Be Safe Out There

This weeks edition contains a couple of warnings to help you stay safe.  Earlier this week, I spoke at Mississippi State University's Insurance Day on the topic of ethics.  Ethics is a broad topic, so I spoke on one of my favorite topics, fraud.  Most people do not fail ethically because they cannot determine the difference between right and wrong, they fail because they want the benefit to be gained by doing wrong.  (As I freely admit, I would have no problem with sin if it did not look like fun).

A couple of attendees approached me after the session with their stories.  Their losses were caused by misplaced faith.  As Ronald Reagan said, "Trust but verify!" The simplest and most effective fraud deterrent is for the small business owner to receive the bank statements unopened and review canceled checks. Review for reasonableness of payee, amount, and timing. Occasionally follow up with your personnel to let them know that you are looking.

My second caveat relates to the valuation of start-up or high-growth companies.  In most cases involving such companies, the business valuator relies on the discounted future cash-flow method.  Under these circumstances, the valuator must challenge the assumptions which underly the forecast, which are generally provided by the owner of the company, if said owner does not prepare the forecast.  As you may expect, we often encounter the following circumstances:

• Unrealistic revenue growth, both in terms of rate and duration.
• Growth in expenses at the CPI rate of inflation.
• Over-valuing of a patent or patent application.
• Overstated benefit of synergies.

Generally, crunching the numbers in such a valuation is straight-forward.  An analyst needs to earn his/her keep by determining whether the key assumptions are reasonable and by assessing the effect of small deviations in the forecast.

One final caution on patents.  Patents are relatively cheap to obtain.  Enforcing them is very costly - consider a ballpark figure of $7 million per case.  Statistics indicate that half of all patents have NO strategic value.  Only 2-5% of patents generate any royalties.

Keep your eyes open.  As Yogi Berra says, "You can observe a lot just by watching."