What is a good investment opportunity?

Do we know when we are facing a good business opportunity?

We are facing a good investment opportunity when the expectation of obtaining a substantial profit is based on credible and reasonable assumptions. However, the benefit must be expressed in relative terms, which is, being measured in relation to the investment made and the time necessary to obtain it.

In economic terms, the magnitude that expresses the goodness of an investment opportunity is the profitability. The comparison of the benefit with the investment is a simple economic return that must be considered in terms of the period of time elapsed since the investment is made and the benefit is obtained.

In this case, we associate the time variable with the term “financial” and consequently the magnitude that expresses the economic and financial profitability of an investment is the Internal Rate of Return (IRR).

Thus, every investor can reach plenty of opportunities that will be greater or smaller depending on the restrictions that are relevant for him such as market, legal certainty, currency, term, type of business (object), liquidity and competitors.

Once the investor’s restrictions have been identified, the opportunities will offer profit and time expectations that must be evaluated considering another fundamental variable, the Perceived Risk. That is why every investor uses one or more methods to discriminate and prioritize their “good investment opportunities”.

How to asses investment opportunities?

The most used methods to value investment opportunities are the Net Present Value, the Internal Rate of Return and the Payback Period. The first two consider the investor’s restrictions by setting a minimum discount rate in terms of IRR, that the investor sets based on his perceptions of risk and the alternative opportunities for that level of perceived risk.

Therefore, any entrepreneur who wants or is thinking about the sale of his company has to consider the following: what profitability can the buyer of the company obtain, how is he going to obtain it, what risks does the exploitation of the company’s main business present, what reasonable growth possibilities the company has that makes the investment attractive, what competition exists, what are the trends in the market where the activity takes place and how the future buyer can materialize this profitability.

It should not be forgotten that the profitability and risk binomial is directly related and therefore, the higher the expected return is, the greater the associated risk is, and viceversa.

Buying and selling companies as a investment opportunity

In the world of business transactions, if you read buying and selling companies, associated with Small and Medium Enterprises (SMEs), we could say there is no organized market that gives liquidity to the purchase of companies beyond the Alternative Stock Market (MAB), which we are not making reference to. Therefore, to buy a minority package (without control) of shares of an SME is not the same than buying a package of shares that grant Corporate control. In the second case, the apparent liquidity of the investment is notably improved and therefore, the interest for the buyer too.

Additionally, the company growth options must be considered as very relevant aspects to make its purchase or corporate control package attractive for the buyer or investor.

It is a good investment opportunity when it offers a credible return (in economic and financial terms) higher than the investor return based on his perception of risk and the alternative returns accessible for that level of risk, taking into account it could be monetized, that is, the benefit can be obtained in terms of money in the time horizon set as the investment objective.

This is what is known as an expected quality benefit, that is, it is easily understandable, achievable and which comes from the creation of value generated by the exploit of the business so that a third party can clearly perceive it and pay for it on time and form.