Growth and transition
Early merchant banks were centered in various European capitals, eventually settling in London, where they became deeply entrenched as power brokers. Many of the most powerful merchant banks were created and ruled by family dynasties, providing generations of both fortune and reputation to back up their deal-making. In their heyday, European and British merchant banks wielded power equal to and even exceeding that of national governments. They were of fundamental importance to the development of the British economy, and thus to the growing international economy. The banks could thus afford to be selective about their clients, who had to seek them out and request the “honor” of doing business with them.

By the late 19th century, merchant banking was also flourishing in New York, with the powerful House of Morgan at the top. U.S. railroads became big business, spreading rapidly around the country. With no government regulation and a voracious need for capital, railroads provided tremendous opportunities for these institutions to cement the position of American merchant bankers as the top financiers in the world. For example, the influence of the Morgan empire, perhaps unimaginable to us today, spread around the world, into governments, industrial giants, and wealthy families.

Meanwhile, however, public and government concern over this consolidation of power and influence escalated. The Glass-Steagall Act of 1935 set up a regulatory firewall between commercial and investment bank activities, as well as curtailing and controlling them. The Act’s goals were admirable – to rein in overzealous commercial-bank risk-taking with depositors’ money in the stock market, considered at the time a major cause of the 1929 crash and ensuing depression. The Act’s consequences were mixed, however, and it was repealed in 1999. Today, we can trace many current and former obstacles to capital to the Act. More recently, deregulation in London and New York has broken down some of these old regulatory barriers.

The decline of merchant banking was accelerated by Glass-Steagall, but there were many other contributing factors. This history provides valuable insights into what went wrong and how to ensure that our revitalization of the model does not go down the same road. While they were certainly not a homogenous group, many banks suffered from a complacency born of enormous success. They stopped searching out new clients and opportunities and stopped evolving to accommodate client needs. When new opportunities arose, the old firms were often slow to seize them. And since much of the real power of these institutions lay in their networks and connections, their growing isolation was fatal.

Merchant banking today
What is a merchant bank today? It’s not easy to come up with a widely accepted definition. To begin with, one of the great strengths of merchant banking limits our understanding of its history and current status: the strong tradition of confidentiality, of closely guarding information about clients and their businesses. Also, the evolution and shifts in the merchant bank’s form and substance have yielded wide variations among public perceptions and professional attitudes toward the term and the institution itself. One thing is certain, however: over the centuries, the tremendous success and growth of merchant banks have been built on the centrality of the relationship, not just the transaction.

Reflecting this closeness, the merchant bank’s tremendous versatility and willingness to change with their clients was – and continues to be – invaluable. As its clients’ wealth began to grow, for example, a traditional merchant bank would create an investment management division to manage client assets. If needed, the bank created a foreign-exchange business that was a department in its own right, or a commercial banking department that would cover more traditional commercial functions such as lines of credit and term loans. At Hambros, for example, many of our clients had fleets of large equipment, such as airplanes, where leasing was clearly the solution – so we developed a lease finance department. As we grew along with our clients, working in more industries, we developed new expertise. For example, the corporate finance department was often organized in teams reflecting a particular sector such as shipping, or the financing of oil and oil platforms.

Many institutions label themselves as “merchant banks” today. Only a few can rightfully claim the title, however: Lazard, Greenhill, and Rothschild, among others, and for the most part they limit their clientele to huge accounts of a billion dollars or more. Otherwise, merchant banking services are provided by highly specialized “boutiques”, with each offering only its own specialty. Very few offer the traditional range of services that are still available through some European merchant banks.

Updating the classic merchant-bank model for contemporary small business
Many small businesses struggle to achieve their full potential. The reasons for this are as wide-ranging and diverse as the businesses and their environments. For inner-city small businesses, these challenges are often exacerbated by their lack of access to high-quality financial advice and growth financing. Without these supports, urban small businesses face an uphill battle in tapping opportunities that emerge.

Some of these barriers are measurable and concrete, such as the dwindling availability of loans from the Small Business Administration. Others are attitudinal, such as misperceptions about the risk of investing in urban companies. But the major barriers are related to the changes in the banking world over the last 25 years: consolidation and centralization, tightening regulatory and compliance constraints, the decline in relationship management, and loan practices that are designed for much larger businesses in order to facilitate economies of scale. The unfolding credit crisis is likely to exacerbate all these and other challenges.

Typically, business owners who approach Next Street are looking for help with enhancing their financial stability or satisfying a specific short-term need for capital. They are often extremely good at running a business on a day-to-day basis but haven’t realized the business’s full potential and haven’t developed a strategic view of their businesses and their markets. They may lack insight into their business challenges because of inexperience or because they are overwhelmed by daily pressures, so they don’t know that they need a merchant bank until they go looking for something else. To be sure, most of them are stymied by a lack of financial resources. But almost as many are missing key non-financial skills and support. Thus, one of the first tasks with our portfolio companies is to help them recognize both these needs, and begin planning to address them.

Next Street’s updated merchant-bank model is specifically structured to address this issue of growing needs and emerging challenges. In particular, we have developed a range of advisory services that are tailored for this market, truly an innovation in merchant banking. For the most part, even classic merchant banks didn't do this kind of consulting; instead, they directed their clients to management consultants. Next Street has formalized and integrated this function, exponentially strengthening the model as a whole, by recruiting staff with expertise in finance, strategic consulting, and long-term relationship management. This blend of sound advice with a long-term relationship becomes a core part of the implementation, ultimately reducing risk. Like classic merchant banks, Next Street expands and adapts our operations to accommodate these, adding creative services, real estate advisory, and organizational development, among others. Thus, Next Street brings its clients talent that rarely focuses on this market: world-class, Wall Street-quality advice and support.

Looking Ahead
We’ve traced the evolution of the merchant bank, starting with trade, then financing, and then on to new issues as the capital markets evolved. Throughout this process, we see merchant banks stretching to do what it takes to serve their clients. Like these venerable institutions, Next Street continues to evolve in order to address the needs of its clients.

Many of today’s merchant banks have strayed from their roots as the cornerstone of modern finance. The traditional financial institutions that once served the inner cities have also abandoned this market as they underwent their own transitions in the last decade. As a consequence, smaller businesses have languished. By reviving and refining this powerful model, Next Street brings a creative approach to a unique market with high potential that has never had access to “the wisdom stuff”, as Jeff Swartz calls it, on this level. Based on the track record of the merchant bank over hundreds of years, we expect that the market will respond, replicating the model around the country.

For us, the most important ingredient of Next Street’s merchant bank model is serving the whole client, whatever that takes. We believe that’s how to make a difference with each client, and ultimately with the cities and communities that are their homes.