Wednesday, July 18, 2012

Risk Management for Financial Agreements

Risk payroll taxes is often a source of confusion and concern for both individuals and businesses. The word itself can be misunderstood because of disagreements about what constitutes a risky activity. Because risk can have so many different interpretations, strategies for reducing or managing risk can prove unsuccessful merely because the risk management goal is not adequately described. But this difficulty does not mean that risk management should be ignored. Instead it should serve as a caution signal that a bumpy road is on the horizon when dealing with risks of any kind.
How do financial agreements fit into a risk management conversation?
When companies talk about the risks they are exposed to, it is usually in the context of unknown events such as the economy and political outcomes. It seems unlikely that a manager would point to her commercial mortgage financing agreement when asked to identify the top ten business risks faced by her company. Nevertheless financial agreements like this do provide a unique risk exposure that is often overlooked until it is too late to avoid a serious problem.
Small businesses frequently experience different risks than those at larger companies. The lack of personnel is a common factor contributing to this. While a large company might have someone (or several people) whose full-time job is to handle risk management, a smaller company is more likely to have its business owner attempting to keep risks under control whenever possible. When managing risk is just one of several dozen important responsibilities, risk management is by default handled much differently than when it is a full-time job.
Within this hectic managerial environment for a small business owner, now try to imagine how familiar they are with the terms of their financial agreements. Some of these could involve contracts like the following examples:
  • Credit Card Processing
  • Commercial Mortgage
  • Working Capital Financing
  • Payroll Taxes
  • Various Insurance Contracts
The commercial mortgage agreement will be used to illustrate how risk management can be a helpful tool to prevent unexpected surprises. In many commercial real estate financing contracts, it has become increasingly common for banks to insert language that gives them the right to cancel the mortgage loan even when payments have been made as agreed. As a banker might say, it might not be fair but it is legal. These terms are especially common for small business mortgages, and very few commercial borrowers are aware of these provisions until they receive an official notice from the bank stating that the loan must now be paid in full or refinanced (with another lender).
With prudent risk management strategies in place for financial agreements, this surprise would either have been eliminated by negotiating the removal of this restrictive loan covenant at an early point or anticipated as a possibility from the beginning. Financial agreements can introduce a surprising number of risk problems, and managing risks should involve identifying these potential problems before they disrupt business operations.