The growth of black-managed private equity funds in South Africa is an important development in the transformation of the financial sector. The Sector Codes issued under the Broad-Based Black Economic Empowerment Act (B-BBEE Framework), create a significant incentive for portfolio companies that receive investment from qualifying black-managed funds. However, these opportunities come with equally significant legal risks if misunderstood or abused.

The B-BBBE Framework rewards portfolio companies by allowing them to treat the entire equity stake held by a qualifying private equity fund as black ownership, regardless of whether the underlying investors are themselves black. 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.

But this recognition is conditional. To qualify, a Black Management Company must satisfy several requirements including at least 51% of the exercisable voting rights must be held by Black People; at least 51% of the executive and senior management must be Black People; at least 51% of the profits - after realising investments - must accrue to Black Persons by written agreement; and the Black Management Company must be structured as a company (not a trust, partnership or other entity) owned by black persons. Additionally, 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.

On paper, these requirements are reasonably straightforward. However, the way fund structures are implemented in practice can create significant compliance risks.

The most pervasive risk is what can be described as a “form without substance” problem. 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. 

This principle applies in the private equity fund context, and it leads directly to 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.

The B-BBEE Framework's private equity provisions are designed primarily to grow the black fund management industry. This 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.

Active management means that the Black Management Company should make investment decisions and it should also drive the identification, evaluation, negotiation and approval of investments. It should also exercise ongoing portfolio oversight and hold real authority over fund governance. Key fund decisions - drawdowns, distributions, valuations, and material changes to investment strategy - should also be subject to its meaningful input. 

The Black Management Company should 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 has been economically marginalised,  which is precisely the kind of arrangement the B-BBEE Framework's definition of fronting is alert to – one that strips 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 private equity fund’s credibility rests.

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

In structures, where the investment committee is constituted predominantly or entirely by individuals who are not part of the Black Management Company’s team; and in which investment recommendations are subject to a committee veto that can be exercised without meaningful engagement with the Black Management Company - the Black Management Company’s role is reduced to implementing decisions already made by a committee on which it has no meaningful representation or influence.

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. 

When considering the B-BBEE Framework, the Courts have warned against black ownership and management in form, without the substance of genuine control and decision-making authority.  Any fund structure in which an investment committee plays a significant role must therefore be scrutinised carefully. The investment committee should advise and review, 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 determinative, and the fund’s constitutional documents must reflect this in clear, unambiguous terms.

Fronting is a criminal offence under the B-BBEE Act, with penalties including fines, imprisonment and loss of B-BBEE status.

A properly structured black private equity fund should show the same core features - the Black Management Company should be the true decision-maker across the investment lifecycle; governance documents should clearly reflect this authority; economic participation should be real, market-related, and aligned with performance; investment committees should be advisory, not determinative; and the fund should operate as a genuine, active private equity vehicle, encapsulating functions which are typical for a private equity fund.

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.

Written by Dylan Cunard, a Director at Werksmans Attorneys