As we wrap up our special series on corporate risk, let’s review the elements we’ve covered. We began with integration risk and high capex. We then examined cyclicality and specialized sectors. Our third part covered short borrower histories, hockey stick growth, single products, and customer concentrations. Technology, regulatory, and legal risks followed that, as well as geographic concentration and second ways out.
Our last two risk elements are barriers to entry and non-sponsored ownership.
Barriers to entry – Capitalism being what it is, no company is impervious to competition. But private equity sponsors value businesses with high barriers to entry. Similarly direct lenders analyze how difficult it is for other companies to take market share from the borrower.
A number of factors enhance these barriers. We discussed trademarks and patents earlier in our series [link]. While these are helpful, it doesn’t mean a better mousetrap won’t steal clients. Some brands protect trade secrets by not patenting products; Coca-Cola being the prime example.
High switching costs discourage customers from leaving for a competitor. The flip side is that new clients are hard to win.