Business Risk And Financial Risk 3g5z3q

6 Reasons Why So Many Acquisitions Fail In my last post, Why Innovation Through Acquisition Is Such A Darn Good Idea, I commented on the crucial importance of mergers and acquisitions in the business innovation ecosystem. From an entrepreneur’s-eye-view, M&A provides lucrative shareholder exits. Viewed through the lens of the public company, innovation-throughacquisition can be a legitimate strategy for entering exciting new technologies or markets by first allowing startups to do the de-risking. And yet history shows that, in at least half of all cases, after the deal closes, acquisitions sour. (There are dozens of studies and papers, and estimates of how many M&A deals fail to meet financial expectations run from 50 percent to as high as 90 percent.) So all too often from a startup’s perspective, the good news is that entrepreneurs, option-holders and investors cash out, but the bad news is that the employees find themselves in an oxygen-starved bureaucracy and the startup’s customers end up confused or even orphaned. And from the acquiring company’s perspective, it’s all too common for the business advantages they sought – some combination of access to new products, access to new markets or geographies, market share increases, growth faster than purely organic growth, and/or economies of scale – to simply fail to materialize. I’ve sat on both sides of the fence in M&A on multiple occasions, selling my startups to public companies as well as being on the acquiring side. I’ve witnessed things from the executive seat, the board seat, and as an

advisor, and I’ve experienced superb outcomes, mediocre results, and unmitigated disasters. From that perspective, here’s my list of 6 key reasons why M&A deals come unraveled after the fact – and what you can do about it: 1. Misgauging Strategic Fit If the acquisition is too far outside the parent company’s core competency, things aren’t likely to work. A company that sells to its business customers chiefly through catalog and Internet sales ought to be very cautious about acquiring a company that relies on direct sales – even if the products are, broadly-speaking, in the same industry. Similarly, a company whose traditional strength lies in selling products to businesses might want to think twice before making a foray into a consumer-oriented business. Consulting firms have been known to acquire software companies driven by the rationale that the parent’s client companies use these sorts of software apps, and the applications are in the same broad domain as the consulting firm’s expertise; then they discover that selling B2B applications is wholly different from managing consulting engagements. An honest strategy audit up-front is the answer: don’t stray beyond your core competencies, and ask whether the target company fits your strategy, your operations, and your distribution channels. 2. Getting the Deal Structure Or Price Wrong We all understand that if the acquiring company pays too much in an auction environment, it’s going to be tough to get the acquisition to show a positive ROI. To protect themselves, some acquiring companies like to structure acquisitions with half or more of the purchase price held back based on achievement of future performance hurdles. But watch out:

such earn-outs can backfire on the acquiring company in unexpected ways. If, for instance, a major payment milestone is based on postacquisition sales performance but 99 percent of the sales people are working for the parent company – and therefore are neither aware of nor incentivized by the sales milestones – then the acquired company employees may well feel demoralized due to having scant control over achieving major payment milestones. I’ve seen similar things happen with product-delivery-oriented earn-out payments: the good news is that the parent company hires in dozens of additional product developers, but the bad news is that only a tiny proportion of the newly-constituted product team knows about or is incentivized by achievement of a major earn-out milestone for the acquired company. In both cases, wellintentioned deal structures that held back payments based on future performance ended up having unintended consequences and souring the deal. The better bet – easier said than done – is negotiating a fair price up-front. 3. Misreading The New Company’s Culture Just because your two companies are in the same industry doesn’t mean you’ve got the same culture. It’s all too easy for the acquiring company’s integration team to swagger in with “winner’s syndrome,” and fulfill the worst fears of the new staff. Far better if they enter the new company’s offices carrying themselves with the four H’s: honesty, humanity, humility, and humor. 4. Not Communicating Clearly — Or Enough In the absence of information and clear communication, rumors will fly, and people at the acquiring company will assume the worst. Communicate to the entire team, not just the top

executives. Communicate clearly and honestly and consistently. If there’s bad news, be sure to deliver it all it once, not piecemeal, and make it clear that that’s all there is – that folks don’t have to worry waiting for another shoe to drop. And when you think you’ve communicated enough, you’re one-quarter of the way there. 5. Blindly Focusing On Integration For Its Own Sake Don’t assume that all integration is good. I’ve watched all too often as the parent company insists on fixing things that aren’t broken: The acquired company has established a strong brand, but the parent insists on “improving things” by replacing it with something that blandly blends with the corporate naming conventions. New standard operating procedures are imposed that suck all the oxygen from the room and demoralize the team. A small sales team has clear authority, but the parent knows better and makes the newly-acquired offering the 1,400th anonymous product in its sales force’s price list. The acquired product works perfectly well as-is, but the parent company insists on rebuilding it so that it fits into the parent’s technical architecture – thereby punishing customers and freezing all product enhancements for years. The bottom line is don’t be too heavy-handed. If this company was worth acquiring, it’s probably worth trusting, funding and encouraging to thrive. 6. Not Focusing Enough On Customers And Sales (vs. Cost Synergies) The most fundamental scorecard of acquisition success is financial performance, and on that count it’s far more important to focus on revenue growth than cost control. An insightful McKinsey study (published a decade ago, but whose conclusions remain completely valid) pointed out that small changes in revenue can outweigh major changes

in planned cost savings. A merger with a 1% shortfall in revenue growth requires a 25% improvement in cost savings to stay on-track to create value. Conversely, exceeding your revenue-growth targets with your newly-acquired company by only 2 to 3 percent can offset a 50 percent failure on cost-reduction. And the worst thing you can do is have a sales drop-off immediately after the acquisition – which is all too common given confusion among the newly-merged team and the customer base – because you can never make up those lost sales. Knowing the paramount importance of uninterrupted revenue – read: sales momentum – the first thing the parent company ought to do in concert with the acquired-company team is get out in front of customers, tell them what’s going on, and reassure them. Yet it’s amazing how rarely that happens. As with the acquired company’s staff, with their customers, in the absence of clear communication, rumors and negative assumptions will fill the void. So get out in front of your newly-acquired customers, tell them they’re still loved, and provide them with a clear, comfortable, consistent and honest story. And when you think you’re done communicating with your new customers… you’re probably one-quarter of the way there.

How Normalization of Income helps you establish a value for your company.

To determine an expression of value of the net worth of shares or assets of a company, the first exercise is to analyze and normalize the company’s financial performance as if it were a company being run “By the Book”. Today, the most common “thumbnail” valuation methodology is based on a multiple of normalized EBITDA. (Earnings Before Interest, Taxes, Depreciation, and Amortization) EBITDA is the approximate measure of a company’s operating cash flow based on the company’s financial statements, before charging, interest, income taxes, depreciation and amortization, plus all other normalizing adjustments; some of the more common being described below. Common items requiring a normalization adjustment to net income include, but are not limited to: 

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Management Salaries – Careful consideration should be given to what a normal management salary, or salaries, would be for the new owners to operate the company effectively. Net income should be adjusted accordingly. Costs that would not exist under new ownership. Automobiles, cell phone, gas cards, car insurance, internet home office costs etc, Family or others on the books, who draw a salary or receive other benefits but do not actually perform work for the company. Commercial rent or property costs should always be adjusted to reflect actual market costs that would be incurred if the business premises were to be leased by the new owner at prevailing market rates. Perks that will not exist under new ownership. Examples are personal meals, entertainment and hips. Owners benefits such as key man insurance or personal term or whole life insurance, as well as pension or RRSP contributions being paid for by the company.

Each individual company may have other costs or revenue adjustments that may be required; the above are the most common. A review of the Balance Sheet should then be conducted to determine what the true retained earnings or net worth of the company is. This exercise helps identify other assets or liabilities that may impact on the valuation of the company. In the case of a share sale, this review will also help determine how much cash will be required to be left in the business as “working capital”. Other important shareholder items of concern are loans to, or advances from, the company, and capital gain taxation considerations The final factor to be determined is appropriate multiple of EBITA; essential to establishing a provisional value of your company. "Normalization of Income: Where Business Valuation Meets Forensic ing, Part 1" by Terry Silver by Terry Silver, A, CVA, CFF

This article was originally published in The Legal Intelligencer Blog. The valuation of virtually every closely held business requires normalization adjustments. Although these adjustments may be made to either the balance sheet or the income statement, the most common normalization adjustments are imposed upon the income statement. The International Glossary of Business Valuations defines “Normalized Earnings” as “the economic benefits adjusted for nonrecurring, non-economic, or other unusual items to eliminate anomalies and/or facilitate comparisons.” As closely held businesses are controlled by one or just a few individuals, the valuation analyst should consider whether the economic benefits being paid to its owners are above, below or at market levels. Sometimes the analyst can easily identify which items require normalization and at other times the analyst is left to his or her own devices to identify the income normalization issues. The International Glossary of Business Valuations defines “Fair Market Value” as “the price, expressed in of cash equivalents, at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arm’s length in an open an unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts.” Both the hypothetical buyer and seller base their respective value estimates on the anticipation of the entity’s true economic income. Normalization may be required to adjust to the true economic income. Examples of common items that are normalized in the valuation of a closely held business are:    

Related party rent Prerequisites such as insurances, automobile, employee benefits, etc. Items that would normally be considered personal, but are nonetheless paid for through the business Owner and related party compensation Business owners sometimes compensate themselves with the remaining profit left over after the payment of all other business expenses. The analyst must determine whether that compensation is at market level. Fair market value requires that the future cash flow be burdened with the market level compensation instead of the actual compensation that was designed to soak up any remaining profits. There are databases that assist in identifying market level compensation by reference to industry, location and employee demographic attributes (age, responsibility, experience, accreditation, etc.) The analyst normalizes the owner’s compensation actually paid to a level consistent with their peers. Entities often lease real property, machinery and equipment from related parties. The rents set by the owner(s) may be above or below the market rental. Any excessive or bargain rents paid between s require normalization. Owners sometimes manipulate the entity’s earnings by diverting revenue, enhancing expenses or fabricating journal entries. Because the identification of true economic income is so vital to valuation, the analyst may find it necessary to go to more extreme steps, for example, a forensic examination. A forensic examination includes the interviewing of management and employees, obtaining information from other third parties, and the use of data mining software. More on that in my next posting.

1. Business Risk A company's business risk is the risk of the firm's assets when no debt is used. Business risk is the risk inherent in the company's operations. As a result, there are many factors that can affect business risk: the more volatile these factors, the riskier the company. Some of those factors are as follows: Sales risk - Sales risk is affected by demand for the company's product as well as the price per unit of the product. Input-cost risk - Input-cost risk is the volatility of the inputs into a company's product as well as the company's ability to change pricing if input costs change. As an example, let's compare a utility company with a retail apparel company. A utility company generally has more stability in earnings. The company has les risk in its business given its stable revenue stream. However, a retail apparel company has the potential for a bit more variability in its earnings. Since the sales of a retail apparel company are driven primarily by trends in the fashion industry, the business risk of a retail apparel company is much higher. Thus, a retail apparel company would have a lower optimal debt ratio so that investors feel comfortable with the company's ability to meet its responsibilities with the capital structure in both good times and bad.

2. Financial Risk A company's financial risk, however, takes into a company's leverage. If a company has a high amount of leverage, the financial risk to stockholders is high - meaning if a company cannot cover its debt and enters bankruptcy, the risk to stockholders not getting satisfied monetarily is high.

Let's use the troubled airline industry as an example. The average leverage for the industry is quite high (for some airlines, over 100%) given the issues the industry has faced over the past few years. Given the high leverage of the industry, there is extreme financial risk that one or more of the airlines will face an imminent bankruptcy

The two primary risks that every company has to face on a daily basis are business risk and financial risk, and contrary to common belief, they are not one in the same. Understanding these two types of risk is critical for keeping your company profitable and manageable, especially during times of economic uncertainty. Knowing the difference between financial risk and business risk is also important when it comes to speaking with investors, financial institutions, and other people or organizations that may have a financial interest in your company. What Is Business Risk?

Business risk usually involves all of the risks attributed to the business’s strategic decisions, with the exception of the company’s financial decisions. Such risks could include the decision to introduce a new product or service into the market, or a potential partnership with another company. In estimations of business risk, internal efficiency and production quotas are commonly measured to determine whether or not a key business decision is worth the risk. What Is Financial Risk? A company’s financial risk is predominantly targeted at its shareholders and those who own or buy the company’s stocks as this type of risk is based on how a company’s finances are structured, and traditionally focuses on corporate debt. Companies that rely heavily on business financing are often considered risky. What Affects a Company’s Business Risk? There are several factors that can affect the business risk level of a company. The fluctuations in demand for a certain product or service can certainly affect business risk as this will have a direct impact on a company’s profits. In addition, every time a competing company introduces a similar product to the market, it has the potential to drive down costs and sales, both of which can affect a company’s earnings. Changes in business risk can also be attributed to external factors like government actions and changes in consumer preferences as well as internal factors like the company’s ratio of fixed to variable expenditures. What Affects a Company’s Financial Risk? One of the most common things that can affect a company’s financial risk is the quality of the financial system within its country of operation. If a company is based in a country that has a poorly functioning financial system or devalued currency, its financial risk will usually be relatively high as the company’s holdings could easily be eliminated. For most American-based companies, however, their financial leverage is usually used to determine their risk level. Financial leverage is a company’s debt to equity ratio. The more a company relies on debt to finance the business, the higher their financial leverage is and therefore, the company is a higher financial risk.

Definition of 'Capital Structure' A mix of a company's long-term debt, specific short-term debt, common equity and preferred equity. The capital structure is how a firm finances its overall operations and growth by using different sources of funds.

Debt comes in the form of bond issues or long-term notes payable, while equity is classified as common stock, preferred stock or retained earnings. Short-term debt such as working capital requirements is also considered to be part of the capital structure. Investopedia Says Investopedia explains 'Capital Structure'

A company's proportion of short and long-term debt is considered when analyzing capital structure. When people refer to capital structure they are most likely referring to a firm's debt-to-equity ratio, which provides insight into how risky a company is. Usually a company more heavily financed by debt poses greater risk, as this firm is relatively highly levered.

These two , merger and acquisition are frequently used as though they are synonyms, but have different implications. The main difference between a merger and an acquisition is their mode of finance.

A merger takes place when two companies, usually of around the same size, decide to become one new firm instead of being seperately owned and operated. This type of action is more exact reffered to as a merger of equal value. Both companies' stocks are given up and new stocks are distributed in its place.

However, real mergers of equal value don't often occur, normally, one of the companies will purchase the other and as a portion of the contracts' conditions, merely permit the attained company to declare that the deed is a merger of equals, although it's officially an acquisition. To be purchased very so often bears negative conotations, nonetheless, by describing the transaction as a merger, contract makers as well as the chief managers try to make the buyout more acceptable.

A securing contract can as well be known as a merger if the two CEO's be in agreement that ing together is in the paramount attention of the two organizations. But if the contract is not acceptable, that is when the aim organization doesn't want to be bought, it is at all time considered as an acquisition.

For a purchase to be viewed as a merger or an acqusition actually depends upon whether the purchase is a pleasant one or unreceptive and the way it is announced. The actual difference however, is in how the purchase is articulated to and accepted by the target organization's top managers, the workers, and the owners.

An acquisition is a bit different from a merger, infact, it might just be the name that differs. In the same way as a merger, an acquisition is an action by which organizations seek out bargains of weight, effectiveness as well as improved market connectivity. The only difference between mergers and acquisitions include one organization buying the other, they don't have to exchange reserves or alliance as a new organization.

An acquisition is very so often agreable, and all the parties involved feel more satisfied with the deal. Another kind of acquisition is a reverse merger, a deal that allows a private organization to get openly

listed in a very limited period of time. A reverse merger happens as a private organization with strong prognosis is keen to increase its investment purchases an openly ed organization, normally one without a business and with very limited assets.

Acquisition vs Merger

Diffen › Economics › Business Although they are often uttered in the same breath and used as though they were synonymous, the merger and acquisition mean slightly different things.

Whether a purchase is considered a merger or an acquisition really depends on whether the purchase is friendly or hostile and how it is announced. In other words, the real difference lies in how the purchase is communicated to and received by the target company's board of directors, employees and shareholders.

When one company takes over another and clearly established itself as the new owner, the purchase is called an acquisition. From a legal point of view, the target company ceases to exist, the buyer "swallows" the business and the buyer's stock continues to be traded.

In the pure sense of the term, a merger happens when two firms, often of about the same size, agree to go forward as a single new company rather than remain separately owned and operated. This kind of action is more precisely referred to as a "merger of equals." Both companies' stocks are surrendered and new company stock is issued in its place. For example, both Daimler-Benz and Chrysler ceased to exist when the two firms merged, and a new company, DaimlerChrysler, was created.

In practice, however, actual mergers of equals don't happen very often. Usually, one company will buy another and, as part of the deal's , simply allow the acquired firm to proclaim that the action is a merger of equals, even if it's technically an acquisition. Being bought out often carries negative connotations, therefore, by describing the deal as a merger, deal makers and top managers try to make the takeover more palatable.

A purchase deal will also be called a merger when both CEOs agree that ing together is in the best interest of both of their companies. But when the deal is unfriendly - that is, when the target company does not want to be purchased - it is always regarded as an acquisition.