Monthly Checklist Series

Weighing the Risks

 Business valuations help your clients–and your firm–understand an entity’s strengths, weaknesses, vulnerabilities and market share in the event of its sale. In any valuation, it is important to assess financial risk–income potential vs. vulnerability to disaster. To better measure such risk, consider the following factors:

Quality of earnings

• How profitable is the company?
• How steady have sales and profits been over the past seven years?
• Is the company too young (less than five years old) to determine if its earnings will be consistent?
• Are sales flat or growing only at the rate of inflation?
• Have sales exceeded the rate of inflation, or are they not keeping pace with it?

Type of business

• Is the cost of entry into this industry very high?
• Does the need for expensive fixed assets limit competition?
• Is it a service business with few securable fixed assets?
• Are inventory and equipment a large part of the company’s total value?
• Does the business depend on the health of other industries over which it has no control?
• How long has the company been in business?

Prospects for the future

• What is the outlook for the industry as a whole?
• Does the company provide ordinary products in a field with little growth?
• Is it likely the company’s products and processes will soon be outmoded?
• Does the company possess up-to-date technology and a well-developed research and development program?
• Is foreign competition emerging?
• Does the company’s health depend on the economy’s health?

Competition

• How competitive is the market for the company’s products or services?
• What is the company’s standing vis-a-vis the competition?
• Is there a low cost of entry that encourages new competition, or are there high start-up costs or proprietary products to reduce competitive threats?

Employee issues

• Do the company’s products or services require special skills, education or licensing?
• Is the work desirable? Does it take place in a pleasant environment?

Quality of fixed assets

• Real estate. Assess the location and desirability of facilities; the degree of obsolescence, adaptability to other uses, deferred maintenance and environmental cleanup liabilities; and the underlying land value and quality of title.
• Machinery and equipment. Assess the degree of obsolescence and cost of deferred purchase.   Structure of the purchase transaction
• Will any purchase of the company be highly leveraged (lots of debt)?
• Would a buyer need to sink lots of cash equity into the deal?
• Is the company adequately and safely capitalized?
• How do the financial ratios compare to those of other companies in the industry?
• Does the purchase involve a transfer of stock? What are the potential liabilities?

Other factors in assessing risk

• Is a labor union present?
• How strong is the staff that would remain after a sale?
• What is the risk of competition from former staff?
• How is the health of key personnel?
• Is there heavy government regulation?
• How dependable are the lending sources?
• How healthy is the region’s economy?
• Are customer accounts diversified?
• Are products and services diverse?
• Is production susceptible to weather, international events or other uncontrollables? How likely is it an event affecting production will occur?

Source: Unlocking the Value of Your Business by Tom Horn. Charter Oak Press, 609 Whedbee Street, Fort Collins, Colorado, 1998. www.charteroakpress.com .