Business owners and corporate executives tend to overinvest in their businesses, often ending up with a large portion of their wealth at risk to the fortunes of one company. However difficult, these owners need to diversify their financial assets to better survive periods of stress. The rules of prudent investing tell us that any more than 10 percent of one’s wealth invested in any one company is too much.
“Diversifying is not natural to individuals so closely connected to one business, but it can be a serious risk to their underlying wealth and the financial health of their entire family,” says Nina M. Baranchuk, CFA, Senior Vice President and Chief Investment Officer at First Commonwealth Advisors.
Smart Business spoke with Baranchuk about how to structure portfolios to diversify or offset these concentrated risks.
Why do corporate executives or business owners need to diversify?
Even regular employees get a company paycheck and buy company stock in the 401(k) or the employee stock purchase plan, so the concentration risks for all employees can be severe. Senior executives often accumulate additional large holdings of company stock and options as part of their compensation.
A business owner’s company may also be a disproportionately large part of his or her portfolio as well. An owner bears the risk of the entity and any economic, competitive or regulatory forces that might impact it. Like putting all your chips on red, there are serious consequences to holding so much ‘concentrated’ wealth if things don’t go well. In addition, these holdings can be illiquid — there is no easy exit under times of stress.
How should business owners construct their passive investment portfolios?
In some cases, it may not be possible to diversify much. If an owner can take cash out of the business, he or she should work with a qualified portfolio adviser to ensure that all of his or her passive investments are built to complement or offset the risk. A qualified adviser can craft a portfolio that helps to mitigate your specific concentration risks and manage your overall exposures.
For example, a local Pittsburgh businessperson might be concentrated in a steel or metal fabrication business. So, he or she would share exposure to the fates of this or other industries as well their end markets in the U.S. or overseas. He or she also may have significant risks to things like geography, interest rates, significant product input costs, etc.
You can easily have issues of exposure based on subtle or indirect connections. Some risks to a firm are really in your supply chain or the financial health of a customer’s industry. Maybe you have one or two dominant clients that represent a large percentage of your revenue stream. Geographical risks loom large for some companies as well.
A portfolio built to offset these risks might exclude many other holdings in the industrial arena and overinvest in industries that often do well when industrials/metals do not — think consumer-purchase staples like food and household products or utilities.
What’s another example of offsetting your risk?
One family we worked with had made its wealth in the real estate business — owning everything from apartment complexes to high-rises. Our analytic work found that two good offsets for these holdings were private equity and financial stocks. Thus invested, whatever happens to interest rates, private equity and financials will react in opposition to the direction of real estate, counteracting one of its most impactful environmental factors.
What should executives consider?
While many executives have limited ability to divest their options or stock, they should certainly not invest their 401(k) in the company stock or buy additional shares. Remember that the executives at Enron and WorldCom went down together, along with their options, pensions, paychecks and other compensation.
In this world of heightened competitive and financial risks, no business is immune from potentially negative outcomes. We urge our clients to make sure they have done everything possible to ensure their family’s financial health by planning for worst-case scenarios.
Nina M. Baranchuk, CFA, is a senior vice president and chief investment officer at First Commonwealth Advisors. Reach her at (412) 690-4596 or firstname.lastname@example.org.
To learn more, call (855) ASK-4-FCA, or visit ask4fca.com.
Insights Wealth Management is brought to you by First Commonwealth Bank
Not all executives have a financial or legal background. However, most would acknowledge a need to have a basic understanding of those areas to facilitate better communication with the company’s finance and law departments. Yet when it comes to information technology, executives often would rather leave all decisions to the “techies.”
“IT is a newer field that started as a separate entity — a black box that we didn’t understand,” says Sassan S. Hejazi, Ph.D., director of Kreischer Miller’s Technology Solutions Group.
He says executives have been comfortable delegating IT responsibilities to specialists, but there is a growing population who have taken the initiative to become more tech-savvy.
Smart Business spoke with Hejazi about the separation between executives and IT departments and the technology fundamentals all business leaders need to know.
Why do executives tend to take a hands-off approach when it comes to technology issues?
They understand the concepts, but think technology people should handle technology issues. They want to delegate these business improvements rather than get very involved themselves because they might not be familiar with the technology or are intimidated by the jargon.
What fundamentals do executives need to understand regarding technology?
Executives need a basic understanding of the:
- Right IT systems for the business; the wrong ones will not enable the company to achieve its business goals.
- Latest changes in technology. For example, IT systems are moving toward the cloud. Executives need to know what is happening with cloud technology and how it addresses the overall needs of their business.
- Impact of social media. They need to know how social media changes the ways customers interact with companies.
- Quality of data. If the right data is not being captured, decisions are not made properly. Executives need to be adamant about ensuring a high level of data quality in the system and that they’re capturing the right analytics.
Executives need to understand technology projects in order to take ownership of them and leverage specialized IT resources for those projects. If they want to gain a competitive advantage from IT investments they have to think of those projects as business improvements or business transformation initiatives rather than just technology initiatives.
When you have an IT professional in charge of an IT project, the tendency is to think of it as just a technology project. Implementing a new accounting system, client/customer management system, management dashboards or social media marketing program are very technology-intensive, but at the core they’re business projects.
How might leaving decisions to IT managers put the focus on technology instead of cost or business needs?
Even if they have an appreciation of business results, IT personnel are not impacted directly and are not involved in pricing and delivery of the company’s products and services. As a result, their decisions are focused on technological efficiencies rather than business realities. That’s why it’s important to have non-IT managers champion projects and be held accountable for their success from a business standpoint. Make sure they’re working closely with their IT counterparts, but leverage IT personnel as a resource rather than having them lead projects.
IT departments are viewed as a means to execute plans instead of participants in the planning process, and it’s often assumed that they don’t understand the business. If executive management makes decisions in collaboration with proper IT resources, it sets the tone for the organization and ensures IT managers are integrated within overall management decision-making. As non-IT managers become more tech-savvy, IT managers need to be more business-savvy. IT employees are also there to achieve business goals and involving them in the process makes them more engaged and productive team members.
Sassan S. Hejazi, Ph.D., is a director at Kreischer Miller. Reach him at (215) 734-0803 or email@example.com.
Book: Get Sassan’s new book, “Tech-Savvy Manager: Harnessing the Power of Information Technologies for Organizational Performance” at Amazon.
Insights Accounting & Consulting is brought to you by Kreischer Miller
Michael J. Torchia, a managing member at Semanoff Ormsby Greenberg & Torchia, LLC, gave a seminar to executive clients on individual liability several months ago. “Even if some supervisors knew they had liability under a statute or two,” he says, “seeing their actual exposure to 12 or 14 statutes shocked them.”
“I don’t think business owners have any clue how vulnerable they are to being sued under various employment statutes,” Torchia says.
This exposure is prevalent in areas like discrimination cases, and wage and hour claims which include unpaid overtime, exempt and non-exempt employees, and independent contractor status.
Smart Business spoke with Torchia about individual liability and strategies for protection and avoidance.
How are executives vulnerable to individual liability?
Many state and federal statutes explicitly state an employee has a right to relief against the employer and an individual. Some simply define ‘employer’ to include certain individuals. Examples include the Pennsylvania Wage Payment and Collection Law; Fair Labor Standards Act; Family and Medical Leave Act; Pennsylvania Human Relations Act; Pennsylvania Whistleblower Act; Immigration Reform and Control Act; and COBRA. There are also common law court cases allowing an individual to be sued under a variety of claims such as intentional infliction of emotional distress and defamation. Although incorporation helps shield individual assets — as opposed to, for example, a sole proprietor — the corporate veil does not protect individuals here because the statutes specifically allow action against them.
How far into management is the risk?
Generally, if an executive, manager or supervisor is considered a decision maker when it comes to employee issues, especially with regard to compensation, benefits or termination, there could be individual liability. In some organizations, that could be those at the ‘C’ level, president or vice president, but in others a secondary or middle manager could be individually liable.
What about executives who say, ‘I was following orders’ or ‘It was unintentional’?
‘Just following orders’ or ‘company policy’ may help, but is not an absolute defense. And whether the improper act was or wasn’t intentional is only relevant if the statute requires proving intent, bad faith or a knowing violation.
So, how can executives protect themselves?
At a minimum, managers, supervisors and executives should make certain they have adequate insurance. There are a variety of policies for individual exposure, such as employment practices liability, directors and officers, fiduciary liability, and errors and omissions. There are also lesser known policies that cover, for example, inadvertent disclosure of private information.
Another factor is asset protection. In Pennsylvania, assuming the executive is not already named in a lawsuit or under imminent threat of a claim, which could result in a fraudulent transfer claim, assets can be protected by putting a house, cars and bank accounts in joint names with a spouse. If not married, executives may consider increasing contributions to retirement accounts, which are not usually subject to collection.
How can executives and their companies avoid problems in the first place?
Training and education for managers, supervisors and executives — especially your decision makers — is key. They need to know how to handle all aspects of their supervisory duties, such as hiring, discipline, firings and employee complaints.
The company’s written policies should be consistent with the manager training and what is actually done day to day. Policy review and training should occur at least every three years, and sooner if there is turnover or changes in the law. Seminars and in-person training for middle managers is routinely overlooked or disregarded as unnecessary, but that it is one of the most important steps a company can take.
Most often decision-making executives, managers and supervisors are not trying to violate the law. However, with authority to bind the company, they can unknowingly cause liability to themselves or the business.
Michael J. Torchia, Esq. is a managing member at Semanoff Ormsby Greenberg & Torchia, LLC. Reach him at (215) 887-0200 or firstname.lastname@example.org.
Insights Legal Affairs is brought to you by Semanoff Ormsby Greenberg & Torchia, LLC