Prior to reviewing a debtor’s financial statements, keep in mind the industry in which it operates to determine what is the most relevant. Doing this will help you frame due diligence efforts and credit risk assessment.
Five Factors to be considered
In 1979, economist and professor at Harvard Business School, Michael Porter identified five forces to consider while developing a business strategy. This five-factor approach remains useful even today.
1. Power of customers
Your primary focus should be understanding the debtor’s market. A company may be at the mercy of key customers since it relies heavily on a few customers. This happens especially when there are multiple competitors in the market and no long-term contracts. This specific factor affects the terms and prices a debtor can negotiate with its customers.
2. Power of suppliers
Now the focus shifts to identifying the companies that a debtor purchases resources and raw materials from. Keep in mind the existence of long-term contracts and possible alternate suppliers, in case the key supplier goes out of business or breaches a supply contract.
Gain knowledge about other companies that sell similar products to the debtor’s customers. Your knowledge should include their pricing, reputation, financial position, market share, and channels of distribution. Afterwards, compare your debtor’s business model with those of its competitors. What factors differentiate your debtor? Is your debtor a follower or market leader?
4. Ease of entry
It is significant to gain knowledge about how much money the start-up needs to participate in the industry. In case, entering an industry requires licensing, compliance with local or federal regulations, or a significant investment in equipment, inventory and property, it lowers the risk of new competitors emerging and taking away market share.
factors influence investment process
5. Product substitution
Analyse whether there are substitute products that customers could use instead of what your debtor sells. Often, companies overlook alternate products and are blindsided when customers make an unexpected shift in their buying patterns.
These five factors shall help you frame due diligence efforts and credit risk assessment. To know more, visit LINQQ.