Question

Discuss enterprise risk management (ERM) in its most current form and how it has evolved to assess risk management in today's environment.

Discuss alternatives available for companies to raise capital. Describe the pros and cons a company must analyze prior to going public.

Answer 1

Enterprise risk management (ERM) is a plan-based business strategy that aims to identify, assess, and prepare for any dangers, hazards, and other potentials for disaster—both physical and figurative—that may interfere with an organization's operations and objectives.

More recently, companies have managed such risks through the capital markets with derivative instruments that help them manage the ups and downs of moment-to-moment movements in currencies, interest rates, commodity prices, and equities. From a mathematical point of view, all of these risks or "exposures" have been reasonably easy to measure, with resulting profits and losses going straight to the bottom line.

Companies have been managing risk for years. Historically, they've done this by buying insurance: property insurance for literal, detrimental losses due to fires, thefts, and natural disasters; and liability insurance and malpractice insurance to deal with lawsuits and claims of damage, loss, or injury. But another key element in ERM is a business risk—that is, obstacles associated with technology (particularly technological failures), company supply chains, and expansion—and the costs and financing of the same.

There are a number of other funding sources that you should explore before raising equity capital. Here are five, in order of most to least preferred.

• Cash flow from operations: A basic principle of business strategy is to invest profits in areas that will create high returns on investment. First determine how you can maximize cash flow, then deploy that cash flow to fund high-value investments. Profits, not revenue, are the fuel for growth.
• Founder's equity: Without putting yourself in a highly risky financial position, you should look to invest any outside capital you have in the business. This allows you to retain ownership and avoid dilution from other capital providers, but it also is an important signal to future equity contributors that you believe in the business.
• Friends and family: Much like the founder's equity, raising funds from friends and family shows that you and your trusted advisors believe in the business. You also avoid giving up control to third parties with potentially conflicting interests.
• Bank loans and lines of credit: Bank loans, especially those supported by SBA lending programs, are often the best source of funding. These typically must be backed by inventory or accounts receivable, however, and often require a personal guarantee.
• Venture debt or mezzanine debt: When traditional bank loans are not sufficient, alternative debt providers are an option, albeit at higher interest rates. Venture debt typically is backed by assets of the business, while mezzanine debt is often a high-interest rate debt that may be convertible to equity in some business scenarios.

An initial public offering (IPO) is the first sale of stock by a company. Small companies looking to further the growth of their company often use an IPO as a way to generate the capital needed to expand.

• Advantages for IPO:
  • Access to more capital
  • Increased visibility
  • Less dilution
  • Improved financial position
  • Liquidity
  • Enhanced ability to raise more capital in the future
  • Improved credibility with business partners
  • Better ability to attract and retain personnel
  • Improved personal net worth
• Disadvantages of IPO :
  • Increased financial transparency and loss of confidentiality
  • The pressure to maintain growth pattern
  • Management demands
  • Ongoing reporting obligations
  • Greater legal exposure
  • Less control and more influence by the board of directors
  • Huge financial requirements
  • Potential for increase in income taxes