ENSC300 - Risk Factors

Business
Basics
forEngineers
by
Mike Volker

Risk Factors

Contact: Mike Volker, Tel:(604)644-1926

"I'd rather take a risk and fail than not take a risk and become a nobody" (Some successful MIT businessman)

It's a Risky Business

Well, what business isn't risky? The likelihood that a business (or a project within a company) will fail is very high. In high tech companies, the possibility of failure is even higher than in "ordinary" firms due to additional factors that are essential in high tech - like a good technology base, skilled people, technology adoption factors, etc. Managers, at all levels, who are not aware of the risks facing them, may be doomed from failure. It's like sailing off in clear weather not anticipating that a storm may arise and hence making no provisions for that possibility. Prudent business people are aware of risks and put systems and procedures into place to mitigate risk.

Risk Disclosure

In addition to being aware of risks, it is important to articulate risks to potential investors. This is true for both private and public companies, but especially so for the latter. When raising capital, it is important to identify all those things which can go wrong. After doing this, the list may frighten away an investor. However, it'll certainly make it more difficult for someone to sue you on the claim that you didn't disclose possible risks. Having identified risks, it is then very constructive to discuss the precautions which the company is taking in case these risks materialize. It demonstrates to investors and others that you are not flying blindfolded and it allows you to sleep better at night.

Take a look at various prospectus documents for public companies to learn how they disclose risk factors. For Canadian companies, these can be found at the SEDAR (http://www.sedar.com) website. As an example look at some recent public offerings (e.g. Sierra Wireless or CREO in B.C.).

Types of Risk

There are basically two types of risk: controllable and uncontrollable. Controllable risks are those which you can do something about. These would include currency exchange risks, addressing skills issues, poor cashflow (i.e.lack thereof), lawsuits, etc. Uncontrollable risks might include natural disasters (floods, storms, etc). It is difficult to prevent these from happening, but you can at least mitigate damage by taking out insurance or putting in place disaster recovery systems and backup procedures.

Identifying Risks

Make a list. Simply think of everything that can go wrong. Then, add some more things that can go wrong. What about the market, the buyers, the environment in which you do business, regulations, rules, technological change and advancement, unions, labour issues (skills shortages), taxation, health, international trade (currency exchange), trade barriers, theft, fraud, reliance on key people, etc, etc. The list goes on. Certainly this is an area where some prior experience is helpful. It is difficult to know about certain risks if we've never encountered or heard of them before. So, speak to others. What is their experience? What are some of the risks that have faced successful people and how have they dealt with them?

The Primary Risk Factor

The "real" entrepreneur takes responsibility for all risks. Such a person will never use an external factor as an excuse for failure. S/he will never say: "the market turned against me", or "the economy is weak", or "the government is screwing up my business", etc, etc. S/he will say that s/he neglected to be aware of the market or take economic factors into account, etc. Some will go so far as to say that if an earthquake destroys their business it is still their own fault - not because they can control earthquakes but they can certainly make sure that if an earthquake does occur, it will not put them into jeopardy. Such an approach certainly instills confidence!

In a sense, all risks can be either managed. The one risk that is elusive is competition. It is difficult, though not impossible, to be aware of what others are doing. And one has little control over what others do. But, one can strive to be better, i.e. more competitive. Competition will only beat you if you are weaker. Hence, you may be the risk factor in the business. I call this the "primary risk factor" because it all starts (and ends) with you. I believe this to be true if you are running a large corporation or if you are managing a small unit within a company. Therefore, be aware of your limitations and weaknesses. The successful manager complements these shortcomings.

Managing Risk

Most risk can be managed. For example, you can use currency futures or options to avoid wiping out a profit due to an adverse change in exchange rates. A 1% drop in the US-Canadian exchange rate can easily wipe 20% or more off your bottom line. But, this can be avoided with an appropriate hedging strategy using futures contracts or commodity options. Other risks can be avoided through recovery procedures or through proper due diligence (e.g. check our personal references before you hire) or security measures. Once the risks are identified, you can determine how to best manage them. If all else fails, a good insurance plan may be the solution along with a disaster recovery and backup plan.

Go back to Main Page