EP 97: 62 Business Risks

Welcome to another episode of the defenders of business value podcast, I'm your host, Ed Mysogland. I had, I had a real favorable response to my article on the the five levels of grief in m&a. And so I may or may not have mentioned that I've been writing a book and, and in the research, that's one of the things that came out. But also, I thought I would share a couple other tidbits that I've I've bumped in along the way. So today we're going to talk about risk. And for those of you unfamiliar with business risk, as it relates to value in the sale of a company, as risk goes up, value goes down. Okay, that's just the risk and reward relationship, you probably remember that from your economics classes in high school in college. And it's the same for business value. And when you're looking at acquiring companies, this is all about risk, earnings, risk and growth. That's all all i all my I spend my life in this sale world, that's all I do is try to evaluate. Where's the business going? What kind of earnings does it have, and what kind of risk is inherent to the company. So today, I'm going to talk to you about 62 different types of risks that that are in a business and and I want to give attribution to a woman by the name of Anna Mar, I can't find her I can't find any reference to to her. This, you know, I've dug, I dug this 62 components of risk out, it's probably at least three to five years old. But I can't find I can't find her on LinkedIn, Twitter or any of the socials. So but I do have a note that this, this is some of her work. So I added my own. But nevertheless, I wanted to kind of go through these 62 attributes of risk in a business. So the first group is strategic risk. So the first one is corporate governance risk, and that means that employees won't act in the best interests of the owners or the stockholders. And so when you buy a company, I mean, that's one of the primary risks is, is everybody going to hop on board with the new owners. So that's the first one competitive risk. Now, it's the general risk that you're going to lose to competition everybody in when we write our marketing information. That's what we spend a lot of time doing is identifying where do you look at the grand scheme of things versus the business and its industry? locally, nationally? How is how is competition going to affect affect the the company that you're buying? Innovation, you know, innovation risk is that competition, or new entrants will outdo you. And when we think of that, competition is really innovation. You know, I think you're seeing a lot of buyers that are buying businesses that have not necessarily kept up with the times as far as technology and equipment. And then they can retool it and, and really go out and compete. But innovation risk is is serious when you're evaluating a business that are you at a technological disadvantage. Intellectual property, right. Intellectual property risk is, and when we're talking about intellectual property, we're talking domains, we're talking IP, we're talking processes, all that is intellectual property. So so, you know, a, you know, do your competitors or other people get a hold of that intellectual property? Or is it impaired in some ways, somehow? You know, and we're seeing, like, AI is really doing a number on an on on businesses right now, because everybody doesn't know, you know, how is that going to affect their IP? So m&a risks or mergers and acquisition risk is the risk associated with integrating companies. And I think we've we've talked about this on the podcast before. You know we're talking about you know, when you buy a company, can't it company buying a company can you can cultural He operationally and financially, does this work financially we can make it we make the numbers work. But I, there was a study, there was a study by Oh, I believe it was the Harvard Business Review, in which 87% of mergers fail. And the biggest risk is or the biggest problem is culture. So m&a risk is certainly certainly something to think about the the rough rule of thumb that that we have always Shinto, we have always but that we, we find, and John Warrillow, from Built to Sell we talked about this many times over the years is that a company needs to be proud that the acquiring company needs to be roughly five times larger than its target. And there and the reason being is that it diversified the risk that, you know, if things don't go as planned, then they don't go as planned. And certainly we take it on the chin, but we don't capsize our business. Alright, so next business risk, it's just the overall, you know, risk that businesses that the business you have will not be effective, yeah, might not be accepted by the marketplace. economic risk, that's the risk that the prevailing economic conditions kind of like today, you know, that will go into a recession, you know, for some businesses that'll benefit, but up for other businesses as well. You know, cost capital and things like that. The economic risk is considerable technological change, that's the risk that technology and investments will become, technology investments will be obsolete. And as you're seeing this things are rolling out. Technology that is, you know, you're seeing that, well, let's just take the pandemic, you look at zoom, and everybody, it was a big land grab to get into virtual meetings, well, not the pandemics out, you've got technological change, and, and you've got a lot of new entrants into the market. So that's a risk, project risk, that's a risk that some of your undertakings aren't going to come to fruition, ethics risk. You know, the integrity of the company is the mission and the people that are guiding the company. You know, that's that's the risk that there's an there's an ethics breach. reputational risk, that's the risk that you damage your your corporate image, reputational risk and reduce the trust in your business, and ultimately, damage value. And I think you'll see, we certainly when you read the news, you find that, you know, business owners, and somebody will have been a bad boy or girl and, and it makes the newspaper and and as a result, you know, the business? Yeah, takes it on the chin because of the sins of the owner. All right, now we move into financial risk. So profit risk, you know, that's, that's the general risk that you're not going to be profitable. That's just inherent with business. capital availability, we're bumping into that now, you know, and I say we're bumping into that now work, the cost of capital is, is, is causing some havoc in small business, but deals are still getting done. But capital, it's the availability of it, you can't a lot of businesses can't grow without access to lines of credit. And, you know, and growth capital, I will tell you as of today, and we're talking late September, that, that businesses, especially if you are a if you are in the let's just say, I'll say HVAC, let's just let's pick on you're a plumber, and you're a plumber, and you want to grow your business through acquisition, if you are buying a company that is in the same industry, so another plumber, and this is based on your NAICS code or next NAICS code, I guess some people pronounce it, the SBA will will fund that acquisition with no equity out of out of your pocket. So it's a the money will be expensive, you know, so the your your cost of capital is high, high as prime and maybe prime plus one or two, depending on the bank you go with. But you can grow through acquisition without any kind of any kind of capital expenditure on your part. So keep that in mind. Alright, the next one we're talking about is asset risk.

Ed Mysogland  9:57  
Some businesses are asset heavy And what is the risk associated with, you know, those businesses that are able to keep the value of those assets? Good. And like, for example, like real estate, you know, when real estate values fall, you know, that's a that's a risk to the business, because you don't necessarily have that level of collateral that you once did. We just talked about cost of capital. So interest rate, you know, interest rates, cause havoc, you know, right now, and I don't see that coming down. You know, for those of you that do that, have you no, business with foreign countries, certainly the currency risk is, is to be considered, we have inflation, the risk of price increases and credit in critical inputs, like energy and for the transportation industry is a real good example, investment risk is the risk of the change in value of investments. Yeah, it, it depends, you know, those are predominantly for bigger businesses that, that do investing on behalf of their company. liquidity risk, this is, you know, this is a, this is a huge one for small businesses, because when we start talking about liquidity, it's what's the likelihood you can sell your business. And the the rough, rough rule of thumb from an industry standpoint, and again, it just depends on the type of business. But as an industry as a whole, I mean, your, your success ratio is only running about 20 to 30% success ratio of selling your business. Now, I can tell you that we, in our shop, were higher than that, we're in the, depending on the type of business like manufacturing, you're probably 70 80%. Yeah, you're small retail, it's probably in that 20 to 30% just depends, but liquidity is a big thing. So let's talk about systematic risk. That's next, the risk that the, you know, the whole global financial system of UK country will collapse. Now, if you're doing international work, that's one thing here, small businesses, probably not going to be a risk to you. concentration risk, when we talk about concentration, its dependency of a customer and employee supplier, those are that's a big, that's a big problem for any buyer. Because if if, if you're concentrated there, there's a concentration, that means that there's higher risk, if that person place or thing goes away. credit risk. That's, you know, we're seeing, I don't know, let's say we're seeing, let's just say it from this standpoint, that, you know, with the the amount of capital and the velocity of capital that was available in the last two or three years, now, there's a lot of people have borrowed a lot of money. And for those that are on variable on variable debt, it's it's gotten pretty serious form. So there's a credit risk that the borrower will default on loan fraud risk, always, you know, I've got some some friends that do fraud work, forensic accounting, there's all that that goes on. And there's that risk, accounting risk. You know, knock on wood, you know, we haven't, we haven't had it, but, you know, you botch up accounting, I can tell you that my accountant spends a fair amount of time after, at the, at the end of the year fixing my QuickBooks sins. So, you know, but there's that risk of accounting and, and, and money in and money out and I will tell you that that's a big one from a from a business sales standpoint, because what we're talking about is you have to be in a position to be able to explain now here's my texture and my texture and my financial statement, my financial statement ties to my my internal bookkeeping, my internal bookkeeping ties to my, to my deposits and ties to my invoices. That's what how accounting is so important. But who Sherry Let's move fiduciary breach risk. Yeah, if the risks that your firm will breach those fiduciary responsibilities you have with your client. Next, let's move into marketing. So marketing and sales risk. So certainly revenue shortfalls that your your marketing bland does not you know, does not does not work as an anticipated the demand you You overestimate how much people will want your product or service market competition, the risks that that, you know, let's just talk Pay Per Click the cost to advertise on Google. Now, there's all kinds in my world, there's all kinds of people, you know, looking to, to drive up the the, the cost to be seen on Google. And yeah, they're not they're not in our neighborhood, these are people that are all across the country that are that are, that are out trying to, you know, out market us in our own market. All right, next to the sales forecast risk, that's a risk of clearly, but that means that you're gonna make some forecasts, and they don't come to fruition, new product, you introduce a new product, and it falls flat, that just that you underestimated, perhaps the total addressable market, it doesn't come to, to pass it, the market is is interested in it. That's a real thing. Customer Relationship risk. Everybody, everybody waves the flag on relationships. But the it seems as though we're getting, you know, we're getting further and further away, we're doing things more things on email and text, rather than belly to belly work. So we're seeing what kind of it's hard to get a relationship in that manner. But people are doing different things. But my point is that, that though, that the relationship that you maintain with your customer, or your or your clients, your customers, clients, employees, vendors, you know, that's, that's that, that is risk, you have brand value, the risk of brand awareness, publicity risk, we're just talking about that up up in strategy where you have a, an issue with the sense of the owner will affect the brand. And yeah, let, right now let's just talk about, you know, let's move to football, you know, you have Chicago Bears defensive coordinator, that the FBI raided his house. Well, that's, that affects the brand of the bears, because it's like, what are you associating with this kind of guy for? So that's, that's a an example. Publicity risk, the risk of bad publicity, certainly the bears are on on high alert, they're large account, again, we're large account risk we're looking at, you have concentration of any kind is bad. So let's move into operational risks. So infrastructure, these are the things that run your business there. And the risk of those things going out. Like, for example, let's take our business, you know, we run we need electricity to run computers and phones. That's it, that's what we that's what we use. So it goes down, we've got problems. So maintenance risk, the risk of maintenance, failure, like, like, for example, aircraft, you know, the human error and aircraft maintenance, that's a bad day.

Ed Mysogland  18:06  
product failure, the risk that you thought the product or service will fail. Product liability, I don't think that needs any, any explanation. It's just, there's a defect and in your product, and something happens and there's a liability that's associated with it. So then we move into operational quality. This is the general risk of operating your business failures, for example, like we use, like our website, for example, if it goes down, are we out of business? No, but it's hard for us to to connect with the people that are expecting to be able to see all of our deals. So that's, that's an operational quality risk. So production shortfalls let's just say like Ford, for example, you had Ford that did not that was unable to get their their chips, so the supply chain issues that is a risk so your so they failed to meet the production targets. We'll just let's move to logistics and the logistics, logistics risk is that you're unable to deliver your your your wares your goods and services, to your customers. Procurement. Again, back to back to the chip example. This is a matter of you're unable to get what you need in order to provide your product or service. So now let's move into information technology or it. So architecture risk, you know, the risk that what you've built won't work or will fall will fail to meet the business objectives, data quality, where I had Mike Butler from see spring on on the on The podcast a few months back, and we talked about data quality. So if you have poor data, you're gonna make bad decisions, technology quality, you know, what is the software and hardware you use? Like, for example, I have, I have a friend that, that doesn't update his computer, I don't know why it just when it breaks, then all of a sudden, we have to jump in and, and fix all of those problems. I said, data quality risk is a real thing. Especially for those that didn't necessarily grow up using computers. So the platform risk, like I have a a marketplace platform, you know, and and, you know, just working right now to try to figure out product Product Market Fit does does the does the platform work to serve the people I'm trying to serve? I don't know, we'll see. Information security risk, you know, cybersecurity is a big thing right now. And I don't think it needs a whole lot of discussion. It's just, you know, how, how locked down is the information that you hold? Alright, moving on to HR, HR, workplace safety. Again, you know, the the risk of act accidents or poor environment impact impacts employees. And if it impacts employees, you got to keep those them because too hard to hire these days. So employer reputational risk, you got outfits like Glassdoor that reviews, exiting employees, and you know, what kind of experience that they had working for you. It's hard to unwind. Unwind disgruntled employees, product or employer employer liability risk. It's the risk that your business practices will get you in trouble by the people that work for you. Employment Law compliance, the risk of non compliance with employment related laws and regulations. Believe it or not, there's a lot of people that do not follow the law. And in fact, we, you know, that's one of the one of the when you when you sell a company, that's one of the things that you have to represent and warrant that you're doing is adhering to the laws. Talent Management Risk, it's the risk of losing a player's and it happens a lot. Compensation and benefit risk. We're seeing that and like, let's talk HVAC, I mean, you know, it's just a race to the top to get that talent and you're seeing people poach a lot of, of, you know, higher iron talent from other companies, just you know, just for, for, you know, a couple dollars difference, we see that you see that in home health care a lot, like people will like the nurses will jump for 25 cents an hour. It's that when I say nurses, I'm talking like CNAs and things like that hiring risk. Everybody, what was the I think it's Zappos that will pay will pay you $1,000 If you leave, all right, rather than take the job. And that's, you know, the risk that you will hire the wrong candidate because they, they Zappos recognizes that you make that kind of mistake. It's the cost associated with the mistake is far more than the $1,000 it is to say, you know, what, this isn't for you. And then employ policy privacy risks, you it's the prospect that you will the risk that you will leak personal information, that employee will leak personal information related to the company, then you've got compliance and legal risk. So certainly compliance risk, you know, are you complying with the laws that that govern your company? Mandatory reporting risk, you got to file your tax returns, for example, is a good one. And, yeah, and I will just tell you that if you don't file your tax returns, you're probably not going to be able to sell your business. Next is liability risk, the risk of lawsuits. You know, we're in a crazy, litigious time where, you know, people are quick to to, to file suit. All right, now let's move to catastrophic risk. So force majeure acts a major thing, crazy things happen. You look at, you know, the flooding and earthquakes and fires. You know, those are all real. Things that affect business pandemics are another good thing that that that That affects negatively affect businesses. And then lastly, you know, we're moving, we're coming up to an election year political risk, you know, depending on who's, who's who and who's driving the bus, at a national as well as state level affects business. So those are the 62 business risks that that can affect the value in the saleability of a business.