This post is contributed by Jason Dirkham.
In these uncertain times for business and entrepreneurship, there is one strategy that can help you and your businesses stand the test of time: diversity. Typically, entrepreneurs find the majority of their wealth can get tied up in their business, especially as they attempt to scale up and grow into new markets. Of course it’s your natural inclination to align your interests, but could result in some significant drawbacks and a greatly increased vulnerability to economic shockwaves. So having the intention to diversify your business and financial interests into a broader range of interests can be a solid decision. That isn’t to say that you won’t face barriers when pursuing a diversification strategy – funding outside investments can come with challenges. However, with focus and perseverance, you can overcome them and work towards a strengthened future.
Why Should Business Owners Diversify?
Some degree of concentration and specialism seems to be inevitable for business owners, and it’s not always a bad thing. However, entrepreneurs more than anyone else can be extremely vulnerable since they often have much of their personal financial value tied up in the interests of their business as well. This can also be the case for senior executives, who are often paid partly in company stock to encourage performance. In fact, this can be a route to wealth for many, but the downside is enhanced vulnerability to economic shocks – as we are now seeing played out all around us in the wake of the global Covid-19 pandemic.
You manage your business carefully and with skill – but no matter how great you are at leading your business, there will be macroeconomic factors affecting it beyond your control. Social, political, economic and technological developments can all have a seismic impact on the profitability of your operations over time. Diversification is a strategy that helps with risk management and can provide you with some alternative sources of return. What this means in practice is different for everyone.
Some leaders will choose to develop their company in several different directions or in diverse global markets in order to broaden the sources of their revenue streams. Others will take a look at their personal wealth and portfolios and seek to develop them – whether that is simply diversifying the risk profiles of the funds they choose to invest in, moving away from stocks and share to other investments such as art, property or even racehorses, or looking to get into crypto day trading.
When you go into your choices with diversification in mind as a goal, you and your business are less likely to be damaged by setbacks in any individual sector, asset or region. And if you’re smart, you can also use this move to offset some of the potential vulnerabilities in your core business at the same time.
What Should Your Portfolio Really Look Like?
When you concentrate your capital, say by funneling it all into growing your business, it can bring great returns. However, this great reward comes at great risk – and it’s a risk that is often hidden from plain view. Naturally, many successful business leaders who have built up their wealth don’t realize that the strategies which work well to create wealth aren’t always the ones that best preserve it. Using external investments can help you to avoid this fate and also reveal new opportunities to you which could prove valuable in their own right.
Diversifying Your Business Ventures
Where finances will allow, investing in other business ventures is generally a good idea. If things go well, you gain a huge second income stream. However, there are drawbacks to be aware of, such as spreading your own energy too thin to be effective, and the set of risks that introducing another business creates on it’s own terms. And you don’t want to risk any setbacks in that direction.
Keep The Balance Of Liquidity
There is always a fine balance to be had between keeping enough liquidity in your finances and investing in assets as well. In fact, entrepreneurs usually need more liquidity than other types of investor. This is to give them the means and flexibility to pursue opportunities as they come up during the course of business. But holding that much cash can quickly become a habit, and entrepreneurs often think they need to hold more cash than they actually do, even during an emergency. When the price of stocks fluctuates rapidly, it can almost seem more sensible to hold onto cash. But if you do that, you don’t benefit from value rises when equity markets fall – whereas if you have diversified your investments into highly rated bonds, you can profit as their value rises in that situation. Some financial experts recommend that business owners should hold from three to five years worth of typical income in liquid assets. Beyond that, you may be running the risk that your portfolio won’t service your overall financial aims, and you’ll be missing out on better returns from a more diverse strategy. Instead, you would likely be better served by splitting your assets among those that are liquid, those that are low-risk and geared towards longevity and those that work towards the legacy you want to build.
Include Stocks As Part Of Your Strategy
Entrepreneurs can be controlling by nature – it can be a vital part of having the drive to succeed in a competitive business landscape. So to go from concentrating most of your worth in your own business, where you control, and where if you remain unlisted, the paper value doesn’t fluctuate can be challenging. You’re moving from that into public stocks in a business you don’t control, whose decisions may be opaque, and whose value is constantly in flux on the open market. That has to be a struggle in some respects. Coming at it from a perspective where your main focus has been your own business, you may even have an exaggerated perception of the volatility of stocks and shares, which may also lead you to underestimate the potential returns you might stand to gain as well. But adding stocks with potential high returns should be a valid part of your diversification strategy, entrepreneur or not. It’s entirely possible to build a diversified and stable investment portfolio without making too many drastic changes. Some of it may depend on what stage you are at in your career. If you have more mature businesses then a traditional profile with a split of bonds and equities might be more suitable. But younger leaders with high-growth businesses and a longer horizon for investments to mature may be more able to weather options with higher risk and higher returns. Your strategy should depend on your personal circumstances, and working with a financial advisor can be a good step towards making sure your portfolio is optimized for your position.
Building A Custom Portfolio
You can go even further with the theme of tailoring your portfolio to fit as well. Taking account of the current position of your own business, you can look to reduce the exposure of your portfolio to countries, global regions or sectors in which your business is significantly exposed, to further balance your overall risk. This is an advanced move, where you can analyse where you transact most of your business and choosing investments that are allied to other geographies. Or you might choose to focus on investments well outside of the sector your main company operates in, or focus on buying into companies whose returns are not in any way linked to the performance of businesses in your own sector.
Go On The Counter Offensive
And there is another, even bolder strategy that you can choose to follow- and that is choosing businesses who could potentially disrupt yours to invest in. As part of a long term investment strategy this can be particularly effective. As well as a private investment, you could consider a co-investment platform which focuses on what are sometimes called high impact investments. These are centered on companies that aim for a positive environmental and social impact to what they do as well as looking to generate risk-adjusted financial returns. Including these kinds of investments as part of your overall diversification strategy is a great way to spread out risk and insulate against challenging circumstances in any one sector.
How Can I Move Forward With A Diversification Strategy?
If you see the logic behind having a strong and broad ranging portfolio – with business activities, personal investments or both, then you need to work out a way to move forward. Your moves are going to require funding, and how you do that depends on multiple factors, including your tax situation, what stage your business is at, and the specific reasons that you have to drive your activities. Entrepreneurs are often reluctant to make the move of selling part of their business, but the key is to think long-term and take a holistic approach to your wealth creation. There are other routes available. If credit lines are good and interest rates low, borrowing to fund a diversification strategy that you’re fairly confident in could work. Or if revenues within your existing company are strong, you could consider drawing on that in order to branch out and strengthen the whole.
This post is contributed by Jason Dirkham.
