The other key question for business owners to consider is: are they missing out on other opportunities by concentrating risk? This can mean over-investment in a single company, over-reliance on a single market, over-exposure to a single currency, or over-investment in a single asset class.
If the answer to question one was no, or the answer to question two was yes, then diversifying wealth is likely a rational next step.
However, diversification is not without associated costs, therefore entrepreneurs need to consider carefully their options for how to go about funding it.
Alternatives to selling part of your company
As an entrepreneur you may be reluctant to sell all or part of your business. Doing so could reduce your control over the company, which can be particularly unattractive if your business is young and growing fast. Likewise, a sale can generate a large tax bill.
Executives may not be able to sell their corporate stock holdings due to company or regulatory restrictions.
However, there are ways to unlock funds without incurring major tax bills.
Parts of your business may be doing less well, potentially generating taxable losses to offset gains. There are similarly numerous vehicles that can offer tax efficiency, including exchange-traded funds, charitable trusts, and foundations.
Exchange or ‘swap’ funds enable investors to exchange large holdings of a single stock for units in a portfolio without producing immediate capital gains. These funds have several advantages: funds typically manage companies in a wide range of sectors and control the entry of new investments if their holding becomes unbalanced.
Drawing on salary or dividends
If your business generates cash, drawing on it to diversify can be a good option.
More mature companies may create fewer compelling opportunities for which returns exceed the cost of capital. At this point, taking dividends and investing in the market may produce a better outcome.
Executives holding stock also may not be able to spend dividends until the stock vests.
Tax efficiency remains an issue, though, since dividends and income are subject to taxation in many jurisdictions. But you do not need to generate a large capital gain through this method.
Borrowing
Entrepreneurs are often accustomed to using debt. It may have played a significant role in building their business.
While many traditional savers focus most on the risks of borrowing, entrepreneurs recognise the opportunity to earn returns in excess of the cost of debt. And when their company is growing fast; borrowing can prevent them from having to sell.
Entrepreneurs can use several types of borrowing to fund diversification. They can borrow against property or against other physical assets. They can also borrow against a single stock.
Borrowing against assets entails risks.
