FEATURE: In Europe, Deals Are a Family Affair –

Increasingly, U.S. private equity firms are looking toward the European Union for investment opportunities. Many expect the advent of the single-currency market, as well as an impending Internet explosion, to create unprecedented growth and restructuring in the region.

A particularly attractive feature for U.S. private equity firms doing business in Europe is the plethora of family-owned businesses there, many of which face little chance of surviving another generation without a partnership or buyout. Buyouts of family businesses in Europe have increased markedly over the past five years, and many U.S. firms want a seat at the table. But partnering with an Old World family group can be a real challenge. Besides the challenges that inevitably arise in a family business, such as succession problems and internecine squabbles, many businesses are constrained due to the suffocating structure of European laws or because they simply cannot compete in the larger market.

Dysfunctional Family Business

In the aftermath of World War II, European entrepreneurs started up private family businesses. Half a century later, the founders of those businesses, who have dedicated their lives to the success of their companies, now find that a successor with the same dedication, interest, and strategic plan is hard to come by – especially within the family.

“Clearly, there is a big generational change going on,” says an executive at a major European-based buyout firm, “Often the second generations do not want to take over the family business. They’re off running restaurants or working with Goldman Sachs. They’re not running the family widget manufacturer, where traditionally [management] was handed down father to son.”

Even if an appropriate successor is identified, the European tax laws can be the straw that breaks the camel’s back. C. Derek Anderson, senior managing partner at Plantagenet Capital Management LLC, a firm that has invested in French family businesses, says, “[Family businesses in Europe] have been engineered by inheritance tax laws to be inefficient, disorganized, and structured in such a way that they really can’t succeed to the maximum.”

In France, the laws levy taxes on inherited business assets at progressive rates based on the relationship between the deceased and the recipient. Surviving offspring can be taxed from 5% to 40% – depleting capital necessary to sustain the business. A non-relative inheritor can be taxed a rate as high as 60%. Similar laws exist throughout Europe and can be detrimental to an already-struggling family firm.

“The inheritance laws in Europe are such that every child inherits equal interest in the business enterprise,” says Anderson. “So consequently it’s not a meritocracy and so parents’ view of their respective children is not a factor in deciding who owns the company. As a result you have many family enterprises where the interest of the siblings greatly diverge from each other.”

In addition to succession and tax issues, there is the problem of competition. “Europe is populated by a lot of one-company towns or two-company towns,” explained one European investor. “It’s far less fragmented than the States’ economy . . . There are towns that grew up [with a particular family business]. The company grew up as a regional champion in Bavaria, or wherever, and didn’t really look abroad too much.”

As industries expand and strengthen in Europe, family companies are being forced to loosen their grip on the niches they ruled.

All these elements can begin to play off each other and have the effect of creating a stagnant company. “Not only do [family firms] have to have a cohesive and unified strategy amongst the family members but then they have to be able to attract the management talent to execute that strategy and the capital to do so,” says Anderson. “And on the latter two, family enterprises generally are reluctant to open management to outsiders. And if they do, generally it’s hard to attract a top outsider unless you cede a significant portion of the company. Even then, an outsider might be faced with all sorts of battles at the board level – let alone implementing strategy.”

These companies also lack traditional access to capital in many cases. Abel Halpern, the managing director at the Texas Pacific Group Europe office, explains, “Very often their corporate structures, past experience or personalities have prevented them from having traditional bank financing, traditional equity financing. It has made it hard for them to go public in the past. So you have to think very aggressively as you do these types of deals how you can actually bring capital into the situation.”

Keeping it in The Family

Family businesses are plentiful in Europe. In France, family businesses account for 80% of all companies; Germany has approximately 50,000 private family businesses; and in the U.K., 75% of all businesses are family-owned, according to the French Association of Medium-Size Family-Owned Companies, Frankfurt investment bank Doertenbach & Co., and the Family Firm Institute, respectively. But investing in these companies, say experienced private equity professionals, is not for the faint of heart.

Assessing a family-owned company is not an easy feat because they are commonly structured differently than corporate, institutional and publicly traded companies. “They’ve gone from big to small in a really short period of time without having the institutional infrastructure to support that growth,” says Halpern. “So what you very often see are private companies that have rather complex and sometimes seemingly Byzantine corporate structures, which often make it not very transparent when you are looking at the company from the outside – trying to assess financial performance, profitability, fiscal issues, etc. You have to be a bit more creative.”

The owners usually have a very strong emotional attachment and are often hesitant to give up control. “It’s always difficult negotiating because families are really torn between two masters – one is control, the other is taking a lesser role to someone like us,” says Anderson. “But usually the battles within the family are so great that ultimately a Plantagenet investment becomes more appealing.”

For Plantagenet, buying a control stake in the family business is a necessary condition if the firm is to pursue the investment, Anderson says.

“There are much more subtle issues,” says a source at a major European buyout firm. “You are normally talking with tax advisors, legal advisors, many of these people are very concerned, particularly in Germanic and Italian Europe.”

Going Native

Texas Pacific’s Halpern, whose investment in Ducati Motor Co. in 1996 was one of the first in a major European family-owned business by a U.S. buyout firm, explains that one of the most important parts of working with a family business is humility. “One thing you must leave at the door is your aggressive Wall Street persona,” he says.

“You have to be a very humble, respectful, deferential person who appreciates the beauty and the magic of the local culture, and the fact that there are multiple stakeholders. And I say stakeholders, not shareholders, because the stakeholders could be the local politicians, the people who live right next to the factory, or the local church. There are many stakeholders in each one of these deals and you must be respectful of every one of them.”

Often, an expansive family must be assured and appeased one individual at a time. One executive recalls accompanying a Germany-based partner to a meeting with a family-owned business and having to talk to each of the approximately 60 owners of the company individually.

American investment firms face several difficulties investing in European family companies. However, most of the firms that have made a first investment have gone back for seconds and thirds. The key is to understand the idiosyncrasies of the market and the negotiation process, say investors.

San Francisco-based Plantagenet Capital, has targeted financially troubled and family-owned businesses in Europe in an effort to capitalize on the changing mid-market in Europe. Its first European investment was the acquisition in 1999 of the French Champagne Albert Le Brun from the Le Brun family. Although the firm sees opportunity throughout the European Union, they decided to focus on France initially because they were familiar with local nationals. Plantagenet’s Anderson says that an important part of the firm’s success has been establishing a Paris office and leaving the negotiating process up to their local partners. “We think it’s very important for us to have a local presence in terms of a citizen of that particular country or region that we decide to do business in,” he says. “It would be foolhardy for us, as Yankees, to get involved.”

In a similar fashion, when The Carlyle Group invested in the French publishing company, Le Figaro, last year, Carlyle Europe invested E26.5 million for a 20% stake, while the firms EU-based strategic partners invested another e26.5 million for a 20% stake.

Most recently, Carlyle agreed to purchase a 50% stake in Sigla Engineering, a holding company for Italy’s Riello family interests. The $300 million deal was sourced through Carlyle’s Milan office (See story p. 18 ).

Establishing a local office also downplays the fact that it is an American firm, which occasionally catalyzes some resistance. “There is resistance [to U.S. buyout firms], but we purposely structured this in such a way that our French team has the majority interest in this enterprise. And that will be the case as we expand throughout Europe,” Anderson said.

Plantagenet currently has plans to establish offices in two other European nations.

To be sure, not all firms have encountered resistance. “It really varies case to case, but I have found in my experience, the case to be somewhat the opposite,” TPG’s Halpern says. “This notion that there is one homogenous Europe is just wrong when it comes to culture . . . and sometimes it really is an advantage being an American. There’s no cultural history that becomes a source of tension. Americans are known for being very straightforward, very direct and doing what they say they will do and not doing what they say they won’t do. I have found people to appreciate that.”

A source at a European buyout firm says that he has not noticed any xenophobia towards outside investors. He thinks it is more likely that the European companies are concerned that U.S. buyout firms lack knowledge about their structuring and tax codes and also lack references in Europe.

References are an important qualification to family business owners. Firms such as Plantagenet, Texas Pacific, and Doughty Hanson, which have established themselves as friendly investors, interested in continuing the family strategy, are favorable to those investors preparing for a quick exit.

Texas Pacific, which recently invested in Gemplus, a maker of memory and microprocessor-based smart cards owned by French entrepreneur Marc Lassus, has learned the value of building a relationship with business owners. “I knocked on Marc’s door about two years ago and I became friends with him,” Halpern says. “It was only after we became friends that he decided that TPG was worthy of investing in his company. His attitude was I need to trust you. I need to know you’re for real and I need to know you are going to add real value.”

“At the end of the day you can get money from a lot of different places but [sellers] need to know that the chemistry is right,” adds Halpern.

To a family business, a trustworthy investor concerned about the future of the company may be more important than a higher bid.

Often, the priority is not money for family business owners. “It’s more of a beauty pageant,” says the source at the European investment firm. “Let’s say they wanted 100. They’re not going to take 80. But they might take 90, if somebody else is bidding 110, if they felt that that would be in the best long term interest of the company and that the people who were buying the company had a tradition in doing that and [had] lots of good references.”

Without a reputation as a friendly investor or solid relationships in Europe, family-owned businesses open for investment may be hard to find. When a family name is tied to the business, it is not likely that they will publicize that the business is in trouble or that they are seeking a buyer. In almost all cases, a family business was brought to the attention of a firm through local entities such as financial institutions, accountants, political entities and prior relationships.

However, the family business buyout is becoming increasingly popular. Last year there were 224 family-firms bought by private equity firms. And in the past five years, sales of family firms have increased 56% according to Initiative Europe, a European company with a focus on family-owned businesses. In that time, a number of disorganized family-business have graduated into successful IPOs and industry leaders with the help of buyout firms.

So while buyout firms grumble about too much money chasing too few deals in the U.S., they may want to consider chasing down a few European family deals – the challenges are big, but so, too, may be the rewards.