Impact of private equity on GCC Family businesses Essay Example

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Transparency and accountability are major concerns in household businesses, as they often lack openness regarding finances and other aspects. These businesses have no obligation to disclose any documents to the public and operate without independent board directors to ensure checks and balances. Moreover, many foreign companies' expansion efforts in the region encounter challenges due to governments implementing protectionist measures. Nonetheless, it would be unjust to generalize all household businesses in the region with a single classification.

The organizational structure of household businesses in this region is complex and difficult to understand, mainly due to cross ownership. Fundraising gained momentum around 2006 because of extra liquidity from high oil prices, but the global financial situation has since significantly changed. However, companies are increasingly interested in the region as there is no dominant player in this market and numerous potential opportunities to seize. Private equity players also worry about the lack of skilled professionals in this area, which hampers their prospects. Furthermore, a significant number of companies here are privately held, unlike most notable companies in Western countries that are publicly listed.

Private equity participants in the region are seeing numerous opportunities for investment and eventual public offerings of companies. Family businesses in the area have substantial cash reserves and are seeking expansion into foreign markets, creating a mutual flow of capital. The ongoing reform process is attracting private equity players, leading to increased investment from both sides.

This poses a unique challenge for family businesses as they may encounter tougher competition and step outside their comfort zone. Additionally, there is a new phase emerging for family businesses in this region. Many were established 30-40 years ago, and now most

are approaching the point where the next generation will assume control.

However, global statistics indicate that most family-run businesses struggle with successful transitions beyond the second generation, with even lower success rates for the third generation. Consequently, family businesses in this area face three major issues moving forward: diversification across sectors such as retail and construction among others.

Amalgamations and acquisitions have been infrequent and not focused on possible synergies or fitting into existing company portfolios. The region had limited expansion opportunities, so businesses had to look internationally for growth. However, foreign companies are now competing with local businesses, both domestically and abroad, due to gradual reform processes. One major challenge for these firms is their disorganized structure, with a wide range of unrelated companies. Additionally, traditional family-run businesses struggle in the increasingly complex market conditions they face. Success in this region relies on networks and personal relationships, which are difficult to maintain in the constantly changing and non-traditional environment.

The Role of Private Equity

Private equity participants prioritize creating value for their clients. They believe that businesses should have a specific structure and focus their assets in a particular way. When they invest in a company, their main focus is determining the company's primary or core market in terms of product, geography, etc., to generate maximum returns. As a result, the company can concentrate on improving its performance in those business areas and units that are not meeting expectations. In this case, family businesses in this region can then concentrate on selected attractive sectors and divest from the rest, which are not performing well and offer limited potential for improvement. Divesting from these

businesses will help raise extra capital, which can be invested in the core activities and units of the business.

Private equity can offer valuable expertise and knowledge to family businesses, assisting in improving their practices and restructuring efforts. Additionally, private equity players have extensive global networks that can greatly benefit these businesses. Moreover, family businesses already have established contacts and networks of their own which are crucial in this region. Therefore, there is potential for integrating these networks, especially when the company is considering expansion into new markets.

But private equity firms can benefit from this situation as well. By gaining access to these networks, they can discover potential deals that were previously not possible. This means that a strategic alliance between a GCC family business and a global private equity firm can create value for both parties.

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Administration

GCC businesses, including family businesses, have several concerns such as corporate governance, regulatory compliance, transparency, etc. Traditionally, these companies have made decisions informally by the owners without much transparency or scrutiny. They lack effective communication channels and do not consider the needs of various stakeholders associated with the business.

Most companies in this region lack a formal plan to prevent fraud. The absence of proper corporate governance structures can deter major private equity investors who need confidence in the due diligence process. In terms of reforms, Oman and Kuwait are making progress, while Saudi Arabia and Dubai have yet to prioritize this issue. Two main factors are driving improvements in this area: GCC companies are increasingly investing abroad and engaging in mergers, acquisitions, and takeovers, aligning their standards with international ones.

The decision of the cardinal Banks to comply with Basel I

and II norms in the GCC was a major factor. These norms have imposed stricter regulatory requirements on companies, including disclosing more detailed information in financial statements and implementing better risk management processes. Limited partners worldwide have welcomed this development, but there is still a long way to go.

Role of Private Equity

Private equity players aim for a successful exit when investing in a business. However, for this exit to be successful, the organization must meet a certain standard of corporate governance. Therefore, when private equity players invest in or form alliances with private businesses in the GCC region, they ensure that corporate governance levels and transparency align with international standards.

Most household concerns are run according to the whims and fantasies of the owner. However, private equity ensures that the focus is on the management rather than the individual and that the management operates based on specific rules and regulations. They also ensure that a proper system of internal controls is established within the organization. Private companies in the GCC region are increasingly recognizing the significance of having a strong corporate governance structure in place. This is primarily to reduce instances of misconduct and fraud, as well as to ensure better information flow and utilization within the organization. A robust corporate governance structure also facilitates access to credit and debt markets, especially as regional banks tighten their regulatory requirements. From the perspective of private equity, corporate governance is crucial as it helps improve valuations.

This is because potential investors will see investing in the administration as a less risky opportunity which directly affects the rating. Private equity brings various global models and best practices in terms of

corporate governance that can be applied in these family businesses. It may help if the first generation of family business owners lay the groundwork/framework for a corporate governance structure, while involving the second generation to ensure the process remains intact in case of succession.

Sequence, Management and Boards

In family businesses in the GCC region, similar to anywhere else in the world, there is a tendency for most top positions as well as managerial roles to be occupied by family members, and ownership also passes down from generation to generation rather than to external shareholders or others. This can have a detrimental impact on the day-to-day operations and management of the company.

Most of these houses lack proper sequence planning, with the original proprietors continuing to oversee daily operations well into their 70s and 80s. This problem is primarily caused by the large size of families in the GCC region, which poses significant challenges for succession planning in family businesses. Successful sequence is crucial for any organization worldwide, as mishandling it can lead to failure, as observed globally. In the Gulf region, the common approach to addressing sequence issues is transferring control to the eldest son, yet this often results in conflicts that negatively affect the organization.

In certain cases, the eldest son may lack the necessary skills, talents, or expertise to effectively manage a business. This can have severe consequences if the person in charge is clueless about what they are doing. Some members may believe they deserve a managerial position while others might exploit their ownership stake based on market conditions. Both of these situations can create problems within the organization. Moreover, family businesses in this region

and many other places struggle with distinguishing between ownership and management. Crucial decisions about the company are often made informally and spontaneously during family meals. This decision-making process can pose significant sustainability challenges as it excludes employees who feel powerless in shaping the company's operations.

In today's competitive environment, the administration can suffer adverse effects due to the complete lack of delegation and centralization of control. Concerns also arise regarding boards of companies in this region, particularly when it comes to minority stockholders who have minimal influence on the board. This is especially true for family-run concerns where family members dominate the board and are reluctant to include external individuals. As a result, there are no external checks and controls on the administration's operation, raising significant accountability concerns. Furthermore, the administration misses out on access to expertise from foreigners.

Role of Private Equity

Private equity plays a role in assisting GCC household concerns by facilitating proper separation of ownership and management.

Private equity can be instrumental in establishing a proper administration structure that ensures command integrity and responsibility within an organization, regardless of its family size. Additionally, they play a crucial role in defining boundaries for different family members. As an unbiased third party with no hidden agenda, private equity's sole objective is to create value and ensure the business's ongoing growth and success. Their involvement can effectively resolve complicated inheritance issues. Furthermore, private equity investment offers attractive exit options for family members seeking to leave the business. This opportunity becomes particularly significant considering the poor performance of six out of ten stock exchanges in the Middle East region. To enhance exchange development in this area, the UAE has

taken the initiative of passing regulations that allow family businesses opting for an IPO to retain majority ownership.

However, the success of this measure is uncertain as a similar initiative taken by Saudi Arabia has not yet made a significant difference. Although mergers and acquisitions are increasing, they have not reached a level where family businesses can consider them as viable options for exiting the business. As a result, private equity offers a highly feasible exit strategy for family members who wish to leave the business. In addition, private equity investment will also bring in professional and competent directors and board members.

By incorporating professionals into the administration, accountability and transparency will be enhanced. Moreover, valuable knowledge that was previously inaccessible will now be brought in. These professionals will have specific objectives to accomplish, and if they fail to meet them, they will be compelled to leave the administration. This contrasts with situations where family members hold these positions as they do not face the same consequences for poor performance. Consequently, a culture based on meritocracy rather than favoritism is being established. Furthermore, private equity's introduction of management standards and best practices can support the growth of local talent by facilitating their close collaboration with highly skilled managerial experts that private equity investors will bring into the administration.

Typically, in companies with private equity investors, the board of managers plays an active role in the day-to-day operations. This board consists of experts from different fields and representatives of the private equity investor. As a result, family businesses in the area must be open-minded and adapt their business practices. They must relinquish the control they have had for a

long time and accept scrutiny of their actions. Similarly, private equity participants must consider the sensitive matters and situations specific to family businesses. They must respect traditions and handle situations carefully rather than impulsively.

Therefore, it is evident that a partnership/alliance between household run concerns in the GCC part and private equity participants can lead to a mutually beneficial situation. This partnership has the potential to create value and ultimately benefit the businesses involved.