Risk Management for Startups | Planning for Profit…and Loss

For sometime now, I have been looking for a decent read on risk management. The task has not been easy. One of the biggest challenges for our generation is sifting through the noise to actually find words of substance. And over the weekend, I finally found them.

Despite the proliferation of business schools across the globe, I believe the entrepreneurial discipline remains an apprentice-style mode of instruction. You cannot learn entrepreneurship in a classroom. You simply have to roll up your sleeves and get your feet wet. If you don’t have a mentor, seek them out in books. No, not in a textbook–but in the stories of the entrepreneurs themselves. Then again, with all the PR fluff out there, it is hard to know how much of it is spin.

Still, I believe there are a few underlying principles that shape the discipline of risk management–regardless of what field you are in. And in Max Gunther’s books, I finally found them.

The Swiss Banker

The story begins in Jerusalem in 1118. The Knights Templar would look after pilgrims’ wealth whilst escorting them to the Holy Land. For the duration of the pilgrimage, people would leave their valuables with the Order in exchange for a letter of credit, an early form of traveller’s cheque that is still used today in commerce. Once the Knights settled in Switzerland in the 1300s, they became known as good hosts to negotiate trade and finance with.

Since then, banking in Switzerland has grown into a complex, regulated and global industry. The landlocked country is now one of the largest offshore financial centres and tax havens in the world. Banking is seen as emblematic of Switzerland and the country has a long, kindred history of banking secrecy and client confidentiality dating back to the early 1700s.

The financial sector, particularly the banking sector, is now one of the cornerstones of the Swiss economy. Almost half of the €7,269 billion assets currently managed by Swiss banks originated overseas. This equates to approximately 25% of the market share in global cross-border private wealth management business, making Switzerland the global leader in the field.

How did the Swiss get to where they are today? The answer lies in risk management.

The Zurich Axioms

The Zurich Axioms is a book about managing risk and reward. The Twelve Axioms that are outlined in the book define how to think about risk and uncertainty in such a way that you’re more likely to be rewarded than not. The keyword here is likely. Entrepreneurship is not for the faint-hearted. Every startup founder will inevitably incur loss at some point or perhaps even at many points. We are not taught to lose or to incur loss. We are not trained to fail quickly and get up again. In fact, we are taught to avoid any failure, any risk, any pitfall and anything out of the ordinary.

But then again, no entrepreneur is ever ordinary.

Max Gunther was an Anglo-American journalist and writer. He was born in England and moved to the United States at age of 11 after his father became the manager of the New York branch of a leading Swiss bank. Gunther’s book, The Zurich Axioms is largely based on his father’s trading advice.

One thing I can say for certain is that risk management, by its very nature, cannot be common sense. Most of us avoid risk. We run from it like the plague. We are taught to avoid it by seeking stability, structure and sustainability in all the things that we do. The few amongst us who do dive head first into risk, have the battle scars to show for it. It is considered foolish, foolhardy and downright dangerous. We become a cautionary tale for why one shouldn’t do it.

So why do entrepreneurs do it?

Because the potential upside far outweighs the potential downside. The truth is, we never know if things will work out until we actually take our chances. The real question is–how do we manage risk when things go south? And the other less asked question–how do we know when to get out when things actually start looking up? The answer to both questions are not straightforward. They demand a considerable amount of mental discipline, an ability to bear losses with dignity as well as knowing that an upward momentum will most likely not last for long.

The Goddess of Fortune is known to be a fickle ally. She can be here one day and gone the next. In view of that, both loss and gain are temporary states. They do not last forever. A solitary success may well be a fluke. Even when there has been a long history of continued success–an external (or perhaps even an internal) event could wipe everything out.

The Stock Broker

While formulas, datas and benchmarks do try to create some ‘measurable facts’ with which to assess our data, they are ultimately flawed. Gunter writes, “The stock market is a colossal engine of human emotion. Prices of stocks rise and fall because of what men and women are doing, thinking and feeling. The price of a given company’s shares doesn’t rise because of the abstract figures in an accounting ledger, nor even because the company’s future prospects are objectively good, but because people think the prospects are good.”

Back in the day, when I used to work in brokerage, I worked alongside both fundamental analysts and technical analysts. They never got along.

Fundamental analysts evaluate stocks by attempting to measure their intrinsic value. They study everything from the overall economy and industry conditions to the financial strength and management of individual companies. Earnings, expenses, assets and liabilities all come under the microscope of the fundamental analyst. If you’re a trained accountant like me, this is your bread-and-butter. It essentially tells you how well a company is doing and what it is worth. Once again, this is all based on past and historical data. In a way, it is akin to reading a history book with lots of numbers and then shaping a story around that data.

Technical analysts, on the other hand, attempt to identify opportunities by looking at statistical trends, such as movements in a stock’s price and volume. They assume that all known fundamentals are factored into price and thus there is no need to pay close attention to them. The intrinsic value of a company is not part of the picture. Instead, they use charts to identify patterns and trends to extrapolate what a stock might do in the future.

The assumptions themselves, while necessary; don’t really make all that much sense when we’re talking about this unknowable entity that we call ‘the future’. We can’t see it, feel it, or even hold it; so let’s forget about predicting it. Much like the breadcrumbs in Hansel and Gretel, we have clues–but we have no idea where in the world we are headed.

These numbers are at best calculated guesses and have no tangible basis in any reality. Gunther writes, “The truth is that the world of money is a world of patternless disorder, utter chaos. Patterns seem to appear in it from time to time, as do patterns in a cloudy sky or in the froth at the edge of the ocean. But they are ephemeral. They are not a sound basis on which to base one’s plan… Formulas can be wrong, but markets never are. The market does what it does. It makes no predictions and offers no promises. It just is.”

So how do we know if the investment we’re making is the right one?

The answer is simple: we don’t. We haven’t got a clue till we give it a shot.

Possible Futures

Any startup, at its very inception (for some reason I almost wrote inauguration), has a limitless number of future possibilities. Some good… and some bad. It would be foolish to allow oneself to get caught up in pessimism… or even optimism. After all, the ‘good’ outcomes and ‘bad’ outcomes are equally likely.

As a startup founder, you have to remain optimistic about your chances of success. You’re likely to encounter a lot of pessimism around you and there is no need to be your own biggest critic. You don’t even have to think of all the things that can go wrong–because all your ‘well-wishers’ are more than willing to do that job for you! So once you’ve been sufficiently prepped for failure by your ‘well-meaning well-wishers’–all you have to do is prepare for what you’re actually going to do when the loss occurs.

Don’t get me wrong. I’m not suggesting any startup founder invest in any business that they know will end in a loss. All I’m saying is that the founder needs to be prepared to hold those losses to a minimum. How much of a loss are you willing to incur before it’s time to call it quits? As a startup founder, you may be too close to the day-to-day running of the business (and might I add emotionally invested) to always keep an eye on the big picture. This is especially true in the early days when there is a never-ending to-do list that magically gets longer and longer. That’s when the COO–your second-in-command–needs to step in and pull the plug. I have always believed that the COO is the leader’s leader. By virtue of being second-in-command in the organisation, they have an uncanny way of being the first-in-command of the founder.

Every startup team needs someone who is savvy at risk management. This person is open to taking risks, holds a bird’s eye view of the situation as well as clamps down on projects that are heading south–or that may not have much long-term potential in terms of profit. If you’ve got clowns working for you who are afraid of taking risks, you need to get rid of them. Fast.

Having spent a lot of time with both VCs and Angel Investors, I know that many of them have particularly strong instincts when it comes to identifying duds. At the same time, they are not correct 100 percent of the time. Every investor has lost money at some point. But they have not been on a losing streak that ended in oblivion. On the flip side, they have also missed out on investing in opportunities that later turned out to be highly profitable. Most VCs and investors I know rarely speak of regrets. To them, it is all part of the business. It is all part of the game.

The only plan any business needs–as far as money is concerned–is an intention to actually make it and get rich. Exactly how a business will accomplish that purpose is something you cannot know.

All you need to know is that you will do it somehow.

Dipa Sanatani is the Publisher at Mith Books and the author of The Little Light and The Merchant of Stories. In The Merchant of Stories, Dipa takes the reader on a personal journey–narrated through a series of candid journal entries–on what it takes for entrepreneurs and creatives to start their very first venture.


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