There is a popular misconception floating around that successful entrepreneurs are big risk takers. The assumption is if you want to “win” in the entrepreneurial game then you must be prepared to take a gamble with your time, money, and other resources. While there is definitely an element of risk to starting any new venture, successful entrepreneurs are actually not in the business of making bets. They don’t just take risks; they take calculated risks.
The Unavoidable Risks of Starting a Business
Of course, all business startups involve some measure of risk, and almost every business decision, like many things in life, will include a certain degree of uncertainty. For example, here are just few of the everyday risks that come with entrepreneurship and running a business:
- Personal opportunity cost risk. When a person decides to start a new venture, it may mean leaving behind a paying job or dropping out of college. This is both a financial and a career risk since these entrepreneurs are giving up their salary or wages as well as formal educational opportunities in favor of self-employment.
- Credibility risk. When the product or service being offered is completely new, then entrepreneurs must build up their reputation and credibility from scratch. When they bring their offerings to the market, there is thus significant pressure to provide a positive customer experience, otherwise it could jeopardize the whole business. Most established brand names, on the other hand, can often rely on their current reputation and market presence to influence the purchasing decisions of potential customers. In fact, almost 90 percent of consumers across the globe report that they consider the reputation of company when purchasing a product or service. According to another study, about 59 percent of consumers prefer to buy products from brands that they know, and 21 percent say they bought a new product because it was from a brand they already like.
- Expansion risk. Business owners must decide when to seek loans or outside investment and when to expand to a new location or market segment. Increasing financial resources through loans or investment always increases the risk of not being able to repay the debt that comes with them. Investors may additionally want equity in the business and, thus, a say in how the business is managed in exchange for their investment. In this case, there is the risk that investors may clash with business owners on important business decisions. On top of this, expanding into another market always carries the risk of failure and lost profits.
- Market risk. Periods of economic turbulence or uncertainty can lead to sharp, sudden changes in demand. Outside market forces, such as changes in legislation and technology, can also significantly influence demand for a product or service. Just take a look at what’s happening in the S. vaping industry. A ban on flavored e-cigarettes is sure to put a lot of small suppliers out of business– and no one saw it coming.
- Operational risk. This involves the risks of operating, including hiring new employees, having adequate cash flow, and relying on digital technologies that can put sensitive data at risk of being stolen or lost as well as systems and networks that can suffer from downtime. For businesses that have a physical location of some sort, there is also the risk of natural disasters, fire, and theft.
- Competitive risk.The product, pricing, and marketing strategies of competing companies can affect a business’ market share and thus sales volume. Disruptive technologies and business models can also significantly alter the competitive field.
The High Cost of Unmitigated Risk
But, even where there are risks associated with starting and running a business, successful entrepreneurs don’t approach these risks blindly. They also don’t take excessive risk. Doing so will almost certainly lead to business failure or worse, damage to the entrepreneur’s financial health, personal life and credibility.
Entrepreneurs who recklessly take risks may compromise the trust and loyalty of their employees, business partners, customers, and investors. They may also significantly overestimate the potential for success and suffer crushing losses as a result. Of the top reasons why businesses fail, including lack of capital, poor business management and planning, and marketing mishaps, every single one of these issues involve not being able to properly mitigate the risks of running a business.
Why are so many entrepreneurs and business owners seemingly blind to the costs of excessive risk taking? It may in part have to do with a phenomenon called “survivor bias.” This refers to a tendency to consider only the successful outcomes, while ignoring the accompanying failures. So, if a few college drop-outs end up being wildly successful entrepreneurs, people think they can also drop out and become a huge success, all while totally ignoring the countless other individuals who have taken the same path and failed. If a few companies can raise millions of dollars from investors and then turn a profit, some entrepreneurs may believe that simply raising such sums will practically guarantee a successful business. But, it doesn’t usually work that way in real life.
The How and Where of Taking Calculated Risks
Research suggests that contrary to popular belief entrepreneurs are not more prone to risk than other people. Successful entrepreneurs are actually not big risk takers. They are calculated and deliberate decision makers. As one entrepreneur put it, “The difference between risk takers and calculated risk takers is the difference between failure and success.”
To put it more bluntly, most entrepreneurs are actually risk adverse. They figure out a way to hedge their risk with every step and business decision they make. How do they do this? Usually, they follow several key strategies:
- They make a realistic assessment of their risk tolerance. They continually assess how much money and other resources they and their business can afford to invest in a new product or opportunity. Should the initiative fail can they handle the loss? The most successful entrepreneurs also possess a certain level of self-awareness, that is, a conscious understanding of their personality, key motivations, and desires. In fact, in a recent survey of 75 members of the Stanford Graduate School of Business Advisory Council, self-awareness as rated as the most important quality for leaders to develop.
Not surprisingly, when entrepreneurs are clear about their personal strengths and limitations, they are more likely to set healthy boundaries, learn from mistakes, and seek assistance where needed.
- Every major decision is research-based. Successful entrepreneurs spend a lot of time and money on both qualitative and quantitative research. On one hand, they are constantly keeping their fingers on the pulse of customer sentiment. They research customer trends and preferences and watch their competitors, all while keeping their eyes open to new opportunities. But, they are also continually testing the market for direct validation of their current initiatives. Included in this risk reduction strategy is learning from past failures, mistakes, and erroneous assumptions and putting those lessons into action.
- They have a plan in place to measure progress. To see if and when goals are being met, successful entrepreneurs are continually evaluating and measuring a clearly defined set of Key Performance Indicators (KPI’s). Endeavors that aren’t giving their business a sufficient ROI, can then be abandoned.
- They work with a team of trusted advisors. Even the best and brightest entrepreneurs can’t be an expert in everything. They therefore make it a point to surround themselves with other professionals who can help them to broaden their perspective and give them support in times of uncertainty. This team can include: lawyers, CPA’s, industry peers, professional consultants and mentors.
- They learn how and where to hedge against risk. Just as financial investors will hedge their investment portfolio against loss, successful entrepreneurs seek out ways to reduce the risk of loss as they move forward with their business. This can include several initiatives, such as regularly conducting a risk-assessment of their business, getting adequate insurance coverage, and protecting their business data and networks with things like effective data backup, data encryption, and other cyber security measures.
In short, successful entrepreneurs know how to successfully manage and reduce the risk inherent to starting and running a business, and being a big risk-taker doesn’t necessarily mean a person is fit to start a new venture. In fact, usually the opposite is true. Confidence and boldness coupled with the excessive gambling of resources is not a winning combination.