Entrepreneurs can face a variety of risks that employees generally don't. They are risk-takers at heart, which can lead to very bad financial outcomes. However, a financial advisor can help construct a portfolio for clients who are entrepreneurs so that the negative impacts of their entrepreneurial activities are rarely disastrous.
What Types of Risks Do Entrepreneurs Face?
Aside from all of the non-financial risks that an entrepreneur takes, there are many financial risks that are usually associated with starting a new venture. The guaranteed steady income associated with a W-2 wage-based job evaporates. There is an increased probability of wiping out personal savings. The entrepreneur's overall amount of debt may also increase due to increased usage of credit cards, personal loans from banks or family-based loans. The trifecta of no more positive cash flow, nest egg depletion and increased liabilities can wreak havoc on an entrepreneur's life in both the short term and long term. It is important to structure an investment portfolio properly in order to combat these risks.
Mitigating Lost Income
While a main goal of an entrepreneur's activities is to create something new and useful, the entrepreneur also wants the business to provide financial success. This comes at the cost of leaving a safe and steady job to begin building a business. Reliable income dries up upon leaving an employee role If the entrepreneur has an existing investment portfolio. Therefore, it may be wise for the entrepreneur to restructure his or her portfolio for income. Portfolio diversification has its benefits, but after deciding to become an entrepreneur, the growth component of the portfolio should be ratcheted down. The entrepreneur's own business is now the main growth component of his or her overall portfolio. Thus, the investment portfolio should be rebalanced to focus more on income-based investments, such as bonds and dividend-paying mutual funds and exchange-traded funds (ETFs). Many ETFs pay out their income and dividends on a monthly basis. If, for example, an entrepreneur has an investment portfolio worth $500,000 and it is totally restructured to have a yield of 6%, that could provide $2,500 per month of income. This amount may help dramatically as the business grows.
Mitigating Savings Depletion
An entrepreneur may decide to use capital in savings accounts to help fund his or her business. The entrepreneur's financial advisor can lessen the effect of this by restructuring the entrepreneur's investment portfolio to tilt towards income-based assets. Over time, the interest and dividends may help rebuild any used-up savings. The advisor can also carve out a portfolio from the existing portfolio to cover the necessary capital expenditure. For example, if an investor has a $500,000 investment portfolio and $15,000 in savings, and needs $10,000 to help start the business, it may be much wiser to sell some assets in the portfolio, reducing it to $490,000 and keeping savings at the exact $15,000 level for future emergencies. Cash on hand and liquidity may be much more important in the short term for general lifestyle and emergencies.
Mitigating Increased Liabilities
An entrepreneur should start a business with as few liabilities as possible. However, the entrepreneur may need to take on debt to get the business up and running. If other assets can't be sold and debt must be used, the best way to mitigate this risk is to create solid financial projections for the business and work directly with a financial advisor to construct a detailed, month-by-month cash flow projection for the entrepreneur's life. Once this is in place, it can be easy to see where the entrepreneur needs to make adjustments. Perhaps the investment portfolio should be restructured, certain personal expenses must be reduced or eliminated, or in extreme cases, the entrepreneur may need to sell off major items, such as an automobile or property.