risk-reward

New Venture Risk

In Managing Risk by Steve Sliwa

The ability to assess key risk factors for a new venture is crucial for angel investors, venture capitalists, and entrepreneurs who must invest their own money and time or the money of their investors. Likewise, business leaders frequently must approve new products, product lines, areas of market pursuits, acquisitions, or spin-outs. The ability to assess the risk of such activities is a fundamental part of the decision process. So, it’s important to have a methodology for organizing a risk assessment.

Many articles, treatises, and books have been written on the topic. However, my experience is that most professional investors and leaders of new ventures use the following criteria:

  1. Technical Risk
  2. Market Risk
  3. Execution Risk
  4. Financing Risk

Before investing in a start-up or launching a new product line, each of the above factors needs to be assessed. The main question is are the risks appropriate for the stage of investment – seed, start-up, mezzanine, etc. – and are there plans to sufficiently manage each of them.

Technical Risk

Can the product or service that is envisioned actually be built? Typically, one or more of the following stages will challenge the development and need to be navigated prior to the technical risk being eliminated: invention/innovation, design, testing, component sourcing, and design for production.

Market Risk

If the product or service is produced, will the market value it? This means the actual value proposition needs to lead to significant and sufficient demand for the product. Frequently, this requires adjustments to the product or service design as well as tuning the business model before eliminating the market risk.

Execution Risk

If the Technical Risk and the Market Risk are eliminated, then the business needs to scale to meet customer demand. Can the business unit solve the myriad of operations and business problems that accompany a rapidly growing company? Sometimes, there are external factors that are tough to overcome, but a significant portion of these issues come from internal problems.

Financing Risk

Invariably, the previous risks, even when resolved, result in the schedule delays. Such postponements usually result in cost over-runs and the need to raise additional funds. Unfortunately, new venture over-runs are on the order of 2x to 5x of the original cost estimates. So to raise new funds, the team needs to execute milestones that reduce the risks described above and have sufficient talent to be able to raise more funds. Fundraising could be for venture capital (additional rounds), debt financing (e.g., bank lines of credit and bond issues) or raising funds from the parent company for an intrapreneurial project. Occasionally, the best ideas fail because the founding team is incapable of raising sufficient funds to fully execute the concept and provide time to reduce the risks.

Best Way to Overcome New Venture Risks

A common parable in real-estate investing is to observe that the three most important factors in the value of a piece of real estate are location, location, and location! Similarly, in the new ventures arena, it is often stated that the three most important factors in valuing a new venture are management, management, and management!

The prime reason it is so critical is that the risks mentioned above, in combination with a plethora of unknowns and changing external factors, make the ability to predict the ways forward virtually impossible. No business plan can predict the future. It’s very similar to playing chess. No game plan prior to the game will be able to anticipate the situation after only a few moves. 

The only way one can have confidence that a new venture will successfully navigate these challenges and potential obstacles is to rely on a talented and experienced management team that will find effective solutions to every issue that presents itself. One cannot predict the issues and write down the solutions a priori, but a talented executive team maximizes the probability that the business will successfully adapt on the fly. Hence, a reasonable maxim is as follows:

[blockquote  type=”left”] The best inoculation against new venture risk is a capable management team.[/blockquote]

Summary

New venture risk can be factored into technical, market, execution, and financing risks. The best way to ensure a new venture will maximize its probability of circumventing these risks is to empower a capable management team.


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