the best interests of the company.

  • With the degree of care, skill and diligence that may be reasonably expected of a person:

    • carrying out the same functions in relation to the company as those carried out by that director;

    • having the general knowledge, skill and experience of that director.

Alternate directors, "prescribed officers" (which may include managers who exercise executive control) and board committee members are deemed to be directors for the purposes of directors' duties under the Companies Act.

Employees and managers also have general duties to their employers, including duties of confidentiality and to avoid conflicts of interest. Therefore, directors and managers must not disclose non-public information to any potential investor or buyer, unless authorised to do so by the directors.

 
21. What terms of employment are typically imposed on management by the private equity investor in an MBO?

Management can enter into new employment agreements unless the existing agreements adequately cover issues relating to notice of termination and non-compete provisions.

 
22. What measures are commonly used to give a private equity fund a level of management control over the activities of the portfolio company? Are such protections more likely to be given in the shareholders' agreement or company governance documents?

A private equity fund may secure some form of control by nominating directors (being representatives of the private equity fund) to board positions. In addition, if the private equity fund is to acquire a minority stake, that fund typically insists on key matters being approved by the fund's nominee directors, or by the fund in its capacity as shareholder.

These rights are typically contained in the company's Memorandum of Incorporation. They can also be found in any shareholders' agreement. This type of provision is included in the Memorandum of Incorporation because the Companies Act provides that in the case of inconsistency between the Memorandum of Incorporation and the shareholders' agreement, that inconsistency will be resolved in favour of the Memorandum of Incorporation's provisions.

 

Debt financing

23. What percentage of finance is typically provided by debt and what form does that debt financing usually take?

The senior debt market is dominated by a limited number of large commercial banks. Traditionally they have been the providers of senior debt.

Previously, a debt to equity ratio of up to 80%:20% was possible. Recently, higher levels of equity are being required, even up to 50%.

Banks also provide financing in the form of preference share funding. Changes to income tax laws relating to dividends, security and the winding down of credits in respect of secondary tax on companies, have impacted on preference share funding to some degree.

Highly leveraged transactions have a mixture of:

  • Senior term debt.

  • Senior working capital facilities.

  • Senior revolving capital facilities.

  • Senior or mezzanine preference shares.

  • Mezzanine or payment in kind (PIK) funding.

  • High yield international placements.

There is also a growing appetite for debt capital market (DCM) issuances.

The structured leveraged buyouts of five years ago with sizeable international, high yield and PIK issuances have recently come up for refinancing. Where possible this debt has been moved onshore to mitigate, among others, currency fluctuation risk which has led to sizeable hedge exposures, and in anticipation of the impending withholding tax on interest due in 2015.

Preference share funding is generally not available to international banks operating in South Africa, due to the underlying tax. However, some international banks have participated through limited risk guarantees or sub-participations. International banks operating in South Africa do not seem to have the strength in depositor base, making their Rand-denominated lending possibly more costly than for South African banks. However, with the increase of cross-border leveraged transactions, foreign banks' ability to fund in US dollars gives them a slight advantage.

Development finance institutions have also been growing in prominence in South Africa, including in some instances in private equity transactions. There they will participate at a senior level as well as providing debt or preference share funding into the equity participants.

 

Lender protection

24. What forms of protection do debt providers typically use to protect their investments?

Senior lenders generally ensure that the security package covers all material assets of the borrower as well as of material group companies, whether at the time of acquisition or subsequently acquired.

Security

Security is taken:

  • Over real estate by way of registered mortgage bonds.

  • Over movable assets by way of a registered special notarial bond that specifies assets, usually high value movable property.

  • Over general movable assets, including trading stock by way of a registered general notarial bond.

  • Over shares and rights and claims (including rights under agreements, book debts, insurance proceeds, bank accounts, and so on) by way of a cession in security.

Contractual and structural mechanisms

Security providers other than the borrower provide guarantees to underpin their security. Guarantees and security amount to financial assistance if the companies are related and this requires specific authorisations including confirmation of solvency and liquidity by the security provider.

Future assets that are movable are also capable of being secured in advance under the general notarial bond and cessions in security.

When there are multiple lenders or syndication is expected, security is often housed in a special purpose company established for the purpose of:

  • Holding the security.

  • Issuing guarantees in favour of the senior lenders against receiving indemnities from the relevant security providers.

Senior lenders also require that any other shareholder debt or mezzanine debt is subordinated in their favour. In cross-border transactions, parallel debt structures may also be used.

 

Financial assistance

25. Are there rules preventing a company from giving financial assistance for the purpose of assisting a purchase of shares in the company? If so, how does this affect the ability of a target company in a buyout to give security to lenders? Are there exemptions and, if so, which are most commonly used in the context of private equity transactions?

The board of directors can authorise a company to provide financial assistance by way of a loan, guarantee, provision of security or otherwise. Subject to the requirements of the Companies Act having been met, the assistance can be given to any person for the purpose of, or in connection with, both the:

  • Subscription of any option or securities, issued or to be issued by the company or a related or inter-related company.

  • Purchase of any securities of the company or a related or inter-related company.

These requirements provide that the board cannot authorise any financial assistance unless both:

  • The financial assistance is under either:

    • an employee share scheme that satisfies the requirements of the Companies Act; or

    • a special resolution of shareholders, adopted within the previous two years, which approved that assistance either for the specific recipient, or generally for a category of potential recipients.

  • The board is satisfied that both:

    • immediately after providing the financial assistance, the company would satisfy the solvency and liquidity test; and

    • the terms under which the financial assistance is proposed to be given are fair and reasonable to the company.

In addition to these requirements, the board must ensure that any conditions or restrictions in regard to financial assistance set out in the company's Memorandum of Incorporation have been satisfied.

In the context of a buyout, the target must comply with these financial assistance requirements.

 

Insolvent liquidation

26. What is the order of priority on insolvent liquidation?

On insolvency, creditors have priority over shareholders. Between unsecured creditors, certain categories of unsecured debts rank ahead of others, including certain employee entitlements.

 

Equity appreciation

27. Can a debt holder achieve equity appreciation through conversion features such as rights, warrants or options?

A debt holder can achieve equity appreciation by means of rights or options convertible into equity.

 

Portfolio company management

28. What management incentives are most commonly used to encourage portfolio company management to produce healthy income returns and facilitate a successful exit from a private equity transaction?

A portfolio company's management are typically incentivised to maximise returns on a successful exit by being provided with an equity share in the company. Common forms are shares in the investee company or share options in the investee company.

 
29. Are any tax reliefs or incentives available to portfolio company managers investing in their company?

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

 
30. Are there any restrictions on dividends, interest payments and other payments by a portfolio company to its investors?

The directors can make any distribution (which includes a dividend) at any time provided that both:

  • The board of directors has authorised the distribution.

  • It appears that the company will satisfy the solvency and liquidity test under the Companies Act immediately after completing the distribution.

In the context of foreign investors, South Africa has exchange control regulations, which limit the free flow of capital (including intellectual capital) in and out of the country. Investments into South Africa must be reported to the authorities and share certificates evidencing the investment must carry a "non-resident" endorsement. Non-residents who wish to invest in South Africa through loan capital must obtain prior approval from the South African Reserve Bank, particularly for intended repayment dates and interest rates.

 
31. What anti-corruption/anti-bribery protections are typically included in investment documents? What local law penalties apply to fund executives who are directors if the portfolio company or its agents are found guilty under applicable anti-corruption or anti-bribery laws?

Anti-bribery and anti-corruption is primarily regulated through the Prevention and Combatting of Corrupt Activities Act 2004 (Corruption Act). Section 3 of the Corruption Act sets out a general offence of corruption and the Corruption Act also contains a number of other specific offences.

Accessory and inducing offences

Offences. Assuming that a director was not actively involved in the commission of an offence of corruption:

  • Accessory offence. Section 20 of the Corruption Act provides for the offence of being an accessory to or after the offence. The accessory offence occurs when any person who, knowing that property or any part of property forms part of any gratification that is the subject of an offence under the Corruption Act, directly or indirectly, on behalf of himself or any other person, either:

    • enters into or causes to be entered into any dealing in relation to that property; or

    • uses or causes to be used, holds, receives or conceals that property.

  • Inducing offence. Section 21 of the Corruption Act provides for the offence of attempt, conspiracy and inducing another person to commit an offence. The inducing offence occurs when any person:

    • attempts to commit an offence in terms of the Corruption Act;

    • conspires with any other person to commit an offence in terms of the Corruption Act; or

    • aids, abets, induces, incites, instigates, instructs, commands, counsels or procures another person (or attempts to do these things) to commit an offence in terms of the Corruption Act.

Penalties. Section 26 of the Corruption Act provides for various penalties. A person convicted of the accessory offence is liable (section 26(1)(b), Corruption Act):

  • In the case of a sentence to be imposed by a High Court or a Regional Court, to a fine or to imprisonment for a period not exceeding ten years.

  • In the case of a sentence imposed by a Magistrate's Court, to a fine or to imprisonment for a period not exceeding three years.

A person convicted of the inducing offence is liable to the same punishment as for the offence to which the inducement offence related. Sentences range from three years to a life sentence.

Reporting obligations

Offence. Section 34 of the Corruption Act applies to any person who holds a position of authority (which includes any person who has been appointed as chief executive officer or an equivalent officer of any corporation, or any other person who is responsible for the overall management and control of the business of an employer) and who knows or ought reasonably to have known or suspected that any other person has committed either:

  • An offence under another, specified part of the Corruption Act involving an amount of ZAR100,000 or more.

  • An offence of theft, fraud, extortion, forgery or uttering a forged document, involving an amount of ZAR100,000 or more.

That person must report this knowledge or suspicion (or cause this knowledge or suspicion to be reported) to the Directorate for Priority Crimes Investigation, which is a department of the South African Police Service. Failure to do so is a criminal offence.

Penalties. The penalty for failing to comply with section 34 of the Corruption Act is the same as that for failing to comply with section 20 of the Corruption Act (see above, Accessory and inducing offences, Penalties).

Representations and indemnities

Appropriate representations can be included in the investment documents to the effect that the sellers have not induced any person to enter into any agreement or arrangement with the company that has involved the payment of any bribe or improper gratification. Appropriate indemnities may also be included in that regard.

Although anti-corruption or anti-bribery protections have not typically been included in investment documents in the past, there is increasing demand for these protections and they should be included whenever possible. Best practice should be followed in this regard. This includes positive undertakings by the target company not to breach any anti-corruption laws and warranties that they have not done so in the past. In addition, detailed anti-bribery assessments should be done as part of any due diligence completed.

 

Exit strategies

32. What forms of exit are typically used to realise a private equity fund's investment in a successful company? What are the relative advantages and disadvantages of each?

Forms of exit

The most common form of exit is a trade sale of the company of its business. A buyer may be able to complete a due diligence relatively quickly. However, a listing of the company can often achieve higher returns.

Advantages and disadvantages

Trade sale. A trade sale can be a clean cash-only exit, and the sale can be private.

Initial public offering (IPO). An IPO provides long term capital, enhances financial position and liquidity, and increases public profile. However, the costs involved in an IPO are high and the process is time consuming.

 
33. What forms of exit are typically used to end the private equity fund's investment in an unsuccessful/distressed company? What are the relative advantages and disadvantages of each?

Forms of exit

Investors may have express contractual rights in the Memorandum of Incorporation or the shareholders' agreement to force the sale of an investing company or its assets.

Advantages and disadvantages

These types of provisions are generally enforceable under South African law, and may facilitate an exit in these circumstances. The main disadvantage of these exit rights is that, by their nature, they may limit the company's overall financial worth.

 

Private equity/venture capital associations

Southern African Venture Capital and Private Equity Association (SAVCA)

W www.savca.co.za

Status. SAVCA is a non-governmental organisation.

Membership. Currently, 85 GP members and 46 associate members.

Principal activities. SAVCA is the industry body for the private equity and venture capital industry in South Africa. It is a promoter and advocate for the industry and its members.

Published guidelines. See website above.

Information sources. See website above.



Online resources

W www.gov.za/documents

Description. Official government website. Statutes available on the website are unofficial (only statutes in the government gazette have official status). Potentially out of date.



Contributor profiles

Lance Roderick, Director

Norton Rose Fulbright

T +27 31 582 5654
F +27 11 582 5754
E lance.roderick@nortonrosefulbright.com
W www.nortonrosefulbright.com

Professional qualifications. South Africa, Attorney; England and Wales, Solicitor

Areas of practice. Investment funds; private equity.

Non-professional qualifications. BComm degree and an LLB degree, University of KwaZulu-Natal

Recent transactions

  • Advising Absa Bank on its disposal of its interest in Absa Capital Private Equity Fund I to a consortium of bidders comprising HarbourVest Partners and Coller Capital. To date, this is the biggest ever private equity fund secondary transaction in South Africa.
  • Advising the sponsors, including Agence Française de Développement (AFD), African Development Bank (AfDB) and the Government of Spain Agence Française de Développement, African Development Bank and the Government of Spain, of the African Agriculture Fund established in Mauritius.
  • Advising the Government Employees Pension Fund (GEPF) and African Development Bank (AfDB) in relation to their respective investments in the Pan African Infrastructure Development Fund II (PAIDF II).

Languages. English

Stephen Kennedy-Good, Director

Norton Rose Fulbright

T +27 11 685 8556
F +27 11 301 3267
E stephen.kennedy-good@nortonrosefulbright.com
W www.nortonrosefulbright.com

Professional qualifications. South Africa, Attorney; South Africa, Notary

Areas of practice. Corporate; mergers and acquisitions; securities; private equity.

Non-professional qualifications. LLB degree (Cum Laude), Nelson Mandela Metropolitan University; Master of Laws degree in Commercial Law, University of Cape Town

Recent transactions

  • Acting for AgriGroupe Holdings Proprietary Limited in relation to the takeover offer made by AgriGroupe by way of a scheme of arrangement to acquire all of the shares of AFGRI Limited, listed on the Johannesburg Stock Exchange.
  • Acting for Absa Bank Limited in relation to its acquisition of Edcon's store card book for ZAR10 billion
  • Acting for Alliance Grain Traders Inc. (listed on the Toronto Stock Exchange) in relation to its acquisition of Advance Seed Proprietary Limited.
  • Acting for Cepheid (listed on Nasdaq) in relation to its acquisition of Pro-Gen Diagnostics Proprietary Limited.
  • Acting for Industrial Development Corporation of South Africa in relation to the takeover offer made on behalf of Naledi Foundry of Republic of South Africa to acquire all of the shares of Dorbyl Limited, listed on the Johannesburg Stock Exchange

Languages. English

Publications. Contributory author to "Directors' Liability and Indemnification: A Global Guide", Second Edition and "Doing Business in the Brics: A Practical Legal Handbook".

Andrew Wellsted, Director

Norton Rose Fulbright

T +27 11 685 8809
F +27 11 301 3200
E andrew.wellsted@nortonrosefulbright.com
W www.nortonrosefulbright.com

Professional qualifications. South Africa, Attorney

Areas of practice. Exchange control; regulations and investigations; tax.

Non-professional qualifications. Masters degree in Tax; specialised diplomas in Capital Gains Tax and Mining Tax Law

Recent transactions

  • Advising Macquarie Security South Africa on implications of a scrip loan transaction.
  • Providing the Industrial Development Corporation with an analysis of its preference share funding structures to assist it in ensuring that it achieves its development funding objectives most efficiently.
  • Advising Rio Tinto on the restructuring of existing preference share funding arrangement.
  • Advising Barclays Bank on the reorganisation of its African subsidiaries in conjunction with Absa.
  • Advising clients on appropriate transaction structures that comply with the exchange control regime in place from time to time.
  • Obtaining approval from the financial surveillance department of the Reserve Bank to (Finserv) or an authorised dealer on behalf of clients.

Languages. English


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