While the thought of business risk might bring flashbacks of Tom Cruise dancing around the living room to “Old Time Rock ’n’ Roll” in his underwear, entrepreneurship can be Risky Business.
But taking chances is an unavoidable aspect of starting and running a business. For founders and seasoned executives alike, understanding the types of business risks and learning tools to assess and manage risk will make sure your operations are smooth sailing.
What is business risk?
Business risk refers to internal and external factors that can lower a company’s profits or lead it to fail.
No business is without risk. From startups and to multinational corporations in every industry imaginable, all companies are exposed to threats that can harm their success.
When David Ly Khim, co-founder of marketing agency Omniscient Digital, was starting his company, his team operated with the mantra of “faith, not fear.” Instead of focusing on fear, his team chose to believe in themselves to figure things out and tackle each obstacle as it came.
While you can’t eliminate the possibility of risk, you can take steps to mitigate its presence or impact on your business.
Types of business risks
Entrepreneurs have to consider a myriad of factors, from cybersecurity and environmental risks to operational and reputational risks. Here are top 10 risks to look out for.
Examples of business risks
1. Cybersecurity risk
Protecting your business from hackers has become increasingly critical. According to a 2021 survey, cybersecurity ranked as the leading risk to businesses globally. Cybersecurity risks stem from an inability or disinterest in taking measures to protect your business from a wide range of internet attacks.
Potential prevention techniques include two-factor authentication, endpoint protection, and employee training.
Examples of cybersecurity risks include:
- Phishing attacks
- Malware and ransomware
- Weak passwords
2. Legal and compliance risk
Legal and compliance risks are the potential for legal penalties that may cause financial or material loss. A company’s inability to follow laws, regulations, or industry best practices could leave it open to lawsuits, or a loss of integrity with customers.
Examples of legal and compliance risk include:
- Data collection and data breaches
- Insufficient contracts for employees or suppliers
- Legislative compliance
3. Strategic risk
Strategic risks appear when a business has adopted an incorrect business strategy. It poses a threat to a business’s ability to execute, and is often a byproduct of an organization's misguided strategy or objectives.
- Changes in senior leadership
- Introducing new products or services
- Geographic expansions
4. Environment, social, and governance (ESG) risk
Environment, social, and governance, or ESG for short, is a company’s consideration of sustainability and good governance alongside financial incentives when making business decisions.
Interest in ESG risk is growing fast. According to a 2021 survey by Deloitte, 47% of respondents said climate risk and social responsibility will be an extremely or very high priority for their businesses.
Examples of ESG risk include:
- Emissions, sewage treatment, and waste
- Social impact of products and services
- Business ethics (e.g., treatment of factory workers, impact on surrounding communities)
5. Reputational risk
While other risks may affect reputation, reputational risk is the damage that occurs when a business fails to meet the expectations of its stakeholders. The outcome is a negative perception that can carry through to investors, employees, customers, and the general public.
Examples of reputational risk include:
- Workplace misconduct (e.g., a hiring discrimination scandal)
- Poor quality products and services
- Missing deadlines for delivering products or services
6. Operational risk
Operational risks stem from ineffective or failed internal processes, people, and systems that disrupt a company’s operations. It may also come from external events that hinder a business’s ability to perform.
The impact of operational risks is far-reaching, from product recalls to a reconfiguration of supply chains.
- Ineffective employee training
- Issues with automation technology (robotics, artificial intelligence, new machinery, etc.)
- Natural disasters or states of emergency
7. Human resources risk
This encompasses loss to an organization caused by inadequate people management, employee behavior, and hiring and firing practices. From your company culture to employees’ work-life balance, human resources risk can be emotionally charged and should be taken seriously.
- Neglect and negligence from management
- Workplace harassment
- Alcohol and drug abuse
8. Financial risk
Financial risk refers to your business’s ability to manage debt and fulfill financial obligations. This type of risk typically arises due to economic instabilities, losses in the financial market, or movements in stock prices, currencies, and interest rates. Use forecasting to help spot financial risks before they appear.
- Stock market volatility due to changes in industry, regulatory, or economic developments
- Defaulting on a loan
- Cash flow problems (e.g., overbuying products, unprepared for seasonality)
9. Competition risk
Industry rivals may prevent or hinder your company’s growth and success. Competition is a normal part of a healthy market, but you’ll want to take defensive measures to stop your competitors from undermining your business trajectory and stealing your customers.
- A rival undercutting your pricing
- Competition over resources
- Competition over trademarks, patents, or other intellectual property
10. Physical risk
A company’s physical assets pose risks, too. Physical risks include threats to your buildings, equipment, and merchandise that can cost your business time, money, and even legal action to replace and resolve.
- Fire or flooding
- Theft and vandalism
- Damage to employee equipment
Assess and manage risks in business
The impact of business risks can be wide ranging, from a small inconvenience to significant losses or even closure. Implementing a risk assessment and mitigation process will help ensure the long-term success of your company.
A good risk management strategy will help you measure the potential outcomes of a risk and make smart business decisions to avoid the pitfalls.
While there is no one-size-fits-all strategy for risk evaluation, consider this six-step process to help you get started planning for risk management.
Step 1: Identify
Identify the potential risks that are most relevant to your business. For example, if you own and operate a small storefront, perhaps physical risks are your greatest concern. But if you’re running a multinational software company, security risks are much more threatening.
Think through all the risks that your business faces or could face, and document them.
Step 2: Prioritize
Develop a method that helps you predict the potential impact of the risks you identified. If one member of your team falls for a phishing scam, will your business have the resources to resolve the issue while continuing to operate? What if a competitor crops up and offers the same products or services at a lower price?
Tying each risk to a predicted financial result will help you understand its impact and help you decide which areas to focus on.
Step 3: Evaluate
Evaluate and analyze your business’s current vulnerabilities; get started with the tools below.
- SWOT analysis: SWOT stands for strengths, weaknesses, opportunities, and threats. To use this tool for risk evaluation, identify an area of risk, such as human resources. Then, chart your organization’s strengths, weaknesses, opportunities, and threats in that risk area, which will help you find what you should work on.
- Root cause analysis: A method for identifying the fundamental reason for a problem, this framework is helpful if you’re experiencing an issue, but are unsure of the cause. To start, list your issue’s symptoms and possible causes. Then separate out contributing factors that may influence the problem but are not the root cause. Use this information to write a clear problem statement and root cause.
- Probability and impact matrix: This matrix is a qualitative assessment method that charts two elements of risk on a grid, probability and impact. For each risk area, you can predict the likelihood that certain events will happen, paired with the severity of those events to bucket risks into low, medium, and high-risk categories.
For example, perhaps you seldom have to deal with legal contracts and work in an industry with a simple regulatory landscape. Legal compliance risks would have a rare probability and minor impact. Therefore, legal compliance is low risk.
However, cash flow has historically been a challenge and is of high importance for your business. This risk could receive a likely probability and major impact rating. Cash flow would then be high risk.
Step 4: Monitor
For each risk, ensure there is a manager who can focus on and be responsible for the threat. This could be a leader on the team who is bearing a specific business risk.
If you have the resources, you could create a department head who’s responsible for risk management, such as a chief risk officer. This team could establish the company’s risk tolerance strategy, review and approve risk management techniques, and follow up to ensure each team is on the right track.
Regardless of who is responsible for monitoring risk performance, distill your risks into metrics that you can measure. For instance, employee engagement and satisfaction could be a core metric for human resources risks; emission offsets could be a core metric for ESG risks; and cash on hand could be a core metric for financial risks.
Step 5: Mitigate
After establishing evaluation and monitoring systems, put mitigation techniques in place to minimize your company’s exposure to threats. Identify the levers you can pull to manage each risk and systematically use them to decrease risk exposure over time.
Here are a few examples of risk mitigation in action.
Risk: Introducing new products or services
Mitigation Strategy: Establish clear value propositions for each product or service to avoid displacing your existing product or services.
Risk: Missing deadlines for delivering products or services.
Mitigation Strategy: Set delivery expectations upfront during the purchasing process and proactively communicate any potential delays with your customers.
Risk: Cash flow problems
Mitigation Strategy: Establish a business emergency fund to keep your business running for at least 12 months in case of changes in market conditions.
Step 6: Evaluate
In some cases, once you’ve set your strategies, you won’t know if your work has paid off until moments of crisis occur. If your business is unable to compete with a new entrant or launch a new product line, for example, your risk mitigation methods have failed you.
However, risk management cannot be a set-it-and-forget-it strategy. Continuously identifying your risk priorities, launching mitigation efforts, and tracking performance indicators will help you evaluate and adjust your risk mitigation strategies.
As your business grows, the risks you encounter will evolve. Keep an eye out on evolutions in your market, such as buyer behavior and competitor research. Annual financial planning can inspire new opportunities, but will also demand new risk mitigation strategies. Conducting risk assessment and management on an ongoing basis will help your organization stay ahead of the curve.