Most small business owners put everything they have into
their businesses as they are growing them.
They are entrepreneurs, risk takers and are successful in part because
of their willingness to take on risk.
Along the way, they build net worth and value in their business. They also build a concentration in one stock,
the stock of their operating company, comprising a large percentage of their personal
net worth. For most business owners the
value in the stock of their operating company, along with the equity in their
homes, will represent the vast majority of their net worth.
For most businesses owners, developing this concentration is
almost impossible to avoid. For some it
is by design. Many years ago I was
touring a manufacturing operation with the owner who was giving me a tour of
his facilities. I asked him about other
investments he had and I referenced the stock market’s activity that day. We were up on the second floor of his
warehouse and he motioned with his arm toward the floor below and said “this is
my stock market”. He went on to tell me
he had no other investments and everything was in his business. Although that works as long as your business
works having most, if not all, of your eggs in one basket is generally a
dangerous endeavor.
It’s understood that in order to grow one’s business,
capital is required and retaining profit inside the company is essential to its
ongoing operations. The challenge comes
later in one’s career, as significant value in the business is accreted, to
diversify holdings such that the concentration your business represents in your
net worth is mitigated. There are no hard
and fast rules regarding how large this owner operated business concentration
should be. The goal to reduce the
portion that your business value represents as a percentage of your overall net
worth may not be achievable until your business hits the maturity stage of its
life cycle. That being said, the purpose
of this article is to bring the issue to the forefront and have the business
owner develop a plan to diversify away from this concentration.
A goal I have discussed with business owners is aiming for
the value of their business to comprise 25% or less of their total net worth. Any business owner, particularly a
construction firm, should seek diversification and mitigate any concentrations
in their net worth. There are a number
of ways, after your business has reached maturity, to take some of the chips
off the table. These options include
sale of minority stakes to key employees who desire, and are worthy of, equity
ownership, sale of non-voting stock (in order to retain control), ESOPs,
distributions of excess working capital (yes, this is still possible in 2012 in
select cases) just to name a few. The
option you choose will depend on your particular circumstances. Be sure to include the bond company and bank
in any discussion regarding your options.
You don’t ever want to do anything to adversely affect your ability to
obtain credit as you do your planning. As
always, consult with your trusted advisors as well.
We’ve all heard that the two of the strongest pillars of
wealth are 1) knowing how to make money and 2) knowing how to keep it. As I’ve cited before, the old saying goes all
contractors are one bad job away from going out of business. The execution of a plan for diversification is
essential in keeping a lifetime of work and wealth accumulation intact and
provides peace of mind allowing the entrepreneur to sleep easier.
