How to Manage Startup Risks

Opportunity and risk work together in a business to chart the path of success (or failure). The markets move on the assumption of a direct relationship between risk and reward – the greater the potential upside, the higher the risks involved. At the same time, the converse may not be true as situations involving higher risk may have little or no upside. Being aware of these intricacies and ability to judiciously pick the risks to take and to avoid differentiates a successful venture from failed one.

I. Assessing Risks
The startup entrepreneur needs to ascertain risks that threaten the venture and assess their significance in the specific situation. Startup ventures are inherently risky as:

• Customer acceptance for the products / services is not established.
• Venture is usually financed through (interest bearing) borrowed funds and the entity may not make sufficient profits to repay these loans.
• As a business expands, the founders will invariably have to delegate responsibility for certain tasks to employees whom they do not know well. The employees bring uncertainty and risk related to their skills and performance.
• Correct price for the product may not be known leading to frequent changes in prices – running the risk of estranging customers.
• Logistics channel are not established and the geography is unknown.
• The compliance framework may not be fully aware of.

Startup venture involves accepting the risks that are necessary or unavoidable and making efforts to mitigate controllable items are reasonable costs.

As reducing the risk to zero is impossible (or extremely expensive), the startup entity shall decide on the type and degree of risk the entity is prepared to accept.

II. Risk Management Strategies:
Success or failure of the entity would depend in the on specific situation and how accurately the entrepreneurs can answer it. The major risk would include:

1. Talent Risk
Two major manifestation of talent risks that every startup confronts are:

1. Hiring a wrong team member; and
2. Risk of losing good team members.

The impact of talent risks is the highest during the early stages of the startup which is dependent on a small core team. With increase in size, the entity may hire more people so that the risks get diversified and reduced.

• Founding Team
  Talent risks include unskilled co-founders, disagreement amongst founders over money or direction of the business, and the departure of a talented founder.
  One way to mitigate these risks is by choosing someone already known well as a co-founder, instead of rushing into arrangement made hurriedly or with someone known through online media.
  To reduce the chances of knowledge gaps, make sure that the co-founders are chosen with skills complementary to your own. With a a good team, there is less likelihood of losing them by providing them equity that vests over time.

• Employees
  As your business grows and you delegate responsibility to employees, part of the success of your venture will rest in their hands. The earlier the hire, the more critical an individual is to the success of your company.
  To minimize the risk of working with the wrong person, hire slowly and fire fast. Multiple interviews with core team members are useful for getting a second or even third opinion on the hiring decision.
  Employees who do not perform as expected, who are persistently negative, critical or abusive are a threat to your business and should be let go as quickly as possible. Assuming the employee has a good attitude, some knowledge deficits are inevitable; the entity should cultivate such employees and provide them training to overcome any skill gaps.
  To prevent key employees from leaving, offer adequate financial compensation and add clauses to their contracts that prevent them from joining competitors.

2. Legal Risk
Common legal risks include:

• Compliance
  The entity should ensure compliance with all applicable regulations, including business licenses, employment laws, corporate governance, and tax compliance. Depending on the specific industry and jurisdiction, compulsory insurance might be required for certain aspects of your business.

• Errors & Omissions
  Businesses run the risk of loss and legal liabilities resulting from inadequate or failed internal processes, fraud, human error in processing transactions, etc.
  These risks can be minimized by establishing SOPs and adding control steps at appropriate points in the process workflow. Also, businesses should obtain a professional liability insurance that protects companies and individuals against claims made by clients for inadequate work or negligent actions.

• Intellectual property
  To discourage competitors from stealing innovation, the entity may consider investing in copyrights, trademarks and patents. Very small businesses should assess whether the costs of potential litigation (including opportunity costs) justify the expense of IP protection.

• Work safety
  To protect your employees and avoid falling foul of Health and Safety legislation, entrepreneurs should formulate contingency plans for emergencies such as fires and explosions.

3. Financial Risk
The startup management must ensure that they never get to the stage of liquidity crisis – for short term and long terms. The entity may face financial risk due to:

1. Customers’ refusal to pay invoices (credit risk).
2. Sudden increase in the raw materials cost forcing increase in sales process.
3. Customers switch to a competing product.
4. Improving local currency making the export less profitable or weakening currency causing increase in the costs of running foreign operations (exchange rate risk).
5. Increased cost of working capital due to increased interest rates (interest rate risk).
6. Impairment in the value of stocks or properties pledged as collateral forcing the bank to cut credit lines (asset price risk).
7. In slowing economy, the product may not find sufficient demand to justify it in volumes.

One way to minimize financial risk and give the venture a long runway is to take funding when it is available and keeping it in reserve for a rainy day; this is the strategy that most “hot” startups take.

Other financial risks may be minimized by establishing a prudent cash management approach, A/R collection policy and proper budgeting.

4. High Concentration Risk
Reliance on any single factor (or a small group of factors) in any aspect of a business is a serious risk and should be carefully managed through adequate diversification.

• Client Concentration
  Small businesses that are financially dependent on one or two large clients run the risk that these contracts may fall apart or the key clients may run into difficulties of their own.
  To mitigate the concentration risk, entrepreneurs should diversify their income stream and avoid having a majority of their revenue coming from a very small number of clients.

• Marketing Channel Concentration
  If the entity has a single marketing channel that is bringing most of the customers, there are multiple risk to the business if that channel falters or that channel hijacks the business idea.
  The best way to avoid such a risk is to have diversified marketing channels.

5. Political Risk
Countries with political uncertainty, weak judicial systems, high rate of corruption, stifling bureaucracy, or high taxes can make it very difficult for entrepreneurs to launch and grow a startup. Entrepreneurs in such place end up spending majority of their time dealing with inefficient activities that do not create genuine value for their business.

To minimize the chances of falling prey to such bureaucracy, founders should consider setting up startup in business friendly ecosystems that offers political stability, a rule of law, IP protection, no corruption, and low taxes.

Conclusion
Risk is integral part of the business. To be successful, entrepreneurs must learn to accept those risks that are unavoidable and mitigate those that can be managed. The best safeguards against risk are a good core team, a business-friendly government, diversified marketing channels, and prudent financial management.