Think back to the time when you made your first big investment. You were super excited. You were certain you picked a winner. The anticipated return was already burning a hole in your pocket.
We’ve all had that feeling at some point in our lives. On the front end of major life decisions, you always feel good about the risk you are taking. Why wouldn’t you? There’s no questioning your belief at that point. Reality typically sets in at some point in the future when some unanticipated circumstance impacts your investment.
Given the constant drumbeat of a potential recession, it makes sense to revisit a common misstep that many business owners make. Over 20 years of banking, I’ve seen a myriad of projects pitched to business owners. Generally these projects are unrelated to the business owner’s core business. The returns on the project being pitched typically look outstanding and outpace a typical stock market return. The ownership of the new project generally consists of three or four other individuals. Everyone writes a check for their equity position, and it is smooth sailing.
Until something unexpected happens.
An example that comes to mind from the recent past is the sheer number of business owners who thought they would hit a homerun by becoming an investor in residential subdivisions. Everyone was making a lot of money selling residential lots in 2007 and 2008.
Then the Great Recession hit. Lot sales stopped as home demand fell off a cliff. Land values plummeted, yet banks wanted to get paid so investors needed to come up with money out of their pockets to make loan payments. Some could, many couldn’t. This resulted in lawsuits and bankruptcies amongst ownership groups. The investors with financial wherewithal paid dearly when those without walked away. It was an ugly experience for everyone, but one from which we can all learn from.
The key to mitigating risk is understanding the risk. During downturns, understanding who your business partners are is paramount to navigating a challenging situation. Did you know that your business partner has no liquidity or cash flow to support monthly loan payments should your new business venture not get off the ground as anticipated? Did you know that your partners have no direct experience in the industry your joint venture operates within? Is their personal financial situation burdened by significant debt? These are the types of candid conversations you need to have with your business partners prior to committing to new business opportunities.
Hopefully you already have a high performing business. Be very hesitant to shift time and resources from your existing operation to chase a return on a venture you don’t fully understand or can’t afford to cover should financial issues arise. Don’t lose focus. In many situations, you will be better off continuing to invest in new equipment, talent, or a building expansion for your existing business.