1. Introduction

1.1. The growth of black-managed private equity (“PE“) funds in South Africa is a significant development in the transformation of our financial sector.

1.2. Sector Codes issued under the B-BBEE Act 53 of 2003 (“B-BBEE Framework“), provide a framework intended to grow the black fund management industry and the regulatory incentives offered to portfolio companies whose shares are owned by private equity funds managed by qualifying black fund managers are substantial.

1.3. Yet this opportunity also introduces serious legal risks as the structuring of these transactions is complex. The law, as enforced by the B-BBEE Commission, demands substance and where substance is absent, the consequences range from loss of B-BBEE status to criminal prosecution.

1.4. This article focuses on a risk that is, in our experience, most commonly misunderstood and most frequently encountered in practice, which is the failure to ensure that the black fund manager actively manages the private equity fund.

2. The Regulatory Framework: What is Required

2.1. The B-BBBE Framework creates a powerful incentive for portfolio companies to seek investment from black-managed private equity funds. Where a qualifying the Black Management Company (the “Black Management Company”) manages a private equity fund, the portfolio companies in which that fund invests are entitled to treat the entire equity stake held by the private equity fund as being held by black persons — irrespective of whether the underlying investors in the fund are themselves black.

2.2. This is a deliberate policy choice. The B-BBEE Framework recognises that if black fund managers were required to raise capital exclusively from black investors, the growth of the black fund management industry would be severely constrained. By decoupling the racial profile of the investors from the B-BBEE ownership recognition at portfolio company level, the B-BBEE Framework allows black fund managers to compete for capital in the institutional market.

2.3. But this recognition is conditional. For a fund to qualify, the Black Management Company must satisfy all of the following requirements –

2.3.1. at least 51% of the exercisable voting rights in the Black Management Company must be held by Black People;

2.3.2. at least 51% of the executive and senior management of the Black Management Company must be Black People;

2.3.3. at least 51% of the profits— after realising investments — must accrue to Black Persons by written agreement; and

2.3.4. the Black Management Company must be structured as a company (not a trust, partnership or other entity) owned by black persons.

2.4. In addition, the Black Management Company must progressively invest a growing proportion of its funds under management in companies with at least 25% black shareholding, starting at 5% in year one and escalating to 51% by year nine.

2.5. On paper, these requirements are reasonably straightforward. In practice, the manner in which fund structures are actually implemented is where the risks arise and where, in our experience, many structures fall short.

3. The Key Problem: Ownership Without Control

3.1. The most pervasive risk we encounter in advising on black PE fund structures is what can be described as a “form without substance” problem.

3.2. The B-BBEE Framework defines fronting broadly as any transaction, arrangement or conduct which directly or indirectly undermines or frustrates the achievement of the objectives of the B-BBEE Act 53 of 2003. The definition captures, amongst other things, arrangements in which black people are appointed to roles that lack substance, in which economic benefits do not flow to black people in the ratios specified in the documentation, or in which a legal relationship with a black person is concluded for B-BBEE compliance purposes without conferring on that person the economic benefits reasonably expected to accompany their role.

3.3. This principle applies in the private equity fund context and it leads directly to what we regard as one of the most important and most misunderstood requirement in the structuring of a black PE fund, (a requirement not expressly stipulated in the B-BBEE Framework) namely that the Black Management Company must actively manage the fund.

4. The Importance of Active Management

4.1. The B-BBEE Framework’s private equity provisions are designed primarily to grow the black fund management industry. This is not an incidental objective but it is the central purpose of the regulatory framework. A structure that claims B-BBEE recognition while effectively sidelining the Black Management Company from genuine fund management does not advance this purpose and arguably subverts it.

4.2. Active management, in the context of a private equity fund, means that the Black Management Company should –

4.2.1. make investment decisions. The identification, evaluation, negotiation and approval of investments should be driven by the Black Management Company’s team. This is the core function of any fund manager, and the B-BBEE framework requires that black managers exercise this function in substance, not merely on paper;

4.2.2. exercise ongoing portfolio oversight. Managing a PE fund does not always end at the point of investment, it typically encompasses active engagement with portfolio companies, monitoring of financial performance, participation in board governance, and the strategic management of exits. the Black Management Company should be involved in these functions;

4.2.3. hold real authority over fund governance. The key decisions of the fund, drawdowns, distributions, valuations, and material changes to investment strategy, should be subject to meaningful input by the Black Management Company.

4.2.4. earn a market-related management fee. This is both a legal requirement and a practical indicator of genuine management. A fund manager that is not paid market-related fees is a fund manager whose role has been economically marginalised. The B-BBEE Framework’s definition of fronting, alert to arrangements that strip economic benefits away from black participants. A black fund manager that is appropriately qualified, properly compensated, and genuinely in charge of day-to-day management decisions is not merely a regulatory requirement, it is the foundation on which a black PE fund’s credibility rests.

5. The Problem with Investment Committees

5.1. One of the most common structural mechanisms that can undermine the role of the Black Management Company is the role of the investment committee.

5.2. Investment committees are a standard and entirely legitimate feature of private equity fund governance. They provide a structured forum for the collective review of investment opportunities, risk management and portfolio oversight and in well-run funds, they are a useful asset.

5.3. The problem arises when an investment committee is structured or operated in a manner that effectively displaces the Black Management Company as the decision-maker. We have seen fund structures, sometimes drafted with the best of intentions, in which –

5.3.1. the investment committee is constituted predominantly or entirely by individuals who are not part of the Black Management Company’s team;

5.3.2. the Black Management Company’s investment recommendations are subject to an investment committee veto that can be exercised without meaningful engagement with the Black Management Company;

5.3.3. the investment committee’s composition and terms of reference give non-black participants effective control over all material investment decisions; and

5.3.4. the Black Management Company’s role is reduced to implementing decisions already made by an investment committee on which it has no meaningful representation or influence.

5.4. In any of these scenarios, the risk of fronting is acute. the Black Management Company becomes, in substance, an administrator rather than a manager. It holds a title and receives a fee, but the actual management function, the core of what the B-BBEE Framework requires, has been transferred elsewhere.

5.5. This is precisely what the Courts have warned against generally when considering the B-BBEE Framework: black ownership and management in form, without the substance of genuine control and decision-making authority.

5.6. Any fund structure in which an investment committee plays a significant role must therefore be scrutinised carefully to ensure that the Black Management Company retains genuine decision-making authority. The investment committee should advise and review, it should not govern. The Black Management Company’s team should either independently or by holding sufficient representation on the investment committee, ensure that its voice is not merely heard but is determinative. And the constitutional documents of the fund must reflect this in clear, unambiguous terms.

6. Conclusion

6.1. Fronting is a criminal offence under the B-BBEE Act, with penalties including –

6.1.1. fines of up to 10% of annual turnover;

6.1.2. imprisonment of up to 10 years;

6.1.3. severe reputational damage; and

6.1.4. loss of B-BBEE status across portfolio companies.

6.2. Beyond governance design, we frequently see private equity vehicles designed primarily for B-BBEE recognition, without the other true private equity characteristics, such as fundraising, an investment strategy or an exit strategy, which risk falling outside the B-BBEE Framework entirely.

6.3. A properly structured black private equity fund show the same core features –

6.3.1. the Black Management Company is the true decision-maker across the investment lifecycle;

6.3.2. governance documents clearly reflect this authority;

6.3.3. economic participation is real, market-related, and aligned with performance;

6.3.4. investment committees are advisory, not determinative; and

6.3.5. the fund operates as a genuine, active private equity vehicle, encapsulating functions which are typical for a private equity fund, not merely as a compliance construct.

6.4. In short: substance should match form at every level. For fund managers, investors, and sponsors, the safest and most durable position is also the simplest which is to build structures where substance leads, and form follows.

The post Substance over form: Structuring black private equity funds under the B-BBEE framework: The importance of active management appeared first on Werksmans Attorneys.

1. Introduction

1.1. For much of the past two decades, the conversation in South Africa’s private equity (“PE”) market has centred on primary fundraising, deal origination, and exits. The secondary market, involving the trading of existing interests in PE funds and the restructuring of fund portfolios, has largely remained an afterthought, a niche mechanism rarely discussed in public forums and even more rarely executed in practice.

1.2. That is beginning to change. And the global trajectory suggests South Africa would do well to pay close attention.

2. What are Secondaries?

2.1. The private equity secondary market encompasses transactions in which investors (limited partners, or (“LPs”) sell their existing interests in PE funds to third-party buyers before those funds reach their natural end of life or where fund managers (general partners, or (“GPs”) restructure their funds by transferring assets into a new vehicle, offering existing investors a choice between cashing out or rolling into the new structure.

2.2. These two broad categories, LP-led secondaries and GP-led secondaries, have very different origins and serve very different purposes, but both have become increasingly indispensable tools in the modern PE toolkit.

2.3. LP-led transactions are driven by investors seeking liquidity, like a pension fund that needs to rebalance its portfolio, an insurer facing regulatory capital constraints, or a finance institution seeking to recycle capital into new mandates. In these transactions, the LP sells its fund interest (often at a discount to the fund’s net asset value (NAV)) to a secondary market buyer, who acquires exposure to a more mature, de-risked portfolio of investments.

2.4. GP-led transactions are initiated by the fund manager itself. The most common structure is the continuation fund (or continuation vehicle) where the GP creates a new fund specifically to acquire one or more assets from an older fund, giving existing LPs the option to either cash out at current fair value or roll their interests into the new vehicle and participate in the asset’s further upside. This mechanism has become a vital exit pathway in environments where traditional routes such as stock exchange listings, trade sales, or secondary buyouts are constrained or unavailable, as has often been the case in South Africa.

2.5. A further variant, which we have advised on, and which is gaining traction globally is the locked box structure, where a sub-portfolio of assets within a fund is ring-fenced for a defined group of investors, effectively creating a bespoke investment vehicle within the broader fund architecture.

3. From Niche to Mainstream

3.1. The secondary market was once viewed with stigma, as a mechanism of last resort for funds in distress. That perception has largely been dismantled. What was once a backdoor exit has become one of the most sophisticated and actively growing segments of global private capital markets.

3.2. The numbers tell a compelling story. Global secondary market transaction volumes reached a record $162 billion in 2024, and volumes exceeded $200 billion in 2025 which is a trajectory that has confounded even optimistic projections from just a few years ago. By the first half of 2025 alone, global transaction volume had already reached $103 billion, representing a 51% increase on the same period in 2024.

3.3. On the fundraising side, capital commitments to dedicated secondary funds has seen exponential growth and the world’s largest ever private equity secondaries fund, Ardian’s Secondary Fund IX, closed on $30 billion in 2025 alone.

3.4. GP-led transactions have been a particular engine of growth.. Continuation vehicles now represent the dominant transaction type within GP-led deal flow, driven by a recognition among GPs and their investors alike that the continuation fund has become, a permanent fixture in the private markets landscape.

3.5. In the United Kingdom, historically the most active and sophisticated PE market in Europe, the secondary market has matured rapidly over the past decade. UK and European GPs have embraced continuation vehicles as a legitimate and increasingly preferred mechanism to retain high-quality assets beyond the life of an original fund, particularly where public market conditions are unfavourable for listing. Regulatory clarity, institutional secondary buyers, and a culture of transparency around fund governance have also made the London secondary market a reference point for global best practice.

4. The Future of South Africa’s Secondary Market

4.1. South Africa has one of the most mature and institutionalised PE industries on the African continent yet the infrastructure for secondary market activity remains underdeveloped. Most PE fund agreements have historically been drafted without contemplating the secondary market as an active tool of fund management. Institutional LPs have had limited options when seeking mid-life liquidity and GPs have had few established mechanisms to extend the life of their best assets without forcing a premature exit. However, the structural conditions for a more active South African secondary market are increasingly more favourable.

4.2. Several converging dynamics make South Africa a compelling candidate for secondary market growth in the years ahead. Many South African PE funds raised in the 2013–2018 years are now approaching or have exceeded their natural life cycles. GPs face pressure to return capital to LPs, yet public market conditions and the pace of M&A activity have generally not cooperated. The secondary market, both LP-led disposals and GP-led continuation structures, offers a credible and increasingly accepted solution.

4.3. South Africa’s institutional LP base, anchored by large pension funds, insurance companies and development finance institutions, is growing in sophistication. As these LPs mature in their private markets allocations, portfolio management tools such as secondary sales will become increasingly relevant. Regulatory requirements around capital allocation and liquidity management will only accelerate this trend.

4.4. For GPs managing high-quality assets who simply need more time, the continuation fund offers a compelling alternative to a forced or premature exit. Internationally, continuation vehicles have proven that GPs can retain their best assets, provide liquidity optionality to existing LPs, and attract new capital, all within a single, well-structured transaction. South African GPs with strong track records and quality portfolios are well placed to explore this structure.

4.5. Global secondary funds are increasingly looking beyond North America and Western Europe for deal flow. African markets, particularly South Africa, are on the radar of sophisticated secondary buyers who recognise the quality of assets and the opportunity for differentiated returns. A mature secondary market in South Africa would not only recycle capital more efficiently but would meaningfully improve the overall attractiveness of the asset class to both domestic and international investors.

5. Structuring Secondaries Transactions

5.1. The growth of secondary activity, in particular GP-led continuation funds, raises important legal and governance questions for South African legal practitioners.

5.2. We recently advised a major South African private equity fund on a complex GP-led follow-on transaction, in which a general partner sought to restructure assets across two encommandite partnership funds, effectively transitioning the investment portfolio from a first-generation fund into a continuation vehicle, while preserving the economic interests of existing limited partners and ensuring governance integrity throughout.

5.3. The transaction raised a range of issues that are likely to arise in any South African secondary or continuation fund context:

5.4. Where the same management team oversees both the transferring fund and the continuation vehicle, the transfer of assets is, in substance, a related-party transaction. This requires careful management, including independent valuation, full and specific disclosure to all affected limited partners, and the obtaining of informed consent. Disclosure alone is insufficient; affected investors must be placed in a position to give fully informed approval to both the terms of the transaction and the conflicts inherent in it.

5.5. In a related-party context, valuations conducted by the GP itself are unlikely to be regarded as sufficiently independent, regardless of the broad discretion typically afforded to GPs under partnership agreements. Best practice, and, we would argue, the applicable standard in any South African secondary transaction, requires an independent third-party valuation or fairness opinion confirming that the transfer price reflects fair market value and that the terms of the transaction are fair to existing limited partners.

5.6. Where fund structures incorporate locked box arrangements, the protections afforded to locked box limited partners are significant. No step which adversely affects their rights may be taken without their vote and, typically, a 75% supermajority approval. Any continuation fund or secondary transaction touching locked box assets must be structured to comply with these requirements as well.

5.7. Existing investors must be offered a meaningful choice between the option to roll over into the new vehicle and participate in future upside, or to exit at fair value and receive their cash proceeds. The information package provided to investors in connection with this election must be comprehensive, covering the rationale for the restructuring, the terms of the new fund, changes in economic terms (including fees, carry, and duration), the independent valuation and the valuation methodology, and include a full conflicts memorandum.

5.8. Where a fund’s governing documents do not contemplate an advisory committee (as is the case with a number of South African partnership agreements), consideration should be given to constituting an independent transaction committee of respected industry professionals, retired auditors, or former LP representatives to oversee the process, review the valuation, and confirm the fairness of the transaction. The committee’s report should accompany the election materials sent to investors.

5.9. These are not merely technical considerations and, in our experience, getting this right is what distinguishes a well-executed continuation fund from a contentious and reputationally damaging one.

6. Conclusion

6.1. South Africa is a market to watch. It has a sophisticated PE industry, a growing institutional investor base, a developed legal framework for limited partnership structures, and an increasing awareness, among both GPs and LPs. Of the importance of the secondary market.

6.2. The global experience is unambiguous: secondary markets deepen, mature and ultimately strengthen primary PE ecosystems. They improve capital efficiency, enhance LP liquidity, provide GPs with greater flexibility to maximise value, and attract new investors. They are not a sign of market stress but a sign of market maturity.

6.3. South Africa’s PE market is ready. What is needed now is the confidence to execute, the legal and governance rigour to do so properly, and the institutional knowledge to guide the market forward.

The post South Africa’s private equity market finally has a liquidity market: The growing market for secondaries appeared first on Werksmans Attorneys.

A multi-billion dollar revolution in global private capital could arrive in South Africa.

South Africa’s private equity industry has long had a quiet problem: getting capital out can be harder than getting it in. Exits depend on a cooperative stock exchange, willing trade buyers and investors patient enough to wait out a fund’s full life. When none of those conditions are met, options run thin.

The secondary market is changing that — and the numbers behind it are extraordinary.

Global secondary transaction volumes reportedly hit a record $162 billion in 2024 and exceeded $200 billion in 2025. By mid-2025, volumes were already up 51% year-on-year. The world’s largest-ever fund established to invest exclusively in private equity secondaries, raised by French-founded Ardian (Ardian’s Secondary Fund IX), closed on $30 billion last year alone, showing that this is no longer a niche area but one of the fastest-growing areas in global finance.

Investor-led or manager-led

The secondary market takes two main forms, either investor led or fund manager led transactions.

When investor-led, an investor — such as a pension fund, that is rebalancing sells its fund interest to a third-party buyer before the fund reaches the end of its life. The buyer acquires a mature, de-risked asset. The seller acquires liquidity.

The second form is more impactful. A fund manager creates a continuation vehicle — a new fund designed to acquire assets from an older fund approaching the end of its life. Existing investors choose either to cash out at fair value, or to roll into the new structure and keep participating. There is no forced sale or forced premature exit and it allows more time for quality assets to reach their potential.

Once viewed with suspicion as a sign of distress, continuation funds have been rehabilitated. In the UK and across Europe, they are now often a preferred tool for sophisticated managers who are looking to hold winning assets for longer. The stigma is largely gone and been replaced by a market worth hundreds of billions of dollars annually.

South Africa’s opportunity

South Africa has one of the continent’s most mature PE industries. What it has lacked is exactly what the secondary market provides: an efficient mechanism to recycle capital and manage fund lifecycle flexibly.

The conditions for change are converging now. Many South African funds raised between 2013 and 2018 are at or beyond their natural end-of-life. Managers face pressure to return capital, yet listings are difficult, M&A is slow, and traditional exit routes remain constrained. The secondary market — both investor-led sales and GP-led continuation structures — offers a credible, proven answer.

South Africa’s institutional base is also maturing. Pension funds, insurers, and development finance institutions are growing in private markets sophistication. As they do, secondary sales will shift from an optional to an essential portfolio management tool. Meanwhile, global secondary buyers are actively hunting deal flow beyond North America and Europe. South Africa will be on their radar.

Careful implementation

Secondary transactions involve complex issues and require careful implementation.

GP-led continuation funds involve genuine conflicts: the same manager oversees both the fund selling the assets and the fund buying them. That demands independent valuation, real investor choice, and comprehensive disclosure — not just disclosure of transaction terms, but disclosure of fee changes, conflicts, and valuation methodology. Investors must be able to give truly informed consent and not merely rubber-stamp a process.

Where fund agreements lack a formal advisory committee, best practice is to appoint an independent transaction committee to oversee the process and confirm fairness. The difference between a clean transaction and a contentious one almost always comes down to process rigour and the quality of investor communication.

The bottom line

Secondary markets emerge from maturity. Major PE centres with developed secondary markets have benefitted greatly from, increased liquidity and have managed to attract new capital as a result.

South Africa’s market is well placed and institutional sophistication is building. What remains is the confidence to act.

Secondaries are ready to make a big impact.

The author advises on private equity fund structuring, secondary transactions, and continuation vehicles.

The post Will secondaries solve liquidity issues in South Africa’s private equity market? appeared first on Werksmans Attorneys.

Delegation of authority is an important element of effective corporate governance for companies. It involves the process of the board of the company conferring certain powers to other persons and subcommittees, with the goal of optimising role clarity and efficiency within the company.

Assessing and improving the delegation of authority within a company is one of the ways in which a new private equity investor can, through its board representatives, help to bring about organisational efficiencies as the company grows its business operations.

This article briefly explores this concept and established best practice principles within the South African corporate environment.

Delegating authority in the South African corporate environment

In the context of our Companies Act 71 of 2008 (“Act“), section 66(1) states that the business and affairs of a company must be managed by or under the direction of its board, which has the authority to exercise all of the powers and perform any of the functions of the company, except to the extent that the Act or the company’s memorandum of incorporation provides otherwise.

It is not practical and efficient (if not impossible) for all aspects of the day-to-day business and affairs of a company to be managed by the board itself, which is why section 66(1) contemplates that these can be managed under the direction of the board i.e. where it delegates powers, functions, roles and responsibilities to subcommittees of the board, members of management, employees and even third party service providers.

In Huth v Clarke (1890) 25 QBD 391 395; 1886–90 All ER Rep 542 544 Wills J said: “Delegation, as the word is generally used, does not imply a parting with powers by the person who grants the delegation, but points rather to the conferring of an authority to do things which otherwise that person would have to do himself.”[1]

When considering the existing delegation of authority framework within a company, it is recommended that it be measured against established best practice principles and recommended practices.

In this regard, it is useful to consider the Code of Governance Principles for South Africa King IV of 2016 (“King IV Report™“)[2] as documented and amended from time to time, which sets out principles and recommended practices in relation to various corporate governance topics including delegation of authority.

Effective delegation within a company’s structures

It is highly beneficial for the boards of companies (whether they are private, public or listed) to, from time to time, review and look to improve their delegation of authority framework and the terms of reference of their subcommittees to ensure that these are keeping pace with best practice and are resulting in the benefits for the company which flow from an effective delegation of authority framework.

When developing a framework, companies will often use a so-called “RACI”-matrix in terms of which persons and/or committees are allocated different roles, depending on their expertise, in relation to various types of matters which are dealt with by the company, in order to achieve an effective delegation of authority framework.

Each of the letters of represents a different role. For example, persons allocated as “Responsible” are responsible for performing the task/activity. Persons allocated as “Accountable” are the decision-makers in relation to the task/activity.

Persons who are to be “Consulted” will be consulted by the Responsible person to obtain their recommendations/insight in respect of the task/activity. Lastly, persons who are to be “Informed” are kept informed on the progress or outcome of the task/activity and may not necessarily have direct involvement in the task/activity.

In relation to different types of matters, different persons or committees may perform the abovementioned roles.

When allocating these roles to persons and/or committees, such allocation should be tested against best practice principles to ensure that the envisaged delegation is effective. Effective delegation of authority allows for quick decision-making, empowers employees to do their job, reduces red tape within the organisation and it increases organisational efficiency and performance.[3]

As mentioned above, a company’s board cannot practically complete every single task that needs to be executed for the proper functioning of the company – instead, powers are often delegated to other persons, such as management to attend to tasks within their area of expertise.

Best practice principles state that powers should be delegated to management in a manner which promotes “role clarity and the effective exercise of authority and responsibilities.”[4].

The role of the chief executive officer (“CEO“) is particularly important when considering effective delegation. In Kaimowitz v Delahunt and Others[5], the court confirms that the office of a director does not intrinsically involve participation in the day-to-day running of the company and that a managing director (i.e. the CEO) is often vested by the board of directors with all, or of a substantial part, of its general powers and control of the affairs of the company on a day-to-day basis.  

The King Report on Governance for South Africa 2009™ states that the CEO acts as a chief public representative of a company.[6] According to the King IV Report™, the CEO –

“should be responsible for leading the implementation and execution of approved strategy, policy and operational planning and should serve as the chief link between management and the governing body; and should be accountable, and report to the governing body.”[7]

The King IV Report™ provides that a governing body should determine if and when to delegate particular powers and authority to a particular position – i.e. to the CEO, or to the chief financial officer or other members of management or to a committee,[8] and that “the governing body should set the direction and parameters for the powers which are to be reserved for itself, and those that are to be delegated to management via the CEO”.[9]

It states further that the allocation of roles and associated responsibilities should be considered holistically to avoid duplication or fragmented functioning.[10]

The King IV Report™ provides that a governing body should ensure that delegation within its structures promotes independent judgment and assists with a balance of power in the effective discharge of duties.[11]

It is important to note, however, that delegating authority does not mean that the board divests themselves of all responsibility, as they are required to continue to exercise proper supervision over the matters which they have delegated to others because they remain ultimately responsible for the outcome of such delegations.[12]

For this reason, it is important that the board has in place appropriate reporting mechanisms to enable them to exercise oversight in respect of the matters delegated.

Delegation of authority to committees of the board

It is important for the board to ensure that the roles of different committees is clear. For example, a company may have several subcommittees including, amongst others, a financial committee, an audit and risk committee, a social and ethics committee, and a remuneration committee.

Certain financial matters could arguably fall within the responsibility of both the financial committee and the audit and risk committee, which can lead to confusion, duplication of work and inefficiency.

Therefore, in accordance with the King IV Report™, it is suggested that a written terms of reference be prepared when delegating powers to each committee of the board, and that such terms of reference should deal with, amongst others, the following:

• a committee’s specific role and the associated responsibilities and functions it is required to perform;
• the extent of the delegated authority which the committee has with respect to decision-making; and
• when and how the committee should report to the governing body and to members of management.[13]

The King IV Report™ further provides that a governing body should consider allocating roles and responsibilities and committee-composition holistically so as to achieve, inter alia, effective collaboration through cross-membership between committees, where required; coordinated timing of meetings; and avoidance of duplication or fragmented functioning in so far as possible.[14]

Conclusion  

This article briefly summarises the purpose of delegation of authority within a corporate structure and refers to some of the established principles and recommended practices which should be considered and applied when developing or reviewing a company’s delegation of authority framework and terms of reference for its committees.

These principles and recommended practices cannot however be considered in a vacuum, and the boards of companies need to consider their company’s specific circumstances, operational needs, human resources at various levels and the nature of its business and the industry within which it operates, when reviewing and developing a company’s delegation of authority framework.

Moreover, it is imperative to obtain corporate governance and legal advice from the right specialists who can help to assess the adequacy of existing delegation of authority frameworks and committees’ terms of reference, and to identify where changes, refinement and clarification are needed.

Footnotes

[1] The Law of South Africa (LAWSA) / Companies Part 1: Volume 6(1) – Third Edition / Governance of Companies / Section 141 Delegation of powers  H H Stoop  at footnote 15.

[2] Copyright and trade marks are owned by the Institute of Directors in Southern Africa NPC and all of its rights are reserved.

[3]  Outcomes-Based Governance A modern Approach to Corporate Governance – Mervyn King & Fabian Ajogwu, page 73.

[4] Institute of Directors in South Africa, The King IV Report on Corporate Governance for South Africa 2016, page 100 – “The King IV Report on Corporate Governance for South Africa 2016, Copyright and trade marks are owned by the Institute of Directors in Southern Africa”.

[5] Kaimowitz v Delahunt and Others 2017 (3) SA 201 (WCC), page 206.

[6] Institute of Directors in South Africa, The King III Report on Corporate Governance for South Africa 2009, page 37 – “The King III Report on Corporate Governance for South Africa 2009, Copyright and trade marks are owned by the Institute of Directors in South Africa”.

[7] Institute of Directors in South Africa, The King IV Report on Corporate Governance for South Africa 2016, page 58 – “The King IV Report on Corporate Governance for South Africa 2016, Copyright and trade marks are owned by the Institute of Directors in Southern Africa“.

[8] Institute of Directors in South Africa, The King IV Report on Corporate Governance for South Africa 2016, page 54 – “The King IV Report on Corporate Governance for South Africa 2016, Copyright and trade marks are owned by the Institute of Directors in Southern Africa“.  

[9] Institute of Directors in South Africa, The King IV Report on Corporate Governance for South Africa 2016, page 59 – “The King IV Report on Corporate Governance for South Africa 2016, Copyright and trade marks are owned by the Institute of Directors in Southern Africa“.  

[10] Institute of Directors in South Africa, The King IV Report on Corporate Governance for South Africa 2016, page 54 – “The King IV Report on Corporate Governance for South Africa 2016, Copyright and trade marks are owned by the Institute of Directors in Southern Africa“.  

[11] Institute of Directors in South Africa, The King IV Report on Corporate Governance for South Africa 2016, page 54 – “The King IV Report on Corporate Governance for South Africa 2016, Copyright and trade marks are owned by the Institute of Directors in Southern Africa“.  

[12] The Law of South Africa (LAWSA)/ Companies Part 1: Volume 6(1) – Third Edition/ Governance of Companies / Section 141 Delegation of powers, H H Stoop; Corporate Governance The Director’s Guide – Tom Wixley, Geoff Everingham, Karen Louw, page 105.

[13] Institute of Directors in South Africa, The King IV Report on Corporate Governance for South Africa 2016, page 54 – “The King IV Report on Corporate Governance for South Africa 2016, Copyright and trade marks are owned by the Institute of Directors in Southern Africa“. 

[14] Institute of Directors in South Africa, The King IV Report on Corporate Governance for South Africa 2016, page 54 – “The King IV Report on Corporate Governance for South Africa 2016, Copyright and trade marks are owned by the Institute of Directors in Southern Africa“. 

The post Delegation of authority in the context of corporate governance appeared first on Werksmans Attorneys.

A common transaction structure that is utilised by a purchaser to acquire a commercial farm in South Africa is to purchase the business as a going concern as opposed to purchasing the shares in the company which owns the farming enterprise.

However, regardless of the transaction structure which a purchaser may seek to implement, it is important to conduct a thorough due diligence into the business and affairs of the farming business, before concluding a sale agreement.

Sale agreements for the acquisition of a commercial farm should be drafted by attorneys with experience in these types of transactions and having regard to any issues or risks identified during the due diligence.

Purchasers should be cautious about signing a standard template offer to purchase immovable property as these do not cater for the types of issues which arise when purchasing a commercial farm.

What is a legal due diligence

The legal due diligence can be equated to a type of audit of the business and affairs of the farming enterprise and it assists a prospective purchaser in identifying any material legal risks, issues, non-compliances or liabilities (“material issues”) associated with the farming enterprise before they proceed to purchase the farming enterprise.

If these material issues are overlooked at the time of concluding the sale contract, it can lead to significant losses or disputes for the purchaser in the future.

Identifying these material issues can inform the basis on which purchasers negotiate their purchase transaction and can lead to a reduction in the purchase price or assist the purchaser in negotiating that the seller rectifies these matters before implementing the sale or that the seller provides adequate security for such matters for a period of time after the sale is implemented.

It is therefore pivotal that an appropriate due diligence investigation be conducted on the farming enterprise to identify any material issues associated with the farming enterprise.

Matters which should be investigated when purchasing a farming enterprise

Whilst every farming enterprise is different to another, the types of matters that should typically be investigated during a legal due diligence are similar.

The following list is a high-level overview of some of the matters that should be considered.

The title deed of the farm

A conveyancer’s certificate is usually obtained to shed light on any encumbrances that may be registered against the title deed of the property. This ensures that the seller is lawfully entitled to sell the farm to the purchaser and that there are not any restrictions applicable to the intended sale.

Typical encumbrances that should be looked out for include mortgage bonds, pre-emptive rights, and servitudes in favour of neighbouring properties or other persons or governmental authorities.

It is also prudent for purchasers to appoint a land surveyor to carry out a cadastral survey of the property to identify any irregularities regarding, amongst other things, the true size of the property, the location of its boundaries, and the location of servitudes on the property.

Water rights

Water is essential for the success of every farming enterprise. It is important to investigate the nature and extent of the lawful water use rights that exist in relation to the farm and whether any required water licences are in place, in order to verify that the owner of the property is lawfully entitled to extract and/or use water for the farming activities being conducted on the property.

If there are material issues identified concerning the extent of the water use rights associated with the property, this could translate to significant losses for a purchaser if it were only determined after it became owner that the permitted water use rights are significantly less than what the purchaser assumed them to be.

Therefore, a qualified water consultant should be consulted to investigate the water use rights associated with the farm.   

Liquor licences

Where a purchaser is considering the acquisition of a wine farm, or a farm with a restaurant which serves liquor, it is important to consider whether the seller has the appropriate liquor licences in place and whether such liquor licences comply with all applicable laws relating to the production and/or sale of liquor on the premises.

If the purchaser intends to continue producing and/or selling alcohol on the farm, it will need to obtain its own liquor licence/s or arrange for the transfer of the existing liquor licence/s from the seller.

Zoning and land use rights

The property must also be appropriately zoned for its intended use. Where the purchaser intends to run a guest house on the farm in addition to the farming operations, it would need to ensure that the appropriate consent use for such facilities is in place or will need to apply for such approval after it becomes the owner.

It should also, for example, be determined whether the buildings on the property have been built in terms of building plans approved by the local municipality.

In this regard, a town planning consultant should be appointed to assist with identifying any risks from a zoning and land use perspective.

Environmental considerations

Certain activities being conducted on a farm may require specific environmental authorisations. Moreover, certain environmental authorisations are required for certain structures to be erected on a property i.e. where these are conducted within a certain distance of a watercourse.

Where structures have been erected without such authorisation having first been obtained, or where a property owner conducts certain activities on the property without the appropriate environmental authorisation, significant fines and penalties could be imposed and the relevant authority may require that the structure be demolished or that the activity cease which can impact on the purchaser’s intended use of the farm in the future.

It may however be possible that the appropriate authorisation for such structures and activities be applied for and obtained ex post facto.  

Plant breeders’ rights

Various forms of intellectual property may be relevant in a  proposed sale. For example, plant breeders’ rights protect the creators of new plant varieties and it becomes important to verify whether any plant breeders’ rights are associated with the orchards and vineyards on a farm and to provide for appropriate agreements to assign such rights to the purchaser with the consent of the holder of the plant breeders’ rights.

Another form of intellectual property to consider is whether copyright that is used by the seller (for example, copyright in labels used on wine bottles) has been assigned to the seller by the creators of the label designs in the first place (i.e., whether the seller is lawfully entitled to use and sell such copyright).

Mineral resources

Mineral rights in South Africa vest in the people of South Africa, with the State as the custodian who is tasked with administering prospecting or mining rights.

It is important to verify whether any person has any right to prospect or mine minerals on the property in question.

Terroir condition

Terroir is a combination of factors, including climate, soil, and elevation, that can influence the quality of crops. It is important to assess the terroir condition of the farm to determine its suitability for the intended use, for example, farming vineyards for wine production versus table grapes or other kinds of fruit or vegetables.

A specialist consultant who has expertise in analysing the abovementioned factors is often appointed to provide an assessment of the suitability of the terroir for farming of particular types of crops.

Farmworkers and other persons residing on the farm

South African law places high importance on securing the rights of occupants of rural land to continue residing there.

It is therefore important for a purchaser to determine the number and identity of occupants that permanently reside on the farm and obtain advice on the legal protections that these occupants are afforded in regard to their right of residence on the farm. 

Contracts in respect of the farming business

An assessment of the contracts that apply to the farming enterprise should be conducted.

Specifically, purchasers will seek to identify the contracts which they consider to be critical for the successful operation of the farming business and to seek to obtain the consent of the counter parties to these contracts for the assignment of these contracts to the purchaser as part of the sale transaction.  

Conclusion

When considering the acquisition of a commercial farm, it is important that purchasers engage the services of experienced legal advisors who can conduct an appropriate due diligence on the farming enterprise and who can engage and instruct specialist consultants who can advise on the specific matters discussed above which often arise in these types of transactions.

The post The importance of a legal due diligence when acquiring a commercial farm in South Africa appeared first on Werksmans Attorneys.

Local and cross-border private equity investors continue to support the growth and development of companies in South Africa, as well as the economy as a whole.

With an increase in the establishment of private equity funds both globally and in South Africa, as well as their appetite for investing in emerging markets, keeping track of the approach of private equity funds and M&A lawyers to legal aspects surrounding private equity deal-making is becoming increasingly important.

One of these aspects that require careful consideration is the need to conduct a thorough legal due diligence to identify and understand material legal risks associated with the business and affairs of the target company or group.

Whilst investors or the counter parties to a potential transaction will typically have a pre-determined view on the time frame for the conducting of a legal due diligence and thereafter for the negotiation and closing of the transaction, experience has shown that the amount of time required to conduct a thorough due diligence into the business and affairs of the target is sometimes underestimated by the parties.

In this article, we discuss some of the key considerations which private equity investors should bear in mind in the context of how they approach legal due diligence investigations.

A realistic timeline for the transaction process and recognising the value of conducting a due diligence

Whereas a projected timeline to conduct a due diligence and close a transaction is important and necessary, it is sometimes the case that sufficient time is allocated for contract negotiations and the preparation of the transaction documents, but that too little time is allowed for conducting a proper legal due diligence investigation.

The reason for this, in some cases, is that a legal due diligence is viewed as a “formality” which could be completed in a short space of time (or which could be completed concurrently with drafting and negotiating the transaction agreements).

Some view it as an expensive exercise and misguidedly believe that they can instead “negotiate warranties, indemnities and ask for security” to cover themselves for any risks which would have been identified by the legal due diligence.

This is an over-simplification of the issue because it begs the question: how can one negotiate and draft for the appropriate protections in a contract if one does not have a clear understanding and appreciation for what risks and issues they are trying to protect themselves against?

Bearing in mind that a legal due diligence is aimed at identifying risks associated with the target, the outcome thereof will often  lead to an adjustment of the timeline for the negotiation of the transaction agreements that could not have been foreseen at the onset.

For example, where a material risk is identified which could result in a substantial liability for the target (and by implication for the investor), investors may seek to negotiate contractual protection in order to be adequately indemnified against such risk (over and above “usual” warranties and indemnities included in a sale or subscription agreement).

This could include an escrow arrangement or the need for warranty and indemnity insurance or the provision of a guarantee by bank or affiliate of the target or seller, all of which the parties would not have been expressly contemplated at the time of the term sheet negotiations and which necessarily have an impact on the timeline for the transaction process.

It should also be borne in mind, when determining a deal-making timeline, that a legal due diligence can only effectively commence once the target is in a position to collate all information and documents relevant to the due diligence and to populate such information and documents in a virtual data room to enable the investor’s attorneys to review same.

For the above reasons, it is advisable for a private equity investors to engage with its legal advisors at an early stage (preferably at the term sheet stage) in order for them to assist in the determination of a realistic timeline for the due diligence.

This can help to ensure that the appropriate time and resources are allocated to the conducting of the due diligence which in turn will result in better quality information and valuable insights on the target being provided to the investor which will place it in a stronger position for the negotiation of the transaction documents.

The old adage “knowledge is power” remains applicable in private equity transactions just as it does in other spheres.

The source of the knowledge held by an investor in respect of a target is primarily the legal due diligence conducted and the quality of such knowledge will depend on how it is conducted and whether sufficient time and resources are allocated to the conducting of it.

Transaction structure

Whereas parties often contemplate a specific transaction structure during term sheet negotiations or the submission of an expression of interest letter (“EOI“), the outcome of a legal due diligence investigation will often dictate changes to the initially conceived structure for the transaction.

By way of example, the parties may have intended to conclude a sale of shares agreement, however issues identified during the legal due diligence may cause an investor to conclude that there are good commercial reasons to structure the transaction differently (i.e. as a sale of business).

Alternatively, following the outcome of the due diligence, investors may seek to restructure the target group prior to becoming a shareholder in the holding company of the target group (as there may be good commercial, strategic or tax reasons to do so).

Such a determination will then lead to an investor requiring that additional suspensive conditions (which would not have been contemplated in the term sheet or EOI) be negotiated and included in the transaction agreement, in order to  achieve such a restructuring prior to the implementation of the investor’s investment in the target group.

Price adjustments

Having regard to the material risks or issues identified in the legal due diligence and the extent to which such risks or issues are able to be resolved or mitigated against by contractual or other measures, certain of such material risks or issues may justify the investor in negotiating a downward price adjustment to take account of the commercial/finance impact of such risks/issues on the valuation of the target.

Therefore, when negotiating a term sheet or concluding an EOI, sufficient flexibility should be included to allow for subsequent price adjustment of the proposed purchase/subscription consideration offered based on the outcome of the legal due diligence.

The valuation methodology used to determine the purchase price may also inform the nature of the legal due diligence to be conducted.

For example, if a net asset value pricing methodology is used, then the nature, title and encumbrance of the assets and the finance and debt agreements will be of particular relevance, whereas if an earnings multiple pricing methodology is used, such as using EBITDA, then the material customer and supplier agreements of the target will be of particular relevance.

These considerations can impact on how much time and resources are allocated by the investor and their legal advisors in focusing on particular areas and documentation of the target.

Conclusion

Where parties only have a short window to implement a transaction, the need to conduct a thorough legal due diligence should still be prioritised.

The outcome of the legal due diligence will often impact on the projected timeline as the findings thereof may give rise to further negotiations between parties on risks and issues identified, and can result in changes to the transaction structure and the negotiation of additional suspensive conditions.

By giving adequate time and attention to the conducting of a legal due diligence, a private equity fund is able to place themselves in the best possible position when negotiating the purchase price as well as other salient terms to be included in the transaction agreement, which could include escrow arrangements and other forms of security, warranties and indemnities and even price adjustment mechanisms that take into account risks and issues identified through the due diligence). 

The post Legal Due Diligences for private equity transactions: a powerful tool if used correctly appeared first on Werksmans Attorneys.

The integration of environmental, social, and governance (ESG) factors has become a crucial consideration for investors across various asset classes, including private equity funds. I first encountered this development working as a funds lawyer in Paris in the early 2000’s. Private equity funds receiving investment from development finance institutions (DFI’s) were the first to adopt ESG principles. As the global focus on sustainability and responsible investment continues to grow, more of our fund management clients across all asset classes (including hedge funds, venture capital and pension funds) started looking to incorporate ESG principles into their fund operations and our investor clients looked to incorporate these principles into their investment policies.

A few weeks ago, I attended the Super Return Conference 2023 in Berlin, which brought together industry leaders, experts, and stakeholders in the private equity industry and sought to shed light on the latest trends and developments in the private equity sector. This article aims to delve into some of the key discussions and insights shared in relation to ESG at the conference. In short, nearly two decades down the line, we seem to be at a crossroads with some managers rejecting ESG whilst others have recommitted to the principles and moved beyond traditional implementations of ESG.

Understanding ESG in Private Equity

ESG refers to a set of criteria used to evaluate a company’s performance in areas such as environmental impact, social responsibility, and corporate governance. The push to integrate ESG principles into the operation of private equity funds is motivated by various factors.

Firstly, the private equity industry, like any other, is under regulatory pressure to improve sustainability. In the early days, ESG’s incursion into the private equity industry was driven largely by the climate change obligations of the governments that funded DFI’s. As a result, the focus globally has for a long time been on the E in ESG and many fund managers understand ESG to be an environmental programme. Over time, governments have increased regulation around environmental issues. Increasingly, investors are subject to regulations that seek to apply ESG principles. In the United States, for example, the Securities Exchange Commission has increased climate disclosures for listed companies (many of the large private equity firms are listed). In a recent study by EY, 14% of the private equity investors polled noted that they are already required to invest in socially-responsible products and a further 29% anticipated such requirements being imposed on them in the next three years. This does, however, leave 57% of investors who do not require ESG and do not envisage this being a requirement in the next 3 years.

Secondly, the trend towards responsible investing is being driven by attitude changes in fund investors looking to make positive social impacts with their investments. This is sometimes attributed to a shift in social values within the post-baby boomer generations. Most of these investments are being channelled into either ESG-dedicated portfolios or funds that have some portion of their assets dedicated specifically to investing to address ESG issues.

Finally, some private equity firms are incorporating ESG principles into their operations because they believe that the principles mitigate risks and create long-term value

The Business Case for ESG Integration

When ESG first rose to prominence in the private equity industry, the business case was front and centre. “Do well by doing good” was the mantra. The G in ESG is something most funds do anyway but the shift from focussing on pure returns to environmental and social impacts was novel and controversial. With regard to the environment, it was argued that a focus on environmental sustainability and impact is not only a risk mitigator but also a generator of efficiencies – both of which enhance returns. Similarly, good social relations mitigate the risks of doing business. Of course it also feels good to do good.

The private equity industry is … well … private and it is difficult to obtain data, particularly regarding the investments fund make and the returns on those investments. Much of the data supporting the business case for ESG is therefore generated by consultants offering ESG-implementation services. It is therefore hard to say definitively whether ESG contributes to the bottom line of portfolio companies or to fund performance.

But the business case has another leg to it. The demand for ESG from investors and the requirements imposed by regulatory bodies create a business case all of their own.

According to a study, analysts and investors used to see ESG initiatives as gratuitous, but over a 15-year period starting in the early 1990s, “analysts [started to] assess these firms less pessimistically, and eventually they assessed them optimistically.” In other words, analysts advising investors on where to invest, see ESG as a positive. Another study shows that “in 2021, 20% of investors decided not to invest with a manager because of inadequate ESG policies. This rose to 26% in 2022.” Whether or not ESG actually contributes to the bottom line, some investors are increasingly demanding it.

Increasing Regulation

Businesses in South Africa are all too aware of the increasing regulations around social impacts. This is becoming a global trend. One of the themes of the Super Return conference was the massive growth in the private equity industry over the last decade. It is now twice as big as it was in 2010. The largest private equity firms – Blackstone, Carlyle and KKR – are public companies. They collectively hold in excess of $200 Billion in assets. Globally, small, privately-owned companies with fewer than 500 employees outnumber large public companies (by more than two-to-one in the United States). The environmental and social outcomes of private equity activity is significant and this increases the regulatory pressure on this sector. Governments worldwide are implementing stricter regulations and disclosure requirements related to ESG factors and this trend is likely to continue for larger players.

Tools and Frameworks for ESG Integration

At Werksmans we have developed a comprehensive suite of documents for fund formation that integrate ESG principles into the fund operations – from assessment of investment opportunities to measurement of performance, investor reporting and fund operations. Our transaction teams are well-placed to implement these principles into portfolio company due diligences, purchase and exit transactions.

Various tools and frameworks are available to private equity firms for effective ESG integration including tools to assist in evaluating ESG risks and opportunities throughout the investment lifecycle. A plethora of consultants stands ready to advice on impact measurement methodologies, ESG scorecards, PRI and Sustainability Accounting Standards.

At the investment stage, ESG principles require private equity funds to include in their due diligence processes the assessment of ESG risks and opportunities. This involves evaluating environmental impact, labour practices, supply chain sustainability, corporate governance, and other relevant factors.

Engagement with portfolio companies is a crucial aspect of successful ESG integration in private equity. Increasingly investors are looking to see active involvement of portfolio companies in ESG initiatives, such as setting clear ESG goals, monitoring progress, and providing support and resources to drive sustainable change. This results in a trickle down of ESG principles through to the portfolio companies and their suppliers.

ESG in South Africa

South Africa is somewhat ahead of the curve when it comes to corporate social responsibility. South African firms have been under pressure to address transformation for some time and have, both through voluntary initiatives and as a result of regulatory pressure, integrated social responsibility into their operations. Attending the Southern Africa Venture Capital Association conference this year, I was struck by the shift on the part of fund managers and pension fund trustees from a pure returns-based analysis to factoring in the social impact of investing. This is not a self-evident development. Pension fund trustees, for example, have fiduciary obligations to members and beneficiaries to maximise returns.

There has been a veritable explosion of ESG fund service providers over the last decade and most of them are active in South Africa. Funds and their managers have access to a myriad consultants offering advice on applying ESG principles when due diligencing portfolio companies, applying ESG principles in fund operations and reporting to investors.

CRITICISMS of ESG

Over the last decade, the grumblings about ESG have grown. There is now more vocal criticism of ESG and within the private equity industry. The criticism is both that ESG places too much emphasis on factors other than returns and that it does not place enough emphasis on those other factors.

Impact Funds

In our practice, we have seen a trend towards impact funds that make no bones about their focus on effecting social change through their investments. Whilst these funds still seek to deliver returns, generating measurable social and environmental impacts is equally important. These funds have moved beyond ESG in the sense that the investment strategy itself is to effect social change rather than merely taking into account environmental and social factors in order to enhance returns. We were involved in the establishment of the One Thousand and One Voice fund in 2013, a fund that blends traditional private equity and philanthropy and since then we have helped establish a host of impact funds for clients whose focus is on the impact of their investment rather than pure returns.

The Return, Stupid

The rise in impact investing is balanced by a simultaneous return on the part of some investors and managers to traditional investing. Fortune Magazine recently noted that, “Critics say ESG investments allocate money based on political agendas … rather than on earning the best returns for savers. They say ESG is just the latest example of the world trying to get ‘woke’.” In South Africa, we have seen pension fund managers under pressure to allocate investment to government infrastructure projects.

These developments do raise interesting questions around the fiduciary duties of managers and trustees. If faced with a  choice of investing in a company that promises a higher return but lower social impact, what does a pension fund manager do? This question recently arose in the United States when the labour department made a ruling allowing pension funds to consider ESG factors when making investment decisions. Republicans described ESG as a, “Woke scam infecting our corporations and changing our nation.” The Senate promptly overturned the labour department ruling.

Sceptical Investors

The controversy around ESG has also created opportunities for managers looking to service sceptical investors.

Some investors see ESG as another money-making scheme and the scepticism seems to be growing as the business data continues to be unconvincing. It has been noted, for example, that BlackRock’s ESG Aware fund charges fees five times higher than those of its Core S&P 500 fund.

When Tesla lost its place on the S&P 500 ESG Index, Elon Musk described ESG as a “scam” that “has been weaponized by phony social justice warriors.” Noting that six oil companies were listed on the index, Musk criticised business for complying with a political agenda. Many fund managers have also noted that the preoccupation with ESG has created opportunities for managers running anti-ESG strategies. It is noted, for example, that during a global energy crisis, Exxon, which is owned 21% by private equity firms, has decided to shift away from fossil fuels to renewables, which will necessarily reduce its energy output. At the same time, the new chief executive officer of Shell, Wael Sawan, has promised to be “ruthless” in his pursuit of higher returns for shareholders. “Ultimately what we need to do is to be able to generate long-term value for our shareholders,” Sawan told the FT. “The answer cannot be, ‘I am going to invest [in clean energy projects] and have poor returns and that’s going to vindicate my conscience’. That’s wrong.”

Greenwashing and Lack of Accountability:

On the other side of the spectrum, some critics of ESG raise concerns about “greenwashing,” where companies or funds overstate their ESG commitments without meaningful action. These critics counter that the problem with ESG is that it is not being properly implemented, properly monitored and properly regulated.

One of the central challenges private equity funds seeking to implement ESG face is the lack of any universal accounting or reporting standard. Private equity funds have a unique mandate to produce substantial returns quickly and any cost that threatens to reduce those returns is treated with scepticism. Some fund managers who have implemented ESG into current vintage funds point out that there is no consistent data establishing a positive link between ESG investing and financial returns.

Advances in technology, such as data analytics and machine learning are being touted as facilitating ESG data collection, analysis, and reporting. Most of the exhibitors at the Super Return conference, for example, were service providers touting the artificial intelligence they utilise in providing reporting and administration services to funds.

Certainly, without proper verification and standard accountability mechanisms, there is a risk of ESG integration being used as a marketing tool rather than driving substantial change. Those who have to sought to look beyond firms’ marketing collateral, have found that the majority of private equity ESG efforts are superficial with firms frequently putting new labels on cost or efficiency initiatives that they would have implemented anyway. Of the roughly 9,000 private equity firms operating globally, around 700 have signed up to the United Nations Principles for Responsible Investment (“PRI“). Less than 16 of these firms disclose ESG impacts on financial returns and only half use ESG principles in monitoring the bulk of their portfolio. This translates to less than $0.5 trillion in a $3.4 trillion industry.

Conclusion

As sustainable and responsible investing continues to gain traction, large private equity firms will be under increasing pressure to integrate ESG into their operations. Given the controversy around the contribution of ESG principles to the returns that drive this industry, the trend is likely to also result in opportunities for smaller firms that eschew these principles and seek to benefit from the reduction in price of assets seen as “unclean”.

The march towards incorporating these principles will continue to be driven by investor and regulatory demands. Fund managers will need to carefully assess the market to ensure that they remain competitive – avoiding being taken in by the feel-good factors and overspending on ESG, whilst at the same time committing sufficiently to ESG to remain regulation-compliant and attractive as an investment.

Some valid concerns have been raised about certain managers losing focus on returns and in light of fiduciary concerns and financial services regulations, caution must be exercised by managers seeking to take into account other factors when making investment decisions – particularly where investors have not given the manager a specific mandate to take these factors into account.

Particular attention must therefore be applied to the wording of the fund documentation to ensure that the ESG obligations the fund takes on are discharged and that the fund does not apply principles that it does not have a mandate to apply.

The post ESG in Private Equity Funds: Insights from the Super Return Conference 2023 appeared first on Werksmans Attorneys.

Private equity investors play a role in supporting the growth and development of companies in South Africa. When a private equity investor is considering an investment in a company whose business is centred around software which has been developed for use in the operation of the business and/or which is licensed to customers in the form of software products and services, it is important that you have the right legal team guiding you on the legal due diligence aspects of your potential investment transaction – especially where open source software has been used in developing its software.

When conducting a legal due diligence (“DD“) on a company which operates in the technology space, it is normal for a legal team to make enquiries regarding the circumstances surrounding the development of the software which is used and/or licensed by the company in selling products and services to its customers. This is because the software concerned is often considered by the company and its shareholders (as well as the private equity investor) to be one of the ‘core’ assets of the company for purposes of determining the value of the company and its business.

If the company advises that the software used by it in its products and services to customers is owned by it, then the DD must verify that the copyright in all source code associated with such software is indeed owned by the company alone (i.e. that such copyright is not owned in conjunction with any other person). This includes verifying that external consultants who were involved in developing the source code, have contractually assigned ownership to the company, to the extent that the company did not exercise control over the making of the source code.

A DD could uncover that the employees or external consultants, who were involved in developing the company’s software, used open source software (“OSS“) alongside code written by themselves, in the development of the company’s software stack.  According to reports 78% of companies are using OSS extensively with OSS components being found in over half of proprietary software.

Section 1 of the Copyright Act 98 of 1978  (“the Act“) states that an author of a computer program is the person who exercises control over the making of the program. As a point of departure, subject to the exceptions listed in section 21 of the Act, ownership of copyright in a work vests in the author. If new works are created using OSS, licence terms and conditions applicable to that OSS may affect the rights and impose obligations on the author/owner in relation to such works. This may affect the value of the new software, and by implication, the value of the company (if a large part of its value is derived from its software).

The term ‘open source’ could give many people the wrong impression that OSS can be freely used however you wish and for whatever purpose, without any intellectual property obligations or restrictions with regard to their use of, and copyright ownership in, works created by using OSS or which is incorporated into new software.

There are upwards of 80 types of OSS licences and the terms and conditions of such OSS licences (i.e. the terms and conditions which regulate a user’s rights to use, modify or distribute such OSS) can differ materially from case to case.

For example, the terms and conditions of certain OSS licences place restrictions on the sub-licensing of the new works generally or specifically for commercial gain, which would be problematic if the company sells licences for its software products if these comprise OSS or in respect of which OSS has been used, to which such restrictions apply.

Another example of a common OSS licence is a “GNU GPL” (General Public Licence) which requires a user (i.e. the company) to make available, under the same licence terms and conditions, the complete source code of works or modifications of the original source code. In other words, the source code which the company has created (and which it may believe to be proprietary to it and commercially valuable) may actually be subject to the same ‘open source’ copyright and other licence terms and conditions as the OSS used in its development. This means that there could be an obligation on the company to make such newly created software available to the public on the same terms and conditions.

Often software developers do not have a full appreciation of the legal implications associated with using OSS in the development of a company’s software systems and products as they are not always aware of the types of licence terms which apply to the use of third party software (including OSS) and which licence terms they have in fact agreed to on behalf of the company which they represent in the course and scope of their duties as an employee or contractor.

Companies should make their developers (internal and external) aware of these considerations and require them to understand the terms and conditions associated with using third party software (in particular OSS). It is also important that companies retain records of the licences agreed to by their employees and contractors when using third party software, including OSS, in the development of the company’s software. This information becomes very important in the context of a DD, as it assists the investor and its legal team to assess the legal aspects of the company’s software more efficiently if it is readily available.

In the context of a DD, records of such information will enable a legal team to identify the OSS used in the development of the company’s software. With the help of technical experts, where required, a DD team will seek to determine the functionality of the OSS in the context of the company’s overall software stack, including how and where it is used by the company’s business as well as determining if the OSS is modified in any way.

The lawyers involved in the DD will review the licence terms and conditions associated with the OSS used by the company to ascertain the consequences thereof in relation to the company software , including in relation to ownership, on-sale and sub-licensing.

Depending on the nature and extent of the use of OSS in the creation of software in the company’s business and the importance/purpose of such software in the business, as well as the effect of the OSS licence terms on such software, the assessment of these considerations could materially affect the investor’s view of the software that has been developed by the company and the valuation to be placed on the company.

As such, it is important that private equity investors instruct the right legal team who can advise them on the above issues in the context of private equity transactions involving technology companies whose core assets comprise software developed by or for the company’s business.

Please note that this article is intended for information purposes only and should not be considered legal advice.

The post Exercising due caution with regard to open source software in private equity transactions appeared first on Werksmans Attorneys.