As Rates Rise, It’s Time to Better Manage Risks – Part 2

Our previous blog discussed how rising interest rates can lower business valuations, and – from our perspective as business valuation experts in Canada – we argued that while business owners can’t do anything about higher borrowing costs, there are a few concrete steps they can take to support and even enhance the value of their company.

It comes down to lowering risk. Let’s take a simple valuation formula: Value = Annual Cash Flow divided by Risk Rate. To increase Value, there are basically two options. Option 1 is to boost Annual Cash Flow, perhaps by cutting costs or raising prices or expanding your operations; in the current environment, however, any business’s ability to do so might be very limited. Option 2 is to lower the Risk Rate. Borrowing costs (which have gone up) are one contributor to that overall Risk Rate, but there are others – and business owners often have at least some control over them. Mitigate those risks, and you have the ability to increase the value of your business.

So what are some of those risks, and what can business owners do about them? Here are just a few that we routinely encounter in our work as business consultants and valuation experts:

Transfer Risk

Most business owners we know are intimately involved in their companies. Running a business is not just their job; it’s their passion. Yet one big risk to business valuation can evolve from this otherwise commendable trait: when you sell, what happens to it when you are not around to run it? If you or your key personnel are no longer going to be running the company, and if the remaining staff are not skilled enough or trained enough or committed enough, then its value in the eyes of a potential buyer could go down. You can lower this transfer risk by establishing clear lines of delegation, by ensuring your staff are both competent and adequately trained, by formalizing marketing and service processes that increase customer retention, and by planning for transitions with key personnel and documenting your plans.

Recurring Revenue Risk

Buyers value strong revenue, obviously, but they are not just looking for quantity – they also want to see consistency. A business whose revenues are predictable from year to year will always attract buyers; fluctuating revenues, on the other hand, will raise a lot of questions – and risks to the buyer. If your company’s cash flow goes up and down like the proverbial rollercoaster, then it’s time to ask why. What forces are driving volatility? How can you address them? Are there ways to smooth out seasonal low points, for instance by expanding your product or service offerings? Are there opportunities for limited-time offers (LTOs) to incentivize repeat customers? Could operational changes raise your company’s revenue “floor” during down periods?

Concentration Risk

If your business relies upon a limited customer base for the bulk of its revenue, then it has heightened concentration risk. A buyer will look at such a company and ask: What happens if it loses one or more of these outsized sources of revenue? Risk goes up; value goes down. Again, diversifying revenue streams is the key. Can you offer expanded services or products to broaden your customer base? Could relocation or expansion decrease your reliance on a single revenue stream? If your company depends upon a mega-contract, have you planned adequately for the risk of losing that revenue? And what about marketing? Could better marketing attract new and different sources of cash flow? A business valuator in Canada can help answer those questions.

Accounting Risk

Inconsistent or improperly applied accounting practices will make any potential buyer skeptical about what’s lurking under the hood of your business. On the other hand, solid financial records assure a potential buyer that your company is what it appears to be. Good accounting equals lower risk, from the buyer’s perspective, and simply getting sound, professional accounting advice can go a long way to enhancing your business’s value.

Audit Risk

Poor record-keeping and shoddy financial or operational management raise the risk that your business could be audited by the taxman, by professional organizations or by third-party payors. That is a big risk in the eyes of a buyer. To lower it, make sure that records are up-to-date and thorough – and that documentation protocols are adequate to the demands of your business. You also have to rely on your staff: make sure they’re properly trained on how to keep good records and why it’s important to do so.

Obviously, there is not much (or anything) any business owner can do about rising interest rates or their impact on the value of their company. But we would argue that there are things an owner can do to support their business’s valuation. Understanding the impact of business risks, being able to identify them – and then finding ways to address them wherever possible – can go a long way towards ensuring that the value of your company remains strong, no matter how far or how fast interest rates climb.