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15 Oct How to Become a Better Business Risk-Taker

For some, dealing with the stresses of risk is a nightmare. Others consider it pure adrenaline. One of the key components of entrepreneurship is learning how to successfully manage the inherent risks. That’s what we’ll be discussing here — how to become a better risk-taker and deal more effectively with risk. This article has only one purpose — to help educate family-owned businesses on the stresses inherent in running and successfully selling a business.

Money matters inherently involve risk. Think about it. Whenever you spend money, you’re betting that you won’t regret the expenditure the next day or six months down the road. Every time you make an investment, you’re banking on the uncertainty of a yield. When you’re paying an insurance plan, you’re hedging against the disaster while the insurance company is betting that the disaster won’t occur. If you jumped ship to a new job, you’re giving up a known for an unknown in hopes of improving your plight.

Risk is always present and nobody bats 100 percent. But the winners, those that really get ahead, have a much better, a much higher batting average than the losers.

How you personally feel about risk often isn’t that important. Some people love risk. They embrace it with a passion; it’s a high. They cherish the thrill of letting it roll. To them, it’s “no guts, no glory” all the way, so they have the tendency to just wing it to go for.

Others loathe the risk. They live with it; accept that it’s reality but to test it. Their natural tendency is to avoid, to duck any risk. But whether you’re a risk lover or a risk hater, if you don’t know deal with risk effectively, your natural tendency will kick in and you’ll end up losing.

There are many people, both risk lovers and haters, who react only to the risk instincts and do a lousy job of dealing with the risk. As a result, they make dumb decisions on a regular basis — decisions that cost them all along the way. Their batting average is lousy. Others, even many perceived wimps, who dread risk become excellent risk-takers — smart players who know when and how to let it roll.

What separates the winners from the losers? It is the will and the ability to tackle the risk; the ability to strip the risk to its bare essentials by analyzing all relevant credible information and then properly assessing the stakes and the odds. It takes effort, energy, and some brain power. And because it takes some effort and is not easy, there are two mistakes that many poor risk-takers routinely make.

The first is that they mistake risk-taking for ignorance. They just don’t expand the time and energy to gather useful necessary information that’s available with a little effort — information that, if known, would make it critical in handicapping the risk and often would have the effect of reducing, eliminating, or perhaps completely moving the risk. They’re just lazy and their rationale for this approach for being lazy is that nobody really knows what’s going to happen in the future anyway. But with nearly every decision, usually there exists critical facts, important information that enables a good risk-taker to smartly balance the odds and the stakes and measure all the trade-offs.

The person who never gets the information, or worst, yet gets bad information from unreliable sources is just batting on the state of his or her own ignorance. It becomes a game of dumb luck, not strategic risk-taking.

The second mistake that lousy risk-takers often make is that they place too much emphasis on their perception of the odds. If the odds are favorable, that is, there is a good chance they’re going to win, going to prevail, they just jump; they go for it. If the odds are not favorable, they walk. Smart risk-takers don’t start with the odds. They start by carefully and fairly assessing the stakes, the upsides and the downsides, and before even looking at the odds they ask this question: “Can I live with the downsides if I lose this one? Will I still be a player?”

You see, they understand that there are some risks with hugely favorable odds that they can never afford to take. The downside, no matter how small its chances, is just too catastrophic. On the flipside, they know that there are other risks with unfavorable odds, often less than 50 percent, that they can afford to take all day. The reason is that the upside of being right is huge while the downside of being wrong is no big deal, often peanuts.

Let’s illustrate these mistakes and the importance of tackling risk by focusing on three real-life bad decisions made by a lousy risk-taking couple. The facts here are true and sadly enough aren’t that uncommon. They involve Jim and Mary, a young couple with an infant daughter. Jim has worked for five years as a manufacturer’s rep. Mary is a budding freelance author. As a sales rep, Jim has done a good job and as a result is looking at a potential job change.

The first decision involved life insurance on Mary’s life. After sizing up the cost and the benefits, they concluded that they really didn’t need any insurance on Mary’s life. They based their decision on four facts: First, the actuarial odds of Mary dying at her age are miniscule. Second, Jim read somewhere that insurance companies almost never pay any death claims on term life policies because the insured nearly always cancels the policy before dying. Third, Mary’s father always said that insurance companies were a rip-off. Finally, Mary’s present earnings are insignificant. Jim is the real breadwinner, so they decided that given the odds, there really was no need to waste money every month on life insurance covering Mary’s life.

Now this is a dumb, irresponsible decision — a classic example of bad risk taking. The first two points about the odds of Mary dying are right, but so what? Young people die every day. They sadly beat the odds, so to speak.

The third point of the ignorant biases of Mary’s father also is irrelevant. And as for their fourth point, why is Mary’s income a factor if her untimely death would create financial havoc for Jim and their infant daughter? And it would. What is relevant and what should be the sole supreme consideration is that if Mary dies, no matter how small the odds of that happening, Jim’s life and that of their infant daughter would be turned upside down. Jim would have to find a new way to cover all the bases that Mary now handles — both the actual and opportunity costs for Jim would be substantial. New costs would need to be incurred and Jim’s productivity at work would likely suffer as he deals with all the fallout from Mary’s untimely death.

The complexity and economic pressures of Jim’s life would immediately intensify to say nothing of the grief that he would have to fight through. A tax-free hit of, say, $250,000, $500,000 to help Jim and his infant daughter get through it all could make a huge difference. At Mary’s age, the cost of the protection likely would be less than $20 a month. This is a risk that they shouldn’t take no matter how favorable the odds. The downside of being wrong is just too catastrophic. Young parents sometimes die. It’s a reality. This decision was born in ignorance and fueled by a misplaced desire to save a few peanuts each month.

Jim and Mary’s second decision involved a recent investment. Jim’s brother is a savvy computer tech for a company that was recently acquired by a small public company. His brother received some stock options in the deal and enthusiastically proclaimed to Jim that the stock of the public company offered a ground floor investment with huge upside potential. His brother prophesied that this would be his ticket to real wealth. Armed with this information and the desire to keep pace with his brother, Jim rated his savings and borrowed on the line of credit to buy stock in the company. Had Jim tackled the risk and done some homework, he would have quickly learned that the public company plagued with weak earnings and a weaker management was simply trying to bolster and sustain itself by using its stock to acquire small strategic companies. It was a super high risk, a long shot deal, while the ground floor hit the basement real quick. It was a classic case of betting on one’s own ignorance.

Jim’s next decision involved a potential job change. One of Jim’s customers, a small fast growing company, was impressed with Jim’s work and offered Jim a position as a regional sales manager. If all worked, the upside to Jim would be huge: lots more pay, more responsibility, and more say. Jim again focused on the odds. The chances of the small company surviving and thriving versus the perceived stability of the huge company that he now worked for, Jim just assumed that the small company with its humble offices and meager employment base was vulnerable. As Jim looked at the opportunity, he saw hard work — the need to reprove himself, the discomfort of change and newness, and the risk that he might be forced to make another change down the road if things didn’t work out.

So he passed on the opportunity for these reasons. Had Jim really focused on the stakes, he would have seen a big upside — an upside that could have taken his career to a whole new level. And the downside: if things didn’t work out, really not that big a deal. Given his excellent track record as a sales rep, he could easily land another rep job. It may take some time, cost a little, and create some discomfort but that’s the risk — the only risk of having a shot at a real quantum improvement in his life.

Here was just another case of laziness, of not tackling the risk. Had Jim done some real homework, he would have learned that the small company was solidly positioned in its market despite its humble offices. But beyond not getting the facts, Jim just lacked the energy, the will, the guts to go for it; to endure the uncertainty and discomfort of change for the privilege of tackling a smart risk that could produce big life changing results.

In evaluating risk, it’s usually helpful to be mindful of two forces within your control that can help you tackle your risks, be a better and smart risk-taker. The first is time. You will have a better batting average if you take time to ponder the risk, the decision, after you have assimilated all the relevant information. Sleep on it, clear your head, and get some exercise. A little time often will allow you to develop a confidence in your decision — a peace about your decision by removing clouds that made everything seem so foggy just a few hours or a few days earlier.

The second force that often helps is that feeling deep down inside of you. It has many names: intuition, inspiration, instincts, the still small voice. The one I prefer is gut feel. What does your gut feel tell you about the decision? And how important should your gut feel be in making the decision and taking the risk?

Above all, it should be never ever be an excuse for not tackling the risk for shortcutting, the fact gathering, and analytical processes. Here is a rule of thumb I found useful. To take a strategic risk, two things need to line up. Your hard analysis of the facts and the tradeoffs need to support the decision. And after studying the issues, you need to have a good gut feel about any decision to move forward. Both must be present. If the hard facts and the objective analysis suggest you should go for it but your gut feel after fairly analyzing the risk says no, then pass on the risk. And if your gut feel tells you that it could be a good deal but the hard facts and your analysis suggest otherwise, then also pass.

Never ignore hard facts staring you in the face to take a significant risk just because you think you feel good about it. Always be mindful though of an important caution when trying to get in touch with your gut feelings. Do not confuse gut feelings with “gutless.” Most wise, bold, smart decisions require courage guts to get it by the raw fear created by the decision. Fear of change, fear of failure, fear of the unknown. If you must take this normal fears with intuition, instinct, gut feel, you’ll back off; you won’t tackle the risk, you’ll just chicken out. Your excuse will be that you just don’t feel good about it when in fact you’re just scared. You’ll end up always losing. Just acknowledge the fear, accept that it’s normal, neutral, and then move beyond it to higher level that permits real analysis and insightful pondering.

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Nate Nead
Nate Nead is a licensed investment banker and Principal at Deal Capital Partners, LLC which includes InvestmentBank.com and Crowdfund.co. Nate works works with middle-market corporate clients looking to acquire, sell, divest or raise growth capital from qualified buyers and institutional investors. He is the chief evangelist of the company's growing digital investment banking platform. Reliance Worldwide Investments, LLC a member of FINRA and SIPC and registered with the SEC and MSRB. Nate resides in Seattle, Washington.