Impact of private equity on GCC Family businesses
Ithmar Capital is a private equity firm that is focussed on the GCC region. It's made up of a team of experienced and knowledgeable personnel. They have offices located in Dubai and London. Their main focus is on ensuring the success of the companies they are investing in and to create value for their investors. It has also entered in to a partnership with 3i which is strategic in nature. It is a truly remarkable partnership as it will create a combination of Ithmar's in depth knowledge and understanding of this region and the global perspective, reach and network that 3i will bring to the table. Ithmar has assets under management exceeding $500 million. They also have a very diverse investment portfolio as they have invested in companies across a wide variety of sectors including healthcare, oil and natural gas, construction among others.
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Family is a very important part of most people's lives in the Middle East region. People in this region tend to depend on their families for social and economic support. A major reason why people engage in businesses in this region is not only to generate profit and wealth but also to increase the standing of their respective families in the community. But contrary to popular opinion, family businesses play a prominent role around the world and not only in the GCC region. On the fortune 500 list, 35% of the occupants are family businesses. They also play a very prominent role in providing employment opportunities as well as creating future employment opportunities. They also contribute to about half of the country's GDP. Family businesses play an even more crucial and important role in the GCC region. As per some estimates, in this region in terms of most activities those are commercial in nature; a majority of them are controlled by family businesses. There are approximately over 5000 family businesses in this region. Their total assets are in excess of $500 billion and they also provide employment opportunities to around 70% of the working population.
Networking and networks play a very crucial role in terms of the success and influence of businesses in the region be it in the banking sector among others. A large number of commitments in this region tend to be informal rather than contractual in nature. What further contributes to the importance of networking is the increasing rate of urbanisation that is spreading across the GCC region. In terms of family businesses the prominent names in the region include Kanoo, Al Touq, Al Fahim among others.
One of the major problems with these family businesses is the lack of transparency concerning financial and other aspects. They don't have any obligation to make any documents public and there is a complete lack of checks and balances like having independent directors on the board. Also the expansions plans of many foreign companies in the region have hit major roadblocks because of governments adopting protectionist measures.
But it would be unfair to club all the family businesses in the region under one category. The organisational structure of these family held businesses is extremely complex and often difficult to understand due to issues like cross ownership among others.
Fundraising in the region had definitely gathered pace around 2006, due to the excess liquidity floating around due to the high oil prices but the global financial has definitely changed the scenario to a great extent. But interest in the region is definitely growing because firms realise that there is still no out and out dominant player in this market and the potential opportunities are too good to miss out on. Another cause for concern for private equity players is the lack of a proper human and managerial talent pool available in this region and this adversely impacts the prospects of private equity players in this region.
Another factor that is very attractive for private equity players is that a major proportion of companies in this region are privately held companies as against in the Western world where most notable companies are publicly listed. So the private equity players see a great scope in terms of investing in these companies and eventually taking them public. An important 2 way flow of capital seems to have begun in the region with most of these family businesses being rich in cash, looking beyond this region in terms of expanding into overseas markets and the private equity players are being attracted by the reform process that is slowly and gradually taking place in this region. With increased two way investment it will pose a unique challenge for the family businesses in the region as they may have to face upto the prospect of stiffer competition and get out of their comfort zone.
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Also a new phase seems to be emerging for family businesses in this region. Many of the businesses were started 30-40 years back and now most are at a stage where the reigns of the companies will be handed over to the second generations. But the statistics don't paint a very pretty picture in terms of the fact that most family run businesses around the world are unable to complete a successful transition beyond the second generation, with the percentage falling further when it comes to the third generation.
Therefore family businesses in this region are facing three major issues going forward:
1. Restructuring and market strategy
Family businesses in the GCC region are spread across a diverse variety of sectors be it retail, construction among others. Mergers and acquisitions have been few and far between and when they do take place not emphasis has been placed on the synergies available as well where the acquisition would fit into their portfolio of companies. When the region became flush with liquidity due to high oil prices many of these businesses had to look abroad to grow in terms of takeovers or M&A's because of the limited scope for expansion in many of the markets in this region. But with foreign companies also flooding towards the region attracted by the slow but gradual reform process theses family businesses are being subjected to completion at both home and abroad. In such a situation one major handicap for these firms is their haphazard organisational structure with their portfolio consisting of a large number of unrelated companies and so on. The tradional family run businesses are also being challenged by the increasingly complex market conditions they operate in. Businesses in this region thrive based on networks and strong personal relationships but the family business owners are finding it increasingly hard to maintain them due to the complex and ever changing environment they operate in which is no longer stuck in traditions.
Role of Private Equity
For private equity players the main thing is creating value for their clients. From their point of view businesses have to have a certain structure and their assets have to be focussed in a particular direction. Once they invest in a company their main focus is always on finding out where their main or core market lies in terms of product, geography, etc in order to generate maximum returns. The result is that then the company can focus on those business areas and units where the performance is not upto the mark. In this case the family businesses in this region can then focus on some selected business sectors that are particularly attractive and divest from the rest where they are not doing well and there is not much scope for turning around the situation. The divestment from these businesses will help in raising additional capital which can then be used to for investment in the core activities and units of the business. Private equity can help in terms of bringing their expertise and knowledge onto the table in terms of best practices and can help these family businesses refocus and restructure. There is also the fact that private equity players have huge and powerful global networks that they bring to the table, the businesses in this area also have their long term and established contacts and networks that play a very important role in this region. Therefore we could potentially see the coming together or integration of these networks. This is especially very useful when the firm is looking into getting into new markets. But this is also a win win situation for private equity firms in that once they have access to these networks they can be great source of other potential deals which may not have been feasible earlier. Therefore a strategic alliance between a GG family business and a global private equity firm can lead to value creation for both of them.
Some of the main issues concerning GCC businesses especially family businesses are the matters of corporate governance, compliance with regulatory requirements, transparency, etc. Business decisions in these firms have traditionally been made in a very informal manner by the owners without much transparency, openness and scrutiny. There is a complete lack of consideration when it comes to the needs and requirements of various stakeholders associated with the business such as lack of proper channels of communication. Most of the companies in this region don't even have a formal program in order to prevent frauds from taking place. The lack of these proper corporate governance structures can be major turnoff in terms of attracting investments from major private equity players as they will not be able to have complete faith in the due diligence process. In terms of reforms in this regards the markets that seem to be progressing in the right direction include Oman and Kuwait whereas those that are yet to follow this path in a serious manner include Saudi Arabia and Dubai.
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There are two main factors that are leading to improvements in the above regards including the fact that companies in the GCC are increasingly investing abroad and are indulging in M&A and takeovers abroad and as a result their standards are gradually coming in line with international standards. The second major factor had been the decision of the central banks in the GCC to comply with the Basel I and II norms which have forced greater regulatory requirements on firms including disclosing greater and more detailed information in financial statements and creating better processes to manage risks. This has been welcomed as a positive development by limited partners around the world but there is still a long way to go.
Role of Private Equity
When private equity players invest in a business, they do so with the ultimate aim of a successful exit. But in order for there to be successful exit, the levels of corporate governance in the organisation have to reach a certain level. Therefore when private equity players invest or enter into an alliance with a private business in the GCC region, they will make sure that the levels of corporate governance and transparency in the organisation are compliant with international standards. Most of the family businesses tend to be run as per the whims and fancies of the owner but what private equity will ensure is that what gains importance/prominence is the organisation rather than the individual and the organisation runs based on certain rules and regulations. They will ensure that a proper system of internal controls is established in the organisation. The private companies in the GCC region themselves are increasingly realizing the importance of having a good corporate governance structure in place primarily to reduce the number of instances of malpractice and fraud and to ensure better flow and utilisation of information in the organisation. A better corporate governance structure also makes it easier to access credit and it makes it easier to access the debt market as well, especially as banks in the region begin to tighten their regulatory requirements.
From private equities point of view corporate governance is very important as it helps to improve valuations. This is because then potential investors will view investing in the organisation as a less risky prospect which has a direct impact on the valuation. What private equity brings to the table is various global frameworks and best practices in terms of corporate governance which can be applied in these family businesses. What may help in this regards is if the first generation of family business owners start laying the groundwork/framework for a corporate governance structure, while keeping the second generation in the loop to ensure the process does not fall apart incase of succession.
3. Succession, Management and Boards
In family businesses in the GCC region like anywhere else in the world, there is the trend and tendency that most of the top positions as well as managerial roles are occupied by members of the family and ownership also passes down from generation to generation rather than to external shareholders or others. This can have an adverse impact on the day to day running and management of the firm. There is little or no proper succession planning in most of these firms with the original owners continuing to run day to day affairs into their 70's and 80's.
One of the main reasons behind this problem is the huge size of the families in the GCC region, which inevitably poses problems when it comes to succession planning in family businesses. Succession is a very important stage for any organisation around the world if it's not handled with proper care and caution it can lead to the failure of the organisation as has been seen around the world. The trend in the gulf region in terms of dealing with succession issues is to transfer control to the eldest son, but this also often results in conflicts that have an adverse impact on the organisation. Also in certain cases the eldest son simply may not be capable of running a business as he may not possess the skill, talent or acumen to do so. This again can have dire consequences for the organisation if the person who is supposed to be guiding the organisation in the right direction has no clue as to what he is doing. There may also be a feeling among some of these members that they are entitled to some managerial post in the organisation or on the other hand there may be a large number of members who wish to cash in on their stake depending on the conditions prevailing in the market. Each of these scenarios can cause a potential problem for the organisation.
Also in family businesses in this region like many others around the world there is no proper distinction between ownership and management and a number of important decisions pertaining to the organisation are taken over the dining table in an ad hoc and informal manner. There are serious sustainability issues involved concerning the organisation if the decision making process is carried out as indicated above as it would alienate the employees completely as they would feel like they have absolutely no say in the functioning of the organisation. And in today's competitive environment such complete lack of delegation and centralisation of control can have adverse consequences for the organisation.
There are also serious question marks when it comes to the boards of companies in this region. The minority shareholders hardly have any voice or say on the board and incase of family run businesses the boards normally consist of members of the family and they are very reluctant to let any outsider or external person become part of the board. This ensures that there are absolutely no external checks and controls on the functioning of the organisation, and very few question marks are raised concerning the way the organisation is being run and this leads to serious concerns with regards to accountability. Also the organisation also losses out when it comes to having access to outsiders expertise.
Role of Private Equity
Private equity can help the GCC family businesses in properly separating ownership and management. They can ensure that a proper/formal organisation structure is put into place that ensures that there is proper unity of command and unity of responsibility in the organisation regardless of the size of the family involved and it will also clearly lay down the red zones for different members of the family. What makes the role of private equity important in this case is that they are a neutral third party with no alternate agenda and their sole aim is to create value for the business and to ensure its continued growth and prosperity and can therefore play a crucial role in sorting out the succession issues which can otherwise prove to be very prickly and thorny issues.
Private equity investment also presents a very good opportunity to those members of the family who are looking to leave the business as far as exit options are concerned. This is clear from the fact that as per reports among the 10 stock exchanges around the world that are the worst in terms of performance, six of them actually lie in the Middle East region. In terms of steps to ensure better development of the exchanges in the Middle East region, the UAE has taken an initiative by passing a regulation that allows the family run businesses who decide to go in for an IPO, to actually retain their majority stake in the business. But to what extent this step ends up being successful remains to be seen given that a similar initiative taken by Saudi Arabia has not made a substantial difference up until now. While mergers and acquisitions are on the rise they have not reached the level where they can actually be considered by the family businesses as viable options in terms of exiting tghe business. Therefore private equity provides a highly viable exit strategy for family members looking to leave the business.
Along with private equity investment will also come the introduction of professional and competent managers and board members. This will ensure greater level of accountability and transparency in the organisation as well as bring in tremendous and unique knowledge possessed by these individuals which the firm did not have access to up until now. These professionals will have set targets to achieve and incase they fail to achieve them, they will asked to leave the organisation, a luxury not available when these posts are occupied by the members of the family. Therefore a performance based culture is introduced in the organisation rather than a culture bordering on nepotism. The management standards and best practices introduced by private equity can also help in the development of local human and managerial talent who will benefit from the experience of working closely with the top notch managerial talent that the private equity investor will bring into the organisation to work alongside the existing management. Normally in companies where private equity players invest, the board of directors tend to play a very proactive role in terms of the day to day operations of the business. In such companies the board will have representation from experts from various fields, representatives of the private equity investor among others.
Therefore the family businesses in the region will have to have an open mind and drastically change the way they do business. They will adjust their way of functioning and let go of the absolute control that they have had over businesses for a very long time and will have to get used to the fact that their actions will be subject to close scrutiny. Likewise the private equity players will also have to take into account the various sensitive matters and situations involved in family businesses and will have to give due respect to their traditions and will need to handle various situations with care and caution rather than haste.
Therefore it can be seen that a partnership/alliance between family run businesses in the GCC region and private equity players can lead to a win win situation for both parties involved with value being created and with the ultimate winner being the business concerned.