Entrepreneurs tend to be good at a lot of things. Their diverse skill set is often what allows them to take an idea from concept to execution, to scale. And because they are gifted, they sometimes assume that they can handle anything, including their own investing strategies.
It may come as a surprise, but personal investing seems to be a common weak point for many successful entrepreneurs. It is anyone’s guess as to why that is and it is likely that there is more than one right answer. Entrepreneurs are serial optimists, they trust their own judgment even in the face of criticism, and they are used to betting on the underdog (themselves). Those same attitudes make for poor investing strategies.
To understand what entrepreneurs get wrong in their personal investing strategies, I spoke with Paul Adams, CEO and Founder of Sound Financial Group, a Seattle-based investment firm that manages over $350 million in outside capital.
Here are some extracts from the interview:
Unrealistic Net Worth Calculation
Entrepreneurs are known to stretch the truth when talking with their friends and other business owners. While most of the time this is strictly about ego, it can also be the direct result of simply not understanding exactly how to calculate their net worth.
Adams says, “Entrepreneurs put an unrealistic value on the equity stake in their business. There is a difference between your personal balance sheet and that of your business. A business owner’s plans can dramatically change if his business gets sold for less than he planned. Entrepreneurs need to realize that they retire with their personal balance sheet and not their business balance sheet.”
Conventional wisdom says that an average investor can achieve a rate of return of 4% on total invested assets in developed markets and about 10% in emerging markets with a fairly conservative investing strategy. So let's say a business owner is earning $500,000 per year and the company is then sold. Just to maintain his lifestyle, he will need to have at least $12 million invested.
Adams says, “Once an entrepreneur sells his or her business, they are unemployed, and they need to make sure that they have enough passive income from investments to continue living a similar lifestyle for several years."
Is Business the Best Place for Investment?
Entrepreneurs love their business. It is often their passion that makes their business succeed or fail. But that does not mean it is the best place to deploy investment capital.
Just because business was good one year does not guarantee that it will be good the next. “A business venture is inherently risky,” notes Adams. “Expecting a steady stream of income from your business for the rest of your life is unrealistic. When you are looking to exit your business, it is only worth what someone is willing to pay for it.”
Entrepreneurs are optimistic people, and many think that their business will be worth several hundred million dollars when they choose to retire. Oftentimes, those plans do not work out. It is important for entrepreneurs to plan their personal investments diligently right from the beginning.