It’s a mistake Philip Leathers sees all too often, a mistake with different implications for both larger corporations and small businesses. An investment representative at Edward Jones Investments in Carson City, Leathers once observed a small mom-and-pop cafe in North Carolina. Confident they could eventually sell their business, the café owners failed to financially plan for retirement. Then, a larger restaurant reviewed the market, built its coffee shop next to the mom-and-pop establishment and drove the smaller restaurant out of business. Mom and pop were left without a business — and without even the hint of an investment portfolio.
“In smaller businesses, owners often focus more on keeping cash for operations,” noted Leathers. “Most of their investment portfolio is the inventory on the shelves. They often think either the children will step in and take over the business at a later date, or they’ll be able to sell the business and retire.”
Think again. An effective investment portfolio is a crucial component of most businesses. Even larger corporations are hurting themselves when they fail to maintain a successful portfolio. While an investment portfolio may not impact a big corporation to the extent it affects smaller operations, investment analysts say some corporations are losing hundreds of thousands of dollars a year by making poor investment decisions.
The booming stock market has enticed many business owners to become more investment savvy. Even so, experts say many entrepreneurs neglect their money or make lukewarm investment decisions. Business owners or chief financial officers of corporations are frequently too busy extinguishing internal fires to nurture an investment portfolio. “We see a lot of money out there that just sits, not really earning what it could,” observed Bob Kasner, co-owner of Henderson-based Paragon Asset Management. “It just isn’t a priority, even though having an effective investment portfolio is an easy way to increase your company’s bottom line.”
Increasing the bottom line and funding retirement are just two reasons to maintain a quality investment portfolio. Another advantage is the ability to self-finance business-related expenditures by borrowing against the portfolio rather than turning to banks. Investments also serve as a backup plan for worst-case scenarios.
“The economy’s great now;’ said Margaret Maul, CEO of Maul Capital Management in Las Vegas. “Businesses are doing wonderfully and it’s easy to think it’s always going to be good. But building a portfolio can help you continue to operate if the economy slows. Rates are going up and bank lending policies change. So it really is important to have a contingency plan.”
Those who think they can’t afford to invest sometimes have valid concerns. Mark Mushkin, senior vice president at First Union Securities in Las Vegas, pointed out that most growing companies pay more to borrow money than they can make in a risk-free market. For example, an automobile dealer pays at least 1 percent a month in flooring costs on inventory, 12 percent a year. That means the business must earn 12 percent to make the endeavor worthwhile. “Car dealers don’t put their money in the market,” Mushkin explained. “Usually, they put their money in their inventory. Most business owners make more money with their inventories than they do with their investments.”
According to Paragon’s Bob Kasner, casino megaresorts represent another example of investment-shy companies. Such businesses often pour their money into building projects and are short on excess cash. Revenue is used to pay off debt rather than establish investments.
Still, as with the mom-and-pop café, almost any business can benefit from developing some sort of investment portfolio. Choosing the right investments is the key. According to Maul, the best way to accomplish this is to draft a brief investment policy statement, usually with the help of an accountant and an investment advisor. “Most companies don’t even think about putting down on paper why they’re building a portfolio, what their parameters are, or how they’re going to use the money:’ said Maul. It’s vitally important to do so, however. The accountant can explain what’s applicable to your specific industry and explain tax advantages or disadvantages, while the investment advisor can help develop an effective plan. The policy statement should explain the purpose behind the portfolio and outline investments that will accomplish this purpose. The statement also should offer general investment criteria based on the company’s needs. For example, a statement can declare that business owners want 50 percent of the portfolio devoted to bonds rated “A” or higher, or bonds with no more than five years in maturity.
Investment policy statements are individualized for each company, but there are some general factors to consider when deciding among different investments. First, Maul recommends choosing liquid investments. In other words, avoid real estate, because if a company needs cash, property can’t be turned around quickly. In addition, financial institutions do not recognize real estate investments as part of a company’s net worth.
Another rule of thumb is to avoid exotic stocks. According to Leathers, business owners are risk takers by nature, and that frequently carries over into their investment philosophies. Often, when a customer raves about the latest Internet company, business owners jump on the chance to purchase stock. “Instead of putting together a portfolio,” Leathers explained, “the owner will buy one or two stocks based on gut reaction instead of research.”
The best bet, said Leathers, is to purchase stock in companies with a proven track record, companies that provide products you use daily, companies that likely will continue to grow at the same speed as they have in the past. One example is General Electric. Every day, consumers use GE light bulbs and cook dinner in GE ovens. General Electric products are more than a trend — they’re necessities with enduring uses. For the same reason, Microsoft and Oracle are also safe investments.
“I like to have my clients focus on the long-term, high-quality investment and not start chasing the latest dot-com,” Leathers explained. “If you’re going to buy a technology stock because your buddy or a client told you about it, it’s important to do a lot of research and determine the nature and extent of the role these companies play. Are they infrastructure providers? Or do they just build bridges? Because there are only so many bridges you can build.”
Maul agreed. She pointed out that when someone pitches a new idea to a business owner, it often appeals to his or her entrepreneurial spirit. Consequently, investing in that new idea seems natural. What might be a good investment for that business owner individually, however, could be a poor investment for his corporation. For example, if an entrepreneur wants to develop a high-growth portfolio for himself, he may include publicly-traded startup companies or initial public offerings.
“This might be personally suited to him, but it’s not going to meet the needs of his corporation’s portfolio,” Maul said. “The difficulty arises when business owners see the company as an extension of themselves, and it’s not. It’s a legal entity. I think that’s psychologically the biggest stumbling block to the savvy management of corporate investments.”
Consistency is especially important, Maul said, considering most business investments usually entail shorter term maturities, such as two to five years. Personal investments, on the other hand, may span two decades.
Even conservative investors shouldn’t keep all their eggs in one basket. Concentrating money exclusively in one investment or category of investment, such as stocks, bonds or certificates of deposit, may take a bite out of the return. For example, many consider bonds a safe investment. But bonds are interest rate sensitive. According to Leathers, a “safe” U.S. government-guaranteed Treasury bond with a 30-year maturity has lost as much as 17 percent of its value over the last year. “No one investment is worthy of all your money, whether it’s certificates of deposit, your own inventory, the latest dot-com stock or real estate,” Leathers said. “You need to diversify.”
Diversification becomes particularly important in light of a company’s short-term cash needs. If a corporation plans to build another office building in three years, company executives would want to structure low-risk investments that they could easily liquidate in time for ground breaking. According to Maul, in this scenario, bonds may be the ideal option, because liquidating a bond is frequently a more flexible option than selling stock at the wrong time.
Developing this timeline for investment takes careful planning. Many businesses run scared, keeping so much cash in short-term investments that their rate of return suffers. According to Kasner, a lot of corporate money is sitting in six-month or shorter investments. Kasner estimates some businesses could boost their annual interest income by 2 percent if they extended those six-month maturities to 18 months. Ironically, Kasner has observed even banks making this mistake. According to Kasner, one bank has kept between $40 million and $70 million invested in overnight investments for two years. Although banks do need immediately accessible reserves, the fact that this money has remained untouched for two years suggests that an extension of the short-term investment over a longer time frame is feasible.
This is especially important for C corporations, said Mushkin, which need to make certain that the investments match their long-term strategic plan.
“It’s a great way to miss some opportunity if you’re investing in six-month windows and you actually have a 10-year business plan:’ said Mushkin. “Make sure the time horizons on the investments match the time horizons on the corporate needs for the cash.”
According to Ted Schlazer, Kasner’s partner at Paragon, many business owners elect to take the easy way out by keeping their money in sweep accounts. In sweep accounts, banks keep the amount needed to cover checks and apply interest to the excess funds.
“The problem with that is they’re paying you up to 4 percent to do that, whereas if you went out in the market you’ll get 5.5 percent,” Schlazer noted. “But it’s a very easy thing to do from the business owner’s standpoint. There’s no input involved from the client at all. The banks are taking advantage of them and charging a tremendous fee to do that. It’s very expensive to do in terms of the yield you’re giving up.” Leathers marvels at the number of business owners who keep their money in non-interest bearing checking or savings accounts simply because that particular institution doesn’t pay interest on business accounts. Leathers suggests shopping around for a bank that does offer interest. “Business owners will do the research to find out the best price for their inventory or the best distribution route, but all too often they forget that they can ask a lot of questions of their financial institution:’ Leathers said. “They should ask, ‘What services do you provide that I’m not aware of? I don’t know the questions to ask, so just guide me through.”
For small or family businesses, insurance represents another oft-overlooked component of an effective investment portfolio, according to Leathers. A plan outlining what will happen to the business once the owner dies may lead to “key man” insurance. This is an industry term for insurance that provides capital to replace the deceased business owner. A succession plan may also be in order to provide insurance for whoever takes over the business after the owner’s death. A succession plan using insurance often infuses enough cash flow into a business for a junior partner to step up and take over, freeing up other capital for investments.
For C corporations, the proper investments can even offer tax advantages. According to Chris Wilcox, CPA, a shareholder in the accounting firm of Johnson, Jacobson and Wilcox, C corporations may receive tax-free dividends from investing in other corporations. If a C corporation, for instance, owns less than 20 percent of the stock in another corporation, 70 percent of the dividends received from that stock are non-taxable. This is a simplified version of a complicated tax rule. To learn more about tax regulations on investments, visit an accountant.
Experts emphasize the importance of seeking the advice of not only an accountant, but also investment advisors who know the territory. By visiting an investment expert, business owners can sift through the hype to learn the facts. Last year, when one mutual fund enjoyed returns exceeding 80 percent, the news made national headlines. Leathers’ phone rang off the hook with people eager to invest in the fund — until Leathers put the brakes on their enthusiasm. “What caused that fund to go up 89 percent?” he asked them. “Was it a fluke? What if they have one great year and now they’re going to go back down to a 10 to 15 percent annual return?”
Leathers compares the situation to a hockey game. When one interviewer asked a famous hockey player what made him so successful, he replied, “I just skate to where the puck is going instead of where the puck has been.”
“So many times investors find themselves skating to where the puck has been and are disappointed when it doesn’t produce results they hoped for;’ Leathers said. “Where’s that puck heading? That’s what you need to know.”
