The Entrepreneurs Advocate

Archive for May, 2008

Like me, you probably serve on a few non-profit boards. Giving of yourself can be very rewarding, but sometimes frustrating in the non-profit arena. A key difference between your business and the non-profit is that when you serve a client, the profits that are subsequently generated increase resources. When the non-profit serves a client, resources typically are consumed and must be replenished by outside sources.

When I took my first non profit board seat many years ago, I thought I was there to share my insight and knowledge ;).  I slowly learned that guidance, strategy and the fiduciary duty are important, but there are three critical roles that need played. You either:

Give Money, Raise Money and/or Do Critical Work

In a new or under capitalized non-profit these areas are magnified. As you look at your board make up, slot all the members (including yourself) into each category. My guess is that there is some dead wood who do none of the three. Their main job is to “pontificate”. They need to go unless their insights rival Peter Drucker’s. If you are lucky, you have an even mix of all three areas. If you are really lucky, you have a few superstars who fall into 2 or 3 of the categories.

Look for balance in the board makeup. To many of one or not enough of any of the three board member types can lead to problems. Too many pontificators will lead to failure and ruin.

In AccuVal’s (a global leader in valuation, advisory and asset management services) most recent newsletter, the above question was asked. Here is their answer:

A: In addition to the appraisal approach, business risk, financial risk, and liquidity risk should also be considered.

Business risk is defined as the degree of uncertainty of realizing expected future returns of the business resulting from factor other than financial leverage. Business risk is applied to all factors that can have an effect on forecasted earnings, including any issue that may impact administrative and operating expenses, cost of sales, and sales. An appraiser takes into consideration the competition, industry, management focus, and working capital of that specific company.

Similar to the definition of business risk, financial risk is defined as the degree of uncertainty of realizing expected future returns of the business resulting from financial leverage. Financial risk pertains to interest expense. Interest expense can impact the pre-income tax earnings that were forecasted. Financial risk is company specific and is assessed on the asset base of the business. The level of financial risk varies. It can be considered minimal if business is primarily financed by equity. If financed by debt, however, the financial risk would most likely be considered medium to high.

Liquidity risk is industry specific, whereas business risk and financial risk are company specific. It is also not relative to the realization of some level of income. Liquidity risk relates to the uncertainty associated with the disposal of a closely-held business at fair market value. The uncertainty stems from the length of the disposition period as it relates to the time value of money.

Whenever we take on a new Exiting client, we get a 3rd party business appraisal done by a reputable company (one that the banks will take, hold up in court, etc.). We also utilize a business appraisal in our targeted search program for Entering Clients. Our website is chock full of good reasons to get one. Occasionally in addition to a regular or enterprise appraisal, we use a Hypothetical Appraisal. From the American Society of Appraisers (ASA) website, here is the definition:

Hypothetical Appraisals- A hypothetical appraisal is an appraisal based on assumed conditions which are contrary to fact or which are improbable of realization or consummation. The Society takes the position that there are legitimate uses for some hypothetical appraisals, but that it is improper and unethical to issue a hypothetical appraisal report unless (1) the value is clearly labeled as hypothetical (2) the legitimate purpose for which the appraisal was made is stated, and (3) the conditions which were assumed contrary to fact are set forth. A hypothetical appraisal showing the value of a company which it is proposed to form by merging two existing companies would he deemed to serve a legitimate purpose. On the other hand, a hypothetical appraisal of a projected apartment house, based on an assumed rent schedule which is so much above the market that it is practically impossible for it to be realized, would not serve any legitimate purpose and its issuance might well lead to the defrauding of some unwary investor.

So from this you can see why we sometimes utilize a hypothetical appraisal. If your business will be purchased by an individual or financial buyer who hopes to run it, grow it and earn a nice living after debt coverage; a hypothetical appraisal is probably not right for you. If your business is large enough or unique enough that it will add immediate synergies to a strategic buyer like a PEG or larger company, then it make sense.

Warning! There are unscrupulous companies who try to get $40,000 or more from business owners selling them on the merits of purchasing a hypothetical appraisal. They will dangle their roster of strategic and international buyers as a lure. Please use some common sense. If the size of your business or its lack of uniqueness would not entice these larger buyers, don’t be fooled. These companies are in the business to sell appraisals for $40k, not to sell your business. A reasonable appraisal will be a fraction of that price. See this INC article for details.

In these tougher economic times, collection of your AR needs monitored more closely. The credit worthiness of your clients has probably degraded and their ability to pay you may be at risk.

There is only one thing worse than no sales and that is delivering the goods and not getting paid

What steps can be taken to protect your business from credit default or slow pay risk? Let’s look at a few:

Credit application on File?

“Legalese” on the back of your Invoice?

Interest on Late Payments?

Security Interest in Goods?

Lien Rights if Applicable?

Personal Guarantee of Customer?

Limited Return Policy?

Insure your Accountants Receivable?

Sell Your Accounts Receivable?

Current Credit Data on Your Clients?

Cross Collateral Protection?

Many of the points are self-explanatory, but if you are worried about the collectability of your AR, please comment on this post and we will try to send you in the right direction for help.