26 Sep Protecting Business Value Through Risk Reduction
The lifeline of a business venture is building, growing, and sustaining its value. The purpose of any business strategy therefore is to give birth to, nurture, and mature that value. This article will briefly address value maturity in a business, and specifically address the role and purpose of risk reduction. To do this, the article will use a hypothetical, family-owned, high-end fashion label as the case study.
For the purpose of the discussion, the focus will be on the father who is the sole, founding owner of the company. Currently, the he is serving as the Chairman and CEO of the company. He is planning to retire and transition his ownership very soon. The outcome of his decision and plan will determine the fate of family investments and the future of the family business.
Steps in the Value Maturity Cycle
Before we look at risk reduction metrics, it is important to review key factors in value maturity. Value maturity starts with identifying the value of a business. Consequently, the first task of the current CEO is to identify the current value of the family business, and do so accurately. This must be where the value maturity cycle starts. When, and only when, a business owner has identified the current true value of a business, can he or she take the second step in the value maturity journey, namely protecting that value.
Importantly, the survival of any business is exclusively determined by sustained ROI. How well, reliably, and measurably the business can transform capital into profits, and the level of risk appended to that process, creates the story of value, growth, and potential profitability. In this process therefore, the first important step to take is to establish the accurate, guaranteed, and ascertained business value.
Based on that foundation, the discussion can now review the second step in value maturity, which is the role of the present article. This step exclusively focuses on protecting the value that has already been identified, from the dangers of current and potential risks. As shall emerge hereafter, protecting the current business value, and one already identified, demands optimised reduction of current and potential risks.
Risk Profiling, Protection and Resolution
Knowing business value is not the end but the start of value maturity. There would be little sense for the CEO to understand business value, however impressive it is, if the succession plan does not consider and initiate proactive steps of protecting that value. For a business owner, and the case study CEO, protecting value primarily mandates addressing and resolving current and potential risks.
There are three distinct areas where a business owner must address risks facing current and future value. These three risks represent the three legs of the business value stool, namely:
a) Business risks
b) Financial risks
c) Personal risks
Regardless of which of the three areas of risks a business owner is addressing, the common risks are of two types. Indeed, protecting value from assorted risks in each of the three areas involves confronting two major challenges. These challenges include:
a) Risk resolution (involves minimizing and addressing or resolving current risks and risk-related issues)
b) Mitigating risks (involves addressing or mitigating potential or likely risks before they emerge)
Protecting Value from Risk
To begin with, the ultimate goal of taking any of the two steps of risk protection is to de-risk the business. Addressing current and potential risks ensures that the business is de-risked. Then and only then, will a business translate to greater value, be more profitable, and attain a sustainable level of competitiveness in what is gradually becoming a crowded global market.
The more the risk a business must bear or faces represents its potential level profitability. This directly translates to the overall attractiveness of its investment value. The value of a business is thus determined by the level of its potential and current risks. This explains why high-risk businesses are less attractive investment avenues. Conversely, the less the risk a business represents, the higher its price tag as an investment avenue.
That argument, however, should not contradict the true character of an investor or a business owner. Business owners, particularly entrepreneurs are by virtue, risk takers. Their priority always involves bearing a significant level of risk, followed by findings a profitable balance between the risk and the reward (return on investment). The life of an investor and that of a business owner is taking strategic steps to balance risk, and that describes the function of any business.
Nonetheless, even as they take significant risks, there is a very critical difference on how business owners perceive risks. The mindset of a business owner always considers the mentality of a customer and their likelihood of feeling burdened by a risk. This mentality helps consolidate the success of any business, where risk is balanced with potential return, and the business value is protected from current and potential risks.
Most business owners fail to identify risks that can be categorized in each of the types of risks. Doing so would mean identifying the risks faced in the three areas/legs of a business value stool. Common examples of the risks business owners face include:
a) Business Risks
Common business risks include:
1) Running business operations that are too dependent on the owner
2) Having key customer concentrations being over-concentrated and over-weighted in just one or a few business areas
3) Occasions in which the most important and critical employees leave the business
4) Relying on technology that needs upgrading and improvement, and which may be compromised, may break down, cause breach security, and undergo data loss
5) A declining market segment in which the company specialises
6) Lack of adequate diversification in the product and or service mix offered
b) Financial Risks
Common financial risks include:
1) Current or potential taxation implications and costs
2) Net worth of business owner (80% of a business owner’s net worth is frequently in a business)
3) Unexpected economic constraints, harsh economic pressures, and unplanned business changes can affect business operations and necessitate unforeseen capital expenditures, losses, or penalties
4) Business debt not accurately structured and aligned to market-appropriate conditions
5) Aging of plants, equipment and property, that can impede current production and operational processes, thus making the business seem less valuable in the offer price, prior to upgrades and replacements
6) Personal Risks
Common personal risks include any and or all risks in the 5 Ds profile, namely:
Sudden death of a business owner, a key employee or stakeholder (i.e. death of our hypothetical ABC Company owner and CEO after a short illness before preparing succession)
Any form of disability occurs on of a business owner, a key employee or stakeholder either permanently or on the long-term
Undergoing divorce in the life of a business owner, a key employee or stakeholder thus demanding finances, time, and effort that compromises daily business operations, more so for privately held business.
Disagreement and disputes between of a business owner, a key employee or stakeholder on a variety of issues such as strategic business direction or legal issues thus demanding finances, time, and effort that compromises daily business operations
For a business, distress may accrue from stagnation or declining performance in any industry, which may occur due to the loss of customers or increased dominance of competitors.
Ultimately, therefore, in the value protection step of value maturity relies on how well business owners identify and characterize potential and current risks. Once the risks, current or potential, are identified and categorized, the business owner can then strategize on what to do when mitigating. Risk reduction involves strategic business planning and delegating of specific tasks in the mitigation process.
Such a process underscores the basic reality, that risk mitigation processes are equally as important to the identification step, in value maturity. At the heart of the entire process is learning how to protect business value from current and potential risks. Then and only then, can the business value be made sustainable, and be progressively increased in worth.
Strategically de-risking a business is a vital framework that business owners should regularly implement as part of creating, building/growing, and protecting the value of their businesses. The first step in initiating a de-risk process is identifying current and potential risks with precision. The next step is then to profile these risks to specific categories of the three-leg value stool. Once each risk is correlated with the respective risk categories, the business owner can then advance to resolving and mitigating the risks. Indeed, value maturity is the product of identifying, profiling, and protecting business value from the risk landscape.