First things first. (I'll answer the two questions below in my next Post; however, I invite the reader to respond as the replies may be illuminating.)
What is the difference between an economist, accountant and a finance professional?
What is the difference between cost, price, value and worth?
If there is a series of transactions of public stock between sellers and a buyers ("investors"), then there are two unique things occurring. The amount between the ask and bid is referred to as a "spread". Somewhere between is where parties agree and a transaction is consummated.
But in those unique transactions, the buyer believes there is upside potential unique to the specific investment and the seller believes that liquidity or an alternative investment is preferred. Can they both be "right"?
This takes us to the notion of if the majority of advisors or investors are acting on bullish or bearish behaviors can they both be "right" or do they cause the "herd" to create a self-fulfilling prophesy? (It's a contrarian play!)
So, we go full circle to the issue of "risk". Whose risk when and why? Let's start with individual choices. While many wish to become entrepreneurs, fewer actually do. And among those who choose the entrepreneurial route few succeed to remain in business and a few more have created a job and some degree of independence, but not much else. So, the pyramid getting from $1 million in sales to $5 million narrows and to $10 million to $25 million narrows more with those achieving $50 million and above rare. They have mastered not just their product and service offerings, but have been adept at managing both their financial and human capital as well as risk.
Admittedly, there is an ongoing founder struggle with gratification. versus growthThis means the founder chooses the sum to be paid for time, ability and risk versus what is to be reinvested to grow the company and receive the reward of a higher value. Most would be shocked to learn if the company fails to have an adequate amount reinvested versus the shorter term benefit, this is a primary reason for being stuck at $5 or $10 million in sales. Worse, the value can be many fold greater due to compounding in as short as just 10 years.
Then there are those who prefer the reliability of steady pay with some aspiring to become CEO, Managing Partner or tenured one day. Similar to professional athletes, there are many who aspire, but few who actually achieve these outcomes.
So, when an advisor working at a financial institution, law or accounting firm suggests to an entrepreneur they should mitigate risk, the real question becomes risk as opposed to what? The common answer is diversification and often this means publicly traded securities. Yes, this might result in less risk and more liquidity, but it does also mean less control. This is why many an owner is hard pressed to act on such advice in a big way as the advisor doesn't have shared skin in the game or may economically benefit by the prospect or client acting on the suggestion.
So, as another example, the accountant may focus on the "risks" of taxes. How does that influence risk of the performing asset, such as an operating business or real property holdings? Stated another way, if you were earning $1 million in profit and paid 40% in taxes, but could earn $2 million and pay 40% in taxes would you select the $1.2 million over the $600,000? So, don't let the tail wag the dog.
Then there are the issues of asset protection tabled as a way to preserve principal. Again, the common end game tends to migrate to liquidity and diversification. If an owner is pocketing $2.5 million annually and spending $2 million annually and then sells the asset for $20 million net and can expect 4% after tax, this produces $800,000 in annual spendable funds. Unless the prospect/client expects to reduce his expenditures by $1.2 million a year, the viability of protecting principal is an artificial construct.
So, what "is" the solution to the above realities? The asset would have to net at least $50 million to generate the $2 million annual spend (pre-tax). If the the prospect/client relies upon the trusted advisors who are unable, unaware or unwilling to assist in enhancing the value by another $30 million are their ideas of "risk" aligned with that of the person they're seeking to serve?
Stated another way, if the client "knew" that services rendered would be billed for $300,000 or even $1,000,000, but would produce the $30 million increase with a return of 100x or even 30x on fees expended would they agree to doing so?
Then there is simply "out-of-the-box" options. Options may include hiring an industry executive who would be all too happy to have a salary plus participation in profit and/or value growth (of course that would mean that parties would have to know the benchmark value). It might mean hiring an MBA student as an intern to learn the industry while the MBA educates the founder on best practices. It might mean grooming key staff for more important roles. It might mean selling a minority interest to a private equity firm that has the funds and personnel and contacts unique to the industry.
The next time a client, prospect or a trusted advisor from a different profession asks what are your fees and commissions, it is more likely they have little knowledge of the answers to the first two questions raised above. The entrepreneur knows there are risks and has had some success in seizing opportunities. Perhaps the question is how do advisors prove their mettle to be more worthy of the services they wish to provide and is there a distinction between the solutions they offer that reflects a track-record of helping past clients grow their businesses to 8- and 9-figures or more?
Equity Value Enhancement (Amazon Link) was written with a focus on risk identification, measurement, management and mitigation. It suggests that most can have a reasonable influence on business' finances (sales and profit growth and adequate levels of capital). The challenge is the human capital which calls for having a legitimate strategy (versus tactics) to leverage uncommon knowledge and relationships to influence risk. (The lower the risk, the greater the multiple and closer to the $50 million target in the example above. More to the point financial capital alone won't buy its way to the target without a merger or acquisition or a holistic approach to harness the human capital of advisors, owners, staff and other stakeholders.)