This post is the first in a series discussing financial planning for attorneys and innovative approaches to risk management, asset protection, estate planning, and investments.
De-Risking Balance Sheets
Private wealth management should encompass de-risking the client’s entire balance sheet. In my experience, most advisors give cursory attention to the balance sheet and instead focus on the financial assets.
This is a serious mistake.
My approach begins with an overview of what I call total wealth and includes the client’s entire balance sheet as well as their future cash flows. This philosophy reveals hidden risks that would not otherwise be apparent.
The presence of these systemic risks has profound implications for the client and their finances. Indeed, when these risks are unearthed, they suggest previously un-contemplated but suddenly obvious investment allocations and financial strategies.
Throughout this analysis, I will use a representative “client” who is an AmLaw 100 firm partner, working and living in Manhattan with a practice focused on corporate transactions in the healthcare sector. However, the issues highlighted apply equally to litigators, lawyers at boutique firms, and lawyers at firms located anywhere in the country.
Financial Planning Using Total Wealth
All individuals have four primary types of wealth:
- Human capital: all the knowledge, skills, training, and social contacts that make up what and who an individual knows. (This can be estimated as the present value of all future earnings);
- Real estate;
- Pensions and other non-wage cash flows, and;
- Financial assets.
These different types of wealth have been well documented in the economic literature and can be referred to collectively as “total wealth”.
Despite being well known and studied, total wealth is frequently ignored by financial advisors, who tend to focus on financial assets. This myopia can lead to disastrous results when an investor’s total wealth is exposed to one company, industry, or country.
I will examine the risk of common exposures across an attorney’s total wealth. For Manhattan AmLaw 100 partners, these risks can be pronounced. Furthermore, they can be exacerbated by opportunities to co-invest with firm clients in direct investments. While these deals are frequently offered at generous terms and are looked at as a perk of working at the firm, they can become self-inflicted wounds.
These common exposures lead to what I call Company Town Risk®.
The Company Town
For much of the 20th Century, there existed what were called “company towns”. These communities typically existed because of one local company that employed virtually everyone in the community as well as owned almost all the stores and housing.
In such cases, individuals working for the company had virtually all their total wealth directly or indirectly exposed to the company. Their income came from a company job, their human capital consisted primarily of skills the company needed and had trained them for, their pension was funded by the company, and their house was owned by the company.
These company towns could be exploitive or utopian. As Hardy Green writes in The Company Town:
A company town seems necessarily to be a place where one business exerts a Big Brother-like grip over the population – controlling or even taking the place of government, collecting rents on company-owned housing, dictating buying habits (possibly at the company store), even administering where people worship and how they may spend their leisure time…
But another model regularly shows up in the United States, recurring across the decades: ideal communities backed by companies that promise to share their bounty with workers and their families. These utopian towns were and are characterized by modern public buildings, libraries and facilities for leisure, education, and cultural enrichment, and comfortable dwellings for managers and workers.
Whether the company town was evil or good, if anything happened to the company, the workers and residents could have their total wealth decimated overnight.
Historically, such decimation was not uncommon. A train trip from New York City up the Hudson River to Albany is at once bucolic and a testament to the gales of creative destruction. Dozens of once thriving mills and factories mark the path northward. These former enterprises supported vibrant company towns, but they, and the communities they spawned, are gone. All that remains are the husks of the old factories, slowly falling in on themselves.
More recently, over the past 14 years I have personally been involved in cases where investors with high Company Town Risk® exposures were essentially wiped out when those risks were realized. Those involved employees of Kodak, living in Rochester, NY, and, more recently, residents of Puerto Rico.
While old mills on the Hudson River may seem anachronistic, the modern economic landscape is replete with company towns. Some of these towns are still tied to one company, but many are larger versions, tied to one industry or geographic area. Some obvious examples include:
- Detroit and the automobile industry;
- San Francisco and the technology industry;
- New York and the finance industry.
As we will see, being significantly exposed to even one Company Town Risk® can be hazardous to your wealth.
Company Town Risk® for Attorneys
Working for an AmLaw 100 Manhattan law firm while living in Manhattan is a high tech version of an old mill town. The accoutrements may glitter more, but the risks are the same.
To see how this works I make the following assumptions about the total wealth of our representative attorney:
- Human Capital: $17.25M, which is the present value of her $2M/year after-tax compensation for the next 10 years, discounted at 2.84 percent (the yield on the 10-year US Treasury bond);
- Pensions: $5M, comprised of defined benefit and deferred compensation plans at the firm;
- Real Estate: $5M, the equity value of a $4M Manhattan apartment and a $1M Connecticut second home;
- Financial: $10M, in liquid investments, allocated 50/50 between stocks and municipal Bonds. The stocks are in broadly diversified mutual funds and one private equity fund focused on carveouts from large cap healthcare companies. The municipal bonds are invested evenly between New York State and New York City issuers;
As mentioned above, most financial advisors would look at our attorney’s balance sheet and liquidity position and conclude that she is in a strong position and well diversified.
That would be a mistake.
While our attorney has certainly had success accumulating real wealth, she faces a number of insidious Company Town Risks®, which include.
- Capital Markets;
- Healthcare Sector, and;
In my next blog post, I will unpack these risks and discuss how they could be mitigated.
Bantam Financial Planning Services for Attorneys
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 Hardy Green; The Company Town: The Industrial Edens and Satanic Mills That Shaped the American Economy; Basic Books; New York; 2010; 3-5.