Managing Entrepreneurial Risk and Petting Strange Dogs
Written by Dr. Drew Starbird
October 26, 2022
We all know that risk is the chance of bad things happening in the future. Everytime we go for a drive, pet a strange dog, or buy Twitter stock, we are taking a risk. Risk “aversion” is how economists describe our preference for a low probability of a negative outcome. I wear my seatbelt and drive in the far right lane, I never pet strange dogs, and I only buy US Treasury bonds. I am risk averse. But what about entrepreneurs?
The conventional wisdom is that entrepreneurs are bold risk takers who are willing to put everything on the line for their ideas. However, according to Raffi Amit, former academic director of Wharton’s Goergen Entrepreneurial Management Programs: “There’s a myth that entrepreneurs are risk takers. But research has shown that they try to manage risk.” How do they do that?
The first step in managing risk is understanding and describing the risks that your business faces. To me, the five risks facing every small businesses are financial risk (running out of money), product or service risk (failing to solve customer’s problem), marketing risks (customers don’t know about you), competition risk (taking away your customers), and operational risk (wrong stuff, wrong place, wrong time). These aren’t the only risks, of course. There are a number of other risks that depend on the type of business. For example, businesses in highly regulated markets face compliance risk and data intensive businesses face a growing cybersecurity risk. Whatever your business, you need to describe your risks before you can manage them.
The second step in managing risk is making sure you create a mindset that puts risk in perspective. It’s easy to overlook risk. We do it all the time because most of us, and especially optimistic entrepreneurs, are focused on reward. It feels good to drive fast and pet dogs - even strange ones. Putting risk in perspective means that we need to be able to do five things: to accept uncertainty, to estimate probabilities, to forecast payoffs, to accept losses, and to recover quickly. Some of these aptitudes depend more on the entrepreneur, like accepting uncertainty, some depend more on the nature of the business itself, like estimating payoffs, and some depend on both, like being able to recover quickly when things go wrong. Are you going to pet that strange dog? If so, accept the uncertainty and estimate the probability you might get bit. Weigh the pleasure of petting a dog against the pain of the possible bite. And, of course, even if you do get bit, don’t stop petting dogs!
The third step in managing risk is making it a part of the conversation. Whether you are talking to investors, partners, employees, or even customers, you need to be fully transparent and honest about the risk your new business faces. No one wants to be the “Debbie Downer” in the room, but ignoring risks, or assuming everyone understands the risks is not managing risks. As an entrepreneur it is your responsibility to understand the downside and the upside, share your assessment of the chances of success, and talk about what success and failure look like with others on your journey. Good luck!
Drew Starbird is the Executive Director of My Own Business Institute (MOBI) and Professor of Information Systems & Analytics at the Leavey School of Business.