Addressing Concentration Risk

June 8, 2020 Jeffrey Kaplan

All Eggs in One Basket

Financial advisors have a dynamic and demanding set of responsibilities, made only more difficult during times of uncertainty.  When their client is a business owner, these challenges are amplified even further – the result of communication complexities and portfolio concentration.

The skill set needed to build a company often overlaps with that of an effective relationship manager.  Both portfolios and balance sheets need keen oversight and steady management.  And effective engagement, with either clients or employees, requires attentiveness and empathy.  But these similarities can create problematic redundancies in an advisor-business owner relationship.

Although consultants are commonplace in business, an owner’s self-reliance and fiscal acumen can minimize the impact of a financial advisor’s good advice.  The barrier isn’t impenetrable, but it takes a top-notch communicator to break-through and earn their client’s trust.

Yet even the best communicators can find themselves hamstrung by a heavily concentrated portfolio.  When markets are climbing, a lack of diversification can easily be overlooked.  Rising tides lift all boats and smooth out the imperfections of even the most lopsided portfolio.  But when the waters get rough, the bigger the boat, the greater the chances of sinking. 

For many clients, this sort of exposure can be properly mitigated through risk tolerance evaluation, long-term plan reassessment, and portfolio re-balancing – in addition to some candid, yet thoughtful communication.  For business owners, similar interventions, while helpful, generally don’t go far enough.


On average, owners of closely-held companies have up to 90% of their net worth tied up in their businesses. 

As a result, a re-balancing of a business owner’s actively managed assets does little to address their broader concentration risks.  Whether a business is cyclical or counter-cyclical, it will likely face a moment where fortunes turn, losses mount, and survival is threatened.  These prospects become far more tangible when the world goes topsy-turvy.

A conversation with business owners about addressing diversification can make for a precarious exchange.  Here’s where a financial advisor needs to deliver grounded solutions in addition to open, empathetic dialogue.

Options include:

  • Third Party or Private Equity Sale – these are straight-forward liquidity plays, but owners aren’t always willing to part with their businesses, and in many cases, their legacies.
  • Dividend Recapitalization – this debt financed transaction can deliver special payments to shareholders without sacrificing equity, but the returns are taxable, and the financing may strain a company’s capital structure.
  • Employee Stock Ownership Plans (ESOPs) – while not an optimal choice for distressed businesses, this transaction effectively combines an internal leveraged-buyout, with tax advantages, and profound retirement benefits for employees. Owners gain liquidity, can continue to hold stock and/or warrants, and continue to play a meaningful role with their companies, while the business entity maintains the freedom to make future transactions.

Each of these options represents a complex financial transaction, and timing is crucial both in terms how these solutions are shared with a client and if/when that client decides to execute a liquidity transaction.  Sometimes, it takes a bump in the financial road to break the ice.  The sting of a down-market and a depressed business valuation may help both parties think twice about an unattended concentration risk.

There’s no such thing as the perfect time to engage in a business diversification conversation.  But if left unsaid, the consequences can be critical for advisor and client alike.  So, whichever side of the relationship you occupy, give some thought to breaking the ice on concentration risks and the strategic alternatives for business owners.  And start communicating before the next crisis hits.

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