Understanding Types of Investment Clients & Customers

Instructor: Gabisile Ndwandwe

Gabisile is a certified management accountant. She has experience teaching CIMA at managerial and strategic levels.

This lesson provides a high-level overview of the types of investment clients and customers. Each type is described along with examples of why they would invest in financial markets.

Investment Clients

In this lesson, we will look at various types of investment clients and/or customers. We will cover their characteristics and motives, starting with natural persons. The law defines a natural person as an individual able to think, make decisions, and enter into agreements for themselves. Private individuals fall into this category as they are most likely to invest money in financial markets to achieve personal financial goals like buying a house or saving for retirement.

Investing as Individuals

Consider the case of Shona and John, a newlywed couple that aims to buy their first home within a few years. Homes in the neighborhoods they like cost between $300,000 and $500,000. With $50,000 in savings, they are seeking ways to stretch that enough for a decent down payment. An investment banker advises them to look into investing in financial securities like stocks and bonds. After some research, they hire an investment adviser to help them maximize their returns and manage risk as individual investors.

Individuals as Business Owners

While setting up their client profiles, the adviser learns that they both make their living as sole proprietors. A sole proprietor is an individual who owns and operates a business and is legally considered to be synonymous with their business, owning all its rights and obligations. They are held personally liable for all matters relating to their business including investment decisions.

Shona owns an interior design business that she operates from home. She plans to set up a design studio in the new home which will cost $5,000 in addition to the purchase price of the house, so they tell their investment adviser to adjust their investment plan to cater to the cost of the studio. In the meantime, John has been looking into opportunities for synergy between his architecture practice and Shona's design business.

Rethinking Sole Proprietorship

John suggests they combine their businesses to form a general partnership. As general partners, they'll both be fully involved in daily operations, giving them equal rights and obligations in the business, and also making them equally liable for all business matters including investment decisions. A limited partnership would not suit them as that would require one of them to be a silent partner in exchange for limited liability.

Having settled on a general partnership, they decide to make the design studio bigger to accommodate John's drawing tables, equipment, and building plans. This adds another $2,000 to the cost of the studio. The additional investment will enable them to grow and expand the scope of services they can offer to new and existing customers. They authorize their adviser to make a further adjustment to their investment plan. Seeing the couples' plans evolve, their adviser cautions the couple against overexposing themselves to financial risk as their business grows. She takes them through alternative options to protect them from personal liability, starting with a limited liability company.

Managing Financial Risk

To begin with, the adviser explains that a limited liability company (LLC) offers the advantage of providing small business owners with protection from personal liability. Under this structure, owners are referred to as members instead of partners. It also offers some flexibility with regards to taxation, as it allows owners to elect to be taxed as a partnership or a corporation.

A corporation is an entity in which owners are considered separate from the business, associating with it through their investment as shareholders. A significant disadvantage is that corporations are taxed as C corporations by default, meaning the business entity is held liable for corporate tax and shareholders are held liable for tax on distributed profits (dividends).

She advises against this structure as it will reduce cash available for them to invest in growth and achieve their short term financial goal. To address this, she recommends they elect to be taxed as an S corporation which is exempt from corporate tax. Under this, only shareholders pay tax on their share of corporate profits, which should maximize net profits available for investment.

Building Wealth

Seeing opportunity in the couple's lifetime value as clients, the adviser offers them free wealth management and estate planning as added value services. To get these up and running, she creates a family trust for them which is a legal entity set up to safeguard assets and/or capital held on behalf of designated beneficiaries. It will be managed by individuals elected by the couple known as trustees, with a mandate to protect and increase value held in the trust. Given her familiarity with the couple's financial affairs, they appoint her to advise the trustees on how to increase the value of assets in their care.

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