The Washington region is home to a number of successful entrepreneurs who are building vibrant small and medium-sized companies across a wide spectrum of industries. This is evident in the growing number of venture capital firms, angel networks and private investors that are seeding start-ups in the city and its suburbs in Northern Virginia and Maryland.
The Interestate 270 corridor is lined with new technology companies, fueled by the National Institutes of Health and Lockheed Martin, both headquartered in Bethesda, which are helping power new biotech, health and security companies.
Meanwhile, alongside those start-ups are the myriad of business owners focused on providing healthcare, real estate, media and other traditional services. And most of them, no matter the nature of their business, take the profits from their companies and pour them back to the business to fuel greater growth.
So when these entrepreneurs look ahead to their eventual exit strategy, they often expect to finance a comfortable retirement simply by selling their biggest asset — their company. But what many of them fail to recognize is that they themselves are often their company’s greatest asset, and much of their company’s value goes with them when they depart.
Instead of focusing solely on building their business to one day sell it, entrepreneurs should consider two possibly counter-intuitive options to ensure their future financial security: One, allocate free cash to a long-term investment plan, and two, despite today’s booming stock market, invest in assets other than equities.
Rather than simply plowing profits back into their companies, many business owners would be better served by developing a long-term financial plan that is funded by their free cash flow, with deposits starting as early in their working lives as possible and allocated on a consistent basis. Ideally, the plan should be created with the assistance of a financial professional, and it would entail a careful evaluation of their most important needs, their risk tolerance and formulating written objectives oriented towards meeting those needs.
Portfolio reviews should be done regularly to monitor performance and respond to any changes in the individual’s financial circumstances and in the financial markets that may affect their investment philosophy. Executing the plan should be accomplished over a period of time rather than all at once, since it is sensible to diversify not only by asset class but also by timing of investments.
Moreover, investors often consider their portfolios diversified if they own equities across a range of sectors, and with the market attaining unprecedented highs in recent months, no one can be blamed for wanting to purchase stocks. Who wouldn’t want portfolio returns of up to 25 percent a year? But this represents the classic investment error of looking backward, not forward, when considering options.
The worst time to enter the stock market is precisely when it is booming. Instead, successful entrepreneurs should resist taking the easy route – buying stocks and more stocks – and put their free cash into less obvious asset classes with a longer time frame.
Among the options to consider are...
Multi-strategy hedge funds: As suggested by their name, multi-strategy funds engage in a variety of investment strategies, with diversification benefits that help to smooth returns, reduce volatility and decrease asset-class and single-strategy risks. These funds will not be the best performing category of hedge funds over a short-term time horizon. In the long term, however, the consistency and performance of multi-strategy funds should prove their worth, delivering high risk-adjusted returns, both in absolute and relative terms.
Private equity funds: Another option that has historically produced strong returns with fixed terms of 10 to 12 years is a private equity fund. These funds invest directly in private companies to fund new technologies, expand working capital within an owned company, make acquisitions, or strengthen a balance sheet. And
Real estate: Despite market turmoil of recent years, real estate is still an attractive option. For cautious investora, there are defensive real estate sectors such as self-storage, student housing and medical offices that generally hold up well in economic downturns.
Although each investor must determine his or her own risk tolerance and liquidity needs, a good rule of thumb for entrepreneurs would be to place 25 percent of their portfolio into long-term, illiquid alternatives. This will help to set in place a successful exit strategy and ensure a comfortable retirement, whether or not they manage to sell their firms for a high price. And by placing a portion of their free cash into alternatives, they will benefit from one of the better byproducts of these investments, namely, their very illiquidity.
Consider how many people sold equities at the bottom of the market and never bought back in. Those who instead were invested in private equity and hedge funds with quarterly, semi-annual and annual tender periods were forced to sit tight. By the time they could actually sell, the market had rebounded, demonstrating, once again, the value of a disciplined commitment to investing for the long term.
Jeff Leventhal is managing director and partner of HighTower Advisors in Bethesda, Maryland, where he specializes in complex financial planning, estate-planning strategies, institutional money management and small business consulting.
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