Saudi family firms grapple with succession

16 October 2008
As the kingdom’s stock markets mature and regulation increases, family-owned businesses face increasing scrutiny over issues such as governance and succession planning.

With about 90 per cent of Saudi corporations family-owned, family businesses are, effectively, the Saudi private sector.

The kingdom’s sustained economic growth has allowed family firms to evolve into powerful conglomerates, yet in the most prominent firms, such as the Juffali, Olayan, Xenel, Al-Futtaim, Kanoo and Zamil empires, family members retain the controlling interest.

In many cases, even where firms are publicly listed, a family will hold the controlling interest. Some 30 per cent of firms listed in Saudi Arabia have more than two directors from the same family, and 20 per cent of board members are related.

These family businesses engage in a diverse range of activities, with a typically pyramidical corporate structure.

Usually, this involves a holding company with several operating companies and affiliates.

Family members form the executive management in these firms and the family largely maintains full ownership.

The model is tried and tested, and has helped to make family-owned businesses the most important players in the kingdom’s economic life since the beginning of the oil era in the 1930s.

Logical model

The family model has strong internal logic. Controlling shareholders have incentives to closely monitor the company and its management, which has a positive impact on performance.

The presence of high net worth individuals on the board also serves to boost credit worthiness, as private wealth can be used to avert an embarrassing default.

But as the kingdom’s markets mature and regulation is introduced, Saudi firms have to deal with increasing levels of scrutiny and risk.

Debate is raging over the future of the Saudi family firm, precipitated by growing concerns over their secrecy and vulnerability to succession disputes.

Where family businesses in the West have diluted their holdings from majority to minority stakes, allowing professionals to direct corporate strategy instead, the kingdom’s family businesses have yet to fully adapt to 21st century global corporate culture.

There is, for example, a strong resistance to relinquishing boardroom control and having to submit to more stringent standards enforced by market regulations.

The need to submit quarterly financial reports to shareholders, for example, jars with the local preference for long-term business planning, one prominent Jeddah-based businessman tells MEED, adding that reporting to share-holders on a quarterly basis deflects from the pursuit of long-term strategic goals.

Resolving disputes

Succession is perhaps the most difficult issue facing family businesses. In the stereotypical narrative of the evolution of family wealth, the founder builds up the company from scratch, the second generation allow it to stagnate, and the third squander the money through bitter disputes over succession.

This generalised description of the progression of family wealth is not unique to Saudi Arabia, but it does reflect the lack of maturity in the kingdom’s private sector.

Unlike traditional markets, where dominant family business are in the ownership of the fourth and fifth generations, in Saudi Arabia the big conglomerates are mainly under first and second-generation ownership.

In this model, the biggest problems arise when ownership passes to the third generation, who now run about 20 per cent of Saudi firms.

This third generation of business owners are commonly seeking to reform the family-led model into a more professional structure by ensuring that proper governance systems are in place and, critically, reviewing financial strategies.

“There have been significant issues faced by families upon the passing of the founder,” says Amin Nasser, a partner at consultant PricewaterhouseCoopers’ family business advisory service.

“Some families have had major conflicts and ended up in courts, and this has resulted in the fragmentation of family wealth and had a major impact on family business continuity.”

Sharia inheritance laws in Saudi Arabia provide for the estate of the deceased to be granted to relatives. Male family members get a higher proportion of the shares, on a 2:1 basis.

Typically, founders give each of their children one or two business lines to run. With the passing of business into the third generation of owners, the fear is that by following the tradition of allocating business lines to an ever-expanding number of family members, the businesses become diluted and lose cohesion.

“The trouble with this is that although the sons run their own business lines, they rarely work with each other to discuss the overall family strategy or the bigger picture,” says Nasser.

“They would each have to go back to the founder when they want additional funds or strategic approval of their business.”

With these issues coming to the fore, there is a growing consensus that governance structures need to be overhauled to plug serious gaps in succession planning and transition, and to avoid the prospect of the third generation degrading corporate performance.

Founders are beginning to put transitional arrangements in place where the next generation are involved in the strategy of the family business and allowed to make those important decisions while the founder is still alive.

These arrangements are broadly framed to separate management from control, decoupling the ownership issues from the management issues of a family business.

This can be done by creating a separate forum for the family shareholders, such as a family council or shareholder assembly, which deals with ownership and family issues. This body is totally separate from the holding company management board.

In this way, business issues are dealt with separately from family issues. Shareholders and beneficiaries can hold discussions and then mandate the board, which can then act independently.

Family firms seeking to separate family and business issues can set up specific processes for managing disputes between family shareholders.

“What happens is that people blame personalities for problems, but actually it is a structural problem that is normally fixable,” says Peter Leach, founding partner at UK-based firm Peter Leach, which advises family businesses. “It is the structure that causes the problem.”

Relinquishing control

Separating management from family control enables firms to embrace mainstream corporate structures without the family losing influence completely, and side-steps the requirement for greater transparency that comes with listing.

“It [splitting family and business issues in this way] is seen as the lesser of two evils as it does not involving relinquishing control of the company and requires far less public disclosure than if a company goes down the initial public offering [IPO] route,” says Philipp Lotter, a Gulf-based analyst at ratings agency Moody’s Investors Service.

Only a handful of Saudi family firms have gone public, despite the liquidity boost that opening their equity base beyond the immediate founding family can provide.

A family business survey published by consultant Ernst & Young in May this year found that only 20 per cent of Middle East family businesses had firm plans to go public.

Much of the initial hype about going public was linked to the wave of IPOs that hit Saudi Arabia before the crash of the stock market (Tadawul) in 2006. However, there is also a generational element to the IPO debate.

“The younger generation are saying there is the lot of value to be unlocked by doing an IPO,” says Nasser.

“But as long as the founders are alive, it is a difficult sell. So what some of them are doing is starting to professionalise their business, putting the governance structures in place and then in a few years’ time, if they want to go for a listing, they are better prepared for it.”

Firms that have taken the initiative to go public have done so for specific commercial reasons.

In November 2007, diversified food and retail group Halwani Brothers announced preparations to convert itself into a joint stock company, with the aim of boosting sales from SR600m ($160m) to SR2bn within five years.

Jarir Marketing Company, founded in 1974 by the five Agil brothers, is another group that invited in outside investors, offering 40 per cent of its equity via a private placement in 2000, and then launching a public offering in 2003.

The Saudi bookseller and office supplies group offered about 500,000 of its shares to the public when it first listed on the Tadawul in 2003, while retaining more than 50 per cent ownership.

The liquidity boost was designed to support the company’s ambition to triple sales to $2.4bn by 2010, enabling it to expand throughout the GCC and into Egypt.

Other family firms have broadened their investor base in different ways. In August, Al-Sawani Food & Industrial Supply Company, a Saudi retailing giant with more than 550 outlets spread across 12 countries, sold out to a Kuwaiti private equity firm.

Under the deal, the Hafiz family will retain a 40 per cent minority holding in Al-Sawani, with the Global Buyout Fund, run by the private equity arm of Kuwait’s Global Investment House, taking the controlling stake.

Al-Sawani plans to open 150 stores on the back of a $100m capital injection from Global.

Family firms have taken a step-by-step route to spreading their investor base beyond the immediate family.

In 2003, power and engineering group Al-Babtain transformed from a limited liability company to a closed joint stock family, renaming itself Al-Babtain Power & Telecommunication Company.

Then in late 2006, Al-Babtain held an IPO to sell off 30 per cent of its share capital.

“What tends to happen is that families do not usually IPO the holding company - they look at the good performers within the portfolio, the companies that have a track record and a bright future, and then try to cash out,” says Nasser.

“But before they take their companies public, they have to radically change their strategy, their mindset, and professionalise the governance within those businesses.”

The route chosen by the giant Al-Zamil group is typical of the cautious approach to going public taken by the most prominent Saudi family businesses.

In 1998, the founders formed a joint stock company, Zamil Industrial Investment Company, to house its main units - Zamil Air Conditioners, Zamil Steel Industries and Zamil Glass - in which the Zamil holding company maintained a 60 per cent interest.

Zamil is now preparing for an IPO, probably in 2009, offering for sale shares in a new unit that will comprise the company’s plastics and chemicals businesses.

Rather than a bid to stump up capital, the company sees the IPO as part of a growth strategy to expand across the region.

Zamil is also considering an IPO of its shipbuilding and maintenance business, while its affiliate, Saudi International Petrochemical Company, launched an IPO in September 2006.

Delaying listing

The Saudi stock market slump in 2006 dampened enthusiasm for IPOs. “Several family firms are holding fire but there will be [further IPOs],” says Ihsan Bu-Hulaiga, head of Saudi-based Joatha Consulting. “They are waiting for conditions to improve.”

Others suspect it may be a generation before there is greater appetite for going public. “It will come, but as long as the first and second-generation owners are in charge, it is unlikely,” says Lotter.

The muted reaction of UAE family firms to the decision of the Dubai International Financial Exchange (DIFX) to reduce the minimum free float for its IPOs to 25 per cent from 55 per cent, to encourage them to list, suggests it could be a long wait.

In the meantime, Saudi families will be busy improving their governance structures in preparation for the challenges posed by succession issues.

Those expecting a flood of Saudi families converting to joint stock operations may be disappointed, but the inward-looking model of the traditional Saudi firm cannot last.

The likelihood of board members of holding families taking in non-family members is growing.

“They don’t want board members discussing family issues,” says Nasser. “Family issues should be discussed at separate forums such as family councils.

Some of the more successful families have the holding company board comprising both family and outside professionals, and the discussions are about the business strategy, growth and profitability. They also want the outside professionals on the board to add value and challenge the family.”

Key Fact

90% - Proportion of Saudi firms that are family owned

The family office

The family office concept is slowly permeating the consciousness of Saudi family businesses. These are entities that either run a family’s financial affairs separate from the family’s control, or are controlled directly by the family itself.

Although many Western firms run family offices, there is a residual reluctance to taking up this model in the Gulf.

Many Saudi families, concerned about confidentiality, have informal family offices within their organisation that look after administrative aspects.

Abdulmohsen Alomran, a former member of Goldman Sachs’ Wealth Management team, founded the Bahrain-based firm The Family Office in early 2004.

He saw opportunities to help Gulf families invest their wealth more effectively by bringing in outside experts.

“A lot of families invest wealth in a scattered way between one bank and another, with little co-ordination,” he says. “That is how the idea was created.”

The first step is to outsource family firms’ investment portfolios. “It is a lot easier than outsourcing the day-to-day management of their businesses,” says Alomran.

“The Family Office does not get involved in the governance of Saudi businesses, or in succession issues, but in planning wealth and how to maintain it.

“We show people that of the Forbes list in the 1980s, only 5 per cent of the families on the list then are still wealthy now.

“Their wealth was destroyed by a lack of planning and co-ordination between family members.”

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