March 15, 2018
Many successful entrepreneurs invest the lion’s share of their personal wealth in their business when getting started and reinvest any earnings so that it continues to grow. This practice is sound and often financially beneficial for the business owner. However, the flip side of the coin is that over time, the owner accumulates a concentrated position in his or her own company stock that can be difficult to unwind.
From a wealth management perspective, business owners with concentrated stock positions are overly exposed to very specific risks. To be sure, one of the most effective ways to accrue a significant amount of wealth is to make calculated bets. But, as Warren Buffett famously said, “It's only when the tide goes out that you learn who's been swimming naked.”
Unfortunately, designing an exit strategy to mitigate the risks business owners face can be a challenge because of the desire for control. Entrepreneurs have worked hard to develop and grow their businesses and are often unwilling to give up a portion or all of their control by reducing their ownership stake, which would free up cash to invest in other assets. Furthermore, most business owners believe they know something about the market in which they operate that no one else does, which is why they do not view a concentrated ownership position as risky. For the same reason, they may be hesitant to invest in markets that they do not understand as well.
With the help of a wealth advisor, there are diversification strategies business owners can pursue that do not require giving up control of the companies they worked hard to build.
One option is to implement an Employee Stock Ownership Program (ESOP), which can have many benefits including the ability to transfer ownership to participating employees without giving up operational control of the business. It also creates a viable market for the company’s equity that may not otherwise exist.
Another option is to create a cash reserve by gradually reducing an equity stake through succession planning or by setting aside capital distributions and income, which can then be used to invest in a diversified portfolio of liquid assets that complement the business. Liquidity is key, so that investments may be easily sold if additional cash is needed.
Understanding the company’s business cycle is essential when developing a proper diversification strategy. For example, owners of cyclical businesses, like construction or auto sales, may benefit from also investing in defensive industries like healthcare and utilities. During recessionary periods when cyclical businesses typically face headwinds due to curbed consumer spending, it can be helpful to have exposure to companies with services that have more consistent demand. Holding a portfolio of assets that have little or no correlation with the company’s business cycle can smooth investment returns and protect against significant capital losses.
The economy is in good shape, and most markets have performed well over the last several years, making diversification less valuable. However, volatility has already begun to rise across global markets and correlations among asset classes are falling. Business owners who have accumulated concentrated positions in their company’s equity, especially those in cyclical industries, may be well served by considering strategies that provide additional diversification and liquidity benefits. Growing wealth often requires taking on additional risk, but preserving wealth requires a more balanced approach.
Erin Dickes is a senior relationship manager for CIBC Atlantic Trust Private Wealth Management with 24 years of experience in the investment industry assisting high net worth families and their related interests.
Gary Pzegeo, CFA
May 17, 2016
Judy Saxe, AEP®, CAP®
May 05, 2016
Ryan Christine Coulson
June 21, 2017
* Required fields
Internal Custody:If your assets are custodied with Atlantic Trust, please select the internal custody version of Atlantic Trust Portfolio Online to view your portfolio information.
External Custody:If your assets are custodied with an external custodian, such as Schwab, Fidelity or The Bank of New York, you may access the external version of Atlantic Trust Portfolio Online.
Sponsored Funds Investors:If you are an investor in any of the Atlantic Trust Sponsored Funds, you may access the Atlantic Trust Investor Dashboard here.
Safari Browser Users:To access login links, you will need to deselect the "Block pop-up windows" option under your security preferences.
For further assistance, please contact your Atlantic Trust client service team.