M&A for Family Offices

​published on 11 January 2022 | reading time approx. 7 minutes

The number of successful and wealthy entrepreneurs who handle the management of their private assets on their own is steadily increasing. For this purpose, they establish family offices as an alternative to investing through (investment) banks. By now, for rates of return related reasons, they also invest by way of direct investments in other companies.

This sounds simple at first glance, but it is often a complex process in which numerous aspects should be considered. A family office will only be successful in the long run if it is organised professionally based on appropriate structures and also acts so. In the following interview, our experts – Anna Luce, Isabelle Pernegger, Dr. Oliver Schmitt and Michael Wiehl discuss the topic of “family office” and show what aspects should be taken into account.

How do you understand the term “family office”? Are there any typical structures of family offices?

There is no straightforward definition of the term "family office" and there is a wide variety of structures a family office can be organised into. Generally, family offices are tasked with the management of assets not being operating assets with the aim of achieving diversification and spreading risk. The legal structures used for that purpose are extremely diverse. The assets are often legally separated from the operating assets, can be owned by the family office or privately held by the wealthy individuals and families, but also through various companies or partnerships, or as part of a foundation. A family office can provide services to multiple families (multi-family office) or be run by a single family to individually handle the management of their assets (single-family office).

What are the asset classes and business areas that family offices invest in from your experience?

Family offices typically invest rather passively on the capital market (stocks or funds on the regulated market), in real estate and agricultural assets. For some time now we have however observed a considerable trend towards more active investments such as Private Equity, Venture Capital or classic direct investments. Especially in the German SMEs sector, an increasing number of direct investments by family offices is being observed.

Why do you think this is happening?

The reasons for this are manifold. First, there is still mistrust towards banks and structured financial products, fuelled by the financial market crisis. This also partly applies to private equity companies. Also, the lack of transparency and of direct control from investing family offices makes these forms of investment less and less attractive compared to direct investments. Compared to investments in private equity companies, direct investments offer family offices far greater flexibility in investing their assets and the opportunity to select and structure their investment portfolio according to the interests and needs of the investor family. Recently, we have also increasingly observed that many medium-sized, owner-managed companies shy away from selling shares to private equity companies or strategic investors. This often offers family offices preferential access to these targets.

What should be particularly considered in the case of investments where shares are acquired directly by family offices?

Historically, family offices have been run by investment managers or officers with banking experience. Other skills are however needed as regards active investments. From our experience we know that important here is industry-specific experience, partly also operational management and, foremost, a totally different approach to the selection and investment process. With regard to this type of investments, family offices are not very much different from classic private equity investors.

In our view, it is important that also family offices have a clear investment strategy – as in the classic investment sector – and that it is underpinned by professional processes for the selection, integration and management of investments and that the investment is not just purely opportunistic.

Based on what you have said, what are the success factors for a successful family office?

The success of a family office does not only depend on whether it makes successful investments but that it is operated throughout generations in such a way that the capital is preserved and, ideally, increased, also for the following generations.

Thus, before establishing a family office, the investing family should clearly know the goals of the family office and define clear long-term governance structures. This should ensure reconciliation of the different interests within the family and enable the management of the family office to act more independently of the family within certain ranges. Important areas to regulate include, e.g., how decisions are made in the family office, who has which competences, who can be a shareholder in the family office at all, and whether it is possible to dispose of shares in the family office.

Another central aspect in this context is the management structure of the family office. It is rather an exceptional situation that a family member is able to manage the family office professionally. It is not uncommon for family offices to rely on external managers. Here, it is important to balance the desire for flexibility and acting on one's own responsibility and the need for control.

Finally, the professionalisation of the family office is of central importance. The increasing investments in companies on the one hand and the competition from usually professionally organised private equity companies make it necessary for the family office to have the necessary structures that consider the increasing complexity of existing and future investments, but also the increasing administrative workload involved in existing investments. Family offices are therefore usually well advised to engage external advisors to deal with ongoing accounting and tax issues. This also applies to legal and tax consulting for investment projects and the performance of due diligence reviews.

How do direct investments by family offices differ from those by private equity companies or strategic investors?

What private equity companies and family offices have in common is that neither of them usually aims to run the day-to-day business of the respective target company. Both usually lack the necessary human resources and the professional expertise. In investments both by family offices and by private equity companies, the success of the investment depends primarily on the motivation, competence and quality of the management of the target company. Unlike private equity companies, however, family offices often do not strive to have a dominant or direct influence on the management.

There are also differences in the periods of holding the acquired investments. Due to repayment obligations and the returns expected by the company’s existing investors, the time span between acquisition and sale of investments made by private equity companies is only about four to seven years. The situation is different for family offices. Here, generally, the long-term management and preservation of the family's assets is paramount. Depending on the asset class, we observe holding periods of well over ten years.

But we also see cases where the former entrepreneur wants to pass on his experience and not only buys shares in companies, but gets involved as the so-called business angel. This also rather suggests a long-term and close nature of the relationship.

Family offices therefore do not usually pursue a “buy to sell” strategy like private equity companies. This is what they have in common with strategic investors. Thus, family offices should not select target companies on the basis of short-term growth potential, but rather focus on long-term returns and the sustainability of the business model. Personal relationships between the family office and the target's management may also play a role in the selection of the target company.

You have said that the management of a target company is of central importance for the success of the direct investment by a family office. What instruments does a family office have as an investor to retain the management in the long term?

There is a broad range of models to incentivise the Management. They usually involve the management's own contributions to the target company. This is to help create the so called “owner manager mentality” rather than (only) an “employee mentality” among the management.

The so-called “temporary shareholder” model is a suitable incentive model. In this model, the manager is a “real” shareholder in the target company. At the end of his service, he returns his shareholding, either to the family office itself or to another investor or manager. The manager has, thus, a share in the current profit while serving as a shareholder. However, he has no share in the increase in the value of the company itself. Therefore, he can make no profit by reselling the shares later. 

If, on the other hand, the manager is not to have any share in the current profit, but is to have a share in the increase in the value of the target company by being able to sell the shares later for profit, it is essential to ensure that a long-term period is selected for the purpose of determining the purchase price. Otherwise, a false incentive could arise for the manager to artificially increase the EBIT of the target company in the short term.

What is the typical holding structure for family offices?

The typical structure of the acquisition vehicle usually consists of a two-tier or multi-tier holding structure. In the two-tier holding structure, the family office acquires the shares in the target company through an acquisition company (AcquiCo) established for this purpose. The shareholder in the AcquiCo is in turn an intermediate holding company (HoldCo), whose shares are fully held by the family office. However, the appropriate structure of the acquisition vehicle in each individual case ultimately depends on several factors. In addition to the tax aspects, which are usually paramount, special aspects arising from capital market law or any financing of the transaction by lenders also play a significant role in the selection of the optimal structure of the acquisition vehicle. Finally, the decision of the family office to structure the investment as a so-called club deal or to invest in the target company together with another investor as part of a “co-investment” also has a significant influence on the structure of the acquisition vehicle.

What should be considered in the case of minority shareholdings?

If the family office acquires a minority shareholding in the target company, as is usually the case, special attention should be paid to ensuring that it has sufficient opportunities to influence and have a say in its future role as the shareholder. Beyond the mandatory legal provisions for the protection of minority shareholders, the family office should insist on contractually incorporating further provisions to protect its investment into the share purchase agreement or the articles of association of the target company. Such provisions include, above all, reservations of consent for certain measures of the management or the shareholders, the granting of certain special rights, the establishment of an advisory board at the target company, whose composition the family office is entitled to co-determine, as well as regulations on dilution protection.

How do club deals or co-investments differ from other investment processes and what legal restrictions are they subject to?

The main difference between club deals and direct investments is that you not only have to reach an agreement with the seller or investee, but also within the group of investors. This means there are two different levels of negotiation that, however, must go hand in hand for the deal to pass. On the one hand, the purchase agreement has to be negotiated with the seller, and on the other hand, the co-investors have to negotiate a shareholders agreement setting out the rules for the cooperation and decision-making processes up to the exit. This often does not make the process any easier, even though the capital power in club deals is of course significantly higher.

In addition, for club deals, many legal aspects are of relevance which in the case of a direct investment are either not significant or only need to be clarified in relation to one investor.

What aspects of regulatory law should family offices consider?

Family offices provide a wide range of services related to the management of family assets, ranging from purely administrative services to investment consulting, financial portfolio management and investment management. These are classic areas of banking and financial services, the commercial operation of which is subject to the requirement of obtaining a licence under the German Banking Act (Kreditwesengesetz - KWG). This generally means that an application for a banking licence must be submitted to the German Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht - BaFin) to be able to provide such services. Violations of this requirement are subject to severe sanctions. However, at least in the case of single family offices (SFOs), the licence is generally not required, even if such family offices provide banking and financial services. However, this only applies if and as long as they only invest and manage the assets of a single family. Multi family offices (MFO), on the other hand, usually have to obtain a licence. However, it should always be carefully examined on a case-by-case basis whether a licence is required under KWG. Finally, it should also be noted that even the provision by the family office of a single service that requires a licence can lead to a situation where banking transactions that do not actually require a licence will require one under KWG.

Special attention should also be paid to the provisions of the German Capital Investment Act (Kapitalanlagegesetz - KAGB). Here, too, SFOs – with some exceptions – generally are not required to hold a licence under KAGB as long as they handle the management of and invest only the private assets of one family. The decisive factor here is above all that the assets must originate from the “closest family circle”. Caution should be exercised especially when assets of “more distant” relatives are added to the pool of the managed assets.