Risk - How Relative Is It and Relative to What?

I am in Montreal, Canada attending a family function. I ran into an old acquaintance who I have not seen since elementary school. He was, and still is, a very smart  person, at least acedemically. Turns out he is a mid-level manager at an aerospace company here, and he absolutely hates his job. He makes a decent living I suppose, but he told me he always wanted to own his own business. He told me about a bunch of businesses he considered buying in the past ten years, but at the end of each story, he finished by saying: "I decided it was too risky, what do you think?" I replied each time "I don't think so based upon what you told me." However, he paid no attention whatsover to what I said because he had long convinced himself otherwise.

It brings up a frequent topic raised by many people that find themselves in the process of buying a business. The first thing you need to realize is that you can never completely eliminate all the risk in any initiative that has a relative reward down the road. It does not matter whether you are talking about buying a business, taking a new job, or getting married. Risk is inherent with any decision, or change you make in your life. If you do not have any tolerance for it, then you are wasting your time looking to buy a business.

However, while there is always some element risk in any deal, let me dispel one hard-core myth: buying a business does not have to be a risky venture. Understanding risk, and embracing it, will actually play in your favor.

Personally, I think investing in the stock market regardless of the economy, carries a greater risk because you are betting on a business where you have zero control. Yes, I know that many of you will debate this point by saying that over the long-term stocks have always proven to be a good investment. That is true, but if you want to be in your own business, your timeline for success is shorter, and there is potential for a much greater upside.

There is no question that there is always some level of risk whenever you invest your money, regardless of where it is placed. Additionally, there are many people who simply cannot get over the hurdle of risk and never end up acquiring a business. However, the goal of any business buyer is to mitigate the risk involved. The only way you can to do that is by conducting a thorough review, and exhaustive research of the business and industry you are considering.

But the "risk" involved when buying a business does not simply entail its risk relative to the potential reward, nor should it only be measured as relative to other investment opportunities. It must be relative to the specifics of the business you may be evaluating.

For example, some areas that I deem to be risky when analyzing a business are:

• A major customer concentration issue.
• Potential looming threats beyond your control (i.e. legislation or technology that could severely impact the business in the future).
• Reliance on a limited number of key employees that possess certain skills and/or licenses needed to operate that you do not possess.
• A declining business.
• A business that cannot be grown (while there are some ultra-stable businesses that are not in a growth industry, ultimately, they will decline).
• Any business that relies solely on price to generate its sales (these are usually low-margin businesses, as well, which again, I believe are risky).

The beauty of these so-called "risks" is that a knowledgeable business buyer can easily take precautions to limit them by structuring a deal that protects them accordingly.

On the other hand, you can easily convince yourself that any business for sale has "too much risk". One thing I can guarantee you, is that every successful entrepreneur on the planet has faced and embraced risk on their road to success.

In most cases, the biggest risk when buying a business actually lies with the buyer's incompetence, or lack of confidence to operate the business. If you are not willing to bet on yourself, or if you do not have the self-belief to be a boss, then no deal structure can ever protect you.

With the current economy, the perceived risk can be magnified. Your friends, family and possibly some advisors will make a case that right now it is too risky to buy a business. Of course you have to respect their opinion, but ultimately, you have to make your own decision.

If you go about the process diligently, if you properly prepare yourself, and if you take the time to first learn how to buy a business, then you can make a well-informed decision. And a well-infomed decision, coupled with effective deal terms, can address all of the isuses.

Buying a business should never, ever be a leap of faith. Just like and other major decision, knowledge is your greatest ally, it is your parachute. Instead of being distracted by all the ebbs and flows of the current market, or becoming unduly influenced by the doom and gloom, attention-grabbing news headlines, do yourself a favor and carry on with your quest, but go about it armed with the knowledge to structure a deal that addresses the relative risk of the business. When you adopt this strategy, you will soon gain comfort with any perceived risk, and while others are sitting on the sidelines, you will be on your way to the rewards you deserve.

Comments

[Plant]

I will argue your statement about risk. Sure you have more control over the business you are invested in when you own a company, but there are many outside factors that are beyond your control that can kill a business. The stock market allows diversification that greatly mitigates risk. In the long run, owning the business should be profitable and something you enjoy. That creates personal diversification (life balance) that the market cannot provide. I think buying a business only for the money is folly from an investment strategy stand point. Business owners are well advised to diversify as soon as their company starts to spin off profits or risk reaching retirement age with no nest egg.

[Sean Seaman]

Reading this article sounded like me talking to every potential buyer I meet with. There were phrases in this article that I have been using lately almost verbatum over the past few months. Very well stated and we need more intelligent buyers to use this mind set. Thanks.

[Website Business]

Hi Richard,
I found your article timely and intelligent as always. I was having a conversation with a buyer the other day who was arguing that, despite the sound fundamentals of the website business they were pursuing, the risks of potential decline in search engine positioning, sales etc, meant the buyer needed to provide personal guarantees to circumstances beyond there control - especially post sale! In the end, the buyer is inexperienced, not very knowledeable and lacking self confidence and wanting to protect this lack with unrealistic unfair clauses in the agreement! My advice to the seller is to walk - be patient and wait for the astute buyer that has done their homework, assessed the risk and rewards of the opportunity and have the intelligence, confidence and experience to take the business to a much higher level. Talk to any true entrepreneur and risk is part of the challenge and excitement of starting or buying a business. People like your "rocket scientist" will ultimately remain in their science fiction world of dreaming of entrepreneurship and independence and trudge through real life with fear, loathing, regret and limitation. Finally, every economic cycle creates fabulous opportunities - you need to be armed with knowledge, insight, courage and passion to take advantage where others see only problems.
David Fairley
Websiteproperties.com

[Richard]

From Richard: Great comments everyone - thank you.

TO "PLANT" - I always enjoy a counter-point. I found it interesting that you mentioned that "Business owners are well advised to diversify as soon as their company starts to spin off profits.." I agree completely and that is precisely my point...the owners had to initially get into a business to provide them with the excess cash to allow for such divesting activities. The main point when I discussed buying a business versus investing in the market is precisely because of the timing...the market may very well be a long-term investment strategy but owning a business is the vehicle to fund it AND, it can provide infinitely more short-term opportunity, if/when you buy the right one. I think we will agree that it takes a healthy combination of both strategies. Thank you for your input.

TO SEAN: Glad to know my comments reflect your reality. So here's my "sales pitch" - You need to send your buyers over to our site to buy our guide and I guarantee they will come back to you with a brand new attitude!

TO DAVID - As always - GREAT feedback..thank you.

Have a successful week.

Richard

[Don Wilson]

To Plant: I would argue that he whole purpose of purchasing a good business is to make it great (improve cashflow) and sell it. Then when you do reach retirement age you have something to retire on!

"The stock market allows diversification that greatly mitigates risk" Like your retirment nest egg losing 40-50% of its value because of idiots excessive greed to get something for nothing.

Don Wilson