The main advantage of private equity backed companies over normal family businesses has always been their ability to focus on increasing the value of the company quickly. Speed of execution and focus on shareholder value is the name of the game.
A recent report by Ernst & Young on the impact of PE ownership on corporate performance in Europe and the US reveals that PE increases the company value during the ownership tenure, and, even post-exiting. During PE ownership, the average value of PE owned companies increased by 26% compared to 12% for listed companies during the same period. More surprisingly, the growth of value in PE-backed companies continued after the PE fund sold its stake. Profits at the biggest US and European companies sold by private equity last year grew much faster than at their publicly listed rivals, supporting the buy-out industry’s claims of superior management skills, according to the E&Y report.
Despite the nascency of private equity in the region, private equity players have demonstrated similar ability to their international counterpart by focusing and quickly increasing shareholder value in several family businesses. Take for example Depa United Group, the leading interiors contractor who is planning to go public in 2008. TNI and other institutional investors have bought into the company since 2004, and were able to increase its revenue more than 10 folds and its value more than four folds over that period. Another example is Aramex. The once privately owned but currently listed logistics company grew its bottom line five-fold over the three years when it was in private hands, and its phenomenal growth continued post IPO.
But not all investments in family businesses have such happy endings. Unfortunately, the leap of faith that many private equity players do when they invest in a family-owned business is that business owners seek to maximize their company value in the next three to five years. In most cases, this is a wrong judgment call. In practice, the owner rarely makes maximizing his company value a top priority. Company or share value means very little to someone who is keen to keep his shares and pass them over to his children and grandchildren. Many family owners extract more value from things like revenue growth, market share and market dominance, and professional and industry prestige. The problem becomes more acute when the owner is the manager of the business, and hence, is driving the business according to his own agenda.
Without addressing this misalignment of interest, an investment in a family business is doomed to be problematic. Bulletproof agreements, good intentions, well defined strategies, and nice people will not mitigate the problem in a Middle Eastern business environment. Only when the business owner realizes a tangible financial benefit from increasing the company value will there be proper alignment and hopefully big returns from the investment.
Imad Ghandour is Head of Strategy & Research, Gulf Capital and Board Member of the Gulf Venture Capital Association.