Risk management in the land of startups is a very confusing concept. The main reason is that risk management is usually associated with managing a balanced, diversified portfolio of investment. While this principle is applicable for startup investors, it is hardly applicable for startup founders who are by definition all-in on their high-risk startup project.
So, here are the three principles that would allow you to manage risk correctly as a founder:
1. Allow Yourself To Be Lucky: Risk Pennies To Win Dollars
The first thing to internalize is that you are playing the game of startups partially blind – everybody is.
Markets are extremely complex, and startups (being innovative and unproven) add a layer of complexity on top of that. Don’t fall for the illusion of understanding the mechanics of a market – nobody on the planet can accurately predict cause and effect in complex systems fully and continuously.
“In theory, theory and practice are the same. In practice, they are not.” – Albert Einstein.
The big outcomes – successes and failures, usually come from what is surprising and unpredicted, rather than what is expected and predicted. Fortunes aren’t made by carefully thinking and analyzing for decades and then making one big bet. Instead, they are made by constantly testing hypotheses against reality until one leads you to an unexpectedly big win.
Consequently, as a startup founder, your job isn’t to be a theoretician or a market analyst. It is to be an empiricist, constantly running small experiments and testing ideas against reality, or more specifically – products or services against clients.
In other words, you should continuously invest low amounts of money, time, and effort (low downside) into ideas with big upside potential. In time, you will get lucky and one success would more than pay for the unsuccessful experiments.
2. Fail Fast
Unlike an investment portfolio manager, you cannot afford to hold a large number of positions (i.e. make a lot of bets) all at once. This is because as a founder your bets require time and effort, and when you are not investing time into a project, entropy undermines your progress.
This means you are forced to make your bets one at a time. Because of this, the way you gain the benefits of diversification is by running many experiments one after another. Time is your most valuable resource. It’s a mistake to invest a lot of it into a project that doesn’t show a lot of promise when you test it against reality by validating the idea or product.
Resilience is often quoted as the number one important quality for startup founders. However, resilience doesn’t mean stubbornly trying to force the market to accept your offering. Instead, it means staying involved in the entrepreneur game while constantly testing new ideas and approaches.
So, fail fast. Once an idea indicates low market traction – iterate, pivot, or just try something entirely new.
3. Complexity Is Your Enemy
First, remember that you are gambling pennies. Pennies cannot buy you a lot of complexity and sophistication. You have limited time and effort. Trying to build something overly complicated just takes too many resources. Considering that the likely outcome is a failure, investing too much into an uncertain outcome doesn’t make sense.
Because of this, complexity is something that accumulates naturally around a successful project. However, it isn’t something that a successful project has from the start.
Second, and much more importantly, complexity actually increases your chance of failure. Building a whole car that doesn’t work is a very bad position to be in when there isn’t a single mechanic in the whole world that can help you, as your car is innovative.
Instead, it’s better to build a skateboard. This way the points of failure are much fewer and much more obvious, which means that you’ll be able to fix and improve your skateboard on your own.
- Continuously experiment with new products and services to allow yourself to be lucky. Make experiments with a low downside (low money, time, and effort investment) and a huge upside.
- Quickly discard ideas and projects that don’t receive a positive reception from the market. Try something new.
- Keep it simple.