Heitor Moura 2007 Risk Management for private equity investments

8/14/2019 Heitor Moura 2007 Risk Management for private equity investments

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Heitor Moura

A RISK MANAGEMENT PLANA RISK MANAGEMENT PLAN

UNICONSULT SERVIOS TCNICOS LTDA. RIO DE JANEIRO

January 2007


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Risk and its managementRisk and its management

Risk is the possibility that an event will occur, which adverselyaffects the achievement of objectives.

Risk management is: an on-going process, a means to an end; carried out through plans, policies, surveys, controls, information and

fundamentally by people;

PROJECTPROJECTPROJECTPROJECT jANUARY 2007 2

applied in a strategic setting, that is, directed towards objectives; applied throughout the organization, at all hierarchical levels and regional units; aimed at identifying and managing potential adverse events and situations; designed to offer reasonable assurance to its management and board of the

organization's understanding of risks and of its capability of minimizing their

effect.


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Risk Management ProcessRisk Management Process

RISK MANAGEMENT

PLANNING

RISK MANAGEMENT


MONITORING

RISK OCCURRENCE

RESPONSE


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Risk Management ProcessRisk Management Process -- PlanningPlanning

RISK IDENTIFICATION

RISK ASSESSMENT

RISK OF DELAY IN

INVESTMENT DECISION

RISK MANAGEMENT

PLANNING

RISK MANAGEMENT

MONITORING

RISK OCCURRENCE

RESPONSE


RISK-RESPONSE PLAN

MITIGATION OF

LIKELIHOOD

MITIGATION OF

EVENTUAL IMPACT

LIKELIHOOD: IMPROBABLE

IMPACT: SMALLTIME-FRAME: SHORT-TERM

PROJECT SCHEDULE

SIMULTANEOUS PROJECTS

PARTIAL-DECISION PROCESS


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Risk Management ProcessRisk Management Process -- ResponseResponse

OCCURRENCE OF

RISK EVENT

RESPONSE

TO SITUATION

DECISION IS DELAYED

RISK MANAGEMENTPLANNING

RISK MANAGEMENT

MONITORING

RISK OCCURRENCE

RESPONSE


CONTROLOF RESPONSE

ASSESSMENT OF

SITUATION POST-EVENT

ACTION TO SPEEDEN DECISION

ACTION TO SUBSTITUTE PROJECT

FOLLOW-UP ON

ACTIONS

REVIEW OF PLAN

REVIEW OF RESPONSE


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Risk componentsRisk components

DECISION TO TAKE

ON RISK

POSSIBILITY OF REDUCING

LIKELIHOOD

EXPECTED IMPACT OF

OCCURRENCE

LIKELIHOOD OF

OCCURRENCE

TIME-FRAME


INTENSITY OF EFFECT EXPECTED RESIDUAL RISK

POSSIBILITY OF

COVERAGEEFFECT OF RISK

PLANNED RESPONSE TO

EVENTUAL OCCURRENCE


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Risk components 2Risk components 2

Likelihood of occurenceProbability Likelihood

0% to 1% : highly improbable

over 1% to 5%: improbable over 5% to 20%: eventual over 20% to 50%: probable over 50% to 100%: highly probable


Time-frame for this occurence within 2 years after investment:

short-term, i.e. there is little time to change risk conditions until 8 years after investment:

medium term. i.e. there is some time to change risk conditions


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Risk components 3Risk components 3

Effect of risk Delay in operations Increase in cost Loss of revenue

Loss of assets Increase in liabilities

Intensity of effect


ow

medium high

Result of occurence

small: affects standard IRR by less than 1% p.a. medium: affects standard IRR by over 1% up to 3% p.a. great: affects standard IRR by over 3% up to 5% p.a. drastic: affects standard IRR by over 5% p.a.


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Risk coverageRisk coverage

MITIGATION OF

EVENTUAL IMPACT

INSURANCE

HEDGE


ABSORTION OF

RESIDUAL RISK

GUARANTEE

OTHER CONTRACTUAL

TRANSFER


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Risk categories combined with resultsRisk categories combined with results

100 200 400 800 3200 100 200 400 1600

50 100 200 400 1600 50 100 200 800

20 40 80 160 640 20 40 80 320

10 20 40 80 320 10 20 40 160

5 10 20 40 160 5 10 20 80

2 4 8 16 64 2 4 8 32

1 2 4 8 32 1 2 4 16

2 4 8 32 1 2 4 16


Small Medium Great Drastic Small Medium Great Drastic

SHORT TERM MEDIUM TERMRISK CLASSIFICATION

From 1 to 7 Acceptable


From 20 to 31Acceptable


From 64 to 99 Only acceptable if covered



500 or over Not acceptable


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Decision parametersDecision parameters

Acceptable risks Define risks Analyse possible reduction of likelihood and mitigation of impact Include cost of these counter-measures in investment analysis

Risks acceptable only if covered Define risks Analyse possible reduction of likelihood and mitigation of impact


s a s coverage nsurance, e ge, secur y

Include cost of these counter-measures and coverage in investment analysis

Non-acceptable risks Define risks

Analyse if possible counter-measures or coverage can change their classification Reject investment if this is not feasible and efficient (investment phase) or Take drastic counter-measures or divest operation (after investment phase)


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Main risks in each phaseMain risks in each phase ofof ProjectProject

Investment decisions Delayed decision Competition for each investment Unprofitable choice

Entry into each local business

Resistance from local groups Delay in establishing management procedures and controls

Operation of each local business Technical risks Regulatory and tax context


Management efficiency

Joint operation of all businesses Market fluctuations Lack of or reduced synergy among operations

Divestment of each business Market

Protracted negotiations Competition for new investors

Post-divestment Outstanding liabilities


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Risks in the investment phaseRisks in the investment phase

An exampleAn example

Risk identification

Type

Level


Likelihood

Impact

Time-frame


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RISK TYPE LEVEL LIKELIHOOD IMPACT TIME-FRAME

1 Delay in identifying prospects OrganizationHuman factor

1-Project 2-improbable 1-small 3-short-term

2Delay and/or non supply of information bysellers

Human factor 1-Project 3-eventual 1-small 3-short-term

3 Delay in making decision OrganizationHuman factor

1-Project 2-improbable 1-small 3-short-term

4 Delay in concluding negotiations EconomicHuman factor

1-Project 3-eventual 2-medium 3-short-term

5 Back-trading by sellers EconomicHuman factor 1-Project 4-probable 2-medium 3-short-term

6 Change in country market context Economic 2-Country 5-highly probable 3-great 2-medium-term

7 Change in world market context Economic 3-Organization 5-highly probable 3-great 3-short-term

8 Change in country business context Economic 2-Country 3-eventual 3-great 2-medium-term


9 Change in world business context Economic 3-Organization 3-eventual 3-great 3-short-term

10Delay in establishing and executingdocuments

Organization

Human factor1-Project 2-improbable 1-small 3-short-term

11 Inclusion of undesirable/incorrect clause OrganizationHuman factor

1-Project 1-highly improbable 2-medium 3-short-term

12 Non delivery of mandatory licensesRegulatory

Human factor1-Project 2-improbable 2-medium 3-short-term

13 Delay in delivery of mandatory licenses RegulatoryHuman factor

1-Project 3-eventual 1-small 3-short-term

14Non discovery of unacceptable risks orliabilities

Organization

Human factor1-Project 2-improbable 4-critical 2-medium-term

15 Fraud in delivered information Criminal 1-Project 2-improbable 4-critical 2-medium-term

16Resistance from local management /labour

Cultural

Human factor1-Project 4-probable 1-small 3-short-term


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RISK REDUCING LIKELIHOOD MITIGATION OF IMPACTINSURANCE

POSSIBILITIES

HEDGE

POSSIBILITIES

GUARANTEE

POSSIBILITIE

S

RESIDUAL

RISK

1 Delay in identifying prospects Pro-active search Simultaneous projects None None None Low

2Delay and/or non supply of information

by sellers

Documentation list

Local follow-up

Expliciting the requirement

Expliciting consequences

Partial-decision process None None None Medium

3 Delay in making decision Project scheduleSimultaneous projects

Partial-decision processNone None None Low

4 Delay in concluding negotiations Project schedule Simultaneous projects None None None Medium

5 Back-trading by sellersClear negotiation

Reputable partners

Simultaneous projects

Competitive negotiationNone None None Medium

6 Change in country market context NoneAnalysis parameters with

expected time-frame averageCountry risk Price hedge None Medium

7 Change in world market context NoneAnalysis parameters within

expected time-frame averageNone Price hedge None Low

Sensibility analysis within


expected parameter range

9 Change in world business context None Sensibility analysis withinexpected parameter range None Price hedge None High

10Delay in establishing and executingdocuments

Competent legal advisors

Internal reviewSimultaneous projects None None None Medium

11 Inclusion of undesirable/incorrect clauseCompetent legal advisors

Internal reviewNone None None None Low

12 Non delivery of mandatory licensesCompetent legal advisors

Local representatives

Contractual obligation to deliver

correct informationNone None

Contractual

obligationLow

13 Delay in delivery of mandatory licensesCompetent legal advisors

Local representatives

Contractual obligation to deliver


Contractual

obligationMedium

14Non discovery of unacceptable risks or

liabilitiesComprehensive due dilligence Contractual generic guarantees None None

Contractual

obligationLow

15 Fraud in delivered information Comprehensive due dilligenceContractual obligation to deliver


Contractual

obligationLow

16Resistance from local management /labour

procedures

Winning local management

Communication program with local

Contractual generic guarantees None None None High


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List of potential risksList of potential risks 11

Commercial - Sourcing Performance: non delivery of raw materials Performance: late delivery of raw materials Performance: raw material off specifications

Change in availability of raw materials

Commercial - Sales Credit: Non-receipt of sales


re : a e rece p o sa es

Performance: non acceptance of products by buyer Performance: delay in acceptance of products by buyer Performance: raw material off specifications


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Commodity markets Cost of raw materials

Materials not yet purchased Materials purchased but not fixed Materials in inventory

Sale prices of produced goods Unsold products Products sold but not fixed

Price fluctuations in straight commercial open positions (purchases and sales


unre a e o pro uc on

Exchange markets Exchange rate fluctuation as to investments

investment in USD x earnings in local currencies

Exchange rate fluctuation in current operations foreign sales x domestic costs


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Agriculture Climate rain Water (availability, investment for sourcing, cost) Labour (quality, possibility of strikes, cost)

Agricultural management (quality, availability, cost)

Industry Equipment (unplanned maintenances, delays, costs)


Supply of equipments (availability, delay, cost) Necessity of increasing industrial facilities Necessity of changing industrial process Labour (quality, possibility of strikes, cost) Industrial management (quality, availability, cost)


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Logistics Availability of transportation vehicles

Third parties Own investment Financing for third parties

Availability of routes Availability of storage capacity

Third parties Own investment


Financing for third parties

Availability of maritime terminal time Availability of ships within required regularity Cost of land transportation Cost of storage Cost of maritime terminal Cost of maritime freight


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Financial Interest rates fluctuations Existing and expected bank debts Other existing and expected financial debts

Existing and expected tax liabilities Existing and expected labour liabilities

Management


Implementation and maintenance of required controls agriculture, industry, logistics, sales, markets accounting, taxes, labour IT infrastructure and hardware

Implementation and maintenance of reporting process Implementation and maintenance of risk management process Motivation of local management and labour


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Environment Existing environmental liabilities (in agriculture, industry and logistics)

known, but not evaluated evaluated but without payment obligation evaluated with payment obligation

Potential environmental liabilities (in agriculture, industry and logistics) Environment-related licenses (delays, cost)

Re ulator risks


Labour regulations Taxes regulations and compliance (on agriculture, industry, logistics, domestics

sales, exports, earnings, assets) Accounting regulations and compliance Labour relations compliance

Other regulations compliance


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Corporate risks in local operations Conflict with previous owners Conflict with remaining partners Conflict with government

Conflict with competitors

Country risks General political risk


n eres ra e eren a rom coun ry ra ng

Social turmoil, acts of God Countries:

with local operations sources of raw materials and products sales markets

General corporate risks


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Agenda for a risk management planAgenda for a risk management plan 11

Review and establish parameters for: risk identification (list of risks in each phase of Project) organizational levels involved time-frame likelihood of occurrence

impact (type of effect, monetary and non-monetary consequences) levels of risk tolerance (acceptance, acceptance with coverage, rejection)

Define, for each risk listed:


the risk

possible impacts how it will be assessed (statistics, market talk, model estimation etc.) who will supply basic input, who will carry out analysis time-frame for this analysis (daily, weekly, monthly,...) process flow of the risk analysis (local level >> country level >> corporate level)

possible likelihood-reduction strategies possible impact mitigation strategies initial response plan to eventual occurrence


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Define documentation on risk management For each project, during investment phase For each operation, after investment phase For each type of occurrence, during life-time of Project

To be delivered to local management To be delivered to country management To be delivered to corporate management


To be delivered to investors To local authorities

Define functions/persons responsible for Establishment of risk management plan Assessment of risks in each project, during investment phase Assessment of risks in each operation after investment phase Assessment of corporate risks


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Month 1 Define persons/functions responsible for the establishment of a Preliminary Risk

Management Plan (valid until First Closing)

Establish and approve this Preliminary Risk Management Plan

Months 2 and 3 Include extract of Preliminary Plan in presentations to possible Investors


Work on Risk Management Plan for investment process

After First Closing (or on assurance of go-ahead) Establish and approve the Risk Management Plan for the investment process Define responsibilities for the execution of the Risk Management Plan during the

investment process Organize the means and resources for this execution Beginning discussing and drafting the Operational Risk Management Plan


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Heitor Moura

A RISK MANAGEMENT PLANA RISK MANAGEMENT PLAN

January 2007

Heitor Moura 2007 Risk Management for private equity investments

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