SARBs new loop structure allows foreign investment for startups

Source: Bizcommunity, 18/04/2017

Local unlisted technology, media, telecommunications, exploration and
other research and development companies can establish companies
offshore in order to obtain foreign investment without prior Reserve
Bank approval according to a recent circular from the Financial
Surveillance Department of the South African Reserve Bank (SARB).

The circular amends the Currency and Exchanges Manual for Authorised
Dealers. Previously the manual required companies to apply for
approval from the SARB to list offshore to raise loans and capital.

It is now possible for a South African company to create a so-called
“loop structure” in order to raise capital overseas, says Brendon
Ambrose, associate, commercial IP, Spoor & Fisher
Four conditions

“A loop structure is one whereby a South African resident will form an
offshore company which will in turn reinvest into South Africa by
acquiring shares or some other interest in a South African company or
asset. Up until recently this sort of structure contravened regulation
10(1)(c) of the Exchange Control Regulations, 1961.”

Establishing such an offshore company, however, is subject to four
conditions, namely these companies have to register with the financial
surveillance departments; the offshore company must be a tax resident
in South Africa; full details of the percentage shareholding in the
offshore company (including the group structure) must be provided; and
an annual report must be submitted to the financial surveillance
departments on the operations, including details of funds raised offshore.
Higher burden of disclosure

“This subsection, while providing that South African companies may now
establish an offshore company to raise funding, places a high burden
of disclosure on the offshore company,” adds Ambrose.

Disclosure of the details of the group structure and the requirement
to submit an annual report creates an administrative burden on South
African companies. These administrative requirements are certainly not
deal breakers but must be borne in mind when considering a loop
structure as a capital raising mechanism.

The second new section completes the loop, as it allows the foreign
company to, in turn, hold investments and or make loans in to South
Africa. The allowance of loop structure is important for South African
startups looking to raise capital from foreign investors. A loop
structure makes the remittance of the capital back to the South
African company substantially simpler

The investor, in order to mitigate its risks, may only be willing to
invest funds in a company registered in the investor’s own country.
Control by equity

The South African company can set up an offshore company (first half
of the loop) where the foreign investors will purchase equity. This
offshore company will, in turn, purchase shares in the South African
company (second half of the loop). The key here is the control; the
foreign investors are happy as they now have equity in the South
African company allowing them to exercise some level of control over
the South African companies’ IP.

Previously, there was no way for the foreign investors to gain this
control by equity unless they were willing to purchase shares in the
South African company directly.

“This is a huge step forward in opening up South Africa to foreign
investment and such loop structures should be considered quite
seriously by South African tech, fintech, telecom and R&D startups,”
says Ambrose