Dealing effectively with risks–anticipating, managing and avoiding risks–is a key element of the CEO's role. When/if you have investors or outside board members, they normally share the risk management responsibility. However, if potential investors and key allies judge you incompetent or unreliable at risk management, they are unlikely to join your configuration.
The capacity to recover from negative consequences is correlated to the power and resources of the enterprise–the less robust the enterprise, the greater the danger posed by risks. In my experience, risk management can be a very challenging domain for entrepreneurs. Without some tolerance for risk, ambiguity and uncertainty you would never have launched the enterprise you now lead. Usually the CEO is the chief promoter of the company, and developing rigorous narratives of risks differs from developing narratives of strengths and opportunity.
What is Risk?
Risk comes from not knowing what you are doing. Warren Buffet
I remember Warren saying at one of the annual Berkshire meetings, "If you're writing insurance and you don't know what you're doing, you can be in a rowboat in the North Atlantic and customers will find you."
Risk is an assessment or interpretation we make in a domain of concern or action. Risks are situations–present or anticipated, that threaten accomplishment of your ambitions and intentions; risks are sources of harm and/or thwarted intention.
As an investor, I seek to develop 3 key narratives regarding risk:
- Is the CEO sufficiently capable and trustworthy to source and lead a team and culture to compete successfully in the marketplace?
- Are any other key individuals–executives, investors, founders, etc.–sufficiently capable and trustworthy to follow, contribute and do their best to have the enterprise succeed? (I am always surprised to find key individuals with much to gain from the success of the business acting in ways that thwart the CEO, the strategy and the operating plan.)
- The industry or market:
- What interpretation of the forces of the industry do I accept?
- Does the CEO have a market analysis?
- What is the market in which the company can be a leader?
- What is the company's competitive advantage in this market?
- How stable and robust is this competitive advantage?
- The investment:
- Does the pre-money valuation compensate me for the risks I assess?
- How and when will I get my capital back?
- Do I accept the narrative of how the company will increase value? Is the narrative complete, or is it high concept?
- What help does the CEO have to develop the enterprise? Do I assess this configuration as sufficient and satisfactory?
Other Sources of Risk
Business model risk –Is there a clear business model? Do the unit economics seem to work? If not, what are the assumptions required to achieve [maintain] profitability?
Execution risk – Does the team have the right skills and passion to reach their goals? If not, are they amenable to finding others to complement their skills?
Capitalization structure risk – Does the company have enough room in the cap table to take more investment necessary to grow while still ensuring employees and executives are well compensated?
Legal risk – Does the company have a high likelihood or lawsuit for patent or copyright infringement? Does the company have outstanding complaints with early employees or founders? Are their regulatory challenges involved in this sector?
A Practice for Risk Assessment
If you're thinking of raising outside capital, or just intrigued by reflecting on risks, I recommend a project for assessing your business as a prospective investor would. I suggest the criteria and standards for assessing a business specified in Venture Investing by David and Laura Gladstone.
Relevant Prior Posts
Photo Credit: Flicr user/Kristen Becker