Private banking in Italy: Holistic advisory for family-run business in an increasingly globalised environment

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1 Private banking in Italy: Holistic advisory for family-run business in an increasingly globalised environment by Andrea Cingoli, Banca Esperia SpA The Italian private banking sector is developing a new holistic approach to address the needs of entrepreneurs and especially family run businesses. The investment and economic environment in the aftermath of the global financial crisis has introduced a range of challenges in both wealth management and the ability of entrepreneurs to access growth capital to support their businesses. The globalisation of markets and the requirements of businesses to expand internationally have added a new dimension. Private Banks must be able to offer an expanded range of services whilst understanding the overall needs of their clients. The unique requirements of the family-run business Supporting the unique needs of family-run businesses and ultra-high net worth individuals (UHNWIs) requires a range of specialised private and investment banking solutions. Firstly, many private banking clients have built their wealth as owner-managers of family businesses and as a consequence have large portions of their net worth directly invested in their businesses and in associated real-estate assets. For these individuals, tailored solutions that enable them to diversify their investment portfolio, releasing capital to invest in their business or to facilitate diversification of their wealth into other asset classes, are of key importance. In addition, many of these entrepreneurs are considering succession planning and are either starting to structure their companies for the next generation of the family, or are preparing for a change in ownership either with the introduction of external strategic investors or perhaps a move to the public markets. Furthermore, many of these entrepreneurs operate in fragmented industries that are cyclical in nature and where the challenges of operating in an increasingly globalised environment and taking advantage of opportunities in growing overseas markets are greater than for larger businesses. The current macroeconomic environment also introduces further challenges. While markets have moved into a period of reduced volatility following the global financial crisis, growth in many developed markets remains subdued and the investment returns earned by fixed income assets is likely to remain low for the foreseeable future. Furthermore, access to credit for many family-run SMEs remains challenging and the IPO markets in many European countries either remain largely closed, or where they have seen renewed activity, focused on larger companies. The consequence is that, in many cases, smaller, familyowned businesses face a more restricted range of financing options. Moreover, these same macroeconomic trends that have reduced investment returns in many Figure 1: Number of family-run SMEs per thousand inhabitants in European countries Italy Spain France UK Germany Europe Source: Rassegnaest 1

2 assets traditionally held by UHNWIs, such as sovereign debt instruments and corporate bonds, are encouraging individuals to seek a wider range of investment opportunities and to diversify their own investment holdings into potentially higher-growth international markets. Therefore, UHNWIs and family-run businesses face a unique range of wealth management and financing challenges and require private investment banking solutions that can take a holistic approach to their needs. It is essential that these individuals are offered services that not only incorporate traditional corporate banking products and advice on personal investment solutions, but also additional wealth management, and real estate advisory solutions along with investment banking advice oriented to the needs of small and medium-sized companies. The family-run business in Italy Small and medium-sized enterprises (SMEs), typically family run, are a significant segment of the Italian economy. Only 19% of Italian companies have more than 500 employees, while more than 50% of Italian companies have fewer than 50 employees. A total of 71% of Italian companies are family businesses and the number of family-run SMEs per thousand inhabitants in Italy is more than 30% compared with the average of the European market (see Figure 1). Italian family-run businesses have a number of typical characteristics. Many were founded by entrepreneurs who started their business in the 1950s and 1960s and as a consequence their family wealth was acquired relatively recently. Given the absence of well-developed public and private equity markets for Italian SMEs, these firms are frequently financed by their founders using their own private wealth. As a consequence, many of these businesses are either undercapitalised and their owners have a significant proportion of their capital tied up in illiquid assets such as real estate. Moreover, not only are entrepreneurs the major shareholders in their family-run business, they are also deeply involved in the management of their companies, whilst also having the objectives of maintaining control of their businesses and successfully transferring ownership to the next generation. Starting in the 1980s and 1990s many entrepreneurs have begun to face the challenge of succession, which involves the transfer of leadership of the family business to the next generation. However this process has a number of potential difficulties, with younger family members frequently lacking the founder s management skills and deep knowledge of the business. As a consequence, only 31% of Italian family businesses are successfully passed to the next generation and only 15% remain in family ownership by the third generation. Despite entrepreneurs in their sixties heading up 43% of Italian SMEs, and some 66,000 family-owned businesses seeing a generational shift in ownership each year, only one-third of Italian family-run business have succession plans in place. A poorly executed succession runs the risk of undermining the growth of the company and putting at risk the family s principal source of wealth. In some cases, a succession solution may be to bring in external professional managers, and for the founding family to transition to the role of nonmanaging shareholders. If this is the preferred route, it is essential that appropriate governance measures are put in place to protect the family s financial interests and to structure the business in a way to appropriately incentivise the new management team to successfully grow the business. A further challenge for Italian family businesses is how to respond increasing levels of competition in their home market and to ensure they have the appropriate strategies and organisational structures in place to successfully expand in international markets. Given the challenging and uncertain economic environment in Italy, expanding in international markets is increasingly seen as a viable growth strategy for many family businesses, yet few SMEs have successfully made the transition: indeed, only 13% of European SMEs are currently doing business outside the EU. However, expanding outside traditional markets may require new management expertise in the business along with additional capital requirements. The Private Bank as a partner of family-run business Private Banks should shift in their role, away from their traditional activities focusing mainly on asset management solutions, towards a new platform designed to address the wide range of requirements that family-run business demand. This new model comprises a holistic and comprehensive advisory framework, encompassing wealth planning, corporate and real estate advisory and financial investment solutions. Wealth planning and trusts Wealth planning is taking a leading role in the offerings of many private banks, supporting entrepreneurs in protecting their wealth, establishing a governance framework and taking a more structured family planning approach. 2

3 Wealth planning needs to be an integrated advisory process, based on a full understanding of the challenges and objectives around the family s wealth. Typically it is structured around a formal fee based wealth advisory mandate, offering personalised advisory solutions designed to support family business entrepreneurs in identifying the most appropriate strategies in areas such as wealth governance, wealth protection, generational change and the impact of any transactions associated with the family s business. It also requires an advisory tool with a complete overview of all the main instruments available alongside the provision of in-house planning services and the capability to draw on specialist third-party advisory abilities when required. Corporate and real estate advisory The objective should be to offer solutions to assist the family business entrepreneur in preserving the illiquid portion of their wealth associated with investments in their business and real estate assets. Corporate assets advisory must give strategic support to the entrepreneur to optimise and preserve the value of their company, taking into account the competitive environment faced, capital market opportunities and the prospects of possible succession in the business. It should help the entrepreneur make the transition from a hands-on founder and manager of the business, to a less active shareholder. Financial investment solutions Financial investment solutions represent the evolution away from the traditional portfolio management offering, towards a comprehensive framework of tailor-made discretionary and advisory services. This investment service framework is integrated by a structured investment approach based on the individual assessment of client s goals to define an investment strategy consistent with the risk profile of each client. The process involves the creation of portfolio models, combining the private bank s strategic market view, the selection of specific investment ideas and a quantitative methodology defining asset allocation with regards to the desired level of risk exposure and financial regulations. Illiquid investment solutions (investment clubs) Private Banks may assist with facilitating investment into the companies whilst they are still unlisted, linking the family business with a group of investors who are looking for more unorthodox investment opportunities and have founded an investment club to take advantage of these. Value proposition for each area of the business model Wealth planning: Enhancing family governance through the trust Over the past few years, trusts have become an increasingly common instrument used by private banks to manage the assets of Italian family-owned businesses and to ensure their succession plans are executed as smoothly as possible. Trusts vary in type and can be tailored to the type of business or estate they are charged with all however are designed to ensure that wealth is sustained over the long term and is protected as family-run businesses seek to transfer ownership to the next generation. The activity of estate planning starts with an analysis of the personal situation of the customer and the process of designing and drafting documents to establish the trust is carried out via a series of interviews with the client and in some cases with their families or other trusted advisers. Each trust established is unique and designed as a tailor-made instrument to suit the needs of an individual customer or family. The important role of trustee can be undertaken by a private bank, sometimes acting as a co-trustee to assist an individual in the management and administration of complex estates. By employing an independent Trust Company to manage the trust the family can ensure continuity over time which is particularly beneficial to long-term trusts, as this relationship can in some cases exceed the life-span of other trustees. Corporate and real estate advisory: Optimising the illiquid portion of portfolios Many entrepreneurs at the head of family-run businesses have a significant portion of their net worth in illiquid assets such as real estate. These assets may include commercial real estate assets built up as their businesses have expanded. Whilst the ownership of properties used for their business can bring advantages in terms of lower operational costs, it can be an inefficient use of capital, particularly if the business has financing needs that it would otherwise fulfil using higher-cost external sources. It is also advisable for clients to take a more diversified approach to their personal investment portfolios, particularly if they are approaching a potential succession event in the family business or have alternative requirements for their wealth due to business or personal objectives. Typically 10%-20% of an individual s net wealth should be held in more liquid assets and in many cases the heavy-weighting of property and business investments means that UHNWI s and entrepreneurs lack the diversity in 3

4 their personal holdings that would be advisable to reduce risks or increase potential investment returns and yields. Therefore advisory services for corporate and real estate assets are essential to optimise and protect these illiquid investments and should be centred around guiding clients as to the most appropriate ways to enhance their real assets. Corporate asset advisory services are required to help clients find the best ways to optimise and preserve their business assets in the context of a family-run business, whilst simultaneously ensuring suitable flexibility for the future requirements of the enterprise. Whilst it may be advisable for entrepreneurs and family-owned businesses to diversify their investment portfolios and divest of some of their commercial property holdings, the asset class has become of increasing interest to institutional investors due to its ability to generate stable yields and potential capital growth in a low interest rate environment. In addition, there has been a heightened degree of interest in the European and Italian commercial property sectors from international investors, seeking to diversify their own investment portfolios and to take advantage of stable investment opportunities in developed real estate markets. Therefore, investment-banking solutions that can match the requirements of business owners for increased diversification in their asset portfolios, to the needs of institutional and international investors are of great importance. In particular, many of these large institutional investors and private client managers are looking for investments into a portfolio of property investments, so banking solutions that enable individual real estate assets to be consolidated into multi-asset structured products will maximise the potential audience of investors. It is also essential that private banks are able to support their clients in assessing real estate trends and opportunities, so that they are well informed when they come to make major decisions about their own portfolio. This expertise can either be provided in-house or can be developed in partnership with highly specialised services providers. Such providers are able to create tailored solutions which combine a deep understanding of the clients and their needs, as well as an extensive and holistic knowledge of the real estate sector. Financial investment solutions: Diversifying personal investment portfolios One of the greatest challenges for private banks is to help clients take a more global approach to the management of their personal wealth, assisting with portfolio diversification strategies. However, in order to achieve the right mix of investments, it is necessary to offer dynamic asset allocation strategies whilst also ensuring that risks are adequately assessed and controlled. As private banks respond to clients needs in this area they must take into account a number of important issues. Firstly, clients have traditionally looked for stable income generating assets that are seen as being low-risk or risk free. However the sovereign debt crisis has taught them that even investing in their own government s debt is no longer risk free. The low interest rate environments seen in most global markets since the financial crisis has meant that it has become harder to find assets that deliver positive real rates of return whilst also having low risk characteristics. Accordingly, clients are often directed towards investing in equities, which offer the potential for dividend income and capital growth, but are potentially volatile, a characteristic unwelcome for many private clients. As a result attention has shifted to investing in so-called alternative assets that are de-correlated with wider equity markets, such as commodities and hedge funds. However, experience over the last few years has revealed that these assets do not offer the downside protection against negative market movements as hoped. In many cases their overall performance is more closely correlated with wider market movement than originally expected. Hedge fund investments illustrate the potential problem with this approach. Initial investments into these instruments were based on the premise that they would offer positive returns in times of good market performance, but would preserve value, or outperform the market in downturns. The investments initially performed well, but as the global market crisis persisted, some clients were disappointed with the outcomes due to the illiquid nature of many of these instruments. In many cases the investment industry s search to control certain risks has only resulted in the emergence of new, previously unidentified, risk factors. This is due to the critical correlation between an asset s volatility, returns and liquidity potential: the financial industry is always looking to create products or develop asset allocation strategies that attempt to minimise volatility in order to stabilise returns. However, at the same time, high levels of liquidity are required, should the client s investment position need to be changed at short notice. This mix creates new volatility. In short, the more the industry has sought to control risks the more probable it becomes that new risk factors are unearthed. The paradox whereby the industry s 4

5 search for safe investments has generated other risks has caused clients to loose trust as well as triggering chronic weakness in the financial system. Illiquid investment solutions (investment clubs): Accessing illiquid investments whilst pooling risk As private clients have sought to diversify their portfolios and generate returns for their investments in a low interest rate environment, their attention has increasingly shifted to investing directly into corporate or real estate assets that offer the potential for positive returns and the participation in real economic trends. However the potential barriers for investment into these assets are typically higher than for more traditional financial investments. In many cases these investments are more complex to access, with the assets not being visible on markets in the way that, for example equities or fixed-income securities would be. Also by their nature, these assts are illiquid, investments are difficult to separate into units, information on them may be scarce and transaction costs may be substantial. One solution for overcoming these barriers is the investment club, which has become an area of increasing focus for private banks. Such private banks can help facilitate investments into alternative assets, high-potential business initiatives and unlisted companies. Clients can be offered the chance to join forces as part of investment clubs, benefiting from a number advantages found from pooling their investments. Foremost among these is the opportunity to join a network of likeminded partners who are able to jointly identify and manage investment opportunities through the exchange of information and their specific experience. The club is able to draw on its expertise and contacts to identify potential investment targets, or alternatively, an ad-hoc club could be formed to take advantage of a specific opportunity. The format of investment club investing also gives those involved a much closer connection to the entities to whom they are entrusting their money, than investments made via private equity schemes. As such, the approach is attractive to entrepreneurs. Membership of investment clubs does not require an immediate financial commitment, and individual club members are able to decide independently what investments they participate in. A key feature of investment clubs is their business-oriented view and their approach to creating long-term value via diversification. Private banks can act as the club s trustee, responsible for introducing potential club members to each other, co-ordinating and steering activities. Specifically, the bank can offer: Support in establishing the investment club: i. helping to define and implement the club s rules and governance procedures; and ii. defining the investment club s mission. The identification and vetting of specialised operators to help support the club in the selection of targets or additional club members. Help in selecting investment opportunities identified through the club s network of clients, prospects and business partners. The sourcing of adequate special-purpose vehicles for specific investments in corporate and real estate assets. The investment club may target a number of different types of transactions: Income generating investments: Investments into specific medium to long-term income generating projects, such as real estate, tourism and renewable energy schemes. Transactions carried out in this area may include acquiring an income generating asset or financing the development of projects through equity or debt and adopting either controlling or non-controlling positions. Foreign markets: Investment clubs can be used to access investments in countries with high growth potential that may difficult to access for Italian-based investors, without using local intermediaries. Growth companies: Financing small and mediumsized companies with high growth potential, who have future flotation plans, with investments made via convertible debt and equity instruments. Mid-corporate projects: Investments in established companies helping them to restructure, acquire other companies or enter new markets. In this case the investment club may help companies achieve the step change in growth needed to progress towards an IPO. In summary, investment clubs offer a number of advantages over other investment propositions, including the involvement of club members in the investment decision and the management of the assets as well as access to a wide range of innovative and niche opportunities with tailored risk profiles. Clubs also offer the advantages of speed, with fast decision and execution times after the identification of opportunities and give members the ability to constantly monitor investment performance over time. Conclusions It is clear that Italian family-run businesses have a unique and increasingly complex set of requirements 5

6 and this has necessitated an evolution in the business models of private banks serving them. Private Banks must maintain their long established attributes of discretion and trust along with their intimate understanding of their clients needs but must also increasingly deliver a range of tailored solutions to address the changing needs of their customers and the increasingly global focus of their businesses and investments. Author: Mr. Andrea Cingoli, CEO, Banca Esperia SpA Via Filodrammatici, Milan, Italy Tel: Fax: PA Website: www. gruppoesperia.com 6

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