Imagine you are the general manager of an NFL team. You have the first pick in this year’s draft. Your job is simple: pick the player with the highest potential and lowest risk.
Football scouts measure potential objectively by comparing players on their 40-yard dash or the number of times a player can bench press 225 pounds.
But risk often takes more digging.
As a GM, you might ask a doctor to analyze a player’s potential for future injury or hire a private investigator to look into a player’s personal life. As a GM with millions on the line, you would do just about anything to protect your downside.
Like sports executives evaluating a player, acquirers analyze the downside risk of buying your business.
How Acquirers Evaluate Risk
For an acquirer, risk can come in many forms. An overdependency on a big customer, employee, or significant supplier is a risk that can discount your company’s value.
Another threat to consider is how beholden you are to changing government regulations. Look at the story of California-based entrepreneur Lorenzo de Plano. In 2015 de Plano co-founded Solace Technologies, one of the first vape companies in the United States. As de Plano told John Warrillow in a recent Built To Sell Radio episode, the goal of the business was to create a discreet vape pen that customers could use as an alternative to smoking cigarettes. The U.S. Food and Drug Administration (FDA) initially viewed this product favorably as one that could help people quit smoking.
Until, that is, the industry introduced fruit and mint flavors, luring kids into nicotine addiction.
As the FDA started to threaten the e-cigarette industry with new regulations, the value of industry players began to drop. For example, Juul’s valuation plummeted 85% between 2018 and 2020. De Plano decided to get out while he could salvage some value and sold to Turning Point Brands in 2019 for just over $15 million, a significant discount on what the business was worth before the threat of new industry regulations.
Just as NFL general managers like selecting players with lots of potential upside and fewer risks, acquirers think the same way about the businesses they evaluate. Yes, they want a company with significant potential, but they also want that upside at the lowest possible risk. Therefore, the more you can de-risk your business for an acquirer, the better chance you have of walking away with a life-changing exit.