Risk Tolerance in Entrepreneurship: A Guide to Successful Business

Risk Tolerance
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Do you think that entrepreneurship as a profession didn’t bring risk to you? Are you an entrepreneur who doesn’t want to take risks when starting this profession? If there is a risk, how much risk tolerance do you have?

If you are already an entrepreneur, I think you are not a person who doesn’t take a risk because you already have taken some risks when you decide to start your company.

Entrepreneurship is closely related to risks and risk-taking from your side as an entrepreneur. You cannot become an entrepreneur without taking some risks.

đź“– Key takeaways

  • Risk-taking is important in entrepreneurship because it can bring innovation and growth to your business, increase competitive advantage, you will learn more, become adaptable to changes, and overcome the fear of failure.
  • You will experience different risks, such as financial, operational, technology, market, and reputational risks.
  • Risk tolerance is how tolerant you are as an entrepreneur of specific risks. You can measure risk tolerance on a scale from 0 to 100, which will tell you how much chance there is to take specific risks. Also, you must respond to three critical questions regarding risk tolerance.

Introduction to Risk-Taking in Entrepreneurship

Why is there a risk for entrepreneurial ventures?

You invest the money you have in your pocket. But, if you don’t know if it will bring you more or the same amount of invested capital in the future, you are in trouble. That’s the first initial risk that you as an entrepreneur take on yourself and, in most cases, on your family because you must short the satisfaction of their needs in exchange for the required financing of your company.

You’ll never be 100% sure about the future of your business. Also, you’ll never know with 100% precision how successful your company will be or how much money you’ll earn in the first, second, or third year. Because of that, there will always be risks in entrepreneurial ventures that you want to start. However, not all risks are equal, and prioritizing smaller, less costly opportunities can be beneficial.

Each potential or future entrepreneur needs to answer this question before they decide to leave their current job and become an entrepreneur: Is it worth starting a company compared with the future if you didn’t take this step? You will often relate this risk to your risk tolerance and fear.

What is Risk Taking in Entrepreneurship?

Risk-Taking Definition

Risk-taking in entrepreneurship refers to your willingness and ability as an entrepreneur to make decisions and take actions that involve uncertainty and potential loss. It is an inherent part of your entrepreneurial journey as a business owner who wants to venture into the unknown and uncertainty and aspires to business growth.

Being a risk-taker is crucial in entrepreneurship. It allows you to learn from taking risks and experimenting with new ideas that will lead to innovation and success.

As an entrepreneur, you will take risks for various reasons, including the desire for financial freedom, personal fulfillment, and the thrill of the unknown.

The Importance of Risk-Taking

Risk-Taking Importance

Why is taking risks important to the success of your small business?

There are many reasons, but let’s look at some of the most important that can really make a difference between successful businesses and mediocre or failing ones.

1. Taking Risks Will Bring Innovation and Growth

Risk-taking is essential for pushing innovation and achieving business growth. Entrepreneurs who are willing to take calculated business risks want to change the status quo and, because of that, often come up with new ideas and challenge conventional thinking. This will help them disrupt existing markets with new products, business models, and processes.

2. Without Risk Taking, There is No Competitive Advantage

Entrepreneurs who take calculated risks often gain a competitive advantage in the market. They can differentiate themselves from competitors by identifying hidden opportunities that others may overlook or consider too risky.

3. You Will Learn More and Become More Adaptable

Risk-taking in entrepreneurship provides valuable learning experiences. Even if a venture does not succeed, the lessons learned from failure and taking risks contribute to personal growth and professional development.

4. You Will Overcome the Fear of Failure

Fear of failure is a common psychological barrier for entrepreneurs. However, taking risks allows entrepreneurs to confront and overcome this fear because the learning experience is a much bigger treasure than the fear itself.

Types of Risk in Entrepreneurship

types of risks

Financial Risk

Financial risk is the most common type of risk faced by entrepreneurs. It can be the potential loss of investment or some of your own or your business’s financial resources. Entrepreneurs often invest their capital or secure funding for their ventures, and in such a way, they are exposing themselves to financial risks.

Market Risk

Market risk relates to the uncertainties associated with the market’s demand for a product or service. It doesn’t matter how you have analysed market trends and predict the future, predictions and trends are never 100% sure.

So, entrepreneurs must conduct market research and assess market conditions, customer preferences, competitiveness, and potential changes that could impact their business. This way, they can carefully plan the future and minimize or eliminate potential business risks from the market.

One of the biggest market risks, for example, is competitive risk. Competitive risk refers to the possibility that direct or indirect competition with similar products and services impacts your business’s market share.

Operational Risk

Operational risk refers to challenges and uncertainties faced in day-to-day business operations. It includes risks such as supply chain disruptions, production issues, regulatory compliance, talent acquisition and retention, and technological failures.

Reputational Risk

Reputational risk involves the potential harm to a company’s brand or image due to negative publicity, poor customer experiences, unethical behavior, legal issues, or product failures.

To manage reputational risks, entrepreneurs must be conscious of their actions, maintain transparency, and prioritize customer satisfaction.

Business Risk

A business that takes too high a risk when launching a new product or entering a new market can potentially risk its existence. Entrepreneurs must consider the potential risks and consequences of their actions.

Technology Risk

With the rapid development and high-level reliance on technology, there is also an increased risk of technological failures. These failures can range from cyber attacks to system malfunctions, seriously impacting a company’s reputation and bottom line.

What is Risk Tolerance, and What Are the Types of Risk Tolerance?

risk tolerance definition

Risk tolerance is your entrepreneurial willingness and ability to take on certain risks to achieve specific business goals.

For example, as I already mentioned, you will face many risks. However, you will ignore some of them and take action without careful planning or preparing to overcome those risks. In most cases, you decide to ignore it if you have a higher risk tolerance for such risks.

So, you can consider risk tolerance as a scale from 0 to 100, where 0 means you are totally intolerant while 100 means that you are totally tolerant of those risks. It is simple the chance in percents regarding your tolerance to specific risks.

For example, when investing money, you can have:

  • A low risk tolerance involves taking minimal risks and prioritizing stability and security.
  • Conservative risk tolerance focuses on preserving capital and avoiding any downside risk.
  • A moderate risk tolerance balances risk-taking with caution, while a high-risk tolerance involves taking high risks to achieve higher rewards.
  • Aggressive risk tolerance involves allocating most of the portfolio toward riskier assets, such as stocks and real estate, with the prospect of higher returns over time but a greater chance of losing value in the interim.

However, when it comes to business, different types of risk tolerance include low, moderate, and high, as shown in the image below.

risk tolerance - high - medium - low

Taking Calculated Risks: The Key to Successful Business

What Means Taking Calculated Risks

Taking calculated risks involves carefully assessing potential risks and rewards before making decisions rather than simply jumping into unknown territory without proper consideration. Entrepreneurs are risk-takers, not gamblers.

This mindset allows entrepreneurs to strategically take calculated risks that could greatly benefit their business. By analyzing various factors such as market trends, competition, and financial projections, entrepreneurs can make informed and smart decisions about what risks are worth taking to achieve their desired goals.

For example, how much risk will there be if we decide to expand our business to new markets?

Characteristics of Successful Entrepreneurs Who Take Risks

Successful entrepreneurs are decisive and willing to take calculated risks to propel their businesses forward.

Let’s look at some of the biggest risk-takers:

  • Elon Musk is well-known for his risk-taking mentality. Musk has consistently taken on high-risk ventures, investing billions of dollars into electric vehicles and space exploration industries still characterized by many unknowns.
  • Sara Blakely is another example of a risk-taking entrepreneur. She took a leap of faith by investing her life savings to launch her innovative shapewear product.
  • Richard Branson is known for his adventurous and risk-taking spirit. He has built an extensive empire through various industries, including music, travel, and telecommunications.
  • Jeff Bezos is known for his bold and risk-taking strategies. In the early days of Amazon, Bezos expanded the company’s offerings from books to a wide range of products despite doubts about the profitability of online retail.

Risk Tolerance Questions

1. Can your current potential provide survival?

In most cases, each company’s early startup stage is based on the entrepreneurial potential to bring that business to life. You’ll need to invest your time, money, knowledge, and skills into the future of your business.

You can’t start a business without your commitment to it. That commitment will need your time. You can’t start a business without money because you’ll need to provide all future requirements for normal business operations, such as an office, equipment, raw materials, etc. Also, you can’t start a company if you don’t have enough knowledge about the industry of your new business, the market where it will operate, or the products and services it will offer. You’ll also need skills that are much more than required if you have corporate work. You’ll need to have negotiation skills, analytical skills, sales skills, networking skills, etc.

Remember that you will have different driving forces that will move you forward as an entrepreneur. You will also need the mental ability to handle being an entrepreneur.

The more you have to invest, the more risk you will face as a potential entrepreneur. The higher the risk, the more critical your risk tolerance will be for the success of your business.

Questions you need to answer:

  • How much money do you have or can you find to finance your company?
  • How much time can you invest in building your company?
  • Do you have enough skills and knowledge to start such a company?

The real case of the entrepreneurial nightmare and risk tolerance

I know an entrepreneur who left a large corporate work with a solid salary ($7.000 monthly) and started his own company. He didn’t expect to earn such a salary, but he didn’t expect the new company to eat his cash in the first three months.

critical risk tolerance

Entrepreneurial excitement quickly becomes an entrepreneurial nightmare. Why does this happen in most cases?

First, he didn’t accurately scan and analyze his business possibilities. He has money, but the startup process costs more than his predictions. Second, he didn’t make a proper sales prediction. Sales and cash flow are the most important things for small businesses in the startup stages. If it doesn’t have sales, he must invest his money to survive this stage of his newly created company.

As an entrepreneur, you will need to manage all possible risks. Here is a complete risk management guide to help you in your entrepreneurial journey.

If I recapitulate the case of this entrepreneur, we can tell that:

  • He invests his time and commitment to transferring his business idea to a real company.
  • He invests his finances in the new entrepreneurial venture, but he doesn’t realize that it will not be enough because of the lack of proper sales forecasting for the future. And money becomes the biggest problem for the future of his business success.
  • He knows the business in general.
  • He doesn’t have enough skills in planning, managing, and finances. This lack of skills brings problems after three months of operations. He used aggressive marketing campaigns in the first month after startup but didn’t have a proper system to measure the results of those campaigns. In such a way, he spent too much money on advertising without real results for his company.

2. What will be possible gains and losses if you take risky action steps?

This is an important question when calculating specific risk tolerance for specific risks. To answer these questions, you can use a two-column table and write possible gains in one column and possible losses in another. However, you must use math to make the right decision regarding risk tolerance because different gains and losses will have different measurement units. Some of them will be in currency, some in time, etc. My recommendation is always to try to convert different measurement units into currency.

possible gains and losses

As an entrepreneur, you must predict the next five to ten years. Especially about how much you can earn from your company. It is not the whole income from the company, but how much will remain with you after you pay all expenses and taxes?

For example, your sales in the first year will be $400.000. After paying expenses and taxes, you have only $50.000. You predict your sales will increase by 10% annually with the same percentage of expenditures and taxes. After ten years, you can earn $647.500.

3. What gains and losses will be possible if you don’t take risky action steps?

The same process from the second question you must implement for this question.

Let’s continue with our example. When you know how much you can earn for ten years if you start your company, you must compare that sum with the sum you can earn if you stay at your current job.

Let’s say you have an annual salary of $50.000 with all benefits you will earn. That is $500.000 for ten years.

Is it worth starting a company and leaving your current job to earn $147.500 more for ten years?

But, There is Much More

Until now, we have discussed any possible risks for you as a would-be or potential entrepreneur. In the end, we finally came up with some concrete numbers about your possible earnings as an entrepreneur and the potential of your current earnings for the future.

The calculation was that starting your own business can earn you $147.500 more. This result leads to the logical conclusion that starting a business is a good idea because you will earn more money and be your own boss.

Risk Calculation: Is it the same as the corporate job?

Before we continue with the calculations, I would like to compare your current job to your future activities as an entrepreneur.

You Don’t Have a Supply Department

When you work for a company, everything that you need, from paper and pencils to toilet paper, you will receive from a supply department. There are people whose job is to make the best possible working conditions for you. However, in your business, especially at the startup level, you are the only person who must provide everything your business will need for everyday operations. Because of that, if you plan to work on innovative things in your business, forget it. You must add an additional hour daily to supply your business with everything necessary.

Nobody Will Prepare You Coffee

When I worked for the corporation every morning and noon, I received coffee from colleagues whose job was to make and distribute coffee for all of us. Then, when I started my own business, especially in the first days of the job, making coffee was my only responsibility.

You Will Not Have an Administration Department

When you work in the corporation for all your business trips, a department prepares documents like tickets, hotel reservations, visas… When you are your boss, in most cases, you will be responsible for accomplishing all these tasks when you must go on a business trip.

These are only three possible cases and comparisons of some tasks you will have when you become your boss. But, in reality, there are many more tasks than this.

What does this mean for you? You will need to increase your working time by several hours. With more responsibilities, you need to invest more time.

Let’s continue with the numbers to calculate the risk

In your current corporate job, you work 2000 hours in one year. For ten years, you will have 20.000 working hours. If we continue with the earnings from the first part of this post, which was $500.000 for ten years, you will be paid $25 for an hour.

In the same example, your business will earn you $647.500 in the next ten years. If these additional activities are for you, you will work only eight hours weekly, which is 416 hours more annually. You will need to work 24.160 hours for your business for ten years. In such a case, you will earn $26 an hour.

risk and efforts

This example tells you you will earn $1 more with your business hourly.

What do you think is it worth to start your own business?

You will earn more, but you will need to invest much more in your effort to earn more money.

This is only an example. The important thing is that you need to make your own calculations when you decide whether to start your own company or stay at your current job.

There are also examples of entrepreneurs who succeed in managing their businesses correctly. In this way, their businesses work for them. These entrepreneurs don’t work for their businesses. However, this is only a small portion of cases.

Conclusion

Entrepreneurs should take risks, but that doesn’t mean they should be careless risk-takers. Instead, entrepreneurship involves welcoming uncertainty, making decisions on calculated risk, and taking proactive actions to drive innovation, gain a competitive advantage, and foster personal growth.