Sooner or later, every entrepreneur asks themselves what will happen to the business they have built from scratch. This difficult reflection and decision-making process can often take years. The most important question boils down to whether the next generation is willing and capable of taking on the responsibility of managing the family business. If not, how will the role of the family need to change?
If the family does not want to continue with the business, a full or partial sale, perhaps even an IPO will need to take place. This leads to a shift in the total assets of the family from predominantly illiquid assets – the company and any operationally necessary real estate – to predominantly liquid assets which need to be invested and managed.
As soon as any transaction is completed, entrepreneurs must immediately get used to their new role as investors to protect their financial legacy and, hopefully, create further wealth. Not all entrepreneurs succeed in this metamorphosis, and it involves considerable financial risks. The development of these new assets follows a similar path to the development of a reputation. It’s a long and rocky road – and, just like your reputation, it can be ruined because of one bad decision. From my experience of working with families who have made this transition, new investors must consider the following three steps.
1. Define an investment strategy and plan your liquidity needs
Inevitably, when you sell your company, the news quickly makes the rounds. As a result, there is often no shortage of investment opportunities brought to your attention from a variety of sources.
It might be tempting to jump on the first or most attractive offer from one of these many suitors, but as with your own company, a clear strategy is of vital importance as you begin your journey as an investor. In which areas do you want to invest and what do you want to avoid investing in?
One crucial dimension here is liquidity planning. This consideration often plays a subordinate role for entrepreneurs at the private level, since a flourishing business usually delivers the liquidity needed for the family’s living expenses. This situation changes abruptly after the company is sold.
Liquidity does not normally become a problem due to excessive living costs, but rather due to the new investor making too many investments focused on long-term capital gain. In particular, the balance of direct investments into companies must be managed with discipline. Former entrepreneurs often see in another entrepreneur the same fire as they possessed back in the day and, as a result, they are more inclined to invest in these kinds of opportunities. Far too often, this leads to an imbalanced portfolio that is overly weighted towards entrepreneurial ventures, making it harder to take sufficient care of each investment and posing risks from a liquidity perspective.
If the necessary income fails to materialize to manage short-term liquidity needs, for example, it can trigger an abrupt rethink of current investments to meet those liquidity requirements. This can force an untimely exit from existing investments to meet current financial obligations. In turn, this sudden exit tends to have a negative impact on the valuation of the assets and usually leads to a loss.