BEE Deal Gone Wrong · An Old Estate Duty Scam Revisited · IVSC

Charles Hattingh valuation buzzValuation Buzz series is written and published by Charles Hattingh CA (SA)...

BEE Deal Gone Wrong

I have seen quite a few situations where BEE partners take, say, a 26% of the share in a company, CC or business, the entity benefits from having achieved its BEE credentials and then the relationship breaks down and a valuation has to be carried out for the purpose of re-acquiring the holding. The question to ask in this situation is: ”What valuation basis does one use?“

If the BEE partners assisted in creating relationships with customers and suppliers that will last after they leave, then they should be compensated for such value created. If the disappearance of the BEE partners will result in business being lost to the entity, then they cannot be expected to be compensated for the value they helped create.

Another ”if“: If they did not pay for their share of the established business before entering the arrangement, they cannot be expected to be compensated for that part of the business when they leave.

I came across a situation where a new entity was formed on the admission of a BEE partner and all business procured by him was processed by this entity. When he exited from the arrangement the assets that had been created by his relationship with the existing business were ring-fenced. The valuation was, therefore, made easy: it was merely the value of the assets in the entity. He did not share in any other part of the operations.

Of course, in a country like SA logic and common sense do not always prevail so when performing valuations in these situations, each case will have to be evaluated on its own merits.

An Old Estate Duty Scam Revisited

Since I can remember, there has been a tax scheme in existence in SA to avoid estate duty. It goes like this:

You have a business worth R20m. You form a holding company to acquire the entity in which the business resides and the shares of the holding company are issued as follows:

10,000 R1 ordinary shares to a trust of whom your children are the beneficiaries (R10,000), or better still, you make the trust a non-discretionary trust.

15000 R1 non-cumulative preference shares with full voting rights (R1,000).

Shareholder's loan of R19,975,000.

Over the years the dividends from the subsidiary are used to re-pay the shareholders' loan. Meanwhile the value of the underlying business has now grown to R200m.

On the death of the preference shareholder (Daddy) the administrator of the estate has to obtain a valuation of the preference shares. In the past SARS used to accept that the value was R15 000. That was until a very sharp SARS official, since deceased, by the name of Ben Pretorius said to a valuer: ”I would be delighted to pay R100 000 for these preference shares as holding them would give me control over R200m of resources. Just imagine what I could do in such a situation? Pay myself a salary of...the sky is the limit“. When Ben phoned me with this idea I started a bidding war: I am happy to pay R250,000 for obtaining control over R200m of resources. What would you be prepared to pay for this right? The only thing you cannot do is to pass a special resolution. Under the ”old“ Companies Act with a 51% vote you could even sell all the assets of the company to yourself.

A valuation for fiscal purposes requires a fair market related value. To arrive at such a value one has to imagine a list of hypothetical potential buyers. Bear in mind that the existing ordinary shareholders would love to get rid of the controlling shareholder so they would be at the hypothetical auction. Now you have to try to imagine what the utility value of this right is to the hypothetical buyers. R500,000? R1m? R1,5m? Going, going, gone to the lady in the pink dress at the back of the room.

Many years ago I wrote an article called ”Valuation volcano“. When you base tax on a market related fair value between hypothetical buyers and sellers, you are going to get silly situations.

IVSC

The International Valuation Standards Council has published an exposure draft on the valuation of intangible assets for IFRS and for other purposes. This will come in handy for IFRS 3 measurement and recognition. It has also published guidance on the valuation of investment property in the course of construction.