Financial advisors have a dynamic and demanding set of responsibilities. When their client is a business owner, these challenges are amplified by communication complexities and concentration risk.
An entrepreneur's skill set often overlaps with that of an effective relationship manager. Portfolios and corporate balance sheets need keen oversight and steady management. And effective engagement, with either clients or employees, requires attentiveness and empathy. These similarities can create problematic redundancies in an advisor-business owner relationship.
An owner’s self-reliance and fiscal acumen can mute a financial advisor’s good advice. It often takes gifted communicator to break-through and earn their client’s trust. But even the best conversationalists can find themselves hamstrung by a business owner's concentrated wealth position.
Portfolio concentration is a uniquely difficult challenge for business owners.
On average, owners of closely-held companies have up to 80% of their net worth tied up in their businesses. Risk tolerance evaluation, long-term plan reassessment, and portfolio re-balancing are viable mitigation strategies for standard clients. But a re-balancing of a business owner’s actively managed assets probably won't address their broader concentration risks.
Whether a business is cyclical or counter-cyclical, it will likely face a moment where fortunes turn. Nonetheless, a conversation about personal diversification can be precarious exchange. An owner's relationship to their businesses can be intensely personal. For many, equity sales can be unthinkable.
Here’s where a financial advisor needs to deliver grounded solutions in addition to open, empathetic dialogue.
Liquidity and Diversification Options:
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.
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
While not an optimal choice for distressed businesses, a leveraged ESOP can effectively act as an leveraged-buyout of one's own company, with tax advantages and profound retirement benefits for employees. Owners gain liquidity, maintain equity, and can continue to play a meaningful role with their companies. Meanwhile the business remains independent and can still take part in 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.