It has never been more exciting to start a business. The startup economy is bursting at the seams with opportunity, innovation, and potential. At the same time, however, it is fraught with high-stakes risks. Identifying these risks early on will make the venture significantly less intimidating and increase your chances of success.
Startups should assess the following risks and identify appropriate controls to mitigate the same:
- Risk that company has not identified a genuine market need.
- Risk that addressable market is not as big as initially though to be.
- Risk of not being able to implement the innovation.
- Risk of not being able to sell the product or service for more than it costs.
- Risk of not having the right management team.
- Risk of not being able to stay one step ahead of the competition.
- Risk of getting sued into bankruptcy.
- Risk of getting buried in regulatory red tape.
- Risk of running out of money.
- Other risks that are unpredictable yet real.
Some risk categories are provided below:
Business Model Risk
Is there a clear path to financial success in the future? Are the unit economics correct? What are the assumptions underlying the pursuit of profitability? Many venture capitalists are hesitant to invest in startups that lack a clear business model, but some of the best investments are services that attract a large number of users but lack a clear monetization strategy, such as YouTube, Snapchat, and others.
Does the startup have a way to reach and acquire customers in a scalable and profitable way? Are they dependent on another platform like Facebook, Amazon or Apple to reach their customers? Is that sustainable? Is there a path to a direct connection with customers?
Why is it now? is one of the most important questions to have an excellent response to. Most startup ideas have been tried and failed before. Why is now the ideal time for this concept to succeed? What’s the difference? Good responses frequently centre on market or technological changes.
Is the product/service appealing to the customers? What are your options? What is the level of competition? Are there any entry barriers or threats from new entrants?
Do the founders have the necessary skills and motivation? Have they ever built anything before? Are they completely committed? Is this a mission? Can they persuade customers and potential employees to join them? Will they break down doors to make this happen?
Determine what you will sell. It appears to be a simple task, especially for an entrepreneur. However, explaining what your product is, the problem(s) it solves, and why it is worth investing in is much more difficult than it appears, and it must be your top priority when starting a business. If you can’t do that, you can’t expect people to listen, let alone part with their money.
This is a manageable risk: make sure the product addresses a large enough market, as well as the right opportunity within that market, at the right time. It is critical to conduct research, understand the landscape, and be able to articulate how your company fits into that landscape.
Knowing your customer, as well as why, how, and where they buy related products, is arguably the most important risk factor to consider before launching your product. Investigate this thoroughly. Identifying these routes to market and whether you can build them effectively, on time, and within your budget could easily determine your company’s success. There’s no reason your business can’t succeed if market risk falls in your favour and you enter your market early enough.
The use of an ineffective pricing, marketing, or distribution strategy poses a significant risk. Many new social websites, for example, declare that they will provide a free service and rely solely on advertising revenue (not likely in the first year without a huge marketing investment).
Unless you sell a commodity, there is no easy way to predict how a new product will be received by the market. Friends’ feedback, surveys of potential customers, focus group testing, and beta testing are all effective methods for gauging market acceptance. Nobody, not you, not your best friend, not your venture capitalist, can tell you whether people will pay for your solution until you try to sell it.
Avoiding perfection is one way for entrepreneurs to reduce market risk. It is a fallacy to believe that any product will ever be “finished” in the sense that it will completely satisfy all users. When your product is good enough to satisfy some customers, get it into the market so it can start generating cash flow and feedback.
There are very few businesses that can be started without money. As the founder, you will be expected to put “skin in the game.” The business plan should be realistic about how much cash is needed to break even and how much money investors will make in the first five years.
First-time entrepreneurs are fortunate to have the option of raising funds through crowdfunding. Furthermore, friends and family, angel investors, and traditional VCs are all rich sources of this vital life blood.
Make a list of key business milestones and schedules that clearly show when equity or debt investments are required to reach the next major milestone. If you can successfully articulate your business plan, growth path, and milestones, potential investors will be more likely to write the next check.
Does a new technology have to be built to make this happen? How long will it take? How likely is it to happen? Most software startups have minimal technology risk. Tech risk is more applicable to startups dealing with atoms like hardware, cleantech, and biotech.
New technologies, particularly those labelled “paradigm shifts” or “disruptive,” may have lengthy and costly acceptance cycles, or they may encounter unpredictable performance or manufacturing issues.
The keys to mitigating technology risk are to innovate, bite off more than you can chew, and deliver on your product roadmap ahead of schedule. It’s also critical to keep your dependencies to a minimum. If you use open source technology, make certain that it is here to stay. Don’t over-customize it to the point where you can’t take advantage of future innovations. Make sure you have adequate resources, and don’t become complacent when your technological superiority and engineering excellence are called into question.
A nuclear reactor built on an earthquake fault line is extremely dangerous. Evaluate the sensitivity of your business and location to floods, hurricanes, and catastrophic pollution problems, such as an oil spill in the Gulf of Mexico.
There is no way for one person to eliminate all risks. That is why having a great team and a personal sounding board, a mentor, confidante, or even a startup incubator to help prepare for each challenge is essential. Your team is also excellent at bouncing ideas around in order to develop a product, bring it to market, and sustain successful growth.
Consider your role as an entrepreneur, and then let the team do what it does best. Invest in people who believe in your product and instill confidence in them that they can help your company succeed.
Do the Founders get along? Is there noticeable tension in the meetings? Have they worked together before? Is there anything weird on the cap table that may be a problem in the future? Founder relationship blowups are one of the more common reasons for early-stage companies to fail.
Many entrepreneurs get so caught up in the details that they lose sight of the overall company trajectory and strategy. Alternatively, some company founders maintain a high level of awareness and overlook critical details, resulting in major problems. A dichotomous approach of assessing the details while maintaining a keen focus on overall business execution will ensure the highest likelihood of long-term success in building a great company.
Some risks are under your control, while others are not. To be a successful entrepreneur, you must seek advice from others on risk management. However, never give one person complete control over the decision-making process. Participate, assess the risks, and don’t be afraid to change course.
Is the startup likely to face a patent/copyright infringement lawsuit? Are they in violation of the law? Are the Founders reliable? Is there anything they’re keeping from you about the company? Are there any regulatory issues to address? Are there any known complaints from employees or others in the startup’s vicinity?