What Family Offices Must Consider Before Acquiring Companies

Following the sale of a family business, where most of their wealth was tied up in a single asset, many family offices were created to make passive investments in private equity funds and public securities. As a new generation of investment managers takes over, many now counsel a more active strategy of directly acquiring and operating individual companies, which was the original wealth driver of the family.

This significant growth in direct acquisition activity among family offices frequently leads to surprises because the buyers lack a comprehensive understanding of the risks they are acquiring along with the companies and an active plan to manage and integrate those risks into the family's overall profile.

Risks Impact Results

While assets typically receive the greatest attention during due diligence for an acquisition, family offices need to examine just as closely the most pressing risks that may impact the business in the foreseeable future. How will those risks affect the family’s overall risk-bearing capacity? What will it cost to reduce those risks to a comfortable level?

Critical to any acquisition is ensuring the family office and its other assets are protected from risks associated with the new company. After all, when a family office invests with a fund manager, they may be one of dozens of passive investors, with layers of protection limiting any negative direct impacts. But when making a direct acquisition of a company they’ll operate or influence, they’re likely to face potential exposures they may not have experienced. Strategies such as D&O insurance and executive liability coverage are key elements of a protective wall between the new company and the family’s assets.

In New Territory

If a family office’s existence results from having sold a previous business, there may be a danger associated with unfamiliarity, especially when a serial entrepreneur leads the family. Success in one business is rarely a guarantee they’ll do as well with another, especially if it’s in a different industry or the family had little involvement in day-to-day operations.

In addition, as new owners of a smaller company, they may find themselves handling issues in which they lack personal experience. They may not even be familiar with the types of coverage they need or aware that having more liquid assets may make them a more attractive target for lawsuits.

Risk Is Not Always Obvious

These issues underscore the value of working with a risk management consultant with a formal process for identifying and prioritizing the top five to eight risks that deserve the greatest time, attention and financing.

An excellent illustration involved a family office’s $300 million purchase of a non-core unit of a Fortune 500 company. An analysis revealed high-value risks that weren’t insured adequately. This arose from the differences in risk, culture and appetite inherent in the larger, more complex corporate entity. It created unhealthy financial risk for the family office that would manifest as a P&L impact from single or multiple losses that the larger seller considered a cost of doing business and inconsequential. One of the key examples involved the quality of receivables being acquired, which were subsequently credit-enhanced through the use of trade credit insurance.

Engineering the Balance Sheet

Another element of the process involves what we refer to as engineering the balance sheet. Developing a post-closing plan for what the buyer wants to accomplish and how the balance sheet should look once the acquisition is complete addresses post-closing integration and cost-saving opportunities.

Risk management consultants can model both entities individually and then combine the forward-looking exposure base, unit rate averages, and volatility to arrive at an actuarial forecast. They can then identify options for insurance coverage or other transfer tools to limit risks. When combined with the family’s other holdings and personal assets, this provides a unified approach to transferring risk across the enterprise.

Decapitalizing Risks

Ultimately, an analysis allows family offices to consider their insurance spending in a different light. Can they increase their deductibles to take on more risk—and if so, how much can they safely absorb? Should they purchase insurance through a third-party provider? Or does forming a captive or using another risk financing method make more sense?

These are critical questions because being able to decapitalize their insurance spend allows them to redeploy that capital into strategic projects, making risk management an investment decision rather than an expense.

Expertise Matters

Insurance brokers and others associated with risk management don’t always have specialized experience assessing the unique risks facing family offices that choose to enter the acquisition marketplace. Achieving the family’s objectives depends largely on working with professionals who understand the intersection of acquisition risks and the types of coverage high-net-worth families need.

Contact Hylant if you have questions or want help conducting an in-depth analysis of your family office assets and risks.

The above information does not constitute advice. Always contact your insurance broker or trusted advisor for insurance-related questions.