The great tradition of merchant banking
The precursors of merchant banks were the largest businesses in the world of the late 17th and early 18th centuries: merchants who made their fortunes by buying and selling goods around the world. Some credit the creation and growth of many English colonies, and later Dutch colonies, to the efforts of these merchants to identify and secure ever-widening sources of goods in order to expand their businesses. For example, the East India Trading Company, with its exclusive rights to lucrative trading in India and exemptions from customs, presided over the creation of the British Raj there. The company went on to establish the first trading posts and to secure military dominance in Southeast Asia, facilitating establishment of Burma, Ceylon, Hong Kong, British Malaya, and Singapore as British Crown Colonies. The American colonies can also be traced back to these powerful merchants, specifically the widely known Hudson Bay Company.
As these trades became too much for any single merchant to finance, merchant banks stepped up to take a central role in the negotiation, financing, and implementation of transactions. They built specialties in certain types of businesses and transactions, then sought to convince potential providers of capital that a given transaction would ultimately produce "collectable" profits. As accepting houses, merchant banks could accept letters of credit, with the right to discount them with the Bank of England. An indispensable element of the process was the willingness of merchant bankers to put their own reputations and money on the line to back up the promises of their clients. By the same token, the banks guided their portfolio companies – such as commodity sellers and cargo owners – in order to maximize the chances that they would meet their obligations.
Lazard Frères, the powerful international bank and advisor, started as a merchant bank. It was founded as a dry goods business by French brothers in New Orleans in 1848. They soon moved on to take advantage of the opportunities generated by the Gold Rush, financing the purchase of equipment and exporting gold bullion – a classic example of the merchant bank bending and changing to address the needs of its clients, wherever and however they emerge. When clients needed investment support, the bank added those services. In fact, Lazard evolved into an investment advisor and bank because of its deep commitment to serving its clients.
This financing function became a core business of merchant banks: accepting risk on behalf of customers, and then laying that risk off with investors. The mercantile work then faded into the background in favor of finance, which had traditionally been an element of their mercantile functions but now became dominant.
