The Entrepreneur’s Guide to Financial Maturity ®
Risk Management for the Small Business
As a business consultant and teacher at NYU School of Continuing and
Professional Studies, I have the pleasure of meeting many entrepreneurs and
potential entrepreneurs and reviewing, or assisting in preparing, their business
plans. I have often heard small business owners telling me and/or potential
investors that investing in their business opportunity is as safe as investing in
government bonds.
I have seen an entrepreneur try to offer potential investors 6% per annum on
risky investments such as second mortgages on construction projects. Further,
that entrepreneur might have virtually none of her own money at risk, is
inexperienced as a builder or developer, and it is highly probable that there will
be significant delays in starting and completing the project. Additionally, as
with most construction projects, in all likelihood there will be cost overruns. It
is clear that if delays or cost overruns occur, an investor will either be
compelled to invest more money (in a failing project to protect his or her
investment), or (potentially) loose some or all of his or her investment. In my
opinion, either option is unacceptable considering the meager 6% annual
reward. Similarly, I have seen undercapitalized small businesses and startups
offer low returns to potential investors.
When I delve into entrepreneurs’ motivations for offering meager returns, the
response generally has been, it is better than earning 1% or 2% in your money
market account and it is just as safe. Those entrepreneurs are ignoring the
possibility that investors could lose 100% of their investment.
Those entrepreneurs either failed to recognize certain business risks, failed to
recognize the implications of assumptions they made or chose to ignore the
risks. One reason why 4 out of 5 businesses fail within 5 years of their
inception is that entrepreneurs do not understand business risks before
they start or buy their business. Entrepreneurs and their friends, families
and investors loose billions of dollars each year when their small businesses
fail.
My experience tells me that part of the reasons a business owner feels his or
her business opportunity is low risk, is because the business owner:
Is too close to the situation and therefore lacks objectivity
Oversimplifies what has to be done to achieve certain their goals and
objectives
Underestimates the importance of the assumptions they made
Does not understand the true risks of their business
Has not explained thoroughly how risks have been mitigated
Most business plans I review do not adequately address business risks, and
many plans do not address business risk at all. In addition, those business
owners who have their business plan in their heads or on the back of napkins,
tend to oversimplify their business and do not appropriately address business
risk.
The business risks I will be addressing in this article are not whether you
should incorporate, or what type of insurance to carry. The business risks
outlined below are not all inclusive. It should be used to help stimulate your
thought process so you can better understand your existing or potential
business. If you are prepared to invest money (either your money or friends
and family money) into a new or existing business, you will make a more
informed and better decision after you and your team has fully evaluated the
business risks. After evaluating the business risks, often the entrepreneur
recognizes that the initial thought process was flawed, and backs away from
making what would have become a bad investment.
To summarize how various types of investors evaluate your company, they
generally look at the risks associated with the following major categories:
Startup
New Product Development
Manufacturing
Distribution
Marketing/ Market Acceptance
Management
Growth
Financial
Exit Plan
For example let’s look at some basic risks that virtually every company faces
or will face at some time in its business life cycle.
Startup Risk:
Startups and companies that have a limited or no operating history generally
carry considerably greater risks than profitable companies. When I deal with
startups, often the business owner’s information about the business is limited.
The start up company has no revenues, and often has to pay for equipment,
furniture and fixtures, inventory, supplies, security deposits and carrying costs
until the business generates sufficient “cash flow” to support itself. Often
events do not occur as anticipated and it takes more money to accomplish those
elusive goals and objectives. If the company is undercapitalized, and it takes
longer to generate sales than anticipated, it could be out of business.
Management Risks - Reliance on a limited number of key people:
Often many small businesses have not developed a company infrastructure or
succession plan. If hypothetically, you or a key member of your staff got “hit
by a bus” how would that impact your business? If that, or similar events
would cripple your business, your business is high risk.
Reliance on a limited number of key people is one small component of
management risk. There are a wide variety of risks associated with
management risks.
New Product Development Risks - Delays in getting your Product or
Service to Market:
Delays in getting your “deliverables” to market can be devastating. This is
true regardless of whether you are involved with:
New product development
Sales of goods or services or
Real Estate
If your company has monthly overhead (monthly operating expenses), than
excessive delays will burn through cash. If it takes several months longer to
get your service or product to market, your company needs the cash, or credit
facility to support operations during these delays. Lack of knowledge and poor
planning frequently causes excessive delays. If an investor does not feel
comfortable with your product, industry, customer knowledge, you will be
perceived to be a higher risk than someone who has that knowledge. If you
burn through your cash before you are market ready, you are destined for
failure.
Delays in getting your product or service to market are one small component of
new product development risks. There is a wide array of risks associated with
this category.
Marketing Risks - Not fully Understanding your Selling Cycle:
When I ask small business people to describe what it takes to sell their product
or service, many are perplexed. I generally ask a series of questions including
those listed below so that we can better understand what it takes to make the
sale.
Who are your customers?
What are their shopping habits?
Where do they shop for products similar to yours?
How frequently do they shop for such products?
How many different stores or service providers do they go to before
making a decision?
How many days are spent shopping before the purchase decision is
made?
How many competitive products do they consider?
The above is a very short list of understanding how you are going to generate
revenue, the cornerstone of any business.
Marketing Risks - Your Competition’s reaction:
Those entrepreneurs that fail to recognize that the marketplace is dynamic and
constantly changing are destined to become the dinosaurs of their industry. If
you become a lower cost provider of a service, others may react in order to
maintain their existing customer base. Enhancing productivity through
innovation is the norm. As you improve your processes, so will your
competitors. As you change your pricing, don’t be surprised if your
competitors match what you are doing. If you are anticipating a 20% increase
in your sales volume by enhancing your service or reducing your price, do not
assume your competitors will not react. In all likelihood your competitors will
do what is necessary to keep the business their existing business.
Not fully understanding your sales cycle and your competition’s reactions are
two small components of marketing risks
Manufacturing Risk:
Many businesses that sell products using their own brands do not manufacture
or assemble their own products, and therefore feel they have no manufacturing
risks. Many entrepreneurs take the position that they are purely marketing
companies, and the product, which is sold under their company’s label, is
incidental. “We are outsourcing our product to Company X and they
manufacture for some of the top companies in our industry.” Accordingly,
“we have no manufacturing risks.” Those statements show their naivety.
When I ask a business owner how did they select the subcontractor, and why
did they select one that is overseas, they quickly point to a cost savings of
having the manufacturing. When I question them ask as a small business
wouldn’t you be better off producing the products locally, since you can
monitor production and quality better, they agree.
Business owners often fail to recognize that goods are manufactured to
specifications. If you are using the same manufacture as your competition and
your specifications are different than your competition, the products are not
necessarily comparable. If your product has seasonality, and a large
competitor needs more of their product, your production will be done once the
manufacturer has free time. That may cause you to miss deadlines or selling
seasons.
If your product were produced locally, you or one of your employees would
visit the manufacturer frequently. You would determine if the products used
were as specified.
You would be able to make sure it met your standards for quality.
If your products are being manufactured abroad and you are not monitoring
those contractors in the manner you would monitor a subcontractor located in
next door, you have quality control and delivery risks. By manufacturing
locally you reduce your learning curve. Once you have gone through the
learning curve you are in a better position to negotiate terms with a
manufacturer. When you achieve certain sales volumes you can have someone
monitoring your manufacturer in a cost effective manner. If you fail to
monitor for overseas manufacturer and there is a problem, you might not find
out about production problems, quality control problems etc., until it is too
late.
In Conclusion:
Understanding your risks and how others perceive your risks can have a
dramatic impact on your company’s vision and business operations. It will
become a factor in how you allocate your resources and time. Your outside
Board of Advisors should help you focus on risks and how you are allocating
your resources.
Financial Maturity ® is a registered trademark owned by Morris Bocian. Copyright © 2003, 2004 and
2005 Creative Business Planning Incorporated. All rights reserved. All information is from sources
deemed reliable. Such information has not been verified and no express representations are made nor
implied as to the accuracy thereof, and it is submitted subject to errors and omissions, and is subject to
change or withdrawal without notice.
doc_697285724.pdf
Risk Management for the Small Business
As a business consultant and teacher at NYU School of Continuing and
Professional Studies, I have the pleasure of meeting many entrepreneurs and
potential entrepreneurs and reviewing, or assisting in preparing, their business
plans. I have often heard small business owners telling me and/or potential
investors that investing in their business opportunity is as safe as investing in
government bonds.
I have seen an entrepreneur try to offer potential investors 6% per annum on
risky investments such as second mortgages on construction projects. Further,
that entrepreneur might have virtually none of her own money at risk, is
inexperienced as a builder or developer, and it is highly probable that there will
be significant delays in starting and completing the project. Additionally, as
with most construction projects, in all likelihood there will be cost overruns. It
is clear that if delays or cost overruns occur, an investor will either be
compelled to invest more money (in a failing project to protect his or her
investment), or (potentially) loose some or all of his or her investment. In my
opinion, either option is unacceptable considering the meager 6% annual
reward. Similarly, I have seen undercapitalized small businesses and startups
offer low returns to potential investors.
When I delve into entrepreneurs’ motivations for offering meager returns, the
response generally has been, it is better than earning 1% or 2% in your money
market account and it is just as safe. Those entrepreneurs are ignoring the
possibility that investors could lose 100% of their investment.
Those entrepreneurs either failed to recognize certain business risks, failed to
recognize the implications of assumptions they made or chose to ignore the
risks. One reason why 4 out of 5 businesses fail within 5 years of their
inception is that entrepreneurs do not understand business risks before
they start or buy their business. Entrepreneurs and their friends, families
and investors loose billions of dollars each year when their small businesses
fail.
My experience tells me that part of the reasons a business owner feels his or
her business opportunity is low risk, is because the business owner:
Is too close to the situation and therefore lacks objectivity
Oversimplifies what has to be done to achieve certain their goals and
objectives
Underestimates the importance of the assumptions they made
Does not understand the true risks of their business
Has not explained thoroughly how risks have been mitigated
Most business plans I review do not adequately address business risks, and
many plans do not address business risk at all. In addition, those business
owners who have their business plan in their heads or on the back of napkins,
tend to oversimplify their business and do not appropriately address business
risk.
The business risks I will be addressing in this article are not whether you
should incorporate, or what type of insurance to carry. The business risks
outlined below are not all inclusive. It should be used to help stimulate your
thought process so you can better understand your existing or potential
business. If you are prepared to invest money (either your money or friends
and family money) into a new or existing business, you will make a more
informed and better decision after you and your team has fully evaluated the
business risks. After evaluating the business risks, often the entrepreneur
recognizes that the initial thought process was flawed, and backs away from
making what would have become a bad investment.
To summarize how various types of investors evaluate your company, they
generally look at the risks associated with the following major categories:
Startup
New Product Development
Manufacturing
Distribution
Marketing/ Market Acceptance
Management
Growth
Financial
Exit Plan
For example let’s look at some basic risks that virtually every company faces
or will face at some time in its business life cycle.
Startup Risk:
Startups and companies that have a limited or no operating history generally
carry considerably greater risks than profitable companies. When I deal with
startups, often the business owner’s information about the business is limited.
The start up company has no revenues, and often has to pay for equipment,
furniture and fixtures, inventory, supplies, security deposits and carrying costs
until the business generates sufficient “cash flow” to support itself. Often
events do not occur as anticipated and it takes more money to accomplish those
elusive goals and objectives. If the company is undercapitalized, and it takes
longer to generate sales than anticipated, it could be out of business.
Management Risks - Reliance on a limited number of key people:
Often many small businesses have not developed a company infrastructure or
succession plan. If hypothetically, you or a key member of your staff got “hit
by a bus” how would that impact your business? If that, or similar events
would cripple your business, your business is high risk.
Reliance on a limited number of key people is one small component of
management risk. There are a wide variety of risks associated with
management risks.
New Product Development Risks - Delays in getting your Product or
Service to Market:
Delays in getting your “deliverables” to market can be devastating. This is
true regardless of whether you are involved with:
New product development
Sales of goods or services or
Real Estate
If your company has monthly overhead (monthly operating expenses), than
excessive delays will burn through cash. If it takes several months longer to
get your service or product to market, your company needs the cash, or credit
facility to support operations during these delays. Lack of knowledge and poor
planning frequently causes excessive delays. If an investor does not feel
comfortable with your product, industry, customer knowledge, you will be
perceived to be a higher risk than someone who has that knowledge. If you
burn through your cash before you are market ready, you are destined for
failure.
Delays in getting your product or service to market are one small component of
new product development risks. There is a wide array of risks associated with
this category.
Marketing Risks - Not fully Understanding your Selling Cycle:
When I ask small business people to describe what it takes to sell their product
or service, many are perplexed. I generally ask a series of questions including
those listed below so that we can better understand what it takes to make the
sale.
Who are your customers?
What are their shopping habits?
Where do they shop for products similar to yours?
How frequently do they shop for such products?
How many different stores or service providers do they go to before
making a decision?
How many days are spent shopping before the purchase decision is
made?
How many competitive products do they consider?
The above is a very short list of understanding how you are going to generate
revenue, the cornerstone of any business.
Marketing Risks - Your Competition’s reaction:
Those entrepreneurs that fail to recognize that the marketplace is dynamic and
constantly changing are destined to become the dinosaurs of their industry. If
you become a lower cost provider of a service, others may react in order to
maintain their existing customer base. Enhancing productivity through
innovation is the norm. As you improve your processes, so will your
competitors. As you change your pricing, don’t be surprised if your
competitors match what you are doing. If you are anticipating a 20% increase
in your sales volume by enhancing your service or reducing your price, do not
assume your competitors will not react. In all likelihood your competitors will
do what is necessary to keep the business their existing business.
Not fully understanding your sales cycle and your competition’s reactions are
two small components of marketing risks
Manufacturing Risk:
Many businesses that sell products using their own brands do not manufacture
or assemble their own products, and therefore feel they have no manufacturing
risks. Many entrepreneurs take the position that they are purely marketing
companies, and the product, which is sold under their company’s label, is
incidental. “We are outsourcing our product to Company X and they
manufacture for some of the top companies in our industry.” Accordingly,
“we have no manufacturing risks.” Those statements show their naivety.
When I ask a business owner how did they select the subcontractor, and why
did they select one that is overseas, they quickly point to a cost savings of
having the manufacturing. When I question them ask as a small business
wouldn’t you be better off producing the products locally, since you can
monitor production and quality better, they agree.
Business owners often fail to recognize that goods are manufactured to
specifications. If you are using the same manufacture as your competition and
your specifications are different than your competition, the products are not
necessarily comparable. If your product has seasonality, and a large
competitor needs more of their product, your production will be done once the
manufacturer has free time. That may cause you to miss deadlines or selling
seasons.
If your product were produced locally, you or one of your employees would
visit the manufacturer frequently. You would determine if the products used
were as specified.
You would be able to make sure it met your standards for quality.
If your products are being manufactured abroad and you are not monitoring
those contractors in the manner you would monitor a subcontractor located in
next door, you have quality control and delivery risks. By manufacturing
locally you reduce your learning curve. Once you have gone through the
learning curve you are in a better position to negotiate terms with a
manufacturer. When you achieve certain sales volumes you can have someone
monitoring your manufacturer in a cost effective manner. If you fail to
monitor for overseas manufacturer and there is a problem, you might not find
out about production problems, quality control problems etc., until it is too
late.
In Conclusion:
Understanding your risks and how others perceive your risks can have a
dramatic impact on your company’s vision and business operations. It will
become a factor in how you allocate your resources and time. Your outside
Board of Advisors should help you focus on risks and how you are allocating
your resources.
Financial Maturity ® is a registered trademark owned by Morris Bocian. Copyright © 2003, 2004 and
2005 Creative Business Planning Incorporated. All rights reserved. All information is from sources
deemed reliable. Such information has not been verified and no express representations are made nor
implied as to the accuracy thereof, and it is submitted subject to errors and omissions, and is subject to
change or withdrawal without notice.
doc_697285724.pdf