This article was first published in The Private Equity Review, 1st edition, April 2012
The recent global financial crisis and forecasts of a protracted financial winter setting in over the globe's traditional economic superpowers has refocused attention on the emerging markets and the opportunities for growth that they present, in contrast with their more developed counterparts. Africa appears to have withstood the global financial crisis and has emerged, in many respects, stronger than before. As the opportunities for real growth become fewer and further between in many of the so-called developed economies, private equity funds have increasingly turned to Africa in their ongoing quest to seek out the most attractive opportunities for sustainable investment returns.
South Africa has long been the leading economic power in Africa. Largely due to its strong entrepreneurial culture, developed infrastructure, and sophisticated regulatory and legal framework, it has seen its private equity industry demonstrate significant growth and resilience over the past few years. A major driver for this growth has been the increase in investors' appetite for exposure to positive, absolute returns and significant portfolio diversification benefits that investments in private equity funds in South Africa offer.2
South Africa is also widely regarded as the 'gateway' or 'springboard' into the African continent by firms who aspire to expand their reach and pursuit of new investment opportunities in some of the world's fastest-growing – and relatively untapped – emerging economies, those of sub-Saharan Africa. Both the World Bank and the International Monetary Fund have estimated that sub-Saharan Africa will achieve some of the highest growth rates over the next five to 10 years.
i. Deal activity
During 2011, private equity transactions in South Africa followed similar trends as in the preceding few years, including investments in family-owned businesses, transactions comprising large black economic empowerment ('BEE') components, and large corporations and conglomerates unbundling their non-core assets.
South African family-owned businesses account for approximately 65 per cent of all business enterprises (slightly less than the global average of between 70 and 80 per cent). Private equity groups have long seen family-owned businesses as one of the African continent's most popular sectors of economic activity, admired for being disciplined and well run, and with generally lower levels of leverage and higher rates of return than most other businesses.3
Private equity in South Africa is and will remain a significant role player in the development of BEE. According to J-P Fourie, the outgoing executive officer at SAVCA, the vast majority of transactions concluded by the private equity industry in South Africa have a significant BEE component and the majority of private equity fund managers have a BEE element to the structure of their funds.4 BEE aims to statutorily redress the inequalities of South Africa's past by giving previously disadvantaged groups economic opportunities previously unavailable to them.
Secondary sales in the South African private equity market have also gained momentum in recent years.
Five new control transactions were reportedly concluded in the South African private equity industry during the 2011 calendar year,5 the most notable of which were the Actis/Tracker deal and the Virgin Active/CVC Capital Partners deal (see Section III, infra).
International investors seeking high-yield investments in emerging markets have driven up the local South African listed market, making delisting a less attractive option for private equity funds, given the higher multiples being expected by sellers. Consequently there were fewer public to private transactions during 2011. One such transaction was the delisting of Universal Industries from the Johannesburg Stock Exchange ('JSE'), by a consortium led by Ethos Private Equity ('Ethos').
2011 saw approximately 12 new growth equity investments take place in the private equity sector in South Africa, including Agri-Vie's acquisitions of strategic equity stakes in each of Hygrotech and HIK Abalone Farm (see Section III, infra).
According to the available statistics, three private equity exits took place by way of trade sale transactions during the course of 2011. A significant transaction in the mobile banking industry was the acquisition by Visa, of HBD Venture Capital's stake in Fundamo, a specialist mobile financial services provider to network operators and financial institutions in developing economies, for $28.2 million. This transaction formed part of Visa's buyout of 100 per cent of the equity in Fundamo for an aggregate amount of $110 million. A further major trade sale transaction implemented during 2011 was the China Investment Corporation's ('CIC') acquisition of a 25 per cent stake in Shanduka Group (see Section III, infra).
A major secondary sale that took place during 2011 was the Actom/Savcio transaction (see Section III, infra).
The noteworthy initial public offering ('IPO') of 2011 was Holdsport, the sporting goods company that owns Sportsmans Warehouse, Outdoor Warehouse and First Ascent, which listed on the JSE on 18 July 2011. The listing was designed to facilitate the exit of Ethos, Holdsport's majority shareholder, which bought its majority stake in Holdsport in 2006 through its Fund V for 681 million rand. Ethos raised 930 million rand by way of a private placement with a broad base of institutional investors.
The number of new investments reported for the 2010 year was 346, with an aggregate value of 5 billion rand. This number was down from 2009, which saw 468 new investments. However, the aggregate value of new investments in 2009 was less than in 2010, at a value of 4.3 billion rand. The 2007 investment levels were an all-time high for the South African private equity market, totalling 599 new investments, at an aggregate value of 24.7 billion rand.6
The total funds returned to investors increased from 2 billion rand in 2009 to 17.3 billion rand in 2010.7
A total number of 83 disposals were reported during 2010 (at an aggregate value of 4.689 billion rand)8. A total of 62 disposals were implemented in 2009, at an aggregate value of 836 million rand, and the number of disposals for 2007 was 135 disposals, at an aggregate value of 9.113 billion rand. The 2010 figures include:
- nine trade sales, at an aggregate value of 947 million rand (2009: four, at an aggregate value of 67 million rand; 2007: two, at an aggregate value of 2.859 billion rand);
- eight secondary sales, at an aggregate value of 1.569 billion rand (2009: six, at an aggregate value of 442 million rand; 2007: 24, at an aggregate value of 4.029 billion rand); and
- 12 IPOs and sales of listed shares, at an aggregate value of 1.511 billion rand (2009: five, at an aggregate value of 95 million rand; 2007: 11, at an aggregate value of 1.704 billion rand).9
Some of the leading private equity firms operating in South Africa include Old Mutual Private Equity ('OMPE'), Ethos, Horizon Equity, Actis, Sanlam Private Equity, Brait, Medu Capital, Basileus Capital, Helios Investment Partners and Capital Works.
During 2011, the US-based private equity investor, Carlyle Group, launched a $750 million African-focused buyout and growth fund. It is understood that the fund will be pursuing buyout and growth capital investment opportunities in companies in sub-Saharan Africa, and will initially target the consumer goods, financial services, agriculture, infrastructure and energy sectors.10
South Africa's E Oppenheimer & Son and Sennet Investments (Mauritius), an indirectly wholly owned subsidiary of Singapore state investor Temasek Holdings, have formed a 50/50 joint-venture private equity fund, Tana Africa Capital. Tana Africa will provide capital and business-building support to African businesses in two primary sectors: consumer goods and agriculture. The joint venture parties have indicated that they will also consider opportunities in media, health and education.11
The New Africa Mining Fund ('NAMF') launched its second Africa-focused junior venture capital fund ('NAMF II'), with up to $110 million in commitments as at its first closing in January 2011. NAMF hopes to have total commitments of up to $300 million by NAMF II's second closing, targeted for early 2012. Like its highly successful predecessor NAMF I, NAMF II looks to provide risk capital for junior mining companies with projects in Africa that are able to demonstrate a minimum of a 35 per cent return on investment.
Lereko Metier Sustainable Capital Fund ('LMSC') closed during 2011, with the South African Public Investment Corporation, the German Development Finance Institution DEG and the Dutch Development Bank being the main first closing investors. LMSC will target equity investments in the renewable energy, energy efficiency, water and waste sectors in Southern Africa.
Worth noting is the number of smaller private equity players emerging in the South African industry, specifically BEE funds focused on the secondary opportunities that exist within the BEE arena (a number of BEE transactions (both listed and unlisted) present opportunities for secondary acquisitions). BEE parties with liquidity constraints are selling out at reasonable discounts, while companies who have 'BEE lock-ins' that are about to expire are seeking new BEE partners.
There have been no notable private equity funds exiting the South African jurisdiction during 2011.
ii. Operation of the market
The market standard equity incentive arrangements in South Africa reflect the international 2/20 rule (i.e., a management company typically earns a management fee of 2 per cent of committed capital, and carried interest at a rate of 20 per cent). South African private equity funds generally implement 'hurdle rates' of approximately 10 per cent.
The standard sale process in South Africa typically entails a merger or acquisition, structured in accordance with the parties' individual requirements. Such transactions can have varied time frames (anywhere from four weeks to 12 months, or longer), depending on the level of complexity necessitated by the parties' commercial needs and regulatory approval required in terms of the preferred structure. Typically, a private equity transaction may require:
- exchange control approval from the South African Reserve Bank ('the SARB'), which could take between four and eight weeks to finalise;
- approval from the South African Competition Commission, which could take up to three months to obtain an intermediate merger approval, and between four and six months to secure an approval for a large merger; and
- if the transaction is structured by means of one of the restructuring provisions contained in the South African Income Tax Act 1962 ('the Tax Act') (either Section 45 or 47), the parties may require a directive from the South African Revenue Services ('SARS') regarding the deductibility of interest associated with the debt used to fund the restructure, as contemplated in the new Section 23K (see Section IV, infra), a process that can take between six and eight weeks to finalise.
II. LEGAL FRAMEWORK
i. Acquisition of control and minority interests
The common legal structures used by private equity funds to invest in South African portfolio companies are: private companies, partnerships (including en commandite partnerships) or trusts.
The partnership or joint venture structure is a relatively flexible and less regulated structure. It may, however, expose the partners to potential liability. The usual partnership structure used in the private equity industry is the en commandite partnership. An en commandite partnership comprises two classes of partners: disclosed partners (usually the general partner) and undisclosed or commanditarian partners (the limited partners). The partnership business will be carried on in the name of the disclosed partners, who are fully liable to third parties for the debts of the partnership, while the commanditarian partners undertake to contribute a fixed sum of money to the partnership business, conditional upon it receiving a fixed portion of the profits of the partnership business, if any are available for distribution. The names of the commanditarian partners may not be disclosed to third parties. In the event that the partnership suffers a loss, the commanditarian partners will not be liable to third parties, but will, however, be liable to the disclosed partners to the extent of the fixed capital that it contributed to the partnership.
A trust is a legal relationship that comes into existence when a person who intends to form a trust (the founder) transfers, or undertakes to transfer, the control of assets to another person (the trustee), to be administered for the benefit of a third person (the beneficiary). The trust is not a corporate entity and does not enjoy juristic personality. Trusts, however, are commonly used as the preferred structures through which investments are held and managed in South Africa. A trust enables the legal ownership of assets to be separated from the enjoyment of the benefits that flow from such assets. There are two types of trusts that can be used as investment vehicles. The first being a bewind trust, where the ownership of the underlying trust assets vests in the beneficiaries and the trustees (typically a sponsor) only manage the trust for the benefit of such beneficiaries. The second type is a vesting trust, where the ownership of the assets officially vests in the name of the trustees and the beneficiaries acquire a 'vested right' against the trustees to participate in the distribution of the assets of the trust at a specific point.
For a variety of reasons, including tax considerations, private equity funds often prefer routing their investments by way of special purpose investment vehicles incorporated in foreign jurisdictions, such as the Cayman Islands, Mauritius or the Channel Islands.
ii. Fiduciary duties and liabilities
South African companies' shareholders (including controlling shareholders) do not owe any duties to the portfolio company or to any other shareholders of the portfolio company. The Companies Act, 2008 ('the Companies Act'), which came into effect on 1 May 2011, does, however, provide various protection mechanisms for non-controlling shareholders. For example, in terms of the Companies Act:
- special resolutions (which typically require at least 75 per cent of the voting rights to be exercised in favour thereof ) are, in certain instances, required to approve proposed corporate activities;
- dissenting shareholders have appraisal rights when, inter alia, the company is considering the disposal of all or a greater part of its assets or undertaking, or the amalgamation or merger of the company with another company;
- for purposes of approving the disposal of the greater part of a company's assets or undertaking, an amalgamation, a merger or a scheme of arrangement, any voting rights controlled by an acquiring party, a person related to an acquiring party, or a person acting in concert with either of them, must not be included in calculating the percentage of voting rights required for the quorum requirements, or required to be voted in support of a resolution; and
- if an offer for the acquisition of any class of securities results in the acquisition by the offeror, of a nominee or subsidiary of the offeror, or a related or interrelated person of any of them holding, individually or in aggregate, at least 90 per cent of the securities of that class, a minority shareholder may demand that the offeror acquire all of such minority shareholder's securities of the class concerned on the same terms that applied to the securities whose holders accepted the original offer.
In addition, the Companies Act has abolished and replaced the common law derivative action by providing that any shareholder, director or prescribed officer of a company or a related company, trade union representing the employees of the company, or any other person who has been granted leave by the court to do so, may serve a demand upon the company to commence or continue legal proceedings to protect the legal interests of the company and may apply to court for leave to bring or continue proceedings on behalf of the company if the company fails to do so. Furthermore, a shareholder is entitled to institute a personal action under common law to enforce its own rights for direct harm done to it.
The directors of a company owe fiduciary duties to the company of which they are directors, and not to the specific shareholders of such company. However, directors are obliged, in terms of the provisions of the Companies Act, to take cognisance of the interests of all stakeholders in the company, subject to always acting in the best interest of the company.
'Director' is defined very widely in the Companies Act, and includes any person occupying the position of a director (by whatever name designated), such as executive and non-executive directors, alternate directors, nominee directors, ex officio directors,12 de facto directors13 and 'shadow' directors.14
The Companies Act sets out the standards of conduct expected from directors and partially codifies the common law duties of directors, namely: the duty to act in the best interests and for the benefit of the company and not in the interests of any other person; the duty to avoid a conflict of interest; the duty not to exceed their powers; the duty not to exercise their powers for an improper or collateral purpose; the duty to exercise an unfettered discretion; the duty to act in good faith and promote the best interests of the company; and the duty of skill, care and diligence. It is noteworthy, however, that the relevant provisions of the Companies Act specifically include references to alternate directors and also extend the duties and liabilities referred to in those provisions to prescribed officers,15 board committee members and audit committee members (even if they are not members of the board).
When a private equity fund appoints a nominee director to a portfolio company's board, there are certain important considerations to take into account. The primary reason for appointing the nominee director would ordinarily be to protect the private equity fund's interests and its investment in the portfolio company; however, often the instances where the private equity fund would look to protect its interests, are likely to be the scenarios in which the nominee director could be conflicted and thus unable to participate in those board deliberations – thereby defeating the primary reason for his or her appointment. The nominee director would not be able to pass any information back to the private equity fund as a matter of law. If the portfolio company gets into financial difficulty, the nominee director could, potentially, also become personally liable.
Other considerations that private equity funds ought to take cognisance of include competition (antitrust) legislation and regulations, environmental legislation and regulations, and anti-corruption legislation. Failure to comply with certain of the statutory duties in respect of the foregoing may well lead to liability for the private equity fund.
One of the principal legal considerations for a sponsor to exit an investment in South Africa would be the tax implications of such an exit, including capital gains tax or income tax considerations, dividends tax considerations and transfer taxes (including securities transfer tax, transfer duty or value added tax in some instances). The South African Exchange Control Regulations 1961 ('the Excon Regulations') will apply in the event of the private equity fund (or any of its investors) being domiciled in a foreign jurisdiction (see Section IV, infra, regarding the applicability of the Excon Regulations).
III. YEAR IN REVIEW
i. Recent deal activity
One of the stand-out deals of the third quarter of 2011 was Actis' acquisition of one of the 'big five' vehicle tracking companies in the sub-Saharan region. Actis led a consortium in a $434 million 100 per cent management buyout of Tracker, South Africa's largest vehicle-tracking company. The transaction saw Remgro (one of South Africa's largest conglomerates) dispose of its 40 per cent interest in Tracker to Actis, while FirstRand Bank restructured its investment to include Rand Merchant Bank, with the former holding 10.14 per cent and the latter 12.54 per cent post implementation. Actis employed a conservative strategy of 50 per cent debt to equity.16
Agri-Vie, a private equity fund focused on food and agri-business in sub-Saharan Africa, acquired a 37 per cent stake in Hygrotech, a South African vegetable seed marketing group, for an undisclosed sum. Hygrotech has a presence in South Africa, Namibia, Mozambique, Zimbabwe, Zambia and Kenya. Agri-Vie's second deal of 2011 concerned the acquisition of a 37 per cent interest in HIK Abalone Farm, also for an undisclosed sum.
Another agribusiness deal of 2011 was the acquisition by South African private equity firm, Inspired Evolution, of a 25 per cent stake in the local abalone farm, Abagold, for approximately $7.6 million. The investment was jointly made with the Industrial Development Corporation of South Africa.
Private equity firm Brait raised 6 billion rand through a rights issue during 2011 in order to fund two major acquisitions – its largest funding project in decades. First, it acquired a 24.6 per cent stake in Pepkor (a South Africa-based investment holding company with retail interests in Africa, Australia and Poland) for 4.18 billion rand. Brait also acquired a 49.9 per cent stake in Premier Foods in a deal valued at approximately 1.1 billion rand.17
CVC Capital Partners acquired a 51 per cent stake in Virgin Active (South Africa's largest health club chain), for an undisclosed sum. The partnership will support Virgin Active's growth in both existing and new regions. Virgin Active has a growing base in a developing market in South Africa, with a strong growth trajectory. The brand is considered to be a class leader in its sector.18
Private equity deals in South Africa remain largely financed by a combination of bank debt, in the form of senior loans, mezzanine debt and equity financing (including by way of preference share funding). The regulatory issues in respect of Sections 45 and 23K of the Tax Act (see Section IV, infra) have forced companies to structure deals in a less aggressive manner than in previous years. The majority of local transactions during 2011 were financed by way of senior debt.19
The primary sources of finance utilised by private equity funds in South Africa include policyholders, pension funds, insurance companies, commercial banks and high-net-worth individuals.
OMPE recently promoted private equity investment as a retail product to the general South African consumer. This product may yet become a significant source of funding.
The average debt-to-EBITDA (earnings before interest, taxes, depreciation and amortisation) ratios for leveraged buyouts was up from 4.2 in 2010 to 4.4 in 2011, signalling that the appetite of the banks or general partners for debt levels has improved. This is largely due to strong asset-backed or cash flow-generative businesses or banks gaining comfort on earnings streams and business prospects.20
High-yield bond issuers traded down in 2011, on the back of challenging market conditions largely caused by the debt crisis in Europe. High-yield bond markets experienced closures during 2010 and 2011, precipitated by peripheral sovereign issues.21
Financing remains available for credits in more stable sectors, less sensitive to market volatility and contagion effects. Debt-equity ratios in excess of 55 per cent are no longer considered favourable, unless they are heavily backed by asset cover. Capital structures for LBOs will be more conservative for the year ahead, with both pricing and terms expected to remain at similar levels to 2011. Senior debt pricing is expected to remain in the range of the Johannesburg interbank agreed rate ('JIBAR') + 3.5 per cent to JIBAR + 7 per cent. Mezzanine debt is expected to become more expensive.22
Examples of key legal terms enforced in respect of financing private equity deals include attractive yields being offered in relation to the credit risk profile of the relevant parties, a borrower not being able to retire its debt prior to the third anniversary of the issue of such debt, and a vanilla bullet repayment made at maturity.
With regard to security required by lenders, they typically need real rights of security, including mortgage bonds over immoveable assets, special notarial bonds over identified moveable assets, general notarial bond over all moveable assets, and pledges of shares and shareholder loan accounts.
iii. Key terms of recent control transactions
Foreign funds investing in South African entities are generally very aggressive regarding warranties and warranty periods. Examples of typical warranties are 'earn-outs' and profit warranties, ordinarily over a period of two years post-acquisition date. iv Exits International private equity funds appear to be pursuing interests in growth assets, particularly in emerging markets. The significant exit of 2011 was undoubtedly CIC's acquisition of a 25 per cent stake in Shanduka Group, a black-owned and managed investment holding company, in a deal valued at 2 billion rand. CIC primarily acquired the equity stake from exiting shareholders OMPE and Investec.23
Extraordinarily, Actis was at the forefront of a second multibillion-rand deal during 2011. Private equity firms Actis and Ethos, with OMPE, as well as BEE shareholders, Sphere Holdings and Aka Capital, sold their stakes in Savcio to Actom, in a deal reportedly worth $500 million. Savcio is Africa's largest privately owned electromechanical provider of maintenance and repair services for motors and transformers. Savcio was originally acquired from Delta Electrical Industries Limited in 2005, by a private equity consortium co-led by Ethos and Actis, with equity and considerable BEE funding from Old Mutual.24
IV. REGULATORY DEVELOPMENTS
There is no particular regulatory body to which private equity firms must report in South Africa; nor is there any one body that oversees private equity transactions. South Africa, however, has a number of legislative and regulatory frameworks (and institutions), of which private equity funds are required to be mindful. The major aspects of such frameworks important to any player in the South African corporate landscape, are the BEE policies, the Takeover Regulations (overseen by the Takeover Regulation Panel), legislation regulating antitrust actions (overseen by the Competition Commission), the Financial Service Board ('the FSB') (in certain circumstances), the Excon Regulations (overseen by the SARB), and in respect of any listed entities, the JSE Listing Requirements (overseen by the JSE).
There have been some important regulatory and legislative developments in South Africa over the past year, which indicate the South African government's acknowledgment of South Africa's economic standing in Africa, and its responsibility to facilitate South Africa's role as the gateway jurisdiction for private equity funds into Africa.
The Tax Act imposes taxes on South African residents on their worldwide income. A corporation will be a South African resident if it is incorporated in or 'effectively managed' in South Africa, but excludes a corporation that is deemed exclusively resident in another country for the purposes of a tax treaty between South Africa and such other country. Non-residents are taxed on income that is derived from a South African source, as well as capital gains on the disposal of immoveable property and assets of a permanent establishment in South Africa.
Important tax allowances relevant to private equity funds are found in the corporate restructuring provisions contained in the Tax Act, in terms of which restructures may be implemented without triggering immediate tax obligations – such taxes are generally deferred until a future disposal event.
On 2 June 2011, the Treasury released the Draft Taxation Laws Amendment Bill 2011, which proposed a moratorium on the use of Section 45 of the Tax Act (one of the cornerstone provisions relied upon for many restructuring, M&A and private equity transactions), in respect of all disposals made on or after 1 June 2011. After extensive public consultation, the Treasury revised its proposal in respect of Section 45.
Against this background, Section 23K was incorporated into the Tax Act on 12 January 2012, and became retrospectively operative with respect to any amount of interest incurred in terms of any debt instrument issued or used for the purposes of procuring, facilitating or funding the acquisition of an asset in terms of Section 45 (as from 3 June 2011), or in terms of Section 47 (as from 3 August 2011), if such transactions were entered into, on or after the respective dates. Interestingly, and contrary to the initial proposals, Section 23K does not apply to Section 44 amalgamation transactions contemplated in Section 44 of the Tax Act; however, Section 44(4) has been amended to provide that an amalgamation transaction may not qualify for roll-over relief where the resultant company assumes a debt that was incurred by the amalgamated company for the purpose of procuring, enabling, facilitating or funding the acquisition of assets by the resultant company.
The effect of the new Section 23K is that interest associated with debt used to finance a reorganisation transaction will no longer be automatically deductible. Instead, SARS may, on application by an acquiring company, issue a directive that such interest will be deductible. A taxpayer wishing to implement a reorganisation should apply for approval from SARS prior to entering into the Section 45 or 47 transaction, whereafter SARS will consider the information supplied against prescribed criteria and, provided that SARS is satisfied that the issuing of a directive will not lead to a 'significant reduction of the aggregate taxable income of all parties who incur, receive or accrue interest' in respect of and for all periods during which any amounts are outstanding in terms of the relevant debt instrument, it may issue the directive.
An amount (other than interest or dividends) received by the holder of a debt instrument, or certain types of shares issued by a company that forms part of the same group of companies, as one of the parties to an intra-group transaction, the proceeds of which were used to fund or facilitate an intra-group transaction, will be exempt from tax in certain circumstances. The exemption will only apply to the extent that the amount is applied to settle the amounts outstanding in respect of the debt instrument or shares.
Amendments to the Tax Act, which came into effect at the beginning of 2011, have the result that qualifying headquarter companies will be entitled to tax relief in South Africa. It is important to note that the requirements for qualification as a 'headquarter company' in terms of the Tax Act differ from the requirements that have to be met in order to qualify in terms of the Excon Regulations.
The corporate restructuring rules contained in the Tax Act have recently been expanded to also include restructure transactions involving controlled foreign companies held by South African-resident companies. These provisions will, in the majority of instances, only find application in relation to transactions entered into on or after 1 January 2012.
As regards the funding of corporate restructure transactions, recent amendments have been made to the tax legislation dealing with preference share funding, particularly relating to security arrangements in relation to such funding. Dividends on preference shares secured by third parties may be subject to income tax in certain instances. The legislation is currently being revised, and further amendments are expected in the future. Refinements have also been introduced to the tax legislation in respect of debt instruments repayable on demand instruments or with variable terms.
The Treasury Budget ('the Budget') was tabled on 22 February 2012, and proposed various amendments to the current tax rates, which will in most instances be effective as of 1 March 2012:
- South African-resident companies will pay capital gains tax at an effective rate of 18.6 per cent (increased from 14 per cent), and income tax at a rate of 28 per cent (unchanged from 2011); and
- individuals will pay capital gains tax on a sliding scale of up to 13.3 per cent (increased from 10 per cent), and income tax on a sliding scale of up to 40 per cent (unchanged from 2011).
Secondary tax on companies ('STC'), previously payable by companies on the declaration of dividends (currently 10 per cent) will be replaced by a dividend withholding tax, with effect from 1 April 2012. Unlike STC, the tax will be a tax on shareholders, rather than the company itself. The proposed rate of dividend withholding tax (tabled in the Budget) is 15 per cent (increased from 10 per cent applicable to STC).
Interest withholding taxes are to take effect in 2013 and will, broadly speaking, be applicable in respect of interest paid to non-residents where such interest is sourced in South Africa, in accordance with certain deeming source rules. It is expected that the interest withholding tax rate will be 15 per cent. Certain exemptions will apply, including interest on listed debt instruments and interest on loans made to banks.
ii. Exchange Control Regulations
The Exchange Control Regulations govern the movement of capital, whether directly or indirectly, across the borders of South Africa. Such movements of capital need to be approved by the SARB, generally through the commercial banks as its agents (referred to as 'authorised dealers'), and subject to certain concessions in respect of members of the Southern African Development Community.
While South African exchange controls have effectively been abolished in relation to non-residents and the South African government is pursuing a policy of gradually relaxing the remaining exchange controls applicable to residents, South African residents remain subject to exchange control measures. Non-resident investors, however, may freely invest in, or disinvest from, South Africa and may remit all income arising from their South African investments offshore. Certain forms of investment by non-residents, however, are controlled by virtue of restrictions imposed on residents and resident entities; for example, the introduction of foreign loans and the payment of interest on such loans require the approval of the SARB. South African subsidiaries and branches of foreign companies are regarded as South African residents for exchange control purposes. Non-resident shareholders must comply with certain formalities relating to the endorsement of the subsidiary's share certificates to ensure that dividends and the proceeds on the eventual sale of the shares may be remitted to their offshore shareholders.
The SARB announced during 2011 that headquarter companies will be treated, for exchange control purposes, as non-resident companies, other than for their reporting obligations. As a non-resident, a registered headquarter company may therefore raise and deploy capital offshore without restriction. The headquarter company can freely borrow from abroad, and such borrowed funds may be deployed locally or offshore. Transactions by South African entities with headquarter companies will be viewed as transactions with non-residents and will be regarded as having been concluded outside South Africa. As a result of this announcement, there is no longer a need for qualifying headquarter companies to obtain the SARB's approval on a deal-by-deal basis for transactions outside the Common Monetary Area, which links South Africa, Namibia, Lesotho and Swaziland into a common monetary union. These qualifying companies now need only acquire upfront approval for foreign investment, and thereafter adhere to their reporting obligations as required by the SARB, including, inter alia, information regarding the source of funds, new or existing funds, destination and loan funds from local sources.
iii. Company law
The new South African Companies Act came into operation on 1 May 2011. The Companies Act includes as its object, the encouragement of entrepreneurship and enterprise efficiency by simplifying the procedures for forming new companies and reducing the costs of forming and maintaining companies in South Africa; the promotion of innovation and investments in South African markets; and the encouragement of transparency and high standards of corporate governance and accountability. A noteworthy revision to the existing position in respect of schemes of arrangement under the Companies Act is that such schemes do not (except in certain circumstances) require court approval, resulting in considerable time and cost-efficiencies.
iv. Pension funds
South Africa's retirement industry is governed by the Pension Funds Act 1956 ('the PFA'). In terms of the provisions of the PFA, the Minister of Finance has the power to make regulations to limit the amount and extent to which pension funds may invest in certain asset classes. Regulation 28, promulgated in terms of the PFA, became effective on 1 July 2011. In terms of Regulation 28, pension funds can invest a total of 15 per cent of their assets in hedge funds, private equity investments and any other investments. Funds may not, however, invest more than 10 per cent in hedge funds or private equity. The maximum allocation to a single private equity investment is further limited to 2.5 per cent, with a 5 per cent maximum for fund of private equity funds.25
v. Financial Advisory and Intermediary Services Act
In June 2011 the FSB published a draft Specific Code of Conduct for authorised financial services providers and representatives conducting financial services business with professional clients ('the Specific Code'). The FSB has recognised that certain types of clients do not require the same level of protection as provided for in the Financial Advisory and Intermediary Services Act. The proposed Specific Code is more in line with the internationally accepted principle that legislation should provide for different degrees of client protection, depending on the relative level of experience and expertise of clients concerned. Under the current draft of the Specific Code, a private equity fund may qualify as a 'professional client'. If the definition of 'professional client' contained in the current draft is retained in the Specific Code, the consequence will be that investment advisers to private equity funds would only have to comply with the Specific Code in respect of financial service rendered to the fund.
Typical conditions imposed upon private equity funds or private equity transactions include restraints of trade in relation to investments in industries similar to those in which the disposing investee company has been operating. Such restraints are generally implemented for periods ranging from two to three years post acquisition date.
A number of key funds operating in the South African private equity market, such as Brait, Ethos, OMPE and certain other funds have 2004–2005 vintages, and will consequently find themselves in a position where exits are necessary in order to return cash to their investors. These funds will in turn be launching new funds – Ethos has already launched its Fund VI and OMPE plans to launch its new Old Mutual Multi- Manager Private Equity Fund 3 in the second quarter of 2012.
It is expected that private equity funds will continue to focus on their existing investments, and extracting value from such investments. General partners are likely to grow their portfolio assets through 'bolt-on' acquisitions or strategic value-added opportunities.
The outlook over the industrial sector in South Africa sees a continued international demand for African resources via industrial firms. This is expected to drive demand for rail, port and logistics, renewable energy, water, waste and energy-efficiency spend. Upgrading of infrastructure will lead to new private equity firms focusing specifically on these areas. The consumer sector outlook is positive and the consumer theme is expected to continue for the ensuing year, with household demands remaining a positive driver of growth. There are, however, unlikely to be larger private equity opportunities in the listed arena. The health-care sector is defensive with growing revenue streams and strong cash generation. Continued growth in the pharmaceutical industry, particularly for generic medicines, can be expected.
The global investment trend of seeking opportunities for sustainable returns in emerging markets is likely to continue and be a key driver of inbound investment into the South African private equity market. South African sponsors are also expected to forge ahead in their quest to claim their fair share of the ever-growing sub-Saharan market's high-yielding investment prospects.
1 Mohamed Sajid Darsot is a director and Tanya Lok is an associate at ENS (Edward Nathan Sonnenbergs Inc.).
2 KPMG and the South African Venture Capital and Private Equity Association ('SAVCA'), 'Venture Capital and Private Equity Industry Performance Survey of South Africa covering the 2008 calendar year', May 2009.
3 Michael Dynes, 'Keeping it in the family', 1 November 2010, www.africa-investor.com.
4 J-P Fourie, 'BEE and private equity powering on together', August 2009, www.accountancysa.org.za.
5 As at the date of publication, publicly available information (from SAVCA) was limited to years prior to the 2011 calendar year. In addition, the general trend in South Africa is that only the larger private equity deals are publicly announced and the values of transactions are often not disclosed, making obtaining reliable and verifiable statistics very challenging.
6 KPMG and SAVCA, 'Venture Capital and Private Equity Industry Performance Survey of South Africa covering the 2010 calendar year', May 2011.
7 Id. The 2010 aggregate figure includes an amount of 8.8 billion rand attributed to the Venfin disposal.
8 Excluding the value of the Venfin disposal.
9 KPMG and SAVCA, 'Venture Capital and Private Equity Industry Performance Survey of South Africa covering the 2010 calendar year', May 2011.
10 'Carlyle to launch Africa fund', 10 March 2011, www.privateequityafrica.com.
11 Janice Roberts, 'New $300m private equity fund formed', 8 August 2011, www.businessday.co.za.
12 An ex officio director means a person who holds office as a director of a company as a result of holding some other office, title, designation or similar status specified in the company's memorandum of incorporation ('MOI'). The Companies Act states that ex officio directors have all the duties, and are subject to all the potential liabilities, of any other director of the company, irrespective of the company's MOI.
13 The duties and liabilities of directors in terms of the Companies Act, as contemplated in footnote 12, are also likely to attach to a de facto director (and to a 'shadow' director – see footnote 14), being a person who has been elected or appointed as a director, but in whose election or appointment some defect or irregularity exists, or a person who has not been formally appointed to the board, or who was previously appointed and has ceased to hold office, but who nevertheless takes part in the management of the company and/or is held out as a director. Accordingly, senior managers of a company may be regarded as de facto directors.
14 A 'shadow director' is considered to be a person who is not formally appointed as a director and who does not directly participate in management, but in accordance with whose directions or instructions (whether they extend over the whole or part of the activities of the company) the directors of the company are accustomed to act.
15 A 'prescribed officer' would be a person that exercises, or regularly participates to a material degree in the exercise of, general executive control over and management of the whole, or a significant portion, of the business and activities of the company, irrespective of any particular title given by the company to an office held by that person.
16 'Tracker deal signals market recovery', Catalyst, Volume 8 No. 3, September quarter 2011
17 Sure Kamhunga 'Brait raises R6bn in markets for acquisitions', 3 March 2011, www.businessday.co.za.
18 'CVC flexes its guns', Catalyst, Volume 8, No. 3, September quarter 2011.
19 Source: Mohsin Cajee, OMPE.
20 Source: Standard & Poor's Rating Services and SCD.
21 Source: Datastream.
22 Source: Mohsin Cajee, OMPE.
23 I-Net Bridge, 'Old Mutual Private Equity sells Shanduka stake', 22 December 2011, www.moneyweb.co.za.
24 David Dolan, 'S Africa approves Savcio sale to Actom', 13 February 2012, www.reuters.com.
25 Gareth Stokes, 'The Nuts and Bolts of Regulation 28', 13 April 2011, www.fanews.co.za.
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