The amendments to the South African Companies Act, which came into effect in December 2024, include a long-awaited amendment to sections 40(5) and 40(6), which clarify the requirements in relation to structuring transactions using a version of prospective “sweat equity”, whereby future non-financial contributions, such as skills, expertise and time, may be exchanged for upfront equity.
“Sweat Equity” arrangements have long been used in global transactions, particularly in start-ups, where individuals and companies may be issued equity shares in a company based on their future non-financial contributions (such as time, expertise and effort) to the growth and success of the business. Unlike traditional equity arrangements that rely on financial investment, this mechanism recognises and rewards the value that people bring to a company through their hard work and skills. In the South African context, particularly in relation to black economic empowerment transactions, sweat equity is also an innovative way to enable individuals, especially historically disadvantaged individuals who may not have access to cash, to participate meaningfully in equity transactions, without requiring upfront financial investment.
It is a fundamental principle in South African company law that shares may only be issued against payment of “adequate consideration”. However, in cognisance of the benefits of the sweat equity concept, the 2008 Companies Act included sections 40(5) and 40(6), which provided that shares could be issued for future benefits, future services or future payment, but that if the consideration was in the form of an instrument such that the value cannot immediately be realised by the company, or in the form of an agreement for future services, benefit or payment, then such “consideration” would only be deemed received when the value is actually realised / payment received. In the interim, the equity must be issued and then transferred to a third party, “to be held in trust and later transferred to the subscribing party in accordance with a trust agreement.” Although the inclusion of these sections was considered to be quite far-reaching and innovative at the time, the concept was not clearly captured.
The phrase “in trust” initially caused confusion in the South African market, given that this wording could lead to an interpretation that such arrangement required the establishment of a formal trust in terms of the Trust Property Control Act 57 of 1988 (TPCA), along with all the legal formalities and governance requirements required for trusts under the TPCA.
However, over the years, lawyers and transaction advisors came to the conventional and common sense view that this did not require a formal trust as contemplated in the TPCA. Some interpretations in the market likened the trust construct under section 40(5) to a debenture trust, which has been held in case law not to be registrable under the TPCA (Conze v Masterbond Participation Trust Managers (Pty) Ltd [1996] SA 786 (C)). Essentially, the market view became that section 40(5)(b)(ii) of the Act requires nothing more than that the shares be transferred to a third party other than the company or the subscriber, and the words “held in trust” are simply used to describe the nature of the holding of the shares in escrow.
The 2024 amendments to the Companies Act have given effect to this long held market view and now provide that such shares could be held in terms of a type of escrow arrangement by a “stakeholder”, to be held in terms of a stakeholder agreement and later transferred to the subscribing party in accordance with the stakeholder agreement. This welcome amendment now unequivocally confirms that, in terms of the TPCA, no formal trust is required to be formed in terms of this section. The amendment goes on to provide that a “stakeholder” means an “independent third party who has no interest in the company or the subscribing party, who may be in the form of an attorney, notary public or escrow agent;” and the “stakeholder agreement” means a written contract between the stakeholder and the company.’’ That said, it must be noted that these amendments to Section 40(5) are not available for JSE-listed companies as the JSE listing rules require shares to be fully paid up.
However, for private companies, replacing “trust” with “stakeholder” provides a significant and very welcome clarification, which may be very useful – particularly for the structuring of Black Economic Empowerment Transactions (although these will still require careful structuring in order to ensure compliance with economic interest and voting rights requirements).
In addition, although this amendment paves the way for more flexible sweat equity arrangements, prudent structuring will still be required; for example, to avoid insolvency risks, the parties must ensure that the stakeholder is a financial institution, trust company or attorneys’ firm, properly governed by laws that expressly require and regulate that such shares are held in escrow and are excluded from their personal estates. Furthermore, valuation will remain another key consideration. Sweat equity, by its nature, involves contributions that are often intangible, such as time, skills and intellectual property. While these contributions are valuable, assigning a monetary value to them can be complex.
All in all, this amendment creates additional flexibility for companies to drive transformation while unlocking new opportunities for collaboration and growth. By valuing contributions beyond financial investment, South Africa is paving the way for a more inclusive and innovative economy. The task now is to turn this vision into reality, ensuring that sweat equity becomes not just a tool for empowerment, but a cornerstone of sustainable business success.
Vivien Chaplin is a Director and Phetha Mchunu an Associate in Corporate & Commercial | CDH
This article first appeared in DealMakers, SA’s quarterly M&A publication.
DealMakers is SA’s M&A publication.
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