Risk is an inherent part of being in business. It can be managed and its adverse outcomes can be mitigated. The greatest challenge for small business owners is to find the proper balance between peace of mind and profitability. Trying to completely eliminate risk from your business is unrealistic and can be prohibitively expensive or cause you to institute policies that may be so risk averse that your business never grows.
When many business owners think about “risk management” it’s usually limited to purchasing standard insurance protection without much consideration for other ways to protect the business. Risk management can be very complex, but it doesn’t have to be at first. Get started with a simple, easy to follow plan for managing and mitigating business risks and if needed expand from there.
Take these steps to put an initial risk management plan into place at your company:
First: identify risks
Some risks are common to most or all businesses. Others are very specific to your business and only you as the owner can know them. The best way to approach this is to use a standard risks checklist as a start and then add to it based on your specific expertise. The Small Business Administration provides a Small Business Insurance and Risk Management guide which addresses potential risks.
Some initial risks to think about are:
- Property losses – typically occur from physical damage, loss of use and/or criminal activity.
- Business interruption losses – occurs if your business stops selling for some reason (say because of a fire). In addition to the property losses incurred, the company would not be able to produce goods and sell them. This “interruption in your business activities” can be protected.
- Liability losses – refer to legal liability for damages or injury caused to others by your company.
- Key person losses – refer to the costs associated with an important employee or owner becoming sick, disabled or dying. The impact of a key person loss on a small business can be catastrophic.
- Injury to employees – refers to the costs associated with an employee becoming injured while at work.
Second: determine your company’s vulnerability for each risk
Vulnerability is a function of probability – what are the odds that a particular risk will materialize- and cost – how much does your company stand to lose as a result. The goal of this step is to quantify which risks are worth worrying about and which ones aren’t. For the ones that are worth worrying about, the question becomes how affordable is it to protect your company against that risk. If a particular risk has a low probability of occurring and if it did would cost your company a maximum of $50,000 in losses but it will cost $45,000 to protect against this risk, it may not be a good use of resources to protect against it.
Third: prepare contingency plans
Contingency planning goes beyond just buying insurance. There are many ways to manage risks:
- Implementing policies that value employee safety over speed
- Installing a security system to guard against property losses
- Avoiding transactions with dubious potential customers
- Training high potential managers on the roles and responsibilities of their superiors to protect against key person losses
- And more...
An effective risk management plan is comprehensive and creative. It goes beyond insurance.
Fourth: Acquire the right types of insurance
Insurance, however, should not be forgotten or minimized! It is a central part of risk management. Key types of insurance are:
- General liability insurance – Covers expenses related to legal liability for injury to a third party. Typically covers property damage, bodily injury, medical expenses and the cost of hiring legal counsel to defend your company.
- Product liability insurance – Covers expenses related to legal liability for injury or damage caused by a defective product. If your company manufactures, distributes or sells products at retail then it would be wise to obtain product liability insurance.
- Professional liability insurance – Similar to product liability insurance, but for services instead of products. This protects against malpractice, errors and negligence. It is sometimes referred to as “errors and omissions” insurance.
- Commercial property insurance – Covers the loss of and damage to business property. Property losses and business interruption losses discussed in the first step are typically covered by commercial property insurance.
Fifth: Monitor and adapt as needed
Risk management plans should be reviewed and updated regular. Taking a few days every six months to review and update it for the current conditions of your business is a wise investment. This review meeting should include the owners, department heads and (if warranted) a risk management consultant. Many times insurance companies – with an eye on reducing payouts on claims – provide hands on advice on mitigating new risks as they come along. During the update period it would be a good time to reach out to them as well.
Having a good grasp of risk management for your business will also be important if you plan to raise capital from investors. It is essential for getting them comfortable with the investment opportunity.
Reckless leaders take reckless risks; prudent leaders take calculated risks. Risk management is the “calculator.”
Mike Periu is the founder of EcoFin Media, LLC an independent producer of financial, economic and entrepreneurial content for television, radio, print and the internet. Over the past ten years he has started three companies and advised over 50 companies on financial strategies including fundraising. Mike also hosts regular small business webinars on a range of topics relevant to business owners.