Tag Archives: risk mitigation

The Warren Buffet-Listening Entrepreneur

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We all know that life is full of risks. Some are more serious than others. I hold the view that I’d rather “manage” risk than “take” risk. I’ve said before that taking a risk seems a bit arbitrary. “Gee, I think I’ll try to run across this eight-lane expressway right now!” Sounds silly, right? But in a way, that’s what taking a risk seems like to me. While it may not be as spontaneous as this overdramatized example, taking a risk feels like gambling. Meanwhile, managing a risk is calculated. It is studied and planned. Risk mitigation strategies are developed. If I’m to run across the eight-lane expressway, I’m going to figure out every possible way to do so as safely as possible. That’s risk management.

One very important element of risk management is a concept that was espoused by one of the most revered investors of all time, Benjamin Graham (1894 – 1976). And this concept is practiced today by his acolyte, Warren Buffet. The concept is that of margin of safety. Entrepreneurs absolutely must understand margin of safety – but every member of society would benefit from practicing it as well. Graham and Buffet narrowly defined margin of safety as the difference between the intrinsic value of a stock and its market price. I look at margin of safety on a broader basis and define it as the difference between success and failure. In some cases, this difference can be razor thin, and in others, it can be as wide as the Pacific Ocean. The key is to take the steps necessary to push the margin as wide as possible.

In our businesses, organizations, and lives in general, we have an opportunity to become expert at creating margins of safety. One of our companies purchases apartment properties. Because we tend to hold these assets for five to seven years or longer, there can be a great deal of uncertainty about the future. What can we do to stack the deck in our favor and create a healthy margin of safety when we’re looking so far down the road? Obviously, we make year-by-year financial projections that are based upon a set of assumptions. Those assumptions include rent levels, rent increases, operating expense levels, expense increases, occupancy percentages, rates of return on which a sale price can be calculated and various aspects surrounding debt financing. The Excel spreadsheet is quite comprehensive with all these assumptions and projections – but how do we overlay a margin of safety on the process?

With one of our properties, we obtained a certified appraisal as a part of the due diligence process that indicated a value $3 million higher than we paid for the property. That’s a margin of safety right there. Perhaps we budgeted an initial increase in rents of $110 after making several physical improvements but were able to achieve $200. Our assumptions might have anticipated a stabilized economic occupancy of 91%; but we were able to operate at 93%. Operating expenses may have been right on the money, but rent increases averaged 3.25% each year rather than the 3% that we had forecasted. And remember our baseline started $90 higher than the $110 initial increase that was projected. In summary, we pushed several levers to create several different margins of safety that when combined, produced a much better bottom line throughout the holding period than expected. In so doing, we are better protected from market factors that could degrade the future value of our asset.

The principal takeaway here is to find as many margins of safety as possible. If we make decisions based upon 100% optimal results, there’s no room for error. Then a blip in the market or a miss with operations could mean failure. I have learned the hard way that if there’s no way to create sufficient margins of safety, the risk I am contemplating may be too difficult to manage. So, I move on to something else.

Developing the concept of margin of safety is an exercise in positive thinking. We are looking for ways to increase the probability for success – and that’s always a good thing.

This blog is being written in tandem with my book, “An Entrepreneur’s Words to Live By,” available on Amazon.com in paperback and Kindle (My Book), as well as being available in all of the other major eBook formats.

Is the Lone Ranger Dead?

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One of the businesses with which I’m involved is in the venture capital space. We identify, evaluate, vet and fund startup companies in the animal health, agribusiness and human health verticals. As you might imagine, we see everything under the sun. Founders present some pretty unique ideas along with financial projections that are pretty concrete on one end of the scale, to total pie in the sky on the other; slide decks that range from extremely good to extremely poor; business plans that might be exquisite or often are ridiculous; and valuations that are mostly “are you kidding?” though there are a few that are quite reasonable.

We really dig into the details, ask a lot of questions and look at a lot of documents. We pay close attention to whether or not the founder has the right passion and temperament as well as what kind of a problem his or her idea solves. It’s a good sign if the founder has some skin in the game and a vision that goes beyond simply cashing out down the road. And then we get to one of the central Go vs. No-Go questions – is the founder the Lone Ranger or is there a strong team in place?

Believe me when I tell you that there are some amazingly brilliant entrepreneurs out there. These people are scary smart and have world-changing ideas . . . but many won’t get funded because they haven’t (or won’t) put together a world-class team. The risk is too great from an investor’s perspective to make a bet on a Lone Ranger. Growing a business to any scalable level requires some very talented human capital. And the founder that says, “Invest in me now and I’ll go out and hire the talent,” just doesn’t understand. As investors we want to know who is going to be on the team from the get-go. It’s important for us to know if the chemistry is right; if everyone is committed; if the necessary principal skillsets are covered, and if all members of the team are on the same page.

There’s an obvious parallel here between startups looking for funding and our own entrepreneurial endeavors. In fact, we should step back and take a hard look at our own organizations as though we are presenting to venture capitalists. And here’s the hardball question we must ask. If we are hit by the proverbial bus today will our team be able to carry on tomorrow? Will our company survive and thrive or will it die? I know many entrepreneurs who believe their businesses are too small to justify a world-class team. To manage the risks that are inherent in entrepreneurship I think we need to scale to a size where such a team is a must-have. But can we afford not to have such a team in place as we push to scale? Think about it this way. It’s kind of like walking on thin ice across a lake. We hope with every step that we can make it to the other side without falling in. And if the ice breaks and we fall through we’re dead without the team. On the other hand if the team is in place, it can pull us out of the water should we take the icy plunge.

Some of us may be Lone Rangers because we think we can do it better than anyone else. In other cases we may know we need to build a team but don’t know how to find the right people. And there may yet be other instances where we don’t believe we can afford to hire the team at the present time. My response to all of these reasons is a repeat of my previously posed question, “If I’m hit by the bus today, will my company survive and thrive tomorrow?” If the answer is no, then it’s probably time to get busy with developing and implementing a strategy to build a strong team as quickly as possible.

While the Lone Ranger was a beloved fictional character from a different era, it isn’t a concept well-suited for a growing company. Building a world-class team is a solid way to manage risk in today’s entrepreneurial environment.

This blog is being written in tandem with my book, “An Entrepreneur’s Words to Live By,” available on Amazon.com in paperback and Kindle (My Book), as well as being available in all of the other major eBook formats.

Lone Ranger

Noise

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Question: Sometimes when I’m trying to make decisions I begin to have doubts. There are so many external factors that could impact my decisions. How do I get past this paralysis?

Answer: We are so inundated with information these days it’s easy to become overwhelmed. And when we’re overwhelmed the paralysis you reference sets in. Sometimes rather than becoming paralyzed, this crush of information causes us to reach false conclusions and we act irrationally. The best example of this is the stock market. The day starts out with good economic news and the Dow Jones Industrial Average soars. So does the NASDAQ and the S&P 500. Early in the afternoon word of political issues in a foreign country cause a major reversal and the markets close substantially down. The next day, the markets rebound and close higher. How can a seemingly unrelated event in a foreign country have that much impact on our economy and on our financial markets? It shouldn’t and it really doesn’t.

It’s all just noise. Markets move on fear and on jubilance. Neither really makes much sense. But we’ve become conditioned to volatility in the financial markets and the overload of information permeates the rest of our lives causing similar volatility in our decision-making process . . . or just paralysis.

It’s important that we recognize noise when it’s present. The best way to do this is to have a clear understanding of the goal or objective we are pursuing. That goal has attached to it a series of decisions that must be made. Is there information that we sift through that might have a true bearing on this goal? If we always measure against the goal we can then block out the noise. For example, let’s say that my goal is to renovate an historic building in a small town and convert it to apartments. A lot of data will come flooding at me every day. I’ll hear about political strife in another country; political strife in our country; the stock market rose/fell 200 points; oil prices may be rising; a competitor just abandoned an historic renovation project (what does he know that I don’t?); interest rates may increase; the cost of lumber may increase; new regulations may be implemented by OSHA, and my favorite restaurant is closing. What to do?

I focus on my goal and I quickly process the information deluge. Of course there are a lot of unknowns, but if I’ve properly assessed the risks of my project, I have a mitigation plan for things like rising interest rates and higher material costs. The rest of it . . . I ignore.

Life is full of noise. The trick is to turn it into white noise that is in the background with no discernible impact on our daily lives. We do that by remembering our goals, our assessment of the risks and our plan to mitigate those risks.

This blog is being written in tandem with my book, “An Entrepreneur’s Words to Live By,” available on Amazon.com in paperback and Kindle (My Book), as well as being available in all of the other major eBook formats.

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