With Eric Schurenberg, Editor-in-Chief of Inc. Magazine
When Do Entrepreneurs Cross The Line From Passion To Self-Neglect?
Eric Schurenberg, Editor-in-Chief of Inc. Magazine, joins The Steve Pomeranz Show to talk with Steve about an article Inc. published on the financial habits of highly effective entrepreneurs and wealthy CEOs. The overriding principle, that in the long run separates successful executives from the rest of the pack, is “diversification,” which, in this case, refers to a diversified personal wealth portfolio. A common scenario with entrepreneurs and CEOs is that they’re so focused on growing their companies that they neglect their personal finances. Passion can become a kind of myopia equating the success of their company’s future with personal financial sacrifices made in the present. They convince themselves that any type of personal enrichment—from taking a larger salary to saving money in personal accounts to selling company stock—is at cross purposes with growing their business. Needless to say, not only can this outlook be personally damaging in the here-and-now, the negative impact it could have on the entrepreneur’s estate can also affect their families and other beneficiaries.
Extreme Lack Of Diversification
The attitude we’re describing is informed by a philosophy that goes something like: “Take care of the business today, and it will take care of you down the line.” While total commitment to their company’s growth and success is in many ways par for the course for entrepreneurs and is generally lauded by peers and outside investors, when it comes to managing their personal financial goals and risks, company founders and executives would do well not to sink every last dime into their companies. Instead, they should diversify their wealth, just like everyone else. Too many company founders believe so fervently in their company’s story that they see their own path to riches as running through their company’s eventual success, to the exclusion of every other kind of investment they might make while building their business. From a risk standpoint, this is borderline crazy. No financial planner would ever advise a client to put all of their eggs in a single basket, and the fact that the basket, in this case, is one’s own company makes no difference. There is also a widely-held belief that publicly investing all of your money in your company is a show of faith and confidence that will inspire investors and employees. This might be true to an extent, at certain junctures anyway, but that doesn’t make it a wise strategy overall.
1. Getting Started: Dedicated Retirement Account
Instead of betting everything on a huge payout down the road, entrepreneurs and CEOs should spend time and money diversifying their assets today. A good place to start is setting up a dedicated retirement account. A surprisingly large percentage of entrepreneurs skimp on this (up to 75% according to Inc.com), thinking that they will enjoy generous benefits when their company reaches a certain maturity. Eric describes a “solo 401k” program for people running solo businesses with only outside contractors. This has a big advantage over other 401ks because the maximum contributions are much higher, up to $50K a year, or $100K if a spouse works for the company as well. Entrepreneurs may never need this money if their dreams for their company come to fruition, but think of this as an insurance policy against the possibility that plans to become wildly wealthy come up short. There are, of course, a number of other types of retirement accounts that can be set up, each with different advantages, tax features, and so on.
2. Buy Stocks Outside Your Sector
On a closely related note, entrepreneurs and executives should not load up their retirement accounts with company stock. It may seem sensible to them because they’re convinced they have a strong grip on the underlying value of their company, but this can be another case of losing sight of the forest for the trees. They also shouldn’t invest in young companies in their own vertical—competitors, in other words—that they have confidence they understand well and expect to succeed because of their conviction that the whole sector is on the rise. Investing outside one’s “circle of competency” (i.e. in other industries) so that the cyclical pattern of one industry doesn’t over-determine investment results is a good start towards diversifying one’s wealth, but it ought to go much further than that. A financial planner can, of course, point out numerous other opportunities to diversify portfolios, and it’s a near universal consensus in that profession that one should own a mix of stocks, including some from foreign markets, bonds, real estate, and other assets.
3. Sell Equity Along The Way
Owning a lot of “sweat equity” in the form of stock or stock options is not sufficient to guarantee future wealth. There is a myriad of potential setbacks or digressions from the master plan that young companies can be subject to. For this reason, among others, it’s a good idea for founders to occasionally sell off some equity or options to increase their personal liquidity and, in turn, make investments in other assets. Selling some equity while the company’s stock is thriving can be a hedge against a future scenario where founders might be under pressure to raise cash by selling stock when its price has been beaten up.
4. The Necessity Of Teamwork
The fourth habit of successful entrepreneurs that Eric talks about is putting together a team outside of the company for providing guidance on tax issues and estate planning. This follows the general principle that it’s smart to hire outside experts when one’s own knowledge is limited. A tax advisor—again, not from the accounting team in charge of the company books—will bring valuable expertise to the table that’s relevant to personal wealth. Entrepreneurs face some unique challenges and opportunities related to stock options and equity. Without a sound strategy for dealing with these technical tax challenges, the IRS may end up taking a large portion of founder’s net profits. It’s equally critical for company founders to talk with an estate planner, as this is an area that can get complicated for non-experts very quickly. Estate planning attorneys help navigate complex federal and state laws and minimize the amount of money held in a taxable estate. Mistakes here can be very costly for family and charity beneficiaries. There are strategies like setting up trusts that can minimize both taxes and the disclosure of financial details in probate court.
Wrapping up the conversation, Steve asks Eric to elaborate on the findings of a survey conducted by Inc.com of Fortune 500 company founders which revealed that 77% of them used their own money (and company income) to fund and grow their companies, as opposed to raising money from venture capitalists or angel investors. Playing devil’s advocate, Steve wonders why startup founders don’t pitch their business plans directly to banks to get loans. Eric explains that getting outside investment brings headaches and complications, primary among them the expenditure of time trying to win funding, certain dilution of equity, and a risk of losing strategic and management autonomy. While funding rounds from VC money play well in the press and contribute to a kind of score keeping among rivals, in the end, it amounts to a selling part of the company before it has even gotten off the ground. Eric argues that seeking outside help is sometimes necessary but is always also a mixed blessing. Outside investment entails admitting new advice and influence on the direction of the company. Without the financial sweetener, Eric wonders if the input and advice of VC and similar firms would ever be sought out. His advice to entrepreneurs is to resist the allure of outside money and bootstrap their companies with their own cash and operating income. The discipline acquired from working within available means can lead to better results over time.
Disclosure: The opinions expressed are those of the interviewee and not necessarily United Capital. Interviewee is not a representative of United Capital. Investing involves risk and investors should carefully consider their own investment objectives and never rely on any single chart, graph or marketing piece to make decisions. Content provided is intended for informational purposes only, is not a recommendation to buy or sell any securities, and should not be considered tax, legal, investment advice. Please contact your tax, legal, financial professional with questions about your specific needs and circumstances. The information contained herein was obtained from sources believed to be reliable, however their accuracy and completeness cannot be guaranteed. All data are driven from publicly available information and has not been independently verified by United Capital.
Steve Pomeranz: I’d like to welcome Eric Schurenberg. He is the Editor-in-Chief of Inc. Magazine, a wonderful magazine and Eric is with us right now. Welcome to the show, Eric.
Eric Schurenberg: Nice to be here. Thanks.
Steve Pomeranz: One of your articles that I enjoyed reading was the “Four Financial Habits of Highly Effective and Wealthy CEOs.” You know, Eric, with most entrepreneurs laser focused on their business, so many forget to take care of their own personal finances. Tell us about that.
Eric Schurenberg: Well, you’ve got that absolutely right. The main thing about these four habits of highly effective and wealthy CEOs is that they avoid the biggest problem—they don’t diversify. They have all their risk and all their hopes in one basket, namely their company. They figure that sometime in the future “I’ll sell this for millions of dollars and I’ll be set.” Maybe or maybe not. The habits are ways of getting your generic hydrocodone risk out of your company and diversifying.
Steve Pomeranz: Very good. What would be the first blush habit to do?
Eric Schurenberg: The first one is to fund a dedicated retirement account. You may think that this is obvious, especially if you’re working for a company, but for a lot of entrepreneurs, it’s not obvious. They really think that it’ll be taken care of at the company. One of the best ones if you are a solo worker or hire only contractors is what’s called a solo 401k.
Steve Pomeranz: Why is that good one?
Eric Schurenberg: It allows you to set aside as much as $50,000 a year or retirement income. If your wife is working for you, you can each do that, so that equals up to $100,000.
Steve Pomeranz: That can build up pretty quickly.
Eric Schurenberg: It can. It can. You have to have enough income to support that, but it not only can add up quickly, but it’s tax deferred. It comes off right off the top, off your personal income. As far as the IRS is concerned, in the year you earn it, it disappears. You only have to pay taxes on the backend when you pull the money out.
Steve Pomeranz: Right, and then the money grows, of course, tax deferred, like an IRA or something like that.
Eric Schurenberg: Exactly.
Steve Pomeranz: Sure. Fund a dedicated retirement account for yourself once you can afford to do that. Remember one other, I think, rule of thumb that people forget about is make sure you diversify within your pension plan. I want to discuss that in a little bit more detail later on. Let’s go to number two. Number two is what?
Eric Schurenberg: It’s very similar to that idea that you just raised which is when you fund that 401k, solo 401k or whatever kind of retirement plan you have, profit share rate, whatever, don’t overload it with your own company stock. It’s an easy mistake to make because you think, “Well, I know this company. I have a lot of faith in it, and buying stock will show that.” Nobody has perfect foresight into the future. You don’t know that your company is going to be healthy without any interruption. You want to spread your risk out. Get some of your future out of your company and diversify it across a whole range of stocks or other investments, not just stocks.
Steve Pomeranz: Here’s an interesting point as well. Let’s say you do put some money aside in a retirement account and you don’t put in your personal, your own company stock rather. You’re in an industry and let’s say you like other companies in your industry. Let’s just say you’re in the auto industry, not a great example, but don’t go out and buy other auto industry stocks. There’s a tendency when a cyclical industry goes out, you know the tide goes out, all of the boats go out with it. When you diversify, also diversify outside of your industry, not only outside of your company. What do you think of that?
Eric Schurenberg: I think that’s a great idea. Doing otherwise is like suggesting you have a well-stocked wine cellar because you have 100 cases of wine but they’re all the same vintage.
Steve Pomeranz: Very good point. All right, number three, this is, again, the Four Habits, The Four Financial Habits of Highly Effective and Wealthy CEOs. Number three, Eric.
Eric Schurenberg: Is to sell some of the equity. Again, diversification is the key overriding factor here. Get the money out of your stock, out of your own stock or your own options. What you don’t want to find yourself in is a situation in the future when you have to sell, when you’re under pressure, because you’ll probably be selling at the low point in the cycle.
Steve Pomeranz: Do many entrepreneurs or these wealthy CEOs, do they do all this by themselves, or do they put together a team to help them?
Eric Schurenberg: I think it’s always better to have a team. You’re running a business, and that is a full-time job and then some. You’re not going to be current on investment, and tax, and retirement planning strategies. You want to have a financial professional. You want to have a financial planner. You probably also should have an estate planning attorney who helps you make sure, if you’re not around, that your money is going to go where you want it to.
Steve Pomeranz: My guest is Eric Schurenberg. He is the Editor-in-Chief of Inc. Magazine, and we’re talking about “The Four Financial Habits of Highly Effective and Wealthy CEOs.” You want to build a team. You want a tax advisor, maybe an estate planning attorney, an experienced investment advisor. Someone who is working in your best interest, and someone also who knows how to work with a team of professionals to help you. It’s like any other area of your business. Stick to what you know, and what you don’t know, hire a group of experts for you. Is that right?
Eric Schurenberg: Yes. That’s exactly right.
Steve Pomeranz: What does an estate planning attorney bring to the mix onto this?
Eric Schurenberg: Estate planning laws are a science unto themselves. What they can help you do is make sure that all the complications of estate planning law, estate taxes, that vary at the national level and the state level, work in your favor. This area is fraught with mistakes, that if you make them, there is no going back. Your heirs will be saddled with your mistakes forever. Tax rates on estates are very high. They run 55%. To get something wrong, to have too much money in your estate, to have too much money in your taxable estate, is a problem you will pay for.
Steve Pomeranz: Also, a smooth transition between you and your heirs is also pretty valuable. Estate planning can take care of that so your money doesn’t get caught up in probate which can be a public affair. Probate has to be declared to the public, but you can set up trusts and others that don’t.
Eric, I want to change topics, here quickly. A survey that Inc. recently conducted, I think, when against conventional wisdom because so much is written, when a new company gets started, about getting financing for that growing business. Finding equity investors or angel investors, but your survey found something completely different. Tell us about that.
Eric Schurenberg: This survey was conducted with Inc. 500 CEOs, so these are the CEOs of the 500 fastest growing private companies over the past three years. These are very successful people, and yet 77% of those founders told us they got their company started using their own personal savings. Nearly the same number of founders told us that they funded their growth, during this growth spurt that got them into the Inc. 500, also without going outside. They funded it with cash flow from their own operations.
Steve Pomeranz: Again, I don’t know why, maybe it’s the media’s fault, or it’s just something to write about, I’m not really sure, but you really get the sense that the first thing you need to do is put together a business plan and go to a bank. That, in fact, is just not the way it’s done. Why isn’t it done that way?
Eric Schurenberg: There’s many reasons it’s not done that way. I was about to respond to the question you didn’t ask about, why does the press give so much attention to venture capitalists? The answer is they’re public events, they’re dramatic events, they’re a way to keep score. You know, “I raised $13 million in an A-round of funding.” I think that’s the fascination for it. Remember that when you raise money from an angel or a VC, you’re basically selling your company before you’ve even gotten started. You lose control. Then think of all the opportunity cost, all the time you spend on road shows trying to drum up money. It distracts you from the growth in your own company.
Steve Pomeranz: That’s very true. Yeah, I know an investor that actually did get a parent company, a private equity firm, to help fund. As he grew this division within the company, he was funding it with his own money because, in order to bring that private equity firm back in for further funding, he would have to dilute his own shares. He was unwilling to do that. It’s kind of a different take on the same subject, whether you’re starting your own, or whether you already have a private equity investor, but you really don’t want to go back to the troth and ask for more.
Eric Schurenberg: Yes. That’s really true. You think about it, if money were no object, you wouldn’t bring in all these other people unless they really were partners and really were advisors. It can be a major distraction. Depending on how many investors you have, there are that many more voices who are giving you, perhaps, contradictory advice about what you ought to do next with your company. Raising capital from the outside is sometimes necessary, but it is almost always a mixed blessing.
Steve Pomeranz: Would you say that too many start-up entrepreneurs look to outside capital first, rather than attempting to build incrementally through their own internal sources?
Eric Schurenberg: I would say that’s really true. It’s tempting, but the discipline that’s imposed by bootstrapping your own company is the sort of thing that will serve you well over the life of your company.
Steve Pomeranz: Very interesting. My guest, Eric Schurenberg, Editor in Chief of Inc. Magazine. Thanks so much for joining us, Eric.
Eric Schurenberg: My pleasure, Steve.