As you well know, I can drone on all day about financial ratios and collateral and why they are important in assessing repayment. But stepping back from the technical analysis, what is it that really makes a business good? Are there certain qualities that you can tell right away separate a good business from a bad business?
The first quality that makes a business opportunity shine is certainty. If a business has a predictable flow of revenue and a predictable cost structure, then you are dealing with a business on solid footings. In these instances, you are often asking how do we find a way to work with this business instead of why should we bother?
The key factor for most certainty comes from obtaining contracts that can be enforced and are collectable. Take for example someone who wants to open a restaurant. Your stomach may start to churn, because there is little, if any, certainty in such an industry. The barriers of entry are low, so anyone can open up a competing restaurant with relatively little money, and the fickle tastes of customers are subject to change depending on new fads and trends. As we see, restaurants open and close all the time.
Now, let’s take that same person who wanted to open a restaurant, but say he/she also notifies you they have obtained several contracts with reputable businesses to cater several of their meetings and functions. These contracts last a couple years, and provide reasonable payments on a recurring basis. Now this restaurant idea doesn’t sound as bad, since a considerable part of their operations will be devoted to honoring contracts that provide a steady stream of revenue.
Even in this situation, you may be saying to yourself that this only seems reasonable if you have effective managers running the operation too. This brings us to the second quality of a good business, which is good management. Quality management is a tough thing to assess. In this case, history is often the best indicator. A track record of success is always ideal. In our example, we may be asking if our aspiring restaurateur has previous experience running his own establishment. If he/she does, then what brings them here? Have their past ventures failed? Did they sell off and cash out of performing restaurants? A resume would also be helpful in assessing the manger’s experience.
While a successful business must be profitable, math and statistics cannot tell us the full story. This is why it is important to know business owners and managers on a personal level, and even meet them onsite. A good operator will have done a successful job at creating a predictable stream of revenue and has expenses under control. Solid experience, accompanied with a level of certainty about the future, is what makes for a good business in any industry.