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Managing StartUp Risks
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![Bharat Panchal, Chief Risk Officer - India, Middle-East & Africa, FIS Bharat Panchal, Chief Risk Officer - India, Middle-East & Africa, FIS](https://www.siliconindia.com/images/simag_images/uploaded_images/newstransfer/qgfsi.Bharat-Panchal,--1.jpg)
India is home to the world's third largest startup ecosystem, having added over 1,300 tech startups in 2019. As per Nasscom report India will have 95 to 105 unicorns by 2025. Startups are bringing new jobs and as data suggests, Startups created 60,000 direct jobs in 2019 alone compared with 40,000 jobs in 2018.
However, like any other business, running any start-up business is full of risk. Especially in start-up business, the risks are multifield as its arise from uncertainty about various aspects of the business a risk about viability of business customer preferences, technology on which business will rely, what will the customer preferences in the future be, overall policy and economy situation, existing and future competitors etc. Therefore, it's very much crucial to be aware of the risk that one has to manage and prioritize them appropriately for specific risks which are unique in startup business.
As seen, Startup business is mostly lead by very young entrepreneurs who are less averse to risk and often ignores them. While it is good initially, as the business grows, the entrepreneur should be cognizant of the risks that the business may face or already facing. It's a time take an informed call about which risks need to be mitigated and to what extent. This article provides a general framework for assessing and managing the risks that confront most startups.
Why Risk Management
Risk and opportunity are complementary. There is a direct relationship between risk and reward the greater the potential upside, the higher the risks involved. However sometime situations that involve great risk sometimes have little or no upside. The successful startups achieves through a keen awareness and management of risks. Risk is an integral part of entrepreneurship, it should not over whelm you.
Major Risks for Startups
Like any other business Startups also needs to identify the various risks that can impact the venture and make an assessment of their importance to specific risk scenario. Few of the risk scenarios which are true for starting up business:
•There is no guarantee that you will have good market and customers will like your products or services. (Market Risk)
•Startups needs to borrow hefty money to finance their venture in its earliest stages there is a chance that they will not make sufficient profits to be able to pay these loans back.(Financial Risk)
•With growth of the business, the founders will invariably have to start handing over responsibility for certain tasks to employees whobring uncertainty and risk related to their skills and performance. (People Risk)
•Startups may not be in position to determine the correct price for their product at the beginning which may result into to raise prices or change their business model, running the risk of customer dissatisfaction
•Startups will have to face risks that are external to the day-to-day operations, natural disasters, civil unrest market economics etc.But most important risk which would be government reforms and policy towards startup business.
It may not be possible to mitigate every risk. Hence an entrepreneur must decide their risk tolerance. What kind and how much risk are you prepared to accept? Below is the outline the risks faced by most businesses and offer some strategies for mitigating them.
People Risk
The risk of losing good people and hiring bad people are biggest risks. Poor management of these risks can damage heavily during the early stages of the company when it is dependent on a small core team; as the firm grows and is able to hire more staff, these risks get diversified and are reduced. Other risks include unskilled co-founders, disagreement amongst founders over investment or the business model and the departure of a talented founder. One good way to mitigate these risks is by choosing someone you already know well as a co-founder, as
opposed to just bringing someone you meet online or at a Meetup. To reduce the chances of knowledge gaps make sure that you choose right co-founders with skills complementary to your own.
As your business grows and you delegate responsibility to employees part of the success of your venture will rest in their hands. Infosys is the best example in this scenario where started by just seven founders as a startup and today it has more than 2.5 lacs employees. Selecting a right set of people with mix of talents and position is a big task. Prospective employees are also equally taking a risk to join in a startup so they also have their own risks to manage before taking a final call to join with you.In long term risk mitigation, if the employee has a good attitude, some knowledge deficits are inevitable you should cultivate such employees and provide them training to overcome any skill gaps. In general, a smart and hard working employee should be retained even if there is a gap between his or her specific skills and your needs.
As the same time to prevent key employees from leaving, offer adequate financial compensation like ESOP, sweat equity etc. and add clauses to their contractsthat prevent them from joining competitors. In India, an option plan(ESOP) whereby employees are awarded equity that vests over time is a strong mechanism to retain good employees. Similarly, spreading an annual bonus award over a period of time(such as four equal payments each quarter of the following year) is also a good strategy to retain good employees.
Financial Risk
No cash means no business. It is the most crucial risk one has to manage and must ensure that they never get to this stage. However, there are many financial risks that can lead you to this stage:
Customers can refuse to pay your invoices(credit risk).
•The cost of your raw materials or suppliers could rise suddenly.
•Customers may switch to a competing product and not buy your product or service any more.
•Foreign exchange rates go high and you have not a sufficient hedging for such risk. A strengthening local currency can reduce the net profits from your foreign customers, or a weak currency can increase the cost of running your foreign operations (exchange rate risk).
•A spike in interest rates could raise the cost of your working capital or government decides to end benefits given to a start-ups business. (Interest rate risk).
•A slowing economy could reduce the demand for your product or service.
Not all of these risks are relevant for all businesses but as a startup you must know which ones may affect to your venture. The best safeguard against running out of money is to have enough of it as invested capital. It’s a fact that it difficult to raise money when you need it most while everybody wants to give you money when you don't need it. Best way to minimize your financial risk is to take funding when it is available and keeping it in reserve for a rainy day this is the strategy that most startups take.
Risk of Concentration
Focusing on any single product or service or any aspect of a business is a serious risk. This risk is not that risky when you are at the early stage of the business. But once the business has become mature, non-diversification could be a big risk for long term sustainability.
While diversification is mainly associated with financial portfolio management theory but start-ups should realize that the same general principles also apply to running a business. The key here is that you should not rely on a single product or service in your business. In general it’s very important to prevent a concentration of risk in a small group of clients, vendors, products employees and marketing channels or at even geographies.
Dependency on one or two large clients run the risk that these contracts may fall apart or the key clients may run into difficulties of their own. To mitigate this risk, startup should diversify their customers and avoid concentration risk of their revenue coming from few set of clients.
Risk of Government Policies and Non-Compliance
The government policy changes the behaviour in the startup business environment. For example the government has declared tax holidays for startups for 10 years. But the government can make changes in this policy at any point in time let say by Imposing on a particular sector more taxes or duties than are necessary will make the investors lose interest in that sector. This is one of the important risks which has to be accepted and closely monitored.
Similarly, businesses not following the government regulations can face fines and even prosecution. To avoid this problem, it is very much important to define a compliance framework which should ensure that they comply with all the regulations that affect their business, including necessary permits and licenses, employment & labour laws, corporate governance, and tax compliance.
Intellectual property is obliviously the biggest asset for any startup. Therefore, to prevent competitors from stealing your innovation, consider investing in copyrights, trademarks and patents.
Conclusion
Startup business is surely full of risks and some risk is inevitable and cannot be mitigated. To be successful any startup must learn to accept those risks that are unavoidable and mitigate those that can be managed. The best safeguards against major risks in startups are a good core team and talented employees a business friendly government diversified products and marketing channels and prudent financial management.
While diversification is mainly associated with financial portfolio management theory but start-ups should realize that the same general principles also apply to running a business
As your business grows and you delegate responsibility to employees part of the success of your venture will rest in their hands. Infosys is the best example in this scenario where started by just seven founders as a startup and today it has more than 2.5 lacs employees. Selecting a right set of people with mix of talents and position is a big task. Prospective employees are also equally taking a risk to join in a startup so they also have their own risks to manage before taking a final call to join with you.In long term risk mitigation, if the employee has a good attitude, some knowledge deficits are inevitable you should cultivate such employees and provide them training to overcome any skill gaps. In general, a smart and hard working employee should be retained even if there is a gap between his or her specific skills and your needs.
As the same time to prevent key employees from leaving, offer adequate financial compensation like ESOP, sweat equity etc. and add clauses to their contractsthat prevent them from joining competitors. In India, an option plan(ESOP) whereby employees are awarded equity that vests over time is a strong mechanism to retain good employees. Similarly, spreading an annual bonus award over a period of time(such as four equal payments each quarter of the following year) is also a good strategy to retain good employees.
Financial Risk
No cash means no business. It is the most crucial risk one has to manage and must ensure that they never get to this stage. However, there are many financial risks that can lead you to this stage:
Customers can refuse to pay your invoices(credit risk).
•The cost of your raw materials or suppliers could rise suddenly.
•Customers may switch to a competing product and not buy your product or service any more.
•Foreign exchange rates go high and you have not a sufficient hedging for such risk. A strengthening local currency can reduce the net profits from your foreign customers, or a weak currency can increase the cost of running your foreign operations (exchange rate risk).
•A spike in interest rates could raise the cost of your working capital or government decides to end benefits given to a start-ups business. (Interest rate risk).
•A slowing economy could reduce the demand for your product or service.
Not all of these risks are relevant for all businesses but as a startup you must know which ones may affect to your venture. The best safeguard against running out of money is to have enough of it as invested capital. It’s a fact that it difficult to raise money when you need it most while everybody wants to give you money when you don't need it. Best way to minimize your financial risk is to take funding when it is available and keeping it in reserve for a rainy day this is the strategy that most startups take.
Risk of Concentration
Focusing on any single product or service or any aspect of a business is a serious risk. This risk is not that risky when you are at the early stage of the business. But once the business has become mature, non-diversification could be a big risk for long term sustainability.
While diversification is mainly associated with financial portfolio management theory but start-ups should realize that the same general principles also apply to running a business. The key here is that you should not rely on a single product or service in your business. In general it’s very important to prevent a concentration of risk in a small group of clients, vendors, products employees and marketing channels or at even geographies.
Dependency on one or two large clients run the risk that these contracts may fall apart or the key clients may run into difficulties of their own. To mitigate this risk, startup should diversify their customers and avoid concentration risk of their revenue coming from few set of clients.
Risk of Government Policies and Non-Compliance
The government policy changes the behaviour in the startup business environment. For example the government has declared tax holidays for startups for 10 years. But the government can make changes in this policy at any point in time let say by Imposing on a particular sector more taxes or duties than are necessary will make the investors lose interest in that sector. This is one of the important risks which has to be accepted and closely monitored.
Similarly, businesses not following the government regulations can face fines and even prosecution. To avoid this problem, it is very much important to define a compliance framework which should ensure that they comply with all the regulations that affect their business, including necessary permits and licenses, employment & labour laws, corporate governance, and tax compliance.
Intellectual property is obliviously the biggest asset for any startup. Therefore, to prevent competitors from stealing your innovation, consider investing in copyrights, trademarks and patents.
Conclusion
Startup business is surely full of risks and some risk is inevitable and cannot be mitigated. To be successful any startup must learn to accept those risks that are unavoidable and mitigate those that can be managed. The best safeguards against major risks in startups are a good core team and talented employees a business friendly government diversified products and marketing channels and prudent financial management.