Blog Post

How PE Firm CFOs Can More Economically Manage Cyber Risks

June 10, 2024

Table of Contents

TL;DR

  • PE firms and their portfolio companies (PortCos) are emerging as prime targets for cyber attackers due to their reputation for relatively low cybersecurity investment coupled with access to extensive amounts of personal data.
  • With such dire financial consequences, the PE firm CFOs, in particular, need to play a direct and proactive role in cyber risk management, helping to minimize a portfolio's exposure.
  • On-demand cyber risk quantification (CRQ) is especially helpful in this area, as it can translate complex cyber terms and metrics into understandable business implications, such as financial loss and ROI, assisting CFOs in making data-driven, informed decisions.
  • CRQ can provide an aggregate view of the portfolio’s cyber risk exposure, offering insights such as average annual financial losses due to cyber events in general, the likelihood of experiencing specific cyber events, and the respective monetary damages. 
  • By leveraging this quantified information, CFOs are equipped to recommend cost-effective mitigation plans, optimize cyber insurance policies, reduce liability levels, and determine the proper resource allocation necessary to ensure portfolio stability.
  • CFOs can likewise harness cyber risk quantification during the M&A due diligence process, ensuring that the potential partner's financial risk is well accounted for before any deal is closed. 
  • Adopting an objective-data-driven approach to cybersecurity spending is key for PE firm CFOs, and CRQ can help them develop strategies that minimize spending while also fostering innovation and portfolio growth. 

Optimizing Cyber Resource Allocation With Cyber Risk Quantification

Private equity (PE) firms are becoming increasingly attractive targets for cybercriminals. Malicious actors are keen to capitalize on the ecosystem's access to an incredibly extensive and diverse array of sensitive data, particularly susceptible during and after M&As, as well as the notoriously low cybersecurity measures in place among the smaller businesses that some PE firms chose to hold.

When a vulnerability within a portfolio company (PortCo) is indeed exploited, the consequences can be resounding, echoing well outside the victim company's walls. For one, there can be, and often are, severe damages to the firm's reputation. The overall portfolio's market valuation could be undermined, and the firm's other investments become prime sitting ducks for malicious actors hoping to build on the momentum generated by the earlier exploitation.

The direct monetary implications of these outcomes warrant the attention of the PE firm's chief financial officer (CFO), who is tasked with maintaining portfolio stability and long-term growth. However, for someone coming from a financial background, it can be difficult to convert the complexities of cyber into a language more commonly used for effective risk management strategy development.

On-demand cyber risk quantification (CRQ) was designed specifically to address this language barrier, translating a portfolio's cyber risk into objective values easily understood by all non-technically oriented stakeholders. Once armed with the myriad of business insights generated by these innovative solutions, CFOs are in a strong position to mitigate cyber risk cost-effectively, make informed decisions that equally weigh risk and growth, and ensure portfolio stability.

Assessing the Portfolio's Cyber Risk Exposure in Aggregate

No organizational leader, regardless of their budget, wants to allocate more than necessary in cyber risk mitigation. At the same time, investing too little increases the chances of greater losses in the future. For CFOs to find the balance between the former and the latter, it's imperative to conduct an assessment that can accurately reflect the firm's unique cyber risk posture.

This cyber risk assessment should consider numerous factors, all of which determine a PortCo’s risk posture, such as its operating models, industry, geographic location, revenue, and third-party service providers. If a risk assessment is conducted without accounting for these variations, it's nearly inevitable that any ensuing management plan will be uneconomical and wasteful.

Fortunately, on-demand CRQ platforms can quickly account for each of these defining characteristics that make up a PortCo's cyber exposure, illuminating not only the likelihood of certain loss scenarios due to cyber events but also the respective financial damages that would transpire. Subsequently, with these realistic forecasts, exposure levels can then be aggregated, providing the CFO with an in-depth understanding of the cyber risk the entire portfolio faces. 

The Aggregate-Level View: Key Insights

Once aggregated, a slew of quantified information about the portfolio's cyber risk environment can be extrapolated. This comprehensive view helps in understanding not only individual risk factors but also how these risks interrelate across the portfolio. For instance, by taking into account the event correlation between PortCos, the level of market capital diversification arising from cyber can be calculated. 

The exposure correlation can likewise be illuminated, revealing how many of the PortCos would be affected in the likelihood that a systematic cyber event occurs. 

Moreover, by evaluating PortCo exposure levels in the aggregate, CFOs can also gain an understanding of the overall exposure according to event type. This information highlights the likelihood of the portfolio experiencing a specific event (e.g., ransomware), along with the forecasted average and median financial costs, should such an event occur.

With access to this high-level view of cyber risk, the CFO can make more informed decisions about where resources should be focused and prioritize them accordingly. This comprehensive understanding enables the formulation of a strategic cyber risk mitigation plan based on objective, data-driven financial calculations, ensuring the most critical issues are addressed to enhance the overall resilience of the portfolio. 

Establishing a Comprehensive Cybersecurity Mitigation Strategy

After assessing the portfolio companies via CRQ, aggregating the results, and achieving unified awareness of potential losses, the CFO can plan respective risk management strategies or advisory plans. Generally, one of the following three options is proposed:

  • Transferring the risk to a third party by buying insurance
  • Investing resources in mitigation efforts by hiring people and implementing security controls
  • Absorbing the risk (if in line with risk appetite)

Cyber risk quantification helps determine the cost-effectiveness of each option, revealing crucial information such as the reduction in financial exposure of security control upgrades, the ROI of mitigation activities, and the likelihood of exceeding current premiums if an insurance policy is already in place. Leveraging this data, CFOs can more easily decide on the best course of action and harness the PortCo's limited resources to minimize loss while accelerating growth.

Optimizing the Cost of the Cyber Insurance Policies

One of the most common approaches PE firms take to reduce cyber risk is adopting an insurance policy. However, cyber risks pose a unique challenge for insurers due to their rapid evolution. Moreover, while these insurers invest heavily in comprehensive underwriting questionnaires, they often overlook incorporating this information into predictive models. Therefore, to account for the uncertainties, premiums tend to be higher than necessary. 

Conversely, because CRQ assesses each PortCo's unique cyber exposure, highlighting the entire range of potential loss scenarios that could occur along with their respective likelihood, CFOs can quickly determine the probability of exceeding proposed deductibles and limits, equipping them to negotiate for more appropriate, economical terms and conditions

Figure 1: CloudComms Inc.’s annual financial exposure per various loss scenarios compared to its insurance deductible and limit. 

In the case of CloudComms Inc., considering there is only a 1% probability of privacy and data theft costs exceeding the $350 thousand deductible, the CFO may decide that it would be the most economical choice to drop this portion of the policy altogether, reinvesting those saved resources into other business growth areas. Of course, such decisions depend on risk appetite and tolerance levels and should be evaluated accordingly. 

Read more about how one private equity firm’s CFO reduced the portfolio’s cyber insurance costs by 17% with Kovrr’s CRQ forecasts! 

 

Portfolio Risk Mitigation According to PortCo Financial Exposure

Another valuable opportunity for CFOs of PE firms using CRQ is assessing the economic viability of increased security control upgrades. By utilizing the Risk Position Analysis offered within certain CRQ platforms, such as Kovrr’s, the CFO can assess each PortCo’s average annual losses given the state of their current cybersecurity posture and the minimal risk position, highlighting the room for improvement. 

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Figure 2: The risk position analysis scale revealing potential opportunities for financial exposure reductions.

For example, in Figure 2, the cyber risk quantification evaluation has determined that, given the assessed PortCo’s current cyber maturity, taking into account all of the security controls already in place, the average annual losses they face amount to $40.8 million. However, if those security controls were elevated to the highest possible implementation levels, this exposure (“Minimal Risk”) could be reduced by over $10 million. 

When each PortCo’s Current Risk Position, or average annual loss, is compared side by side, along with the respective amount of financial damage that could be reduced if a higher cybersecurity posture was reached, CFOs can quickly calculate whether it’s worth allocating the resources for mitigation. They’ll be able to see which of the PortCos is contributing most to the entire portfolio’s overall financial exposure and focus their attention proportionally. 

Cyber Due Diligence for M&As to Ensure Financial Stability

While proactive management of the portfolio’s existing financial exposure due to cyber risks is a core component of maintaining stability and achieving growth, CFOs would also do well to incorporate a CRQ assessment well before any new partners are taken on. In fact, without evaluating cyber risk during the M&A due diligence process, a PE firm leaves itself open to taking on more financial risk than anticipated. 

CFOs need to understand all the costs associated with doing business with this new potential PortCo in order to make informed investment decisions. By using CRQ to translate cyber risk levels into quantified financial insights, CFOs, directors, and partners are provided with crucial information that can be leveraged during ensuing negotiations. 

These high-level executives will have a clearer picture of how the M&A will impact the firm, enabling them to push for a more appropriate, economically sound deal.

Although rare, a cyber risk assessment may also reveal that the potential PortCo may have a level of financial exposure that the CFO knows is too great for the PE firm to take on, rendering the partnership too risky. Ultimately, cyber risk is a business risk, and ignoring it during the due diligence process could harm the integrity of the portfolio. 

Achieving Portfolio Stability With Cost-Effective Cyber Spending

Given their unique vulnerability to cyber attacks, PE firms and other investment organizations can no longer afford to be reactive when it comes to cybersecurity and cyber resiliency investment. To minimize long-term financial damage and ensure stability, PE firm CFOs should instead be proactive about cyber risk mitigation, adopting a strategic and informed approach that enables cost-effective spending.

With on-demand cyber risk quantification, complex and technical concepts are turned into a language that the CFO speaks at a native level, allowing for the development of appropriate, comprehensive risk management strategies. By understanding the unique cyber risk posture of both individual PortCos and the portfolio as a whole, this financial executive can better protect the firm’s assets and maximize their returns, helping each of their investment companies succeed amid today's volatile digital landscape. 

To learn more about how CRQ can specifically help PE firms optimize investments and spending, contact one of our cyber risk experts today or schedule a free demo

Yakir Golan

CEO

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