Risk Reduction is Value Creation

Risk Reduction is Value Creation

By George Walden

November 30, 2016

Business owners have asked me to advise them on what they can do to improve the value of their company. In a video I posted on Vimeo, I explain about how risk reduction is value creation.  Click on the play button below to see the entire video.

My favorite answer is to reduce risk for the buyer and the value should improve. The only way for a buyer to account for risk is to lower the price.

What are some of the areas a business can evaluate and make value improvements? Some things are relatively easy to change, some are not so easy. Here are some of the easier ways:

1.  Build an organized systemic approach to running your company: Companies should be systems based, not personality based. Clearly defined roles and a systemic approach to your operations make a company less dependent on any single individual. Systems range from IT to marketing, from employee development to operational implementation. The common thread throughout all systems is that they measure and provide information that allows the business to make decisions. This documentation provides a buyer insight into the company and removes risk from the loss of a single employee.

2.  Build bench strength: If you watch a football game and you’re a fan of the Texans you know bench strength is often the difference between winning and losing. Losing a JJ Watt certainly hurt, but having others that know his role and can take his place, the next man up mentality is often how we measure success. Businesses are no different and in many ways bench strength and redundancy can mean the difference between failure and success. Another example is in our military. Their business is risky to the point where casualties are expected and trained for. Loss of a leader simply means the next man is up and the operation continues. Duplication, Systemization and Cross Training of your people reduces the risk of unexpected loss. Having a management team that is capable of making decisions and running the company shows a stability that is attractive to a buying group.

3.  Reconcile your financial reporting and make them an information tool: You would be amazed at how many financial statements don’t reconcile both internally or even with the tax returns of the company. These very basic tools should always add up. If they don’t reconcile they imply poor operating and reporting systems, weak management and it introduces risk. My advice is if you are providing compiled financials have them reviewed. If they are reviewed get them audited. Too many owners use the financial statement as a year-end snap-shot of how they performed to satisfy the bank vs a decision making tool on how to run the business. Step up your game and remove risk.

Risk Reduction is Value Creation

Here are some things you can do to reduce risk that may not be so easy to change.

4.  Customer Concentration: Some businesses by their nature have customer concentration issues. Machine shops are a prime example. They often become known as their customer. They become known as a Haliburton shop or a Baker shop. It is easy to understand, as you develop capacity, your primary customer fills it up. But what happens to the company if the orders go away. When you lose that customer and 50 percent of your company just went away, you have a problem. Smart businesses strive for diversification of customers and spread their risk.

5.  Vendor Concentration: Similar to customer concentration vendor concentration affects your ability to respond to the changing needs of the customer. Delivery dates can be pushed upsetting your company’s capacity to provide their services on time.

6.  Industry Risk: If you are in the exploration side of the oilfield industry you understand what a prolonged downturn can do to a sector. Recently, I attended the A&M Turbo Machinery Show and it was a tale of two different rooms. The companies who were diversified in other industry sectors such as agriculture and water were doing well and excited about their growth prospects. The companies who were fighting for the few oilfield orders were worried about their survival. During good sector growth periods, diversification should be a very deliberate corporate strategy.

7.  Regulatory Risk: We have watched entire industries crushed by the over reach of regulation. The mining industry is the obvious example but most industries can fall prey to the over reach of regulatory issues. Some over sight is good for the environment and the economy, but when the stroke of a pen can overnight change the economic viability of an industry we need to recognize significant risk has been introduced to a buyer.

8.  Volatile Profitability: Some volatility is just the normal business cycle of the rising and lowering tide of economic vitality. But nothing introduces risk for a buyer like significant rises and falls in business earnings. Diversification tends to level the extremes of industry volatility, but when your company is experiencing volatility and the industry isn’t, buyers have no choice but to lower their price to account for the risk within the company.

Removing risk for the buyer should typically translate into a higher valuation for your company. Call your M&A advisor long before you are contemplating selling your company. Have them evaluate how a buyer would look at your company. Effort spent in this area pays very well in the event of a sale. You might find making that transition a very exciting, rewarding direction for your company and its people.

Posted by George Walden.