Deal Breakers: The Business Owner's Guide to Risk Identification

Business owners aspiring to sell their companies are well served to identify and address operational risks that might otherwise go unnoticed until the later stages of a deal. But what if owners have no idea that a particular risk exists?

Over the course of completing hundreds of transactions, Livingstone has encountered potential risks in nearly every facet of business operations. Many of these risks caught business owners by complete surprise at the worst possible time, during the most important transaction of their lives.

Business risks take many forms. In the context of selling a business, risks can be categorized in a variety of ways. For example:

Controllable versus uncontrollable risk. With the right steps, controllable risks can be mitigated or eliminated by the business owner (e.g., company matters of tax, information technology, and environmental compliance). Uncontrollable risks include macroeconomic market conditions (e.g., recession brought on by the subprime mortgage crisis) and “acts of God” (e.g., hurricanes, tornadoes, floods, and earthquakes). Typically, the only way to mitigate uncontrollable risks is via insurance. Even then, insurability against certain risks is not always available.

Identified versus unidentified risk. Identified risks are those of which business owners are aware (e.g., high customer concentration). Conversely, unidentified risks are unknown and, as a result, not understood or quantified (e.g., undiscovered legacy site soil and ground water contamination).

Unidentified risks tend to be most likely to “blindside” business owners and detrimentally impact a deal. In the absence of proactive investigation, unidentified risks often aren’t discovered until late in a sale process, when it’s too late to mitigate or eliminate their adverse effects on a deal. In a best-case scenario, these inconspicuous risks delay closing and lead to the potential for a sub-optimal deal outcome (e.g., decreased purchase price, contingent earnout, and/or increased escrow requirement). In a worst-case scenario, the deal dies and the business owner is left disappointed by a failed sale process.

Time is never on the seller’s side during a sale process. Every day a deal’s closing is delayed, there’s a risk that circumstances surrounding the business could change adversely (e.g., broad economic downturn, major natural disaster, the unanticipated death of a key management member, etc.), which could lead the buyer to walk away. A current example might include would-be sellers with locations in Texas and Florida who must now address the impacts of Hurricanes Harvey and Irma, respectively. A less dramatic example would be the unexpected resignation of an irreplaceable team member, such as the chief engineer or head of sales.

Through the Deal Breakers series, Livingstone will educate business owners of potential risks that can disrupt a deal. Specifically, Deal Breakers will focus on identifiable risks that business owners can control, influence, or insure against. With proactive planning and foresight, these risks can often be mitigated or eliminated before ever attracting the attention of prospective purchasers. This allows business owners to maximize the probability of a successful deal outcome once they make the decision to sell their companies.

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