Private Equity Opportunities for GCC Family Businesses

This article, written by Curtis partner Peter Stewart and associate M. Adil Qureshi of the firm's Dubai office, was first published in the December 2009 issue of the The Brief magazine. It has been reprinted here with the permission of the publisher. ______________________________________________________________ The slowing of the world economy and the restrictive credit environment has pulled back the curtain on many Gulf Cooperation Council (GCC) family firms, revealing structural weaknesses. However, the challenges posed by the economic crisis are not without opportunity. Indeed, the crisis provides strong impetus to reshape GCC family businesses in ways necessary to ensure firms’ long-term survival and success. For many family firms, private equity can provide an effective framework for accomplishing this goal. As the summer months passed, economists, business people and commentators speculated over the timeline of an economic rebound in the Gulf region. Such discussion looked at a range of economic indicators, including employment, oil demand, budget projections and inflation. In their commentary, one factor – the health of family businesses – seemed to be overlooked. Family Ties Family businesses are a vital part of the economic fabric of the GCC economy. Some estimates indicate family businesses conduct more than 90 per cent of commercial activities and employ more than 70 per cent of the workforce in the GCC. The defaults of the massive Saad Group and Ahmad Hamad Algosaibi and Bros (AHAB) earlier this year made it clear that the family sector would not emerge unscathed from the economic crisis. That controversy marked an end to loose credit practices regionally and exacerbated restrictive credit conditions. The most obvious benefit of private equity investment is liquidity. There has been much talk of the appeal of family firms’ holdings to the many private equity firms operating in the GCC in recent years. Such firms could purchase unproductive units, use sector-specific expertise to retool them and potentially combine them with other units, unlocking synergies. If family firms can make the difficult decisions necessary to part with such business units, private equity could provide them with badly needed cash while making a profitable return. The benefits of private equity, however, may go beyond liquidity. Private equity firms can bring to bear the managerial expertise necessary to reshape family businesses by helping to pare down unproductive business units, boost productivity, raise funds, reform corporate governance, professionalise functions, and institute new systems and processes. These steps can prove crucial to securing the prosperity of the company. If permitted to invest in the company and to influence management, private equity can reshape the business for future growth. There are a number of steps family firms can take to increase the likelihood that private equity firms will invest in their business. The first of these steps is formalising corporate governance in line with international standards. The process of strengthening internal controls, risk management mechanisms, and monitoring and reporting frameworks can reveal weaknesses and valuation affecting issues while instilling enhanced managerial discipline. Additionally, firms can recruit independent non-executive board members and bolster the influence and accountability of their boards by instituting typical board committees with written charters, policies and procedures in line with international standards. Separation of Powers Perhaps the most significant governance step that family firms can take is to separate ownership and management. Top management and the board of directors should coordinate with, but be independent of, the family. Such a measure would typically serve to encourage professionalization of management, avoid succession conflicts, and increase transparency. The improvement of governance and the professionalisation of management prior to a deal should also facilitate the implementation of new systems and processes after a deal. Further, the implementation of standard practices, including accounting practices, will signal to investors the reliability of a firm’s figures and improve the likelihood of a successful transaction and later exit. Lastly, family businesses in the GCC should be flexible and creative in structuring private equity deals. While often majority and controlling stakes cannot legally be sold, GCC family businesses should be open to transferring larger stakes and more control in order to allow private equity investors to realise expected returns. Structures involving hybrid securities, debt, dividends and warrants can be considered. Family firms may also consider allowing private equity investors the chance to exit through partial IPOs. Nasdaq Dubai has recently decreased its minimum offering requirement to 25 per cent in a bid to encourage this behaviour and entice more family businesses to offer shares for public trading. Family firms have an honoured legacy in the Gulf for pioneering industries, exploiting new opportunities, and creating wealth. Today, many of these pioneers stand at a crossroads. Will they respond to current pressures by continuing with old ways of doing business, or by embracing change that will enable them to meet the challenges of an increasingly global economy? For many family firms, private equity investment can be an effective catalyst for change helping to meet those challenges.

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What Fund Offering Terms Should Omani Institutional Investors Negotiate? (Private Equity)

Private equity funds are broadly accepted as an established asset class among institutional, sovereign and other sophisticated investors. As a general matter, the performance of private equity funds does not closely correlate with that of the public equity markets, thereby providing an excellent risk diversification tool for investors seeking to make a passive, long-term commitment of their capital. In this article, we briefly examine certain key terms that Omani institutional investors (e.g., sovereign wealth funds, pension and other government funds, private financial institutions, and banks) should consider negotiating for in relation to their capital commitment to private equity funds.

• MFN Clause: The most-favoured-nation clause guarantees the institutional investor treatment no less favourable than that accorded, in the past or future, to any other investor in the fund. Any preferential treatment must be disclosed to the institutional investor, with the option to elect to receive such treatment itself.
• Fees: Generally, management fees should be determined in relation to a fund’s aggregate capital commitments during the investment period and in relation to its declining invested balance thereafter. The carried interest, moreover, should only be paid if a hurdle rate is achieved (generally either 8% or 12% return, depending on the fund’s investment strategy), calculated on a “funds-as-a-whole” basis and subject to a guaranteed clawback. Further, no placement, organizational or other fees should be chargeable unless otherwise agreed with the institutional investor and disclosed on an item-by-item basis. The calculation of all fees and carried interest distributions should be confirmed by an independent audit to provide transparency to the institutional investor, and all fees should be commercially reasonable and in line with market rates.
• Excusal Rights: Under the Executive Regulations and Instructions issued by the Ministry of Finance of Oman, certain institutional investors (such as sovereign wealth funds) may be statutorily forbidden from investing and/or maintaining more than a set percentage of their aggregate assets in investments outside of Oman. In such case, the institutional investor should require the fund to provide it with prior notice of any prospective investment to allow time to consider the permissibility of the investment and to elect not to participate.
• In-kind Distributions: An institutional investor should ensure that all distributions of fund assets are made in cash, unless it specifically agrees to in-kind distributions, in which case it should request the right to establish a liquidating trust to receive the in-kind distribution.
• Transferability: An institutional investor should request a carve-out to the fund’s transfer restrictions to permit affiliated-party transfers (for example, where the institutional investor is undergoing a reorganization) without requiring the fund’s consent.
• Allocations of Carried Interest/Change of Control Disclosure: The fund manager should disclose the allocation of carried interest amongst its personnel and any changes to such allocations. Further, any changes of control of the fund manager should be disclosed to the institutional investor and trigger a suspension on commitment drawdowns.
• Privileges and Immunities: Certain institutional investors may, under Omani law, benefit from immunity from certain domestic and international laws which would otherwise be applicable to them. No provision of any fund document should prejudice such immunity unless deliberately waived by the institutional investor.
• Alternative Investment Vehicle: Where the fund elects to establish an alternative investment vehicle to pursue a particular investment opportunity, the institutional investor should have the right to “opt out” of the vehicle upon sufficient prior notice.
• Forum Selection: Omani courts should have exclusive jurisdiction in respect of any legal action brought against an institutional investor relating to its investment in the fund.

Investing in private equity entails a long-term capital commitment by the investor (up to 12 years), coupled with little or no influence on the decision- making process of a fund. It is, therefore, crucial for Omani institutional investors to negotiate the inclusion of terms, such as the above, in a side letter agreement with the fund manager before investing to ensure high levels of transparency and oversight of the fund manager’s decision-making process, and the alignment of the fund’s investment strategy with the investor’s portfolio diversification and regulatory requirements.

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