Insights from Prof. Giacomo Luciani, Director of the Gulf Research Centre Foundation
Family business groups are the main pillar of the GCC private sector. They are very important in almost all economies, but more so in the Gulf, because relatively few companies are publicly quoted, and those are either controlled by the state or by a single-family business group: only a small percentage of the shares has been floated and is actually available for trading. Prof. Giacomo Luciani, Director of the Gulf Research Centre Foundation, UAE, provides insights on family business restructuring and trends in the Gulf.
Family business groups have frequently grown opportunistically, launching various projects in different lines of business, not necessarily related to each other.
In the initial phase of private sector expansion in the GCC, in the 1970s and 1980s, private entrepreneurs were constantly scouting for good investment projects and opportunities, as their financial situation was rosy and money was chasing projects rather than the other way around.
Business groups therefore developed as conglomerates of a broad range of activities, frequently also imitating and duplicating the moves of competitors. This has indeed contributed to the intensity of competition on the domestic market, but has also led to a proliferation of companies too small to be capable of long-term growth and of making themselves independent of foreign suppliers or providers.
Consensus has it that the reasons for this pattern are largely due to the sources and methods of financing investment. Family business groups relied primarily on internal financing, or secured financing through personal and informal ties based on trust, friendship and mutual knowledge. There was no need to subject oneself to the discipline of tapping sources of finance requiring formal evaluation and control processes, such as would have been required for floating shares or bonds, or receiving financing from banks following international standards of lending.
Local banks, in turn, have been primarily geared towards collecting savings from the public, but had limited opportunities for lending domestically. Consequently, they became conduits for gathering funds for channelling abroad and investing internationally – a posture which offered only limited profit opportunities.
In the drive to increase potentially more lucrative domestic lending, they had to compete with local realities and established business practices – which often meant lending on the basis of the borrower’s reputation and in the absence of a formal process of evaluating the financial well being of the company or the soundness of the project for which the money would be used.
This pattern of corporate organization and business-bank relations has progressively run into difficulties in the past decade.
For some time, the main concern has been with the governance of family business groups – as a growing number of the original founders retired or passed away. Families in the region are frequently very large, making the task of selecting a clear leadership and avoiding conflicts between heirs sometimes very difficult.
The wish to guarantee the long-term viability of the business encouraged the formalization of business structures – that is, their organization in one or more corporations. In a few cases, this was the first step towards flotation of a share of the equity, generally a very small one, leaving control firmly in the hands of the family, as long as conflicts could be avoided.
Until 2006, flotation also was encouraged by the boom in Gulf stock values, which promised to create significant wealth in a short time. But the Saudi stock market bubble burst at the beginning of 2006, and other regional bourses also experienced declining valuations: in a sense the financial crisis for the region’s business families began at that time. The collapse in the market has not entirely eliminated the incentive to go public, but IPOs became more difficult and less attractive.
Private sector investors had also accumulated very significant international assets throughout the previous decades. Although the events of 9/11 prompted some investors to reduce their exposure to the United States market, most of the Gulf private wealth remains invested in real estate and/or financial assets in the US and Europe. This meant that when the global financial crisis hit at the end of 2008, the Gulf private sector was badly affected. The outcome for the individual investor has surely been quite diversified depending on the specific assets they picked up, but on average losses cannot have been much lower than those of all large institutional investors.
Banks in the Gulf have weathered the crisis relatively better than their counterparts in most industrial countries, and in this respect one may argue that there is no reason why lending should have suffered as much as in the industrial countries. However, the lack of transparency in many family businesses’ accounts and the difficulty of ascertaining the exact patrimonial position of borrowers have encouraged retrenchment and dried up access to credit.
In the new situation created by the global financial crisis, it is imperative that family business groups adjust to the more demanding circumstances and gear up to be able to exploit the very significant opportunities for growth, which will open in the recovery phase.
The number one requirement is for more professional management of the businesses and especially more rigorous accounting of financial results. Going public (i.e. floating shares) or publishing financial results may not strictly speaking be necessary, but banks will require better information on corporate finances before lending, and owners should themselves be keen to have better understanding of their own business.
As this first step is accomplished, it will become clear that the family group is more successful in certain lines of business than in others, and the incentive to streamline and focus on the more promising activities will appear.
The Gulf economies will grow rapidly in the coming years and offer numerous opportunities for growth, which in turn will require investment finance. This is unlikely to come either from repatriation of the owners’ private wealth accumulated abroad, or from informal financing from acquaintances – and the banks will not be ready to lend on reputation. Therefore, disposal of underperforming assets and borrowing on the basis of sound financial practices and business plans will become more important as sources of capital. Raising equity through flotation will also become more important, and in some cases investment requirements to stand up to the challenge may mean that the original family owner or initiator accepts to maintain a much smaller proportion of total equity – which in any case does not mean surrendering control.
It is quite clear that the family business model is not at all an endangered species internationally. Indeed, some of the world’s largest corporations have demonstrated that they are incapable of adapting their products and management to changing circumstances and new challenges. In contrast, family-controlled corporations have emerged as relatively successful.
The world has just witnessed the saga of the conflict between the Piech and Porsche families – two related branches of the same family – in Germany for control of the Volkswagen-Porsche auto business; and has on this occasion been reminded that Toyota, BMW and Fiat – which acquired Chrysler – are also family-controlled business enterprises. What is true in automotive is not true in all sectors, but undoubtedly family businesses can become and remain major players on the global scene.
The Gulf family businesses have the potential to acquire a similar status but need to quickly restructure for growth. The prevailing preoccupation for maintaining control and the preference for privacy must to some extent be overcome in favour of more rigorous business practices and greater transparency.
Governments should pay special attention to the establishment of an appropriate regulatory environment for financial markets and intermediaries, a task for which a lot already has been done in the past few years. They should also pay special attention to make sure that credit is available not only to the very large family business groups, but also to the much more numerous small and medium enterprises or individual businesses, which otherwise run the risk of being squeezed out of formal borrowing.
The future may be quite bright for some of the Gulf family business groups, but the experience of family enterprises in the industrial countries and in other emerging countries where they play a major role (e.g. India) must be carefully studied and internalized to develop a new model which is appropriate to the unique Gulf business environment as well as to the requirements of global finance.