Business risk and lifecycle stage

The high-tech bubble is slowly deflating, and more and more individual investors are now returning to securities investments. Markets are consolidating and companies’ appetite for acquisition is still very high, however, there are still things to remember from only a couple of years ago. Allow me to expound, for example, on the risks that an investor or a company should think about before investing in any new business.

I assume most of you don’t struggle to monitor - for example, by following the famous beta indicator -the price volatility risk of stock markets and your favorite securities. Therefore, I’ll focus on providing more insight into fundamental risk factors by focusing on one of the key elements that’s quite often misinterpreted in the investing community, which is the company’s financial and operational health, and the potential risks and issues that it may face. If we think about it from the perspective of the “business lifecycle,“ at any given time a company can be categorized in one of four typical lifecycle stages: start-up, growth, maturity and transfer. Each stage is associated with different strategic and operational risks.

For a prototypical start-up company, an investor should seek to verify the source of financing and ownership structure, looking with the perspective of the business itself, and the regulatory and economic environment in which the company operates or will operate, especially if it’s a greenfield investment. With regard to acquisitions, major risk areas are the valuation of the company, all the internal and external relationships that a new owner is purchasing, and any risks that are normally hidden at first sight, such as obligations in connection with related parties, management contracts, tax position or obligations related to underperforming IT systems. Substantial consideration should also be given to the parent company’s plans with regard to the distribution of profit, if known.

An average company in the growth stage strives for market share and new customers, and, as a result, usually doesn’t pay enough attention to their internal procedures. We’ve seen companies who saw their revenues grow by 100 percent year-onyear but, on the other hand, allowed 20 percent of these revenues to leak internally due to an exclusive focus on external performance. Improper customer risk assessment and categorization, the ineffectiveness of IT systems and issues related to people overload are among the key factors that hamper growth and profit.

A firm that has already achieved its maturity is, in addition to considering different strategies such as horizontal or vertical growth models, foremost looking to achieve efficiency and effectiveness in their own internal operations. Two key words mentioned by most top managers are “cost reduction.“ Of course, this might have a different meaning to different people, but the most effective areas to review are those related to procurement and logistics, staff reduction as a result of process optimization, and optimized use of existing and available IT resources. For a few years now, we’ve seen a growing number of local companies that aren’t afraid to test the business process outsourcing (BPO) model -now a global trend - on the Czech market and, sometimes, outsource any one function of their noncore business to an external company. Typically, this includes one or more elements of their finance function.

I’m very positive that we’ll see this model used by even more companies in the future, since the Czech Republic is currently leading the list of countries most suited to the establishment of shared service centers (SSC) for multinational companies. At the same time, I’m sure that you’ll immediately think of many risks in relation to BPOs or SSCs, but even complex issues, such as tax implications, the quality of service provided (service level agreements), or the confidentiality and security of data, can be addressed if seen as a risk factor. In our experience, 99 percent of companies at the maturity stage are very keen on being benchmarked and compared to other firms. Benchmarking can certainly be done from many different perspectives and can focus on different areas of business. However, the truth is that the benchmark is only as good as the data source used for the benchmark. The highest demand from our Czech clients is in the area of human capital benchmarks, as well as focused process-efficiency benchmarks.

The last stage of the business life cycle, and the least-desirable stage for many shareholders, is the transfer stage. Having said this, not all critical survival issues are related to the performance of the company itself, its employees or its management. There are many cases of the turnaround of a company that struggled as a result of changed market conditions and innovations, some examples are film and camera maker Eastman Kodak Company in connection with the rise of digital photography, electronics firm Sony Corporation in connection with DVDs, and computer giant IBM in connection with home PCs and notebooks. These companies, due to their history and market position, didn’t necessarily have to address total turnaround issues, such as improving their financial health, protection from creditors, business sale or complete business restructuring. These are just a few examples of what companies have to tackle and what the potential risks for investors are.

To summarize, there are risks with any type of business. However, the risks are different - depending on where the firm is positioned in the business lifecycle curve - and on the potential threats to an investor. Many companies, mainly multinationals, are very well aware of this, and are setting their risk management functions not only to protect their assets, but used as a competitive edge. Investors appreciate when they see that a company has recognized risks related to their business and adjusted their internal structure to make the business as transparent as possible. It can be argued that the costs to manage some of these risks are too high. Yes, they might be, depending on the approach selected. But what are these costs compared to those that we have seen in the cases of defunct energy firm Enron, dairy firm Parmalat and a number of others? And, from that perspective, the question to ask is: Is this the right investment for me or my company? *investigative goals. *