There is a perception that people who start and run their own businesses are risk takers. This term may accurately describe those individuals whose businesses are driven by unbounded optimism and instinctive knee-jerk reactions to new business opportunities. However, nothing could be further from the truth in describing those people who succeed in their own businesses over the long term. These people don’t take risks— they manage them.
Risk management involves eliminating risks or reducing them to a manageable level. The process starts with understanding the risks that you face and taking steps to reduce these risks, if not entirely then at least to a manageable level. Although there are some risks that we cannot control, we can plan our responses to these risks when and if they occur. This means that part of your normal planning involves contingency plans that will allow you to respond effectively to risks beyond your control.
Insurance can help reduce if not minimize the risk of some kinds of losses. Property insurance will cover risks of loss to property and third parties. As well, special business provisions can help insure specific kinds of business losses. Life and casualty insurance is good for providing benefits if poor health prevents you from running your business.
What Is Risk Management?
What does managing risks mean? It is not something new, nor is it unique to business. Essentially it means either avoiding or eliminating risks entirely or reducing them to acceptable levels.
We avoid risks by not walking into busy traffic or not consuming food or water we know to be contaminated. Thanks to advances in medical science we have eliminated the risk of dying from horrible diseases like the bubonic plague that killed so many people in the dark ages.
We reduce risks by wearing seatbelts when we drive a motor vehicle and make sure that our hands and work surfaces are as clean as possible when we prepare food.
In living our lives, we don’t blindly expose ourselves to risks that could result in serious injury or even death. We take steps to avoid, eliminate, or reduce the risks we face. Is it not reasonable to follow the same approach in running your own business? Successful business owners do not blindly take risks that could bring their personal and financial world tumbling down around them. They take steps to avoid, eliminate, or reduce the risks they face. And so should you.
So How Can You Manage Risks?
Effective risk management starts with understanding the risks you face. Understanding your risks means researching and gathering information about them. Is it possible that despite your enthusiasm about your goods or services, customers will not buy from you? Of course it is. To address this issue, do your homework to find out if the goods or services are currently being purchased in your marketplace. Who are the customers? Why do they purchase? From whom do they purchase? Why should they purchase from you?
Do these questions sound familiar? They should—they represent the issues that you addressed in preparing your business plan in Chapter 7. As well as serving as a blueprint for how you will develop your business, your business plan is a feasibility study that allows you to gather information about the risks that you will face. Once you understand your customers, you can take action that will eliminate or reduce the likelihood of those customers not purchasing your goods or services.
What other uncertainties does your business face? Potential customers might not know about you or your business. Research or gather information about your potential customers in order to learn how to communicate with them. This will help you with your promotional activities as addressed in Chapter 17. What about customers who need goods or services that you do not as yet offer? Find out what they need and want and then use the information in Part IV of this book to find a way of extending your business to help your customers.
What About Those Risks
Beyond My Control?
In life and in running a business, we all face risks that are beyond our control. Even if we are wearing our seatbelts, we still risk being involved in a collision with other motor vehicles. Although I am doing everything within my power to prevent suffering a heart attack, because of my family medical history I am still at risk.
Since these factors are beyond our control does it mean that we stop driving? Or in my case, do I abandon a healthier lifestyle and accept a heart attack as inevitable? Of course not.
Will a downturn in the economy affect your business? Most likely. What about some new legislation or taxes? Once again, very likely. Does that mean that you shouldn’t start a business because it might be wiped out by an economic downturn? Or that you should wind up your existing business because of the new legislation or taxes? Of course not.
Having done what you can to reduce the risk to an acceptable level, you get on with running your business, trying not to worry about any risks that still exist.
What’s Normal?
We have all heard and perhaps even used the expression “I will be so happy when things get back to normal.” This comment is usually made while dealing with an unusual or unexpected difficulty. The expectation is that once the difficulty has been resolved, a problem-free state of normalcy will return.
I believe that the reverse is true. Dealing with problems and difficulties is normal and the absence of problems is abnormal. Life as we know it is not static. As we live our lives we continue to grow and develop. Growth and development invariably result in our having to learn new ways of doing things and unlearn established approaches. Satisfying and enriching as learning may be, it also brings new problems and challenges. In today’s rapidly changing world, we must be constantly responding to new developments in virtually every aspect of our society. Thus, responding to change and the problems associated with these changes is the norm. On the other hand, freedom from problems can only be found when we escape from our normal activities for a day off, a weekend escape, or a well-deserved vacation.
Assuming that problems are the norm when running a business, what implications does that have for risk management? Essentially it means that as well as planning how you will eliminate or reduce your risks, you must also develop a contingency plan to address different problems as they arise. If your banker declines your loan, what will you do? If your customers don’t buy your goods or services, what will you do? What will you do if your customers buy your goods or services but don’t pay you?
What other risks does your business face? What will you do if they occur? By developing a contingency plan outlining how you will handle different risks, then if they arise you can manage them effectively.
You will be a double winner if it turns out that you don’t use your contingency plan. First, you can run your business more confidently knowing that you are prepared for most risks. Second, the process of preparing your contingency plan improves problem-solving abilities, adding that type of experience to your current set of skills. As a result, if in the future you face a problem or a risk that you were not anticipating, you will have the confidence and the know-how to manage it effectively.
property Insurance Is Good
Insurance is one of the most popular ways of protecting yourself against risks. Most insurance companies provide coverage for small and home businesses. These companies have major limitations for coverage on business property, such as stock and equipment, and for liability, such as slip-and-fall injuries. If requested, however, most insurers will extend coverage to provide protection for incidental business use in the home. The premium for this coverage is usually quite nominal.
Coverage is also available for assets such as computers and furniture that are used in a home business. You can choose either all risks insurance, which provides very broad coverage, or named peril, which covers only those risks specified. You can choose between replacement cost and actual cash value. You can also add coverage for property, such as portable computers or stock in transit that is away from your main location.
If the risks of your business are not too great, many companies can provide home-based business extensions to existing homeowner policies. Some insurers have also introduced small business packages that cover a larger range of businesses, not just the large businesses they used to cover. These policies might also be suitable for home businesses.
Protection is also available for injury to third parties or damage to their property while in your home office or while you are at your customers’ places of business. Your homeowner policy, extended for the home-business operation, would usually provide this protection. Your small business or commercial policy containing business liability insurance coverage would also provide it.
In either case, you are protected against lawsuits resulting from injury or damage to third parties, whether you are on their property or at your office. Note that if your business is incorporated, the corporation either requires its own policy or it should be included in the home-business extension of your homeowner policy.
If you provide advice, or knowledge-based services, consider separate professional liability coverage known as errors and omissions insurance. This coverage is intended to protect you from losses that your customers might suffer as a result of your advice or services. The premium is based largely on the risk involved. The larger the risk, the higher the premium.
The entire issue of liability is fairly complex, with many conditions and exclusions. Consult your own broker for advice on specific situations.
Hot Tip
Consider purchasing business-interruption insurance. This is protection from losing profits and incurring additional expenses after an insured loss such as a fire or explosion. Many small-business packages include this coverage. Other types of coverage also fall under the definition of business interruption. For a home-based business, extra-expense coverage would be important to cover the extraordinary expenses incurred as a result of an insured loss. This cov-erage, which might include rental of temporary facilities or moving expenses, would help keep the business operating. Review your situation with your own broker to make sure that you have the proper coverage.
Entrepreneur Beware
Property insurance can be very complex and confusing. Avoid buying coverage for risks that you will not face. If, for example, you do not store inventory, why should you pay a premium for this type of coverage?
Typical Small-Business Insurance Coverage
| Property | Liability |
| Building and contents | Bodily injury and property damage |
| Accounts receivable | Personal injury |
| Building damage by theft | Medical payments |
| Debris removal | Tenant legal liability |
| Electronic data processing equipment | Advertising liability |
| Fire department service charges | Business interruption |
| Overnight money coverage | Actual financial loss |
| Personal property of employees | Profits |
| Property in transit | Gross earnings |
| Valuable papers and records | Crime |
| Employee dishonesty | |
| Loss inside/outside premises | |
| Counterfeit currency | |
| Depositor’s forgery | |
| Safe burglary | |
Life and Casualty Insurance Is Also Good
For most people, going through the transition from being an employee to becoming self-employed means losing group insurance coverage. What insurance should you use to replace it? In fact, what insurance does anyone who is self-employed need?
In buying insurance, try to protect your essential assets. Your most important asset is your earning power. Without insurance protection, you and your family may suffer unbearable or irreparable harm.
There should also be sufficient funds for a readjustment period, to finance a move or to provide time for family members to fund ongoing financial needs, such as monthly bills and expenses, day-care costs, college tuition, or retirement. Although there is no substitute for a careful evaluation of the amount of coverage needed to meet your needs, one rule of thumb is to buy life insurance that is equal to five to seven times your annual gross income.
Since there are various kinds of insurable risks, there are various kinds of insurance policies to consider. It is also important to take account of your wishes, responsibilities, and time horizon when compiling an insurance portfolio.
The cheapest form of life insurance is term insurance. But if you need protection for the long run, you are probably better off with permanent or whole life insurance.
Life insurance can also provide funds that will allow for the sale of your business either to a stranger or to an employee. Some forms of life insurance are like savings plans, and you accumulate money, which can be withdrawn at a later date. This type of policy will provide money to allow you to train the purchaser on the understanding that once trained, the purchaser will pay you the agreed purchase price. You can then retire on the sale proceeds.
Many business owners have agreements that give employees the right to purchase the business on their death. In this case, the employee would insure the life of the business owner. When the business owner dies, the insurance proceeds would be used to purchase the business from the estate. Of course, any life insurance that you have in place while running your business will survive the sale or closing of your business. The proceeds will be available for named beneficiaries in the event of your death.
Common Insurance Terms
Agent . An authorized representative of an insurance company who sells and services insurance contracts. Broker . A sales and service representative who handles insurance for clients, generally selling insurance of various kinds and for several companies. Brokers resemble agents, except that, in a legal sense, brokers represent the party seeking insurance rather than the insurance company.
Cash value . The amount available in cash upon surrender of a policy before it becomes payable upon death or maturity.
Disability insurance . A form of health insurance that pays the policyholder in place of his or her usual income if the policyholder can’t work because of illness or accident. Usually, policies begin paying amounts after a waiting period stipulated in the policy, and pay a certain percentage of the policyholder’s usual income. Sometimes employers provide this, but it’s also available as a separate coverage.
Group life insurance . Life insurance on a group of people under a master policy, which usually does not require medical examinations. It is typically issued to an employer for the benefit of employees, or to members of an association; for example, a professional membership group. The individual members of the group hold certificates as evidence of their insurance.
Term insurance . A plan of insurance that covers the insured for only a certain period of time (term), not for his or her entire life. The policy pays death benefits only if the insured dies during the term.
Underwriting . The underwriting process evaluates the likelihood that an insured event will occur, determines its likely cost, and develops an appropriate premium for the coverage that is competitive in the marketplace and remunerative to the insurance company writing the policy. For some standardized coverages that are highly competitive, underwriting may be somewhat beside the point—the policy has to be priced according to marketplace pressures if the insurer wishes to remain in that line of coverage. Underwriting still plays a substantial role for many coverages, however, even those in the increasingly competitive businesses of auto, home, and term life insurance. Underwriting differences account in part for the substantial differences in insurance premiums for comparable coverages.
Whole life insurance . A plan of insurance for life, with premiums payable during a person’s entire life.
Hot Tip
Entrepreneur Beware
Many people are overinsured. Avoid buying the wrong kind of insurance or more coverage than you really need.
The Least You Need to Know
Risks can be managed by eliminating them or reducing them to a tolerable level.
There are some risks that are outside of your control; you can, however, manage your response to these risks.
Good planning includes contingency planning.
Property and also life and casualty insurance can protect against specific named losses.
