Creating and maintaining risk in a management program is an investment worth making for private equity firms
By Shruti Shah, Principal, Advisory Services, KPMG LLP
The value of a private equity firm and/or its portfolio companies can plunge before there is even a chance to react. Risk is inherent with investing, but – for private equity – the challenges now go well beyond unpredictable business cycles and volatile markets. Strategic, operational and external risks represent potentially disruptive forces that can wash away everything you built in the blink of an eye.
Private equity firms are encountering risk everywhere, from disruptive technology and cybercrime to fraud and regulatory compliance. And these threats are emerging at ever-increasing speeds. News—especially bad news—travels around the globe almost instantaneously, giving PE firms and their portfolio companies little time to react before the effects are felt.
It’s essential that these firms monitor and manage the growing threats, but this has proven challenging. In many private equity firms, the focus and budgets are not aligned to managing the escalating risks in the industry.
After listening to industry experts, we’ve come up with a list of top risk management issues facing private equity firms. Read our full report to find practical actions to mitigate these risks.
1. Technology Risk
Managing technology risk is more than just information security. For PE firms, changing technologies offer an opportunity to provide business value, anticipate problems and support the firm’s growth. To be effective, technology risk management must not only measure the PE firm’s risk exposure but that of the firm’s portfolio of companies as well. Risk at a portfolio company poses risk to the PE firm as well. As quickly as technology grows and evolves, technology risk management practices need to change with it.
2. Third Party Risk
As their investments expand, private equity firms routinely engage third parties to perform services. Doing so increasingly exposes PE firms to outside contractors, who can easily damage the PE firm’s reputation and investments. Third parties are critical to support operations, but financial services regulators are clear that outsourcing work to third parties does not shift the responsibility from the PE firm.
3. Fraud and Misconduct Risk
Firms that are highly motivated to sell a portfolio company can become victims of fraud caused by outside actors. This risk can be multiplied for firms with holdings in foreign markets where fraud, bribery and corruption are part of the culture. Private equity firms and funds have a long history of transparency with their limited partners and with regulators. This transparency is key when potential fraud or misconduct issues arise.
4. Cyber Risk
PE firms face a number of cyber threats, whether it’s from employees, third parties or other outsiders. Attacks have become so common that some PE firms feel increased spending on better security won’t deter attacks. Yet, in our opinion, this short-sighted approach just makes these firms easier victims of cyber-breach and exposes them to penalties for regulatory failures.
5. Compliance Risk
PE firms are subject to more regulation and oversight than ever before. The laws, rules and regulations impacting the private equity sector have grown exponentially over the past several years. The private equity business model is no longer driven by performance alone – it now must balance costs with a duty to ensure a robust compliance infrastructure.
6. Crisis Management Risk
When corporate crisis hits, the ability to respond quickly is paramount for preserving reputation and ensuring continued success. Allegations of fraud, misconduct or bribery can quickly devalue a private equity firm. Reputations fall faster than they are built. Social media and the speed of news now gives firms only a few hours to come up with an effective reaction. It’s essential to have a crisis management team ready to respond at any moment.
Managing risk is essential for PE firms. While it can be costly and time consuming, it will save the organization much more in the long run.
KPMG LLP is an AIC Tier 2 Associate Member.