Want Venture Capital? Then You Better Understand Risk

Date posted: August 29, 2012

In today’s guest post, Jay Turo shares insider insights into the real meaning of risk when seeking investors.

The elephant in the room in all conversations between entrepreneurs and investors is risk.

Investors are always interested in gaining ownership stakes in high potential companies but are also always weary of the considerable risk-taking necessary to actually do so.

The best investors and entrepreneurs I know take a dispassionate and detached approach. They don’t get caught up in the “drama” that the word risk has unfortunately garnered in our “if it bleeds, it leads” media and in our litigious culture.  Rather, they view risk for what it actually is – simply a measurement of the likelihood of a set of future outcomes.

In the context of startup investing, it has three main drivers:

  1. Technology Risk. Can the entrepreneur actually bring to market the product or service, and in what time frame?
  2. Market Risk. Once the product is in the market, will anyone care?
  3. Execution Risk. Can the entrepreneur lead and manage a growing enterprise?

Critically, investors do their risk calculation not by adding, but rather by multiplying, these factors together.

As such, poor grades on any one factor have an exponential impact on the business’ overall risk profile, and thus its investment attractiveness.

And as should be obvious, companies that raise capital simply have better answers when queried regarding the above – their technology plans are better thought out, they understand their market and customers more deeply, and their people have better resumes and track records.

But it goes deeper than that. Deals judged as higher risk face disproportionate prejudice from investors, even when their expected return more than compensates for their higher risk. As a result, higher risk deals are normally underpriced while the lower risk ones are usually over-priced.

That is good knowledge for investors, but what about the entrepreneur?

Well, you must always remember that the real dialogue going through the mind of the investor when considering a deal is not about really about technology, or market or management, even when that is what they want to talk about.

No, it is almost always about risk – both its reality and its perception. Address this concern above all others, head-on, thoughtfully, confidently and candidly. And then risk will be put back where it belongs – as a factor to consider, and not something that automatically stops a deal.

Jay Turo is CEO of Growthink, a consulting firm that, since 1999, has helped over 500,000 entrepreneurs develop business plans, raise funding and grow their businesses.

Image copyright Karen Axelton

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