The Entrepreneur Sessions: David Edwards
Randy: Hello, this is Randy Kaufman from Aker Advisors. Welcome to the fifth episode of season two of “To Grit with Grace: The Entrepreneur Sessions.” Life is, of course, one big journey. With entrepreneurs, they journey has many highs, and many, many lows. It is only the entrepreneurs with grit who survive to tell their stories of success. They’re the ones who have the courage to get up each and every day and just do it.
Our guest today — my husband — survived a scathing tale. It’s one of the reasons why we bonded when we met. Listen to his story of how he went from rags to riches, down into the valley of death, and then lifted himself up to be the successful entrepreneur he is today.
David Edwards is the President and CEO of Heron Wealth, a New York City-based wealth advisory firm. No one can describe a company better than the CEO/founder. So, in David’s words, this is Heron Wealth.
David: Heron Wealth provides financial planning, investment advice, and tax and estate planning. Our clients are executives, business owners, and rising professionals who enjoy successful careers, but who are worried about their finances. Anything that our clients touch that involves money, we are there with good advice.
Value at Risk
David: I first began investing when I was seventeen years old. My grandfather was a successful veterinarian in the Bronx. Every month for decades my grandfather put $1,000 a month into the stock market, he never sold a share, and by the time he died he had a blue-chip portfolio worth millions of dollars. When I was seventeen years old, my grandfather asked me to take a look at his portfolio and tell him what I thought.
I continued to be interested in stocks all through college, and when I began my career at Morgan Stanley in 1983, I opened a Morgan Stanley brokerage account and did a lot of “low-cost experiments.” I bought this company, I bought that company, I learned from mistakes, and took advantage of a local Barnes & Noble branch that had a huge library of books on investing. As time went by, I became ever more successful at stock investing. It’s not the kind of thing you can pick up in an afternoon, which stands to reason. Nobody picks up dentistry or piloting aircraft in an afternoon, either. It takes years of practice to get really good.
After four years, I quit, went traveling for half a year, came back to New York in January 1988. The world was in disarray, everybody was getting fired after the 1987 stock market crash. So, I swung into consulting for four years, and built value-at-risk models for both JP Morgan securities and Nomura Securities.
A value-at-risk model tells senior management how much money they could possibly lose in one day if there are a couple of worst-case scenario moves in bond markets. The point of those models was to show the SEC and the Federal Reserve that an investment bank had very good knowledge of their risk, and therefore could lever the portfolios more.
This is a very important concept, leverage. What leverage means is that typically, if you invest $10 in a stock, and the stock goes up $5, you’ve made a profit of $5 or 50%. If instead you borrowed $5 and put in $5 of your own capital, and the stock went to $15, now your equity goes from 5 to 10, so your profit is 100%. In extreme examples, you might put in $1, borrow $9, and if the stock goes from 10 to 15, now your equity goes form $1 to $6, and you’ve made a 600% profit.
But that leverage can cut both ways. If you put in $1 and the stock falls to $9, you’re wiped out (you have no equity left), and if the stock falls to $8 or $5, you actually owe money, and you have negative equity.
In 2006/2007, banks like Bear Stearns, Merrill Lynch, and Lehman Brothers increased the leverage on their bond portfolios from 10 to 20 to 30 to even 50 and 75 times.
Here’s the problem with the models I was building for those banks. A model is only as good as the design, it’s only as good as the inputs. A model doesn’t know about things like 9/11. A model doesn’t know about things like the election of Trump. A model only knows what you told it about the past.
Having worked on those models, I thought they were bullshit, and I assumed that senior management knew they were bullshit. But in fact, senior management loved those models, believed in them, hook, line, and sinker, and so were completely unprepared when the models failed to capture the reality of the situation.
One of the things that was built into the model was an expectation that housing prices would always go up. And by the middle of 2007, when housing prices began to sell off sharply, the models couldn’t cope because they had been coded to never account for negative housing prices.
So, the stock market, which follows the bond market to some degree, began to crater as well, and led me to the worst moments of my professional career.
Crisis
The interesting thing about the financial crisis of 2008-2009 was that it wasn’t one sudden event. It was actually a series of events playing out over the preceding couple of years. It’s kind of like we’re all standing on a frozen lake, and there’s a crack here and a crack there and a crack over there, and all of a sudden, the ice shatters and everybody plunges into the cold water.
As of 2008, I thought my life was perfect. I had a thriving solo practice working with about 50 families, managing about $90 million. That provided an extremely comfortable cashflow to me, enabling me to live in New York City, send two kids to private school, and spend my summers in Nantucket, racing sailboats.
In January 2008, I had no idea how much my life would change over the next four years.
One of the oddest days of my life was in March 2008, when my family and I were skiing in Colorado. I got an update on my phone that Bear Stearns, a very large, successful investment bank, had gone out of business over the weekend.
I said to my wife at the time, “Huh, I can’t go skiing today. I need to understand what just happened here.”
What had happened was Bear Stearns had a very aggressively leveraged mortgage-backed portfolio. Interest rates had gone up, the profits of that portfolio had gone way down, and in fact, had gone down so much that it wiped out the equity of the firm in literally days. Bear Stearns was ultimately absorbed by JP Morgan Bank.
So, the stock market sold off pretty sharply in March 2008, but then recovered, although still wobbling.
Later that year, I was taking my family on an expensive trip to Greece for two weeks, and yet, I was spending more and more time having to jump on the phone or my computer and figure out what’s going on back in New York. It was just crazier and crazier.
Well, we got through the summer. Everything seemed to be okay. In September 2008, I happened to be doing a sailing regatta, the IOD National Championships, in Larchmont, New York. We had had a great time, we had a great boat, we were fourth after the first day, third after the second day. Ultimately, we came in second overall. I had some barbecue after the regatta, jumped in my car to drive home, flipped on Bloomberg News, and Lehman Brothers is declaring bankruptcy in the morning.
And I said, “Wow, that’s gonna sting.”
Sure enough, stock market opened down very sharply in September, fell most of the rest of September, and it just continued like that until the absolute nadir, in December 2008, when Bernie Madoff announced that he’d been running a Ponzi scheme for decades and had lost his clients billions of dollars.
The Ledge
That was shattering news. Bernie Madoff was a very respected money manager. He had been the head of the National Association of Securities Dealers (NASD) at one point, and I was like, “Wow, if we can’t trust this guy, can we trust anybody?”
Indeed, that was the reaction of most investors. So, the markets, which had been doing poorly for most of the Fall of 2008, went into absolute free-fall in January, February, and March of 2009.
My firm’s revenues, which were dependent on assets, were slashed, because my assets went from $90 million in June 2008 to about $45 million in March 2009.
At that point, I stopped working for a couple weeks. I pushed back from my desk, and I said to myself, “Maybe I’m not cut out to be an investment advisor. I think these companies are gonna survive, and they’re selling at huge discounts right now, but if everybody else believes they’re only worth thirty cents on the dollar, maybe I just shouldn’t do this business anymore.”
So, I thought about what else I could do at age 50 with 30 years of experience on Wall St, and realized that aside from being a steward on a yacht, I wasn’t qualified to do anything else as a professional career. And since working as a steward on a yacht only pays about $15/hr, I realized I somehow had to save my business and get back into the game.
Rising from the Ashes
So, I pulled together all the resources I had. I sold off my own personal investment portfolio, I maxed out my credit card, I borrowed $250,000 from Chase Manhattan Bank, and I spent the next several years rebuilding the firm.
One of the key ways that my business transformed was that early on in the 1990s when I first started my business, I focused primarily on picking stocks for clients. Growth manager, US midcaps, that’s what I did, but as time went by, my clients began asking me questions, like, “Hey David, is my all-stock portfolio right for my retirement?”
“Hey David, how do I fund my kids’ college education?”
“Hey David, I wanna buy a seance home.”
“Hey David, I need to take care of my aging parents. How do I do that?”
And at first, I was saying, “Call your financial planner, call your tax accountant, call your trust and estate attorney.” But it turned out, I was the guy with my hands on the clients’ money. They wanted answers from me.
So, I began to educate myself beyond just investment management. I began to learn about financial planning, tax planning, estate planning. I still thought of myself as just a stock-picker until I surveyed my clients some years ago, to find out how they valued the firm. On the top 10 list of reasons why clients liked working with me, investment performant was only the sixth-most important attribute. The number one reason why clients worked with me was trust. One client wrote, “Good news or bad, you’ll always hear it first from Dave.”
That’s when I realized that I was not in the investment management business anymore, I was in the good advice business.
Along the way, I also had to rebuild my health. From October 2008 to March 2009, I didn’t sleep more than three hours a night for weeks. The stress of that took a terrible toll on my endocrine system. My hair turned a greasy, leaden gray. I lost all my muscle tone. I had trouble concentrating. I had trouble remembering things. The most scary thing of all was that I was falling asleep while driving in broad daylight. All I can say is, thank goodness for rumble strips. I hit those rumble strips a couple of times.
In 2010, as my business was recovering, as my health was recovering, my wife unexpectedly announced that she wanted a divorce. Nobody was more surprised than me. I had been a boy scout for 25 years, I was the last person I thought would be facing divorce.
When my business was very successful, and I was making lots of money, and I was taking the family on expensive vacations, my wife was very happy to go along for the ride. But when my business was in trouble, when I was de facto bankrupt, when I was extremely sick, my wife looked at me as a sinking ship, and she was the rat that wanted to get off.
Part of the reason that my firm expanded so rapidly after 2011 was because at that point, my wife had divorced me, my children had gone off to college, and my fabulous Labrador retriever had died of old age. At that point, I had no responsibilities to any living creatures. I could go anywhere, do anything. Money I used to spend on kids’ education, or used to spend on family vacations, or used to spend on Nantucket, all could be diverted back into the business.
The fact that I was offering new services and better services compared to my peers was what got me to win enough clients to keep going. It’s been really quite transformational. I went from $90 million in assets before the financial crisis, to about $45 million during the financial crisis. It took me until 2011 to get to $100 million in assets, but it took me only another 10 years to get to $500 million.
So You Want to Be an Entrepreneur…
Whenever I hear that someone wants to be an entrepreneur, I like to have a little conversation with them.
The mythology of an entrepreneur is that things go great, you get your funding, your product launches, you get lots of customers, and next thing you know, you’re on the cover of Business Week, and it’s all amazing.
The reality of being an entrepreneur is that most companies fail within the first two years of business. Even after the first five years, there are still moments of peril. Every couple of years, in my business, I’ve had to take off a year or so, take all my profits, cut my salary down sharply, throw all that cash into the business, to get my firm to the next level of revenues.
I call this the U-Shaped Valley of Death.
Normally, you have a profit margin of ~20%, but when you’re crossing the U-Shaped Valley of Death, your profit margin goes to zero, or maybe even goes negative. And you hope that when you climb out the other side of that U-Shaped Valley of Death, that you’ll have more revenues than before and more profits than before.
In my case, that’s worked a couple of times around. But I will say, the U-Shaped Valley of Death is lined with the skeletons of companies that didn’t make it.
Is it possible just to find a level where you never wanna grow your business any more? Sure. There are lots of static businesses that just survive. Classic example would be a mom-and-pop candy store. But the reality is that things are changing constantly.
For example, prior to 2008, the amount of money and time I spent on internal compliance, cybersecurity, and technology was minimal. Well now, 15 years later, I spend a lot of money on compliance. I spend a lot of money on technology. I spend a lot of money on cybersecurity. And if I had not grown the revenues to absorb those costs, I would have gone out of business a long time ago.
So, the idea that once you achieve a certain level of success you can stand still is a fantasy. Things are constantly changing. The people who stand still eventually get left behind.
I lived pretty frugally for a couple of years. But the money I invested in the business paid off. Now, here I am on the far side in 2022, financially far better off than I had ever imagined I would be.
Because I always had a pretty charmed life up until 2008 and was so roughed up by the next few years, I am now so much more sympathetic to other people’s problems, and it has made me so much better as a wealth advisor.
Randy: Thank you, David, for sharing your story. Thank you Dustin Lowman, my marketing manager, for producing and editing. Thank you Aker Advisors and Heron Wealth for their financial support. And finally, thank you, all of our listeners. If you like what you hear on “To Grit with Grace,” I encourage you to share this with others. We will be back next month with another tale of entrepreneurial struggle and perseverance. Until then, with grit, with grace, with growth, and with much gratitude.