Business is legalized gambling. When you start a business you're gambling that you will succeed. You're also facing the risk that you will fail and have personal and financial losses. How much does this risk bother you? How much risk can you tolerate?

Everyone's risk tolerance level is different. Some people cannot afford to lose a dime. Of course, as they say in Las Vegas: “One who can't afford to lose, can't afford to gamble.” Others say: “I started with nothing. Anything I get is gain.” Still others determine potential losses and say: “It's worth the gamble, but I'm going to do whatever I can to improve the odds.”

To minimize your business risks, you must understand them and their consequences. Chapter 19 will guide you in managing risk once your business is established. However, you need to consider consulting business risks before you invest time and money into starting your business.

Understanding Risk

As you plan for a new or growing business, you know you're taking some kind of a risk, but what does that mean exactly? And how can you keep the risk to a minimum? Your investors (if you have any) want to know the answers — and so should you.

Risk is the likelihood of loss or injury. In business, risk is the possibility of loss of value. Understandably, you don't want to risk everything you have on a business venture that may not return the invested value plus a reward for accepting the risk. The chances of losing money in an insured savings account, for example, are infinitesimal, so the reward is a small rate of interest. The stock market offers greater potential gains — and losses — than savings because the risk is greater.

Value

The greater the value of something, the greater the loss if you lose it. People buy health insurance to reduce the risk of major financial loss in the case of catastrophic illness. Other insurance services work on the same principle: someone accepts a portion of the risk of loss in exchange for something of value — your insurance premiums.

Your business will require an investment of money and time (value) that may be in jeopardy or be exposed to possible loss. You don't want to lose these things of value, so you do what you can to reduce risk to an acceptable limit. You act more conservatively in your transactions or buy insurance as needed. Whenever you make decisions regarding things of value in your business or your life, you (hopefully) consider the risk.

How do you calculate risk? There are complex formulas used by engineers, accountants, and actuaries, but most are based on a simple formula:

R = P × C

Translated: Risk is calculated as the Probability of an event multiplied by the Consequence of it occurring. To calculate business risk, you need to understand probabilities and consequences.

Probability

Probability is the likelihood that something has happened or will happen. For example, what is the probability that your new business will celebrate its fifth anniversary? What is the probability that the service you provide will be profitable? These are important questions to your business's success. How can you answer them?

In some fields, probability is easy to calculate. Mathematics, for example, deals with probability in firm numbers that don't really change. Smart gamblers live by probability tables in making bets. Statisticians use probability based on historical data.

In business, probability is more complicated to calculate because there are often factors that are more difficult to measure, such as the probability of your business still operating in five years. However, there is sufficient historical data to offer a degree of accuracy in calculating probability.

You will use probability in many ways in your business plan and its operation. As you do, seek the most reliable sources of proven or historical data, such as business research resources. Your business plan and activities depend upon the accuracy of these estimates of probability.

Consequence

Consequence is the result of an action. If the result of your business venture's success for five years is that you will have a million dollars in the bank, you will use this fact and the probability of it happening to determine the risk.

In business, quantifying consequences can be difficult and you must rely on an estimate or judgment of approximate value. As with probability, you must consider all resources and use the most reliable ones. The accuracy of your risk calculation depends on how precise your consequence is stated. Estimates are defensible guesses.

Risks of Gambling

Las Vegas is financed by people who don't understand risk. They pay billions of dollars each year to casinos on bad risks. They often make emotional decisions rather than logical ones. “I feel lucky,” they say. Luck, as professional gamblers know, has nothing to do with feelings. The pros know that if the odds (probability) and payoff (consequence) are within an acceptable range of risk, the bet is “smart.”

Starting and growing a consulting business is a gamble. You may win or you may lose. The smart bet is to understand the risk, accurately determine probabilities and consequences, and then make your decisions based on facts rather than feelings. Yes, there is an element of luck (unknown circumstances) in all enterprises, but those who depend on luck to succeed usually discover how unlucky business can be. Before you begin your venture, understand the risks and rewards as well as your tolerance for risk.