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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
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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
PROJECTPROJECTPROJECTPROJECT jANUARY 2007 4
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
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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
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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
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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
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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
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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
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Small Medium Great Drastic Small Medium Great Drastic
SHORT TERM MEDIUM TERMRISK CLASSIFICATION
From 1 to 7 Acceptable
From 8 to 19 Acceptable
From 20 to 31Acceptable
From 21 to 63 Acceptable
From 64 to 99 Only acceptable if covered
From 100 to 299 Only acceptable if covered
From 300 to 499 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
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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
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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
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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
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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
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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
correct informationNone None
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
correct informationNone None
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
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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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List of potential risksList of potential risks 22
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
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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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List of potential risksList of potential risks 33
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)
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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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List of potential risksList of potential risks 44
Logistics Availability of transportation vehicles
Third parties Own investment Financing for third parties
Availability of routes Availability of storage capacity
Third parties Own investment
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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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List of potential risksList of potential risks 55
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
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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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List of potential risksList of potential risks 66
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
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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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List of potential risksList of potential risks 77
Corporate risks in local operations Conflict with previous owners Conflict with remaining partners Conflict with government
Conflict with competitors
Country risks General political risk
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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:
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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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Agenda for a risk management planAgenda for a risk management plan 22
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
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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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Agenda for a risk management planAgenda for a risk management plan 33
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
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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