investing

3 Major Risks You Take When Investing in a Business

Whether you are a Fortune 500 company or a small-time investor, making an investment in a business will always carry some level of risk.

Different industries and businesses will have different risk levels.

If you invest in a struggling tech company versus a tech industry leader, you will naturally face a different risk profile.

No matter what you are investing in, you should consider the three largest risks you take with any business investment.

Bankruptcy

Smart investors consider a firm’s bankruptcy risk before they buy equity or debt in a company.

No matter how stable a company is, bankruptcy will always be a risk.

For example, the advent of the digital camera brought new opportunities for companies like Kodak.

However, when smartphones began having built-in cameras, photography companies stood to take a hit.

This meant that digital cameras were no longer useful, meaning any business in the industry was likely to shrink in size or go bankrupt.

As the camera example shows, changing market conditions and new technology can make even strong, stable companies go out of business.

If you invest in a company that goes bankrupt, you could end up losing all of your money.

During bankruptcy, the company repays debts before it gives anything back to equity investors.

This means that debt like a corporate bond will be repaid before you get your stock investment back as corporate bonds are considered debt.

Stocks are considered equity investments because they involve someone gaining an ownership stake in the business.

Before you make any major investments, get the company’s financial documents.

By calculating things like the company’s debt-to-income ratio, you can see how stable the company is.

Take a look at the company’s cash flow statement to see how their money is getting spent.

If they are burning through cash each quarter, this is a problem.

Dividend cuts and changing auditors are also potential signs of approaching bankruptcy.

Lack of Development

If a company is not growing larger, you will not profit from your investment.

While a company might be at the top of its market at the moment, it cannot stay there forever without innovation and forward-thinking ideas.

In order to achieve a good return, you need to find a company that has a history of innovative and strategic thinking.

Blackberry is a classic example of a lack of innovation leading to the company’s downfall.

For years, Blackberry dominated the smartphone market and achieved a significant market share.

However, the company began to flounder after Apple entered the marketplace.

While Apple had innovative ideas and a better understanding of its customers, Blackberry was just relying on its past success to stay afloat.

Apple moved its products forward and constantly improved them.

Blackberry did little to match the new and improved features that Apple was introducing all the time.

Ultimately, business leaders have to constantly think of new products and services.

One of the ways to achieve this is by getting the best, most talented employees.

When a company works to develop employees, it benefits in the long run.

Employees create the company’s new ideas, which is why savvy entrepreneurs invest in employee training and retention.

Safety Risks and Legal Trouble

Every business faces some level of health, safety, and legal risk.

While companies like coal mines and construction businesses face significant health risks, even basic restaurants or financial firms have some risk involved.

If an employee is injured at work, the business can end up paying thousands of dollars or more for their lost wages and medical costs.

While insurance coverage, company policies, and the right management styles can prevent some problems, it is impossible to remove these risks entirely.

Investors should consider the company’s risk level before they invest in the business.

Some safety problems can cause legal issues, which can lead to significant business costs.

If these costs start to get too high, it could mean reduced dividends or bankruptcy.

A good example of this kind of problem can be found with Purdue Pharma. The pharmaceutical company made billions of dollars by selling painkillers.

Now, the company is looking at millions of dollars in settlements and a potential bankruptcy because it deliberately pushed addictive drugs to consumers while lying about their addiction potential.

Investors in the company may end up with nothing after the company finishes paying for all of its legal settlements.

Investing Wisely Can Help You Avoid Unforeseen Risks

Unfortunately, there is nothing you can do to completely remove all risk.

As an investor, you have to take your time and make the best investment decisions possible.

Read through the company’s financial statements to learn more about their bankruptcy risk and cash flow.

Then, consider the future growth and development potential of the business.

Wise investments take time.

Avoid rushing the process.

With careful planning, you can reduce the amount of risk you face.

In addition, you can mitigate your personal risks by diversifying your investment portfolio.