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Diversification for Entrepreneurs and Public Company Executives

This article appeared in the February 2019 edition of Nevillewood Living.

Financial Fitness Feb 2019

At H&A, we are well aware of how extremely fortunate
we are to have such a wonderful clientele that hail from all walks of
life.  Among the most interesting of our
clients, we would certainly include entrepreneurs and public company executives
(PCE’s).  These individuals all have
great stories of how they started out with a dream and a vision, and then went
on to build something of great value. 

Many of these individuals also have the shared experience
of attaining a high income and net worth. 
With this generally comes the subsequent challenge of the concentration
of investment and income risk in one enterprise (a “good” problem to have, most
would agree). 

Entrepreneurs and PCEs have gotten where they are in life
due to determination and a willingness to assume risk.  At some point, however, they will face the
reality that, although the concentration is what enabled them to build wealth, without
adequate diversification all that they have created will be at risk of
loss. 

In our experience, as compared to entrepreneurs, PCEs at
the pinnacle of their careers seem to be a bit more focused on diversifying
their total investment portfolios to better manage risk.  Perhaps it is the (frightening for many) mark-to-market
experience of seeing their net worth fluctuate dramatically day-to-day as a result
of stock market moves.  Perhaps it is
because their diversification kit contains more tools, i.e., they can sell or
hedge company stock they have accumulated on the open market. 

Of course, entrepreneurs who have accumulated substantial
wealth through the ownership of a private business face the same investment
concentration risks.  And, although they
cannot sell or hedge their stock on the public markets, there are tools and
techniques that entrepreneurs can use to de-risk and diversify their holdings:

  • Recapitalize.  The closely held business can leverage up and
    then pay out a substantial dividend to the owner(s).  The proceeds of this dividend can then be
    invested in a diversified portfolio.  This enables diversification while still
    retaining ownership of the business and preserving full participation in its future
    growth. 

  • Focus on
    other industries
    .  Once entrepreneurs
    begin to diversify away from privately held stock, they too often invest in
    public companies that operate in similar industries because they feel that they
    understand them better.  A better course
    would be to focus on sectors that are counter cyclical to the private
    business.  For example, an owner of an
    industrial company might place more focus on health care and financial
    companies in his diversified liquid portfolio. 

  • Own more
    fixed income in diversified portfolio.
    When setting the asset allocation
    targets within the diversified portfolio, entrepreneurs should be sure to employ
    a “global” or “total” portfolio approach. 
    This may require higher targets for fixed income within the diversified
    portfolio to provide better overall balance and risk management given the
    equity concentration risk within the closely held business.