Expanding the ownership base: Options available for the diversification of corporate ownership

Given the prevalence of family businesses in the Kingdom of Saudi Arabia (KSA), local families may face a decision on how to diversify the ownership of their business to introduce new ideas, raise capital for growth or exit their investment. The challenge lies in considering the best method of diversification for each business.

Options To Consider

Some approaches will involve control being relinquished to another shareholder or shareholders and others will enable the original shareholder to maintain control over decision making.

In this article we consider advantages and disadvantages of taking a KSA company to IPO, permitting another party (a private investor or private equity firm) to acquire some or all of the company, and joint venturing with another company.

Initial Public Offering (IPO)

The decision to take a company public is generally made when large amounts of capital are required or the shareholders are seeking to exit in the short to medium term. Shareholders may sell some shares into the IPO so they themselves receive funds or the company may issue new shares whereby the funds go to the company and not its shareholders. Shareholders need to consider the following:

• The company must be a closed joint stock company with at least five founding shareholders and a minimum of three years of operations;

• The founding shareholders may retain no more than 70% of the shares, meaning they will lose some control but may retain a majority interest;

• The company must have sound corporate governance policies and meet the requirements of the Corporate Governance Regulations. The ongoing compliance and disclosure obligations post-listing are more stringent and the company must be managed in the interests of all shareholders;

• The fees payable to advisers when taking a company public are reasonably significant;

• The company’s profile will be raised, which may make winning business easier and it will be easier to value the company as the market capitalisation is obtainable daily;

• The company must publicly disclose material information about the business in the offering document prior to the IPO;

• The ability to raise additional money on-market later is increased; and

• The founding shareholders can, subject to the Capital Market Authority’s prior approval, exit their investment upon expiry of the initial lock-in period during which they may not sell. The founding shares must be held for at least six months underthe law, but often for a longer period at the discretion of the Capital Markets Authority. Under the insider trading rules founding shareholders and directors need to evaluate whether they possess inside information about the company before buying or selling shares.

Private Disposition Or Capital Raise

A shareholder’s decision to sell shares will generally be made when the shareholder seeks an immediate full or partial exit from their investment as the shareholder receives the proceeds, rather than the firm. Alternatively, a decision by a shareholder to sell some of their shares could introduce a new shareholder with skills and experience to move the business forward. The new investor may be an individual, a competing or complimentary company or a private equity firm wishing to add immediately value to the business before themselves exiting at a profit.

Where the company itself needs funding and there is no justification for an IPO because the capital required is not large enough or the company will not increase its governance and disclosure policies, the company may issue additional shares to a private investor. This may be done with a partial sell down by the existing shareholders so that some shares acquired are owned by the founding shareholders and some are newly issued by the company. Whether the transaction is a disposition or a private placement of new shares, the considerations are similar:

• Often the corporate form of the company can remain post-transaction, although some restructuring of the group may make it more palatable for new investors;

• Consider the ultimate percentage ownership of the new shareholders versus the ultimate percentage ownership of the founding shareholders since this will dictate how much control the founders maintain post-transaction. A shareholders agreement may needed to dictate what decisions can be made by which parties;

• In principle foreign ownership is permitted for all investment activities except those included on the “negative list” of activities reserved for Saudi nationals. If a business is on the “negative list”, foreign ownership and investment restrictions are a concern if the investor is not a Saudi national;

• All material information about the business should be disclosed to new shareholders in advance of the transaction;

• The new shareholders may bring expertise to improve the profitability of the company; and

• Where the new investor is a private equity firm, that company will generally determine when and how the investment should be exited and may force the founding shareholders to exit at the same time.

Joint Venturing

Joint ventures (JVs) occur when a firm is operated together with another firm which is a competitor or a complimentary business. The two predominant legal forms used for corporate JV vehicles are limited liability companies and closed joint stock companies. Any company (other than a cooperative company) may form a JV with another company of the same or different corporate form. If JV parties do not wish to establish a corporate vehicle they may enter into a teaming agreement. Shareholders entering a JV need to consider the following:

• If an incorporated JV vehicle is used, a shareholders agreement should determine how decisions are made and the business is operated. The shareholders agreement or teaming agreement (where no incorporated vehicle is used) should provide how to unwind the JV following non-performance and how to deal with deadlock where the business cannot progress because of disagreement between the parties;

• If part of the business of either party is not involved in the JV, a pre-JV restructure may be needed;

• The value of the business to be operated by and for the benefit of the JV, as each party should contribute value which equates with their percentage control. A party may be adding value in terms of expertise and/or new customers or contracts;

• How each party can protect the intellectual property in their business if it is being operated alongside another business;

• Whether the business of the JV has a “dominant position” or an “economic concentration” (i.e. 40% market share of an industry) such that approval of the Competition Council is required; and

• Foreign ownership restrictions where the JV will be an incorporated vehicle and is in an industry on the “negative list”, where one or more of the parties are foreigners.

• A JV is generally a structure used for longer-term commercial collaboration rather than for shorter-term investment and exit. There are a number of options available to shareholders of family businesses wishing to expand their shareholder base but the above are the most commonly considered methods.

Which method will be most appropriate in each situation will depend on the size and scope of the business and the plans for growth. Businesses looking at diversifying their shareholder base should consult with advisers to determine how they can gain most advantage and return the most value to themselves and their shareholders.