This comes back to the point that however skilfully you manage your business, political, economic, social and/or technological events and developments beyond your control can be disruptive.
In the past two decades alone, we have seen the tech crash of 2001 and the global financial crisis of 2008 as notable examples. Though it would be sensationalist to predict what might come next, it is nonetheless sensible to take preventative measures.
Key Points
- With increased uncertainty, entrepreneurs might be best placed to protect their interests
- Most of entrepreneurs' risk is tied up in their business
- It is important for them to diversify their dividends
This is where diversification can be a valuable tool, as it provides alternate sources of return.
Furthermore, financial portfolios can provide an extra source of cash income, and benefit a business. Entrepreneurs who rely exclusively on their businesses to finance their lifestyles can bias decisions in favour of extracting cash flow from them to the detriment of pursuing long-term opportunities for their company.
A diversified portfolio is less likely to be damaged by setbacks in any individual security, sector, asset class, country or region. Entrepreneurs and executives can go beyond this approach. They can use their portfolios to counteract some of the potential vulnerabilities in their core businesses.
A necessary step?
There are two questions entrepreneurs should consider when deciding whether diversification is a worthwhile endeavour for them. The first being: could they maintain their lifestyle if their business failed?
Entrepreneurs usually bear considerable ‘idiosyncratic’ risk related to the challenges that their businesses face.
Such problems can strike a business even in periods when the global economy and stock markets are doing well.
Companies are exposed to operational risks outside of their founder’s control. Industrial accidents, the collapse of a major supplier or client, or a trade dispute, for example, can lead to major losses.
Entrepreneurs can often bounce back from such setbacks, but nobody wants to have to make a fortune twice. The profitability of a company may also fluctuate in a way that makes it hard to maintain their lifestyle and obligations to family and charities.
This problem can be couched in terms of liquidity, longevity and legacy.
Many entrepreneurs – especially those eager to reduce risk – may want a relatively large component of their portfolio to be liquid.
A liquid asset fund can enable business owners to meet their near-term lifestyle needs without having to make rash decisions that can impair the long-run value of their business.
Holding excess cash is usually not the best option since bank deposits do not rise in value during a crisis.
