The Merchant Bankers Operating Manual

This is part of my operating manual series opening up the playbook of private equity and company building luminaries. Check out past ones with Mark Leonard, Andrew Wilkinson, Robert F. Smith,  John Malone, Felix Dennis and Mike Speiser.

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This one covers a group instead of one person: the great merchant banking families. The Rothschilds, the Barings, the Hambros, the Warburgs, the Lehmans. The material comes from Joseph Wechsberg's 1966 classic The Merchant Bankers, which David Senra covered on Founders #425. Wechsberg grew up in this world. His grandfather was a small town merchant banker in Moravia who arrived in town sitting on top of a haycart loaded high with corn, lent money at 5 percent, and died in 1913 as the richest man in town. When young Joseph asked him how he became a millionaire, he tapped his temple and said, "I used my head. Don't you ever forget that, my child."

The book covers 200+ years and dozens of names, and the names get confusing fast. So I stripped out most of the names and dates and focused on how these families actually ran their businesses. Every family, in every country, in every century, arrived at the same playbook independently.

Merchant Banking Background

Who were the merchant bankers?

The merchant banks were small, private, mostly family owned banks clustered in the City of London (with cousins in Hamburg, Amsterdam, Paris, Milan and New York). In 1966 there were only sixteen true merchant banks in London, the members of the Accepting Houses Committee. Nearly all were founded before 1900. Nearly all started as a family business.

They were, by common consent, "the most interesting and the least known" institutions in finance. Economist Sir Oscar Hobson called them "among the more 'mysterious' phenomena of the City... The names of some of them are almost household words, synonymous with great wealth. But what they actually do, and how they make their money, is a sealed book to most people outside the City and many people in it."

They financed Britain's colonial expansion, equipped whole armies, backed railroads and canals and shipping lines, became court bankers and kingmakers. In 1818 Richelieu said, "There are six great powers in Europe: England, France, Russia, Austria, Prussia, and the Baring Brothers."

Almost none of the founders were British. The Barings came from Bremen, the Rothschilds from Frankfurt, the Schroders and Warburgs from Hamburg, the Lazards from Alsace, the Hambros from Denmark. Immigrants had the languages and foreign connections that international banking required.

How does a merchant become a banker?

Every one of these firms followed the same evolution. They started as traders in physical goods: the Rothschilds in cloth and old coins, the Barings in textiles, the Hambros in foodstuffs, the Warburgs in silver, Lehman Brothers as cotton merchants in Montgomery, Alabama.

They all discovered the same thing:

"Almost all merchant bankers were merchants before they became bankers. They traded with certain commodities in certain parts of the world, and later found it more profitable to leave the actual trading to others and to deal in credit instead of goods. First they attended to their own affairs, later they financed the transactions of friends and clients. It was easier to sell one's signature than a bale of silk; it was also more profitable. As they grew in stature, they discovered they could borrow more cheaply than could other merchants. They would guarantee a transaction by 'accepting' the bill of exchange for which they collected a small commission. If things went wrong — and they did occasionally — they had to pay for the bill themselves."

That last sentence is the core of the business. They sold their name and personally ate the loss when they were wrong. "Such a business demanded boldness and instinct, judgment and knowledge."

What does a merchant bank actually do?

Chairman Jocelyn Hambro's definition: "Hambros is consciously unorthodox. Anything that concerns money we attempt to cater for."

A single typical day at Hambros in the 1960s: backing a chain of shopping centers on the Continent, financing greenhouses in Denmark, an English furniture maker and a Swiss film producer, advising on two big mergers, granting acceptance credits, running new stock issues, developing real estate, trading commodities, financing the diamond trade, and dealing in gold and foreign exchange.

The main product lines underneath it all:

• Acceptance credit. Guaranteeing trade bills for a small commission. The original business.
• New issues. Taking companies to the public markets for capital.
• Advice. Mergers, takeover defense, restructurings. "We could advise a whole economy."
• Special situations. Incubating promising companies from birth to IPO.
• Private banking for a very select group. There was a rumor Hambros wasn't interested in deposits below ten thousand pounds, "but friends, and their friends, are always welcome."

Wechsberg describes the merchant banker as "a sort of family doctor or lawyer or father confessor" for companies and wealthy families.

How did they make money?

Commissions and fees. Acceptance commissions were small percentages on enormous trade volumes. Advisory and takeover fees ran from half a percent to two percent of the amount at stake.

Fees were never discussed upfront: "Fees are not mentioned in the City until the operation is completed. A great surgeon first saves a millionaire's life and then sends him his bill. The merchant banker often saves a millionaire's financial life."

Warburg told his young bankers, "The satisfaction of rendering a good service is more important than the size of the anticipated bill," and "A banker and a surgeon must not think of money when they start to operate."

How big were these banks?

Tiny compared to the commercial banks. Hambros was the largest accepting house in the world and its 1965 balance sheet just exceeded £214 million. The Big Five clearing banks had thousands of branches.

Lord Brand of Lazards: "The joint-stock banks live on their deposits, we merchant bankers on our wits."

From the book: "The merchant bank's most important assets — the experience of the experts inside the bank and its outside contacts — don't show up on the balance sheet."

The Playbook

Why is trust the entire business?

This is the best story in the book. Late one Friday afternoon at Hambros, the phone rings in the Norwegian department. A prominent Norwegian shipowner needs £200,000 within the next half hour. One of his ships finished repairs at an Amsterdam shipyard, and the yard will not release it without a cash payment. If the ship sits over the weekend, the owner loses at least £20,000 in charter costs and crew expenses.

The Hambros manager, a young Norwegian named Otto Norland, picks up a second phone and dictates a telex to a bank in Amsterdam: please pay £200,000 to the shipyard on the understanding that the ship will be released at once. Within three minutes the Amsterdam bank confirms. Norland tells the shipowner, "Call up your captain and give him your sailing orders." Then he hangs up and says, "On Monday morning we'll get confirmation. Until then I'm not going to worry about it."

A young German bank manager, visiting to observe, is petrified. He lists half a dozen reasons he'd be fired on the spot for this: How do you know it was really the shipowner? How do you know he's good for it? You didn't even check with your superiors!

The Hambros man's answer:

"If I had waited half an hour longer, it would have been too late to arrange the credit in Amsterdam. Our client would have lost twenty thousand pounds over the weekend, and we might have lost a good client. He comes to us because we give him fast, personal service. I couldn't tell him, 'I'll call you back.' That's exactly what the big joint-stock banks would have done. It would take them a week, processing his request through channels and committee meetings. If we acted like that, we would be out of business in a couple of years."

And then: "I've known the Norwegian shipowner for years. I trust him... We have no large bureaucracy inside Hambros but a vast network outside. We know a lot about a lot of people. And we rely on the prestige of our name. People trust us."

Why couldn't the shipowner call Amsterdam himself? "He may be known but they wouldn't accept his word over the phone as security for two hundred thousand pounds. They will accept ours."

That is the basic function of a merchant bank: "It's the name of the merchant banker that builds a magic bridge between buyer and seller. They may not trust one another but both trust Hambros."

David Senra ties this to Charlie Munger's line that trust is one of the greatest economic forces on earth. Millions of pounds moved daily on verbal promises. A press photo of the exchange floor was captioned "Where a nod is as good as a contract." (Norland was later promoted to the board.)

Warren Buffett still runs this playbook. I wrote about how Buffett can buy a business with a handshake deal. It's also the biggest edge available to anyone buying small companies today: how to build trust to buy companies.

How fast did they move?

The big banks had committees. The merchant banks had one person who could decide on the spot. "In an emergency, if I am the only one in the partners' room, I make the decision myself."

They accepted the occasional wrong call as the cost of being fast. A young Hambros manager: "We are always encouraged to make fast decisions though it may be the wrong decision once in a while. This is competitive, aggressive business. Very exciting. There is no routine. Every day is different, and you learn as you go along."

When something went wrong, it came up at the daily eleven o'clock meeting and the usual answer was to cut the loss and move on.

What was the rule on reputation?

Never risk the name. The best definition of merchant banking in the book comes from John Crosby Brown of Brown Shipley, written around 1900:

"A sense of commercial honor, an absolute fairness in all dealings, willingness to suffer pecuniary loss, if need be, rather than tarnish by one unworthy act the good name of the firm... character was prized more than wealth... Confidence, absolute confidence, at first between father and son, later between brothers and later still between the partners in different countries."

They took the longest view in the room. A Hambros man on old clients: "If a man has been an old customer and friend we'll do anything for him. Even when money is tight, we won't take advantage of him. We are very jealous of our name."

The Rothschilds started this with their very first coup. When Prince William of Hesse fled Napoleon, old Meyer Amschel Rothschild protected and invested his fortune, then returned it after the wars with interest. The family made a profit and won a reputation, and "Ever since the Rothschilds have stuck to the reputation-cum-profit formula."

What was their information edge?

Sir Francis Baring "learned early in life the secret of the successful merchant banker: to find out a little more a little earlier than the next man."

The old files of a single merchant bank contained notes on the rice trade in Java, gold shipments from Russia, the China tea trade, silver prices in Mexico, insolvencies in Austria, and the weighing of drugs sold in London. "Nothing was too insignificant not to be noted. Today only government agencies could compile such vast files of economic information and political intelligence."

On the Barings: "The Barings had a widespread intelligence network; they knew some of the best-kept secrets. Their deals often seemed so audacious that everybody was astonished until it became apparent, much later, that they had acted on the basis of sound advance information and knew exactly what they were doing."

The information came through relationships. A Hambros department head: "A merchant banker lives on his information and I try to get all the available information on my territory. Much comes from the customers; a man gives himself away by talking about himself." And: "One has to keep a lot of useful information in one's head."

Warburg was asked how he could function while ignoring the daily papers: "I keep my ears open. People tell me everything that's important."

Why all the secrecy?

The motto comes from Walter Bagehot: "We must not let in daylight upon magic."

"Bankers are laconic people who say only ten per cent of what they think. Hereditary merchant bankers say even less." The Rothschilds have never let an outsider go through their archives. The Barings didn't bother to put their name on their letterhead. Advertising was out of the question. At Hambros: "No one outside the family knows how the truly important decisions are made: The Hambros won't say. Why let in 'daylight upon magic'?"

They avoided paper. At Lehman Brothers after an antitrust scare: "There is widespread aversion to putting anything in writing. Everybody is constantly aware of the uncomfortable commitment of the written word. Don't write a memorandum that might someday become a source of conflict."

They also carefully managed their image, down to the props: the grandfather clocks, the ancestral portraits, the subdued voices. Everything designed to convey "This is big money but keep calm, don't get excited." A Hambros man said this about client companies, but it applies just as well to the merchant banks themselves: "Often the company is sound but doesn't project its image effectively."

How did they evaluate a borrower?

Over lunch, without ever discussing the loan. This is my favorite part of the book:

"Some people will never learn the elusive technique of conversation during lunch in an old merchant bank. One talks about everything except the matters one really would like to talk about — such as getting a million-pound credit. The conversation is about farming, roses, horses, politics, families. The chairman grows roses and the deputy chairman breeds race horses. The guest unfamiliar with the City's strange customs doesn't know that all the time he is being carefully scrutinized — his manners, his clothes, his speech, his sense (or lack) of humor, his attitude and personality. The general impression will eventually decide whether he's going to be backed by a million pounds and whether any security will be demanded. This is the merchant banker's assessment — a mixture of experience and flair, analysis and instinct, inherited from generations of shrewdly assessing ancestors."

By the time the port was served, the partners had usually reached unanimity about the risk and about the client.

"At Hambros they like to say that merchant banking is not a concrete science but an abstract art." A Barings partner: "It is difficult to be explicit about this. The whole question is very much a matter of feel. The great thing in this business is to be right at least fifty-one per cent of the time."

Mattioli's version: "People in need of credit come in and want us to look at their plants. So we go and look at their plants, at their machines, at their books. But, above all, we look at the people... Machines do not make profits. People make profits with the help of machines."

What was the complexity filter?

If they couldn't understand it, they walked away, no matter how good it sounded.

Philip Lehman had the merchant banker's sixth sense for people. One day Ivar Kreuger, the Swedish Match King and one of the most celebrated financiers alive, came in and asked Lehman to be his banker. Kreuger talked and talked, while Lehman made a few notes on a piece of paper. When Kreuger finished, Lehman shook his head and said no.

"I have a rule, Mr. Kreuger. If I cannot understand something by reading my notes on the subject, I won't buy it. You are too complex for me, Mr. Kreuger."

Kreuger left, and a few months later he shot himself. His empire turned out to be one of the largest frauds in financial history.

Warburg's personal motto, inscribed on his bookplate: "Progress in thinking is progress towards simplicity." He hated when people confused complicated with deep: "To think deeply means to think lucidly."

The Hambros version, after a partner returned from New York amazed that no one there would talk to him without first consulting a lawyer: "Lawyers, by their very nature, tend to be distrustful. Merchant bankers are basically trustful optimists, otherwise they couldn't go on... Lawyers like to complicate matters. We like to simplify them."

Did they stay inside a circle of competence?

Yes. Jocelyn Hambro: "If somebody comes in with a promising scheme for Brazil we tell him to go elsewhere. We don't know enough about Brazil. We don't want to expand too fast. It's a question of finding the right people. If one gets too big, one loses one's flexibility."

The partners knew exactly what was and was not "Hambros country." When a client asked whether he should buy a competitor making imitation Camembert: "I told him we are no cheesemakers. He must know whether the imitation Camembert is any good... But if he should decide to buy it, we can tell him how he should do it and how much he should pay."

Each house owned its own niches. The Barings were known as the leading "American house" in London, the Rothschilds concentrated on Europe, Lazards was the Far East expert, and Hambros owned Scandinavia and shipping. Riches are in the niches, even in banking. Read my operating manual for vertical market software for the modern version of owning a boring niche.

Hermann Abs of Deutsche Bank had three cardinal qualities for a banker: "First, to be able to put oneself into the situation of the customer, or of the person with whom one negotiates. Second, courage as one approaches a certain task. Third, caution — to know the extent of the risk." Abs studied German banking history, "a history of too much courage and not enough caution."

How were the banks organized?

The partners of an old merchant bank sat at desks in one shared room, called the parlor. The theory at Hambros: "A man who sits alone in his office is bound to make more mistakes than a man who is constantly surrounded by his partners."

"In one merchant bank all letters are opened in the morning and shown to all partners. There are a few papers, no files, no rate books. 'We carry most information in our heads,' they say. Risks are assessed, opinions exchanged, solutions found in quiet conversation, not after long speeches in committee meetings. There is no chain of command; no matters are cleared 'through channels.' A very civilized way of doing business."

A partner: "If I want to talk to one of my partners I don't have my secretary call up his secretary before we talk on the phone like the directors in those superbureaucracies. Most likely he sits in front of or behind me and I can turn around and talk to him."

This is basically Mark Leonard's human scale idea 150 years earlier. Small teams of trusted people, high communication, no middle managers, decisions made by whoever is closest to the information.

Lehman Brothers ran the same way: "Once a man is made a partner, he is very much on his own. He is not told where to go or what to do... Disagreement is inevitable when thirty star performers work under the same roof but disagreement often creates achievement."

How did they handle mistakes?

"People there have been fired for incompetence but never for making an occasional mistake." (Related: Losers Exist, Don't Hire Them.)

They were unusually open about losses. Jocelyn Hambro said right away: "We are often wrong — we lose money as frequently as everybody else." Asked where he learned merchant banking, he shrugged: "I guess in the Coldstream Guards."

"We try anything that generates the making of money, and in the process we sometimes lose money." Once Hambros bought into a promising textile factory and a week after signing, the factory was inundated by the first flood in 150 years.

How did they invest their own money?

Minority stakes, never control. From Hambros:

"A Swedish company told us they want to expand in Holland. We happen to know that a British company had been looking for just such a setup in Holland. We became marriage brokers, arranging another amalgamation. A process of economic cross-fertilization. Incidentally, we may take a minority interest, but never control. We believe the management should be left to the managers. We want to keep sensible influence — after all, we're involved with our money — but we don't want to run hundreds of companies."

Andrew Wilkinson built Tiny on the same promise: buy good businesses and leave the managers alone.

They also incubated companies. The special situations department "likes to nurse promising ideas from birth to a moderate success as a private company and finally to a big success as a public company." Once this was done with money alone; now "it's done with money and advice, and the advice is often more valuable than the money."

Lehman Brothers did the same at larger scale, hunting what the partners called "the wave of the future":

• Potash. Lehman spent months studying the potash industry, decided it was a wave of the future, built the American Potash and Chemical Corporation from scratch and nursed it along until Standard Oil of New Jersey made a very attractive bid.
• Litton. In 1953 Charles Thornton left Hughes Aircraft with a team and needed money. Lehman raised $1,500,000 and bought 75,000 shares "at prices ranging from ten cents to one dollar." After nine months Litton looked like a failure. By 1965 the stock traded as high as $150 and the shares were worth at least $800 million. Partner Joseph Thomas: "Funny thing. The hardest things to raise money for often turn out to be the best."
• Hertz. Partner Frank Manheim kept plugging the car rental business as a worldwide wave of the future. Hertz common stock went from $7 million of market value in 1953 to nearly $100 million in 1965.

Manheim, a former professor of French literature: "I get tired of people who think that banking is accounting. Banking is imagination."

The great regret, from a Lehman partner: "We could own twenty per cent of these giants today and be billionaires. Unfortunately, we did not keep the shares." This reminds me of Nick Sleep's line: the best investors aren't investors at all. They're entrepreneurs who never sold. Same reason to be default greedy and keep your equity in the first place.

What did the founders actually do to get rich?

The gentlemen at lunch talking about roses and racehorses are the third and fourth generations. The founders were cutthroats.

"In every merchant-banking dynasty there is one pioneer who began with nothing and died rich."

This is the same arc as Roy Thomson, Mark Leonard's business hero, and Sam Zemurray, who started out selling ripe bananas nobody else wanted and ended up running United Fruit.

During the Continental blockade the merchant bankers "built up a remunerative trade in contraband goods." When Wellington's army was trapped in Spain and needed gold, Nathan Rothschild shipped gold to France and his brother James smuggled it straight through enemy lines, bribing ministers and police chiefs along the way. The book's dry comment: "When smuggling takes on heroic dimensions, it becomes part of history." (And the polite framing: "In times of war the enemy 'smuggles' and 'spies' on you but when you do it, it's called 'subsidy payments.'")

The great Hong Kong firm of Jardine, Matheson still proudly advertised "the early pioneering days" when two tough Scotsmen, William Jardine and James Matheson, "formed a successful partnership in 1828 — as opium smugglers."

Merchant bankers love to reminisce about "the colorful coups of their ancestors." Every house in the book was started by somebody hungry who bent the rules, and is now run by descendants who prize discretion above everything. That's how all the great houses started.

What did merchant bankers read?

History, philosophy and literature. Almost never business publications.

Warburg is the extreme case. He read Greek and Latin, quoted the classics, and was "prouder of his thorough knowledge of the classics, and of English and German literature, than of his widely admired skill in banking." He considered this practical: "a working knowledge of Greek and Latin a better preparation for merchant banking than a study of modern finance, management technique and economics." His reasoning: "Classical education is a wonderful thing. It helps you to develop logical thinking and to perceive quickly and accurately what you read."

On newspapers: "Newspaper reading leads to a gradual loss of memory since most people read the paper with the subconscious wish of trying to forget as fast as possible what they read." He allotted himself ten minutes a day of glancing at the indexes of the leading papers and spent his weekends rereading the books he loved.

Frank Manheim at Lehman "considers literature and history excellent approaches to investment banking." Mattioli collected rare editions of early economists and saw no difference between analyzing a poem and a balance sheet: "At best, each is a work of art... When I look at either a poem or a balance sheet, I try to see the center of gravity, the focal point... Will the foundations support them?"

The whole job was judging people. Can I trust this man? Will this partnership hold? Do these managers mean what they say? History and literature teach you how humans behave.

People & Talent

How did they develop talent?

Warburg was the most deliberate about this. He had two beliefs: youth and the team.

"'Youth' to Warburg means just that — men in their late twenties. He collects able young people with the same enthusiasm that other rich men show for old paintings." Four of the firm's ten executive directors were in their early thirties. The average age of the top people was well below forty. Warburg called youth "the greatest strength of our firm."

From his chairman's statement: it is not enough to hire good people and mold them into a unit. "It is, above all, necessary continuously to change and develop the composition of such a team and especially to rejuvenate it," with older members moving backstage into advisory roles to make room for younger ones to lead. Older executives who wouldn't act as a sounding board for the ideas of the younger men "may find themselves in trouble with the master of the ship."

He introduced what the City called the nursery principle: "One of the younger men must always be present at all important meetings. Afterwards he is asked to write a lengthy memorandum of the meeting. Often Warburg himself corrects the wording, as carefully as a professor going over his students' homework."

Warburg's uncle used to say, "Der liebe Gott wohnt im Detail." The good Lord lives in the detail. Any letter with a minor typo or an unclear sentence was retyped. "At Warburgs nothing is ever left to chance. He never loses a big battle because he is always prepared meticulously for victory."

Protection ran both ways. A Warburg epigram: "In order to build a good team of men the head of the team must in critical moments not only support the members of the team but must protect them."

Did they tolerate yes men?

No. This shows up in nearly every chapter.

Warburg startled Oxford and Cambridge candidates in interviews by asking: "Would you dare speak up against everybody if you didn't agree with them, or would you remain silent? Would you go it alone, be an outspoken nonconformist?" Many gave the wrong answer.

Mattioli was even blunter: "I don't like people who deliberately try to think in my way. If I turn out to be right, the other fellow will say he was right, too, but if I am wrong, he will say it was all my fault. Besides, why should I pay a man for thinking the way I do? I can do that for myself. It would be a waste of money."

At his weekly meetings Mattioli systematically challenged every proposal: "Sometimes I don't understand what they plan to do, and I tell them so. That makes them sit up and think a little harder... we play a continuous and complicated intellectual game here. A game like that is very healthy for bankers."

Was it a meritocracy or a family business?

A bit of both. Jocelyn Hambro called the system "enlightened nepotism": "The family selects those best suited for what is now often a 'laborious' trade. If a Hambro is as good as the outside chap, he gets the job... Still, if a Hambro is not as good as the outsider, he won't get the job." Some Hambros didn't make the grade and went elsewhere. Of seven managing directors on the Hambros board, five were not Hambros, including three who started as bright young men in the bank and rose on ability.

Warburg went the other way and tolerated no nepotism at all. His son worked as an accountant, but not at S.G. Warburg & Co.

The founding generations ran on family trust because nothing else existed. Old Meyer Amschel Rothschild sent four of his five sons to the financial capitals of Europe: James to Paris, Salomon to Vienna, Kalmann to Naples, Nathan to London. "Confidence, absolute confidence, at first between father and son, later between brothers and later still between the partners in different countries."

For an American family dynasty running the same playbook, check out my breakdown of Jay Pritzker and the Marmon Group.

The Individual Operating Manuals

Siegmund Warburg's personal rules

Warburg arrived in London in 1934 with less than five thousand pounds and built the most influential merchant bank of the postwar era. By 1964 Mercury Securities, his holding company, earned about £2.3 million before taxes. His personal rules:

• Choose the harder path. From his grandfather via his mother: "My child, if you have to choose which way to go, always ask yourself first which is the harder and choose it. It will be the right one."
• Criticize your own mistakes every day. His mother's advice: "Before you pray, my child, ask yourself what you did wrong today and could have done better. All of us make mistakes every day. One must be critical about one's mistakes."
• Duties over desires. His life philosophy came from a favorite family quotation: "Happiness is not the fulfilment of desires but the fulfilment of duties."
• Influence over power. A Warburg epigram: "Influence is more important than power. This applies both to nations and individuals."
• Don't change your coat. A friend told him: "Your strength in business is that you don't change your coat when you leave your home, you are always the same man."
• Keep worrying after the win. "He rarely enjoys the fruits of victory. After twenty-four hours, while his associates are still celebrating, Warburg is worrying again." At the start of every big transaction he asked, "But what are we going to do if...?" He described the banker as "a pessimist surrounded by risks."
• No superfluous words. Clients "learned that Siegmund will not utter a single superfluous word. Big people gladly pay a premium for lucidity of thought and economy of expression. Warburg clarifies, never merely simplifies, complicated matters."
• Retreat rather than lose. Warburgs never actually lost a takeover battle, partly because it retreated from several "when it came to the conclusion that the price to be paid was too high."
• Advice first, money second. As retiring chairman he listed the firm's activities in order: advisory services first, investment management second, issues third, and "credit and money business" last. He saw the merchant banker as the trusted family doctor of companies, calling in specialists as needed.

One of his teammates on what the job really is: "One can read many things out of a balance sheet — but the intangibles have to be guessed. Management is made up of people, and people are unfathomable."

Raffaele Mattioli, the master of paradox

Mattioli ran Banca Commerciale Italiana in Milan, was a serious literary scholar and publisher, and proved Stendhal's line that "a good philosopher can always become a good banker."

His schedule alone is worth studying. He rarely got to the bank before eleven. At one he walked home for a quiet lunch with his wife, then took a siesta. He returned around five and stayed until ten or later: "Those hours in which the bank is empty except for night watchmen are the time to do some really constructive banking," he said enthusiastically. His home, his bank and his publishing house all sat on the same block, so days could go by without him needing to cross a street.

His father, a village storekeeper, gave him his best line: "A man should never be afraid to admit that he doesn't understand something — particularly if he knows all about it."

He worked all the time. Sundays and holidays meant nothing to him. He phoned employees after midnight. When an executive broke a leg on the last day of a long vacation, Mattioli proclaimed the accident an act of poetic justice.

My favorite Mattioli quote: "Money means nothing unless it is being used. I use one man's money as the basis of a loan so that another man can make something... I have enough to eat and my books. What else do I need? My work, and I have work that makes me happy."

His biggest bet: at the end of the war Enrico Mattei came to him needing money for Italy's natural gas fields. After sizing up the situation and the man, Mattioli lent him a billion lire. By 1962 Mattei's energy empire spanned four continents and was worth almost two billion dollars. As Mattioli put it, "the unorthodox investment often proves to be the soundest investment of all."

The Stories

What was the craziest deal in merchant banking history?

The transfer of the Spanish Mexican silver treasure, which the book calls "the most fantastic transaction in the whole history of merchant banking."

The setup: under an 1803 treaty, Spain owed Napoleon an annual subsidy of 72 million francs. Everyone knew Spain could never pay. Enter Gabriel Julien Ouvrard, "a financial genius and perhaps the most controversial entrepreneur of his time." Ouvrard provisioned Napoleon's armies, negotiated enormous credits, was arrested several times, once spent five years in jail, went bankrupt, made another fortune, lost it again. "He had more ideas than principles." He worked for every French regime in sequence and survived them all, "a symbol of financial durability though not of personal integrity."

Ouvrard's idea: France would never collect from Spain, but Spain owned silver piling up in Vera Cruz, Mexico. All one had to do was get the silver out of Mexico and bring it to Paris. Through the British blockade. In the middle of the war. As easy as that.

The execution shows why relationships run the world:

• Everybody said Ouvrard was crazy, so he went to Madrid and got King Charles IV to sign a blank license permitting trade with the Spanish colonies, with the treasure as collateral.
• The British blockade was the obstacle, so he sold the scheme to Hope & Co. of Amsterdam, the oldest merchant bank in the world. They first thought he was "quite mad," but he had enticing figures and a royal license.
• Henry Hope went to see his friend Sir Francis Baring. Sir Francis went to see the Prime Minister and convinced him the operation would "stimulate British trade." Silver was scarce in England and would be valuable to the East India Company, of which Sir Francis happened to be a director.
• Britain agreed, provided British vessels were included in the trade. Four frigates were dispatched. Lloyd's insured one cargo for £656,800, its largest single risk of the Napoleonic Wars.
• The Barings and Hopes sent David Parish to America with the blank license and a letter of credit for one million dollars, plus two "special agents" with excellent connections in Vera Cruz and New Orleans.

"An interesting operation, well thought out, beautifully executed. It lasted three years; by 1808 almost all silver and gold had been removed from the Mexican Treasury." At the final accounting in 1811, profits of £862,000 were divided among the Barings, Hope, Parish and the agents. The operation also permanently opened direct trade between Britain and Mexico, which the merchant bankers then financed.

Only Ouvrard, who thought up the whole scheme, got not a penny. Napoleon quarreled with him again, confiscated his property and put him in prison.

What really happened with Rothschild and Waterloo?

The legend: Nathan Rothschild watched the battle, raced to London, spread gloom at the Exchange, crashed the market and bought everything cheap.

The book corrects the legend. Nathan did get the news early, not by carrier pigeon but from a courier carrying a Dutch newspaper, a full day before Wellington's official dispatch arrived. And the first thing he did was take the news to the Prime Minister. Downing Street didn't believe him. The stock moves attributed to him were modest: consols went from about 70 to 71 and a half. What Waterloo really bought Nathan was enormous prestige as the best informed man in Europe. "Emperors, kings, prime ministers came to New Court for advice or money, or both."

The real edge was the network. Five brothers in five cities with total mutual trust, plus a private courier system faster than any government's.

The Aluminium War

In 1958 and 1959, Siegmund Warburg, the upstart, advised Tube Investments and Reynolds Metals in a hostile bid for British Aluminium. Against him: a consortium led by Hambros and Lazards with most of the great houses behind it, declaring the takeover must be resisted "in the national interest." One banker said, "We must save British Aluminium for civilization."

Warburg's side had quietly accumulated shares through nominees, offered shareholders 78 shillings a share after their own board had been ready to deal with Alcoa at 60, and courted the institutional investors everyone else ignored. Even when the consortium countered at 82 shillings cash, the institutions dumped their shares, disgusted by the consortium's attitude. Nine days after open battle began, Warburg's clients held eighty percent of the company. The establishment consortium suffered a crushing defeat.

Lord Kindersley of Lazards was heard muttering, "I will not talk to that fellow." Merchant bankers crossed the street to avoid each other. It all faded. A favorite Warburg epigram fit the occasion: "Big people will forgive others though they may never quite forgive themselves." Years later Warburgs and Lazards worked the same deal amicably, on the same side of the table.

The Aluminium War changed the City for good. After it, shareholders, not the club, decided who won takeovers.

How did they behave in a panic?

In the fall of 1939, war broke out in Europe and stock prices tumbled. At Lehman Brothers everybody stood around the ticker. Philip Lehman turned to his partners and said, "Well, there's nothing to be done today — let's go home and have a good dinner." Everybody went home. There was no panic.

"Lehman Brothers has learned to live with disaster as with the common cold. There is no remedy against either one, but life goes on."

The one time the system nearly broke, the 1890 Baring crisis, the other houses and the Bank of England organized a rescue in the eleventh hour, "a spectacular demonstration of the 'Princes'' esprit de corps." A Barings failure would have destroyed trust in the whole City, so the City saved Barings.

What happened to the merchant banks?

The book was published in 1966, near the end of the world it describes. The foreword to the modern Dover edition tells the rest: after Bretton Woods collapsed in 1971, transaction volumes and complexity exploded and the small private partnerships were "ill adapted" for it. Most were absorbed by commercial banks or converted from partnerships into joint stock companies.

Barings collapsed in 1995 when a single Singapore trader ran up losses the partners' room of 1890 would never have permitted. S.G. Warburg was sold in 1995 and lives on inside UBS. Hambros was sold to Société Générale in 1998. Lehman Brothers went from private partnership to public company and collapsed in 2008 holding exactly the kind of complexity Philip Lehman refused to buy.

The Rothschilds are the exception. Still private, still family led, still advising on the biggest deals in the world, still not letting anyone into the archives.

The playbook in one page

• Sell your signature, not your labor.
• Eat your own losses. Personal liability is what makes the signature worth something.
• Never risk the name. Take the loss instead.
• Be fast. One trusted person who can decide beats any committee.
• Do business on trust with people you know. Verbal contracts, minimal paperwork.
• Find out a little more, a little earlier than the next man.
• Say ten percent of what you think. People bring secrets to those who keep them.
• Judge the person, not just the numbers.
• If you can't understand it from your notes, don't buy it.
• Stay in your circle. "We don't know enough about Brazil."
• Stay small and flat. If one gets too big, one loses flexibility.
• Fire for incompetence, never for an occasional mistake.
• Take minority stakes and leave management to the managers.
• The hardest things to raise money for often turn out to be the best. Keep the shares.
• Read history and literature, not the news.
• Don't hire yes men. Never pay a man to think the way you already do.

For more, listen to Founders #425 on The Merchant Bankers and grab Joseph Wechsberg's The Merchant Bankers. It reads like a novel.

If you are interested in buying, growing, and selling small companies, check out my course & community on it at IndiePE.com.

If you know of anything I should add to this please reach out @ColinKeeley or Colin@ColinKeeley.com. I'll continue updating as I learn more.

Continued Reading:

• Mark Leonard (Constellation Software) Operating Manual
• Andrew Wilkinson & Tiny Operating Manual
• Joe Liemandt (ESW Capital) Operating Manual
• John Malone (Cable Cowboy) Operating Manual
• Robert F. Smith (Vista Equity Partners) Operating Manual
• Felix Dennis Operating Manual
• Mike Speiser & Sutter Hill (Venture Studio) Operating Manual
• Bending Spoons Operating Manual
• Brunello Cucinelli Operating Manual
• Chenmark Operating Manual
• Pieter Levels Operating Manual
• Jay Pritzker & Marmon Group Breakdown
• Brent Beshore & Permanent Equity

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