Here are examples of risks in businesses I valued recently.
Risk
- The Company has high customer concentration. One customer comprises 80% of sales. If the Company lost this customer, it could go out of business.
- There is key person risk embedded in the knowledge, experience, and abilities of the owners that has not been taught to other employees. If any owner dies or becomes disabled, the Company would have difficulty performing critical functions.
- The Company has no buy-sell, operating, or other legal agreements. The lack of an agreement directing how issues such as retirement, disability, death, divorce, bankruptcy, quitting, and terminations (among others) should be handled could cause delays, confusion, and shareholder disputes. A dispute that cannot be resolved could put the Company out of business.
- No single shareholder can make controlling decisions. This could gridlock the Company when decisions require a legal majority or supermajority.
- Neither the owners nor the Company owns insurance policies covering the lives of any of the owners. The Company will need to buy out deceased owners with Company assets. This could deplete cash and working capital required for payroll and vendors.
- There is no written standby agreement with another company or individuals that could mitigate the effects of losing key people. If enough key people are lost, the Company could go out of business without a backup plan.
Fortunately, you can take action to solve all these problems.
Action
- Diversify your customer base. Actively cultivate multiple new customers that can replace the sales of the customer creating the concentration.
- Train your employees on the knowledge, experience, and abilities of owners and key employees. The book, Traction, has some great examples. A short version is to document your processes using the 80/20 rule and keep it simple.
- Contact an experienced attorney who can draft and put a buy-sell agreement in place. Review it at least once a year to make sure the provisions are still sound.
- Put controlling decisions in the hands of fewer owners or create an agreement that provides remedies to make decisions faster while protecting all the owners.
- Purchase life insurance covering all owners. How this should be structured will be different for every business. It’s good practice to coordinate life insurance with the buy-sell agreement. Be mindful of various income and estate tax provisions you must navigate. You should have a good idea of the value of your business on an ongoing basis so that the life insurance proceeds are sufficient.
- Contact companies that could help run or even buy your Company in an emergency. Emergencies could include death or disability of owners or key employees. You can structure formal or informal agreements with a company that could step in if necessary. This can be particularly important if you’re the sole owner and your spouse would have to find someone to run or buy your Company.
Parting Thought
Take action on each of these risks by putting them on your calendar and chipping away one at a time. It will increase the value of your business and even if you decide not to sell, you will sleep better.
Josh Horn, CPA, CVA
Horn Valuation
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