RISK

An Entrepreneurial Perspective

Why “Risk” May Not Be What It Appears

How to View Risk Entrepreneurially

Dr. Wendell E. Dunn, IIIUniversity of Virginia

Copyright 2002 by Wendell E. Dunn, III All rights reserved.

“RISK”A Working Definition

Risk“expected value of an adverse outcome”

Expected“probability/likelihood the event”

Value“impact/cost/implications of the event”

RISKY STATEMENTSMyth or Verity?

“Risk is a normal cost of doing business”

“Entrepreneurship means Small Business”

“Entrepreneurs are Risk-takers”

“Risk is Risk”

RISKY STATEMENTSMyth or Verity?

“Law of the Conservation of Risk”

“No Pain (Risk), No Gain (Reward)”

“Venturing is (inherently) ‘High Risk’”

RISK TYPESEntrepreneurs’ Perspective

“Business Risk”

Managerial (inadequate skill)

Market Demand (inadequate revenue)

Technological (core obsolescence)

Liability (liability, regulatory)

Liquidity (cash flow, cash out)

Financial (leverage, portfolio)

RISK TYPESEntrepreneurs’ Perspective

“Personal Risk”

Career (restart, opportunity cost)

Private Life (health, stress, family)

“Entrepreneurial Risk”

Exposure of (all) your assets to failure

RISKAlternative Perspectives &

Constructs

Finance: “Economic” vs. “Financial”

Portfolio: “Systematic” vs. “Un-systematic”

Insurance: “Pure” vs. “Speculative”

Entrepreneurial: “Essential” vs. “Optional”

OBSERVATIONSRisk & Behavior

Under-estimate familiar risks

Over-estimate unknown risks

Take unnecessary risks unknowingly

Most don’t (willingly) bear “extra” Risk

Many don’t recognize optional Risk

Risks taken are often assumed necessary

OBSERVATIONSRisk & Behavior

Risk “assumption” can be expensive

Negative market premium for excess

Risk

Risk is not borne by us alone customers, suppliers, employees, lenders,

investors, competitors, families,...

What Can We Learn from Entrepreneurs?

RISK MANAGEMENT What Entrepreneurs Know

Valuation ƒ perceived Risk, Return

Risk inversely related to Valuation

Risk perception is non-linear

Risks can be avoided (acquire assets)

Risk can be reduced, if not eliminated

RISK MANAGEMENT What Entrepreneurs Know

Risk can be divided (e.g., derivatives)

Risk can be shifted; transferred to

others

Risk can be shared with “partners”

Risk can be insured (for a fee premium)

RISK REDUCTIONTime-Honored (Insurance)

Techniques

Collect: any risk for a price, but get

paid

Information:“Know thy Customer”

Document: “Trust, but verify”

Cull: lose the Losers

Un-bundle: reinsure the most-risky parts

RISK REDUCTIONTime-Honored (Insurance)

Techniques

Safety: please, don’t feed the lawyers!

Educate: help policyholders help you

Protect: asset confidentiality/security

Kindness: the Golden Rule

RISK REDUCTIONSome Basic Mechanisms

K.I.S.S.: minimize system complexity

Innovate: simpler, faster, safer,

cheaper

Piggy-back: exploit marginalities

Skinny: minimum effective resources

un-Leverage: less debt (if advisable)

RISK REDUCTIONSome Basic Mechanisms

Leverage “intangible” (capital) assets

Parsimony: substitute sources (1st Law)

Isolate: compartmentalize risk (assets)

Exploit non-linearity in risk-reward

Stealth: “what they can’t see …”

RISK SHIFTING Some Basic Mechanisms

Superior Negotiations

Outsourcing: “Tom Sawyer Gambit”

Contingency Clauses (if, then …)

Negotiated Transfer (use “specialists”)

Compensated Transfer (e.g., insurance)

RISK SHARING Some Basic Mechanisms

Co-opt Stakeholders to create Partners

“OPM” (Other People’s Money) co-principals

co-investors

employees (401K investors)

customers

suppliers

RISK SHARING Some Basic Mechanisms

Pooled information (same assumptions)

Franchise (operating, financing growth)

DEVELOPMENT STAGE RISK LIMITATION

Lessons Learned the Hard Way

Rely on time-tested people

Identify, test, model key assumptions

Limit commitments (“toe-in-the-water”)

Fail Early, Fail Cheaply

(pharmaceuticals)

DEVELOPMENT STAGE RISK LIMITATION

Lessons Learned the Hard Way

Spend imagination and guts, not cash

Joint venture large, risky projects

Consider 2nd unless 1st takes the game

INCREASE COMPETITORS’ RISKSSome Basic Mechanisms

Exploit “Paradigm Paralysis” (blind spots)

Strive for “discontinuous innovation”

Obsolete existing investments

Let large firms spend rather than think

Undermine their business assumptions

Help them believe their own “hype”

DECREASE CUSTOMERS’ RISKS

How Entrepreneurs Sell

Hear and address “buying objections”

Identify risk-based “hurdles” (criteria)

Identify misperceived, exaggerated risks

Address “risk” concerns directly

Identify means to avoid/reduce/shift/share

Resolve residual risk with “guarantees”

CONCLUSIONSome “Take-Aways” on Risk

“Risk” has many forms and faces

Some risks are optional

Optional risks are expensive

Risk-taking should be relative to return

Not all risks have returns

CONCLUSIONSome “Take-Aways” on Risk

Entrepreneurs are appropriate risk-takers

Entrepreneurs accept compensated risks

We can bear most risks entrepreneurially

… as long as we get paid!