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MARK BLACKWELL — Diversification is challenging for business owners

Mark Blackwell

Mark Blackwell

Savvy investors don’t put their entire portfolio in a single stock, yet owners of privately held businesses often keep the bulk of their wealth in one enterprise – their own.  This concentration means that business owners face a myriad of financial risks that others don’t have to worry about.

For one, if anything hurts the business’s revenue – an economic downturn, a natural disaster, or a new competitor entering the market – the owner’s family finances and lifestyle may be at risk.  These events can happen to other investments, too, but market investors tend to diversify their portfolios to minimize single-stock or industry-sector risk.

Especially as the business grows more valuable, it’s important for owners to consider diversifying their investments.  Fortunately, business owners have a number of ways to reduce their financial risks that don’t necessarily involve forfeiting control of the business.

Accumulating personal assets

Business owners should ensure they have a reserve fund by stockpiling cash from profitable years.  These investments in secure, short-term investments can help them ride out inevitable market fluctuations and economic rough patches.

They should also save money in retirement accounts that are invested in portfolio of diversified securities.  Business ownership is generally considered high risk, because many outside forces can affect a company’s value, so business owners should consider balancing that risk with a portfolio of personal investments in lower-risk, less-volatile investments.

Selling equity

Another common diversification strategy used by business owners is monetizing the value of their business.  This can include selling equity to key employees, family members, or third parties.  The diversification strategy a business owner employs depends on his or her long-term goals and succession plans.  For example, if a core team of employees will eventually take over the company, the owner might set up an Employee Stock Ownership Plan, or ESOP, which allows vested employees to buy shares of the company at a predetermined price, receive shares as part of their compensation, or being given shares as part of a profit-sharing program or qualified retirement plan.

The main drawbacks to selling equity in your business are the potential of giving up future rights to any increased value in the company and sharing some of the current cash flow with other equity holders.  For many owners, though, the real issue is losing control of their company.  A potential strategy to address this concern is to divide equity into voting and non-voting shares, selling only the non-voting stock to employees.

Leveraging value

Business owners who aren’t ready to share ownership may have another option: recapitalizing the company using debt.  Leveraging real assets or projected cash flow or a combination of the two – allows owners to securitize a loan against the business and use the cash to invest in a diversified portfolio of securities.  The portfolio could be held as a personal asset, while the cash flow from the business is used to pay off the loan.  The advantage of using debt instead of equity is that the business owner can retain 100 percent ownership in the company.  Also, a loan can be executed quickly and confidentially.

These are just a few of the more popular options available to business owners for protecting and preserving an asset that frequently dominates their net worth.  As every business is different, every solution to provide balance to the business’s unique risk profile is different, too.  So the decision of which option to select begins with a broad wealth and risk analysis encompassing both the personal and business assets and liabilities.

The numbers are just part of the picture, though.  The analysis must also take into account subjective data like the goals and objectives of the business owner, the capabilities of the management team, a profile of the business’s workforce, and other factors that may influence whether one solution is better than the others for the owner’s particular needs.  As in most major business decisions, advice from an experienced team is vital.

For most business owners, their enterprise is the largest asset in their net worth; it is the one most likely to accomplish their long-term goals; and it is the one most exposed to risks that could put those goals in jeopardy.  Deciding how to diversify that concentration of wealth may be the most important decision the business owner has made since the “Grand Opening” sign was taken down!

» Mark Blackwell is the Mississippi Area Executive for Regions Private Wealth Management.

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