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Challenges Facing Saudi Family Businesses
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Ninety percent of all companies in the Middle East are family-owned. Of the 25,000 registered companies in Jeddah, Saudi Arabia, 99 percent are family-owned enterprises. Globally, about one-third of Fortune 500 companies and 75 percent of all companies in the industrialized world are family-owned. Yet, the very nature of these businesses presents unique challenges.
There is a great need to separate business issues from family issues. Control of the business is of particular importance to the family members involved in its operation. Family firms must ensure that young family members are competent and possess the requisite skills and knowledge to make a positive contribution to the continued success of the enterprise.
Another challenge is the requirements of Islamic law (“Shariah”) upon the laws of inheritance and its effect upon the freedom to transfer a business to the next generation. In the West, the owner of a family-owned, non-public business can make a Will bequeathing ownership of his business to whomever he chooses. The transfer can be an outright bequest at his death or by way of a trust created during his lifetime or at his death.
By contrast, a Saudi business owner is bound by Shariah inheritance rules which restrict his bequest to no more than one-third of his net estate after payment of funeral expenses and debts unless all of his heirs consent, or there are no legal heirs at all, or his only legal heir is his spouse who receives her legal share, leaving the residue of the estate to be bequeathed. No bequest is permissible for any person who will automatically inherit from the estate, such as a child or spouse. Similarly, gifts made during the owner’s last illness will be counted against the one-third share permitted by Islamic law.
The Koran clearly states that the share of a male is twice that of a female. Specific shares are provided for every possible survivor depending upon his or her degree of relationship to the deceased person and class. Two kinds of heirs are disqualified from inheriting under Islamic law: a non-Muslim and a murderer. Also, neither illegitimate children nor adopted children may inherit under Shariah.
Although most Saudi family businesses are structured as limited liability companies, and other are run as sole proprietorship or partnerships, there has been increasing interest in forming joint stock companies. One compelling reason is to attract outside investment and increase company capital to ensure continued business growth. Another reason is to continue the business for many generations to come. Only one-third of family businesses survive up to the second generation, and only ten percent make it to the third generation.
Some companies believe that going public is necessary in order to compete globally. In order to do so, family businesses must relinquish at least sixty percent of their shares and offer it to the public. This ultimately places control of the company out of the family’s hands. It also creates corporate governance issues.
Shares that are publicly traded generally command higher prices than shares held by a privately owned company. Shareholders have a ready market for their shares and can diversify their investment portfolios.
Management is generally compensated at a higher level than management in private companies. But when a company goes public, management loses some of its freedom to act without obtaining the approval of its board of directors or, in some cases, its stockholders. Further, shareholders measure the company by its profits, dividends and stock price. This can cause management to focus on short-term strategies rather than long term goals. Management can even lose control of the company if a dissident group of investors obtains majority control of the stock entitled to vote.
Only a few Saudi companies have gone public in recent years, primarily because of the costs and time needed to comply with regulators. Business strategies, financial results, executive salaries, and compensation arrangements all have to be disclosed publicly. Periodic financial reports and proxy statements must be filed with regulatory agencies and distributed to shareholders. Time devoted to complying with these requirements necessitates time away from the management of company operations.
Yet, survival of family businesses after the third generation, if not before, may require conversion to a joint stock company with a broad base of shareholders to provide the necessary operating capital and management succession planning to ensure a company’s continued success.
A new resource for Saudi family-owned firms is the Family Business Academy located in Jeddah. The Academy has been established to offer advice on conflict resolution, succession planning, and other issues unique to family businesses. It plans to offer workshops to family business owners on a regular basis to promote overall economic development in the Kingdom. |
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