Risk management is typically defined as the practice of using various disciplined methods and tools to ensure that your potential investment losses never exceed acceptable limits. It’s about figuring out what could go wrong, assessing which aspects could and should be dealt with, and implementing processes and strategies to deal with those risks.
In my previous post on minimizing/avoiding risk, I assumed the stance of a personal investor. This time around, I’ll be writing from the perspective of a sort-of corporate man in charge of an investment company whose target audience is primarily entrepreneurs and startups.
I find the company angle quite interesting because our investment risk management is different. We at M51 are not venture capitalists which means there’s no typical bullshit that comes with the territory (as Guy Kawasaki nicely summed up in his top ten list) but we do offer more than financial support. We add value through our network of support: the board of directors, legal assistance, fellow entrepreneurs, investors, and other companies in our network that can either help with advice and insights, take the leading role, or just facilitate an intro.
We do not invest in business plans, we invest in people – the first and most important layer to our investment risk management strategy. I can talk to you about the merits of diversification or investing consistently or investing over a long period of time (which you can check out here) and other methods as some of the best ways to manage investment risk but instead, I’ll try to provide the inner workings of an investment company and portray (hopefully) investment risk management techniques and processes that we employ.
The people test
Every business venture, regardless of the economic, market, and other circumstances, has risks. Our first risk assessment and management step are entrepreneurs themselves as we believe it’s the people that ultimately make it happen with their skills and personalities.
If I don’t believe in an entrepreneur, I won’t invest. Everybody has a good idea – ideas are cheap commodities these days. There can be an amazing business plan but if you’re not the type of person that delivers (passionate, competitive, enthusiastic – especially about your own pain point you want to solve, creative, and a problem-solver) and elicits my trust – no dice.
I see this vetting process of sorts as the first step to establishing an investment risk management standard. It’s vital to understand that when you invest, you only sacrifice what you can manage without. Ever so often, absorbing risk is shrewd. I can deal with an ultra-competitive person. I can deal with a bad boy or an unstable business person because we have ways to handle them, and because of our beliefs – that a credible entrepreneur can turn a decent idea into a winning one. It doesn’t work the other way around – a good or great idea can’t make a winner out of a subpar entrepreneur.
There is also the risk of startup and other types of scam artists. So far, I’ve only read about elaborate details that go into these scams and I can only offer my advice – forge relationships. Investing is also about how well you connect over a month or two or whatever it takes to actually close the deal, get everything ready, and stuff like that. You getting to know the person largely mitigates the risk of them being a phony. I also always look to meet their friends and family if possible, and with social media around and the power of a good Google search – do a thorough background check.
The synergy test
In M51, we only invest in companies that know how to work synergistically. I always take into account that there has to be some kind of added value to what we’re giving them. Our mantra is that we automate entrepreneurial success by providing full access to all the assets that we have. That makes it easier to scale the business because there’s familiar and solid ground for both parties – we know what to do even if the entrepreneur doesn’t.
Basically, if someone has a good or really good idea, and we see it fits our template by automating it on a technology basis, we have all it takes to turn it into a global business and build on it. If we don’t love the idea, we evaluate different options with the person in question. However, I would never invest or buy a company if I didn’t have someone in my team that specializes or understands the specifics, whether it’s a product, market, similar businesses, industry, and so on.
Investment risk management becomes even more important if you’re treading new territories. The bottom line is: understand your strengths and preferences, and if you can, capitalize by filling the gaps.
We invest in the long run
Arguably, one of the reasons why numerous investors fail is because they try to “outrun” the market in a very short time frame. You can’t outperform a market at your own pace. My advice is to place more focus on opportunities that generate money long-term instead of focusing on the short-term angle.
For example, that’s one of the reasons why I don’t invest in the cannabis industry, even though there were dozens of proposals I might have otherwise taken upon if I was interested in a short-term agenda. I just don’t see the long-term value in it as there’s no business model around it – the industry is working around the point and developing around the idea rather than the idea itself.
Another reason why long-term investing is more favorable is the scope of investment opportunities during bull and bear markets. These come around in long-term circles which offer more opportunities to discover both at the beginning of bull markets and the end of bear markets.
I can’t claim these are investment risk management best practices – just that they work for us. Whether you find them applicable or not, the fact remains that investors who identify the risks will eventually be better equipped to manage them in a more cost-effective way. Put a system in place to deal with the potential consequences and keep track of the effectiveness of your investment risk management practices. It will not only help you improve decision-making and more efficiently allocate capital and resources but also anticipate what may go wrong, thus reducing the negative effect or better yet – avoiding serious financial loss.