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[capitalminute] Risk Factors
September 01, 2004
** The Capital Minute **
brought to you monthly by Mike Elia
Financial & Marketing Consultant, Author
"Business Plan Secrets Revealed!
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How to Handle Risk Factors In
Your Business Plan

Eventually every investor will ask you questions designed to flush out the amount of risk your business poses. One way to help take the bite out of this negative questioning and boost your credibility is to cover the major risks of investing in your business in a special Risk Factors section within your business plan.

Use this Risk Factors section to list, in order of importance, those risk factors you consider to be unique and substantial risks to an investor in your business venture based on the facts and circumstances of your business plan.

There is no specific number of risk factors to include in your plan. However, after describing a specific risk factor, be sure to tell investors how you plan to mitigate it. This helps show potential investors that you not only understand the risks involved in your business but have plans to address them.

Here are four categories of risk factors to consider covering in your business plan:

1. Risk relating to the Company's Financial Situation

Does your company have a history of losses with no expectation for immediate profits? Has it ever operated profitably since its inception? What is the company's current retained earnings or deficit as of the most recent financial statements? What were the company's earnings or losses over the past three fiscal years or since its inception, which ever is shorter? When will the Company expect to become profitable? Is there any certainty it will become profitable?

Examples of financial risks:

  • Limited operating revenues.
  • Limited capitalization.
  • Substantial intangible asset.
  • Dependency on funds to continue operations.
  • Adverse consequences of not obtaining funds.
  • Significant indebtedness.
  • No history of dividends and no expectation of any in the immediate future.

2. Risks relating to the Company's Business

What stage of development is the company (formation, rapid growth, growth to maturity, maturity)? Has it engaged in any significant operations to date? Is there any certainty that the company will be successful in overcoming the risks of development in order to advance beyond the formation phase?

Examples of business risks:

  • Uncertainty of market for product or service.
  • Unproven product and business.
  • Competition and existence of other entities engaged in similar business which have greater resources.
  • Limited or no manufacturing capability.
  • Governmental regulation of products or services (e.g., licensing, environmental, etc.).
  • Technological obsolescence.
  • Need for additional financing.
  • Trademarks, patents, royalties that are not owned by the company.
  • Dependence upon key personnel.
  • Reliance on efforts of management.

3. Risk relating to the Company's Management

What kind of record does management have in similar or in other prior business ventures? Which company principals have operated businesses of this type prior to organizing this company that resulted in losses to investors? Which principals also operated other businesses in the past that were not similar to this company and resulted in losses to investors?

Examples of management risks:

  • Substantial voting control of the company to be retained by management or existing shareholders.
  • Disciplinary or criminal history of any promoters.
  • Substantial direct and indirect compensation to management.
  • Substantial amount of proceeds being used for the benefit of management.
  • Conflicts of interest and transactions between management and the company.

4. Risks relating to the Type of Investment Being Offered

Will promoters own substantial promotional shares and options? How many shares will promoters own and what is the average price paid and how does it compare to the public offering price. What options or warrants do the promoters own? How and when are they exercisable and what average price?

Examples of Investment Type Risk:
  • Immediate substantial dilution of investor's purchase.
  • Risk of loss of the entire investment.
  • Lack of a public market for the securities and no assurance that a market will develop.
  • Amount of shares of promoter's promotional shares available for immediate resale.

Remember these are merely examples. Take the time to develop your own risk factor disclosure that is applicable to your specific business venture. It will show investors that you've done your research and are ready to take your business forward.


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