Startups live and die by managing risk.
Risk tolerance is necessary in order to turn an idea into reality. But too much of it can lead to overconfidence, then mistakes, then a quick and painful shutdown when the runway dries up.
Risk aversion seems like the antidote — the common sense adult-in-the-room keeping the startup grounded. But too much of that can actually wind up grounding the startup as well, just more slowly and invisibly.
4 Questions Founders Should Ask Themselves About Risk
- What is risk and how much should you take?
- Why does risk aversion creep in on growth?
- Why do you need to actively fight slow growth?
- How do you fight it?
The question this post is based on came to me via Teaching Startup, from a newly hired startup leader, not a cofounder, but indeed the most experienced member of a young multi-person founding team.
This new leader had been an advisor to the startup for a couple of years, helping them land a round of funding that enabled them to bring her aboard. She joined the team because she was impressed with their great idea and great business model, how they were addressing an emerging market within an industry that needs a makeover and because they needed, as she put it, “an adult in the room.”
But right away, she noticed that the founders were gradually seeming to prefer a more conservative, slower approach to growth than the one that got them the funding and, to be honest, impressed her enough to join.
She knew she had to, again her words, snap them out of it.
What Risk Is and How Much Should You Take
Usually the thing you have to worry about with a first-time founding team is the desire to take big, risky swings without considering the unintended consequences. Then you’ve got folks like me, the adults in the room, who never met a risk they didn’t want to mitigate a dozen different ways.
Her situation is a complete flip of those roles, but far from uncommon. It’s caused by the same bravado that fuels early-stage founders to take enough risky swings to land their first round. But then as soon as things become real, they realize that their bravado is just that, and they panic.
Obviously, there’s a balance. But looking back on it, both myself as a founder and the founders I’ve partnered up with during my career weren’t gunslingers. Not a single one. They were just risk-tolerant enough to agree to some of my more wild swings, and I’m just risk-averse enough to need to hold my breath during some of theirs.
Risk is an unquantifiable metric, and it’s hard to pin down rules or guidelines. At the risk of losing some of you readers, I often use poker to help discuss risk strategy. I’ll keep it high-level.
In a poker tournament, thousands of people pay a small price to potentially win a huge jackpot. This is like the startup universe. It’s easy to get started, but hard to establish yourself and grow your chip stack, and there’s always the constant threat of losing all your chips. Usually in the early stages of the tournament, if you flame out, you can buy back in. I don’t like to do this. I’m not made of money, and neither are you. That’s where some of the obvious risk-aversion comes from.
The key is to keep moving forward without having to buy back in over and over again.
The early stages of a tournament are a constant struggle of finding the right moment to take a big swing. You have to take one or two big swings or else everyone’s chip stack grows and yours doesn’t and you’ll flame out. But if you take the wrong big swing, you flame out instantly.
The thing is, in the early stages, you’re not playing to win the tournament, you’re just playing to get to the next level. An experienced player like me usually has a good idea of how many chips are needed to get to that next level, because I’ve been doing it for so long. That looks like risk aversion, but it’s actually prudent strategy. Once I get to that number of chips, I can wait longer for better cards to take less risky big swings.
Eventually, thousands of tournament entrants become hundreds as players flame out, and now I’m playing for the next level and doing it all over again. Then it becomes dozens, and if I’m still there, I’m using the same strategy again. At each stage I’m talking calculated risks, and at each stage I could flame out.
That’s pretty much Startup Risk 101.
Why Risk Aversion Creeps in on Growth
One reason. Fear. Fear is necessary. It keeps us humans from doing stupid things most of the time. Everyone feels fear. The “brave” among us know how to deal with it.
When you have nothing to lose, fear is less a part of the equation. In business, as you grow and take on more responsibility— you become responsible for the success or failure of your customers, your employees, your partners and your shareholders — fear becomes more of an issue. In real life, I put an immediate hard stop to most of my risky behavior once I had kids. Again, it’s a human nature thing.
As businesses grow and become more and more corporate, that fear intensifies and manifests itself. Big swingers are now labeled mavericks. That’s usually why, when a startup gets acquired, the startup immediately stops acting like a startup, despite all the acquirers’ lip service and even best intentions to keep that startup acting like a startup within the acquiring company.
This has never not happened to me. And I always get labeled as the maverick. And I’m the risk averse entrepreneur.
When you’re a young or first-time founder and millions of dollars get injected into the equation, well, that can create a keg of fear.
So it might just be that the script is flipped in our new leader’s situation because she is the adult in the room. She has run this playbook before, and the co-founders have not. She’s felt that fear before, and the co-founders have not. She knows how many chips the startup needs to get to the next level, and the co-founders don’t. So they’re getting very tight and conservative.
Why You Need to Actively Fight Slow Growth
As a startup, all the way up until you exit, whether you’re bootstrapped or VC-funded, you need to be growing at an outsized rate.
A startup is, by its definition – and as a differentiator from a small business – doing something that’s never been done before in a way that is disruptive to the status quo and innovative compared with the existing solutions.
This type of venture must grow quickly and robustly or the status quo and existing solutions will win. If the new thing doesn’t eventually become the established thing, true-believers and early adopters will go back to the established thing.
Now, in this world of disruption and innovation, the easiest way to grow market share is to look like innovation and disruption, but act like just a cheaper/fancier/prettier entrant in the existing solution set.
Building a bridge from small competitor to innovator is hard. If you build that bridge right, you’ll be successful, you’ll become the established thing. If you don’t build that bridge, if you give up, or if you build it too slowly, you’ll just become another small-time cog in the establishment.
Then you’ll either get taken down by the true innovator in the space as they become the new establishment, or a bigger existing player will price-war you out of the market.
So slow growth seems prudent, but none of that is a long-term positive outcome.
How to Fight Slow Growth
Honestly, it’s reinforcement of and adherence to the co-founders’ vision and the startup’s mission.
This is easier said than done. And it’s the primary reason I encourage founders to spend more than lip service defining their vision and mission. It’s your guide, your rock, your north star, especially in times of fear or panic.
I’m going to guess — and I feel pretty good about this guess — that the co-founders’ vision and mission was not to sell a product or service at a single-digit growth rate until they retire 40 years from now.
So the vision and the mission are the roots from which the growth strategy grows. It’s tricky because it kind of grows backwards. You have to start with the endgame and work your way back through various levels to define the level that’s within reach — the one you can get to. Then go all out (or in poker terms all in) to get to that next level.
That may mean giving up immediate small gains to keep dry powder to be able to go all-in to get to that next level. And that’s where risk tolerance comes in, because that totally sounds like the poker tournament analogy I started with.
Our new startup leader’s job is to take some of the weight of that responsibility off the co-founders’ shoulders. Which means she has to help them make decisions that are going to get them back on track to their true north star.
That sounds a little new-agey, but it’s basically the adult in the room giving the team the confidence to take the right big swings. So get in there, look for the source of the fear, define the risk, document the mitigation strategy and map out a path to the next level. Then go all in.