Is Entrepreneurship Riskier Than Employment?

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photo credit to sezzrs

Today’s post was written by Joel Ohman…

Joel Ohman is a Certified Financial Planner and President of 360 Quote LLC.  He is a serial entrepreneur and is currently spearheading several successful consumer comparison websites including Credit Card Chaser and Health Insurance Providers.  Although Joel holds some opposing views towards credit cards, he is a strong supporter of DFA so please welcome him with open arms and inquisitive hearts!

It is quite likely that at one point or another in your life you have thought about striking out on your own and starting your own business. Whether your motivation was/is to bring a new idea to the market in hopes of striking it rich or whether you simply decided that you just couldn’t stomach one more day of being a cubicle dweller and filling out TPS reports for an unappreciative boss – no matter what your reason was or is it is likely that if you haven’t had the entrepreneurial urge yet then most likely you will at some point in the future.

What is also likely is that the second you mentioned your plans for becoming your own boss to your spouse/friend/parent/fill in the blank you were immediately discouraged by the big “R” word – RISK. Not just lower case “risk” as in, “Oh well, I took a risk and I wasn’t successful this time. I will try again.” but “RISK” in all capital letters as in, “OH NO! Honey, why did you take this RISK! What have you done to us! Your business went under and now we are forced to live out of a cardboard box on the street and dig for grubs to feed the children!”

The case I would like to make is that being an entrepreneur certainly involves a level of risk (as does any profession) but just like there are ways to mitigate and manage risk with a “regular” profession there are also ways to mitigate and manage risk as an entrepreneur. My goal is to provide a concrete framework for evaluating the risks of any given entrepreneurial undertaking for anyone who has ever considered becoming an entrepreneur.

Entrepreneurial Risk vs. Employment Risk

Before attempting to compare the risks of entrepreneurship with the risk of being employed one must first admit that there are in fact many risks inherent with being employed just as there are with being an entrepreneur. One underlying assumption that the recent economic downturn has certainly unseated in the minds of most is the misguided assumption that entrepreneurship is full of risk while being employed is risk free. Layoffs, pay cuts, and/or failure to find a suitable job have all been recent and widespread indications of the risks that are inherent to almost any gainfully employed position.

Certainly entrepreneurship has the potential for great reward to accompany its risk but one thing worth mentioning is that the commonly quoted statistic that over 90% of all small businesses fail within 5 years is considered an unsubstantiated myth and other studies put the number at around 50% (which may or may not accurately reflect “failure” as it may include family businesses who shut down on their own, businesses who were bought out, serial entrepreneurs who moved on to bigger and better things, etc.). Granted, entrepreneurship absolutely involves risk and I am not trying to make a case to the contrary. What I would like to present is that even employees have a level of risk that can be quite high and in addition that there are certain things that can be done in order to both manage and minimize the risk of entrepreneurship.

While the risks (and rewards) can be quite different between entrepreneurs and employees there are some important differences that I believe can be summed up in two main areas:

  1. Control – Employees are “at the mercy” of their employers and/or the owners of their company while entrepreneurs have a high degree of control (and of course more responsibility) in controlling their own destiny.
  2. Money – Entrepreneurs typically need to risk not just their time and effort but their own money in order to get their business off the ground while employees typically will not need to risk any of their own money as an investment (for the sake of this discussion we will leave stock options, sales commissions, and other performance based employee pay systems out of this comparison because while not an investment of employee money per se it does involve a different level of risk).

Granted we could spend a lot of time delving into the specifics of each of the two areas but I believe that it is fair to say that the two main differences in risk between the “Entrepreneur Profession” and the “Employee Profession” could be characterized nicely as differences in the general categories of control and money.

Managing and Minimizing Entrepreneurial Risk

As any student of Finance 101 knows within the first week of class, “Generally speaking, the greater the risk the greater the potential reward”. So the goal in becoming an entrepreneur is not to eliminate risk which is for the most part impossible but to manage and minimize the risk so that the risk is appropriate to your specific situation and that you have positioned yourself in an entrepreneurial undertaking that has an acceptable risk/reward relationship to you.

Here are some concrete principles that may help you both minimize and manage the risk that is inherent in any entrepreneurial endeavor:

  1. Save Money by Funding Yourself“Fund Yourself” is a term that is sometimes called “Bootstrapping” and essentially means that rather than betting the farm to invest all of your nest egg into a business idea (or rather than spending a ton of effort trying to raise money from investors) see what you can do to get your idea to the market as cheaply as possible. Sure, you will have to spend some of your money but budget wisely with the goal being to get the idea to market and test out market demand for your product or service. Yes, blowing all of your nest egg into a hare brained business idea can be labeled as bootstrapping but strive to “bootstrap” as wisely and cheaply as possible so that you can gauge market demand and then iteratively make improvements (or if the idea is a dud then you can simply come up with another idea and be thankful that your budgeting allowed you to have funds left over for another business idea).
  2. NO Drastic Changes – This may sound weird to some but drastic changes are not the key to entrepreneurial success. In fact, making a drastic change will only increase (often dramatically) the level of risk associated with anything entrepreneurial. One example of making a drastic change that unnecessarily skyrockets risk is when someone quits their job with no planning and starts their business the next day. You may be gung ho at first but unless you already have experience, contacts, resources, and more in the field of your new business then you have likely just heaped yourself a huge serving of unnecessary risk without the accompanying huge potential reward. A better way to do it (note, that I am just speaking in general risk/rewards terms now and of course some people are certainly the exception) is the way that Matt Jabs continues to work his day job as an Information Technology Manager and then in addition works to build Debt Free Adventure into an ever increasing source of income. When I first started my Florida health insurance agency (my first of 5 companies that I started) I made the decision to continue working my day job as a tax preparer studying for the CFP® (which I passed) while working to build my agency on the side. Yes, there were many weeks of working what was in essence two 40 hour a week full time jobs but the risk of having to live out of a cardboard box if I failed was greatly minimized.
  3. Use the Web – In the past no matter what you wanted to sell you had to face the obstacle of deciding how to reach potential customers. In most cases this meant that you needed to rent space for a physical storefront or pay for space at a tradeshow or any other number of potentially very costly things. Now whether you want to sell shoes or hand crocheted blankets or sea monkeys you can set up a website or blog in a matter of hours and have people buying your products or using your services from the other side of the world. I am admittedly biased about loving the Internet because while some of my most recent ideas have been building a website to compare credit cards and a website to compare health insurance providers I love the concept of being able to think up an idea and then immediately start testing out the idea by putting it live on the Internet for anyone to see when they type in your domain name. With the ease of use in setting up popular blogging/website building software such as WordPress it is often as simple as choosing a domain name and then its off to the races to test out your new idea.

There are likely many other ways to both minimize and manage the risk of being an entrepreneur but I hope that sharing some of the things that I have noticed will prompt you to find a way to make your entrepreneurial dreams a reality.

What do you think?

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