I AM BUYING INTO / INVESTING IN A BUSINESS
Investing in or buying into a business can be riskier than buying a business outright or even starting one from scratch. When you are one of multiple owners of the business, you typically have to share control. Even as a majority shareholder, most states and countries provide protections to minority shareholders that place some limits on the actions of the majority owner. At a minimum, most legal jurisdictions limit a majority shareholder’s ability to compensate themselves disproportionately at the expense of making dividends or distributions to other shareholders (consult your legal counsel for specifics to your situation.) Further, unless you plan to work in the business day-to-day, there is the risk that, despite your oversight, advice and accountability, the people actually operating the business will run it into the ground more quickly than you can act to save it.
These limitations on the power of the business investor translate into additional risk for you. In spite of these risks, these investments can generate attractive returns. Instead, you might view risk as something to be managed. The risk management tools that most successful investors use include:
Get an attractive price. As an investor, you get paid to take risk by buying in at a sufficiently low price so that the return on the investment, in the form of dividends and/or proceeds from the exit. Commission an independent valuation to help you identify the risks of the business and quantify how those risks should impact the price.
Get attractive terms. Terms can be just as powerful to achieving your required return as price. Such terms may include additional board seats, rights to co-sign any financial commitment above a certain amount, or additional shares if the company fails to meet financial goals. This list is far away from exhaustive. The important takeaway is that terms are as powerful a lever to achieve your desired return as price, and sellers are often more open to negotiating terms than price.
Ask hard questions, and lots of them. This is known as “due diligence.” A business valuation entails asking many questions and will uncover many business risks that you need to know about before committing to an investment. However, additional expertise may be needed, such as technical due diligence, market due diligence, and legal due diligence. Accounting firms often offer “quality of earnings” studies that result in producing an independent expert opinion of the sustainability (risk) of the target’s earnings.
To achieve the attractive price or terms that you need to engineer your return, you must be knowledgeable about how the market likely prices the business, be aware of market terms for investment transactions, and you must have full command of the risk profile that the business presents. Expert assistance is your most important risk management resource when buying into or investing in a business. If you want to manage your risk in an investment you are considering, contact us at High Score Strategies to set up a consultation.
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