S TRATEGIC M ARKETS G ROWTH The Essential Guide to: Risk Post IPO Embracing risk for reward
Introduction So you ve made it you have taken your business public. It s been a rollercoaster ride and you have put in the months of hard work. Now at last your ticker symbol is running across the screen. You and your team can be proud. This is an exciting time. Ahead of you are various opportunities to accelerate your growth and take a big step towards your vision of achieving market leadership. However, alongside this natural excitement lies the reality of life on the public markets. As a newly listed business, it s important to be aware of the risks you now face. These can range from: presenting unexpected results to the market uncertainties associated with new initiatives, such as global expansion infrastructure and systems that cannot provide timely and appropriate information to your stakeholders non-compliance with the rules followed by public companies To achieve your full potential and deliver on your pre-ipo promises you must have a clear picture of your new environment both the opportunities and the risks. If you can proactively identify and manage these risks, the result will be a stronger, better managed business with more robust decision making. This in turn can exert a stabilizing influence on your operation, make you more attractive to investors, and help accelerate your growth. At Ernst & Young we know that making the private to public transition is not easy. Our Strategic Growth Markets professionals have worked for many years alongside many of the most dynamic businesses in the world. We have helped them to make the transformation from domestic, entrepreneurial businesses to market-leading public companies. And it s what our people thrive on. So whether you have recently completed your IPO, or are preparing for it, we hope this Essential Guide will provide you with a flavor of what to expect. To find out more, visit our website at www.ey.com/growth, or contact your local Ernst & Young office. After all, your risks are as unique as your business. Risk. Let s talk. Strategic Growth Markets Ernst & Young Global Good risk management is based on knowing what the key risks are, what needs to be done about them, and who is responsible Ernst & Young Companies on Risk Survey 2006 2
Contents Investors Views on Risk 4 Leading Companies Views on Risk 5 The Risk Universe 6 Life Post-IPO Key Risks in Focus 7 Risk Management A Coordinated Approach 8 Post IPO from Risk to Reward 10 Working with Ernst & Young 11 Contact Us 12 3
THE ESSENTIAL GUIDE TO RISK POST-IPO Investors Views on Risk Risk is an inherent part of investing and has always been an important element in any investment decision. But the perception of what risk means in a commercial setting has expanded greatly in recent years, mainly due to compliance-related pressures and companies fears of a major failure in their business. Corporate attitudes have also begun to shift, with companies beginning to better understand how a more sophisticated approach to risk can benefit their business. These benefits extend beyond better decision making. Companies that base their risk management on the principles of transparency, accountability and good communication can improve investor relations and in some cases their valuation. This was demonstrated by a recent Ernst & Young report, Investors on Risk. The need for transparency. We interviewed over 130 investors about risk management in the organizations in which they invest. Significantly, the research showed that four out of five investors claimed they were willing to pay a premium if they saw evidence of good risk management. Conversely, two-thirds of investors told us they shun companies that cannot demonstrate successful risk management, while almost half have de-invested for this reason risk really is that important to major investors. Communication is key What investors want most of all is to understand where a company has come from, where it s going and what the dangers along the way might be. They do not expect to eradicate risk altogether; they 7 simply want companies to manage it efficiently and communicate openly about it. Investors welcome information that helps them to make better decisions. They believe reliable risk management offers fewer negative surprises, greater financial stability and ultimately greater profitability (see Figure 1 ). Leading from the top Investors believe strongly that responsibility for risk starts at the top: they expect the CEO or wider board to take ownership of risk and play an active role in its management. Investors also prefer if both the risk management function and CFO are involved in managing risk within the companies in which they invest. The investors believe that the CEO should be more concerned about those risks that will ultimately affect business performance always a key to investor confidence! Figure 1: The benefits to investors of a reliable approach to risk management Fewer negative surprises Greater financial stability Greater certainty of profitability Lower investment risk Better long-term share price performance Greater confidence to retain/increase stake Greater transparency Lower share price volatility Adds company value 3 6 12 12 15 20 22 23 29 0 5 10 15 20 25 30 % of respondents (137) Q: What do you see as the key benefits for investors of a company having a focused and reliable approach to risk management? For a copy of the full report Investors on Risk. The need for transparency please visit our risk website at www.ey.com/risk/letstalk 4
Leading Companies Views on Risk For leading companies, identifying and managing risk across their entire organization is becoming increasingly important. Being able to demonstrate to your stakeholders that the risks in the business are identified and well-managed will be critical to your continual success. In a recent survey Companies on Risk. The benefits of alignment, Ernst & Young interviewed over 400 executives of leading companies for their views on risk. Two thirds of the executives perceive that risk levels have been rising over the last two to three years and will continue to rise in the future. As a newly listed business looking to develop a robust approach to risk, understanding how leading companies are approaching and managing risk could prove invaluable as you adapt to life post-ipo. The key findings of the survey are: A Board-level Responsibility As we have already seen from the Investor on Risk survey the CEO, CFO and the board now need to have much greater accountability, involvement and focus on risk. While they have always had the ultimate accountability, leading executives are becoming increasingly aware of their own responsibility as they recognize a change in their organizational priorities and demands from their external stakeholders. Key Factors for Successful Risk Management The executives stated that clear ownership of risk, understanding of risk throughout the organization, and internal communications of risk were the critical factors that contribute to successful risk management (see Figure 2). Other important factors include active involvement of the board in the risk management process, having a process that identifies risks and relates them to the company s objectives and investment of sufficient resources in the ongoing risk management process. The executives felt that having a dedicated risk function and taking a centralized approach to risk management were less important. However, there is an important distinction to be made here. Having a centralized approach may not be critical, but having an approach that is integrated and aligned to business objectives almost certainly will be. A Formal Approach The survey highlighted that for a majority of leading companies, all risks from across the risk universe to a greater or lesser extent are covered in a formal risk assessment. Not surprisingly, almost all of the respondents included compliance and financial reporting risks in their assessment, reflecting the increasing importance and focus on these issues. Figure 2: Key factors for successful risk management Clear ownership of risk Understanding of risk throughout organization Internal mechanisms to communicate risk Active board-level invlovement Process identifying risks relating to objectives Integrated approach to risk management Sufficient resources/investment Documented risk management strategy Dedicated risk management department Centralized approach Specific communications policy for major investors Company s appetite for risk-taking 42 42 56 54 52 50 60 71 68 65 77 76 0 10 20 30 40 50 60 70 80 Q: How important are the following aspects to the success of a company s approach to risk management? (High rating % respondents giving 8, 9 or 10 rating on a 1 10 scale) Percentage of all respodents (441) For a copy of the full report Companies on risk. The benefits of alignment please visit our risk website at www.ey.com/risk/letstalk 5
THE ESSENTIAL GUIDE TO RISK POST-IPO The Risk Universe All businesses deal daily with risk, and all business leaders, whether in a public or private company, will be familiar with the range of risks shown in the Ernst & Young Risk Universe. The difference is that becoming a public company means you have a new range of stakeholders that demand a much greater transparency in your business. When you go public, it is easy to underestimate the level of accountability and scrutiny you are going to face, the amount of time this takes to manage, and the skills you need to satisfy new obligations. This is risk, but perhaps not as you have known it. INFORMATION TECHNOLOGY PEOPLE HAZARDS SUPPLY CHAIN REGULATORY PHYSICAL ASSETS OPERATIONAL SALES & MARKETING MARKET TAX LEGAL COMPLIANCE FINANCIAL LIQUIDITY & CREDIT CODE OF CONDUCT COMMUNICATION & INVESTOR RELATIONS STRATEGIC GOVERNANCE CAPITAL STRUCTURE ACCOUNTING & REPORTING MARKET DYNAMICS MERGERS ACQUISITION & DIVESTURE MAJOR INITIATIVES PLANNING & RESOURCE ALLOCATION 6
Life Post-IPO Key Risks in Focus Life as a newly listed business can be exciting. You have just raised capital to help you accelerate your growth your vision of achieving market leadership is beginning to take form. However, life in the public markets is different. Your number of stakeholders has increased and with it so have your responsibilities. As a result you will encounter additional risks, which, if not managed properly, can cause you to lose momentum, distract you from your goal and can result in the hard work of the IPO being undone. To help you focus, we have highlighted some of the key risks that all newly listed businesses should be aware of: FINANCIAL RISKS SURPRISING THE MARKET AND THE NEED FOR TRANSPARENCY Setting expectations on financial performance has always been important. As a newly listed business, it is vital. You must make sure that your goals are realistic and clearly communicated, as meeting these expectations are critical to accelerating your growth. Remember, the market reacts negatively to surprises. Even positive ones can suggest to investors that you are not as in control of your business as you should be. Your new stakeholders will want your business to be financially transparent. They will expect you to provide them with the information they want, how they want it and, of course, when they want it. If they don t get it, then market confidence can slip along with your share price! STRATEGIC RISKS EXECUTING NEW INITIATIVES AND THE NEED FOR GOVERNANCE The IPO has provided capital enabling you to undertake new initiatives to accelerate your growth. A series of acquisitions, or a program of rapid expansion into new geographical markets are likely to be new to your business and as such carry a much higher risk profile. At this time of change, a robust approach to corporate governance is essential for all newly listed businesses. Establishing a framework that starts at the very top of your organization will enable you to approach the future and the new initiatives with the confidence that your business is well-controlled. OPERATIONAL RISKS FOCUSING PEOPLE AND THE NEED FOR INFRASTRUCTURE INVESTMENT Life after the IPO can be distracting for your people especially if they have one eye on the ticker symbol. To drive growth and keep your stakeholders happy, you must ensure that your people remain focused on the business and fully aware of their new responsibilities. Newly listed businesses also need to consider their current infrastructure and systems. Systems, controls and policies that were adequate for a private company may not give you what you need to grow the company and monitor its performance. COMPLIANCE RISKS FOLLOWING NEW RULES AND REGULATIONS AND THE NEED FOR EFFECTIVE CONTROLS As a newly listed business you have to comply with a host of new regulations, legislation and filing deadlines. Failure to comply with these can have serious consequences. Investors are paying much closer attention to how companies approach compliance. To keep your business on track and to achieve your goals, compliance will be a key area that you must address. To do this it is essential that you get the right controls in place. Lead from the top and set and communicate clear policies and procedures. This will assist your business to remain compliant with the regulations and on track to achieve its objectives. 7
THE ESSENTIAL GUIDE TO RISK POST-IPO Risk Management A Coordinated Approach In the run-up to your IPO undoubtedly you will have established controls and systems to mitigate certain business risks. However, as we have already seen, life post-ipo is very different. Your stakeholders and their interests are more varied, your business is changing, and consequently risk management warrants a fresh look and a framework for ongoing reassessment. The recent Ernst & Young surveys, highlighted earlier, show that attitudes to risk are changing. Investors are more focused on how their investee companies approach risk management, and the CEO and boards of leading companies are becoming increasingly accountable for how risk is managed across all aspects of their business. This is leading to companies adopting a much more coordinated and comprehensive approach to risk management. Aligning Risk to Business Priorities Having identified the risks, the next stage must be to prioritize them. For a newly listed business, this stage is critical. You must understand which risks in the business will have the biggest impact on your business goals. By aligning your risk investment to your business priorities (and to your investor agenda), you can direct your time and money to where it should have most value. A coordinated, enterprise-wide approach to risk can yield many positive benefits. Most notably, with appropriate oversight, support and investment from the top of the organization, a coordinated approach to risk can assist with corporate compliance. This powerful combination can assist your plans for becoming a market leader and achieving your business objectives. Managing Risk Across the Enterprise Risk can exist anywhere in a business. This is especially true for growing businesses going through a period of significant change. To be able to demonstrate to investors and stakeholders a strong command of risk issues, many leading companies are either beginning to develop or have already developed an enterprise-wide view of risk. This view is developed by examining all major operating and functional units within the business. All can have elements of risk, and all must be considered. Risk management has created a clearer exchange of information Chief Financial Officer, Netherlands - Ernst & Young Companies on Risk Survey, 2006 8
Risk Management A Coordinated Approach Establishing a Risk Management Approach. To help you stay on top of your risks, the diagram below outlines a three-stage approach to ongoing risk management, posing some key questions you should ask yourself at each stage. ASSESS IMPROVE MONITOR Description Understand business objectives, intiatives, and strategic risks; validate and prioritize risk profile; identify gaps in coverage or improvement opportunities Improve the design and/or operating effectiveness of processes and controls, leveraging leading practices and process improvement techniques Validate that processes are operating as designed, controls are effective, and risks are managed Key Questions What are our key issues? How do we know if we have everything covered? Can we get more from our risk investments? Can we be more efficient and effective? Who does what? How are they coordinated? One of the key issues facing companies as they approach risk management is how to ensure risks are monitored on an ongoing basis. Some larger companies are establishing specialized risk functions, while others are looking to reallocate resources from existing business functions such as internal controls and compliance. However, as a newly listed business, one option is to consider the development of an Internal Audit function. The Changing Role of Internal Audit The Internal Audit (IA) function has changed considerably over the past few years. New regulations, the increasing need for good corporate governance and the growing importance of fraud detection have all impacted the role and size of the IA function. However, perhaps the biggest impact on the function has been around risk management. Many leading companies are now utilizing their IA function to help monitor and control business risks. For newly listed businesses, establishing an effective IA function with responsibility for risk management can add considerable value to your business. Whatever role you want your IA function to play, there are key questions that you must ask. By regularly addressing these questions, you can help your IA function to provide a good return on investment, helping you to achieve your business objectives. Key Questions Does our IA function have the right leadership support and the right people to achieve what we want it to? How do we focus and motivate our IA professionals? How do we maintain consistent quality? Does our IA function have the right tools to deliver value? How do we know if we are continuing to get what we want? Are we investing enough? 9
THE ESSENTIAL GUIDE TO RISK POST-IPO Post-IPO from Risk to Reward While an IPO is not for everyone, for dynamic, rapid-growth businesses with a desire to become market leaders, the benefits are clear. An IPO can provide businesses with the financial flexibility to undertake new initiatives, enhance the profile and brand of the business, and enable you to recruit the best people. However, to make the most of the opportunity presented by your IPO it is essential that you quickly adapt to the risks in your new environment. As a newly listed business it is likely that your resources will already be stretched even before you start to think about risk management. It is therefore essential that you focus on the risks that will have the biggest impact on the achievement of your business goals. Meeting market expectations, keeping your stakeholders well informed, executing new initiatives and complying with public company regulations all carry risks that you simply must address. By effectively managing these risks you can help minimize the disruption and stay focused on your business goals. This in turn may further advance your strategy, lead to greater investor confidence and, ultimately, even greater business success. Although most business leaders acknowledge the importance of good risk management, for many companies it is still treated in a fragmented and reactive way. Even those with a sophisticated approach to their overall business often see risk primarily as a threat, and risk management as a bolt-on exercise. In many cases this has been at the expense of more strategic considerations related to opportunities and performance. As a newly listed business, the challenge you will face is to step back and re-think this balance. Ask yourself: What risks are preventing you from moving your strategy forward? What is the right balance between risk, corporate governance and internal control for your business? Are you treating risk management as integral to your business? What could you be doing better? Risk management can be as complex or as straightforward as you wish. For the newly listed business with limited resources it is often better to keep things simple. Risk management means ensuring you understand the risks that are relevant to your business objectives and responding to them. However, managing risk is not something you do just once. It should be an integral part of your business and, to minimize surprises, should be monitored and enhanced regularly. That way, even when the unexpected happens, you are well prepared and can respond accordingly. An IPO can be hugely rewarding for a company. Don t let the risks of your new environment put you off achieving what you set out to accomplish. As a newly listed business you have an exciting future ahead of you. Embrace the risks and achieve your goals. After the hard work of preparing for the IPO, you deserve it. Our challenge? Getting the risk/reward balance right across all areas of risk Chief Risk Officer, UK - Ernst & Young Companies on Risk Survey, 2006 10
Working with Ernst & Young How can we help? At Ernst & Young we understand the pressures and the excitement you feel at taking your company public. An IPO has presented you with a tremendous opportunity to accelerate the growth of your business, although at times you will wonder whether you have done the right thing. This is where our Strategic Growth Markets professionals can really help. We have worked with dynamic, growth businesses both pre-and post-ipo, so we understand the issues and challenges you face. As a global market leader in risk advisory services Ernst & Young can help newly listed businesses to gain the confidence that your risks are known and well-managed. We will work with you to get past the hype that surrounds risk management, to avoid building a risk bureaucracy and to keep things in control. With our help to manage and control the risks, you can spend more time on delivering your strategy, improving performance, and accelerating growth. Ernst & Young s Post-IPO Support Services Securities markets compliance About the Ernst & Young Strategic Growth Markets Professionals Ernst & Young s global network of Strategic Growth Markets professionals are dedicated to serving the changing needs of fast-growth companies. Whether working with dynamic mid-cap companies or early stage venture-backed businesses, our professionals in Ernst & Young member firms around the world draw upon their extensive experience, insight and global resources to help these businesses reach their full potential. About Ernst & Young Ernst & Young, a global leader in professional services, is committed to restoring the public's trust in professional services firms and in the quality of financial reporting. Its 107,000 people in 140 countries pursue the highest levels of integrity, quality, and professionalism in providing a range of sophisticated services centered on our core competencies of auditing, accounting, tax, and transactions. Further information about Ernst & Young and its approach to a variety of business issues can be found at www.ey.com/perspectives. Ernst & Young refers to the global organization of member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited does not provide services to clients. Business Risk advice Internal audit services Board and audit committee structure Acquisitions due diligence Post-deal integration Tax planning: corporate structuring, tax compliance Internal/external controls analysis Human capital global mobility, incentives and rewards 11
Contact Us For more information about how our network of Strategic Growth Markets professionals can help your business to achieve its potential visit our website at www.ey.com/growth For more insights into Ernst & Young s Risk Management services or to download full copies of the Companies on Risk and Investors on Risk reports, visit our risk website at www.ey.com/risk/letstalk E RNST & YOUNG www.ey.com Copyright 2006 EYGM Limited. All Rights Reserved. EYG NO. CY0009 This publication contains information in summary form and is therefore intended for general guidance only. It is not intended to be a substitute for detailed research or the exercise of professional judgment. Neither EYGM Limited nor any other member of the global Ernst & Young organization can accept any responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication. On any specific matter, reference should be made to the appropriate advisor.