One strategy for successful advisors is to focus your practice on a concentrated group of clients and develop specialized expertise in solving problems that generalist advisors can’t match. As a result, you become the safe choice for this group and word-of-mouth kicks in.
While there are big advantages to this approach, it does have its downsides. One unhappy client can damage your reputation. You could get hurt badly if the client segment you focus on encounters hard times (think real estate developers in 2007). And sometimes your client segment has qualities that can make dealing with them challenging.
A recent conversation with an advisor who focuses on successful business owners illustrated one of the downsides of working with this group and provides some lessons for dealing with clients who have abnormally high appetites for risk. And some new Price Waterhouse Coopers (PwC) research on billionaires who, over the last 20 years, failed to maintain their wealth provides additional perspective on dealing with risk-prone clients.
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The downsides of dealing with business owners
When I ask advisors about the clients they’d ideally like to deal with, high-income business owners are often at the top of the list. Recently I spoke to Robert, a CPA and ultra-successful advisor who has built his practice by focusing on those successful business owners.
I come from a family of entrepreneurs and genuinely like bigger-than-life personalities. Because of my background I can relate to people who run substantial businesses and feel good about the fact that I can add significant value through sophisticated estate and tax-planning strategies, in a way that’s not possible if someone is an employee. I also like that people who run businesses are decisive. I don’t have the patience to deal with clients who dither and can’t make decisions.
Then we got to talking about the downsides of having business owners as clients. In response to that question, Robert made three points:
First you have to be patient. Many entrepreneurs have the bulk of their assets tied up in their businesses so you may have someone with a net worth of $50 million who has an investment account of $500,000. You never know when a liquidity event will take place so that you have to treat these clients as if they have much more money with you than they actually do.
Second, some business owners have huge egos and won’t listen to advice. I’ve learned the hard way that if a business owner is full of himself and isn’t really interested in my opinion, there is no chance of a lasting client relationship.
Finally, some business owners are overconfident about the future for their business, seeing the stock market as a crap shoot by comparison. At one level, I get this – if someone isn’t confident and optimistic, they’ll never get past the barriers that can discourage people, especially early on. But that same confidence and optimism can lead clients to hugely over-concentrate their net worth in their business and become vulnerable to unexpected downturns as a result.
New research on billionaires
Of course, business owners aren’t alone in being overly optimistic and confident. There are numerous stories about employees of technology companies who concentrated their 401(k)s in shares of the companies they worked for during the tech boom. And more recently this New York Times article titled When a Unicorn Stumbles described a start-up that was acquired for less than previous valuations, and its employees found their shares worth a fraction of the tax they had paid on them.
This behavior also extends to the extremely wealthy. A recent report from UBS and PwC, The Changing Face of Billionaires, pointed out the extent to which even extreme wealth can be lost. Twenty years ago, UBS and PwC identified 289 global billionaires. Only 126 of those are still on the billionaires list, making up fewer than 10% of the 1347 billionaires that UBS and PwC have identified.
What happened to the other billionaires in 1995? Unfortunately, 23% died, 8% went through a process of family dilution and 25% are off the list due to business reverses.
|
Died
|
66
|
23%
|
|
Wealth lost through family dilution
|
24
|
8%
|
|
Off list due to business reverses
|
73
|
25%
|
|
Still on list
|
126
|
44%
|
|
Total
|
289
|
100%
|
Of course, clients don’t have to be billionaires to suffer business reversals. Robert told me about an episode with his largest client at the time, an entrepreneur who founded a company that ultimately went public. In 2005, his long-time wife filed for divorce and the client had to come up with $20 million for the settlement that was negotiated. Robert and his client’s accountant and lawyer met with him to lay out some alternatives to come up with the cash. It entailed selling shares in his company.
The client refused to consider selling stock that he considered undervalued and instead borrowed the $20 million using his shares as collateral. The outcome was devastating – in the global financial crisis, the shares plummeted and the client got a margin call that he couldn’t meet. His entire holdings were sold at the bottom of the market and he ended up losing not just his shares but the bulk of his other assets. Today his client has a negligible net worth and rents an apartment, while his ex-wife lives large.
Dealing with overconfident clients
Many advisors have entrepreneurs as clients who are overconfident when it comes to their businesses. As a result, they are poorly diversified and fail to consider worst-case scenarios, take huge levels of risk –often more risk than they realize.
In some cases, these clients simply refuse to take advice and there is little that can be done to help them, except to ensure that your advice is in writing. In other instances, you might be able to enlist support from their lawyers, accountants or other professionals and get them thinking by sharing stories about entrepreneurs who suffered the consequences of failing to diversify.
This 2011 Wall Street Journal article, The Truth About Wealth, could also be helpful in providing clients with a reality check. It describes the shift from a time when people with wealth were more conservative and had lower volatility in their portfolios to today when the wealthy often endure higher volatility than the norm. It describes research pointing to the causes for loss of wealth: overconcentration, leverage, spending and family conflict.
The author also provided seven questions that will be helpful to determine if clients are taking an undue amount of risk. The questionnaire is reproduced below:
How high is your wealth beta?
To find out your "beta" rating – a measure of the volatility of your wealth relative to everyone else – answer these seven questions.
- Is your total debt relative to net worth ...
Less than 10% (1 point)
Between 10%-20% (2 points)
More than 20% (3 points)
- Is your total annual spending relative to net worth ...
Less than 3% (1 point)
Between 3%-5% (2 points)
More than 5% (3 points)
- Your most valuable asset is what percentage of your total net worth?
Less than 10% (1 point)
Between 10%-20% (2 points)
More than 20% (3 points)
-
What percentage of your total wealth is illiquid – that is, invested in a house, company or investment that can't quickly be converted to cash?
Less than 10% (1 point)
Between 10%-20% (2 points)
More than 20% (3 points)
- How often do you gamble, bet or play the lottery?
Never or almost never (1 point)
Once a month (2 points)
More than once a month (3 points)
- In social or business situations, do you believe you are the smartest person in the room?
Never (1 point)
Sometimes (2 points)
Most of the time or always (3 points)
- Do you think your lifestyle five years from now will be ...
Worse (1 point)
Unsure or the same (2 points)
Much better (3 points)
SCORE
7–10: Low beta
11–15: Medium beta
15–19: High beta
19 or higher: High-beta crash waiting to happen
Source: Wall Street Journal, December 11, 2011
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