1. Identify Stakeholders

 

1.1. What Is a Stakeholder?

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A stakeholder is a party interested in a company and can either affect or be affected by the business. The primary stakeholders in a typical corporation are its investors, employees, customers, and suppliers.

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However, with the increasing attention on corporate social responsibility, the concept has been extended to include communities, governments, and trade associations.

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KEY TAKEAWAYS

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• A stakeholder has a vested interest in a company and can either affect or be affected by a business' operations and performance.

• Typical stakeholders are investors, employees, customers, suppliers, communities, governments, or trade associations.

• An entity's stakeholders can be both internal or external to the organization.

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1.2. Understanding Stakeholders

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Stakeholders can be internal or external to an organization. Internal stakeholders are people whose interest in a company comes through a direct relationship, such as employment, ownership, or investment.

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External stakeholders are those who do not directly work with a company but are affected somehow by the actions and outcomes of the business. Suppliers, creditors, and public groups are all considered external stakeholders.

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1.3. Example of an External Stakeholder

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External stakeholders, unlike internal stakeholders, do not have a direct relationship with the company. Instead, an external stakeholder is normally a person or organization affected by the business's operations. When a company goes over the allowable limit of carbon emissions, for example, the town in which the company is located is considered an external stakeholder because it is affected by the increased pollution.

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Conversely, external stakeholders may also sometimes have a direct effect on a company without a clear link to it. The government, for example, is an external stakeholder. When the government initiates policy changes on carbon emissions, the decision affects the business operations of any entity with increased levels of carbon.

 

1.4. Problems With Stakeholders

 

A common problem that arises for companies with numerous stakeholders is that the various stakeholder interests may not align. In fact, the interests may be in direct conflict. For example, the primary goal of a corporation, from the perspective of its shareholders, is to maximize profits and enhance shareholder value. Since labor costs are unavoidable for most companies, a company may seek to keep these costs under tight control. This is likely to upset another group of stakeholders, its employees. The most efficient companies successfully manage the interests and expectations of all their stakeholders.

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1.5. Stakeholders vs. Shareholders

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Stakeholders are bound to a company by some type of vested interest, usually for the long term and for need reasons. Meanwhile, a shareholder has a financial interest, but a shareholder can sell a stock and buy different stock or keep the proceeds in cash; they do not have a long-term need for the company and can get out at any time.

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For example, if a company is performing poorly financially, the vendors in its supply chain might suffer if the company limits production and no longer uses its services. Similarly, employees of the company might lose their jobs. However, shareholders of the company can sell their stock and limit their losses.

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1.6 What Are Examples of Stakeholders?

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Examples of important stakeholders for a business include its shareholders, customers, suppliers, and employees. Some of these stakeholders, such as the shareholders and the employees, are internal to the business. Others, such as the business’s customers and suppliers, are external to the business but are nevertheless affected by the business’s actions. These days, it has become more common to talk about a broader range of external stakeholders, such as the government of the countries in which the business operates, or even the public at large.

 

1.7 Why Are Stakeholders Important?

 

Stakeholders are important for several reasons. For internal stakeholders, they are important because the business’s operations rely on their ability to work together toward the business’s goals. External stakeholders on the other hand can affect the business indirectly.

 

For instance, customers can change their buying habits, suppliers can change their manufacturing and distribution practices, and governments can modify laws and regulations. Ultimately, managing relationships with internal and external stakeholders is key to a business’s long-term success.

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1.8 Are Stakeholders and Shareholders the Same?

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Although shareholders are an important type of stakeholder, they are not the only stakeholders. Examples of other stakeholders include employees, customers, suppliers, governments, and the public at large. In recent years, there has been a trend toward thinking more broadly about who constitutes the stakeholders of a business.

2. Pre-Due Diligence

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Is the initial review of a company through evaluation of data and documents to determine whether or not a company is a good match financially, culturally, and strategically, before committing to a costly full due diligence effort.

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Here are the ten checklists that will help you to gather enough information to perform the pre-analytical procedure for your Preliminary.

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2.1 Goals

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• Determine how serious the seller is in selling the business and why they are selling.

• Start developing a relationship with the leaders of the company.

• Minimally visit the company’s headquarters and observe operations. Visiting additional sites can be important, depending on the type of business.  This is the opportunity to get detailed product demonstrations, as well.

• Perform high-level investigation and analysis of business to determine whether it is a good fit for an acquisition (see II below).

• Determine what price you will offer in your Letter of Intent if you move forward.

• Identify any risks or any show-stoppers in buying the business.

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2.2 Investigation and Analysis

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Since at this stage, there may be other prospective buyers, you will not be allowed to contact customers, suppliers, or partners.  You will also only be able to speak with very few leaders of the company and no other employees since it will still be confidential status. So, most of your information will come from the site visit(s), interviews with the appointed leaders, and your own research of the industry and company.

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Keep in mind that the point of Desktop Diligence is to get crucial information to decide whether or not to move forward with the Letter of Intent (LOI), committing to full Due Diligence, which is costly.  Desktop Diligence should be the right balance of gathering enough information, but not going deeper than needed at this stage, and therefore costing the company more than necessary.

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While this list is by no means comprehensive, some of the documents that you will most likely want to request are below.  The seller may not be willing to share all that you request, but you should develop your list based on what you absolutely need to know to make a go / no-go decision for an LOI.

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• Financial statements for the last 3 – 5 years

• Financial projections

• Employee benefits package information

• Redacted customer list for top 20% of revenue

• Employee salary information

• Real estate information (owned properties, leased properties, etc.)

• IRS records

• Union contracts, if applicable

• Information on any lawsuits or pending litigation

• Information on any environmental studies

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You will probably want to submit a list of questions to the seller, as well. Some examples are below, but the questions need to be tailored, depending on the type of business, acquisition strategy, etc.

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• Describe the nature of any central shared service support that is provided on behalf of the various operating locations.

• Please describe the company’s customer ordering platform. Is it automated or manual? Is it centralized or decentralized? What is the nature of the platform(s) used for order distribution, production planning, and accounting?

• Does the company negotiate supplier pricing and contracts materials and transportation (UPS, FedEx, etc.) at the facility or corporate level?

• How much would the corporate executives consider being retained in a change of ownership and under a potential earn-out structure?

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3. Draft Strong Insurance Coverage

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3.1. What Is Insurance?

Insurance is a contract, represented by a policy, in which an individual or entity receives financial protection or reimbursement against losses from an insurance company. The company pools clients' risks to make payments more affordable for the insured.

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Insurance policies are used to hedge against the risk of financial losses, both big and small, that may result from damage to the insured or her property, or from liability for damage or injury caused to a third party.

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3.2. How Insurance Works

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There are many different types of insurance policies available, and virtually any individual or business can find an insurance company willing to insure them for a price. The most common types of personal insurance policies are auto, health, homeowners, and life. Most individuals in the United States have at least one of these types of insurance, and car insurance is required by law.

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KEY TAKEAWAYS

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• Insurance is a contract (policy) in which an insurer indemnifies another against losses from specific contingencies or perils.

• There are many types of insurance policies. Life, health, homeowners, and auto are the most common forms of insurance.

• The core components that make up most insurance policies are the deductible, policy limit, and premium.

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Businesses require special types of insurance policies that insure against specific types of risks faced by a particular business. For example, a fast-food restaurant needs a policy that covers damage or injury that occurs due to cooking with a deep fryer. An auto dealer is not subject to this type of risk but does require coverage for damage or injury that could occur during test drives.

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IMPORTANT

 

To select the best policy for you or your family, it is important to pay attention to the three critical components of most insurance policies—the deductible, premium, and policy limit.

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There are also insurance policies available for very specific needs, such as kidnap and ransom (K&R), medical malpractice, and professional liability insurance, also known as errors and omissions insurance.

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3.3. Insurance Policy Components

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When choosing a policy, it is important to understand how insurance works.

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A firm understanding of these concepts goes a long way in helping you choose the policy that best suits your needs. For instance, whole life insurance may or may not be the right type of life insurance for you. There are three components of any type of insurance (premium, policy limit, and deductible) that are crucial.

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3.4 Premium

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A policy's premium is its price, typically expressed as a monthly cost. The premium is determined by the insurer based on your or your business's risk profile, which may include creditworthiness.

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For example, if you own several expensive automobiles and have a history of reckless driving, you will likely pay more for an auto policy than someone with a single mid-range sedan and a perfect driving record. However, different insurers may charge different premiums for similar policies. So finding the price that is right for you requires some legwork.

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3.5 Policy Limit

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The policy limit is the maximum amount an insurer will pay under a policy for a covered loss. Maximums may be set per period (e.g., annual or policy term), per loss or injury, or over the policy's life, also known as the lifetime maximum.

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Typically, higher limits carry higher premiums. For a general life insurance policy, the maximum amount the insurer will pay is referred to as the face value, which is the amount paid to a beneficiary upon the death of the insured.

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3.6 Deductible

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The deductible is a specific amount the policyholder must pay out-of-pocket before the insurer pays a claim. Deductibles serve as deterrents to large volumes of small and insignificant claims.

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Deductibles can apply per-policy or per claim depending on the insurer and the type of policy. Policies with very high deductibles are typically less expensive because the high out-of-pocket expense generally results in fewer small claims.

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3.7 Special Considerations

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Regarding health insurance, people who have chronic health issues or need regular medical attention should look for policies with lower deductibles.

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Though the annual premium is higher than a comparable policy with a higher deductible, less expensive access to medical care throughout the year may be worth the trade-off.

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4. Create Action Plan

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Planning on turning your vision into reality? And what’s your best way to avoid challenges and problems during this journey? A solid action plan. 

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We have outlined 6 steps explaining how to write an action plan. Once you familiarize yourself with them, go ahead and use the editable templates below to start planning right away.

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4.1 What is an Action Plan

An action plan is a checklist for the steps or tasks you need to complete to achieve the goals you have set. 

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It’s an essential part of the strategic planning process and helps with improving teamwork planning. Not only in project management, but individuals can use action plans to prepare a strategy to achieve their own personal goals as well.

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4.2 Components of an action plan include

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• A well-defined description of the goal to be achieved 

• Tasks/ steps that need to be carried out to reach the goal

• People who will be in charge of carrying out each task

• When will these tasks be completed (deadlines and milestones)

• Resources needed to complete the tasks

• Measures to evaluate progress

What’s great about having everything listed down in one location is that it makes it easier to track progress and effectively plan things out.

 

An action plan is not something set in stone. As your organization grows, and surrounding circumstances change, you will have to revisit and adjust to meet the latest needs.

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4.2 Why You Need an Action Plan 

Sometimes businesses don’t spend much time on developing an action plan before an initiative, which, in most cases, leads to failure. If you haven’t heard, “failing to plan is planning to fail” said Benjamin Franklin supposedly once. 

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Planning helps you prepare for the obstacles ahead and keep you on track. And with an effective action plan, you can boost your productivity and keep yourself focused.  

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Here are some benefits of an action plan you should know:

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• It gives you a clear direction. As an action plan highlights exactly what steps to be taken and when they should be completed, you will know exactly what you need to do. 

• Having your goals written down and planned out in steps will give you a reason to stay motivated and committed throughout the project.  

• With an action plan, you can track your progress toward your goal.

• Since you list down all the steps you need to complete in your action plan, it will help you prioritize your tasks based on effort and impact.
   

4.3 How to Writing an Action Plan | Best Practices

From the looks of it, creating an action plan seems fairly easy. But there are several important steps you need to follow with caution to get the best out of it. Here’s how to write an action plan explained in 6 easy steps.

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4.3.1. Step 1: Define your end goal 

If you are not clear about what you want to do and what you want to achieve, you set yourself up for failure. Planning a new initiative? Start by defining where you are and where you want to be. Solving a problem? Analyze the situation and explore possible solutions before prioritizing them. 

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Then write down your goal. And before you move on to the next step, run your goal through the SMART criteria. Or in other words, make sure that it is:

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• Specific – well-defined and clear

• Measurable – include measurable indicators to track progress  

• Attainable – realistic and achievable within the resources, time, money, experience, etc. you have

• Relevant – align with your other goals 

• Timely – has a finishing date 

• Use this SMART goals worksheet to simplify this process. Share it with others to get their input as well.  

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And refer to our easy guide to the goal-setting process to learn more about setting and planning your goals.

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4.3.2. Step 2: List down the steps to be followed 

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The goal is clear. What exactly should you do to realize it? 

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Create a rough template to list down all the tasks to be performed, due dates, and people responsible. It’s important that you ensure that the entire team is involved in this process and has access to the document. This way everyone will be aware of their roles and responsibilities in the project. Make sure that each task is clearly defined and attainable. If you come across larger and more complex tasks, break them down to smaller ones that are easier to execute and manage. 

 

Tips: Use a RACI Matrix template to clarify project roles and responsibilities, and plan projects

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4.3.3. Step 3: Prioritize tasks and add deadlines

It’s time to reorganize the list by prioritizing the tasks. Some steps you may need to prioritize as they can be blocking other sub-steps. Add deadlines, and make sure that they are realistic. Consult with the person responsible for carrying it out to understand their capacity before deciding on deadlines. 

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4.3.4. Step 4: Set Milestones 

Milestones can be considered mini goals leading up to the main goal at the end. The advantage of adding milestones is that they give the team members to look forward to something and help them stay motivated even though the final due date is far away. Start from the end goal and work your way back as you set milestones. Remember not to keep too little or too much time in between the milestone you set. It’s a best practice to space milestones two weeks apart.  

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4.3.5. Step 5: Identify the resources needed

Before you start your project, it’s crucial to ensure that you have all the necessary resources at hand to complete the tasks. And if they are not currently available, you need first to make a plan to acquire them. This should also include your budget. You can assign a column of your action plan to mark the cost of each task if there are any.  

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4.3.6. Step 6: Visualize your action plan

The point of this step is to create something that everyone can understand at a glance and that can be shared with everyone. Whether your action plan comes in the shape of a flowchart, Gantt chart, or table, make sure that it clearly communicates the elements we have identified such far tasks, task owners, deadlines, resources, etc. This document should be easily accessible to everyone and should be editable. 

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4.3.7. Step 7: Monitor, evaluate and update

Allocate some time to evaluate the progress you’ve made with your team. You can mark tasks that are completed as done on this final action plan, bringing attention to how you’ve progressed toward the goal. This will also bring out the tasks that are pending or delayed, in which case you need to figure out why and find suitable solutions. And then update the action plan accordingly. 

5. Risk Analysis and Quantification

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5.1 What Is Risk Analysis?

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Risk analysis is the process of assessing the likelihood of an adverse event occurring within the corporate, government, or environmental sector. Risk analysis studies the underlying uncertainty of a given course of action and refers to the uncertainty of forecasted cash flow streams, the variance of portfolio or stock returns, the probability of a project's success or failure, and possible future economic states.

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Risk analysts often work in tandem with forecasting professionals to minimize future negative unforeseen effects. All firms and individuals face certain risks; without risk, rewards are less likely. The problem is that too much risk can lead to failure. Risk analysis allows a balance to be struck between taking risks and reducing them.

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KEY TAKEAWAYS

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• Risk analysis seeks to identify, measure, and mitigate various risk exposures or hazards facing a business, investment, or project.

• Quantitative risk analysis uses mathematical models and simulations to assign numerical values to risk.

• Qualitative risk analysis relies on a person's subjective judgment to build a theoretical model of risk for a given scenario.

• Risk analysis is often both an art and a science.

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5.2 Understanding Risk Analysis

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Risk assessment enables corporations, governments, and investors to assess the probability that an adverse event might negatively impact a business, economy, project, or investment.  Assessing risk is essential for determining how worthwhile a specific project or investment is and the best process(es) to mitigate those risks. Risk analysis provides different approaches that can be used to assess the risk and reward tradeoff of a potential investment opportunity.

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A risk analyst starts by identifying what could potentially go wrong. Those negatives must be weighed against a probability metric that measures the likelihood of the event occurring.

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Finally, risk analysis attempts to estimate the extent of the impact that will be made if the event happens. Many identified risks, such as market risk, credit risk, currency risk, and so on, can be reduced through hedging or by purchasing insurance.

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Almost all sorts of large businesses require a minimum sort of risk analysis. For example, commercial banks need to properly hedge foreign exchange exposure of overseas loans, while large department stores must factor in the possibility of reduced revenues due to a global recession. It is important to know that risk analysis allows professionals to identify and mitigate risks but not avoid them completely.

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5.3. Types of Risk Analysis

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Risk analysis can be quantitative or qualitative.

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5.3.1. Quantitative Risk Analysis

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Under quantitative risk analysis, a risk model is built using simulation or deterministic statistics to assign numerical values to risk. Inputs that are mostly assumptions and random variables are fed into a risk model.

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For any given input range, the model generates a range of output or outcomes. The model's output is analyzed using graphs, scenario analysis, and/or sensitivity analysis by risk managers to make decisions to mitigate and deal with the risks.

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A Monte Carlo simulation can be used to generate a range of possible outcomes of a decision made or action taken. The simulation is a quantitative technique that calculates results for the random input variables repeatedly, using a different set of input values each time. The resulting outcome from each input is recorded, and the final result of the model is a probability distribution of all possible outcomes.

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The outcomes can be summarized on a distribution graph showing some measures of central tendency such as the mean and median and assessing the variability of the data through standard deviation and variance. The outcomes can also be assessed using risk management tools such as scenario analysis and sensitivity tables. Scenario analysis shows the best, middle, and worst outcomes of any event. Separating the different outcomes from best to worst provides a reasonable spread of insight for a risk manager.

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For example, an American company that operates on a global scale might want to know how its bottom line would fare if the exchange rate of select countries strengthens. A sensitivity table shows how outcomes vary when one or more random variables or assumptions are changed.

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Elsewhere, a portfolio manager might use a sensitivity table to assess how changes to the different values of each security in a portfolio will impact the variance of the portfolio. Other types of risk management tools include decision trees and break-even analysis.

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5.3.2.Qualitative Risk Analysis

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Qualitative risk analysis is an analytical method that does not identify and evaluate risks with numerical and quantitative ratings. Qualitative analysis involves a written definition of the uncertainties, an evaluation of the extent of the impact (if the risk ensues), and countermeasure plans in the case of a negative event occurring.

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Examples of qualitative risk tools include SWOT analysis, cause and effect diagrams, decision matrix, game theory, etc. A firm that wants to measure the impact of a security breach on its servers may use a qualitative risk technique to help prepare it for any lost income that may occur from a data breach.

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IMPORTANT

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While most investors are concerned about downside risk, mathematically, the risk is the variance both to the downside and the upside.

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Example of Risk Analysis: Value at Risk (VaR)

Value at Risk (VaR) is a statistic that measures and quantifies the level of financial risk within a firm, portfolio, or position over a specific time frame. This metric is most commonly used by investment and commercial banks to determine the extent and occurrence ratio of potential losses in their institutional portfolios. Risk managers use VaR to measure and control the level of risk exposure. One can apply VaR calculations to specific positions or whole portfolios or to measure firm-wide risk exposure.

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VaR is calculated by shifting historical returns from worst to best with the assumption that returns will be repeated, especially where it concerns risk. As a historical example, let's look at the Nasdaq 100 ETF, which trades under the symbol QQQ (sometimes called the "cubes") and which started trading in March of 1999. If we calculate each daily return, we produce a rich data set of more than 1,400 points. The worst is generally visualized on the left, while the best returns are placed on the right.

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For more than 250 days, the daily return for the ETF was calculated between 0% and 1%. In January 2000, the ETF returned 12.4%. But there are points at which the ETF resulted in losses as well. At its worst, the ETF ran daily losses of 4% to 8%. This period is referred to as the ETF's worst 5%. Based on these historic returns, we can assume with 95% certainty that the ETF's largest losses won't go beyond 4%. So if we invest $100, we can say with 95% certainty that our losses won't go beyond $4.

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One important thing to keep in mind is that VaR doesn't provide analysts with absolute certainty. Instead, it's an estimate based on probabilities. The probability gets higher if you consider the higher returns, and only consider the worst 1% of the returns. The Nasdaq 100 ETF's losses of 7% to 8% represent the worst 1% of its performance. We can thus assume with 99% certainty that our worst return won't lose us $7 on our investment. We can also say with 99% certainty that a $100 investment will only lose us a maximum of $7.

 

5.4. Limitations of Risk Analysis

Risk is a probabilistic measure and so can never tell you for sure what your precise risk exposure is at a given time, only what the distribution of possible losses are likely to be if and when they occur. There are also no standard methods for calculating and analyzing risk, and even VaR can have several different approaches to the task. Risk is often assumed to occur using normal distribution probabilities, which in reality rarely occur and cannot account for extreme or "black swan" events.

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The financial crisis of 2008, for example, exposed these problems as relatively benign VaR calculations greatly understated the potential occurrence of risk events posed by portfolios of subprime mortgages.

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Risk magnitude was also underestimated, which resulted in extreme leverage ratios within subprime portfolios. As a result, the underestimations of occurrence and risk magnitude left institutions unable to cover billions of dollars in losses as subprime mortgage values collapsed.

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6. Know Your Client (KYC)

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6.1. What Is Know Your Client (KYC)?

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The Know Your Client or Know Your Customer is a standard in the investment industry that ensures investment advisors know detailed information about their clients' risk tolerance, investment knowledge, and financial position. KYC protects both clients and investment advisors. Clients are protected by having their investment advisor know what investments best suit their personal situations. Investment advisors are protected by knowing what they can and cannot include in their client's portfolios. KYC compliance typically involves requirements and policies such as risk management, customer acceptance policies, and transaction monitoring.

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KEY TAKEAWAYS

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• Know Your Customer (KYC) are a set of standards used within the investment and financial services industry to verify customers, their risk profiles, and financial profile.

• In the investment industry, KYC stipulates that every broker-dealer should use reasonable effort regarding client accounts.

• The Financial Crimes Enforcement Network (FinCEN) established minimum KYC requirements, including verifying beneficial owners and setting standards for dealing with third parties.

• The SEC requires that a new customer provide detailed financial information before opening an account.

• The cryptocurrency market is not required to employ KYC standards, although some have.

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6.2. Understanding Know Your Client (KYC)

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The Know Your Client (KYC) rule is an ethical requirement for those in the securities industry who are dealing with customers during the opening and maintaining of accounts. There are two rules which were implemented in July 2012 that cover this topic together: Financial Industry Regulatory Authority (FINRA) Rule 2090 (Know Your Customer) and FINRA Rule 2111 (Suitability). These rules are in place to protect both the broker-dealer and the customer so that brokers and firms deal fairly with clients.

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The Know Your Customer Rule 2090 essentially states that every broker-dealer should use reasonable effort when opening and maintaining client accounts. It is a requirement to know and keep records on the essential facts of each customer, as well as identify each person who has the authority to act on the customer’s behalf.

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The KYC rule is important at the beginning of a customer-broker relationship to establish the essential facts of each customer before any recommendations are made. The essential facts are those required to service the customer’s account effectively and to be aware of any special handling instructions for the account. Also, the broker-dealer needs to be familiar with each person who has the authority to act on behalf of the customer and needs to comply with all the laws, regulations, and rules of the securities industry.

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6.3. Suitability Rule

As found in the FINRA Rules of Fair Practices, Rule 2111 goes in tandem with the KYC rule and covers the topic of making recommendations. The suitability Rule 2111 notes that a broker-dealer must have reasonable grounds when making a suitable recommendation for a customer based on the client’s financial situation and needs. This responsibility means that the broker-dealer has done a complete review of the current facts and profile of the customer, including the customer’s other securities before making any purchase, sale, or exchange of security.

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6.4.. Requirements for KYC Compliance

The U.S. Financial Crimes Enforcement Network (FinCEN) has set baseline requirements for KYC in conjunction with the core requirements for the due diligence program. To prevent money laundering, financial institutions must conduct deeper assessments of their client's risk profiles.

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FinCEN requires that financial institutions verify the identities of their customers and their respective beneficial owners⁠—owners with at least 25% ownership⁠.1 For entities with a high anti-money laundering and terrorism finance (AML) risk, additional scrutiny is required and the threshold for ownership is lowered.

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FinCEN requires financial institutions to understand the type and purpose of the customer relationship when developing the customer risk profile. This risk profile is created when the customer relationship is established and is used as a baseline for detecting suspicious activities.

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When using third parties to collect and verify customer profiles, financial institutions must verify that the third party employs specific risk controls and has an appropriate governance structure. To remain compliant, they must secure AML and customer identification program (CIP) certificates from a third party each year.

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Lastly, financial institutions must also maintain current and accurate customer information and continue to monitor their accounts for suspicious and illegal activities.2 When detected, they are required to report their findings promptly.

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6.4. Establishing a Customer Profile

Investment advisors and firms are responsible for knowing each customer's financial situation by exploring and gathering the client's age, other investments, tax status, financial needs, investment experience, investment time horizon, liquidity needs, and risk tolerance. The SEC requires that a new customer provide detailed financial information that includes name, date of birth, address, employment status, annual income, net worth, investment objectives, and identification numbers before opening an account.

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6.5. KYC and Cryptocurrency

Cryptocurrency is wildly praised for being decentralized and a medium of exchange that promotes confidentiality; however, these benefits also present challenges in preventing money laundering. Criminals see cryptocurrency as a means of furthering their illegal activities and as a vehicle to launder money; as a result, governing bodies are looking for ways to impose KYC on cryptocurrency markets, requiring cryptocurrency platforms to verify their customers much like financial institutions. Although not yet required, many platforms have implemented KYC practices.

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Exchanges are classified as either crypto-to-crypto or fiat-to-crypto.3 Because crypto-to-crypto exchanges don't deal with traditional currency, they do not have the same pressures to employ KYC standards as exchanges that deal with fiat currencies.

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fiat-to-crypto exchanges facilitate transactions involving fiat currencies and cryptocurrencies. Since fiat currency is the official currency of a nation, most of these exchanges employ some measure of KYC. Fortunately, financial institutions should have already vetted their customers according to KYC requirements.

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In early 2021, FinCEN proposed that cryptocurrency and digital asset market participants submit, maintain, and verify customers' identities. 5 This proposal would classify certain cryptocurrencies as monetary instruments, subjecting them to KYC requirements.

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6.6. KYC FAQs

 

6.6.1. What Is KYC Verification?

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The Know Your Client or Know Your Customer (KYC) verification is a set of standards and requirements used in the investment and financial services industries to ensure they have sufficient information about their clients, their risk profiles, and their financial position.

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6.6.2. What Is KYC in the Banking Sector?

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KYC in the banking sector involves bankers and advisors identifying their customers, beneficial owners of businesses, and the nature and purpose of customer relationships, as well as reviewing customer accounts for suspicious and illegal activity. Banks must also maintain and ensure the accuracy of customer accounts.

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6.6.3. What Are KYC Documents?

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Requirements differ in different jurisdictions. However, account owners generally must provide a government-issued ID as proof of identity. Some institutions require two forms of ID, such as a driver's license, birth certificate, social security card, or passport. In addition to confirming identity, the address must be confirmed. This can be done with proof of ID or with an accompanying document confirming the address of the record.

 

6.7. The Bottom Line

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Know Your Customer (KYC) are a set of standards and requirements investment and financial services companies use to verify the identity of their customers and any associated risks with the customer relationship. KYC also ensures investment advisors know detailed information about their clients' risk tolerance and financial position.

 

The U.S. Financial Crimes Enforcement Network (FinCEN) prescribed rules financial institutions must follow when verifying the identity of customers and their beneficial owners if any. They must verify the circumstances around the customer relationship, as well as monitor and report any suspicious or illegal activity. Focus is shifting to cryptocurrency markets as pressures to conform to KYC standards increase.

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