By Maurie Cashman
You probably spend a lot of time worrying about how to reduce business risk. This is common to all businesses. It is a critical component in the ownership transition process. It is likely what keeps you up at night. Last week we asked why you want to be remembered. One aspect that often comes up in my discussions about their businesses is that they want to build a business that is sustainable.
After we have established the ownerâ€™s objectives, our next step generally leads us to a discussion of what risks the business faces and how we can reduce those risks to make it more sustainable. Often this discussion must wander a bit and I ask a lot of questions to get a mutual understanding of the risks that exist that are not managed, and may be invisible to the owner.
â€œBusiness mistakes happen, but they need not be fatal. If you respond quickly, admit your errors and look to correct them as soon as possible, you can turn the situation right around.”
–Steve Strauss, author and speaker
Here are five ways that you might consider to reduce your business risk, prevent mistakes and repair mistakes that may have slowly piled up over time.
Understand Your Financial Statements
Many business owners do not have a good understanding of their financial performance and the problems that may be piling up within them. Over a long period:
Are your sales trending up or down? Why?
Is your Gross Margin percentage trending up or down? Why?
Do you have large amounts of cash in your company? Many owners keep large amounts of cash on hand at certain times of year because they will need it when working capital needs rise during peak seasons. This is risky in the event that a liability pops up as this cash is readily available to creditors.
Do you understand what cash flow is doing? Do you even construct a cash flow statement? One of the things I see most often is businesses with little or no debt that do not understand that they are hemorrhaging cash because there are no demands on that cash. When they look to transition ownership they have a nasty surprise when they find that the new owner cannot support the financing necessary to purchase the business at what they thought it was worth.
Is your tax accountant managing your business? If so, you have a problem. I canâ€™t tell you how many times I have heard owners brag about how much their CPA saves them in taxes. Great â€“ until I point out that their â€œinventoryâ€ does not exist, that the lease they are charging to themselves is not market-based and the business should have been changed from a C-corp to an S or LLC years ago. Death and taxes â€“ you canâ€™t cheat them.
Again, it is critical that YOU understand your financial statements.
Understand Your Client Base
Do you have a solid understanding of your customers? Are they growing or shrinking?
What are their struggles and how can you help them overcome them? Are they financially healthy enough to support the credit you are extending?
Are one or two customers becoming a larger component of your sales? It is always tempting to simply shove more business into large customers. Your salesmen love to do this because it is easy. If you have a customer who is more than ten percent of sales, what will the impact be on your company if they are no longer there for any reason?
Understand Your Suppliers
How often do you talk to your suppliers about your business and theirs? Most companies are reliant on a few key suppliers. Often it would be difficult to replace those suppliers.
I was once involved in a sale of a national distribution company in which there were five key suppliers. I tried to get the owner to talk to the suppliers and to get longer term contracts in place. His response: There is no way they would leave me. They are too dependent on us to move their product. What happened: four had no problem with the sale when we approached them. The smallest and fastest growing said not only would they not agree to the sale but they had just signed a deal with a huge competitor and would no longer need my client or its buyer. Twenty percent came off the price one week before closing. We were fortunately able to come up with a plan to salvage the deal to the satisfaction of both parties and the deal closed. However, it could have been disastrous for the owner.
Protect Your Key Employees and Yourself
What do you have in place that will tie your key employees to your business? If they were to leave what would it do to the business? What would it do to a successorâ€™s interest in owning your business?
Do you have employment agreements in place that contain non-compete clauses? Are these agreements freely assignable by the company?
Do you have incentive plans in place that are properly structured to hand-cuff your key employees to your company?
Possibly most important, what is your relationship with your employees? These are the people who make your company what it is. The buzzword are that your employees are your most important asset. In most cases I would argue that they are your ONLY asset!
Benchmark Against Your Industry
Most business owners do nothing to compare themselves to their industry. So how do you know if you are performing well or it simply appears that way because you are in an industry that is riding a wave?
Relative performance is key to understanding the value of your business. If you are falling behind the industry in terms of financial or operational performance, even if you feel satisfied with your performance, your business will be devalued. If you are not keeping up with best practices, your business will be devalued.
Itâ€™s a little like a golf handi-cap. Why do we measure this? So that we know how we are performing relative to other golfers. We keep score so that we know if we are improving and we examine our game to see where we are leaving a stroke here and a stroke there. Often, it is dumb mistakes that can be easily corrected. Remember, 100% of short putts donâ€™t go in. Same with your business, 100% of the things you do that add no value will detract from value.
There are many other business mistakes that can arise and do. These are some of the larger ones I see and also some of the ones that can be easily corrected. It sometimes takes an outsider to objectively look at your business and point these out. There are almost always solutions if you get good advice and are willing to make some basic changes.