Startups are inherently and deliberately risky ventures. A strong understanding and appreciation of risk is an essential skill for successfully managing a startup.
Risk management is the process of systematically identifying and measuring risk, and taking steps to reduce risk where necessary. This is risk mitigation.
So how do we define risk? Risk can be defined as the likelihood of losing money or reputation. This is usually the result of an expenditure or investment decision which does not provide a sufficient corresponding return.
Not all risk is created equal
In risk management there is an old adage that contends that risk and reward go hand-in-hand – in other words higher risk results in higher rewards, and vice versa. However this is not always the case, and for startups it’s critical to distinguish between risks worth taking, and risks which won’t yield significant outcomes even if successful.
Types of risk and mitigation
Risk comes in many forms. The greatest risks faced particularly by startups and possible mitigation actions are listed below.
Put simply, the greatest risk for most startups is running out of cash – being unable to generate sufficient cash (from sales or from ongoing capital raising) to cover expenditures.
Possible risk management actions to mitigate this risk include;
Having a standby source of cash available
- establishing a facility with your existing investors to raise additional investment funds at short notice by way of issuing additional Equity, Convertible Note, etc
- establishing a debt facility – for example, an Overdraft facility or Mortgage redraw facility
Maximise runway and financial flexibility
“Runway” refers to the estimated length of time (using conservative assumptions) that a startup can continue to operate before needing more cash. Lengthening the runaway can be achieved by minimising expenses, and keeping expenses aligned with revenues to the extent possible (i.e. by keeping expenses variable wherever possible – such as engaging contract staff for non-essential functions rather than full-time employees).
Market / Product / Customer acceptance
Risk management is also about getting to the right product or service.
Ultimately a startup will not succeed if its core product / service is not accepted and purchased by customers. Finding the right market and product fit can be time consuming and costly, and there is a real risk that the business will run out of cash before the successful fit is found.
There are several risk mitigation strategies which can be considered;
Start small, validate, and be prepared to pivot
Don’t proceed to build out products / services until you have received market and customer validation through feedback, limited trials, surveys etc. If the product or service isn’t working or gaining traction be prepared to reappraise and if necessary pivot. Don’t over-invest in an idea which isn’t working.
Use a lean approach
The “Lean” management approach is focussed on increasing efficiency, reducing waste and enhancing value. Employ lean “Build-Measure-Learn” principles to develop a focussed and efficient business model where validation is sought quickly and often.
Your risk management process needs to cover people.
Startups are often heavily dependant on key staff. The unexpected loss or disruption to key staff can have significant negative consequences. Mitigation strategies can include;
Implement appropriate incentives and retention strategies
Provide key staff with meaningful incentives in the form of restricted equity or options. Other retention measures include providing regular positive feedback and support and leadership / project opportunities – both of which have been shown to significantly improve staff retention.
Ideally staff structures should provide for a degree of role duplication to reduce reliance on key staff. However while this can be an effective strategy for larger startups it is often not feasible for smaller ventures.
Of course there are any number of other risks to consider – new competition entering the market, legal, regulatory, economic – the list goes on. Each type of risk should be evaluated, and mitigated where significant and feasible.
Many types of risk can be insured, from theft and fire through to cyber attacks and litigation. While insurance has an important part to play in risk management, it cannot be relied on to cover all circumstances so should be used where it can be supported in terms of the cost and potential benefit.
Startups are all about risk – taking a calculated risk on developing a new or improved product / service with limited funds. While there are formal structured methodologies for considering and managing risk, the key takeaway is that, regardless of the approach, risks of all types need to be actively considered, evaluated, measured and managed.