Risk is something every entrepreneur has to deal with. Whether you’re new to entrepreneurship or already managing businesses small, large and in-between understanding and mitigating risk is one of the most critical aspects of establishing a new business.
The better you understand the nature of risk, the easier you will find it to separate what you know you don’t know, from what you don’t know you don’t know.
What is Risk?
Risk is typically defined as exposure to danger. To be more specific, risk is exposure to negative outcomes.
You invest 2 months and $5,000 of your own money into starting a small business.
Success requires finding clients, making sales and providing the good or service.
Risk is the likelihood you can bring all of these positive outcomes together in a timely fashion to generate a positive return (where revenue is greater than expenses).
Anything less than these factors coming together means that you will generate no income for your investment. If this condition persists, you will actually lose your investment as no return materializes over the longer term. This is a very negative outcome.
Breaking down the example further;
If you don’t already have clients lined up, where will you find them? If you don’t know where to find them, do you have a process to discover where they are? Will there be a cost to locate them through advertising, sales calls, etc?
When you find potential clients, can you convert them into sales? Will they buy what you’re selling? Do they have a need for your product or service? Do they have the means to pay?
And last, can you provide the good or service at a quality level that leaves the client satisfied, either ready to purchase again, and/or offer a referral of your business to their peer group?
Implicit in all of the above is also a lot of non-obvious uncertainty. We have uncertainty about the macro economy. About the weather. About taxation. About government policy. About demographic and cultural change. Technological progress. Competition.
So the question becomes, how do we start removing risk (exposure to negative outcomes) and mitigating uncertainty?
I like to stick to a few simple rules for starters.
Rules for Risk
You wouldn’t pick up basketball for the first time in your life, and a week later expect to get a tryout on Lebron James’ basketball team.
Likewise, don’t try to be cute and think you can break into a market that you only have passing familiarity with. It is possible, but also very risky for the simple reason that you won’t even know what you don’t know about the niche.
Stick to what you know, or in the absence of knowledge, stick to something you’re very enthusiastic about. Enthusiasm can carry you a long way, and while it is no substitute for expertise, it is a lot easier to develop expertise if you care about the subject, market or niche.
2. Find similar products/service, markets or business models to observe.
There are already people either in a similar market, or exactly in the market you want to be in. I am a huge fan of emulating other models where we don’t have theory of our own approach, but more importantly, competitors and related firms to show you where to market, what language to use, where to acquire labor or material resources to sell and so much more. Studying who is in the game, how they play, and where they seem to be winning might be the most valuable thing you can do to mitigate risk when starting your own project.
3. Map causality.
On thing I like to do is to write (or type) out every step from where I am, in most cases the starting point, to where I want to be. This means laying out a series of actions and events that would need to occur sequentially in order for me to reach a goal. It may not end up being the path we take, and things may not play out exactly as I planned them. Indeed one of my favorite sayings is:
No plan survives contact with the enemy.
That said, a failure to plan at all is setting yourself up to fail. You’ve got to know what your next step is, and how it leads to your goal if you want to have a better chance than blind luck that you can hit any goal.
4. Measure your exposure.
Start any new business venture off in the most minimal and lean form possible. There are two good reasons for this.
First, by minimizing your labor, time and capital commitment you keep some of those valuable resources on the sideline, saving them from being misallocated, and available should you need them for a change in direction or a doubling down on something that has started to work well.
Second, starting out small and simple allows you to be flexible. It doesn’t lock you in or commit you to conducting your business in a certain way. By forcing yourself to be disciplined with smaller pushes, you give yourself room to grow and for your vision to take a viable shape.
Thoughts on Uncertainty
1. Keep it simple.
One key element of uncertainty is the performance of many factors beyond your control. Weather, economics, war, the banking environment, the venture capital markets etc. Dependence of your business model on ideal conditions or minimal volatility in any of these factors means those uncertainties present very significant risks due to the fact we cannot begin to measure or predict them.
A surer approach is going to be one which doesn’t rely on ideal macro conditions. It needs to be a business that can crush it during the Christmas season, but still make sales in the summer. It’s a business that works great in the USA but can be run in the United Kingdom and Canada as well. If your model is too narrow, too context dependent, any fluctuation in the larger state of the world can wipe you out.
2. Minimize third party dependencies.
Third parties can and will let you down. Whether it is a key employee becoming an alcoholic after their spouse leaves them, or a poorly run supplier going bankrupt, the more dependencies you have on other individuals and firms, the more susceptible you are to outside shocks compromising your business, or attempts at establishing a business.
This isn’t an argument to be a one man army. Placing all of the pressure on yourself is overwhelming, and will also compromise your ability to scale and meet new challenges. Rather, we want to develop redundancies wherever possible so that the failure of one 3rd party relationship won’t bring your entire company to its knees.
That means at the minimum; employees who can fill multiple roles, control over (or diversity in) the manufacturing process, and more than one distribution channel.
It’s much easier to risk $50,000 if you understand what you need to do to succeed, and where things can go wrong. This scenario usually gets labeled investment rather than risk because the outcome is considered to be well understood.
Conversely, it can be terrifying to risk that much money when you haven’t taken the time to deconstruct your goals and understand the impact of the world at large upon them.
Knowledge and diligence illuminate the path ahead, dangerous or not.