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De-Risking a Business to Drive Enterprise Value

De-Risking a Business to Drive Enterprise Value

As an appraiser of every type and size business, my experience and training has helped me develop several key defaults to value, the biggest of which is as follows;

 

Value is driven by three key inputs; risk, growth and cash flows

 

In other online forums and presentations, I’ve represented this truth as a three-legged stool that provides structure and support to an opinion of value for tax, financial reporting, planning and strategic purposes. I’ve explained that the relationship between these three inputs is a simple one based on the direction of the input (with all other inputs unchanged) directly correlated to an increase in  value, in this case, an increase where;

  1. Risk – The lower the risk the higher the value;
  2. Growth – The higher the growth, the higher the value; and
  3. Cash Flows – The higher the cash flows, the higher the value.

I believe that any business owner or individual with some finance background can understand how an increase in growth and cash flows increases the value of a business.  In this blog, I want to talk specifically about how risk impacts value and how a company or business owner can lower or mitigate risk (i.e. “de-risk”) to increases value.

The easiest way for me to explain de-risking is to discuss the concept of insurance.

“Insurance is a contract, represented by a policy, in which an individual or entity receives financial protection or reimbursement against losses.”

In the case of a business, an owner/operator who is vital to an organization puts his/her business at considerable risk every day he/she walks out of the office. A bus, heart attack or accident can be a fatal blow to the owner but also the business. To protect against this loss, the company helps mitigate this risk through Key Person Insurance where the beneficiary is the business and the amount of insurance is at or above the value of the business or the determined impact that person has on the business.

While key person risk is one that can easily be mitigated through insurance, other risks are more difficult to lower or eliminate. Below is a list of risk factors that I believe any business has to manage. Each risk has a “de-risk opportunity” that management can consider in mitigating this risk.  Their ability to de-risk the business through operational and strategic initiatives or investment help the business drive value by lowering its overall risk. And, based on the simple math above, lowering risk increases value.

 

 

Risk Factor Rationale
Industry Risk

Industry risk is associated with the market in which the company competes and how volatile it is compared to the overall market.  Consider the recent pandemic and two industries; grocery stores and restaurants. One was considered essential (grocery stores) and the other was shut down (restaurants).

De-Risk Opportunity: The best way to mitigate or de-risk the business for this factor is diversification. Restaurants who survived the pandemic used delivery and to-go opportunities as a way to diversify its business model.

Execution Risk

Execution risk is based on how well the company has performed in the past in meeting its budgets (top and bottom-line metrics) and the overall strength of the management team.

De-Risk Opportunity: A company can hire specialized personnel to help fill holes in the management team. Other opportunities include building out the board of directors or creating an advisory board to provide checks and balances and accountability.

Technology Risk

Technology risk is most commonly associated with technology tools that lead to higher efficiencies and productivity.

De-Risk Opportunity: Along with hiring specialized personnel, the company can invest in software tools to help with financial planning, manufacturing, point-of-sale, and other programs that can turn hard data into management tools and dashboards.

Supply Chain Risk

In a post-COVID recovery, the term “supply chain” is now the catchphrase for defining risk associated with low to no supply of products and the delay in getting available products to the end-user. That Peloton bike is now six weeks out instead of four because they are having a problem securing the video screens from China…

De-Risk Opportunity: The best way for a company to de-risk supply chain issues is adding additional suppliers to the mix and increasing its inventory when it can to add a few months of extra supply to combat extended turnaround times.

Customer Risk

While retail stores have minimal customer concentration, a construction firm and government contractor may have 70% of its business with the Department of Defense.

De-Risk Opportunity: Diversification in both product and service offerings allows for any company to manage this concentration risk by focusing selling efforts on new industries or new customers.

Integration Risk

This risk is associated with an expected change of control or selling the business. There may be issues with transferring licenses, key contracts (see above) management transition of key people.

De-Risk Opportunity: Overall, this risk is highly correlated all of the others above. For owner-operated companies, putting together an operations manual that defines management roles and outlines key responsibilities will help eliminate “key person” risk. In selling a company, that risk may only be mitigated through consulting agreement that keeps the prior owner or top management in an active or shadow role or involved with a minority equity stake (as is the case with private equity purchases and “rollover” equity that allows the seller to participate again in another sale of the business.

What Does This All Mean?

Focusing on and managing these company-specific risks prior to an exit event will help increase the value of the business and provide the eventual buyer with a stronger basis by which to run the business going forward.  Think about it as a homeowner de-risking the sale of their home by renovating the kitchen, replacing the roof or cleaning up the landscaping and curb appeal. While all of these activities involve an investment (some more than others) the eventual return should come in the form of a quicker sale with more potential buyers which correlates with a higher sale price that, almost certainly, will exceed the cost of the investment.  The same is true with your business; there will likely be a tradeoff of value in de-risking the business through an increased cost structure (insurance, technology tools, increased staff). Remember, a decline in cash flows equates to a decline in value. However, the real challenge for management is to either eliminate other, more marginal costs and/or find leverage in these incremental costs to increase revenue and profits.

Exit Strategies values control and minority ownership interests of private businesses for tax, financial reporting, strategic purposes. If you’d like help in this regard or have any related questions, you can reach  Joe Orlando, ASA at 503-925-5510 or jorlando@exitstrategiesgroup.com.

Businesses Need to Do These Four Things Before 2021

Businesses Need to Do These Four Things Before 2021

Many of us are looking forward to putting 2020 behind us and welcoming in a new year. The idea of a fresh start is refreshing and business owners are looking to prepare their businesses for 2021 and beyond.

Looking back on 2020 and acknowledging what worked and didn’t work for you and your business is vital to mapping your 2021 approach. While there are numerous areas to think about, including operations, human resources, and sales, these four key steps will help point your business in the right direction.

“Flexibility will be the central theme for 2021. Preparing multiple options may help the process of being prepared for the unexpected.”

Build Your Budget

The start of the new year is a great time to prepare your budget. And entering 2021 marks a critical time to sit down and analyze your future.

The COVID-19 pandemic of 2020 caused many businesses to realize that the traditional static budget of using fixed inputs and outputs was no longer necessarily useful. Creating a fluid and flexible budget that can adapt to changing business realities is now the new reality.

As many small businesses were stretched to the max in 2020, feeling like you were always reacting was the norm. You were stress-tested and learned some valuable information. Use that knowledge and combine it with a proactive approach.

Creating a “perfect” budget for 2021 is probably unrealistic, as things possibly get more difficult before returning to normal, building a better budgeting process is attainable. Businesses should consider preparing a few different budgets that capture best and worst-case scenarios that roll back spending to factor in contingencies for scarce resources or slowed demand. This rolled back spending can create contingency funds that can be used say when demand for your products in certain parts of the country increases or when customer retention rates drop.

Collaborate with your managers to prioritize tasks and projects to justify when and how much to spend. New or special projects that were important at the start of 2020 may be optional for 2021. If you pivoted and launched new products in 2020, access whether you want to include these revenue sources in your 2021 budget.

Flexibility will be the central theme for 2021. Preparing multiple options may help the process of being prepared for the unexpected.

 

Tax Preparation Enablement

We provide your organization a true end to end solution to all of your tax needs. Tax season is year round to Protea – if you aren’t preparing daily, it’s too easy to get behind. We are always working with your organization to streamline your businesses tax management.

Talk to Banks and Shareholders

If you haven’t already been having an ongoing dialogue with your bank, start one in 2021. With 2020’s unprecedented business environment, banks have been working round the clock to help their customers. They’ve likely encountered every possible scenario a business could face. You should rely on their expertise to guide you, but they can only help you if you are honest and prepared

Whether you need a bridge loan to finance operations, need help completing your PPP loan forgiveness application, or need a line of credit in the event you need short-term cash flow in 2021, start the conversation today.

Similarly, start a conversation with your shareholders and partners. Set a realistic tone and expectation for 2021. This will be easier to do once you’ve completed your budgeting scenarios. Let them know the worst and best-case scenarios and explain how you’re prepared to adapt as the uncertainty of 2021 unfolds.

Although the thought of having these difficult conversations with shareholders may be stressful, they will appreciate your honesty and place further trust in you that you’re making the right decisions for business success in 2021.

 

Move Your Back-office Away from Paper

If you weren’t previously optimizing your use of technology, the pandemic quickly forced you to. When administrative offices closed to keep employees safe, working remotely became the new norm and accessing documents remotely became vital.

While having multiple filing cabinets and heaps of paper was sufficient when employees worked in an office, it quickly showed its ineffectiveness when the pandemic struck.

Continue the trend to move your office away from reliance on paper files and documents. With numerous electronic storage options, it’s now cost-effective to move away from paper filing cabinets.

Cloud storage providers ensure your data is secure and easily accessible. And unlike paper filing cabinets, electronic document storage is easily duplicated to create back-up copies.

Having only paper files is risky. With only one copy of documents stored in a cabinet or a box means that if that paper is misplaced or damaged (fires are a real risk these days), you have no back-up copy.

 

Upgrade Your Accounting and Bookkeeping

With 2021 being the year of flexibility, having an agile accounting team will position your winery for continued success.

If 2020 caused you to reduce your bookkeeping and accounting staff, your business might be at a disadvantage now. If you find your books are not up-to-date or you’re not receiving regular financial reports from your accounting department, you may be operating leaner than you should.

With more uncertainty to come, having timely financial information about your business’s health has never been more critical. When you’re going to need to make decisions quickly in 2021, you’ll need current, accurate financial statements.

But if you’re uncertain about bringing on more employees, outsourced bookkeeping and accounting may be what you need.

With outsourced accounting, you can quickly scale your resources to meet your business needs. You’ll not have to wait to find and hire new staff and train them so they’re up to speed. Your outsourced team can add new members immediately who are already experts in the winery and beverage industry. And if business slows down, you can scale down your outsourced team until business picks back up again.

Outsourcing your accounting can provide immediate expert advisors who can provide guidance and financial direction in uncertain times. While you might think that having industry expert accountants on your team may be a luxury your business can’t afford, the numerous flexible fee options at Protea fit any budget. With professionals with decades of experience in the winery and beverage industry, you’ll receive the specialized knowledge you need with the personalized service you deserve.

Reach out to us today to schedule your initial evaluation, and let us help you take some of the uncertainty out of 2021.

 

 

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Protea Financial was founded in 2014 to provide high-quality outsourced accounting at an affordable price. Given Protea’s flexible work environment, the Company especially appealed to accountants who wanted to re-enter the workforce after taking time off to start a...

The Basics of Wine Costing

The cost of making wine can vary greatly depending on several factors, such as the type of grape used, the region where it's produced, the size of the winery, and the production process. For example, the cost of producing a bottle of wine can range from a few dollars...

Wine Accounting 101: Understanding the Basics

Wine accounting is an essential part of the wine industry, but it can often be daunting and confusing, especially for those new to the business. Protea Financial offers wine accounting services tailored to meet your needs and help you understand the basics. Our goal...

Protea Conversations: Theresa Wray

Protea Financial was founded in 2014 to provide high-quality outsourced accounting at an affordable price.  Given Protea’s flexible work environment, the Company especially appealed to accountants who wanted to re-enter the workforce after taking time off to start a...