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?
- 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?
- 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 .