8 Steps Every Entrepreneur Can Take to Reduce Their Business Risk and Liability
Business risks facing entrepreneurs include the risk of default, insufficient cash flow, delinquent customers and competitive pressures. Small businesses are especially vulnerable because they usually do not have the financial cushion of larger competitors. Entrepreneurs must take prudent steps to ensure survival, prepare for growth and demonstrate their risk management abilities to potential investors and lenders.
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Operational Risk Management
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Operational risk includes the effect of natural disasters on supply and logistics, quality problems and supply chain financial problems. Risk management options include buying insurance protection, tightening credit control procedures, diligently following-up on unpaid invoices and rigorous cost controls.
Debt Reduction
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Small business owners should reduce their reliance on short-term and long-term debt. This reduces interest expenses and the risk posed by rising interest rates to cash flow. Debt reduction strategies involve converting debt to equity, which means giving investors a share of the company in exchange for funding; using cash flow from sales to finance operations; and refinancing variable-rate debt to fixed-rate debt to make future interest payments more predictable.
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Diversification
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Businesses that rely on one product are vulnerable to changes in customer preferences and to new product launches by customers. Similarly, relying on a few customers for the majority of sales exposes a business to concentration risk. Diversification in terms of products, customers and geographic markets reduces the risk posed by depending exclusively on one source of revenue.
Quality Control
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Defective products may expose a business to expensive customer lawsuits, product recalls and regulatory action. Rigorous quality control and training are two ways to preserve a company's reputation and protect against lost market share to competitors.
Human Resource Planning
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Small businesses often hire contractors instead of full-time staff to manage their staffing levels and compensation expenses. However, this introduces new risks because contractors may leave for better paying full-time jobs, especially if the job market is good, and companies would then have to allocate additional resources to hire replacements and bring them up to speed.
Mentors
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Entrepreneurs should bring on technical advisers and experienced management consultants to serve as mentors and board members, who understand the growing pains of new businesses. The involvement of senior credible mentors is particularly useful when applying for venture capital funding or small business loans, because it assures potential investors and lenders that the company is in capable hands.
Partners
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Collaborating with other small businesses, especially when bidding on large contracts, is another useful risk management tool. However, management must choose the partners with care because incapable or financially troubled partners might increase risk and liability. Businesses with complementary skills and solid fundamentals make good partners.
Walking Away
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Entrepreneurs should not be afraid to walk away from customers who are habitually late in making payments or whose requirements change frequently. Projects that require high initial capital investments may also not be worth the risk for a resource-constrained small business.
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