Why Good Entrepreneurs Make Bad Investors
The Company Owner's Guide to Money
David Lewis knows better. He knows that a well-balanced investment portfolio is a thing of beauty today and a bulwark in one's later years. He appreciates the quiet stability of municipal bonds, the promise of growth in a choice equity position. He isn't panicked by accounting scandals, crooked corporate bosses, or the nasty bear market. He has seen many a down cycle and understands that being diversified and having a level head is the way to get through them. David Lewis knows all that, and yet somehow he doesn't apply the knowledge to himself. He would still rather take the money that his business generates and plow most of it right back into the business. "It's a gigantic bet I'm making," says Lewis, 54, "that by the time I get to retirement age, I can make the business worth more than I would be able to earn in the market."
Lewis is like a lot of entrepreneurs, except for one thing: he happens to be a financial planner. The business he's building -- 17-year-old Resource Advisory Services Inc., in Knoxville, Tenn. -- makes money by helping its customers act on the very precepts that Lewis has put on hold for himself. One of the nation's 1,000 or so fee-only planners, Lewis prides himself on offering financial advice at its most objective, with prudence and diversification as cardinal principles and with risks soberly calculated and hedged. But when it comes to his own money, the entrepreneur in him somehow trumps the planner. His securities holdings are minimal. The narrative of his net worth would describe his company's slow path to breakeven, then a plateau of prosperity that has failed to satisfy his restlessness, and finally his plans for the future: more associates in his business, the new offices he'll move into this month, and his hope of a major payday when he eventually sells a much bigger firm to his employees. "I could cut back to 25 or 30 of the best clients, work with them myself, and live very comfortably," he says. "But just when my life starts to get comfortable, I reach out and commit to something else."
Most people have complicated feelings about investing. But does anyone bring more baggage to the task than an entrepreneur? There is, first of all, the choice that Lewis's situation exemplifies: between building up his core asset -- his business -- and his investment portfolio. And once entrepreneurs do start investing outside their businesses, well, the issues multiply. Following the time-honored principle that you should invest in what you know, many business owners like to invest within their own industries -- even though the positions they build, taken together with their own companies, usually amount to a risky overconcentration. Others find that the traits that help them succeed as entrepreneurs -- a soaring optimism, a high tolerance for risk -- can handicap them in investing, where hardheaded realists tend to be rewarded. "These are people who believe in ideas," says Michelle Bain, owner of Home Instead Inc., a senior-care service based in Omaha. "They believe in exponential growth, and they're willing to bet on it."
Finally, and most fundamentally, there is the difficulty many entrepreneurs have with the personal goal setting that is a precondition for good investment decisions. "Entrepreneurs tend to have visions for their companies but not necessarily for themselves," observes Mike Maddock, cofounder of Maddock Douglas Inc., an Elmhurst, Ill., marketing-communications firm. If business owners do have both visions, they often turn out to be tangled, with the personal goals subordinated to the business objectives. Choosing when and how to take money out of a business and put it to work elsewhere, for example, is a function of (among other things) how big you hope to grow the company, whether you mean to sell or bequeath it, and what your vision of retirement is. Before you know it, you're mulling not just capital needs and investment returns but also your relationship with your spouse and children. In the end, personal financial decisions are complicated -- for everyone, but especially for entrepreneurs -- because they are about so much more than money. "We think we're talking about spreadsheets," says financial planner George Kinder, "when really we're talking about people's dreams."
But here's the rub: hardly anybody achieves the dreams without using the spreadsheets. The task, like it or not, is to translate your aspirations into decisions about stocks, bonds, real estate, and your company -- without being betrayed by your blind spots or tripping over the complexities that are part of nearly every entrepreneur's financial life.
This is not an easy time to be charting your personal financial future. Even professional investors are having trouble sorting through the rubble of a boom gone bust. Was the new economy purely a mirage? Can anyone on Wall Street be trusted? Do stocks -- still trading at historically high multiples -- have further to fall? Could war cause the economy to stall again? And yet the same uncertainties lend urgency to the job of getting your noncompany finances on track -- or at least taking a hard look at the bets you are (and aren't) making.
What's an entrepreneur to do? Alas, few investing rules apply equally to all CEOs, just as few foolproof forecasts indicate what the stock market will do next. The decisions that a particular business owner should make will depend on a host of factors, starting with the stage and nature of the business and his or her personal goals. But just as it's wise to put aside near-term questions about which market sector will be hot and embrace the time-tested principle of diversification, it's also worthwhile to recognize some of the perennial challenges that business owners face as they invest -- and to think about what you can do to overcome them.
Problem: You have a deep emotional commitment to your largest holding.
What to do: Get outsiders to assess your business as a financial asset.
Surprising side effect: You'll learn better what builds your company's value -- and what doesn't.
Just being an entrepreneur probably puts you on the wrong side of a basic investing rule: Don't fall in love with your stocks, because they're certainly not in love with you. Your company represents by far the biggest portion of your net worth, but it's also the hardest part to be objective about.
The more you rely on your company to secure your financial future, the more important it is that you be right about its value and salability. The stakes are high for someone like 33-year-old Tao Miller, owner of a Honolulu-based company called Body & Soul Cosmetics. Married with no children, Miller has few assets outside his company: a home and some money in a savings account. Mostly, he's plowed the profits from two previous business successes straight into the three-year-old, cash-hungry Body & Soul. So far, so good: Miller expects to sell $3.1 million worth of art-deco-packaged lipstick and mascara this year. Several large companies have approached him about selling. But he reckons it isn't time -- yet. "I see my future in selling the company and cashing out," says Miller. "But by growing the business to the $5-million to $10-million range, with a nice profitability, I can get a much better price."
Miller's big bet may or may not pay off as he envisions -- but his youth makes the risk bearable, and he does have some outside confirmation of his company's value. The point here is that you can't plan well without taking a realistic look at your business as a financial asset. "Look at your company as if you were going to sell it -- even if you don't intend to," advises Robert Hockett of Cambridge Southern Financial Advisors, in Atlanta. Miller was fortunate to receive a call from a potential buyer. But don't just wait for your phone to ring; bring in a business broker and find out how an acquirer would judge your company's growth prospects, competitive vulnerability, and balance sheet. You should also think about making arrangements now (such as instituting an employee stock ownership plan) that could help you transfer ownership and gain liquidity later, should the need arise.
Problem: You're a late starter, aren't you?
What to do: Get started. Agree with your spouse on a plan. Make automatic savings deposits.
Surprising side effect: You'll gain an unexpected perspective on your decisions as CEO by building wealth outside your company.
It's not hard to see why you didn't start saving early. You spent years sinking every nickel you could find into your business. Your company is profitable now, but there's so much more you want to do -- buy another truck or upgrade your computers or hire another salesperson -- that channeling money into a retirement account just doesn't feel as urgent. "All the business books tell you to pay yourself first, but it's hard," says adman Maddock. "There is always something more important when you're running a business."
A tendency to shortchange yourself may seem all the more reasonable if you share the fundamental optimism about money so common among entrepreneurs. Whole books have been written about money's deeper meanings. The Seven Stages of Money Maturity, by George Kinder, comes in handy here. Kinder holds that many entrepreneurs are strongly grounded in the first stage of his framework, which he calls, simply, innocence. "Entrepreneurs have plenty of animal spirits and vision," he points out. "But they may be weak on knowledge, especially when they're young."
Mike Maddock has a pretty good idea of what that means. Now 37, he recounts two incidents in his life that taught him he might be a little overoptimistic about money. The first came back in high school. He worked three jobs during the summer before his senior year and earned $12,000. He also managed to spend most of it -- on a motorcycle and a stereo system, among other things. "My father came to me, very sad, and said he felt he'd failed me because I didn't realize I was supposed to contribute a lot of the money to college," Maddock recalls. "But my attitude was, 'Hey, I'll make more."
The second incident came in 1991, the year Maddock cofounded Maddock Douglas and got married. Shortly before the wedding he told his fiancÉe, Ruth, that he'd started the company on credit cards and was carrying some $12,000 in card debt. To Maddock's great surprise, she began to cry. His own feelings, meanwhile, were similar to the ones he'd had in high school. "I thought, 'What's the problem? I'll pay it back," he says.
Pay it back he soon did. But a message had gotten through to Maddock. So when his company turned a small profit in its first year, he and his partner immediately began saving. "I bought an annuity," says Maddock with a laugh. "The most ignorant investment ever." Since then the agency has prospered, and Maddock has redirected his savings into no-load mutual funds that he selects himself and the 401(k) plan the company set up. The most important thing for him is that the savings are automatic. "Every month I put a percentage of my salary in there where my optimism can't get at it," he says.
The lesson? Be like Mike. Talk to your spouse about what's important. Then start saving. Maybe only a little at first, but make it automatic -- you won't miss it, you'll like the way it builds, and you may even find that accumulating some wealth outside your company gives you some additional perspective on the decisions you make as CEO. By the way, that well-designed 401(k) plan you instituted can also help you attract the talent you need.
Problem: You're tempted to invest in your own industry, which you know a lot about.
What to do: Avoid your industry. Diversify.
Surprising side effect: When your industry is down, you'll have a clearer head.
Were investing entrepreneurs among the biggest losers in the tech-market meltdown that began in 2000? That's hard to prove -- but easy to believe. Financial planner Marcee Yager, a principal at Sterling Wood Financial, in San Jose, Calif., was right in the thick of things, with plenty of tech entrepreneurs as clients. "There was a period when people didn't want to discuss anything but technology," she says. "We'd have long discussions about risk, but they didn't have as much effect as we would have liked."
The financial bruising that the CEOs of many technology companies suffered illustrates a risk that every investment expert warns about but that many entrepreneurs blissfully embrace: becoming overconcentrated in a single industry. Betting on the stocks of your suppliers, customers, or associates is tempting; after all, don't market gurus like Peter Lynch tell you to invest in what you know? What's more, there are plenty of business owners whose deep knowledge of telecom or retail or financial services has helped them to identify and invest in good companies. Hey, some of them were even alert enough to sell before bad things happened to those good companies.
But you'd be foolish to try to emulate them. Diversification is the first commandment of investing. Most of your wealth is tied up in whatever industry your company is in; don't put the rest of your nest eggs in that very same basket. It's simple: if your own company's fortunes are tied to, say, those of the auto industry, you want Pfizer, not Ford, in your personal portfolio.
Problem: You're drawn to innovative concepts that could pay off in a big way.
What to do: Avoid trailblazing companies -- as investments anyway.
Surprising side effect: New respect for municipal bonds.
Of course, technology entrepreneurs weren't the only business owners burned in the Nasdaq debacle. Home Instead owner Michelle Bain dabbled in tech stocks, too, as did many other people in her social and business circles. "Tech stocks were all anybody talked about," she says. "At happy hours, after church -- whenever."
No surprise there: having an eye for trends and a nose for opportunities is one big reason that business owners have money to invest in the first place. But the same traits can make you especially vulnerable to the fallacy that a company that's helping to change the way the world works is likely to be a good investment. As early shareholders in railroads, airlines, and Internet companies proved, it ain't necessarily so.
Anyway, since you're already heavily invested in one trailblazing company (your own), you really don't want much exposure to others. Diversification is a many splendored thing. One successful business owner might figure he's facing all the risk he cares to in his own company; he's the guy who will pay cash for a new home and maintain a portfolio consisting mainly of ultrasafe municipal bonds. Another will get fancier: since his is a small-cap company doing business entirely in the United States, he wants some large-cap foreign stocks in his portfolio. How you spread your own risks will depend on your own circumstances and interests -- but spread them you must.
And when it comes to betting on great ideas, take a lesson from the angels. These investors in early-stage companies -- usually seasoned entrepreneurs who have started and sold a company or two of their own -- are fascinated by the search for the next big thing. But as San Diego-based Bill Payne, 61, a leader of the Tech Coast Angels group, explains, he and most of his angel colleagues are working strictly with their "go to Vegas" money, which represents only 5% to 10% of their net worth.
Problem: You're convinced that there's not much you can't do, once you put your mind to it.
What to do: When it comes to investing, delegate. But don't abdicate.
Surprising side effect: A better big-picture view of the economy.
Entrepreneurs have to be generalists, willing to tackle nearly any job. For some, investing is just another item on a lengthy to-do list, to be approached with the same brisk confidence they bring to other tasks. That can lead to problems, as specialists in behavioral finance (a new field in economics devoted to studying why investors often behave irrationally) have shown. The trouble is that most investors -- business owners included -- routinely overestimate their knowledge and abilities.
That's another example of how a trait that helps you build a business can hamper you as an investor. Consider the case of Rob Chewning, 33. Chewning started his company, Southern Woods, in an Atlanta suburb six years ago by going around to contractors and asking what they needed help with. "Floors" was the most interesting answer. So Chewning, a Georgia State University business major, learned about hardwood floors and built a thriving business that has since expanded into carpeting and interior decorating. When he was making enough money to start putting some aside, he approached investing with his typical can-do attitude and set up an account with an on-line broker. "I was aggressive," he says. "Bought a ton of Cisco and watched it drop by 75%."
Not long afterward Chewning started interviewing financial planners. He settled on Robert Hockett of Cambridge Southern Financial Advisors. The stock market, discouraging though it is right now, is getting a regular monthly investment from Chewning. Over time he will build a diversified portfolio of index funds, with some international exposure as well. There will be a good slug of bonds, too.
But what Chewning is most energized by is a real estate transaction that's a classic for business owners. He's personally financing a 12,000-square-foot building in Barrow County. Southern Woods will be the main tenant, paying him rent on 5,000 square feet. That still leaves him 7,000 square feet to rent out to other tenants, plus his investment in the building's appreciation over time. Eventually, Chewning expects to build a portfolio that's about evenly divided between real estate and securities.
Conclusion? For heaven's sake, delegate. Working with a financial planner, as Chewning has done, is one option, though not the only one. (See "Resources: Where to Start Getting Investment Help," below.) Buying mutual funds, as Mike Maddock does, is a form of delegation as well. The one thing that few business owners have the time to do properly is to be active traders in individual stocks. But delegate doesn't mean abdicate; you'll get the most out of your advisers if you stay abreast of investment ideas.
Still, no financial planner is ever going to be able to tell you what you want out of life or for that matter what can help you sleep at night. That's up to you. Planner David Lewis, who seems to enjoy his role as a sometime heretic, likes to tweak his colleagues with this question: What if Michael Dell had consulted a financial planner back when he was starting his company? The message for entrepreneurs is clear. You need to save, you need to plan, and you need to be you, too.
Kenneth Klee is a financial writer.
Making It Automatic
Who: Mike Maddock, 37
What: A principal at Maddock Douglas Inc., a marketing-communications firm in Elmhurst, Ill.
Personal: Married, one child. No longer rides motorcycles.
Investing style: Recognizing his overly optimistic attitude toward money, he started a regular savings program as soon as the company turned a small profit. Now he's building up a nest egg by means of his company's 401(k) plan and some additional investments in no-load mutual funds that he selects himself.
Looking ahead: Maddock hopes someday to sell the business to the people who helped build it.
Quote: "My wife's a dedicated saver. I was wired to make and spend."
Man With a Plan
Who: Rob Chewning, 33
What: Owner of Southern Woods, a flooring and decorating company in suburban Atlanta.
Personal: Married, three kids. Worked two jobs while getting Southern Woods going; saved money by skipping cable TV.
Investing style: After dabbling in on-line investing, Chewning began working with Cambridge Southern Financial Advisors on a comprehensive plan. Now he's building a portfolio of diversified index funds and bonds, with real estate a major component. Chewning is personally financing Southern Woods' new headquarters in Barrow County; he'll receive rental income from his company and other tenants.
Looking ahead: He hopes to retire in 15 to 20 years but doesn't intend to sell the business.
Quote: "My wife, Kyrie, sees the big picture quicker. She's the one who'll say, 'OK, let's sink another $300,000 in the building and have some rental income."
One Big Bet
Who: Tao Miller, 33
What: Owner of Body & Soul Cosmetics, a three-year-old luxury-cosmetics company based in Honolulu.
Personal: Married, no kids. His parents chose his unusual first name in Tibet, where they were married.
Investing style: What investments? Miller puts every nickel he can into his cash-hungry company.
Looking ahead: For Miller, Body & Soul is his financial future. His goal is to build it up to $5 million to $10 million in sales (2002 sales will be around $3.1 million) and then sell out to a major cosmetics company. (Several buyers have already come calling.) He expects to put about half his proceeds in a "very conservative" retirement account and use the rest for real estate and to fund a new venture of some kind.
Quote: "I've been through a lot, and it always worked out. I'm young enough that I can still screw up a few more times."
Resources: Where to Start Getting Investment Help
You have money to manage but also a business to run. A large swath of the financial-services industry is eager to help with the former while you concentrate on the latter. Key questions to ask financial planners: What are they good at -- and how do they get paid?
Financial planners come in several varieties. One kind (visit napfa.org) works strictly for fees, usually a small percentage fee based on the assets managed for you. A larger group (find it at fpanet.org) mixes in commission income from insurance or other products.
Stockbrokers (who may also be financial planners) have traditionally targeted business owners. Most still make their money on commissions, though some (notably at Merrill Lynch, which now calls its brokers financial advisers) are moving toward a fee-based system, the better to align their interests with customers'. Merrill's Business Financial Services unit ( businesscenter.ml.com) provides financing for small businesses and offers personal financial services for business owners.
Money managers offer posh services to the wealthiest entrepreneurs; the minimum account size at Massachusetts-based David L. Babson & Co. ( dlbabson.com), for example, is $2 million. New York City-based Bernstein ( bernstein.com) is known for objective research. Neuberger Berman ( nb.com), also based in New York City, pitches a concept dubbed the "completion portfolio," in which entrepreneurs compensate for overconcentration in their own business by investing in other industries and asset types.
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