Starting a Business Is Risky. Here’s How to Determine if That Risk Outweighs the Reward

How do startup founders decide when the risks are too great?

Economist Amar Bhide analyzed the startup founders on the 2003 Inc. 500 list to determine how they were different from people who start less successful businesses. (The result is the book The Origin and Evolution of New Businesses.)

What did Bhide find? In many ways, the people who reached that high level of success weren’t that different. They didn’t necessarily have a comprehensive, highly-detailed business plan. They didn’t necessarily have a deep knowledge of their industry. They didn’t necessarily have a serious competitive advantage, like special connections or easy access to funding.

But Bhide did identify two key characteristics. One was that many successful entrepreneurs had started service companies. Since service is built on differentiation — even on a personal level — startup founders who are willing to work hard and leverage the force of their own personality can succeed.

The other was that entrepreneurs who succeed tend to enter fields where tremendous uncertainty exists — which means they’re rewarded for taking significant risks. When uncertainty exists, when change takes place at a rapid pace, the barriers to entry tend to be low, and the incumbents tend to quickly disappear.

In other words, many successful entrepreneurs take a significant risk, one that pays off big and allows them to build a successful business. Or one that means they find themselves out of business. Where starting a business is concerned, the failure rate is high. The psychological price can be high. The likelihood of working extremely hard and reaping relatively little reward is high.

Determining risk versus reward.

So how can you decide whether the risk of starting a business outweighs the reward?

Good question. Unfortunately, there’s no single answer.

While every startup involves some risk of failure, serial entrepreneurs — those who have failed and succeeded several times — tend to be good at assessing the feasibility of their idea and their potential to execute that idea based on the resources available.

Over time, experienced entrepreneurs learn to instinctively consider the risks involved not only in starting a business, but in taking the steps required to grow a business, such as introducing new products or services, hiring new employees, and taking on capital. The simple fact is, performing risk-reward analyses is an ongoing process. (And that doesn’t mean we always get it right.)

For a first-time entrepreneur, deciding whether the risks outweigh the potential reward can be a little harder. But not impossible.

Start by assessing the market. The best way is to create a minimum viable product (MVP) and test, test, and test some more. Ask friends and family to take it for a test-drive. Ask people you trust. Ask potential customers.

The surest way to fail is to create a product or service customers don’t want.

Then evaluate your competition. Make sure your idea is not only competitive but offers a dramatic improvement over what is currently available. It can be tough to convince customers to switch if what you offer is only incrementally better.

If you can’t provide a major improvement over a current product or service — whether in cost, or quality, or service, or some other area — then the risk may be too great, especially if a significant capital investment is required to start your business.

Then consider the resources you have available. If you’re bootstrapping your startup, your time may be the largest investment you make, especially if you hope to fund your startup with the revenue you generate. Time certainly has value, but at least the time you “lose” trying to launch a business won’t have the same impact on you or your family that losing your savings, or piling up credit card debt could have.

That’s why I started LogoMix from my kitchen table. I thought I had a great idea. I tested my idea. I used my experience to validate my findings. But even so, I worked to ensure the risks didn’t outweigh the potential reward.

You should too, no matter how confident you feel. If you really want (or need) to minimize your risk, keep your full-time job and launch your startup on nights and weekends. Your kitchen table can be your office; mine was. I got up at 5:00 every morning to talk with developers and keep the business moving forward.

Finally, don’t assume a risk-reward analysis only makes sense in the beginning. As you keep putting one foot in front of the other, periodically take a fresh look at the market, your competition, and your resources. Make smart decisions as you go.

Every step you take in building a business involves some degree of risk. Make sure every step also has the potential to provide a commensurate reward.

All Rights Reserved for Craig Bloem

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