Nov 28, 2010
Creating Value for Your Business
Part II Minimizing Risk
By Philip Elworth
This is the second in a series of white papers on getting your business ready for a transition. As previously discussed this could mean a sale, a recapitalization or a gift. There are many things a business owner can do-- long before the time to transition-- to maximize the value of the business. Every business owner should be in business to create value.
Businesses are often purchased based upon a dependable revenue and net income stream. When this occurs a multiple can be taken of the EBITDA (Earnings Before Interest Taxes Depreciation and Amortization). Another way of describing EBITDA is the Operating Earnings of the organization prior to ownership related expenses. Therefore, to the degree an owner can minimize the risk of fluctuation of this earnings stream and the associated cash flow, the higher the value of the business.
When a buyer is purchasing a home there is a clause in the sale contract that allows the buyer to bring in a home inspector to review the house and let the buyer know the risk they are assuming with the purchase. The same holds true with the buyer of a business. They will send in a team to “look under the hood” of the business and assess the risks they see. So what are these risks that an owner should begin to identify and correct now, prior to initiating a transition process? Below I will unpack the most common risk factors of any business. In addition, each business will have its own unique risks. One of the surprising things I see with business owners is their tolerance for certain risk in their business. When you start up a business or have been running one for a long period of time you become immune to certain risks and actually stop seeing them as risks because you manage around them. These types of risks are the ones a new buyer will be less prone to live with and provide full value.
Accounts receivable is the first area we discuss. Do your customers pay you based upon the terms of their agreement or have you allowed slippage in the payment patterns? Do you have current legal sale or credit documents behind your accounts receivable or have you operated off an old agreement or no agreement at all? Are your sales concentrated in a few key customers or are your sales to your largest customer under 10%? If your sales are by credit card and/or online, is the legal language of your website and the storage of credit card information properly documented and protected?
Inventory; is your inventory properly valued based upon a singular recognized accounting methodology, like average cost? Is the value of your inventory real or is there obsolescence built in? Do you take physical inventory counts on a regular basis? How detailed are your inventory records?
Software; is all the software currently in use licensed appropriately or have a few extra copies slipped in? If you have mission critical software is it properly secured and always available to you or are you dependent upon the supplier staying in business?
Intellectual Property (IP); is this asset adequately registered, licensed or applied for? Have infractions been appropriately contested, or have you allowed others to infringe on your rights thus reducing its value?
Are key processes documented and appropriately backed up? Are key employees being adequately supported or replacements being trained?
In future articles I will unpack additional areas of review. It is important for every owner looking to transition from their business identifies and controls their risk. As a partner with B2B CFO® I can assist you getting your business ready for a transition. Contact me at email@example.com.