There is not even an iota of doubt that family business (i.e., promoters) have always been the backbone of India’s economy (contributing over 70% of GDP) and will continue to do so, but challenges such as cultural boundaries, transparency in conducting business, compliance, and integrity, among others will be the biggest impediments in migrating these companies to the mainstream market i.e., secondary market through initial public offering (IPO).

The family businesses, which are closely held companies, have a low-to-negligibly small degree of Agency Cost – a common parlance used in establishing the capital structure and capital pricing cost – due to the Equity brought in by the family. As a result of this, the accountability toward business growth and performance is hardly visible because of not being answerable due to low Agency Cost, which is also seen as a folklore for growth impediments. The low-to-negligibly small Agency Cost is the reason that triggers the family business to run the company in a way they want to, and by doing so they are unlikely to end up managing the business in a professional way. While lot of these businesses may have flourished in terms of financial growth due to favorable economic conditions, market opportunities, etc., what may have taken a backseat are the elements such as cultural ethos, professionalism, transparency, ethical standards and corporate governance standards – which when seen in isolation, each of these elements are equally important to ensure a sustainable inclusive growth of a business.

Each of the aforementioned elements where the family businesses are falling way behind are, in a way, limiting their abilities to envisage market opportunities, and to capitalize on it and grow in an inclusive manner. Because of the low degree / lack of these elements, these family businesses face a significant challenge in attracting and retaining talent that are due to:

• Cultural Block: If the cultural ethos is low or totally missing, there will always be a huge disconnect between the employees and the management i.e., the promoters. This limits the management’s ability to even acknowledge, let alone accept, that employees are assets to a company. Because of this attitude, there’s a huge difference in the perception of the employees and the management about the company’s future growth. This starts building frustrations among employees – who are talented, have come with a good educational background, and with a hope of contributing and growing along with the company – as they are unable to see a future with the company due to low level of trust from the management and lack of opportunities to fully demonstrate their capabilities.

Example: In my more than twenty years of advisory practice where I have worked with lot of family business as my clients, I have seen a situation in one of my client company where an extremely talented and well experienced person, who did his MBA from one of the top-five global Business School, was ill-treated by the company management just because the promoters thought that he was trying to dictate/command the management. What the promoters/management failed to understand was that he was not trying to dictate anything but was rather suggesting innovative strategies (based on his years of experience and skill sets) on how to spot market opportunities for competitive advantage. This unwanted ego of the promoters created a rift between them and the employee. Anything he tried to suggest was not heard of, and sometimes he would not be even given a chance to speak, thereby leaving him frustrated and humiliated in front of his peers and subordinates. This rift went to a point of no return where the outcome was that, though needless to say, he quit even before he could complete a year. So here I ask – something to ponder – who’s the winner all the way in this rift? Obviously not the company.

• Lack Organizational Structure and Hierarchy: It’s an open secret that promoters, many-a-times, have the habit of meddling in everything in a work process that emanates from the low level of trust for their employees as mentioned above. This habit of meddling in everything has destroyed the prospect of having a proper organizational structure and hierarchy that underlines a career ladder/path for all. Because of this, such companies totally lack in defining roles and responsibilities across various levels, and measuring the performances against those roles/responsibilities and providing corrective feedback through a well-defined HR process. This creates uncertainty and frustration among employees, which corroborates the issue of “Attracting & Retaining Talent”.

• Lack of Offering a Career Path: Since the family business face issues in having a proper organizational structure, it translates into another challenge of designing a proper career path for the employees. Without a proper career path, there is a huge mismatch in employee expectations and what the company has to offer. This leads to high attrition where a company loses its talents to its competitors.

• Lack of Professional Management: The very reason that the promoters want to run the company themselves, restricts them to get a professional management team in place. Having a professional management team in place with strong credentials would not only have taken care of all the above-mentioned points, but would have also deep-rooted the elements needed for a sustainable and inclusive growth.

Therefore, when a family business thinks of the next big step of tapping public funds through an IPO, they are far from being ready if they are demonstrating the above characters. Each of the elements mentioned earlier in this article – Critical Success Factor (CSF) – are put to test when the transitioning phase of a company from private to public begins. So, more the promoters are averse to transform themselves, more will be the pain for them in what lies ahead in the transition phase, since investors and regulators would also be averse if the degree of achievement of the CSFs is low.

Transition Phase Calls for a Paradigm Change – 180 Degrees – in Transformation of Family Offices While Going Public

Getting ready for an IPO i.e., raising public money marks the beginning of the Agency Cost era, which these family businesses have hitherto not being subjected to or experienced. Because of the Agency Cost, the promoters will become accountable for the business decisions, for the projects they undertake, for expansion and growth. Therefore, this is the first fundamental change that these companies encounter in the transition phase., and if they are too deep-rooted with their cultural block, the going gets tough for them.

Lack of professional management aggravates the situation further. With the earlier habit of the promoters meddling in everything and no professional management in place can result in the price momentum wearing off since the investors will not see any confidence in the way the business is going to be run. This certainly limits the attractiveness of the IPO if the promoters take the center stage in deploying public funds. The result would still be the same even if there’s a professional management in place but the executive powers still vest with the promoters.

At this juncture, it’s worthwhile to note that the Kotak Committee on Corporate Governance, which submitted its report to the Securities and Exchange Board of India (SEBI) on October 2017, has, among other things, raised the management structure issue. In its recommendation to SEBI, the committee recommended splitting of Chairman and Managing Director for better accountability (only for listed companies). This is a step to separate the owners (i.e, the promoters) from the management. This further means that – a) there is an accountability of the Managing Director as it will make the person report to the Chairman of the board, b) the executive powers to run the business and take business decisions will rest with the management, and c) the board will preside over the management (i.e., the management will report and be accountable to the board). My take is that this demarcation not only brings in transparency and accountability but also ensures that the companies raising public money are run professionally by competent and experienced teams.

Therefore, the adoption of this cultural ethos whereby promoters hire professional management to run the business by giving them the executive powers and also make them accountable to the board will instill confidence among investors to subscribe to the Company’s Equity. Drifting away from this will only impact the attractiveness of the offering.

The next big thing in this transition phase is “compliance”, which would actually be a nightmare for those who hitherto have not been having a good track record. This transformation – compliance with stock exchange, regulators, ministry of corporate affairs and investors – is not only scary for them but also drains out a lot of time and energy for getting adapted to it. The only change required here is the change in mindset to acknowledge and accept that the promoters would need a professional team to handle various facets of a company’s day-to-day running since the company would be answerable for the public money. While there are many, the most recent example of non-compliance and bad corporate governance is the probe of the Singh brothers (promoters of Fortis Healthcare Limited) by the Economic Offense Wing that revealed the promoters used public money to settle off their personal liabilities. These are the things that will get evaluated, apart from financial strength, when a company goes for IPO, and the occurrence of such things will only limit the attractiveness for investing in IPO.

If family business/promoters are resistant to the above transformation, their productive time and energy will go in handling the challenges of the transition phase and will have little time to focus on the core business activities. This may lead to the financials not falling in line with what was projected, and with this will start the investors’ woes since the downward revision of financials will begin to erode the investors’ wealth.

Where promoters have been able to separate themselves from the core management, they have been able to create some of the most valuable companies, and, therefore, moving away from the promoters’ concept will increase more participation in the IPO segment, thereby making it attractive.

The Light at the End of the Tunnel is Getting Brighter

Within the stakeholders’ ecosystem comprising of investors, dealers, companies, regulators, stock exchanges and ministries, there is an increased awareness and acceptance (with some leading to actionable steps) that the cultural ethos, transparency, ethics and integrity has to be robust in addition to acknowledging the fact that it’s high time to separate the promoters from the management in a public limited company. The interim budget presented by the Hon’ble Finance Minister in July 2019 made an important announcement – a step in the right direction for capital market reforms. The budget announcement increased public shareholding from earlier 25% to now 35%, thereby limiting the promoters’ stake to 65%. This, most certainly, is a welcome step because not only it increases free float and to an extent limits promoters’ rights in the company, but also it enhances liquidity in the market. This step will instill confidence among investors and will create a conducive environment for greater participation.