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Entrepreneurs have a reputation for having a high-risk tolerance. Studies back up this stereotype, and I can too: Of all my clients, small-business owners are more daring when it comes to managing their financial assets.
This approach to risk is understandable. Entrepreneurs are often innovators willing to leave behind a “steady paycheck” to test the workability — and profitability — of their ideas. I’ve also found that this personality type tends toward optimism. Entrepreneurs’ great belief in the upside overshadows any downside.
Experienced entrepreneurs also know the levers they can pull if things don’t go as planned. Or at least they thought they knew. We all thought we knew. Even for those of us who calculate risk for a living, 2020 was a curveball. But if you take an entrepreneurial approach, this past year provided a great laboratory for testing your relationship with risk.
I’m not suggesting I liked 2020’s unprecedented disruption, but it did offer the opportunity to help clients experiment with new ways of doing business. I saw what was successful and where more planning was needed. And, like any good lab technician, I charted the results. Want to know the four variables that led to success during the pandemic? Read on.
1. Keep a healthy stash of cash
The phrase “cash is king” was evident last year, especially in particular industries. A restaurant owner with enough cash to operate for 12 months had a better chance of surviving than one whose reserves only lasted three. Cash gives us flexibility, which was needed in ample supply during 2020. A proper cash foundation is also where we start with our clients.
A company’s cash reserve policy is similar to a personal cash reserve policy: The soundness of your plan increases with your cash levels. At the very least, you need to have enough money for typical disruptions, like replacing a piece of machinery. You also need reserves or a well-designed insurance policy to cover uncommon but substantial emergencies — like if a hurricane damages your property and forces you to close down for months.
2. Establish a strong banking relationship
If you don’t have a stash of cash, access to it — through a bank loan or line of credit — can also be advantageous during unforeseen, or even unfathomable, circumstances. And access starts with a good relationship.
In the race to access the first tranche of the attractive SBA-backed loans known as Paycheck Protection Program (PPP) loans, borrowers with stronger connections to banks were more likely to have their applications approved, according to a National Bureau of Economic Research study.
Knowing a banker personally can also help if you are considering selling your business. Bankers might help you shore up the balance sheet of your company before you shop it for a sale, for instance, or they could lend you money to finance an employee stock ownership plan (ESOP).
3. Draw a line of demarcation (or even a thin veil) between your company’s risk stack and your own
Small-business owners are the face of their businesses. In many cases, they are also the wallet. Particularly when starting out, your business and your personal finances are closely linked, if not intertwined or even lumped. We understand this. Still, while your business may need your personal investment, we recommend having two different financial plans with two very different risk stacks.
This was tested in the pandemic. Consider a gym owner who had to close down for months. Without a veil between assets, she might have chosen to use personal assets to float her gym during the closure. The move may have bought her time, but the pandemic didn’t arrive with an end date, so all the while she was putting all her assets in jeopardy. Having both a personal and business plan could have protected her individual investments even though she ultimately may have run out of cash and been forced to let her company fail.
Related: How to Take the Right Risks
4. Develop a contingency plan for realistic worst-case scenarios
For a business, creating a financial plan involves imagining “what if” and “worst-case” scenarios. Scenario planning often feels like a task that can be put off to another day, but you never know how long you have to get it done.
What we call “break the glass” documents outline what happens if a key leader dies or is disabled. The exercise can help you see gaps in your plan. Managing for the gaps will relieve some of the anxiety. As we say in our office, “Day two of a crisis shouldn’t be its own crisis.”
Even less dramatic disruptions deserve consideration. This winter, as our team shivered and struggled during historic power outages in Texas, we ran a brainstorming session to identify what we will implement to safeguard against interruptions during future storms. We decided to move more of our services to the cloud and to install a generator.
When planning for contingencies, remember to focus on your actual risks, rather than your deepest fears. Humans tend to misestimate the risk of the unknown. Some turn a blind eye. Others can only imagine the worst. But 2020 taught us that the best plan lies in the middle. (Because do you really need a garage full of toilet paper?) If you steel yourself for the worst in normal times, you can avoid unrealistic worst-case scenario planning. Look to the experts for data that can help you more effectively identify the risks and opportunities facing your business and how you can best plan for them.