Helping families in business expand using private equity

Date: 07 Dec 2007


Cobblestone is a specialist, family business, private equity consultancy based in Boston, USA. They work with wealthy families in business to help with preservation of the structure and expansion. Ninety percent of their work is international which has been the case for the last eight years. Eugene O’Malley is managing partner and says he also works with a few USA families on domestic transactions. A recent deal involved two private families merging their businesses together and reviewing the financial and strategic issues involved.

Eugene previously ran the international consulting practice at Arthur D Little based in Cambridge, Massachusettes but in 1989 he set up on his own and was fortunate to be able to take clients with him. He has historically handled all incoming instructions for families wanting to buy businesses and says this has been mainly for Dutch and UK families.

Cobblestone Advisers have wealthy clients all over the globe spanning such far flung places as Brazil and Egypt. I express surprise at this wide spread, but Eugene is pragmatic saying “I understand how to get a transaction done and have a large network of collaborators who’ve worked with me for a long time. This business needs particular skills: families demand honesty and directness and don’t like political people. You can’t play a political game. They value independence and input without any agenda.”

Eugene says his most recent transaction was for a family in Germany where he brought in an Irish private equity investor to create a subsidiary and separate off part of the family business. For family businesses looking at private equity he guesses there is a universe of around a thousand businesses who may each want $50million.

Of the typical type of work he does, Eugene say there is no one circumstance, commenting “I could be working with families wanting to expand from Holland into India, or Holland into Germany. I tend to be called in because families in business want to move outside of their existing client base, particularly in the UK where there are lots of families in business looking to grow.”

The usual investment profile is cross border with Cobblestone working in Brazil, Thailand and he has also helped one Singaporean family invest in Brazil. He says half of his work has some capital requirement, then explains “a family may have great know how but no capital so we’ll put them together with another family with money but without connections.”

Of the trends he sees Eugene says Germany has for many years and will continue to be an important market mainly because there is a strong, capable family owned business sector without liquidity. He comments “I think Germany has the most families in business of any country. It’s the most important market out there now. They don’t have cash because they’re always reinvesting in their business so there is an easy opportunity to help them expand using private equity.” Eugene adds “Germans have excellent skills in technology and have a strong exporting market which other economies are interested in. They also understand global trends. I have a collaborative of families who want to work with other families so I look for opportunities to bring different families together.”

As to why Eugene ended up in the niche world of families in business he says it started as an offshoot of his corporate career. His life before Cobblestone was with Fortune 500 companies in a 3000 strong entity and occasionally families would cross his path. Of this past time he says “seventeen years ago an average engagement was valued at $150,000 which seems paltry now.”

The families that Eugene deals with come to him because they are looking for a one on one project manager. I ask what sort of deals he is doing for them. He comments “as an example, one of the families I’ve worked with, I advised should incorporate a private equity strategy. We built a suitable profile with a view to introducing private equity firms and people into the family so that they could proactively look at it.” Eugene adds “in deals with families there has to be more than just money brought to the table. The majority of the families want someone who understands their business and can add value beyond money. They also want to deal with the decision maker.”

Eugene says he has a long term pool of investors who are successful individuals looking for opportunities and he also introduces these into the families he works with. He comments “one currency trader I work with put $25million into a private equity family office deal. These people are not generally visible but have a lot of money. I also work with funds who see this as an opportunity to diversify their own investments. The families I deal with are more interested in results than a name brand and they want those working with them to be objective and not conflicted out.”

I ask for an estimate of how many family businesses Eugene thinks there are as a universe. He puts a finger in the wind and says “a rough estimate would be around ten thousand families in each country.” He adds “some are going through transitions and many don’t have succession plans. I think private equity can really help them plan for the future. It can take minority or majority positions perhaps with another family member.”

Eugene says all his work comes from referrals and they generally tend to be from families he’s worked with in the past. He says “it may take five years to get another instruction. It’s that type of the business; families don’t need ongoing help of this nature.”

Cobblestone Advisers started working with families in business exclusively around twelve years ago, dropping their corporate client base. Eugene comments “family businesses always have a need for capital because there are always opportunities out there for them to capitalise on. Opportunities arise because they have substantial wealth and assets and so others approach them. Also in many cases it’s not part of the main family business that needs finance, it maybe that they want to expand or fund someone from the next generation into a new hybrid business. Eugene says families may want to expand into new business areas and says there is increasing interest in bio farms and fuel. He comments “there is a big trend to invest in bio pharma and bio fuel worldwide. You have countries like Brazil who are into sugar cane ethanol, lots of interest in the UK and Asians are also in that market place.” He adds “Bio fuel is normally corn based but corn is becoming expensive so investors are looking at other options.”

Of his role in the private equity deals Eugene says he acts as a facilitator but also sits down with the family and maps out a plan so that they are clear about what they want to achieve before they start. He says “there is usually a lack of trust from the family who worry they may end up with a raw deal. They are honest, hardworking and very wary. As there is a certain amount of lockup and disclosure I have to educate the incoming person about the family business. Chemistry is crucial and a positive approach from the private equity house to promote benefits whilst they work out if the partnership can work. It’s a long process with deals usually ranging from $20-50 million.”

Eugene continues saying “in this business, it’s reliant on the families participating. They have to fully disclose their finances and there is nothing you can do to help them if they won’t. Usually there is a defining moment when we are at the table that gets the talk going.” He gives us an example of a recent project, saying “I got a call from a family in Mexico who wanted to grow their business harnessing the internet. They wanted an adviser in a particular area relating to the internet and needed connections. This is the type of thing I will help with to see how they can partner or find finance to expand with appropriate private equity houses.”

Eugene says there have been many changes in the industry and one downside is that private equity firms have become less flexible as they’ve got bigger. He says now they all work on a formula and if the family business doesn’t fit they won’t consider it. He says this creates problems and means the work has become quite specialist navigating private equity houses into this market.

I ask what size of market he thinks he is working in. He comments “there are thousands of families looking to access private equity. There is a tradition in most cultures to pass the business on which is why it can be useful to review private equity and partnership loans. Although in the Americas it’s the reverse and they generally sell off the business and take the capital.”

One of the more complicated deals he has worked on involved a family business that was quite substantial. It was a European family who were offered the acquisition of another family business. Unfortunately there was a situation where one part of the family business had done a major lay off of staff so they felt it was un-politically correct to have an announcement of new deal and that their board may refuse to co-operate. Eugene helped set up a special purpose vehicle that acquired the family business being sold via a private equity deal. The SPV held on to the business for thirteen months, then later the family purchased it from the private equity house with board approval, paying a premium to do so. Eugene says “it meant they went from a number six position to a number one in their industry. An opportunity they would have missed out on.”

Eugene says the pitfalls of a family business/private equity partnership if not properly run, are that the family might end up with a poorly structured deal. He comments “you have to deal with operational and financial issues. It’s like going through a business plan of sales and having a dialogue about expectations on both sides. It’s very important that there is mutual agreement in how to execute the business or things will unravel.” He says often the family may spend more time focusing on the money rather than on the results they will have to deliver after the fact. Eugene says if everything works well these deals have a real impact on profitability. If not and things go wrong then there will be exit provisions for the family, or as Eugene puts it: a planned divorce. He comments “These deals are always about more than just money and families do have expectations with regard to nurturing their business. On the side of the private equity houses, they need good deal flow which is available in this sector.” He says one family business has done business with five different private equity groups in five different regions of the world.

As private equity houses have a habit of loading businesses and staff with debt, I ask how Eugene handles the macho corporate mix into honest, hardworking families. He says “you can’t allow private equity houses to come in without some guidelines. Families can’t be loaded up with debt nor have money taken out of the business so provisions will be made to prevent this. A plan is mutually developed, agreed and executed. Also families don’t take the money and walk away. The private equity house will be in a strong, supportive role to help the family.” Although Eugene adds “clients have become more aggressive with their money making ideas. With one family he was working with he said they were set to make about $4million but the owner said “I want to make $40m not $4m.” Eugene says in this case, they then advised him differently.”

As to what type of deals work in this scenario, Eugene says one of the best uses he has seen is with a first generation family transferring into the second generation with several siblings entering the business. Eugene explains “usually you may get rivalry but here we raised finance to allow each to hive off into a different business to use their skills without conflict. With one family we did this with a five year plan and the father stayed at the head running the main business whilst children worked in separate extensions. It works well in some cultures like the Middle East. It allows each one of the siblings the potential to grow their own business with their own skill sets.” Eugene says in Europe the founder always wants to bring the children in, but because they recognise how difficult it is to succeed in business, this is a good way to provide for their families and motivate their children. He says it can play a role with one child but it works best with multiple family members with net worth of more that a $100million.

As hedge fund people are springing up everywhere, I ask Eugene if he has a view. He says “Most family offices have been involved with hedge funds for ten years or more although it seems as though it’s only been about five years. I think they are generally moving away from them and dropping asset allocation from 20% to 10%. They feel there is so much money in the liquid markets that the returns are better elsewhere.” He also adds a side comment saying “hedge funds are converging with private equity because of the pressures they are under. Their challenge is the deal flow.”

Eugene thinks there are around five thousand family offices around the globe and mentions the well known Sand Aire with Alex Scot in London. He says “I think the average family office has around $25million and there are probably around fifteen hundred in the USA of this size. I would say there are five hundred that are meaningful around the globe which would mean a couple of hundred million dollars.

Advice that Eugene would give to families in business now is to keep a sharp eye on the global economy. He says “there are many opportunities to work with partners in China or India that businesses need not be fearful of.” He also says that private equity transactions can be executed very quickly so there is little downtime before inflows of money.

As much of Cobblestones business is with leading families in their respective countries he is contractually restricted in making any mention of names by telephone or on his website.

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