Where’s Your Wealth?

Ed Stevens believes the company he founded and owns, Shopatron, is the best personal-investment vehicle he can ride. He’s built the San Luis Obispo, California-based e-commerce fulfillment concern to a $16 million enterprise over 12 years and sees a lot more growth on the horizon.

“There’s a chance that the value of my stock will go down, but every year that doesn’t happen I’m so far ahead of where I’d have been if I’d diversified that it doesn’t matter,” says the 43-year-old former software engineer. “If I’m going to get just two or three percent on my money elsewhere, all i need is one year of 35-percent growth of the company and that’s like 10 years’ worth of returns elsewhere.”

Unlike Stevens, some private-company CEO’s lack of diversification is not by choice; they would like to diversify their holdings but are trapped because their stake in the enterprise is illiquid. In either circumstance, dealing with a concentration of wealth poses one of the thorniest investment challenges for both owners of companies and those who advise them. Handling the insurance aspects of risk management is another tricky area, as is formulating exit strategies.

CEOs of publicly held companies must deal with their own often-prickly versions of the wealth-concentration dilemma because regulations have made their stakes in the companies that employ them so transparent. “Making sure that their interests are aligned with shareholders’ can make it quite difficult in some cases, while they’re CEOs, to sell the stock,” says Mike Maglio, investment director of PNC Wealth Management, Pittsburgh.

Chris Reed lives that problem. He founded and remains CEO of Reed’s, a Los Angeles-based natural-beverage maker, with a current stake of about 27 percent in the publicly held concern. “It looks like bad form for a CEO to be selling, although in theory I could be selling modest amounts [of Reed’s stock] into the marketplace,” he says. “But as soon as you’re selling, everyone takes that as a signal.”

Driving Diversification

Despite these obstacles, advisors urge their CEO clients to press ahead with diversification, citing concentration of wealth in the company as the single biggest personal-financial vulnerability of most company chiefs. “Even if you’re the best entrepreneur in the world, there are market forces and things outside your control that can derail even the most successful business,” argues Terry Jenkins, executive vice president of BMO Harris Private Bank, Chicago. “So you start out by managing that risk, not just thinking about rates of return.”

Franco Fidanza has been a willing adherent of this philosophy. “Diversification is definitely the way to go,” says the founder of Planet Wings, a Middleton, New York-based fast-food franchisor with 30 stores in New York and New Jersey. “You never want to put all your eggs in one basket.” The 44-year-old entrepreneur has favored real estate and conservative instruments to bring his holdings outside Planet Wings to about 50 percent of his overall wealth.

Advisors suggest that CEOs set annual goals over a 10- or 20-year period for how much equity to pull out of the business and put into a nest egg, making sure to leave behind enough working capital for the company. One possibility would be to begin diverting all possible current income to other investments. And, they advised, make sure those investments are outside of even the industry in which the chief’s enterprise is engaged.

The founders of Gaspari Nutrition, Rich and Liz Gaspari, keep about 10 percent of their holdings outside their $100-million nutrition-supplement company based in Lakewood, New Jersey. Right now, those assets are mostly stocks, bonds and mutual funds, but the couple also has invested in real estate. “One deal we overpaid for, one we made money on, so we’re kind of even,” reports 39-year-old Liz Gaspari.

Reduce Your Risk

Another option is to make structural changes to the company that can reduce a CEO’s financial risks without necessarily requiring removal of resources from the business. These tools include formation of LLCs, trusts or cross-qualified retirement plans with deferred compensation. “Having all the wealth in a company is different than having all the risk exposure,” notes Christopher Kizis, of Wells Fargo Advisors, New York.

While most CEOs are painfully aware of the risks and rewards of their personal wealth being “all in” with their companies, fewer understand the stakes around how they can insure themselves and their own assets. Many owners make sure they have “key man” policies for their enterprises and directors and officers coverage for their key leaders, but they neglect to address insurance chinks in their personal armor.

One of the most common areas of oversight is liability insurance. Back in the day, $1 million in personal coverage was adequate; but today, limits of $10 million to $15 million “aren’t unheard of and are justified for some CEOs,” points out Christie Alderman, a vice president for Chubb Personal Insurance, Whitehouse Station, New Jersey.

Reasons for the higher exposure include the particulars of CEO life. Nannies, for instance, may seem like members of the family, but they also can be huge liability risks. Handing the keys of your Porsche to a friend who has never driven such a high-powered automobile and has an accident could comprise “negligent entrustment.”

Company owners also tend to entertain other high-net-worth individuals on boats or planes or at exquisite resorts, “bringing on additional exposures that Main Street, USA, may never have,” says Peter Piotrowski, senior vice president at Chartis Insurance, New York.

Chiefs also should strongly consider robust long-term-care insurance policies for themselves, other family members and perhaps even extended family. “CEOs invariably are the beasts of burden for their families,” maintains Joe Duran, CEO of wealth counselors United Capital, Newport Beach, Calif. “If you’re on the hook for long-term care for a mother-in-law who has no money or even a great uncle with no means of support, it’ll frustrate you.”

This Way Out

Duran also knows well the CEO’s reluctance to address adequately how to exit from his or her business. He didn’t have an exit strategy for his first company, called Centurion Capital, which he ultimately sold to General Electric 11 years ago. “If anything had happened to me along the way, I had no parachute of any kind,” Duran recalls. “CEOs never think about the possibility that we might fail.”

The Gasparis risked something similar a few years ago. Only after a serious potential buyer for their company emerged did they realize that their books were unfathomable despite an investment of hundreds of thousands of dollars on a new accounting system. “If you want to do a deal, you’ve got to be able to provide a true snapshot of the business,” Liz Gaspari says.

Similarly, Reed’s exit strategy for his beverage company is “to balloon this thing up. We’re going to get big faster rather than slower; and then, someone will come along to acquire us. We have standing offers.”

But “exiting” never has been in the vocabulary of the four generations of chiefs of the Farmers & Merchants Bank of Long Beach, California. “We spent decades establishing estate planning that allows one generation to transfer all of its assets to the next,” explains CEO Daniel Walker. “We’re not talking about trust-fund babies here but only ensuring a continuity of lifestyle from generation to generation.”

And in those conflicts, many CEOs end up not tending to their own wealth management needs but to the demands of the enterprise that got them where they are.