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How business valuation and credentialing can help you assess third-party risk

Aug 11, 2016 Philip Burgess

How business valuation and credentialing can help you assess third-party risk

Whether financing debt for privately held organizations or partnering with a fellow industry participant, working with third parties introduces several financial risks.

At a high level, every factor could present a possible fiscal liability, from a vendor's geography to a borrower's day-to-day operations. Business credentialing and valuation tools highlight these concerns, revealing potential hazards that could impact your business' financial profile.

3 use cases for business valuation solutions
Several situations warrant the use of business valuation solutions. Industry performance information is not only appropriate when considering the implications of entering a new segment of the economy but also pertinent in the following three scenarios:

  • Financing a startup: With a little more than 130 startups per 100,000 Americans, according to The Kauffman Index, there are plenty of budding businesses in which to invest. Choosing one that will enhance a company's financial profile entails figuring out whether a startup is participating in a growing industry, fulfilling an expected need that other companies are slow to address and enacting a business plan that emphasizes its core value proposition.
  • Acquiring a business: Acquisitions are usually a means to reduce strategic risk, whether by enabling smaller companies to expand their audiences or by allowing buyers to gain human capital. McKinsey & Company recognized one such instance where Cisco acquired 71 companies between 1993 and 2001, increasing its revenue from $650 million to $22 billion across that time span.
  • Lending to a company: This situation calls for more granular assessments. The lender analyzes the borrower's income in dollars, percentages, balance sheets and other financial details to examine a business's profitability. It doesn't pay to lend to a company that has struggled to stay in the black.

Strategic risk isn't the only item business valuations can address. Depending on the tools at an organization's disposal, analysts can estimate the operational, reputation and credit risks associated with engaging third parties.

What is the strategic risk of engaging a particular third party?

Confirming legal integrity
The purpose of a business credentialing system is to reveal any regulatory complacency within the third party. This is especially important when you are accessing consumer credit data from another business for various purposes.

For instance, the Federal Fair Credit Reporting Act mandates that businesses handling consumer credit data must adhere to the following regulations, among others:

  • Receive consent from consumers before supplying their credit data to employers
  • Disclose whatever details are in a person's file at that individual's request
  • Address disputes regarding inaccurate or incomplete data

There's an obvious risk to engaging a business that fails to adhere to these and other regulations specific to various industries.

Enterprises considering collaborating with merchants who are not compliant with Payment Card Industry standards, for example, run the risk of sustaining fines of up to $500,000, as noted by Focus On PCI. While large companies may be able to endure such penalties, these fines may be quite harmful to businesses with homogenous financial portfolios.

Integrating business valuation and credentialing
Decision-makers should view business valuation and credentialing solutions as complementary to each other. Together, they give businesses a comprehensive idea of third-party risk, revealing any details that may affect the outcome of a lender or investor's financial portfolio.