Risk Factors: Protect the Company and the Investor

By Sara Thompson | June 17, 2008
Owning illiquid investments in biodiesel projects, like other investments, involves risk. Many investors may be unaware of all the risks associated with investing in a specific company. Providing current and future investors with risk factors allows investors to evaluate a company and make an informed investment decision. Risk factors are those features of a company that contain an element of uncertainty and where actual results may differ from expected results. Thus, good business practice dictates that companies provide current and future investors with a written list of the most prominent risk factors which may impact the investment.

Management is required to know the risks involved with investing in their company. While companies do not want to publicize possible negative events, the U.S. Securities and Exchange Commission requires reporting companies to list risk factors in offering documents and quarterly and annual reports. A non-reporting company may want to include risk factors in its newsletters or other correspondence to inform their investors of the risks associated with any investment. More importantly, if investors are aware of the risks at the time of the investment, management may have a defense to an antifraud claim that investors were unaware of the risks involved when making their investment decision.

In determining what risk factors are important, keep in mind that investors want to know what risks apply specifically to the company, not risks that could apply to any company. Categories of risk factors include, but are not limited to, risks related to the industry, production, financing, the company, regulation and government action, conflicts of interest of management and other key persons, securities and tax issues.

Due to the difficulties biodiesel companies are facing in obtaining debt financing and the increased cost of feedstock, specific risk factors to consider include, among other things, risks associated with a company's: 1) lack of operating history, 2) lack of profitable operations in recent periods, 3) financial position, 4) business or proposed business, and 5) the high cost of feedstock.

How you draft a risk factor is very important. Write in clear, plain English. Always list the most important risk factors first. State your conclusion as your risk factor heading. Provide the facts supporting your conclusion. Restate your conclusion. For example, a heading for a risk factor may state "declines in the price of biodiesel and its primary coproduct will have a significant negative impact on our financial performance." The risk factor would then explain that revenues are affected by the price at which a company can sell its biodiesel and glycerin and that prices can be volatile due to a number of factors over which the company has no control. The factors affecting the price volatility should also be explained.

Risk factors assist investors in assessing a company and allow for a more informed investment decision. Management is offered greater protection if an investor has been informed of all the possible risks at the time of making the investment decision. Good business practice and legal counsel will tell you that the best way to protect yourself in a lawsuit is to make certain investors have all the necessary information at the time of making their decision. Risk factors are an important means of providing this information.

Sara L. Thompson practices primarily in the areas of securities, employment law and corporate transactions at BrownWinick, a Des Moines, Iowa-based law firm serving the renewable fuels industry. Reach her at sthompson@brownwinick.com or (515) 242-2485.
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