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Why some family businesses do not taste success

Dr. Ali Al-Ghamdi

Published: Updated:

In most cases, family businesses are those firms that are established and run by individuals. Sometimes, the individual owner gives a portion of the stake in the firm to his brothers or sons. The individual, usually from humble beginnings, starts his business and then he expands it, transforming it later into an establishment or company. That individual founder will be the major decision maker of the firm until he becomes aged or breathes his last.

In the event of the founder’s death, his eldest son will normally take over the firm on the basis of a will, if there is one prepared beforehand. There are many instances in which such firms are successful and expand their activities. In other cases, disagreement among the heirs may lead to the collapse of the firm. This might be because of mismanagement by those who run the firm or because of the jealousy and suspicion of some partners about the overall functioning of the firm.

This may be one of the key factors that has prompted many owners of family businesses to convert their establishments and limited liability companies into joint stock companies by floating a maximum of 30 percent of shares into circulation, and keeping the remaining shares in their name and the names of their sons and daughters.

They constitute the board of directors and choose its chairman by exercising their power as long as they are the holders of more than two-thirds of the shares. The shareholders have to agree with the decision of the chairman of the board, and those who try to criticize him or make an observation with which he does not agree might be marginalized to the extent of not having their board membership renewed in the future.

Poor performance

Some family businesses have had a record of poor performance and a subsequent fall in their profits. Some of these firms have failed to earn any profit while others are run at a loss. There are other firms that follow corrupt practices even in the process of their formation and publish false financial statements. These firms float their shares at a high premium and this causes tens of thousands of subscribers to incur huge losses, and eventually results in cases of fraud and cheating.

Subsequently, these cases lead to the trial of the concerned officials and the award of stiff penalties as happened in some cases. There could be alternative ways of exposing these fraudulent practices and prosecuting those who have eaten the money of people in a wrong way, and of helping secure compensation for those subscribers who were victims of fraud and malpractice.

Some companies resort to duplicity by announcing that they had incurred losses after being converted into joint stock companies. This was the case with some companies that announced huge profits before launching their IPO so as to fix a high share premium

Dr. Ali Al-Ghamdi

Some officials of chambers of commerce and industry and concerned government agencies have discovered malpractice in the functioning of some family businesses and have taken action to tackle the fraudulent activities of their boards of directors. These measures are aimed at protecting the rights of shareholders who purchased shares at the time of their initial public offering (IPO).

These companies resorted to duplicity by announcing that they had incurred losses after being converted into joint stock companies. This was the case with some companies that announced huge profits before launching their IPO so as to fix a high share premium. Such unethical practices are more common after the passing of the first generation of the founders of companies.

In such a scenario, it is significant that the Chamber of Commerce and Industry in the Eastern Province (Asharqia) is organizing a forum on the governance of family firms on April 19. The theme of the forum is “Secrets of success of a board of directors,” according to a recent report published by Okaz newspaper. In the report, Abdul Rahman Al-Otaishan, chairman of the board of Asharqia, said that several leading legal and financial consultants specialized in the governance of family businesses will attend the forum.

Procedures of good governance

“Global studies and research have confirmed that family businesses should be converted into joint stock companies with strict application of the procedures of good governance so as to ensure the sustainability of family businesses and their smooth transition through generations. Therefore, Asharqia has taken the initiative of making the owners of family businesses aware that the current governance law needs a comprehensive revamp so as to close those loopholes that have made it virtually useless in effectively regulating these businesses,” he said.

Al-Otaishan noted that in the case of most family businesses, it is the president of the board who holds the majority of shares and, therefore, makes decisions while the rest of the shareholders do not have any noteworthy influence and their voice is not heard. Their numbers in certain firms are very limited and the number of shares owned by them does not give them any voting power.

The current law of governance has proved incapable of preventing conflicts of interest. There are loopholes in the law that allow some companies to restrict items in their general assembly agenda to merely ratifying deals that have been concluded earlier between the company and members of the board of directors.

Hence, an effective corporate governance law is the need of the hour for the smooth running of family businesses. The absence of such a law is attributed to the poor performance of both family businesses and other firms. This has also forced some foreign investors to quit the local Saudi market.

This article was first published in the Saudi Gazette on April 05, 2017.
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Dr. Ali Al-Ghamdi is a former Saudi diplomat who specializes in Southeast Asian affairs. He can be reached at algham@hotmail.com or via Twitter @DrAliAlghamdi.

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