Successful entrepreneurs know how to build businesses. They have put in the time and hard work and been rewarded financially. So when they sell, that liquidity event can seem like the perfect steppingstone to another business venture.
Nancy Marshall, head of family office services at Prime Quadrant in Toronto, frequently sees entrepreneurs who’ve recently sold their business turn around and immediately invest in a new one.
“It’s classic behavior,” she says. “You do what you know, and what you’re good at.”
But while it may be tempting to pour money back into a business, many entrepreneurs don’t realize that that isn’t their only option, Marshall says. Many fail to realize that the money generated by the sale of their business can be invested in a variety of diversified investments they may not know about or have considered. And that a diversified portfolio can help preserve and grow their wealth for future generations.
“It’s the difference between being a wealth creator and a wealth allocator,” she says. And it’s up to a family office to explain this distinction to a client.
Determining the capital’s purpose
Many families have gone from having the majority of their net worth tied up in a business to now having a lot of money in the bank. “Everyone and their dog are calling you,” offering fresh opportunities, Marshall says.
But before making a move, clients need to determine how the aims of their family align with that capital. At this point, family offices need to step in, she says.
Objectivity must be brought to the table, says Neil Hershcovitch, chief operating officer and investment platforms, BMO Family Office. “They’re looking for that advisory assistance,” he says. “Often people don’t know what they don’t know. We’re looking to understand what they’re seeking to accomplish.”
Hershcovitch agrees. “There’s definitely a place for that: Entrepreneurs are entrepreneurs,” he says.
But if the family collectively changes gears and wants to go in a different direction, they need to consider new investments. If the matriarch and patriarch have stated that they want the wealth to be multigenerational, Marshall says, “that’s when you really start to become a wealth allocator, when you’re starting to think generationally,” she says.
Yet the riskiness of the stock market can be a big deterrent for families who have traditionally reinvested their capital in businesses. That’s where education needs to come into play, in order to convey the idea that diversification is more than just fixed income and private equity, says Marshall.
Entrepreneurs pivoting to become wealth allocators need to think less like individuals and more like pension funds, meaning that assets should be matched to liabilities. “They know that they’re going to be paying out to certain groups at some point down the line,” Marshall says. “So they need to ensure that how they invest today matches those liabilities 20, 40 years out.”
A keen desire to learn
Entrepreneurs come to the table with lots of business experience, but many seek financial education, specifically about diversification, says Hershcovitch.
“Families tend to be quite humble,” he says. They often want to know how other families are investing. “There is a keen desire to learn.”
Oftentimes they want information about access to investment vehicles that aren’t broadly available to the mass affluent market, he says. “Access is very important with this segment,” he says. It doesn’t help that Canada lags the U.S. in offering these asset allocation opportunities. As a result, family offices have to demonstrate what they can bring to the table.
That includes educating clients about myriad investment opportunities and making clear that they need to invest across all asset classes, such as private credit, private equity, venture capital and diversified strategies such as hedge funds, says Marshall. “Each of those asset classes has a different role to play in your portfolio,” she says.
A big part of the education process is letting clients know that they need to learn “who the good operators are out there in all these spaces,” Marshall says.
Next, they should be made aware that how these operators are judiciously managing capital is similar to how the family business created its wealth in the first place. “Those parallels have to be made,” she says.
Marshall says that Quadrant Capital employs a chart that tracks various asset classes over 20 years; these include hedge funds, high yield, direct lending, private equity or venture capital.
Clients ‘looking for a philosophy’
“You can effectively, with a well-diversified portfolio, lower your volatility and increase your returns,” she says. She often tells clients to send her details about their current portfolio and runs projections on what it would look like across multiple asset classes. This can help clients visualize how their portfolios could grow over time.
Hershcovitch says it’s critical to discuss the building blocks that need to be included in the portfolio and how an actively managed portfolio can help with what the family is hoping to achieve. “It’s a collaborative process around crafting a broader investment strategy,” he says. And not everything is a fit for everyone.
“We need to determine the opportunities for success,” he says.
More from Canadian Family Offices:
- Five smart ways to transfer wealth to your children, grandchildren
- Paying the absolute lowest in tax no longer top priority for today’s families
- Recent changes to Canada’s tax laws could be costly to family businesses
- Money-related disorders are proof that wealth can’t fix everything
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