As we all know, risk and return are like Siamese twins. One cannot exist without the other. In the context of a divestiture, this means that the buyer is looking to minimise the risk in making the acquisition or pay a low price because the risks are high. On the flip side, the seller is looking to maximise the return, i.e. the price.

If the acquisition candidate represents a valuable and manageable asset to the buyer, the buyer will be in a position to pay the right price for your company. As a consequence, the seller should ask at every step what will reduce the risk for the buyer.

Of course, risk comes in many different shapes and forms. Broadly, risk can be divided into those risk factors that the owner cannot control such as political risk or market timing risk and risk factors the owner has a major influence over. These are the following five main "controllable" risk factors as they pertain to the divestiture process:

1. Volatility 

has to do with the variability of key elements within the company, mainly management and company financials.

a. Management – What happens when the owners leave the company after the transition period? Is there a competent second tier management that has the potential to take the company to the next level?

b. Turnover – Have sales oscillated in the past? Or has management been able to steer the company on a steady growth path?

c. Gross Margin – Has the gross margin been stable over the past and what is the trend? What are the threats and opportunities in the future stability of gross margins?

d. Profitability – Has profitability been steadily growing in the past three years? If not, are there good reasons for the variability (e.g. one-off events) that have no bearing on future profitability?

2. Market risk 

Ideally, the company should be operating in an attractive market segment. From the outset, the market is probably one of the most important factors that a buyer will look at.

a. Take the time to define your market segment, your position in the market and ways to grow within that market. Scalability is a major concern to all buyers.

b. Show how the market size that is applicable to your company can be expanded. For example, can the market be extended in terms of geography. Is your offering also attractive to buyers outside the UK? Or, by widening the range of the offering, which additional market segments can you address?

3. Transparency 

becomes of paramount importance in the evaluation process and during due diligence.

a. Can you satisfy the insatiable information needs of the buyer in terms of financial, marketing and operational data? How strong are your systems to run various management reports. As a cataloguer, you should be able to provide solid information around everything that concerns your customer data base: how many buyers, inquirers over the last 12 months, 24 months, 36 months and beyond. What is the average order value and how loyal is your customer, etc.

b. Business plan. How realistic are your forecasts over the next two years?

c. Reporting process. How useful are management reports? Are you producing and using the right analytical tools to manage the company?

d. Operations. How powerful are your systems (e.g. fulfilment, computer)? Can your systems be easily expanded in the future or will the buyer have to make that investment and take the transition risk?

4. Liquidity  

has to do with the current and future marketability (i.e. attractiveness) of the company.

a. Current marketability. Who will be the likely buyers: strategic buyers, financial buyers, IPO. Make sure you communicate with all the likely buyers. If there are several likely buyers, any particular buyer will learn that your company is attractive to others which lowers the risk to the buyer in terms of future marketability and communication risk.

b. Future marketability. Who will be the likely buyers in three to five years time? Can the company be sold to strategic buyers or can it even go public? Translated to the world of strategic buyers this means that the acquisition should enhance the liquidity of the buyer as a whole.

5. Execution risk

has to do with the management of and during the sale process.

a. Budget. Can you meet your planned budget during the sale process?

b. Due Diligence. What are the "skeletons in the closet" and how will you communicate them?

c. Adviser. Last but not least, do you have the right adviser to ensure a smooth, swift and short process, negotiate the right price, and minimise the effort for both parties?

In summary, we believe that it is in the best interest of the seller to keep the risks in check for the buyer.