In the context of Broad-Based Black Economic Empowerment (B-BBEE), ownership is one of the key elements of measurement. While equity transfer is the most straightforward path to ownership points, the B-BBEE Codes of Good Practice recognise that alternative arrangements may, under certain conditions, also qualify as forms of ownership.
This is especially relevant where companies seek to structure ownership in a way that allows for gradual participation or deferred acquisition, where an immediate acquisition may not be possible. One of these alternative arrangements are Options and Warrants, however not all options are equal. The Generic Codes provide a narrow window for recognition and measurement of ownership.
Recognition of Share Options and Warrants as Ownership
The Generic Code allows for share options and warrants to be recognised towards a company's ownership scorecard, even before the shares are formally acquired, but only if the requirements with reference to the key measurement principles are met. The purpose of this provision is to ensure that economic and voting rights are actually transferred, even if the legal title to shares has not yet vested.
This provides a potential mechanism for companies to score ownership points during a vesting or option period, where difficulty arises in transferring shares outright, but only if the equity instrument is correctly implemented to meet the requirements.
Requirements for Recognition
For an option or warrant to qualify as a form of ownership, the following four requirements must be met:
- The instrument must confer a right to acquire an equity instrument at a future date.
- The voting rights attached to the underlying shares must be irrevocably transferred to the holder of the instrument during the option period and be exercisable prior to acquisition of the shares.
- The economic benefits (e.g. dividends or participation in growth) must also be irrevocably transferred to the holder during the option period, even before they acquire the shares.
- The value of the instrument must be determined using a standard valuation method, consistent with the Net Value calculation principles under the Codes.
These requirements are contained under the Generic Code, however similar requirements apply to various other sector codes such as the Financial Sector Code. These requirements are intended to prevent abuse or deferral of actual ownership, by ensuring that the holder has meaningful rights in substance, not merely in form.
What Are Your Options?
When implementing a Black Economic Empowerment (BEE) ownership structure using options, it is important to distinguish between two fundamentally different equity instruments namely; an option to subscribe for shares and an option to purchase shares.
An option to subscribe involves the company itself granting a right to acquire shares at a future date through an issue of shares. Upon exercise, the company issues new shares to the option holder, resulting in capital inflow for the company, which may lead to dilution of the shares held by the existing shareholders.
In contrast, an option to purchase relates to existing, already issued, shares held by current shareholders. In this case, the option holder acquires shares from a shareholder, not the company, and the transaction does not alter the company's issued share capital.
While both mechanisms are common, they have materially different consequences for compliance under the BEE Codes, particularly in the context of shares which have already been issued and shares which the company is authorised to issue. The first falling in the company's authorised pool and the latter falling in the company's issued pool.
Why Subscription Options may fail the test
One of the key requirements is that voting rights must be irrevocably transferred to the option holder before the option is exercised.
In the case of an option to subscribe, the shares in question are not yet issued at the time when the option is in the hands of the holder. With reference to the wording in the Companies Act 71 of 2008, unissued shares have no rights attached to them, no voting rights, no economic interest, and no entitlement to dividends. As such, it is not legally possible to transfer rights which does not yet exist.
The result is that an option to subscribe cannot satisfy the second requirement set by the Codes in that it would fail to transfer voting rights to the holder of the option, as the voting rights would only come into existence once the option is exercised. Meaning, rights will only vest in the holder of the option upon exercise, at which point the shares are issued and the holder becomes a shareholder.
While section 57(1) of the Companies Act 71 of 2008 extends the definition of a "shareholder" in certain contexts to include a person who is entitled to exercise voting rights in relation to the company, this provision does not go so far as to vest voting rights in respect of shares that do not yet exist. In the context of ownership under the BEE Codes, the requirement is not merely to be a shareholder or to have general voting rights in the company, but to have the voting rights specifically attached to the shares that are subject to the option. Where those shares are not issued, no such rights exist and none can be transferred.
In contrast, an option to purchase shares involves shares would relate to issued shares which already carry vested and exercisable rights. The current shareholder, as the legal holder of those rights, can irrevocably cede or transfer voting and economic rights to the option holder before the transfer of ownership. This makes compliance with the BEE Codes not only possible, but structurally sound.
To ensure legal compliance and recognition of ownership points under the BEE Codes, a share purchase option rather than a subscription option should be used where the intent is to score ownership points before the option is exercised. This allows the transfer of real rights tied to real shares, in accordance with both the Companies Act 71 of 2008 and the ownership element of the Codes.
The distinction between subscription options and purchase options is a practical consideration when considering the transfer of rights for purposes of ownership under the BEE Codes.
Importantly only issued shares carry rights that can be transferred in advance of the exercise of a share option. Unissued shares, by definition, do not carry voting or economic rights until issuance, rendering a subscription option inherently non-compliant with the requirement to transfer such rights during the option period.
For companies seeking to structure ownership in a BEE-compliant and legally sound manner, the recommended approach is to utilise options to purchase shares. This ensures that the transaction reflects real, transferable rights and avoids the pitfalls of relying on potential future entitlements. In this context, it truly is always better to have the right kind of options.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
