Banking for family business a new challenge for wealth management part 2

5 Corporate Finance and Financial Advisory for Family Business Stefano Gatti 5.1 Introduction Wealth management services for clients who are entrepreneurs or hold quotas or shares in family-owned firms (private companies) have some very particular features as regards investment or asset management As a matter of fact, wealth management providers have to take into consideration two aspects of this type of clientele On the one hand, an entrepreneur and his/her family or an entrepreneurial family are considered to be individuals with their own assets and annual income flows which must be optimized according to the established principles of asset management On the other hand, however, the source of the income flows is closely linked to the management of the company and a large part of the entrepreneur’s wealth is invested in the company itself These characteristics raise particular problems in terms of optimizing the client’s wealth This particular aspect has always had and continues to have considerable influence on those providing advisory services to entrepreneurs and entrepreneurial families When financial intermediaries realized that this type of clientele presented some rather unusual features they began to gradually change their private banking activities Although these activities initially focused mainly on managing the financial assets of high or very high net worth individuals, irrespective of the source of their wealth, they gradually turned into highly personalized services This involved switching from an approach based on “financial” private banking to a broader one based on the management of the client’s overall assets i.e “wealth management” The search for a new role also meant segmenting the high or very high net worth clients even more and identifying groups of clients – including entrepreneurs and their respective families – with diversified needs due to the different source of their income or assets portfolio Moreover, the entrepreneur clientele often requires services involving deal planning, deal structuring and funding special transactions for companies in which the entrepreneur or his/her family hold equity stakes Therefore, in the competitive arena, it is common to find not only operators tra- 116 Stefano Gatti ditionally associated with finance (mainly banks and private bankers) but also those associated with management or financial consulting This chapter focuses on the relationship between personal and company asset management Since a considerable part of the family assets are tied up in running the company, it is necessary to examine how corporate finance and corporate financial advisory services are integrated within the overall personalized management services It is also necessary to precisely define what kinds of services can be offered, when they can be offered and who can provide these types of services and the kinds of business models they have developed The chapter is divided in the following way Paragraph describes the position of corporate finance in the more general framework of the management of the entrepreneur’s wealth Paragraph evaluates the consequences in terms of the services requested to optimize the personal wealth of the entrepreneur and his family This paragraph aims to describe, in a prescriptive way, the services that an operator should provide in order to be considered a credible partner in the wealth management business Based on the different kinds of services required, paragraph describes the effects on the offering and the prevailing business models As regards the first point, we explain the links between private banking, corporate finance and the advisory services offered to entrepreneurs or entrepreneurial families; as regards the second point, we illustrate the business models adopted by large integrated banking groups and consulting firms traditionally associated with management consulting and corporate finance We also describe developing trends in wealth management services for family businesses that are empirically observable at the international level 5.2 Corporate Finance Operations and Wealth Management Services for the Entrepreneur and His/Her Family Corporate finance and corporate finance advisory services in the area of family business – often referred to as M&A services – have one thing in common: what changes hands in a transaction is represented by a firm or part of a firm Corporate finance advisory usually deals with shares or quotas representing companies or company divisions If physical assets are to be bought or sold, they are usually incorporated separately from the original firm (parent company) by means of an equity carve-out or a spin-off before the sale takes place Corporate Finance and Financial Advisory for Family Business 117 As regards integrated wealth management services for entrepreneurs, there are two kinds of operations, depending on the owner’s objective: entry and exit business operations; operations aiming at the organizational and managerial rationalization of the existing businesses or the reorganization of the existing ownership structure The first group of operations involves the acquisition of assets or company equity stakes (even by resorting to highly leveraged financial structures) and those involving the sale of an entire business or business divisions to industrial partners, financial operators (private equity) or through listings on the Stock Exchange.1 The second group involves a different approach In the first place, it can involve modifying the company assets so that the organization and management structure best suits the company profile and the separation between company wealth and personal wealth is sharper.2 A company is likely to request these services when it has reached a more mature stage in its life cycle By that time, its turnover is so high and management structure so complex that major changes in management have to be introduced In this connection, particularly useful operations include equity carve-outs of firm divisions, creating group structures or even going offshore to set up holding companies in tax havens This group of operations also includes reorganizing the company ownership structure in order to resolve succession issues through donations, acquisitions/intrafamily sale of shares, spinoffs or mergers This is shown in Fig 5.1 The matrix is made up of two dimensions The first, shown on the horizontal axis, indicates the presence of equity stakes in the entrepreneur’s assets When the company is small, the legal form of the firm is likely to be an individual firm (a firm entirely owned by a single person) or a partnership However, it has been empirically demonstrated that when companies become larger, there is a tendency to make a Berger and Udell 1998 point out that during their life cycle, small family-owned firms are characterized by very different financial structures The role of private equity is statistically more important when the business is at a more advanced stage of development and when the company is rather large See also Fenn and Liang 1998 As regards exit from the business through IPOs, Bitler, Moskowitz and Vissing-Jorgensen 2001 empirically demonstrate that the percentage sold by the entrepreneurs has a negative impact on the subsequent valuation of the firm This confirms the literature on market signaling (the sale of a small quota should indicate that the entrepreneur has a good opinion of the company and values it highly) Ang, Wuh Lin and Tyler 1995 118 Stefano Gatti sharper separation between personal/family wealth and company wealth by creating independent legal structures and concentrating equity stakes in the hands of the entrepreneur However, transforming physical assets (the firm) into financial activities (equity stakes) affects both asset management – the acquision or sale of companies takes place through the acquisition or sale of equity stakes – and the tax system As a matter of fact, in many tax systems, the gains derived from the acquisition or sale of a company are liable to taxation just like corporate income However, the capital gains derived from the sale of equity stakes by a physical person (the entrepreneur) are subject to a tax regime which is different from ordinary income taxes.3 Fig 5.1 Corporate finance operations in the management of family assets )LUP 6L]H H[LW (QWUHSUHQHXU RUIDPLO\ JRDOV 5DWLRQDOL]DWLRQ 2ZQHUVKLS ZRUNRXWV (QWU\ 0HGLXPODUJH ,QGLYLGXDO6PDOO Asset Acquisition Equity stakes purchase Selling the firm to third parties Equity stakes sales (to other firms, private equity, IPO) Leveraged Transactions I (LBO/LBI/FBI) II Donations Equity Carve-outs Group creation Going offshore Leveraged Transactions (LBI/LBO/FBI) IV III Equity carve-outs Leveraged Transactions (LBO/FBO) Mergers/spin offs