‘Funds must recognise the unique characteristics of family-run businesses while driving for professionalisation’
When the promotor family of retail chain Nilgiris dragged the private equity (PE) investor, Actis, to the Company Law Board (CLB), it was the culmination of a dispute that had been simmering for nearly two years. The differences related to many aspects of the business, starting with the pace of expansion to the kind of merchandise the stores should sell.
Nilgiris, present in South India for close to 100 years, divested 65 per cent to the UK-based fund for $65 million nearly three years ago. This was after bitter differences among the family members on whether a PE investor should come on board.
The story of Indian family businesses running into trouble with their PE investors is not new. Industry watchers say that while no specific reason can be given, these tensions are inherent in the difference between the way traditional families run businesses and the approach of global PE investors, who have their own systems and procedures.
For example, promotors of Nilgiris believed they should consolidate in South India, while Actis was pitching for a pan-India presence. “We didn’t want that kind of expansion,” said a source close to the family. A host of issues have cropped up between the two since then and there is talk of Actis looking to exit Nilgiris.
This is not an isolated tiff. Azim Premji’s PE fund ran into problems with another South-based retail chain, Subhiksha, after the retailer ran into huge debts. The fund dragged the company to the CLB alleging mismanagement.
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Another instance is of Chennai-based information technology services company, Cybernet SlashSupport. In the middle of last year, the Hong Kong-based PE fund, SAIF Partner, ousted founders Shiva Ramani and Shiv Kumar and appointed a new chief executive. SAIF Partners had invested $22.5 million in the company. Earlier investors include Goldman Sachs ($25 million) and Sierra Ventures. Industry observers say promotors and investors differed over strategy even as certain milestones were not met.
“Many promoters do not understand the concept of investor, who are generally sophisticated and answerable to their investors. PE as a concept is young in India and promoters do not fully appreciate the pros and cons of having a PE investor in the company,” said an investment banker.
Funds are answerable to their investors. This makes them highly exit-focused, which can be achieved through multiple means such as a listing or a strategic sale. “The time horizon of a promoter (of a family-run business) is 20-30 years. The time horizon of a PE investor is three-five years. This results in a lot of heart-burn,” he added.
There are different types of investors. While some are purely financial, others have a hands-on approach to management, which can cause friction between promoters and investors. Also, investors sometimes drive for professionalisation, like bringing in a professional chief financial officer, which, if not sold properly to the promoter group, can cause tensions. “Also, while the investment is being made, the promoter group agrees to some milestone numbers. Differences crop up when these milestones are not reached,” said an investment banker.
Industry watchers say family-run businesses tend to control how the business should be run and PE investors should recognise this. This should be taken note of as a large party of PE investments in India will continue to be for expansion of family-run companies. Various surveys indicate that 40-50 per cent investments in India fall into this category.
“In order to effectively meet stakeholders’ demands for stronger governance, companies must recognise that family governance is a distinct component of corporate governance in family-run firms, and work with promoter families to clearly define their roles, responsibilities and obligations to the business, guide succession planning, and support cultural change, in addition to their existing responses to enhancing corporate governance,” said a spokesperson of BDO Consulting, a global network company which has a significant risk advisory practice.
For Actis, the differences with family members of Nilgiris aren’t new. It was involved in a legal wrangle with Rajeev Chandrasekhar when he was running BPL Mobile a few years ago. It also had a tiff with Punjab Tractors. While Actis declined to talk on the specifics of these cases, industry observers said Actis had done 40 deals in India and had problems with just three.
Another trouble in the industry is brewing at Ludhiana-based Bharat Box Factory, which is a box packaging company in which Avigo Partners has invested. Sources say there are differences over milestones and strategies between the investor and the management.
“Most family-run companies are dominated by a principal promoter. There is no separation of roles and responsibilities with regards to family, management and ownership (head of family is typically the chairman and managing director of the board and the largest shareholder),” said the official at BDO Consulting, adding, “Promoters of family-run companies, especially first-generation founders, build tight yet informal individual control and oversight over all key aspects of operations. There is typically a strong aversion to ceding control.”
The PE players that operate in India deploy several measures to meet these challenges. With increased scrutiny of corporate governance by stakeholders across the PE ecosystem, funds operating in India will have to redouble their focus on evaluating, monitoring and strengthening corporate governance at their portfolio firms. “Traditional due diligence and post-investment monitoring must be adapted to take into cognizance the unique characteristics of family-run companies in the Indian context,” said the BDO official.