Entrepreneurs need to be smart about diversifying their business activities and capital.
The COVID-19 pandemic has considerably reduced the number of new start-ups in Luxembourg. According to the Global Entrepreneurship Monitor 2020/21, the number of new businesses registered in the country has fallen sharply from an average of 3,500 per year between 2014 and 2019 to around 2,000 in 2020.
Fewer people started new businesses during the pandemic. This is because doing so inevitably involves a high level of risk for entrepreneurs who often choose to forego a secure income and become responsible not only for their own investments in the business, but also for the financial resources entrusted to them by third parties through loans or investments. Moreover, the chances of success are generally not very good – it is estimated that 80% of new businesses fail within the first 18 months. In the meantime, the number of new business registrations has risen again, but this episode has certainly made entrepreneurs much more sensitive to the issue of risk. Here are some tips on how to manage risk wisely.
The danger of self-confidence
Many entrepreneurs tend to invest their assets in one or two ways, i.e. in their company and/or real estate. This is completely understandable – why devote your life to a business venture if you can’t reap the benefits of its success? In this context, entrepreneurs often feel that they can generate a much higher return than any asset manager. This can lead them to underestimate the risks involved and fail to identify the major benefits of diversifying income streams, be it in terms of business strategy or indeed asset portfolio management. To mitigate the risks, good advice can be worth its weight in gold.
Even the most financially sound company can be confronted by trends and forces that are completely beyond its control.
Companies are inevitably at the mercy of market conditions. Even the most financially sound can be confronted with trends and forces that are entirely beyond their control, such as central bank interest rate policy or the development of disruptive technologies.
In addition, potential cash flow problems exist. If you need cash quickly, you cannot afford to sell part of your business. Identifying new sources of funding takes time. It is therefore wise to rely on alternative options through wealth planning to ensure that personal financial plans do not interfere with the business.
A long-term strategy maximises the chances of success
Sound entrepreneurial conduct and long-termism, not to mention seeking advice from experts, such as financial advisers, are essential when it comes to protecting your company’s assets. Although the possibility of selling a start-up for several million euro to a large, financially strong group may seem tempting, such an opportunity very rarely arises and usually involves a major technological innovation or else perfect timing. Even for a successful company, an exit is never easy. To survive, companies must focus on client retention, income streams and raising capital.
Companies need to focus on business sustainability.
Many entrepreneurs are vehemently opposed to the idea of ceding any form of control to external shareholders or investors. However, it is perhaps a good idea for businesses to have access to alternative sources of finance just as it can be beneficial to bring in new ideas from the outside from time to time. This is especially true if an existing source dries up for any reason. There is a need to react quickly as a limited cash flow usually means the death knell for small businesses.
Likewise, sound management means always seeking the most diverse portfolio of clients and therefore sources of income, even if this is not always possible.
Managing private assets securely
The diversification of private assets is even more important than that of commercial activities. It makes sense for entrepreneurs to build up a certain amount of wealth outside of their business through investments not linked to the main source of income. For example, tech entrepreneurs might tend to invest in tech stocks when investing in a private capacity. Of course, it makes sense to invest in what you know, but it also makes sense to invest outside your preferred sector. It is essential that you take a step back from your sector and take a long hard look at it. Business owners must be prepared to think outside the box and invest in areas outside their professional expertise.
This means diversifying in terms of both country and sector. If an entrepreneur is mainly active in one country, it may make sense to look for investment opportunities elsewhere. The United Kingdom’s unexpected departure from the EU (Brexit) has shown how quickly businesses that rely on a single country’s status can find themselves in trouble due to sudden political upheaval.
A consistent mix of assets
While the mix of cash, bonds, stocks, real estate and other assets may vary from entrepreneur to entrepreneur depending on personal circumstances, age, preferences and appetite for risk, the starting point for diversification is always the same. Entrepreneurs should consider whether they are in a position to remain solvent both professionally and privately in the event that their company encounters major financial difficulties, i.e. an economic downturn, natural disasters such as fires or floods, illness, etc.
A diversification plan requires a comprehensive review that includes individual consumption behaviour, family responsibilities and retirement savings. Often, the solution will not only consist of investments, but will also include insurance, such as covering the risk of depending on one sole person (key person risk). For an optimal diversification plan, we recommend consulting a financial adviser.
An entrepreneur’s ideal asset mix may deviate significantly from that of other investors, as he or she must take into account the company’s specific circumstances. You should bear in mind that it is possible to sell all or part of the business at some point in the future, which has implications when it comes to taxation and inheritance planning.