Managing Risk in a Start-Up
The Burst Bubble
The new economy created rapid growth and sudden wealth for many young companies, a great deal of which we all know now has dissipated. As the pink slip parties become routine, it's become a time of introspection at many a start-up. Was our expansion too rapid? Did we expect results too fast? How could we have not considered what we would do if (and when) the bubble bursts and the economy slumps? Did we fail to disclose everything to investors or did we exaggerate just a little too much? Did we embellish our company's circumstances to get business? Did we deceive employees with regard to their expectations?
Surely entrepreneurs are pondering how they could have done things differently, but are they really debating whether their ethical standards were partly or wholly to blame for their downfall? Well, for the most part, they're probably not. However, many failed start-ups might have better managed their risk with an extra touch of integrity and a carefully considered risk plan.
What is the risk in risk management?
Risk is one of the reasons that many people get involved in a start-up. Bringing that great idea to fruition is exciting. However, many entrepreneurs do not consider instituting measures to manage the inherent risks that come along with the attempt to turn that great idea into a success story.
A risk can be defined as the possibility of loss, injury, disadvantage or destruction. In terms of a start-up company the plethora of risks involved can relate to strategic, market or credit activities. Additionally, they can be programmatic, technical, cost or schedule related to name just a few. The risks obviously vary from industry to industry.
Entrepreneurs accentuate the positive when courting potential investors, customers and employees. There is a widespread feeling among entrepreneurs that if a new company isn't cocky and isn't bombastically self assured in its launch phase, no one will look their way. In order to give this appearance, entrepreneurs may fall victim to embellishing on their company's situation. If the company is a great success nobody gets hurt, but plummeted stock prices and the proliferation of dot bombs are indication that more than a few investors/ customers/employees would have preferred that the start-up had come clean up front. Had they done so, the company may have started out smaller, with less venture capital (if at all) but might still be around today in a small but stable form.
An example of a small but stable start-up, that started with no venture capital is CMB Associates, (CMBassoc@aol.com), a Direct Mail and Premium/Incentive consultancy based in New York. The company owner and president, Carey Berg is a former director and V.P. of American Express. When he started his own firm, Berg was able to leverage his numerous contacts in the Direct Mail and Premium industry to get his business started with limited start-up funds. He was able to do this by setting up a comprehensive network of sales agents throughout the U.S. and Canada, that worked on a commission-only basis. This structure also included percentage bonuses based on achieving pre-set sales goals. Additionally, once CMB Associates began showing concrete results to the corporations they represented, they were able to convince these companies to help finance some of the marketing activities that would enable CMB to further grow their business and consequently sell more of these companies' products. These additional marketing activities included key functions such as exhibiting at important industry trade fairs, conducting sales meetings for sales agents around the country and making sales trips to see their customers plus working directly with the individual sales reps. By creating this structure, CMB Associates was able to gradually grow their business and at the same time, limit their risks as a start-up.
The basics of risk management
According to the Carnegie Melon Institute, risk management is a practice with processes, methods, and tools for managing risks in a project. It provides a disciplined environment for proactive decision making to assess continuously what could go wrong (risks), determine which risks are important to deal with and implement strategies to deal with those risks.
Managing risk is akin to protecting a computer from viruses, says Kirk Walsh, a senior manager with the consulting firm Risk International Service Inc. in Charlotte, N.C. Just as a PC needs the latest virus scanner to identify malicious software bugs, Walsh says, a company needs to "scan its entire system" by conducting a comprehensive audit, addressing any quality problems or faulty risk-transfer mechanisms and establishing a means to monitor future events.
Providing for risk in the start-up phase
Most start-ups are not concerned with defining their risks let alone managing them while the company is still in the early stages. Instead of anticipating what might go wrong and integrating the management of risks into their program management, entrepreneurs are involved with putting together a customer base and organizing their business structure. They are occupied with hiring personnel and office management. Additionally, they are busy with getting the new company known through advertising and networking and obtaining the proper financing to stay afloat until the business is up and running. But by then it is often too late. What results is, to use the well-worn term, "putting out fires", or more technically put, "crisis management".
"If you have to rush through a job, and cut corners to make it on time and within budget, it ends up costing ten times as much in the long run and you run the risk of having your new company's image tarnished, which is the death toll" advised Sean McInerney of Atlanta, Georgia. This is the lesson he took away from his failed start-up venture. Reflecting on the initial stages of his start-up, McInerney felt that he could have eliminated a great deal of risk from his business by properly planning and pricing the projects from the very beginning. He claims that it is something that he should have learned over and over again. "After the initial hoopla and the incoming investment money it is so important to make sure that you're accurately pricing your project to coincide with your available resources and schedule." The motto at his new start-up is, "If you don't have the time to do it right the first time, when will you have time to fix it later?"
Insurance and the risks of partnership
Since each business is different , there are different types of risk involved. An entrepreneur can buy insurance for tangible risks which covers common eventualities, as well as specialized insurance for particular risks that are inherent to a particular field of endeavor. The entrepreneur needs to do some creative brainstorming in order to provide for eventualities. For example, Anne Koark and Uschi Plötz, two businesswomen based in Munich, Germany, tried to discuss all eventualities during the launch phase of their company, including what they would do if the other one died. The company was starting out without venture capital. They calculated that the costs associated with renting their office space alone totalled DM600,000 over the five year period of the lease; an amount that could bankrupt either one of them if the business didn't succeed. The possibility of failure would be increased tenfold, they figured, if one of them had to carry the business on their own. Therefore, they decided to take out a personal two way life insurance policy. They also decided to take out invalidity insurance policy for each of them. They reasoned that if one of them contracted a long-term sickness, they would have to hire someone and pay them a hefty salary to assume the responsibilities of the incapacitated partner.
Insurance is only part of the package that an entrepreneur must consider. Contingency planning for non-tangible hazards is just as important as insuring against losses. The entrepreneur needs to be involved in an ongoing process of analysis and communication as an integral part of the business, be it alone or with his or her partners.
This is where the philosophy of the company comes into play with regard to the integrity factor. For example, the two partners discussed above, Anne Koark and Uschi Plötz, put their philosophy on their sleeve by naming their company "Trust in Business". (www.trustib.com) The company which assists international start-ups in setting up subsidiaries in Germany decided to make the association with "trust" a number one priority. During their start-up phase, they entered into negotiations with suppliers, banks and service companies who would be of interest to potential partners, suggesting that volume discounts be reworked such that the volume of their customers be taken as a basis for offering discounts to their customers. The idea was not to find an additional source of income by cashing in on commissions for referrals but to find a direct advantage for customers. Their customer base began to expand based on this one action. The fact that they were willing to forego a commission was proof for the customers that they were true to their name.
The effectiveness of a policy of trust
To address this idea, one needs to first begin by considering what "trust" means within one's own industry and culture. For purposes of this article, I am defining trust in terms of dealing with a business partner or customer in a straightforward and sincere manner and giving them the honest feeling that they are being listened to, taken seriously and that they can reasonably rely on your information and actions. The U.S. still adheres to the old adage that the customer is king. A customer doesn't want to reinvent the wheel each time it has to do business. If it comes upon a company that it knows it can trust (in this sense), is reliable, and addresses its needs, it will remain loyal. The customer not only removes all risks associated with doing business with a new partner but it is also acting in a more time efficient manner.
Managing the risk of de-motivation
All start-ups need to recruit enough people to carry out their plans. Designing the organizational roles and then finding the right people to make it all fit can be daunting. At the same time, it's key for all start-ups that they become a company where all employees feel genuinely cared about. A young company runs a potential risk of falling apart if they don't put together a motivated and capable staff.
The capability is in most cases not the problem, as the company can tailor their employee search to fit the qualifications that it requires. If the company discovers that an employee is really not qualified for the job, then it can let him or her go. Excising an employee, however, will not solve a demoralization problem. It in fact generally has the effect of bringing the morale down one more notch. Motivation runs like an undercurrent in a company, and at best is infectious. Unfortunately, this is also the case when there is a lack of motivation in a company.
Many a start-up brimming with venture capital has made the mistake of assuming that their remuneration packages would keep the staff motivated. A pay check alone has never been enough to keep employees' motivation on a high wire over an extended period of time. In managing this risk of motivation, the company should be realistic with its employees about their career opportunities. Failure to do this will result in employee dissatisfaction and a high turn-over.
It is of crucial importance that the top management not only cultivates the company's level of motivation but that they maintain it as well. Most start-ups staff a business that hasn't even started yet. At that stage, the motivation is high because everyone has the sense of pulling together for a common goal. Once the business is up and running, it becomes an art to keep the employees and that's where a well defined risk management plan with regard to motivation should be put into effect.
Debra Woog McGinty, director of People Strategy at Cambridge Incubator, has found that one of the biggest challenges at a start-up is getting all the members aligned to one vision. When morale is low, a lot of listening and a lot of expressing the strategy and the reasons why the company is working toward those goals is helpful. Additionally, celebrating success of the past and the ones that the company is shooting for, boosts morale.
Taking Calculated Risks
Trust in Business couldn't service their newly acquired customers without office furniture, yet they didn't have any capital to purchase it; a classic catch-22. They approached a local office furniture company, Leonhard Bürogestaltung GmbH Furniture and told the owner of their dilemma, making it perfectly clear that they didn't know if and when they could pay for the furniture and equipment. Stranger things have happened, but Thomas Bromberger, CEO of the company, had a good feeling about the two motivated women and after reviewing their potential client list, he decided to take the chance. He sold them the office equipment on credit without a specific deadline for paying him back. The calculated risk was necessary for the new company to do business. They were in fact able to pay Leonhard Bürogestaltung GmbH back. Bromberger's risk, which he says he based on his business instincts, paid off for him as well. He is now one of the company's most valuable customer references.
Formal v Informal Risk Management
Few start-ups budget the money for an outsourced risk management expert, let alone a formal risk management department. However, just about all established companies of any substance have a formal risk management department. The logic behind these departments, according to the Carnegie Mellon Institute, is that without them, management will not have insight into what could go wrong, consequently more resources will be spent correcting problems that could have been avoided sooner, catastrophic problems (surprises) may occur without warning (and with no recovery possible), decisions will be made without complete information or adequate knowledge of future consequences, the overall probability of successful completion of program is reduced, and your program will always be in a crisis.
An early "risk manager" once said …"An ounce of prevention, is worth a pound of cure." This statement by Ben Franklin was actually fire-fighting advice. Fires were a very dangerous threat to Philadelphians, so Franklin set about trying to remedy the situation. In 1736, he organized Philadelphia's Union Fire Company, the first in the city.
Start-ups without the financial resources for formalized risk management can still informally identify and analyze their risks on a regular basis for relative importance. According to Jarrod Bassman, manager with Arthur Andersen LLP, a company asking itself the following vitally important questions will help in setting an appropriate risk management strategy: "What are the company's objectives? How does it define risk? How does the company feel about risk?" It's wise for a start-up to make all levels of employees aware of the risk management challenges and involve them in the identification of the risks.
Once a start-up has identified the potential risks, the next step would be to examine each risk and cross train employees to handle them, so that the company does not have to concern itself with the potential risk each time someone leaves the company or is absent due to vacation or illness. Although it may seem mundane to the staff, they should learn what to do if, for example, the email server goes down or if the copy machine doesn't work. If there is no technical staff at the company who can deal with the identified risks, the employees should know who to call if such an emergency occurs. It is helpful to create a directory of all of the company's equipment, and the service sources.
The entrepreneurs themselves may not be able to identify certain risks that, say, their accounting staff or secretarial staff might be able to. All employees bring their own personal experiences with them to the workplace and the pooling of knowledge can be invaluable to the new company. An open dialogue that runs throughout all levels of a new start-up will have the added benefit of keeping the morale high, since all employees will have the well-justified feeling that their opinions count and that their input is influencing the policies and direction of the company. Additionally, it will result in piercing any veil of mystery that may be shrouding the employees' views of the actual state of the company.
Stacey van Hooven is an American attorney living in Munich. She is a consultant on American- related business and legal issues. She works in cooperation with Trust in Business, www.trustib.com, a full service company for the start-up phase of international subsidiaries in Germany. For further information, please contact Stacey van Hooven at Stacey@Trustib.com .