An investor acquiring shares or financing a business in another way puts their money at risk for a calculated return on that investment.
A business may face risks posed by the market – external risks such as competition, economic, politically, legal (new regulation or litigation), exchange and interest rate risk. It is possible to take measures to protect from some of these risks but not always. For example, a competitor may enter into the market although registering intellectual property, patenting ideas and registering trademarks can reduce business risk. Managing economic and political risks are much more difficult if not impossible. There are some economic proof businesses, for example an accounting business acting for a portfolio of doctors is unlikely to see the impact of an economic downturn on its revenue (it may on expenses).
Internal risks are easier to identify and to manage.
Internal risks include:
Compliance risk is that of failing to meet legal requirements and regulations. A business could become exposed to penalties or sanctions when it fails to act in accordance with industry laws and regulations. Managing compliance risks is assisted by good policies and procedures.
Taxation risk is that arising from poor compliance and systems resulting in the exposure to additional tax. The main areas of tax risk include the use of tax planning and/or avoidance schemes, employment status, mistreatment of payments to employees and share incentives, operation of national minimum wage, incorrect treatment of certain expenses for VAT and corporation tax such as ‘sponsorship’ and ‘hospitality’. Another area of increasing business risk is that relating to research and development expenditure and whether it qualifies for the favoured tax treatment.
Program risk relates to either a particular business program or a portfolio of projects. The risk relates to the costs associated with that program and whether it is being supported by more successful parts of the business. An analysis requires consideration of the opportunity costs and associate risks.
Innovation risk relates to product research and development, the associated costs, opportunity cost, risks and potential upside. Strategic risk is also associated with innovation.
Strategic risk is that relating to the business plan and overall risks taken on business programs, innovation, use of resources, whether the business is seasonal or periodic and not diversified.
Resource risk is that of not having enough resource to fulfil the goals or commitments of the business. This could include people resource and working capital.
Reputational risk is the chance of declining business as a result of practices or incidents that affect the reputation of the business. It could be that the use of a delivery service declines because of its failure to become environmentally friendly or a retailer is perceived to exploit young employees through lower pay and poor working conditions.
Operational risks arise from day to day operations and relate to people, process and systems:
|Employment law ||Documentation ||Implementation of process |
|Fraud ||Pricing models ||Use of infrastructure – people, IT etc. |
|Unauthorised activity ||Project management |
|Retention of key personnel ||Internal/external reporting|
An investor or an acquirer of a business that is about to commit significant funds will desire the risks to be analysed by a team of professionals to establish what the threats are to the value. The process is often undertaken to identify whether the sales price is fair as well as to establish warranties and indemnities. It is also used to negotiate what amount should be held on escrow and for what period in case one of the risks materialises in a financial cost.
This process can also be turned around for a business that is preparing to sell. The business may engage a risk analysis to prepare itself for sell by reducing the risks for prospective purchasers.