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Eastern Europe: Red alert for Russian families

They have made their fortunes, but now Russian billionaires face the challenge of involving their families into their business, reports Gavin Knight

Family businesses in Russia were once among the most revered in the world. The richest families, such as the Romanovs and Yusupovs, could trace their noble roots back centuries and were renowned for their immense wealth, philanthropy and art collections. However, they lost it all during the revolution of 1917.

Today, Russian family business is dominated by first-generation wealth with many billionaire entrepreneurs, usually men still in their 30s and 40s, who have benefited from the privatisation of state-owned assets after the end of the Soviet Union in 1991.

A typical example is Oleg Deripaska who is only 37 but is already worth $7.1 billion. In the 1990s he took control of Russian Aluminium, the country's dominant producer. Alexander Lebedev meanwhile is worth $3.1 billion and has substantial investments in state companies including Aeroflot, the Russian airline.

The need to accumulate wealth fast after 70 years of lean times under communism means that little time is spent on the complexity of succession planning or family governance. Corporate governance comes to the fore only when an IPO is envisaged and compliance with Western capital market regulations is required.

Interestingly, due to the stringency of Sarbanes Oxley regulations against the questionable corporate governance of Russian businesses, many Russian IPOs have taken place in London rather than New York.  

Sergei Galitsky demonstrates the speed with which modern Russian family businesses have grown up. In 1994 Galitsky opened a wholesale business that sold perfume and beauty supplies in his southern hometown of Krasnodar. An admirer of Wal-Mart, in 1998 he established Magnit, a chain of grocery stores with the slogan "Always Low Prices". There was a rapid regional roll-out between 2001 and 2005 creating 1,500 stores by the end of 2005. As Magnit was prepared for an IPO, corporate governance issues were put in place to comply with best practice. An independent director was elected to the board and an audit committee was established.

One of the most high profile family businesses in Russia is that of investor Megdet Rahimkulov, who now resides in Hungary. Aged 62 he has sought to safeguard his fortune by actively involving his two sons, Timur and Ruslan, in his investment dealings.

Rahimkulov's fortune, estimated at $1.1 billion, started in the mid-1990s when gas giant Gazprom created the Panrusgaz joint venture with Hungary's oil & gas giant, MOL. In January 2008 Rahimkulov and his two sons increased their stake to 10% in Hungary's largest bank OTP. Hungary's OTP is also the fourth-biggest bank in Eastern Europe.

Timur, 30, has received training to become more involved in the family business by graduating from the University of Economics & Sciences in Budapest. He and Ruslan have a number of directorships in the family-owned businesses such as Borsodchem, an energy company, and Kafijak, a consulting group.

Brothers Dmitry and Alexei Ananyev meanwhile made their money importing computers to Russia. Older brother Alexei decided to bring Dmitry into the business so that he eventually became an equal partner. Their business spread into real estate, mass media and banking. They are now worth $1.7 billion and $2.3 billion respectively.

As with many sibling-run businesses it was important to establish a clear delineation of responsibilities. Alexei heads up the IT business and general strategy, while Dmitry is more involved in their bank, Promsvyazbank. Both brothers felt they lacked certain core management skills and studied for MBAs at the University of Chicago in 2005.

Family control and succession
Many Russian billionaires have still only relinquished a small part of their fortune to family members, rewarding their spouses with token business interests which are separate from their own core businesses. In 2006, Russian aluminium magnate Oleg Deripaska bought Ova-Press, a little-known publisher of glossy magazines, which was renamed the Forward Media Group (FMG).

The oligarch's young wife Polina was appointed head of the board of directors and expanded the business in both print and electronic publishing. FMG is now rated among the top-10 publishers in Russia in terms of readership and advertising revenues, its titles have a combined print-run of more than 1.5 million copies per month, and a turnover of more than $24 million. However, this is still a fraction of the wealth of Deripaska's aluminium empire, which is valued at $7.1 billion.

Given the young age of many of the Russian billionaires, succession will not be an issue in the short-term. Sergei Popov and Andrey Melnichenko for example are each worth $2.7 billion but at 34 neither has any children.

However, with second-generation offspring being educated privately in Western schools, graduating from Western universities and heading back to Russia, the issues of reporting lines and responsibility are ripe for change in the coming years.

This could bring them into conflict with first-generation family business members who have a vested interest in adhering to the existing Russian regulations. Succession could therefore be complicated by a desire for greater management competency, the desire to go public or a greater interest in investing outside Russia.

In particular, Russian family businesses will need to deploy greater disciplined planning for the second generation. Creating a family board of directors, a shareholder agreement and defining ownership rights and expectations early on will be key to their future success.

Given that many Russian billionaires are self-made men, training the second generation of family managers will be critical and again, the chance of conflict will be high. Their skills will be different though as the regulatory risk profile of Russia matures and the business assets become more international.

Who you know not what you know
Given the strong influence of government insiders, Russian family businesses also traditionally have very strong ties to government. This suggests the next generation will need to maintain strong political influence if the business is to be located primarily in Russia.

Suleiman Karimov for example, worth $17.5 billion, is a Russian MP. Russia's richest woman, Elena Baturina, who has a vast property empire in Moscow, is also the wife of Moscow's Mayor. Polina Deripaska is the daughter of former President Boris Yeltsin's chief of staff. Deripaska's father-in-law in turn married Yeltsin's daughter, which makes Deripaska connected to Yeltsin by marriage.

But loss of political influence and the threat of aggressive state interference can be a risk to a family business operating in Russia. Mikhail Gutseriyev, worth $3 billion, was forced to resign as president of oil company Russneft in July 2008 after the Kremlin accused him of tax evasion and courts began to seize his properties.

His 21-year-old, Western educated son Chingiskhan was being groomed for succession and was on the board of directors of his father's companies. However he was killed in car crash in Moscow in August 2008, leaving Mikhail with both a personal tradegy and a succession vacuum.

While politics is a big issue, succession planning and corporate governance are the two most pressing concerns for Russian family business. Many of the second generation are already in their teens and will be expected to take greater responsibility for the family business over the next decade. They will come up against an aggressive, bureaucratic and corrupt state that will favour those closest to the Kremlin.

Tax compliance can be used as a weapon to appropriate assets of those who fall out of favour, but second-generation family members with dwindling political connections may ultimately seek to move their assets abroad to more mature democracies where corporate governance processes are more developed. 

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