6 Risk Management Strategies for Private Equity Firms

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By Travelers
6 minutes
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Private equity is a fast-growing segment of the financial services sector, with the potential to deliver strong returns for investors and help fuel business growth. With performance comes greater scrutiny – and greater risk. A private equity firm’s portfolio of businesses faces challenges on multiple fronts, from cybercrime to data privacy to new regulatory standards. It’s essential for firms to monitor and respond to this changing risk landscape while continuing to remain focused on financial growth.

Here are the six risk management strategies for private equity firms to help manage portfolio company risks.

1. Crisis Management

Many unforeseen factors can disrupt a business – from natural disasters and data breaches to supply chain issues and system failures. When confronting unexpected crises, a company needs to respond and recover as quickly as possible. Otherwise, they face significant financial, regulatory and reputational risks.

With so much at stake, having a business continuity plan in place before a crisis or disaster strikes is essential to help minimize losses. It helps eliminate confusion during an event by providing a clear plan of action. Armed with a business continuity plan, the company and its management team can increase the likelihood of recovering from an event with minimal losses.

Developing a comprehensive business continuity plan includes:

  • Evaluating the potential risks to the operation, property and people that could leave a company vulnerable.
  • Identifying critical business functions and the people and processes that support them to consider what is necessary to restore critical operations.
  • Adopting controls to prevent or mitigate loss.
  • Creating, documenting and communicating an incident response plan that provides a clear blueprint of the specific roles and responsibilities in executing the plan.
  • Regularly testing the plan, evaluating policies and updating as necessary.

2. Emerging Technology

Emerging technologies, integrated through the Internet of Things (IoT), can provide a portfolio company with new opportunities to connect and optimize their operations and streamline fundraising, deal management and investor relations. This digital transformation can be vital to remaining competitive. However, the benefits of expanding a company’s digital footprint often come with risks.

Before investing in new technology, it’s imperative to ensure you’re making the right investment for a portfolio company. Consider these key questions:

  • Will the new technology fulfill the business’s needs and expectations?
  • Will the outcome be worth the cost of purchase and implementation?
  • Can the technology integrate seamlessly with your current systems and equipment?
  • Will the technology be able to grow with your business and adapt to its changing needs?
  • What employee training will be required, and what will it cost?

Legacy systems, in particular, warrant careful review. They are often essential to day-to-day operations, but may be outdated, inefficient or present security risks. Yet, replacing them with new technology can be costly and time-consuming.

Before deciding to replace any systems, assess if they:

  • Support real-time transactions.
  • Continue to support the workflow at maximum efficiency and with minimal downtime.
  • Are compatible with new technologies that are essential to the firm.
  • Can benefit from updates to outdated security protocols.
  • Are still supported by the vendor if problems arise.

If the answers to these questions are unsatisfactory, it may be time to modernize with new technology. Be sure you do so with a well-strategized road map that promotes collaboration and productivity, safeguards data security and upholds customer service.

3. Cybersecurity

Cyber incidents are a near certainty for businesses today. They can range from barely perceptible port scans looking for vulnerabilities, to devastating ransomware attacks that can shutter a business. 

Should even one portfolio company experience a cyber event, it has the potential to negatively impact the entire private equity firm’s bottom line and reputation. Preparation is key to effectively reducing a portfolio company’s risk of a cyber event:

  • Begin by making a strong commitment to cybersecurity; include cybersecurity in the firm’s overall risk management program.
  • Adopt a minimum set of cybersecurity controls.
  • Perform due-diligence risk assessments of potential portfolio companies and reassess annually or upon significant change to the partner’s infrastructure or environment. Pay particular attention to portfolio companies with higher cybersecurity exposures or unique security challenges.
  • Develop or update a cyber incident response plan that prescribes how the firm will respond in the event of an attack. This should include a response plan for when a portfolio member is the target.
  • Consider making it a requirement for portfolio companies to purchase cyber insurance, which includes both pre- and post-breach services.

4. Consumer Privacy

Cybersecurity isn’t the only concern for private equity firms. Ensuring consumer data privacy is equally critical. Location tracking and personally identifiable information can provide valuable insights for marketing and sales purposes, but companies may be legally responsible for protecting the information they gather. Failure to properly secure and address consumer privacy can lead to action by customers, regulators and others.

To fulfill consumer privacy/data protection requirements and minimize risk to your financial company:

  • Ensure you understand and comply with all local, national and even international privacy requirements. 
  • Collect only the data you need for the service you’re providing and keep the data only as long as you need it.
  • Encrypt consumer data, and any sensitive data at rest, in transit and in use.
  • Let customers know when and why their data is being collected.
  • Sell or share data only with the owner’s consent.
  • Have clear procedures in place to provide consumers access to their data, and to request its deletion.

5. Suppliers, Vendors and Third-Party Obligations

Outsourcing may be an option for portfolio companies that want to leverage outside expertise while remaining focused on core investment-related activities. However, be mindful that third-party management can present a significant area of risk and it can be imperative that firms maintain strict oversight of their providers.

A formalized oversight program can help companies evaluate how well their providers are managing risk. For each provider:

  • Define the scope of the risk.
  • Determine the amount of due diligence required for vetting prospective providers.
  • Engage providers with a written contract with a service level agreement that clearly defines the provider’s responsibilities and deliverables.
  • Establish a formal contractual risk transfer program that addresses, among other things, your specific insurance requirements. This will help protect a company from liabilities and related costs that may arise from the provider’s service or work activity.
  • Monitor the provider’s performance on a routine basis and maintain written documentation of the results.

6. Ergonomics, Post-Injury Management and Employee Safety

Acquisitions often lead to capital improvements to the acquired company’s physical plants and warehouses. Any time there is a substantial change to a business’s physical environment, it’s important to review and update company safety policies and procedures for any risks that are introduced. Taking a proactive approach can help prevent workplace injuries, improve compliance with laws and regulations, and reduce costs, especially when it comes to workers compensation claims.

Evaluate these areas for possible updates and improvements: 

Travelers can tailor insurance coverages to meet the unique needs of your private equity firm’s portfolio of companies. Our “value creation through risk mitigation” approach features a dedicated private equity service team that can work with each portfolio company to identify a tailored suite of services designed to help mitigate losses.

Speak to your insurance agent or broker about managing private equity risks.

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