Aiding family is a familiar theme in the realm of entrepreneurship and business start-ups, and perhaps the relationship most often mined is that between parent and child. We have seen this story replicate itself again and again: A parent — often, in the older generations, a father – sees an opportunity to help a child get on his or her feet and is anxious to invest in a business idea the child has.
Our client Ron had enjoyed a successful career as a physician and had saved millions of dollars toward his retirement. He worked late into his 60s and was on track to have a very comfortable retirement, in which any lifestyle he chose was pretty much open to him.
Ron’s daughter Amy, meanwhile, started a retail fashion business, and Ron made an early investment. For a while, the company did well and the outlook was promising. It was at this high point, when all was stable, that Ron made what would turn out to be his biggest mistake. Amy, buoyed by the initial success of the start-up, upgraded her lifestyle significantly, buying a house she could not truly afford in an affluent neighborhood. Because Amy couldn’t qualify for the second mortgage she needed, Ron cosigned, guaranteeing the mortgage for his daughter.
In the economic downturn of 2008–2009, however, Amy’s company, like so many others, suffered dramatic losses. At the same time, the value of real estate plummeted and she was underwater in the house. Though the house was now worth much less than what Amy had paid, the large monthly payment was fixed, and Ron was on the hook because he had cosigned. Settled comfortably in the affluent town where they lived, Amy’s family had trouble making needed lifestyle adjustments when income from the business bottomed out, and Ron felt compelled to help out financially. Soon, Ron was bleeding money as he tried to keep the company afloat, keep up with his daughter’s mortgage payments, and cushion the financial shock for Amy and her children.
Facing a business’s failure can be wrenching, and in Ron’s case, the matter was made more complex because it involved his relationship with his daughter. From the time our kids start playing soccer, we as parents sometimes overinvest emotionally (and financially) in our kids’ dreams — we may even make their dreams our own. In doing this, we place on them our own hopes and live vicariously as they do the things in life we did not. Ron invested in Amy’s company because he believed in his daughter — and that is a good thing — but he also took a lot of pride in having a child who was a successful business owner and who had taken risks that he never had. For this reason, Ron kept propping the company up, even after it was clear to most outsiders that he was throwing good money after bad.
Ron nearly threw away his own lifetime of work to benefit his daughter’s dream. Not only did this come close to cratering Ron’s financial independence, but it put a strain on the father-daughter relationship.
My partner Jim Bruyette sums up our advisory’s philosophy regarding the kind of investments Ron made in his daughter’s venture and mortgage: Help your kids, by all means, but cap your exposure. Give your children what you can so they can pursue their dreams, and support them emotionally and financially to the extent that you reasonably can, but keep in view the health of your retirement plans. Remember that you have limited time to recover from financial setbacks and, once you’ve retired, less opportunity to make back the money you’ve lost in entrepreneurial investments.
Too often, we financial advisors learn of a new venture or risky investment only after the business was launched or the investment made. (Of course, we also have clients who don’t buy an ice cream cone without consulting us, and this is largely a difference between personality types — some folks are naturally cautious while others are more freewheeling or impulsive.)
At the point that they sense they are in real trouble, clients may come to us and say, “Alright, I’ve got a mess here. What do you suggest?” While the solutions we apply are highly individualized and tailored to the person’s financial situation and business challenges, I can share our general approach.
First, we want to understand why the business exists: What is the core purpose of the business? What strong need or desire does the business fulfill for potential customers or clients? Next, we need to determine who is involved in the business and define the key roles and responsibilities of those people. Then, we examine the financial statements and evaluate how close the business is to becoming profitable or shutting down. What are the ramifications if the business closes? Estimate what it would take to save the company – and assess, too, why it would be worth saving. If you think the business is worth saving, revisit the Five P’s of developing a business plan discussed earlier.
Those who are keen to start companies or invest in new ventures are often people who believe that because they are successful at one thing, they can be successful at everything. We have seen too many people who have made money in one career become overconfident in their ability to make money in another business or investment venture. They forget the hard work that they put into building their career and the luck that was involved in their success. If you think it will be simple to re-create that success, think again!
Starting a business might be the right thing to do, but it is unlikely to be simple or easy. People who want you to invest in their business or sign on as a partner will often play on your ego, complimenting you on how successful you were. The comments are flattering – and possibly well deserved – but you should take them with a grain of salt.
When any client, but especially one who is retired or close to retirement age, comes to us and asks our advice regarding investment in a new business (her own or another’s), we certainly want to explore both the opportunity and the downside risk to the assets already accumulated. In such situations, it is helpful to know what you can afford to lose and what you can’t. We help them set a predetermined dollar amount that they define as their retirement nest egg and tell them not to allow their investment in the business to exceed that amount. Period. Stress with clients that they don’t want their entrepreneurial investment to disrupt their retirement plans, forcing them back into a traditional job to make up any shortfall. And before jumping in, ask them whether the stress involved in running a start-up, even a successful one, is worth it at this time in their life.
Greg Sullivan, co-CEO of SBSB Financial Advisors, is author of “Retirement Fail: The 9 Reasons People Flunk Post-Work Life and How to Ace Your Own,” published by Wiley. This article is an excerpt from the chapter “The Lure of the Entrepreneur.”