Risk can be a deal killer. The nature of risks evaluated in a deal are broad and diversified. Strategic risks, operational risks, financial risks, regulatory risks, compliance risks, litigation risks, human asset risks, reputational risks …are all risk factors contemplated by buyers and these are just for starters. What we’ve experienced at Exit Strategies is that poorly managed, positioned and presented risk factors can be a bigger liability in a deal than the risk itself. It’s crucial to recognize the distinction between risk and the management of risk. An astute, proactive seller can impact both areas of risk favorably. Portfolio management theory sheds some light here. A seller will help themselves by determining which risks are “systematic” born fundamentally of forces beyond a sellers practical control or influence. In our view sellers tend to become too passive or even fatalistic in the face of these risks. This is where the positioning and presenting of a risk can make a positive difference. Then there are the “non systemic” risks that can be reduced, diluted, diversified and other wise mitigated. These are risks that sellers may be able to invest in and want to invest in reducing. Of course time is also a factor. Some risk mitigation initiatives simply take more time than a seller has.
We find most sellers evaluate the cost of reducing a risk in terms of its projected impact on valuation. Of course this make sense. What is often not considered is the impact of the risk on the overall perception of the business. This is not always exactly the same consideration as valuation. The latter can influence a no go determination by a potential buy in which case valuation impact is less than academic.
Reducing risk where possible and practical and positioning/presenting it more effectively can enhance the probability of closing a deal and maximizing its financial returns and favorability of deal terms.
All business owners recognize risk and that their business has a risk profile. What many sellers fail to recognize is the largely organic differences in how buyers and sellers view and assess risk.
Here are just a few factors that may explain why buyers and sellers view risk so differently.
Most risk factors in a business don’t present themselves in isolation. They’re impacted by obvious and obscure factors. Buyers need context in order to understand a risk and factor it into their analysis of a company. If an owner does a poor job positioning the risk factor it will almost always cause the buyer to overrate the significance of the risk factor.
Example: Litigation Risk
Assume you’re in the late stages of pretrial depositions and motions in a significant suit against your company. You can respond yes to the question in the buyers fact finding surveys and interview and leave it at that and wait for the myriad questions that will follow or you can present the legal risk and in doing so position that risk. The presentation might include a case narrative from your counsel, settlement probabilities, economic impact assessments based on legal opinion and case precedent….
If you’ve built a level of comfort around the case how did you get there? That information could be very useful in packaging and presenting the legal risk.
The bottom line, context matters.
Experience & Familiarity
Anyone who has lived with a risk for any length of time in any long standing environment usually transforms their view of that risk. A psychological callous forms over time and insulates what was a much more raw risk anxiety. An investor who hasn’t lived and breathed this particular risk is by definition presupposed to view it very, very differently.
Example: Customer Concentration
You have one customer who represents thirty percent of your gross revenue. This fact will find its way on to a buyers radar screen. You can manage this risk by explaining that you’ve had this customer for twenty years, you maintain a deep and broad presence in the account, it’s all interesting but it won’t make a buyer sleep well at night.
If you could demonstrate that your efforts to remediate the situation are getting traction you’ll have a much better risk management story. If you can produce a few contracts of new large clients who will contribute to revenue in the next fiscal year and a robust pipeline of impending deals you’ll accomplish much than just offering reassurances.
If an owner’s comfort level with a risk has grown over time they need to be in a position to explain why.
It sounds like meditation on the obvious but owners know their business’s far better than the buyer ever can. An owner has intuitive sensibilities that shape their perception of risk favorably or unfavorably. Most buyers can’t come close to this kind of sensitivity and insight. If you’re a seller you can tell a buyer not to worry about a major risk because you have good feeling about it if you want, but do so at your own risk.
Example: R&D Development
You’re investing heavily in that new software module or unique high speed switching mechanism that dramatically improves performance or that new service that no other provider in your market space offers. It’s early on in testing but you know it’s a game changer and in your view should be reflected in the pricing of your business.
Your enthusiasm may be appreciated but it’s unlikely the buyer will share your excitement in financial terms. If you want your innovation to impact the deal you’d be well served to a produce a list of advance orders, market & customer research data that points to demand and a dramatic demonstration of the innovations impact…
Denial As A Risk Management Strategy
Denying a bona fide risk is generally not a viable management strategy. If a buyer sees a risk that a seller refuses to acknowledge it creates a disconnect and at times even a lack of trust. Buyers are inclined to ask themselves what other risks are lurking in the deal recognized by the seller. You can reduce a risk, reshape a risk, but denying its existence is rarely if ever a good option.
Identifying & Assessing Risk: Think Like A Buyer
A seller thinking like a buyer can be a profoundly useful and profitable exercise. If you’re a seller and you’ve ever bought a business that gives you a significant advantage in exploring the buyer perspective. It might be helpful to imagine if you were buying a business similar but far from identical to yours. Try to imagine how you would view specific risks and what it would take to make you view them more favorably. A cautionary note; Don’t imagine buying your current business. Your deep knowledge of your business will almost inevitably twist and convolute this exercise.
Try to get yourself in a position to evaluate specific business risks in specific environments you’ve never experienced before. Try to experience how the shadows of the unknown serve to elevate your quantification of risk.
Looking at your business’s risk factors try to dispassionately ask yourself questions like these;
Specifically what was I thinking about when this risk factor concerned me the most?
How would a smart business person without deep, specific knowledge of my business view this risk factor?
If I were the buyer what would I need to know about this risk factor? What questions would I ask about it?
If you’re deeply in love with your business this will be a very difficult exercise for you. One of the keys to thinking like a buyer is a dispassionate eye. Rest assured a private equity or any smart money for that matter will not share you sentimental or nostalgic attachment to your business, especially its risks.
Control the Risk Narrative
Controlling the risk narrative is a significant part of managing risk. Needless to say you want to focus heavily on the risks that are of the greatest concern to a buyer. The earlier you know a particular buyers risk sensitivities the better.
Recently a seller opened an initial meeting with a highly qualified private equity we’d brought to the table by saying “Let me tell you what you’re going to hate about my business. Then he said, “then I’ll tell you what you’re going to love about it.” As promised the seller listed four negative realities, two of them were risk factors presented by his business with a depth of knowledge and understanding that was breathtaking. You might argue the merit of his approach but one thing was quickly and abundantly clear: This seller was controlling the overall narrative and specifically the risk component of the narrative about his business.
Business risk is not a sexy subject. Risk management is often difficult work. A seller who reduces the risks buyers are sensitive to and presents existing risk in the best way possible will often be rewarded with not only a sale but a premium price along with more favorable terms.