In our first blog on The Five Stages of Value Maturity, we considered ABC Company, a hypothetical family-owned plumbing equipment supply business. The current President and CEO seeks to transition ownership and retire—yet he must address big issues first in order to make the best decisions for himself, his family and his company.
As we mentioned in this first blog, his first task is to Identify Value. Once the true value of his company is established, he can then embark on the next leg of his value maturity journey: Protect Value.
This is critically important, for there’s little sense in understanding what our business owner has unless he takes proactive steps to protect it. For him – and for you as a business owner – protecting value entails addressing risk in three distinct areas – what we term three legs of the stool— business, financial and personal. Essentially, your challenge entails:
- Mitigating risk (i.e., heading off potential issues before they occur)
- Addressing and minimizing current risk-related issues
The ultimate goal of these steps is de-risking your business, which makes it a more attractive target in an increasingly crowded market. After all, the more risk that your business bears, the less someone will be willing to pay for it. Conversely, a business that’s viewed as less risky will command a higher price tag.
It’s worth noting that business owners, and especially entrepreneurs are, by their very nature risk takers. Most realize bearing risk to some degree, and then figuring out the right balance between risk and reward with each action they take, is part of business. What we’re talking about here is different—and we think business owners need to think differently about risk as a result. Specifically, they must consider how a potential buyer might perceive a risk that they themselves don’t feel burdened by. Will that risk be so undesirable that it could steer them away from a potential acquisition? It’s a question that needs to be asked, and it necessitates a mindset that’s quite different from the one that helped build that owner’s success over time.
In our Owners’ Roundtable series, we ask our owner participants to identify risks related to each of the three legs of the stool. Some common examples include:
- Operations are too owner-dependent
- Customer concentrations may be overweighted in one or more areas
- Key employees could leave
- Technology may need upgrading, may break down or may be compromised, which could result in a data breach or loss of data
- The market into which the company sells may be declining
- The product and/or service mix may not be adequately diversified
- Economic pressures or changes may affect operations, necessitating unforeseen capital expenditures, or even penalties
- Current business debt may not be structured under market-appropriate conditions
- Aging property, plant and equipment could impede production and processes and make the business appear less valuable, since replacements and upgrades could potentially be factored into an offer price
- Potential tax issues that may represent a business risk
- Generally, 80 percent of an owner’s net worth is in the business
Personal: Any or all of the 5 Ds:
- Death – Obviously, death of a business owner, or even a key employee, can affect a business to varying degrees—from mildly to profoundly. If the owner of hypothetical ABC Company dies, either suddenly or as the result of an illness, is the business prepared to continue its daily operations?
- Disability – This also can impact a business—particularly if the owner or a key employee is disabled on a long-term, or even permanent, basis.
- Divorce – For an owner who is in the process of getting divorced, significant time and energy can be diverted from day-to-day business operations. The process is inherently stressful, which can lead to health problems. And from a financial standpoint, the resulting impact can have negative repercussions throughout a privately held business.
- Disagreement – When one or more business owners disagree – over anything from strategic direction to legal issues – time and energy are diverted, and a business can easily go astray as a result. Of course, disagreements and disputes can lead to legal challenges, which are costly, stressful and time-intensive.
- Distress – The business may be distressed due to a flat or declining industry, a new “mousetrap” by the competition, or the loss of a large customer.
Once risk issues are identified, we then ask our owner participants what they are doing to mitigate those risks—and equally important, how they are getting their team involved in that process.
We also bring in outside experts to discuss legal risk, along with a professional to discuss overall enterprise risk management and a former business owner who shares their experience.
The End Goal: A De-Risked Business
The de-risking stage is designed to be completed over a two- to six-month time frame. To get started, ask yourself what specific risks correlate to each of the three legs of your stool. Jot your thoughts down on paper, then review it when you’re done to get a better sense of your risk landscape.