Thinking Risk: Is Your Business Plan Ready for the Worst?

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Foundation cracked; business risk conceptWhen you think about your business plan, what comes to mind? Maybe it feels like a repository for all your ideas or goals—all the things you want to accomplish. Or maybe you’re framing it as a list of compelling reasons for others to invest in your small company or hire you as a consultant.

Though ultimately the document should set out what a considered, healthy startup looks like, it can be hard not to take a promotional track. It’s even harder to be risk-aware when we want to be promotional.

Sure, any good business plan discusses potential risks a company might encounter; you don’t want to be blindsided by an unexpected turn of events and you definitely don’t want to be dishonest or just naive when courting a valued investor. So when we talk about risk in our formal plans, we typically mention them and then offer all the ways we can mitigate those risks as a matter of convention. We don’t really imagine these bad things could actually happen to us—but that’s where the numbers come in.

Business plans should lean heavily on data if they want to paint a clear image of professional potential while also grounding entrepreneurs in the reality of the field. Additionally, investors are primarily motivated by data. They aren’t carried by false optimism and generally have no personal investment in your idea. Running the numbers is the only way to court them successfully.

We tend to overlook the fact that entrepreneurs are natural risk-takers with an inclination toward optimism. When we take risk seriously, though—when we treat it less like a sales convention and more like a real possibility that will trip us up regularly—everything about the plan changes. A smart plan, then, mitigates risk at every step and can keep you from imposing those risks onto unwilling participants. Plus proactively thinking about and dealing with risk factors will keep you in the game for years to come.

Enumerating risk matters

One reason that startups encounter significant unanticipated problems is because entrepreneurs have a tendency to overlook certain small yet common problems when writing their plan. In essence, we tend to think big and strategically. That, in turn, results in overlooking the situations that cause the most common losses, such as server outages, data breaches, or property damage. Business plans tend to get so caught up in the most pressing issues of operations that these everyday risk factors don’t make the cut.

One way to reduce the likelihood that you’ll neglect common risk factors is by hiring a risk management consultant when writing your business plan. The expense may seem out of your range at first, but consider how much you can save by being prepared for these everyday disasters. After all, most startups fail within the first five years—58 percent of finance startups are still operating five years in, but only 37 percent of information startups remain.

What does successful risk management consulting look like? Consider one tech firm with no prior losses—they don’t exactly sound like a company that needs help with their risk management, but it turns out there was plenty of room for improvement. KMRD Partners, their risk management firm of choice, identified numerous coverage gaps, including failure to protect against outages in five of their six locations, lack of flood coverage in a high-risk location, and lack of computer fraud coverage. KMRD’s resulting plan helped the company save $130,000 and serious reputation harm.

Why risk planning equals success

When entrepreneurs start accounting for risk during the planning phase, we initiate an entirely new kind of thinking, a kind of risk-aware definition of success. True success generally isn’t blemish-free—making mistakes and recalibrating is an essential practice. You can succeed within legitimate parameters even if you suffer setbacks or lose clients. It all depends on how you define success, and how you deal with the aftermath.

Too many entrepreneurs fail to define success in the business plan; without a clear framework or a set of milestones for interpreting progress, you’ll find yourself adrift in a sea of questions. Sure, a particular project went well, but does that constitute success? What about having five clients? Is that success? What if you took on seven clients and lost two? Well, whether or not those things constitute success depend on your milestones or key performance indicators. A local bakery is going to set different milestones than a tech startup, but either way, the variables are scaled to sustaining that particular enterprise.

When you have milestones, you’re able to take risks within a secure framework because you know the endpoint. A milestone is different from a step-by-step plan, though, because if you deviate from it, there’s no harm done. You can take a winding path—reassessing as you encounter challenges—and still meet your overall goals. You might make a detailed plan to meet a milestone, like filing legal paperwork, launching a specific project, securing a particular number of clients, or reaching a profit level, but formality isn’t required. Just make sure you have a sense of the steps you need to take to work toward the milestone. If you have employees, this will also give your team more freedom to lead a project based on their own instincts and expertise.

How hedging transforms decision making

Another factor in risk-aware business planning is the concept of hedging your bets as a form of self-protection. Hedging, as practiced by investors, involves splitting up your investments so that if a stock or particular market sector goes south, you don’t lose everything. Another way of thinking about hedging is a kind of portfolio diversification. Entrepreneurs would benefit from taking a similar (though nuanced) approach in their decision-making.

Small operations need to take a different approach to diversification than a wealthy investor or large corporation, but it’s worth considering from a sustainability standpoint. For startups and small companies, product diversification typically means making small adjustments to a service or product, adapting it for both professionals and hobbyists, for example, or stocking related products that the company can upsell to increase their customer base—really it’s about understanding the target market opportunities. You don’t want to diversify in a way that spreads your efforts too thin, but rather in a way that connects, integrates, and foresees customer needs.

By integrating risk awareness and hedging into your decision-making culture, you aren’t abandoning your principles or being wishy-washy; rather, you’re just ensuring you don’t “lose the farm” on the basis of a single decision. That means that you learn to draw up budgets with a sense of what might go awry or change operational procedures while focusing on long-term sustainability. It bears repeating that you’ll want to make decisions about diversification that are based on research and data—both in terms of what the market will bear, and based on what you’ve observed about the buying habits of your own customers.

One way to do this is to run simulations of projects using spreadsheets, scatterplots, and Monte Carlo simulations, and refuse to simply accept assumptions even when your gut says you’re right. Beyond that, keep your finger on your financials. It will help you sleep better and you’re more likely to stumble on potential issues before they’re threatening your viability. Risk-aware decision-making is a strategy unto itself but it takes training from more experienced entrepreneurs and risk management consultants. You learn to see risk everywhere in much the same way you learn to spot a good idea or do your taxes—through hard work, curiosity, and persistence.

Why financial protection matters

Even if your business is small, you carry insurance, right? But are you carrying enough insurance and the right types?

How much insurance you need depends on factors ranging from your field to your physical location. For example, many North American companies have been impacted by a protection gap when they have suffered losses due to flooding or forest fires. Urban, inland companies may have more to worry about from manmade disasters—think the I-85 collapse that recently affected Atlanta, significantly impairing area commutes. No one could have predicted that collapse, but it’s still important to be aware of how disasters can affect your vitality.

Generally, you should consider taking out more than just basic liability insurance. It makes sense for some startups to consider commercial property insurance, which protects from damage or loss of inventory, and from environmental or fire damage; workers compensation insurance, which covers on the job injuries; and vehicle insurance, which covers any company cars and vans, if applicable.

Recent studies reveal that the majority of businesses that face some kind of disastrous circumstances, whether natural or man-made, don’t carry sufficient insurance. According to Wharton School professor Robert Borghese, the problem is that most treat insurance as a commodity rather than assessing their real need. Couple this with an increased rate and severity of disasters and we’re seeing an enormous protection gap. That gap represents the difference between the insured losses and the actual economic losses. In 2015, that gap was $56 billion globally.

No business is too small to insure, and while a startup may have less to lose, as you become more established and bring in more revenue, you’ll want to insure against a range of disaster scenarios. Scaling up your insurance, then, should be part of your long-term business plan. Consider that in a fairly standard, low-risk industry, you’ll pay about $425 annually for a $1 million policy. If a flood wipes out your servers or you suffer a major data breach, you’ll be glad you have that coverage.

Not only are your premiums small compared to what they cover, but when emergency strikes, insurance paves the way to professional survival. When Burton Metal Finishing, Inc., a company based in Columbus, Ohio, was hit by a fire in 2013, for example, that could have been the end. Burton is still operating, though, because they had business interruption insurance. Though it didn’t cover everything, the family-owned company was able to bridge the gap using family savings. Still, the insurance covered over $6 million in damages. Vice President Scott Burton has no doubts his premiums were worth it to keep the family operation running.

Remember: If you think you’re being overcharged for insurance, don’t be afraid to consult with different companies, get quotes, and consider negotiating. A mentor can also help you decide how much coverage you need to start out.

Ultimately, your business plan should offer a clear view of the future, including both ideas about development and diversification and risk mitigation strategies such as insurance investments, company oversight and bylaws, and consultancy contracts. It should assure potential investors that you’re grounded within your field and making data-driven decisions. It’s the foundation for a future in which your investors are your partners.

Learning to think about risk is one of the most important skills an entrepreneur can acquire—in more ways than one. It’s a delicate balance between being able to take calculated risks to develop the ideas that have potential to be brilliant, while being savvy enough to determine when to step back. It helps to be able to see the risk in even the mundane and mitigate it so that you can focus on the real work of running your business.

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Posted in Business Plan Writing