What Does Transitional Risk Mean?
Transitional risk refers to the risk that the buyer takes on if the post-transaction transition fails and/or results in underperforming financial results. Transitional risk may result from a lack of adequate processes and controls, a missed assumption that was not vetted during due diligence, or a missed strategy during the first 90 days. However, transitional risk most often relates to the owner of the selling company, and how he/she is able to move from his/her previous role as president to being an employee of the buyer.
Divestopedia Explains Transitional Risk
The owner of the selling company usually has tremendous value to the buyer, particularly during the first year after the transaction. Even if the plan is to replace this individual, the first year typically requires that he/she manage key customers so none are lost. Furthermore, there is continuous management required of employees, suppliers and other stakeholders, so that their reaction to the transaction is positive. The buyer has bought an expected future cash flow, but this cash flow can easily suffer if stakeholders react negatively to the deal.
A company owner must be certain that he/she wants to stay post-transaction and be a part of the transition before he/she agrees to sell the company. While buyers are aware of transitional risk throughout a transaction, it is difficult to mitigate this risk right away, particularly if the company is highly dependent on the principal for customer relationships.