What made family offices in Germany successful and how are they resetting for the new normal? Which ownership advantages do successful family offices in Germany build to increase their ability to create wealth under high uncertainty? Like so many other industries across the globe that are being disrupted by the pandemic, family offices in Germany face unprecedented forces of transformation. We explore how German family offices get ready for a new normal, where disruption is commonplace.
The hinterland of family offices we use to know
Looking back at the period when “Deutschland AG” was dismantled from 1996 – 2005, the German “Mittelstand”, famous for “hidden champions” such as Würth-Group, EBM-Pabst or prominent brands such as Miele and Bosch received little focus from the banking industry. Taking start-ups public on the “Neuer Markt” was more sexy and more lucrative for bankers than figuring out complex succession issues. Hence, families started to switch from mostly buying wealth management services to building inhouse-structures and hiring very selected specialists.
For many German enterprising families and their family offices, capital preservation is more important than maximal returns gained from capital invested. More aggressive PE-investors may consider this as a result of typical “German Angst”, but betting one’s own money is a different ballgame than betting the money of anonymous strangers. Enterprising families investing directly in other firms regularly pursue a generation-spanning holding-period of +20-years. Investment-portfolios of family offices today include some 10+ firms, with a typical pre-acquisition target-turnover of +/-50 Mio. €, which held a distinctive advantage in a very specific industry.
Many enterprising families in Germany tend to stay close to their entrepreneurial roots when diversifying through related direct-investments along the value-chain of one or two core industries i.e. the Schörghuber family. They own the Munich-based but internationally operating “Paulaner” brewery and as a result, have developed a strong real-estate business in an attractive region over generations. The next generation is now highly successful in large-scale property development – given the globally receding beer-market bursting with overcapacities and price wars.
For many German enterprising families and their family offices, capital preservation is more important than maximal returns gained from capital invested.
Massive liquidity-events through selling the core-firm were rare and considered tragic events of “throwing the towel” by peers until recently. In line with this tradition, today more than 50% of the single-family offices in Germany still have controlling ownership of their traditional family business. Families whose assets are largely tied up in their multigenerational “hidden champion” company and who are the first generation to set up an investment structure often emphasize the diversification of family assets away from firm-induced risks. Families who also hold on to their family-firm but operate an investment vehicle in a later generation, often emphasize the aspect of material security and independence for the respective family business.
Families who have sold their company and are now the first generation to set up a dedicated wealth creation structure often emphasize the reallocation of the realized sales price in a prompt but tax-optimized manner. Finally, families who have also sold their focal business but run their transgenerational wealth-creation organization later down the line often use this entity as an entrepreneurial nucleus of the family. Herein, we see a lot of entrepreneurial holding companies for investments in various fields ranging from start-up funding to industry-specific M&As. Currently, more than half of the German SFOs are 2nd generation or older. Equally, about half of them invest directly in firm-equity. As a result, separate legal entities for family offices have become the norm.
The current global pandemic is a historic moment of truth for many enterprising families whose purpose is to create wealth.
Recent research describes five key-insights of successful single-family-offices in Germany. Firstly, driving long-term creation of family wealth. Secondly, fostering transgenerational entrepreneurship practices. Thirdly, continuously make their governance smarter. Fourthly, pursuing a “buy & build”-approach. And lastly, measuring the success of direct-investments similar to PE.
The current global pandemic is a historic moment of truth for many enterprising families whose purpose is to create wealth (a) for the enterprising family today and (b) its grandchildren under completely new parameters. Founding SFOs having sold their core-business before the pandemic is overthinking their allocation-strategy fundamentally. The same transformation is true for later stage SFOs without their traditional core-business if the industry of their investment-focus is hit hard by shut-downs. 1st-generation SFOs still owning their family business might face a similar situation, depending on the degree of diversification achieved before the pandemic hit.
Many enterprising families in Germany tend to stay close to their entrepreneurial roots when diversifying through related direct-investments.
From surviving to thriving in the new normal
The established mix of reinvesting, diversification, and exit is fundamentally challenged as family offices in Germany navigate into a new normal. Hence, the underlying ownership advantages are being profoundly challenged as well. Some ownership advantages i.e. governance or patient capital have undergone dramatic changes at warp-speed. Simply take virtual owner-assemblies, which have been rather unthinkable not until very recently among multigenerational families of wealth in Germany. Rethinking the governance-mechanisms and fundamentally altering them is as relevant as safeguarding liquidity, both for the business and the family. The same is true for the digital readiness of owners collaborating virtually with the board, top-executives, or selected third-parties from outside such as lawyers.
1. Alignment of interests
Many founder family offices in Germany have pursued a minimum requirement approach on governance and did rarely ask the tough questions in the “good times” as their SFO was founded. Moreover, many family entrepreneurs want to remain in
the metaphorical wealth creation driver seat as they were used to through decades of business leadership. Consequently, here is often not enough time, quietness, and urgency to make governance smarter, to work on the ownership-model.
2nd-generation- and older family offices find it increasingly difficult to align the growing heterogeneity of interests pursued by an ever-higher number of enterprising family-members. Hence, many successful family offices are doing lots of “behind the scenes” work such as aligning diverging family interests. This practice helps to ensure that internal processes and decision-making-procedures remain effective but “silent” and private to third parties or the public. Challenging and activating the established family constitution, by-laws, and board regulations on a regular basis together with the next generation is a powerful alignment practice. Better owners take time to address the alignment of interest and the installed mechanisms regardless of the emergency mode, their family business might currently be operating in.
2. Next-generation involvement
Many successful enterprising families see their family office as an important vehicle for the next generation to (a) either become involved as entrepreneurs in general or (b) to have an alternative to leading the multigenerational business operationally. Some enterprising families have introduced “play money”, allowing the next generation to independently invest smaller portions of their total assets in direct investments. This signals trust towards the next generation at an early stage and helps them shape their contribution as a better owner through stimulating interest, curiosity, but also an entrepreneurial purpose.
SFOs should let the next generation participate at an early stage. The trend towards venture capital observed a few years ago was also driven by the interests and experiences of the next generation. Separate VC vehicles have been attached to the SFO structure. A more flexible structure is important in order to respond to the needs of the next generation and also to offer the opportunity to actively contribute.
3. Smart governance
SFOs that make direct entrepreneurial investments compete with each other in the acquisition process, but also with PE companies. If a potential target company is up for sale, the decision-making speed of some SFOs might no longer competitive due
to a lack of alignment and consensus. So, successful enterprising families have begun to rewrite their investment playbook to become faster without increasing risk exponentially. German governance bodies, which incorporate a two-tier structure contrary to the one-tier board-structure, were mostly rather quick in working more closely and at the same time also increasingly virtually together. A critical challenge for governance will be to switch back from short-term survival orientation as the rule of operations to thrive in the long run. Setting examples is important for family members i.e. by dedicating timeslots for working on the business, not in day-to-day operations of the firm.
Most gains in speed face compliance as a bottleneck today, which gives governance-platforms and applications an attractive edge. Publicly traded companies in Germany have certainly been the pioneers of platform-based governance, but gains for privately held family firms and family offices seem manyfold. This is especially true, as the currently established infrastructure for virtual collaboration is in many cases the result of plain necessity, ad-hoc action, and chance. This can hardly be a lasting basis for highly private and sensitive information to be exchanged and stored.
4. Talent pipeline
SFOs are in direct competition with one another, but also with PE companies or banks for the best talent. This is particularly relevant when the family is unwilling and/or unable to make investment decisions themselves. In particular, an external manager of an SFO must be selected with particular care, as this decision will have a major impact on the family’s assets. Buy and build is a team sport, therefore, direct entrepreneurial investments can only be implemented with appropriate specialists.. Given the seniority expected from team-mates, recruiting as well as onboarding has to satisfy very high expectations. Some positions within SFOs are only filled via their
own network. This unnecessarily narrows the circle of candidates. An appealing internet presence and a dynamic, entrepreneurial appearance to the outside world can increase the attractiveness for talents, but only with competitive remuneration and compensation. Profit-sharing in individual investments is tested to increase the attractiveness of SFOs compared to competitors. Especially SFOs with direct investments poach talents from PE companies after they have made sure that they can offer performance-based remuneration components that are similar to PE funds. Better owners systematically get involved in selected hiring processes and take on rather diverse responsibilities. Making “Chemistry Meetings” with the active owner of the family a routine part of the recruiting to check the alignment of values and purpose has become increasingly normal.
5. Operational excellence
The administrative workload for the SFOs has tended to increase in recent years. This is due to the increasing institutional organization, more professional and complex processes, increasing regulations of the legislature, and increasing salaries for the necessary talents. Hence, SFOs are negotiating increasingly to reduce fees for active asset management. While it is unlikely that after deducting fees, funds or asset managers will be able to beat the respective market if there are various investment products for which there are almost no fees. Outsourcing of reporting and of additional services such as tax, legal advice, due diligence processes, and property management can make the cost-structure more flexible. The outsourcing paradigm many follow is more standardized activities = more outsourcing to external parties = more focus on the investment process as the true driver of wealth. Going down this road requires insourcing of investment decisions. Herein, the enterprising family is more active themselves and has fewer assets managed by service providers. Insourcing and resulting personal lead to higher personnel costs and make it more difficult to stay fast and nimble.
Exchanging lessons learned and sharing best practices
Wealth is a rather private matter in Germany, compared to socially acceptable displays of material fortunes in the USA, Russia, or China. Using this level of privacy can foster high-level exchange among fellow family offices in a similar operating model. More matured and established family offices can bring their long-term experiences to the table, which offers more recently established structures access to highly valuable best practices. Exchange and collaboration among family offices will increase, both on the local level and the global level – each requiring a highly trusted and safe setting.