How to identify risk in your small business investing

A major part of investment smartly, knowing how to reduce your risk. If you are considering investing in a small business (or business or any size), here are some key factors that should raise a red flag. Knowing these risks before you put in any money, can save you big in the long run. Here is what you need to know about how to identify risk in your small business investing. It should be a considered a red flag is the small business has-

• A large dependence on key suppliers-While a prudent management is going to want to keep inventory levels at optimum levels, a dependence on key suppliers could be red flag of cash mismanagement. While management may not want to overextend their cash allocation, and this is perfectly acceptable, even preferable, as it keeps cash in the company's coffers (and, earning interest) rather than in that of its suppliers, can create a problem.Dependence upon a few key suppliers can expose an entity, to the risk that the supplier, may not be able to deliver, significantly hurting sales of a "hot" product.
• A large dependence on a single product- One of the major things potential investors should look for in any investment is an endurable franchise value. It is crucial to understand that if a company derives a substantial portion of its sales, from a product with little or no staying power, any capital you commit to the venture can scarcely be anything other than speculative. Remember when the market evaporates, you don't want to be left holding the bag. Make sure that the small business, you are looking to invest in, has some staying power, for the long term.
• A large dependence on key customers-The lesson here is a simple one: if a businesses future is too closely linked to the success of a single key customer, and the company does not have control over that customer, the investor must consider this in his analysis. Investors should take note about the impact the loss of a key contract would have on the company's sales, profitability, and liquidity. If the success of the small business you are considering is based solely on another entity that they have no control over, this is red flag to look elsewhere.
• An unstable management team-You should look closely at the management team of any small business, you are considering investing in. You will want to know without a doubt that the management team has the investor's best interest at heart. You will want to ask the following questions-

1. Do the executives have a significant portion of their net worth invested in the stock? 2. If they do, does the ownership come from options, or from outright, honest-to-goodness cash purchases? 3. Does management have a history of repurchasing stock when it appears undervalued? This is crucial since a management team that will profit in proportion, to shareholders is more likely to follow an investor-friendly course of action. When management does this it creates a culture of accountability. Further questions that

Can shed light on management actions including:
1. Have dividends increased regularly for at least the past ten to twenty years?
2. Has the company has engaged in mergers and acquisitions, and do the deals appear sensibly priced?
3. Is the company maintaining a responsible level of debt, or has debt relative to equity increased with little or no explanation?
4. Are employee perks reasonable?
5. Are management's communications open and honest?-This is especially significant because as an owner of a business, you have the right to expect a management that is open and honest, about the challenges the business is facing. If the owner's letter to shareholders sounds more like a public relations document, or if you have difficulty understanding the footnotes, you should reconsider your investment. At the very best, they don't have a proper respect for your role as owner, and at worst, they may have something to hide.

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