Does Good Financial Planning Discourage Entrepreneurship?

Posted by Michael Kitces on Monday, March 5th, 3:24 pm, 2012 in General Planning

As financial planners, we have a drive to see our clients succeed, as both a mark of successful financial planning, and because no one wants to be the planner whose clients fail (for both personal fulfillment and legal liability reasons!). As a result, planners often encourage a steady path that may entail some "prudent" risk, but nothing excessive. Yet this often puts planners in a difficult position with very entrepreneurial clients, who often take significant career, business, and financial risks in an effort to build their businesses and significant wealth. Even if the planner is not directly responsible for the entrepreneurial client's business outcome, we don't necessarily want to be there when it all falls apart, either. In fact, if the client has a choice between an entrepreneurial venture or a salaried career, the planner typically recommends the path of lesser risk; it's just prudent, good planning. Yet in the end, does that mean good financial planning actually discourages entrepreneurship and makes it nearly impossible for clients to actually accumulate very significant (e.g., $10M+) wealth?

The inspiration for today's blog post is a recent conversation I had with a small business entrepreneur, who stated that after trying several financial planners, he found planning advice to typically be directly contrary to what had made him successful and capable of generating significant wealth. The problem, as he stated it, was quite simple: financial planners discouraged him from being the successful entrepreneur he is!

To understand the criticism, it might be helpful to give a little more background about my entrepreneurial friend and tell his story... 

To say the least, my friend is quite comfortable taking risks. He's started 6 businesses over the past 30-odd years. The last one is still underway, but in the preceding decades three ultimately went bust, one was moderately successful, and one was a big success. The sale of the latter in particular (which was actually his 5th of the 6 ventures) allowed him to walk away with almost $15M of what is now a net worth well in excess of $20M.

However, the path wasn't so rosy early on. My friend spent the first 12 of his working years bouncing back and forth between moderate and extreme financial duress as his first two businesses each ultimately failed. Fortunately, the third time was a charm. That business survived and grew, and ultimately was sold for a tidy sum (about $5 million!) that would have been enough for most people to live a comfortable life without working again.

Unfortunately - or fortunately, depending on your perspective - sitting back on his laurels is not how my friend is wired. It was less than a year from when he had his "payday" on the 3rd business, before he started going to work on the 4th business, and it was barely another year thereafter before he started to plow some real money into the company as the business began to grow. The entrepreneurial drive in him was exhilarated to see another business growing again. Unfortunately, though, after a few years a key employee left in an ugly blowup, and took several key clients along with him; after much litigation (absorbing even more money), the business ultimately went under. There was less than $2M left of the original $5M from the prior business sale. What could have been retirement became a forced un-retirement (given his desired spending lifestyle).

And so my friend went out for yet another venture, ultimately working with a client from the prior company who wanted to start a new business in a related industry. Fortunately, this venture went more smoothly, although my friend tells me that he depleted his net worth even further in the first 5 years while he was taking almost nothing out of the company during its initial growth. Ultimately, though, the business was very successful, and after 13 years the exit sale finally came; his share, as noted earlier, was about $15M.

At this point, my friend was well into his 50s, and although he has since started yet another business (now his 6th and current), he's taking it a bit easier this time. Having finally reached his current level of wealth, he is more mindful of protecting the bulk of his assets, and while he will likely still venture what might be "a few million dollars" into his latest opportunity, he is genuinely committed to not putting his entire financial future at risk again.

The problem, though, is that it took 5-6 business ventures - including three total failures - to reach that point. The first two failures were at least fortunate enough to come when he didn't have much wealth anyway, although he certainly "fell behind" his peers in saving for the future. The third business failure, though, was bad enough to lose much of the wealth that he had built from his prior success. And alternatively, the wealth he built in his 5th business was far more than he ever would have seen by taking a "safer" path in the first place.

From the financial planner's perspective, this would be one tough client. If my friend had been the client of a financial planner back in his early years, the advice probably would have been pretty straightforward: after a decade of failed business ventures, stop plowing your money into new risky startups, and instead go get a "real" job with a more stable income so that you can start saving for your future. After all, virtually no financial planner is really comfortable telling a client "Sure, go ahead and risk bankruptcy and financial destitution again; after all, your first two businesses ultimately lost everything, but maybe the third time will be a charm." Except the third time was a charm. And the story played out again with near financial ruin in the 4th business, and an even bigger payday in the 5th.

The fundamental conflict here is that entrepreneurship itself is risky, but most financial planners are not risk inclined, at least when it comes to the advice that they give their clients. Who wants to be the financial planner who told this client to keep going for it after the first business failed? After the second failed? What if the third had failed too? And after the third succeeded, would you have ever told the client to go back and risk the majority of his net worth on the fourth and fifth? At which of those various points - perhaps all of them - would most financial planners have told their clients to stop? No planner wants to be the one who was there when the client hit rock bottom by taking risk that went bad.

The unfortunate irony is that by actively discouraging this kind of risky entrepreneurship, we also prevent our clients from creating very significant wealth at all. Because the simple fact is that people can only create so much wealth by getting a job, saving a portion of the salary, and growing it over many years in a diversified portfolio. Yes, you can become a millionaire that way. You might even make it to two or three million dollars. And that will afford you a pretty darn good living in most parts of the world.

But if your goal is more, the reality is that it's pretty difficult to make it to $5 million with a diversified portfolio funded by just spending less than you earn. And no one ever makes it to $10 million by diligently saving and investing a salary in a diversified portfolio for 30 years. If someone wants to see more than $10 million, they have to build or create a business that generates economic value over and above their raw time and labor. You simply can't earn a big enough salary or earn high enough returns in a diversified portfolio to do (at least not over any feasible time horizon). But given our risk inclinations as planners, we actively tell people not to risk their current net worth and financial future in new business ventures (especially after a chain of prior failures) and not to hold concentrated amounts of their wealth in that (or any) business or investment (as my friend did with business #4 that failed, and business #5 that succeeded). By doing so, we may help most clients reduce risk and build "comfortable" wealth - and that probably is more than good enough for most people - yet we are actively discouraging people from entrepreneurial activities and having a shot at "very significant" (e.g., $10M+) wealth.

Of course, most clients don't have these kinds of aspirations for wealth, or the entrepreneurial drive, that my friend has. But on the flip side, I'm not certain most financial planners would know what to do with such clients if we did have them. We certainly aren't very likely to encourage these kinds of risky career, business, and financial behaviors in clients. And clients who are on the line about whether or not to take the risks of entrepreneurship are more likely to be discouraged by a planner, than encouraged (unless perhaps the client is already wealthy).

So what do you think? Is there a gap in the professional skillset for financial planners to effectively guide entrepreneurs? Is it possible to overcome the conflict when a planner wants to support a client's goals, but the goals themselves are so risky that there is fear of a professional liability backlash if things go wrong? Have you ever had clients like this? How did you handle it?


  • moolamaven

    Great point. I believe there is indeed an inherent dichotomy between a typical entrepreneur and a typical planner.I also believe the tension is healthy both ways.. fire and ice:).

  • http://healingfinancialanxiety.blogspot.com jim schwartz

    Michael

    Quite frankly the navigation is quite easy in this situation with entreprenaurs which I dealt almost exclusively when in practice.

    The question is

    1- Becoming 'independent' of one's 'independent' business - giving (I clean this up) screw you ability
    2- Given #1 what is Enough, how to protect it - to be independent of one's independent business with 'screw you ability'
    (I delve into this in the second edition of my book Enough 1995

    The even bigger question especially for entreprenaurs who have a tendency to 'make it lose it, make it, lose it' of self definition - mission (Enough to live on; Enough to live for)- or make it lose will just become lose.

    And when it just becomes lose - it's 'I can't cut the mustard' - but that's another discussion.

    jim schwartz

  • Badrish

    Michael,
    One can draw final blue print on the above example given the probability of success v/s failures, we as planner given too much importance on just helping mere one segment of the income group(i.e. salary ) we do not have either skill set nor conviction nor mentors who can help us in resolving some of the complicated cases like this.

    With one's understanding there is a limitation as far as planning is concerned since such plans has to act in midst of uncertainty. We are driven by our goals,aspirations and personal commitments (Which is also pretty fragile). Fear of failures and professional ethics always have common conflicts. which can be resolved through proper understanding of one's own fear as financial planner. We dont have time to go deep into it.

  • http://www.peaceofmoney.com Charlo Maurer

    The difficulty I've run into with entrepreneurs is that their spouses are miserable with years of worry about whether their spouse will eventually make a profit or not, as they can spend years in spending down mode rather than saving for retirement or college. I see our responsibility is for the overall financial health of the family, so planning has involved setting time deadlines for the entrepreneur. I think it would be much easier to support risk taking for single entrepreneurs than married ones.

  • http://www.ifs-advisor.com Joe Pitzl, CFP®

    Great post Michael,

    This issue is entirely a function of skill-set. The education system for financial planners and subsequently, the systems we build in our firms to increase efficiency and capacity are not designed to advise this type of client.

    If we continue to define financial planning as preparing projections and monte carlo results, we aren't going to work well with these folks. They need and wants a lot of help, but we can't approach them and their situations with the same hammer we use for two salaried employees. If we are unwilling to adapt our services to their lifestyle, we have a responsibility to let them know we aren't a fit for them.

    I would argue that it really isn't good planning to steer these folks toward the path that makes our job easier. Some people are just hard-wired for something different...they see the world through a different lens. Our job isn't to make everyone conform to our ideology and biases. And this isn't an education issue. These are smart people and they understand what we are telling them, but they just have a different opinion.

    In part, our inability or unwilliness to deviate from an AUM model is a major contributor toward the inability for planners to adapt. Entrepreneurs and their families struggle with cash flow, insurance, taxes and estate planning as much or more than the average person.

    There is a massive opportunity out there for the planner who is willing to adapt to work with them.

  • http://www.fjyfinancial.com Dan Joss

    Financial Life Planning on retainer is the key. We encourage clients to follow their dreams, overcome their obstacles and their fortunes or failures are not tied to our fee.

    • Michael Kitces

      Dan,
      I definitely agree that in practice, an AUM model virtually always presents an awkward conflict to highly entrepreneurial clients, who simply aren't interested in "tying up" capital in portfolios. They prefer to keep it liquid to deploy towards business opportunities.

      That being said, I think there's still a more fundamental conflict, about the risk tolerance of entrepreneurs and the risk inclination of advice-givers.

      I still don't see many financial planners on retainer that are really comfortable telling a client "sure, risk virtually all of your net worth, including the home that shelters your family, on this business idea you've got" even if it is the client's dream - although in reality, that's what many active entrepreneurs do, some quite regularly.

      Yet I'd hate to be the financial planner explaining to the wife's attorney how we counseled "well, it was the client's dream..." Not that I'm trying to be tongue-in-cheek here, but there are some real liability risks for the planner when clients pursue these paths; it's an unfortunate reality that sometimes, when they don't work out, there's an effort to place blame.
      - Michael

  • http://opendoorinvestments.com Joseph Alotta

    Michael,

    I went to a top 5 business school. Back in the day, they were stressing entrepreneurship and used their connections to get us students internships at various venture capital consulting companies.

    I personally worked on over 30 startups. I learned the largest cause of small business failure is not having a plan and not working according to it. I am presently assisting two companies in the Bitcoin space.

    Later, when I was working at the bank, I personally invested in several start up companies.

    One lady spoke to me about her business idea. I told her I was "all in". She went off and developed a business plan that needed about $100,000 in capital and came to me for a check. I told her to rework the plan so to make the bottom line $25,000. She was mad. Indignant. But no one else was giving her money, so she came back a few weeks later with something close to $25,000. I tweaked it a little and she become several times over a millionaire in this business of hers. It was an industrial design firm. Yes, it was harder for her to do without the convenience items she originally wanted, but borrowing for these increased the chance of failure dramatically.

    So the answer to your question is three fold:

    1) Entrepreneurs really need financial planning. But startup planning is not just MoneyTree Pro in a box, it takes a lot more. Maybe if your friend had good financial counsel, he might not had as many busts as he did.

    2) If my client had $5mm in total assets, I would counsel him to find a business idea that only needed $500,000 to start. The idea is to get the business off the ground and generating cash as quickly as possible. A lot of business plans have fat that can be trimmed.

    3) It is never your decision to tell the client one thing or another. It is their life and they make the ultimate decisions. You can only show the options. But if you are investing your money, then you have some say.

    Sincerely,

    Joe Alotta.

  • http://www.JLFwealth.com Joyce Franklin

    Excellent post, Michael!

    Your post dovetails nicely with what I'm hearing in the interviews I'm conducting for my upcoming book on IPO successes. I encourage my entrepreneurial clients who have achieved financial independence to carve out what they need to meet their living expenses for the rest of their life, and -- if they are so inclined -- to invest the excess in new ventures.

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