Risk comes with the territory in early stage companies. All questions asked by potential investors when considering an opportunity can be simplified along the lines of the old risk/reward paradigm: how much reward is possible, and what are the risks?
Company founders often view the risks section as an obligation rather than an opportunity – but if you can pair each risk with a way you plan to mitigate it, the risks section can turn into a powerful marketing message. It will hopefully show investors that you don’t look at the world through rose-tinted glasses, and that you have solid plans in place to deal with the challenges that will inevitably arise.
While every company is different and every risk section needs to be individually tailored, certain risks come up fairly regularly across multiple business models and industries. This list is by no means exhaustive – some of these may not apply to your venture, and there may be others unique to your company not listed here. Still, the below list of possible risks and possible ways to mitigate them should be useful as a starting point.
1. Customer concentration risk
Risk: Companies that rely on a small number of customers for a large amount of their revenue are at risk if those customers go out of business or choose to stop using the product.
Mitigation: A strategy of targeting additional customers to diffuse the customer concentration. Also, signing customers to long-term contracts gives additional certainty over future revenue.
2. Key person risk
Risk: It is possible that important team members can leave – whether by choice or being proverbially “run over by a bus”. Hiring replacements may be slow, expensive and disruptive to operations.
Mitigation: Incentivising key management to stay with the company through conditional compensation or equity ownership can mitigate concerns about them leaving by choice. Further, business processes should be systemised so they are not dependent on any particular person, so that continuity is possible.
3. Competitive risk
Risk: Competitors could target the same customers you are, which could impact your ability to gain new customers and retain your existing ones.
Mitigation: Having unique selling features (and barriers to them being copied, such as patents) can allow your venture to differentiate itself from competitors.
4. Regulatory risk
Risk: Unfavourable changes from regulatory bodies may make operating more expensive or impossible.
Mitigation: Being in close communication with regulatory bodies can mitigate the chance of being taken by surprise by changes. In some cases, regulation may be welcomed as it can raise the barriers to entry for your competitors.
5. Dilution risk
Risk: If the amount of capital raised turns out to be insufficient for the strategy outlined, additional capital may be required, which has the potential to dilute the percentage held by existing shareholders.
Mitigation: Create detailed estimates of uses of cash through a high-quality financial model. Then be conservative and build headroom into the amount of cash you raise so you can deal with cost overruns. State an intention to treat existing shareholders fairly in future funding rounds, should they be required.
6. Execution risk
Risk: This is the failure to do what you are planning, and as such is rather broad. For example, the company may choose the wrong opportunities to pursue, or be delayed is executing its strategy, or face higher costs than it currently anticipates.
Mitigation: Drawing on the expertise and track record of the team members will add to the credibility of being able to execute on its plans, and to pivot in the face of unexpected roadblocks.
Investors are cynical creatures, and it’s far better to pre-empt their concerns by admitting to them frankly rather than letting their minds wander on their own.
A great risks section demonstrates that you’re already aware of the risks in your strategy and have contingencies in place to deal with them – take advantage of this powerful marketing opportunity at your next pitch.
Nathan Rose is an experienced investment banker and author.
