Part II Minimizing Risk<\/p>\n
By Philip Elworth<\/p>\n
This is the second in a series of white papers on getting your business ready for a transition.\u00a0 As previously discussed this could mean a sale, a recapitalization or a gift.\u00a0 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.<\/b><\/p>\n
Businesses are often purchased based upon a dependable revenue<\/b> and net income stream<\/b>.\u00a0 When this occurs a multiple can be taken of the EBITDA (Earnings Before Interest Taxes Depreciation and Amortization).\u00a0 Another way of describing EBITDA is the Operating Earnings of the organization prior to ownership related expenses.\u00a0 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.<\/p>\n
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.\u00a0 The same holds true with the buyer of a business.\u00a0 They will send in a team to \u201clook under the hood\u201d of the business and assess the risks they see.\u00a0 So what are these risks that an owner should begin to identify and correct now, prior to initiating a transition process?\u00a0 Below I will unpack the most common risk factors of any business.\u00a0 In addition, each business will have its own unique risks.\u00a0 One of the surprising things I see with business owners is their tolerance for certain risk in their business.\u00a0 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.\u00a0 These types of risks are the ones a new buyer will be less prone to live with and provide full value.<\/p>\n
Accounts receivable is the first area we discuss.\u00a0 Do your customers pay you based upon the terms of their agreement or have you allowed slippage in the payment patterns?\u00a0 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?\u00a0 Are your sales concentrated in a few key customers or are your sales to your largest customer under 10%?\u00a0 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?<\/p>\n
Inventory; is your inventory properly valued based upon a singular recognized accounting methodology, like average cost?\u00a0 Is the value of your inventory real or is there obsolescence built in?\u00a0 Do you take physical inventory counts on a regular basis?\u00a0 How detailed are your inventory records?<\/p>\n
Software; is all the software currently in use licensed appropriately or have a few extra copies slipped in?\u00a0 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?<\/p>\n
Intellectual Property (IP); is this asset adequately registered, licensed or applied for?\u00a0 Have infractions been appropriately contested, or have you allowed others to infringe on your rights thus reducing its value?<\/p>\n
Are key processes documented and appropriately backed up?\u00a0 Are key employees being adequately supported or replacements being trained?<\/p>\n