Navigating risk capacity vs risk appetite in a tough market
In the startup ecosystem, we’ve been hearing a lot of speculations about how the economic downturn will bring correction to the tech industry. We’ve seen layoffs happening across the industry, yet at the same time we’ve also seen news from startups that have achieved significant funding rounds.
Building a startup has always carried a good amount of risks, but during this uncertain time, the need to manage risks seems more pronounced.
As a founder, it’s important to understand your business’ risk capacity and risk appetite in this changing climate as well as your own, so that you can make better decisions for your business. Risk capacity is the amount of risk you or your business can take, whereas risk appetite is the amount of risk you or your business are willing to take.
Business risk capacity & appetite
Startups are mostly perceived as businesses with high risk capacity and high risk appetite. A big component of risk capacity is the amount of funding available now and in the near future. Many in the VC world are advising startups to tighten their belts and rethink their fundraising plans in the next few months. Companies should consider different scenarios and potentially extend their runways accordingly. This is where building solid operations functions is ever more crucial as well as having the right data to help you monitor your business.
According to Crunchbase, although funding is being pulled back at late-stage, seed-stage funding is still going well. Many investors are still looking for startups that are going after big-problems to solve and have the ability to exploit the downturn market opportunities. It seems to suggest that for earlier stage companies, high risk appetite can still very much be rewarded.
So, how should the business balance on the one hand, less risk capacity due to tighter funding; on the other hand, the need for greater risk appetite to come out of this downturn on top?
Part of this could be having a strong understanding of what your core business is and focusing the business ambition on the core. For example, if you’re a marketplace platform, it might seem important to extend your reach into delivery, payments and other auxiliary services. However, your core business really should be getting the most optimal matches between supply and demand. In other words, once you’ve established your product-market fit, that should be the area for your risk appetite.
Founder risk capacity & appetite
Often we assume that startup founders are massive risk takers, and that their businesses reflect their personal attitudes towards risks. Interestingly, in the latest Startup Risk Index 2022, it was shown that 63% of founders consider themselves to be ‘risk averse’, although 65% recognized that they needed to take risk for the business.
The potential mismatch between the business’ appetite for risk versus the founder’s own capacity and appetite is an area that few have explored. Perhaps founders are expected to put aside their personal preferences for the business, however, in reality and especially during uncertain times, it’s understandable that the founders personal attitude will have a part to play in the decision making process.
From our work, we have encountered founders who demonstrate great risk appetite when it comes to product risk, yet at the same time very risk averse to financial decisions. Similarly, we have also worked with founders who are more concerned about financial success and as a result hesitate to move fast when it comes to product decisions. Neither of these situations need to become a problem as long as the founders are aware of their own tendencies.
The worst scenario is when founders are unaware of their tendencies and insist on holding on to all the decision making power. This can really slow down operations and growth. What you can do to combat this aside from building personal awareness is to have a very clear focus of your company direction and being able to communicate that to your team. This way you can start to prioritize decision making and enable your team to move forward with more autonomy.
By understanding your own risk appetite and how it compares with the risk appetite needed to grow your company, you can identify if there’s any misalignment between the two. You need to find that person(s) who understands your business and whom you can be open and honest with. They can act as a sounding board and help you evaluate your decision making.
This person may be internal but also could be an external person who will not be impacted by your business decisions. Last but not least, sometimes it’s good to remind yourself that ‘you’re not your company’, even though at the early stages it can sure feel that way.