Wiebe Associates partners with Carlyle to make a 40 year old candle business competitive.
“The Carlyle Group and Centre Lane Partners Combine Candle-lite Company and PartyLite” – (Press Release)
…. is a head line that is symptomatic of a business restructure (AKA wind down) that occurs with regularity. In most restructures a wind down occurs in at least part of the enterprise.
How does Risk Management (RM) play into this? The answer is that it can be essential in such a restructure. Broadly speaking RM is about enhancing value and specifically for publicly traded companies it’s about shareholder value. The strategy outlined in the above head line is enhanced value and RM is often one of the essential tactics of the enhanced-value strategy.
A troubled business means things have to change and often RM can be very useful to help restructure and re-engineer operations by exploiting three tactics:
Risk identification, mitigation and transfer.
So how are these wind-down tactics applied?
Identification
The answer for the first tactic risk identification (RI) is a qualitative determination of potentially fortuitous events that could obstruct financial and/or strategic objectives of the business restructure.
Identification of potential product liability events inspired modifying product lines to reduce product legal liability risk and enterprise risk. To illustrate; we sold a division with the highest risk products to reduce the Cost of Risk (CofR) among other costs and rebalance the risk utility of the enterprise. This was a nutraceutical product so CofR included high costs of FDA alignment, labeling, testing and liability insurance to name a few. The remaining consumer product lines after the sale had significantly lower CofR than nutraceuticals.
A change in product mix also helped identify risks of the distribution channel. Shedding of a multi level marketing product – a market share leader – reduced the CofR. The reduction occurred because competitors in this type of distribution channel tend to align against market share leaders by instituting litigation alleging unfair trade practices. Eliminating the potential for litigation significantly reduced the enterprise CofR.
Extensive external audit processes typically utilized in a business restructure became an integral part of the RI process and confirmed opportunities such as those described above and others.
Mitigation
The 2nd tactic mitigation can allow for reallocating risk retention, shifting and modification. Execution of this tactic requires experienced professional judgment more than the other 2 tactics because accurate subjective analysis is so difficult and is key to success.
For example, in this Private Equity (PE) acquisition of a publicly traded company compliance processes were reduced. This ownership change meant fewer required internal regulatory processes so those that did not ad to the value of the business were eliminated. Many Sarbanes Oxley (SOX) compliance processes, associated expenses and manpower were redirected to restructuring and other RM activities. Such eliminations created more risk for the enterprise but the risk was managed judiciously.
Here are two such SOX processes that were scaled down and redirected :
- Vendor payment controls to eliminate any possibility of fraud. This was a “belts and suspenders” approach to risk management when a statistically valid random sampling just as adequately mitigated this risk.
- Similar random sampling and testing of operation back up and loss prevention systems also adequately mitigated many operational risks.
These practical risk taking tactics helped reduce internal manpower demands and costs. Some manpower was eliminated and some was redirected to more “top line” tasks. Especially since this business was struggling, judicious risk taking helped reduce the risk of full financial business failure. Experienced professional judgment and honest communication with and among senior management was essential to aligning risk utility of the enterprise culture.
Transfer
Transfer is the last but not the least important tactic. Prior to the restructure significant attorney hours were spent contractually transferring various risks to sub contractors, vendors and others. Such contractural risk transfer included insurance risk transfer. Wind-down execution of this tactic meant:
- “Tweaking” insurance contracts and aligning associated contracts with insurance risk transfer Contractural Risk Transfer
- Implementing or modifying alternative risk funding arrangements to reduce insurance costs
- Structure new ownership (on paper) so that Workers Compensation (WC) insurance policies are reallocated to the new entities. This reduced total enterprise WC costs because experience modification factors are reset to the new entity(s) with no prior history of worker injuries
Changes to alternate funding arrangements included restructuring captive insurer arrangements to leverage captive cash reserves. Additionally captive liabilities were capped with Loss Portfolio Transfer financial instruments.
Summary
The above are examples of the diverse ways RM tactics ad significantly to business efficiencies. RM is equally important to a business enterprise during growth phases, as it is when a business is winding down.
Both extremes of business cycles should have a significant RM focus. In the “down phase” risks may be reduced and risk/reward ratios could be rebalanced and/or shifted so that many aspects of a business down turn are leveraged to revalue the enterprise.
