Currently, most IFRS 2 valuations use option pricing to value vendor-funded B-BBEE structures that are unlisted. This, however, substantially overstates the expense. A much more appropriate valuation approach uses the volatility of income to model the IFRS 2 expense. In their capacities as advisors at Empower Capital, Philip Haslam and Sahana Vaidya have published a peer reviewed article relating to an appropriate valuation approach for vendor-funded B-BBEE ownership shares in the context of IFRS 2. The detail is as follows:

South African legislation requires that local black South African individuals be given ownership in companies. When the company selling its shares lends the money to the black investors to purchase the shares, the accounting standards (IFRS 2) require that the transaction be derecognised. Instead, a charge is expensed in the company’s financial statements relative to the amount of value given away as determined by expert valuation. This paper proposes that it would be inappropriate to use a listed call option pricing model in valuing an unlisted Broad-based Black Economic Empowerment (“B-BBEE”) ownership structure when the B-BBEE party will not practically be able to sell those shares on a listed market at the expiry of any lock-in period. The paper proposes an alternative approach that assesses whether the forecast free cashflows of the business would be sufficient to repay the vendor-loan in the context of a Monte-Carlo simulation (“Cashflow Variance approach”). Using 715 different simulations based on differing assumptions, the IFRS 2 charge was in the range of approximately 7-11% of the value of the B-BBEE shares prior to vendor-funding for an unlisted company. This range is substantially lower than the results from listed call option pricing models due to the lack of listed market price and associated price volatility in unlisted scenarios – key drivers of the price of listed call options. The paper concludes that the Cashflow Variance approach is more suitable in valuing the IFRS 2 charge in a scenario where a B-BBEE party will acquire unlisted, vendor-funded shares.

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