A business mentor, founder and president of BetaMed SA, talks about risk assessment and the chances of making decisive moves.
Most novice entrepreneurs want to reduce the risk associated with running a business as much as possible. As inexperienced people, they are often unable to assess this risk, which prevents them from starting a business. What are the most common mistakes in risk assessment?
Candidates for entrepreneurs often underestimate the risks associated with working full-time and overestimate the risk associated with running their own business. The risk of dismissal or collapse of the company employing an employee does not have to be lower than the risk of the collapse of one’s own company. Additionally, in the latter case, we can have a much greater influence on the development of the situation.
To start your business
I consciously quit my job as a nurse. My work was my passion and it has remained so too. So the risk was relatively small, but I had serious concerns anyway. Today I know that I did the right thing.
I also remember all the time when BetaMed was a small company. My doubts and fears meant that I always tried to devote a lot of time to risk analysis. The development potential that I have seen and can see all the time meant that I was able to risk quite a lot.
Inexperienced entrepreneurs often judge the risk itself, rather than judge it
relationship between risk and profit from a given activity. If our income from business activity is several times higher than the income from full-time work, then we can and even should accept a higher level of risk. We should also remember that there are tons of tools to limit or diffuse risk. First of all, these are knowledge and experience, but also various financial instruments such as insurance, bank guarantees, forward transactions and options.
What risks must a novice entrepreneur be prepared for?
Let’s start with the most obvious statement – all markets are ruled by uncertainty. We do not know the future prices of raw materials, materials needed for production, market levels of wages or exchange rates, as well as the prices at which we will be able to sell finished products. We can only estimate the values of all these variables based on uncertain premises.
We must also take into account that, for example, we will not be able to solve a technological problem, or that a competitor will do it faster than us. With the current level of state interference in the economy, there is a high risk of the entry into force of unfavorable legal changes, credit risk, risk of accidents and natural disasters, or deliberate actions, such as theft.
Quite a lot for a beginner entrepreneur.
Exactly. Only, as I said before, this is not the right way of thinking. Risk works completely different. Let’s start with the market uncertainty. Material prices may rise, but may also fall. In the first case, there is a threat to economic activity, but in the second, there is an opportunity. And please note that the probability of both events is usually around 50%. Competition in the market may become tougher, then we will have to accept a lower margin, but it may also happen that our competitor will fall out of the market, and consequently the profitability of our sales will increase. The rules may change to our disadvantage, but it may also be the other way around. Adverse random events may happen to us, but they can also happen to our competitors. If we look at risk in this way, we will immediately notice that the sum of the impact of various factors on our business in the long run should be close to zero. However, one should not draw too far-reaching conclusions from this, and it certainly does not mean that risk analysis is no longer needed.
In business, we will sometimes deal with the predominance of positive factors (opportunities), and sometimes with the predominance of negative factors (threats). We need a risk analysis so that we know what the worst possible developments will look like. Simply put, we need to know what the losses will be if the venture fails, if and how we will be able to cover these losses, and if we will then have the resources to continue our operations.
Does this mean that when starting a business, we have to think about what will happen if it fails?
Of course. It should be remembered that in the case of sole proprietorship, we are responsible for the company’s liabilities with all assets. A sole proprietorship is still a favorable legal form for tax reasons, but when deciding to do so, we must be careful about the amount of liabilities taken. This means that then we have a rather limited possibility of financing the enterprise from external funds.
And external capital may be necessary, all the more so that with the currently observed level of intensity of competition, companies must grow quickly. They need working capital to take advantage of market opportunities, so if the founder of a company does not have large financial capabilities, you need to look for capital from banks, investment funds, private investors or the stock market. In such a case, a capital company will almost always be the more advantageous legal form. However, also then, issues related to raising capital will be a key factor influencing the level of risk.
We went back to discussing the adverse scenarios again, but there are advantages to risk as well.
As a rule, it is assumed that the greater the risk, the greater the profit if everything goes as it should. However, for this to be true, we must make sure that we know exactly what rules of the game apply to us. This means that we must carefully check the credibility of business partners and, on an ongoing basis, reliably analyze emerging risk factors.
Perhaps the most important thing for novice entrepreneurs is to understand that in business it is impossible to get rid of risk. The economy could not function without uncertainty, so you have to befriend or, in other words, understand the risk. If we learn to properly assess the impact of the environment on our company, there is a very good chance that our chances of success will be higher than 50%. Moreover, there may be times when risk mitigation becomes detrimental to you as it lowers your potential profit. This means that business requires courage, but it must be wise courage, based on knowledge and experience.