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Managing Risk in a New Venture BY Jay Ebben, Ph.D.
You can't get rid of all the risk of starting up a business, but you can certainly take a few steps to mitigate it.
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Most definitions of entrepreneurs that I have seen include something along the lines of "someone who takes risks." While there is certainly some level of risk in every new firm, the process of starting a business should not be about taking risks; rather, it should be about managing the risk that is involved. There are two main sources of risk in a new venture: the risk due to uncertainty surrounding the business and the risk due to what is at stake if the business should fail. You can't get rid of all risk from either source, but there are steps you can take to mitigate it.
Risk Due to Uncertainty Surrounding the Business. No business is a sure thing, but much of the uncertainty can be resolved through analysis of three of its sources: the market, the operational model, and the financial model. Market risk is a result of many factors, including whether the market is large enough to support your business, whether the market is growing, what trends exist in the industry, how the competition is structured, and how distribution works. If industry trends are moving away from your product or service or if potential customers are already locked up by competitors, it will be difficult to gain customer momentum. The issue of market size is also important in feasibility analysis. For instance, if you are starting a microbrewery, it is important to understand that your market likely is not the nationwide microbrew market, nor the local beer market. It is more than likely the local microbrew market, which is much smaller. Additionally, you should understand what regulatory trends are occurring: If you want to open a cigar shop and lounge, for instance, you would be wise to consider the potential impact of anti-smoking laws. Again, though you cannot get rid of all of the risk in entering a particular market, you can reduce your margin for error by understanding the nature of the market and customer buying behaviors. As a mentor of mine likes to say, "Become a student of your industry."
Operational risk deals with whether the business can set up internally to deliver goods and services to customers effectively. For product-related companies, this will include manufacturing and assembly of goods, which is often difficult to set up in terms of cost and quality control. This is even true if outsourcing to experienced firms. For instance, your manufacturer in Asia may ship you goods that have the logos sewed on upside-down -- a simple mistake but significant problem (This happened to a start-up I know in the Twin Cities). Operational risk will also include logistical issues with delivery and returns and effective use of service staff. Remember that your ability to execute internally and keep costs under control will be essential to business success.
Financial model risk refers to the risk that the business won't work due to the numbers. For any business, you should generate financial projections to get a picture of where breakeven will occur and what will drive the business financially. In other words, make sure to understand what revenues and costs must be in order to make the business financially viable and what factors impact revenues and costs the most. This will tell you your critical factors for success and provide you with tools for managing the business. For instance, if your main cost drivers are labor and materials, then you should concentrate on methods that ensure efficient use of labor and lower input costs. Remember that the financial model paints the picture of all aspects of the business and that the business cannot be