Legal Blog

Managing Risk in Investing in a Privately Owned Business – Doing Due Diligence

by Mike Mercurio, Esq. Unlike public companies and their allegedly open books, privately owned businesses represent a different set of challenges for the potential investor. Every investor’s nightmare is throwing money into a black hole of a company where your hard-earned riches are never heard from again. Perhaps no amount of due diligence can overcome a superbly crafted scam, but the vast majority of private enterprises do have enough transparency to properly evaluate and manage risk. One obvious place to begin is in assessing the liquidity ratio, which tells the amount of current assets a company has to cover liabilities. To cash out your investment, whenever you decide to, the company should ideally have as large a liquidity ratio as possible, an indicator of less risk for short-term creditors. Once the liquidity ratio is established, this should be compared to companies in the same industry. This will tell you just where the company stands among its peers. If the liquidity ratio is better than the industry average, there is less risk involved, and the company is probably more valuable. Other financial risks also merit scrutiny, including whether the financial statements are audited or unaudited, as well as the reputation of the accounting firm if they are. And then there is the thorny issue of just how much of the owners’ personal expenses, assets, and liabilities are reflected on the company’s books. Financial statements may have to be adjusted accordingly if these items affect cash flow and the overall financial position. Once the financial issues are addressed, the capabilities of the current management team should be examined. Sometimes the objectives of those in charge are not in sync with current or potential investors. Hidden agendas, ongoing dissension, or unclear goals may be warning signs to stay away. It may be difficult to fully assess management’s integrity and competency beforehand, but it is worth the extra effort to at least have an informed opinion. Finally, assessing the company’s business risks can be a daunting task that requires gathering and analyzing significant amounts of data. Still, overall market positioning, sales methodologies, and customer trends are good starting points capable of yielding valuable information. The search for clarity and even transparency is again essential as business risks need to be clearly defined before an investment is made. Even if investing in a privately owned business is ultimately a case of caveat emptor, at least the informed investor will have mitigated the risk, hopefully significantly.

About Mike Mercurio

Michael N. MercurioMichael N. Mercurio is a Principal at Offit Kurman and Chair of the firm’s Business Law and Transactions Group. He regularly counsels entrepreneurial individuals and assorted entities on all aspects of business and commerce, including formation and structure, ownership, management and control, financial and capital, expansion and acquisition; sale and transfer; and contraction and dissolution. He has substantial experience representing clients in technology, cyber, healthcare, government contracting arena, assisting them through growth and maturation as well as mergers, acquisitions and internal transitions. Mr. Mercurio can be reached at mmercurio@offitkurman.co. To find out more about Offit Kurman’s Merger & Acquisitions Group, please click here.

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