In Mistake #1(M1), we shared the importance of understanding your industry cycle and choosing to rise with the tide, or seizing the opportunity to grow, gain market-share and enhance your capabilities. In Mistake #2 (M2), we demonstrated the many advantages to planning, investing in and executing, your growth plan during the downcycle.
Mistake #3 (M3) is all about understanding your own personal risk profile as well as that of the company (i.e. the appetite toward taking business risks and how risk profiles impact business performance).
Most business owners are comfortable taking some level of risk. As the economy becomes stronger, some will want to sprint out of the gates. Others, however, are uncomfortable with making decisions without more clarity on the state of the economy and may want more certainty to better predict outcomes. Whatever your business and personal level of risk tolerance, it is critical to understand what it is and the risk profile of your team.
What are the Risk Profiles?
To illustrate this concept, we use a simple 10-point scale to denote a level of risk.
None of these scores are good or bad, what matters is having the understanding, the conversation and the agreement about the level of risk the company is willing to take and the actions that are acceptable to grow the business again.
We all know businesspeople who, when the market goes down, sell everything and hunker down with their cash; and others that just ride it out. Understanding the ”why” – this difference in behavior – is essential. Moving into cash quickly, to ensure you have reserves to invest in the future is very different than stuffing your cash into the mattress until there are no more dangers in the business world.
Knowing your personal limits and executing a strategy consistent with your limits is ideal. When risk profiles and business strategy are outside of acceptable levels it can lead to – panic. And with panic – poor decisions are made, and often too late.
There is a second consideration that goes along with understanding appetite for risk and that is understanding your volatility appetite (e.g. the degree of variation of your desired outcome and the actual outcome).
As with risk tolerance – some people can tolerate volatility and others cannot. If you consider the stock market – sometimes the markets are strong and keep going up. Then, when the market comes crashing down there is a huge panic from people with a low tolerance for volatility. On the other hand, there are those who understand that the market goes up and down all day long – every day – and when the market goes down (as they know it will), they execute their plan for a ”down market” calmly. These individuals have a higher tolerance for volatility and adapt more quickly.
Risk tolerance and volatility tolerance are intertwined, but they are not mutually exclusive. You can have a low-risk individual who has high volatility tolerance. These individuals are going make a very small bet and write-off the investment in their heads at the onset. That way if the bet does not pan out – they do not panic.
There are also the high-risk individuals who want a sure thing (but with low volatility) – this might seem like a contradiction. These individuals are willing to take riskier bets sooner because they believe they have identified and worked out all the risks of that investment. They then may choose to reduce the impact of volatility by dispensing their cash investment in tranches or other triggers. This is the modus operandi of many Venture Capital firms.