Reducing Risk to Startup Safely Successful Entrepreneurs Know How to Deal with the Downside
Reducing Risk to Startup Safely: Strategy is tough for entrepreneurs when they love their product so. They just want to get on with it, producing and selling what they’ve got. Let’s do it now—they say.
When approaching strategy with entrepreneurs, I have a tendency to ask them how small can they start, rather than how much money do they need? Isn’t that a bit demotivating? No, not at all. I want them to succeed safely, not burn and crash. They can aim at reducing risk to startup safely by many different mean
Baby Steps to Start
With the exception of hi-tech, or other capital-intensive startups, most new businesses do best by starting with baby steps, gaining their balance and learning to walk steadily, before trying to run, while at the same time calculating the potential impact of the downside. “What if…?’ is always a good question to ask, and then going on to answer the rhetorical question by figuring out what to do if the worst happens. Reducing risk to startup safely, should be a way of life for every entrepreneur.
Of course you need adequate funds for your startup, but what constitutes ‘adequate’ is a stiff question to answer. However, less is likely to be safer than more. There are too many stories of startups that were ‘overfunded’ and allowed the founders to be extravagant before sufficient revenue justified the investment. They may hire staffers when they could buy in expertise on an as-needed basis. They build infrastructure for growth too early. With money burning a hole in their pockets, they do too many things before they’re ready.. and expose themselves to running out of cash. Reducing risk to startup safely would be a much better bet.
Ready, Fire, Aim
Ready, fire, aim is the mantra of so-called lean startups: fail little, fail fast, and fail often. By this means, the aim can be much improved by experiment, rather than theorizing about what to do. Naturally you need a sound business model that describes how you are going to make money, but it starts with the problem you’ve identified and how you’ll solve it for your customers. By this route you should be able to practice SPQR—Small Profits, Quick Returns.
Today, with the cost of producing minimum viable products (MVPs) dropping through the use of the web, 3-D printing, and apps, big money raising at the start is progressively less necessary. The knee-jerk reaction of most people starting businesses is to spend huge amounts of energy on trying to raise equity and loan money, when they could be out selling and interacting with customers, or figuring out why prospects are rejecting their offers.
Raise the Bridge or Lower the Water
There are two ways to reducing the risk to startup safely: raising the bridge or lowering the water. Do you want to go for broke or start small?
Lowering the water is about keeping costs down, bootstrapping and sticking to the essentials, like ‘getting out of the office, onto the road’ and testing your ideas in the market. Your equity should be significantly made up of sweat equity, rather than being beholden to outside shareholders. It generally makes a lot more sense at the outset.
Raising the bridge is about building infrastructure, seeking equity and planning for growth. But it’s better to build value first, then fund when you’re ready. There is too much folklore about the need to find angel investors or raise other forms of seed money. It seems necessary, but it’s probably not.
Most dictionary definitions of the word entrepreneur, refer to a person who takes risks. Taking risks sounds to me like the rock climber who does not follow the simple rule of only moving one limb at a time. Foolhardy might be a better word for that kind of business person.
Whenever I have started a business I did indeed take calculated risk, but never risks, period. For instance, when I started my first business in 1982, I was in my mid-thirties, with five kids and a couple of mortgages. But I was very confident of my abilities, and if indeed the business did go belly-up, I could always find myself a job to support the family. Mitigating risk is often more effective than profit maximization at startup and maybe later, too.
So, while the company was always at risk, I never gave a personal guarantee to a bank, nor did I use personal credit cards to fund the business. Had I loaded them with debt, that would have stayed with me in the case of business failure, just as a personal guarantee would threaten the family home. This was a form of risk mitigation. I have produced some helpful Risk Mitigation Tools—take a look.
Lean Startup professionals push the new business to fail early and often, getting out into the marketplace fast and learning from customer feedback. The same applies to relationships with other stakeholders. If you seek a co-founder, don’t over-negotiate. Try something together and see how it goes, before moving on to something deeper. Think carefully about what wouldn’t work and test it out. You can set milestones, which once achieved, can bring the co-founder to the next stage of ownership or responsibility.
Conserving cash sounds miserly, but actually it isn’t. Too often bankers have told me that founders seek loans when their debt load is already too heavy, or their sales simply could not support any more interest payments. Reducing risk to startup safely involves prudent financial practices, not profligate ones.
On the other hand there are many new ways of raising money that need not involve spilling cash. Revenue based loans, for example, provide entrepreneurs with growth capital in return for the financier being paid a small percentage of future revenues. Technically it’s a loan, but there are no fixed payments, no set time period for repayment, and no set interest rate.
A lot of startup entrepreneurs that I meet, make a great to-do about profitability, and early break-even. They produce spreadsheets of income statements showing exponential growth in profits from month one. They will be sorely disappointed. This comes from the misguided notion that they have to do that, rather than demonstrating positive cash flows through the early stages. You surely do want to figure out when you may breaking profit, so here’s a Breakeven Analysis Tool.
In my first startup we made no profit in the first two years. In the second two, our focus was on growth. These years produced solid cash flows so that in year five we could really concentrate on profit.
This blind addiction to striving for profit from the get-go masks another sort of risk. It is likely to impel charging high prices to achieve high margins, when the better route might be to look at reducing unit costs, or increasing volume through lower prices. Staying alive needs the entrepreneur’s full attention. The customer must love you and come back for more, not admire you for your business investment acumen. Understanding what will get in his way should be a top priority. This means focusing on his needs, not your desires—or even those of your backers or bankers!
Hindsight, Foresight, Insight
Avoiding surprises sounds like a pretty depressing pastime, but it’s not. Strangely enough, as behavioral scientists will tell you, we have a natural propensity to be more creative when thinking negatively, rather than positively. Your brain is simply built with a greater sensitivity to unpleasant news. Research tells us, bad feedback has much more of an impact than good feedback. Those of you who have practiced brainstorming, will have noticed that a team will come up with more reasons why something won’t happen than reasons that they will. This is also true when working on a force field. You’ll get more resisting forces than driving ones.
So, a startup should use the ability to dwell on what did not go well in the past (hindsight), to develop opportunities to succeed against the odds of getting things right, through foresight. It turns out that kicking away the chocks propels the business forward even better than the best laid plans.
A good way to think about strategy is to first analyze failures through hindsight, then with the knowledge gained applying foresight, before being able to develop insight. The best strategists are thus able to both raise the bridge through planning, at the same time as lower the water by mitigating risk.
You could usefully take a look at what Leo Polovets has to say about how to de-risk a startup. He’s a self-confessed nerd and a partner in Susa Ventures, since 2012.