Stock fever is sweeping the Middle East, especially stocks being offered as part of initial public offerings (IPOs). This article is meant to address the subject of IPOs and whether privately owned family businesses should explore this option.

An IPO is the first sale of stock by a company to the public. Generally speaking, companies are either private or public. Going public means the owners of the private company are switching from private ownership to public ownership. Why do companies decide to go public? Among the many advantages are the following:

1) A public company gets direct access to the capital markets and if necessary can tap the stock market for more capital by issuing additional shares in a secondary offering.

2) Public companies are in a better position to attract and retain good employees because they can use the stock and options to reward outstanding employees for exceptional performance. Good and motivated employee in turn create more efficient operations which in turn can translate into higher net profit which then translates into higher stock price.

3) A public company can be more prestigious, better known and because of higher level of transparency and credibility, banks and suppliers are more likely to extend credit to a public company than to a private owned firm.

4) An IPO, or going public, provides the founders with an exit strategy. Therefore there is more of an incentive for the founders to make the business successful and profitable since an IPO enables them with a paced and controlled exit. They can sell part of their stock holding to generate cash for other purposes.

5) Finally, generally speaking public companies are worth more than privately owned companies. Privately owned companies are sold on the basis of a multiple of cash flow whereas public companies can command a healthy multiple of earnings and even sales, if the company has not yet begun to make a profit, as was the case in many internet companies.

And now for some disadvantages of going public:

1) Regulatory Supervision and Reporting. Public companies are required to file reports of their operations, and significant matters relating to stock ownership etc with the relevant securities regulators and the exchange. In the case of Saudi Arabia it would be the Saudi Capital Market Authority. Filing of such information on a regular basis costs money and may also provide sensitive information to competitors.

2) Outsiders in a public company may be in a position to take control of company, effectively changing the management, although in many jurisdictions there are ways to mitigate this risk.

3) Because there is pressure on the management of a public company to keep the stock price up. Therefore it may take actions which may not be in the best interests of the company in the long-term. In other words the focus on the short-term may damage the company’s prospects in the long-term.

On balance though in the case of most family owned companies in Saudi Arabia it would make sense for them to consider going public, if for no other reason than to improve their operations, plan for succession and gain access to capital markets. An important consideration in going public is that family firms combine all the tensions of family life with all the strains of business life. This factor becomes especially of critical importance at a time of generational change. Indeed research on this subject shows that only about a third of the family owned businesses successfully make the transition from each generation to the next. And many family firms fail to successfully make the leap to the next generation, thereby resulting in a sale of the company and/or complete collapse upon the death of a founder.

My sense is that many family owned Saudi firms are afraid that they will lose control of the company if they decided to go public. Indeed under current listing rules in many of the Arab countries, a company wishing to list its shares on an exchange must sell majority of its stock to the public as part of an IPO. However the new Dubai International Financial Exchange (DIFX), following international practices, will enable companies to list as little as 10 percent of their outstanding shares on the DIFX. Clearly this feature would be very attractive as it would enable family owned firms to reap most of the benefits of going public while maintaining control of management.

In the Middle East about 90 percent of the economic activity is conducted by family owned firms whereas the average for the rest of the world is no more than 70 percent. It is also a fact that most of the family owned firms in the Middle East, not being accountable to any outsider, are quite inefficient, and most importantly are unable to successfully plan for succession. In view of the foregoing it may make sense for many family owned firms in Saudi Arabia to explore launching an IPO as it would bring a breadth of fresh air to their operations, which is sorely needed.

(Dr. Muhammad Saleem, [email protected], is a managing director of Oxbridge Capital, US.)