Corporate Finance

Coinvestment for the Family Office

Data now shows that over the long-term, a good private equity portfolio outperforms public equities, and for most wealthy families there is no substitute for a well selected group of private equity funds as an entry point to this asset class. In addition, wealthy families with entrepreneurial backgrounds are increasingly seeking direct private equity investments and looking for co-investment opportunities with other families or institutions.
However, the risks can be very high and the practical obstacles much more substantial than is often appreciated. This paper explores some lternative approaches.

BACKGROUND

Over the last five years - effectively in the aftermath of the “credit crunch” – the market has seen a significant growth in the appetite of wealthy families and high net worth investors for directly held private equity investment. In some cases this is driven by an underlying entrepreneurial confidence and experience in a family’s background, and the prospect of a more exciting return than from portfolio investing. It can complement, or be instead of, investing through funds.

There are a number of factors behind this increased, but in many cases quite generalised, desire to access direct private equity investments. They
include the growth in numbers of ‘super wealthy’ families globally, driven by entrepreneurial activity and some mistrust in the investment community in general and in fund structures in particular. Many believe their direct business experience gives them an advantage over the professional investment community and that they can take a longer term view, working with other families to share ‘offmarket’ opportunities.

Hence many wealthy families and family offices are attracted to the concept that they can bypass the investment community and do their own thing,
investing directly in private businesses and new ventures, often with a controlling interest.

However in many cases the appetite is just that - and has not been satisfied due to the myriad of difficulties in accessing opportunities and finding the correct structures and relationships to invest successfully. Families looking to make such investments face a number of real hurdles:

High entry levels per investment

For all but the very richest families, the amount they can commit to a single investment is limited and this may restrict them to relatively small, early
stage companies, unless they can work with a number of co-investors.

High risk and earlier stage investments

The need to make smaller investments can cause too much concentration at the high risk end of the market, especially relatively young companies
and even start-ups. Investors are often excited by the prospects of early stage businesses; in many cases this is in stark contrast to the experience and expertise of that family and the way they made their original wealth. Such investments may start as a relatively small exposure but they invariably require several further rounds of financing, often without shareholder rigour to make the difficult decisions and management changes that are so often required.

Inadequate resource

Professional private equity managers normally employ a team of at least 6 professionals to identify and appraise opportunities, negotiate deals and manage the portfolio. Typically a private equity fund would look at around 100 projects or companies for each one it invests in and that is just
the beginning of the work. Negotiating the deals requires an immense amount of time, experience and expertise and, in any portfolio, at least 30% of
the investments are likely to have problems which require significant attention, with the possibility of further funds being required and / or terms
being renegotiated. Even successful investments require significant time and attention to ensure management teams remain on track and exit
returns are maximised.

Most family offices do not have a team of sufficient size or specific experience to manage a portfolio on that basis and hence operate a more opportunistic model, often selecting their investments from a far smaller sample. They may feel that they can operate on this basis because they have greater business and / or sector expertise or better contacts than a private equity house and hence are introduced to better quality opportunities from which to choose. This, however, is highly debateable in most cases. Perhaps more credibly, they may have specialist expertise and contacts in areas related to their core business, which may give them significant competitive advantage. This is probably the most persuasive
argument for direct investment by families, but this has the obvious downside of increasing sector concentration.

Narrow focus leads to lack of diversification

Most wealthy individuals or families thus tend to concentrate investments quite narrowly rather than building a well-diversified portfolio. In one
sense they are managing their risks by investing in areas which they fully understand, but on the other hand they are exposing themselves to a downturn which hits one or two sectors as a whole.

Unfavourable ratio between the return and costs

The costs and risks of running a sub scale private equity operation can be very substantial and seriously erode returns. While investors often decry the ‘2+20’ fee model of most private equity funds, the real cost - even before the investment performance - may be just as high or higher within
a family office if it is sub scale.

Lack of suitable structure, governance and administration

For cost and other reasons, families tend not to have the formal structures, processes and disciplines employed by commercial private equity
firms. This can lead to short cuts, inadequate due diligence, monitoring and decisions which reflect the interests of the decision makers (often one or more family members), rather than the interests of all beneficiaries. We have seen several cases of poor decisions being made by existing family
office shareholders, especially to maintain a past valuation that is patently too high, perhaps to save face. Taking a long-term view is one thing - ignoring the reality of a problem situation can cause losses to increase.

Poor quality monitoring and reporting

For similar reasons, monitoring and reporting is often inadequate such that problems are often identified and therefore addressed too late.

Family conflict

Unsuccessful private equity investments are one of the most common causes of family conflict between those directly involved and the more passive
family members, especially where governance and reporting are lacking.

THE CASE FOR CO-INVESTMENT

Co-investment with other ‘like-minded’ family offices is increasingly seen as the solution to many of the problems listed above. Some of the benefits
of co-investing:

• Gives critical mass by pooling resources and enabling participation in larger transactions.
• Pooling of sector and geographic expertise, with one family for instance being the lead investor in Africa and another in South America, one in Health Care and another in Luxury Brands.
• Larger investment pools enabling employment of greater expertise whilst reducing costs as a percentage of returns.
• More formalised structures, governance disciplines and reporting to satisfy needs of external investors and regulatory authorities, will also benefit the family.
• Wider diversification and better risk management.

However, the reality is that far more families talk about such co-investment opportunities than actually participate. The reason that theory is
not always converted into practice is down to the significant levels of trust required to enter into these type of deals.

BUILDING AND MAINTAINING CO-INVESTMENT RELATIONSHIPS

Building sufficient trust and mutual respect to invest in each other’s deals can take many years to achieve. Indeed it is far more likely that such
relationships exist between families operating in the same business sector, where they have direct experience of each other, whether as partners or
competitors.

Those who seriously want to consider coinvestment thus need to focus on how to build and maintain that trust, which not only gives them the
confidence to invest in a deal outside their own area of expertise, but in an investment which is led by a family of which they have no previous
business relationship. Furthermore, as is the case with all private equity, it must be understood that some investments will go wrong, however expertly conceived and implemented, and the relationship of trust must be able to survive some early mishaps and some difficult decision making discussions.

It is thus not sufficient to simply build the trust required to make the first investment. It is critical to ensure that properly defined structures are
in place, with clearly defined responsibilities and accountability to resolve amicably and professionally any problems which may arise after
the investment is made. The issue of fees is likely to cause friction too - few families will feel it is reasonable for them to be the lead investor on a
deal and receive no remuneration for that role.

We have seen this left imprecise at the outset of a co-investment and then develop into a more toxic issue among the investors. Perversely we have
even seen some family investment “clubs” reinvent a similar structure and fee basis as the institutional private equity industry, even if from a different
perspective.

The keys to maintaining trust, even when things go wrong, are often more formal and accountable structures. However, the problem is that, as the
process becomes more formalised, so a family office or high net worth individual can tend to see this as just another form of restriction and structure
they would prefer to avoid.

ALTERNATIVE APPROACHES TO FINDING CO-INVESTMENT PARTNERS

There is a variety of ways of finding and maintaining co-investment partners, from using a family’s own contacts and networks to find partners for
individual transactions on a case by case basis, to the more structured and formal approach of joining a ‘club’ or participating in a fund.

Case by case from own network

This will depend on informal relationships with other families, probably built up over many years. The advantage of this approach is that it is very
flexible and no substantial costs are incurred until a specific transaction is under consideration. The disadvantages include:

1. the co-investor has little control over the deal flow, except those which are sourced through it itself;
2. the co-investor’s most trusted contacts are likely to be biased towards the sector it knows, making it more difficult to achieve diversification;
3. it is unlikely that a clear policy and other parameters are agreed in advance, so every transaction has to be started from scratch, with no investment guidelines and no preferred structuring arrangements.

The investment club

Some families are attracted to the concept of a coinvestment ‘club’, which has been established to bring together a number of families for the purpose of co-investment. At one end of the spectrum, some clubs are entirely informal with no rules or obligations, where the object is purely to provide a forum for families to meet and show each other their deals. Other clubs do have rules and often carry a clear obligation to participate in some if not all the deals undertaken by the club as a whole.

The dilemma for a club is that it does not want members who are there primarily for market intelligence purposes, but are unlikely to invest in
practice. On the other hand, it would be extremely difficult to form a club where each member was required to participate in every investment.

Those clubs which require more commitment tend to be for property investment rather than trading companies. Some, for example, require each member to participate in at least one deal in every three, or their membership will be revoked. In another case Sure Investments run a property
club where, rather ingeniously, each member must participate in every deal but has the opportunity either to double or to halve their allocation, the
result being that if more members wish to scale back than scale up, the investment cannot proceed.

There is one stark disadvantage to investing in these structures. In the competitive and dynamic private equity market globally, the ability to speak for the entire investment funding “cheque” is perhaps one of the most powerful advantages an investor can have. Many of the discretionary investment clubs have struggled to overcome this handicap - they are often seen by savvy sell side advisers and management teams and vendors as second class buyers. To secure investments they are thus faced with either paying materially more than the funded buyers, or investing in opportunities that hang around the market long enough to enable the club to raise money from its members. The bigger the ‘club’ in terms of numbers of members, the worse the issue. A small club of 3-5 investors can get close to overcoming this issue - the larger clubs usually cannot. The smaller ‘clubs’ may even be able to get one of the investors to underwrite an investment, which obviously solves the problem.

Creating a fund

In one sense this is the tidiest solution with several family offices joining together to create their own private equity fund, with its own purpose built management structure. Such a fund would obviously be set up within an appropriate structure and governance framework. For many families, however, this does not give them the independence and control they require, and feels like they are back into the fee and control issues they are trying to avoid.

Building a co-investment programme through institutional channels

This is a topical and interesting route, and one that is developing fast at present. It involves family office accessing co-investment led by an institutional private equity manager (commonly referred to as GPs or General Partners). Why would GPs offer out co-investment opportunities? GPs do this to access more capital for larger deals, but more often they are forced to offer this as “bait” to attract the investor into a fund structure. Increasingly GPs see they must offer investors this top-up facility where the investor puts an amount into the fund structure, at full fees, but expects to be offered coinvestments allowing them to invest an additional 25-50% of this commitment as a co-investment at no fee. This way the investor averages down fees and gets the opportunity to “bespoke” an element of its portfolio.

We are aware of a few large and sophisticated family offices which have used this route as the entry point to co-investment. As all deals are managed by a GP, there is little / no risk of an orphan asset (without a GP to manage it), they have all been through the normal rigorous due diligence process and the GP will almost certainly have had sufficient capital to underwrite the deal - so avoiding being the “second class buyer”. It does not get close to scratching that entrepreneurial “itch” some family offices have, but it is a good way to build expertise and contacts. For a family with little experience of private equity investing, such co-investing can be a good low risk “training course”.

The key downside here is that the investors need to have a significant programme of fund commitments to build such relationships with GPs. And very small investors in funds will by implication have less favoured status in the fight for co-investment, unless the investor can convince the GP that it brings special knowledge to the situation.

The “fundless sponsor”

This esoteric term refers to private equity firms/ teams that do not have a fund from which to invest. The credit crunch and its aftermath has roduced
a number of these, and they raise money for each investment on a case by case basis. To be clear they only do this because they cannot raise a fund - but they make a virtue of the co-investment process to attract precisely the family office investors that we are discussing here. They have had some success doing this, and will have more professional processes than most families or “clubs”, but they will remain subject to the second class buyer problem, as most advisers will know they do not have discretionary funding. The better fundless sponsors will move as rapidly as they can to raise a fund, so the remaining ones could be seen as managers that are not successful enough to do so.

Fees for these deals are lower than on fund terms, but will probably be somewhere around the 1% pa management fee, with a carried interest harge of somewhere from 5-20%. Carried interest structures can be more creative and ratcheted than in a fund, often to the benefit of both GP and investor, although it can have the effect of focusing the GP on taking excess risk to achieve an outperformance ratchet. One of the bigger risks is that the fundless sponsor collapses and the team breaks up as it doesn’t have sufficient income (without a fund) to hold together. The investments may then become “orphans” without clear direction and the investors may have to find a new manager.

The adviser route

The alternative, for those who wish to invest directly, is to seek an adviser who has the experience, resources, infrastructure, network and deal flow to address many of the problems mentioned above. The challenge here – and it is a considerable one – is for the adviser to have a business model which brings reasonable alignment of interest with the client, rather than being incentivised primarily to ‘sell’ the deal. The key to this is a long term,
more broadly based relationship of trust and a remuneration structure which ensures the adviser is not tempted to endanger the relationship for the
sake of a single transaction. He or she can also be relied upon to advise throughout the investment period if required.

Few corporate financiers are well placed to do this and few have the experience and skill set which includes portfolio management. However, a well positioned adviser can add considerable value and is sometimes able to bring together co-investors in a way that suits the objectives of both the investors and the investee company.

SUMMARY

The private equity class is high risk - seductively attractive from afar but difficult to access and even more difficult to do well in practice. The, maybe
understandable, emotional backlash to funds and fees post the credit crunch has in our view bred a rush to direct investment, in most cases
by families without the expertise, contacts and structures to manage a meaningful private equity portfolio. There is no asset class with quite such
a variance between the top quartile and bottom quartile funds - when private equity goes wrong it can go very wrong. For this reason we believe
families need to think very hard about their real motivation for trying to do direct deals, and to rationalise their strengths and weaknesses before
making any steps to source such deals. Of course there will always be some families that can do this well - either with such critical mass, or expertise, or with a talented in house team or a trusted adviser - but the experience of the evolution of the private equity sector suggests there will be some serious casualties along the way.

Encouragingly, we are starting to see some larger families taking a much more thoughtful approach and not rushing straight into direct investing. This includes realising that the family needs to develop its network and expertise first, in many cases by making a small number of “fund” commitments to create strong relationships with established players in the favoured market and accessing lower risk coinvestment
opportunities as a first step. Over time that can be extended to backing “one off” deals and even taking a lead investor role, if confidence
and experience is sufficient.

Each family also needs to think very hard about its internal governance. It is often highly desirable for an experienced outsider to chair an investment
committee and create a firebreak between any family members that have excessive power over new investments, and multiple beneficiaries. In
one instance we have seen one very wealthy family move to institute a policy of excluding any investment sourced through the family members
(one of the supposed benefits of this direct investing route) due to the internal controversy and waste of executive time these ideas were creating.

The good news is the relatively immature private equity sector is maturing to see families as an important and interesting investor base that can
in many cases bring more than just money to the table - and therefore the prospects are good that over the next 5-10 years there will be the
opportunity for sophisticated and patient families to create routes to direct investing that minimise risk and create real long term value for their family
members. It might look less interesting than investing in an exciting looking start up - but it will almost certainly produce better returns and cause
a lot less disruption within the family office.

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The Role and Standing of Experts in the Modern World

A by-product of the BREXIT campaign was the beginning of a debate about the role and standing of experts in the modern world. Michael Gove was widely criticised for saying, in an unscripted response to a question, that people ‘have had enough of experts’, but in doing so, he has perhaps initiated a discussion which is long overdue.

The debate so far has amounted to little more than an exchange of insults between opposing factions. ‘Brexiteers’ have delighted in pronouncing (perhaps prematurely) that most economists and political pundits have been proved wrong, not only over Brexit, but by the election of Donald Trump and the economic reaction. The response of the ‘remoaners’ is to say that in a ‘Populist’ society, major decisions will be taken by people with little knowledge or understanding of the relevant facts and arguments.

The exchange of insults is inevitable, as both sides vent their anger, following an acrimonious campaign. However, there is now a real need for a more thoughtful debate on the role of experts, the value they deliver, their limitations and how effectively we use them. This debate is particularly relevant to family offices and wealth managers, such as Stonehage Fleming, who make extensive use of experts to serve their clients, but also has far wider implications across our society.

Given the relentless trend towards specialisation, more and more experts impact on nearly every aspect of our lives from banking and finance to healthcare, building and planning, and even leisure activities, not to mention giant projects such as commissioning aircraft carriers or nuclear power stations, financing hospitals or expanding Heathrow Airport.

Lady Thatcher once famously said, “Advisers advise and ministers decide”, but it raises the question of whether the advice received has been fully understood and adequately challenged by the decision maker, weighted in proportion to its importance and properly integrated into the decision making process, alongside many other factors.

This can apply all the way down the scale from government ministers making huge capital expenditure decisions and electors casting their votes on the great issues of the day, to ordinary citizens seeking advice on a medical treatment or pensions.

Many of these decisions have become so complex that we are sometimes inclined to rely too much on experts and too little on our own instincts, judgment and analysis. Indeed it is not uncommon for individuals to find themselves in the hands of the wrong specialist, who cannot see the wider picture, with potentially disastrous consequences.

The arguments in favour of specialisation are often very obvious, but it is worth examining some of the negatives, so that we can better equip ourselves to deal with the problems which arise in an expert led environment. This debate is all the more necessary because of the erosion of trust in society, with too many instances of specialists using their knowledge to deceive rather than enlighten their clients, as appears to have happened in the banking industry, for example.

Some would even argue that our increasing dependence on specialists, and the systems they devise, has infantilised the population and according to Yuval Harari in his fascinating book ‘Sapiens’, humans were at their most competent in the hunter gatherer age when they did everything for themselves! It may be helpful to think about this problem from the perspective of the decision makers, who have to ensure they FULLY understand not only the advice they receive, but the scope and limitations of the adviser’s expertise, his or her ability to see the problem in its proper context, from the client perspective, and the possibility that he or she may be subject to bias, for whatever reason.

UNDERSTANDING THE SCOPE AND LIMITATIONS OF THEIR EXPERTISE

No economist, nor anyone else can be considered an expert on the economic consequences of BREXIT, because it is an unprecedented ‘one off’ occurrence, of enormous complexity, where the outcomes are obviously unpredictable. Economists can supply important and useful data and historical precedents which may influence us, but this does not make their opinions on the overall outcome more valid than those of other people with some understanding of business and trade.

The problem was that some economists used their reputation as experts in a particular field to give unwarranted credibility to their opinions on the wider issues. At the same time the public wanted yet more information, as though it would somehow make clearer a decision which was actually based not so much on facts and figures, but a massive leap of faith, heavily reliant on instinct and intuition.

Whenever using experts, the client needs to understand to what extent the expert is bringing facts and analysis and to what extent opinion. It is only too easy to believe that the person with all the facts at their disposal also offers good judgement, but this is not necessarily the case, especially where their area of expertise is just one factor in a larger picture.

CHALLENGING THE ADVICE PROVIDED

The client must be able to question and challenge the advice received to satisfy themselves that it is accurate, relevant, and based on a proper understanding of the overall problem. In many instances the ability to challenge requires some understanding of the expert’s field, especially as many experts are not great communicators. This may necessitate one or more intermediaries as a bridge between the expert and the ultimate decision maker, but the more links in the chain, the greater likelihood of a misunderstanding which may lead to the wrong decision.

The CEO of a group supplying safety equipment to power stations in the 1970’s refused to supply his equipment if he could not find someone in the management who understood the totality of how the power station operated. It is difficult to be confident that there is any modern power station which would meet that test, and we clearly now have a banking system where the operational details are only superficially understood by those in authority, who are increasingly reliant on experts to report to the board on the activities of other experts.

Equally, at an individual level, the ability of the client to understand and challenge the opinions of specialist medical consultants or financial advisers is often very limited, so they may also need intermediaries to question and challenge the experts on their behalf. For the wealthiest clients, these intermediaries are available, at a price, and they will filter, distil and synthesise the opinions of numerous experts across a range of different areas, before integrating all the advice and relating it to the problem in hand. It is a complex and skilled process and, even for the wealthy, advisers with the all-round experience to cover this role are few and far between. For the less wealthy, they sometimes have little option but to trust the advice they receive, whether they understand it or not.

In financial services there has been a great deal of emphasis on transparency to reduce dishonest practices, but the reality is that it is just as easy to hide the truth in too much information as too little, if the client does not have the ability to challenge and interrogate.

ALIGNING THE PERSPECTIVE OF THE ADVISER TO THE CLIENT

Experts can be so absorbed by their own subject that they tend to view the world and the problem in hand through the prism of their own specialism, rather than through the eyes of the client. It is not unusual for advice to be given based on a subtle, but crucial misunderstanding of the problem or on an exaggerated view of the significance of that advice to the wider picture.

The expert must understand his role and the context in which his advice is sought. The client must ensure the expert is properly briefed, genuinely understands the whole picture and has the ability to adapt his advice to a variety of different circumstances. This is particularly the case if the circumstances do not fit the profile of the expert’s normal clients and he has to step outside his usual approach.

Understanding the perspective of the clients can sometimes be as challenging and as valuable as the expertise itself.

EXPERT BIAS

Expertise can itself create bias, in that the expert will tend to look for solutions in the areas he best knows. An example of this was when the opinion of an expert medical witness in a court case about the death of a baby was discounted by the judge, because the doctor concerned had particular theories around the subject of Munchausen’s Syndrome. This caused him to be biased towards a particular cause of death.

Some experts tend to offer relatively standardised solutions and most have a well-established and sometimes deeply entrenched approach. Best practice among experts can become overtaken by changes in the outside world or unusual features of the particular case under consideration. In many areas conventional wisdom can be shaped by ‘group think’, and subject to quite rapid change, when new thinking challenges old practices – even the regulators sometimes find themselves imposing regulations based on outdated thinking. New regulations nearly always bring more work for experts!

From a different perspective, can you rely on an expert in shares, property or gold to predict future price movements, if their career or finances stand to benefit from rising markets? What you need from these experts is information and analysis, but the judgements should probably be made by someone with a broader perspective, more removed from the market concerned.

LANGUAGE AND COMPLEXITY

In some fields, as experts become increasingly specialised, they tend to speak more and more to each other rather than to their ultimate clients. It is entirely possible for them to become excessively absorbed in their own world, often developing their own language and jargon which becomes incomprehensible even to well informed outsiders. Understanding the expert can become more valuable than the expertise itself!

Some experts also have a tendency to overcomplicate their own subject, arguing that further complications are essential to best practice, perhaps in the interests of risk management.

We must remember that complexity, of itself, can be a substantial risk, and when it is combined with specialist jargon it can severely obstruct the decision maker’s ability to reach the right conclusions.

This surely was one of the prime causes of the banking crisis, where the banking system began to resemble the ‘Tower of Babel’ with everyone speaking a different language and with too superficial understanding of what each other did. It is very clear that the boards of the major banks had inadequate understanding of the risks being run in specialist departments.

CAUTION AND DATA DEPENDENCY

On the other hand many experts tend to be very cautious and conservative, deriving their self-esteem from specialist knowledge and the certainty which that brings them. They can be resistant to change and new ideas, which can place them in conflict with the more innovative approach of entrepreneurs and businessmen who are often their clients.

Much of their knowledge is based on processes and factual data (often historic), which may cause them to place too much emphasis on factors which are tangible and quantifiable as opposed to those which are not.

It is of course understandable that experts will want to highlight the risks, so they cannot be held responsible for omissions, but they must also understand the need for advice to be ‘user friendly’.

Anyone who has been in business will relate, for example, to the refreshing experience of dealing with a lawyer who understands the commercial context and sets out the risks in a manner which recognises their materiality to the decisions in hand.

It could be argued that it is up to the client to judge the unquantifiable and to decide what risks they are willing to take, but it can require courage to overturn a very negative expert opinion, which highlights long lists of all the things that could theoretically go wrong.

MANAGING A MULTIPLICITY OF EXPERTS

Some projects, by their nature, require so many experts that massive project management skills and processes are required to integrate their advice into a coherent framework. With every additional expert comes additional risk that a failure of communication may cause a wrong decision. There are so many examples of major government projects going wrong, from PFI Financing of hospitals to Naval Destroyers breaking down at sea, that there must be questions about the ability of those responsible to manage such projects. It may be that too much resource is allocated to paying for the experts and not enough to those responsible for managing their input and ensuring a successful outcome.

At a more modest level, the number of experts now involved in a planning applications can be so great that the cost and difficulty of converting outline to detailed permission and meeting construction conditions may be a real factor in our failure to build enough new homes. Too many experts can create bureaucratic processes which obstruct economic activity and progress.

USE OF TECHNOLOGY AND ARTIFICIAL INTELLIGENCE

Rapidly improving and more sophisticated technology, in particular advances in artificial intelligence, will have an increasing impact on the role of experts and how they are used. This will drive experts to operate more in the space where they add value through judgement and experience, with diminishing reward for delivering information, analysis or process. For some experts this will be an uncomfortable transition and will enable well informed clients and lead advisers to do without their input.

CONCLUSIONS

The object of this paper is not to decry the massive contribution of experts to our society, but to highlight the opportunities to use their contribution more effectively.

1. There is an urgent need to restore the balance between experts and skilled generalists.
2. We must incentivise those who show potential for more broadly based careers, developing the ability to lead a project team, with sufficient knowledge to challenge and integrate expert contributions. Specialist expertise is now so highly rewarded that it is difficult to develop career progressions which enable people to acquire the broad range of experience required.
3. More recognition should be given for judgment and skills as opposed to pure specialist knowledge, which can sometimes be relatively easily acquired.
4. Much more training is needed for experts in understanding the wider context and identifying with the client perspective (this is much harder than it sounds).
5. More training in communication skills is required to ensure experts are able to communicate advice in a well organised and thoughtful way which will be readily understood by the user.
6. A concerted effort is required to reduce unnecessary complexity which cannot be justified by added value to the end user – the regulators sometimes have a vital role to play in this.
7. A concerted effort is required to reduce the number of expert inputs required in any particular area, in order to simplify processes and cut bureaucracy. This will increasingly be supported and enabled by more sophisticated technology.
8. Better processes are needed for the management of major projects.

As a Family Office, handling the affairs of wealthy families with complex circumstances, Stonehage Fleming ensure the input of experts is normally channelled through an experienced Key Adviser, with vast practical experience of similar clients. This adviser stands in the shoes of the client family, has to represent and communicate the interests of all family members and reconcile any differences of view. He or she must therefore ensure the key issues are understood by everyone, in order to build a consensus around the decision to be made. His skills and experience will equip him to identify where expert input is required, to select and brief the best people for the job, to manage their input and integrate the contributions of a number of experts into the overall analysis. He or she will equally recognise when further advice is NOT required and will selectively use enhanced technology to replace expert input.

Training and developing these Key Advisers is an ongoing challenge, because the financial services industry has for many years encouraged and incentivised its best people to specialise and hence produced very few individuals with the more broadly based experience and skills to meet the demands of that Key Adviser role.

The same applies to many other areas of our society.

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Selling the Family Business

A family business is a journey – challenging, rewarding and often unpredictable. Should you decide to sell the business – often a daunting decision – careful planning and skilled execution are required to ensure a successful outcome.

Perhaps the hardest decision for any family business owner is when, or if, to sell the family business. Selling a family business is like no other sale. It requires an approach which addresses both the family’s issues and the business’ issues as one, with the two often closely intertwined. It needs extensive preparation and great judgement, with timing and stakeholder management often critical.

Most owners have strong family and emotional ties to the business – part of their family heritage and their collective identity. They may also wish to achieve specific outcomes for wider stakeholders, including highly valued staff and long-standing customers. The challenge is even greater when family members are actively involved in the company. Some family members may take a purely commercial view, whilst others believe the business should be handed down to their children and grandchildren and be part of their livelihood and collective identity.

The business is often the most valuable family asset, so the sale should not be considered in isolation from the wider interests and future intentions of the family. The use of proceeds and future careers of family members are important considerations in the long-term success of the family.

OWNERSHIP CONSIDERATIONS

It is highly advisable for family businesses to regularly assess their ownership and corporate strategy, both from a business and market perspective, but also with reference to the changing circumstances of the family.

A recent Fleming Family & Partners survey of 90 Ultra High Net Worth (‘UHNW’) families and their advisers (source: ‘The World in 2043: Wealth Strategies for Intergenerational Success’ report), found that they view a lack of strategic planning for the family as the greatest destroyer of wealth. After capital preservation, succession planning was seen as the second most pressing concern. Business owning families need to consider a broad range of factors, including successors to the current owner-manager(s), implications of growth in the next generation family shareholder base and the benefits of wealth diversification.

Individual family members will have additional personal considerations, including their own career aspirations and preference for income, capital returns or long-term investments.

From a business perspective, family owners will regularly monitor and assess market and business developments. Long-term trends such as the impacts of globalisation, increasing regulatory burden or rapid technological change may influence their desire to retain ownership. These developments may also drive wider market consolidation and the family will need to consider whether it has the appropriate resources, expertise and willingness to become an industry consolidator.

THE FAMILY BUSINESS LIFECYCLE AND OPTIONS FOR USE OF PROCEEDS ON EXIT

An essential element when considering the sale of the family business will be planning for events post completion, including use of the proceeds, as illustrated above. This may include re-investing in new business opportunities, acquiring a more diversified investment portfolio, investing in property or satisfying philanthropic objectives. This is discussed further in the Post Sale section.

PREPARING THE FAMILY

It is imperative that the ground work is done well before there is any question of a sale. The more distant the prospect, the greater chance of rational discussion which gives everyone the opportunity to air their views, without the debate must be to work out some parameters and a ‘road map’ which will help those responsible for making the decision when the time comes. Noone can predict the precise circumstances, but if some broad principles have been agreed by the family at an earlier date, the potential for a destructive conflict is greatly reduced.

These principles will help define what factors should influence the decision. They should include a clear statement of the purpose of continuing family ownership, which may or may not include active involvement of family members in the management team. They should also include broad guidelines for the sort of circumstances in which the business should be sold, if it is not purely a commercial decision, and suggest a decision making process which involves all relevant family members.

Ideally, such parameters will be drawn up by the founding entrepreneur, at least 10 years before retirement, preferably in consultation with the family. Failing that, if the business is already in the hands of the second or subsequent generation, it is in the best interests of all for a family agreement to be initiated as soon as possible.

PREPARING TO SELL A FAMILY BUSINESS

From a business perspective, positioning and preparing the business well ahead of the initiation of the sale process are key to a successful outcome. However, whilst families should be prepared and proactive, they should also be responsive to more immediate developments, whether this is an increase in sector valuations or receipt of an unsolicited approach.

Advance preparation is especially important if an owner-manager or other family members in senior management positions intend to exit the business. Their knowledge and expertise will need to be disseminated to other members of the management team and replacements may need to be recruited and integrated into the business. It is often wise to engage advisers at any early stage to assist with these preparations, to help with identifying any specific areas to be addressed pre-sale, developing a roadmap and positioning the business to maximise its value to a variety of potential purchasers.

Crucially, the family must discuss and agree whether the sole measure of success is price maximisation or if other factors should be considered, such as ensuring the business is transferred into ‘good hands’, to preserve its identity, to safeguard the family brand or to protect the future of the management or staff. There may be strong differences of view among family members and a valuation exercise should take account of these preferences, so that the family can debate the trade-off between price maximisation and other factors.

There may also be disparate views regarding the structure of any disposal. This could relate to the timing of the sale or the degree to which family members wish to remain involved post sale. Some family members may be willing to give warranties and indemnities or receive deferred consideration based on an earn-out in return for potentially higher overall proceeds. There may also be differing views with regards to the form of consideration and whether it will be cash, shares in the purchaser or a combination. Generally, the sooner these issues are discussed, the better.

Once a decision has been made regarding longterm ownership, the family should position the business appropriately to maximise its attractiveness to potential acquirers. This could include operational matters such as where to focus business investment, exiting loss making sectors or improving cost efficiency. They may also wish to develop relationships with decision makers at certain potential acquirers.

Timing is often critical. Sell too early and the family may sacrifice substantial gains; leave it too late and the business may have lost value, perhaps because of sector decline or because the company is losing market share to competitors. In certain circumstances, it may be appropriate to seek outside investment or a strategic partner, for example where finance for additional growth is required. For the purposes of this document we have only considered a full sale; however, in certain situations a partial sale may be more appropriate.

The main areas to be considered are summarised in the diagram:

KEY FOCUS AREAS KEY

TRANSACTION EXECUTION

Selling a business is often highly demanding of senior management, distracting their attention from the day-to-day requirements of running the business, perhaps for a lengthy period. This is especially the case where there is a small senior management team with limited experience of corporate finance transactions. The Chief Executive and Finance Director are normally key team members, usually with a corporate finance adviser who preferably has deep experience of family businesses and can help manage the family perspective as well as the business issues.

It is important to design a streamlined and structured sale process, which minimises the burden on senior management’s time.

The corporate finance adviser will work with management and shareholders across all the work streams to maximise shareholder value. They will also advise on numerous practical issues such as whether to commission independent due diligence which can be sent to bidders (known as ‘vendor due diligence’) or if the seller should prearrange financing packages to offer to bidders (known as ‘staple financing’).

Transaction execution stages

1. BUYER APPROACH AND TACTICS

• Marketing the business to a wide number of bidders can drive up the value attainable.Some sellers may, however, be uncomfortable with the risk of confidential information being too widely distributed and potentially falling into the hands of competitors. At the other end of the spectrum, an approach to a single party is more discreet,but can result in a greater completion risk and the risk that a higher price could have been achieved elsewhere.
• The team will also need to discuss the respective merits of trade buyers versus financial investors and overseas buyers and how these tie in with the objectives of the sale, particularly in the event that the family wants to ensure the business continues to trade as an independent brand with its own management.
• The timing of any approach to potential purchasers and the manner of that approach will be determined on an individual basis, depending on a number of factors such as the nature of the existing relationship,the nature of the company (e.g. direct competitor,vertical industry consolidator,financial investor) and the decision-making speed of the entity. It is vital to ensure in the initial screening process that any buyer identified has the resources, appetite and management decision making capability to see through the transaction, and again,this is a key role for the corporate finance advisor

1. DUE DILIGENCE AND INFORMATION PROVISION

   • The due diligence process (covering commercial, financial, legal, tax and other matters) needs very tight management, including the format and level of detail of initial information to be provided and the process for responding to buyer questions. Managing a buyer’s due diligence requests can often be time consuming, but delays in responding can cause loss of confidence.
   • Every business has sensitive issues which need to be disclosed with care and, to the extent possible, these should be identified in advance. However, a seller should also be prepared to deal with unforeseen issues that come to light. Any buyer concerns that cannot otherwise be alleviated may result in additional warranties or indemnities.

2. NEGOTIATION

   • Negotiation strategy starts with close analysis of the business from a buyer’s perspective. Equally important is an understanding of the acquisition rationale of each buyer, their specific requirements and concerns, and the motivations and constraints of their lead negotiators.
   • Central to the negotiation strategy will be increasing the competitive tension throughout the process, which requires careful planning as well as expertise and experience. A holistic and consistent approach is essential from pre-execution planning, initial buyer engagement, and buyer communications strategy through to the detailed negotiation stage.
   • Momentum is key. Delays, for example in provision of information, must not be allowed to derail the process. Each buyer will have multiple concerns and a number of practical developments could also affect their appetite to proceed, such as a deterioration in business performance, a decline in the political or macroeconomic backdrop, or a change in the buyer’s strategy or management team.

3. LEGAL DOCUMENTATION

   • Reviewing the legal documentation must not be left entirely to the lawyers! There is no substitute for the detailed involvement of someone at the centre of the team who fully understands the business and the transaction and will be able to spot any potential oversight, inconsistency or misunderstanding. It is vital to ensure terms agreed are accurately incorporated, particularly seller representations and associated warranties, non-compete clauses, covenants and undertakings and any conditions precedent to closing (e.g. regulatory approval) and commitments post sale.

4. COMMUNICATIONS

   • Communications with the family, staff, customers and suppliers are often given too little consideration until late in the day, by which time damaging rumours may have spread. The timing of communications is vital, but can be complicated by the specific nature of a family owned business. For example, family members involved in the business may be required to have a greater level of detail and more updates than those family members not actively involved.
   • The nature of the message will need to be tailored for each recipient. Family owners may be more focused on the long term brand reputation and the immediate impact on their wealth and roles, while employees may be more concerned with the purchaser’s ownership and business strategy, any impact on the company’s culture and their own employment and remuneration prospects.
   • Confidentiality will be a major constraint, but a leak strategy should also be prepared to manage any unauthorised disclosure.

POST SALE

The closing of a well-planned transaction can be highly rewarding for the shareholders, business and management. For the family this can often be a major liquidity event which allows for new strategic direction and flexibility - consideration and determination of which should ideally be agreed well ahead of initiating the transaction. However, this liquidity event can also remove some of the glue that holds the family together and to some extent can cause a loss of purpose and collective identity, especially if family members, including future generations, are no longer involved in the business post completion.

Once the transaction has been completed individual family members often find themselves in very different circumstances with regards to wealth options and personal tax situations and often need to ensure a smooth transition to the next stage of their family journey. Some families may decide to set up a family office to manage their wealth collectively or set up trust(or alternative) structures to manage and protect current and future generational wealth (whether managed directly or via professional advisers), whilst others are happy to transfer wealth to individual family members immediately following the deal.

Defining a common set of family values and objectives can act as a foundation for the family’s new wealth management strategy and help with making decisions regarding specific investments. For example, the focus could be on capital preservation or appreciation; dividend income or capital growth; wealth retention or philanthropy. The collective knowledge and experience built up within the business can also be applied to future business opportunities and investment decisions.

Those families who have a clear plan for the subsequent use of proceeds are most likely to preserve the benefits for subsequent generations.

On the 15th January 2015 Stonehage Group Holdings Limited completed a merger with Fleming Family & Partners Limited (‘FF&P’), a London-based Multi-Family Office.The combined company is called Stonehage Fleming Family & Partners Limited (‘Stonehage Fleming’) and is the leading independently-owned multi-family office in Europe, Middle East and Africa. Its advisory division provides corporate finance and direct investment advisory services as part of a holistic approach to advising wealthy families.

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