Thursday, October 15, 2015

IPOs from a Family Business Perspective - Pre-IPO Legal Due Diligence

The GCC region has a high number of family run businesses. Recently Oman has witnessed a growing interest amongst such businesses to opt for an IPO. To initiate an IPO, an internal decision must be made by the shareholders. Once the decision has been made to pursue the IPO, the legal advisor has an important role to carry out comprehensive legal due diligence with the cooperation of management and shareholders. Due diligence is critical to examine the business’s legal risks such as its corporate and tax position, major contractors with suppliers and customers, and debts and liabilities. 

Initial Public Offering (IPO) of a business marks a major milestone in the life cycle of the business enterprise and entails months if not years of hard work and planning by the management team and the shareholders.  In the case of family-owned and -run businesses, the decision to opt for an IPO is even more difficult.

In the GCC region, the business sector is dominated by family businesses and we are beginning to witness a growing interest amongst such businesses to go for an IPO.  The reasons for such a decision include reducing the founder’s equity in the business, succession planning, expanding the shareholder base and increased emphasis on transparency.

Factors to Consider When Offering Shares to the Public

The IPO process starts with an internal decision of the shareholders to explore the option of an IPO.  The usual next step is the appointment of the Issue Manager, Financial Advisor and the Legal Advisor.  The Capital Market Authority (CMA) regulations outline the key responsibilities of the advisors.

In the case of family businesses considering a public offering, the role of the Legal Advisor is very important and at times precedes the scope of work to be undertaken by the other advisors.
Due to various local practices, Sharia requirements and applicable regulations, the family businesses at times tend to have assets (in particular real estate) registered in the name of individuals instead of the business entity.

Moreover, we see a lot of related party arrangements between entities owned by the shareholders/family members.  Furthermore, the investments of a family business can also be disorganized and the assets/liabilities may not be backed up with proper contractual documentation as compared to non-family-run businesses.  Obviously, some family businesses are well organized and are managed in a similar manner to public listed companies in the country.  However, it is important to be aware of some of the typical challenges/practices that one may notice and which need to be considered carefully once a decision has been made to offer shares to the public.

Importance of Pre-IPO Due Diligence

Once a family business opts to offer its shares to the public, one of the first actions it should take is to appoint a legal advisor to undertake a comprehensive legal due diligence of the business and identify gaps and help take remedial actions.  The success of such legal due diligence largely depends on the cooperation and commitment of the management and shareholders and it is important that everyone involved in the process understands and shares the same vision.

The purpose of the legal due diligence includes examination of the business to identify key legal risks faced by the business entity and should cover the following areas:
  1. corporate and tax position;
  2. existing consents, permits, licenses and other authorizations;
  3. major contracts with suppliers and customers;
  4. debts and liabilities (and related finance facility and security documentation);
  5. employee contracts and related matters;
  6. title to the business’s major assets; and 
  7. status of any disputes, claims and litigation. 
A key aspect of the legal due diligence exercise is to review loan and related security documentation and ascertain if any security offered to the bank(s) needs to be reviewed and alternate security offered instead.  It is possible that a family business may have offered a property owned by one of the family members as collateral and the lender may have created a legal mortgage over such property to secure its interests.  If such property is actually beneficially owned by the business then the business entity should enter into an arrangement with the secured lender to remove the mortgage, transfer the property in the business entity’s name and then re-create the mortgage.

Similarly, it is important to review and assess the related party transactions and to ensure that these are being done on an arm’s-length basis and that proper legal documentation exists to support such transactions.