An entrepreneur I know made good money selling his high-tech company back in 1999. After paying off his mortgage, he reinvested the proceeds into other technology companies. Why not? The sector was on fire, and unlike most investors of the day, he understood many of the computer and communications companies in which he was investing.
Then came the market meltdown in 2000, the slow agony of Nortel — and a series of jobs in technology sales after my friend realized that he still had to work for a living.
Whether he knew it or not, my friend was following a typical entrepreneurial model: if it works, do it again. In his attempt to diversify his portfolio, he wound up investing all his funds in one sector. While sophisticated financial planners might laugh, it’s an improvement over many entrepreneurs, who keep most of their eggs in a single basket — their own business.
If you’re one of those owners who thinks that keeping your business afloat is Job One, here’s a wake-up call: assuring your financial future is just as important. That means recognizing that money in your business isn’t safe. In the event of recession, an industry slump, personal injury or a dishonest employee, the financial cushion that is your business can fray fast. Fortunately, there are many advisers and financial models that can help you spread the risk — but none matter a whit until you realize that getting money out of your business is almost as essential as getting it in.
Financial planners who specialize in serving business owners don’t like criticizing their clients. Privately, however, many agree that entrepreneurs must often be arm-twisted into accepting diversification. “When entrepreneurs start a businesses, it probably represents all of their capital,” notes Lance Howard, president of the Lance Howard Group in London, Ont. “It also consumes their lives. They tend to put their own wealth into it to keep it going, because most businesses take a while to start producing regular, predictable cash flow.”
Even when they can, says Howard, many entrepreneurs don’t like to take money out of their businesses. “First, it’s not in their nature. Then, they hate the idea of paying tax. The next thing you know, it’s five years later, and it’s just been easier to keep investing in equity and inventory.”
Peter Merrick, president of Toronto-based MerrickWealth.com, sees another barrier preventing business owners from cashing out. “They don’t need me to make them rich. If they have $200,000 to invest and are looking at making more money, they’d probably do best by investing in their own business.”
But there comes a time when business owners have to think about the future. When Howard meets an entrepreneur who insists that, “My best investment is my business,” he asks a simple question: “If you got up one day and felt tired — and decided you didn’t want to work so hard any more — would you be disappointed if you had to?” If the owner says yes — as most do — Howard is ready to work with them. If not, he moves on. “When I was younger, I thought I could save everyone,” says Howard. “Now I only want to work with people who are coachable.”
Howard’s process involves studying individuals, examining their hopes, their goals and their risk tolerance, as well as the strengths and weaknesses of their business. Then he and his staff come up with a plan for transferring funds out of the business — often using a holding company that puts the business’s retained earnings out of reach of most creditors. (The money is usually lent back to the company.)
Like Howard, most financial planners offer more than diversification. “Business owners are very different from employees,” says Merrick. “They’re looking for business solutions, not investment advice.” The first step toward diversification is usually risk-reduction. Disability insurance and key-man insurance, for instance, are essentials overlooked by many owners. “The No. 1 thing entrepreneurs must do is protect their ability to make money,” says Merrick.
Professional advisers will then point you toward pension products, to boost your future income. Once you’ve maxed out your RRSP, a retirement compensation arrangement can provide supplemental pension benefits, with more flexibility than a formal pension plan.
There are also other means of diversification. In most markets, your home makes a solid — and tax-free — investment, while many entrepreneurs also do well by owning their own building. For the most part, though, financial advisers will point you toward a diversified investment portfolio composed of fixed-income instruments such as bonds and T-bills, as well as mutual funds and blue-chip equities. Just one caveat: no choosing your stocks.
“Entrepreneurs tend to think they’re good stock pickers,” says Howard. Many are convinced they have the pulse on their industry — but lack the time to properly research and track investments. Sandeep Sangha, an investment adviser with Canaccord Capital Corp. in Vancouver, says he meets lots of entrepreneurs who badmouth portfolio diversification — mainly because of the losses they’ve suffered in their own stock picks. “They tend to stick to their own business and to what they know,” he says. “And they hold on too long. Typically, they’re very undereducated about investing.”
Besides, as most professionals agree, having the right balance of investments outperforms stock picking every time. Says Sangha: “75% of returns come from asset allocation.”
Alice Bastedo, an investment adviser with RBC Dominion Securities Inc. in Toronto, says RBC clients enjoy an everchanging basket of equities and funds that represent four key sectors of the economy: interest-sensitive stocks such as banks, consumer staples, industrials and technology companies, and natural resources. Their weightings will vary depending on the economy, but Bastedo says RBC also considers the nature of your business in balancing portfolios. If your firm is in technology, for instance, she’ll recommend minimizing tech stocks in your portfolio. It’s the opposite of what many entrepreneurs would do, but that’s the point of managing risk.
Sangha takes things further, noting that Canaccord offers privately managed portfolios for clients with nest eggs as small as $100,000. More actively managed than mutual funds, with specialty strategies such as puts and calls and the opportunity for year-end tax-loss selling, Sangha notes that private portfolios “offer a little more creativity, peace of mind and a good return.”
And if you’re dying to pick a few stocks, some advisers will allow you a little mad money — say, 1% to 2% of the value of your portfolio. “That fits into any strategy,” says Bastedo, “but it’s enough to be amusing. And sometimes it even works out.”
