Are the best entrepreneurs risk takers or risk averse?

by | Jan 2023 | Start a Company

TLDR: There are solid examples of each, of course, but independent research indicated that risk averse founders, who remain in their day job while launching their business, are 33% less likely to fail.

We often assume entrepreneurs are risk takers because starting a new business venture involves uncertainty, requires the speculative investment of resources, such as time, money, and knowledge, and comes with a decent chance of failure. No matter what you know or how experienced a founder may be, there is no guarantee of success.

On the other hand, many successful startup founders are considered to be risk averse. Their strategy is not to rush in blindly but to assess and manage risks carefully in order to maximise the potential of a positive outcome.

So, are entrepreneurs big risk takers? Not the smart ones.

Are the best founders risk averse?

Investors aren’t looking to place risky bets. Nor are wise founders. In fact both want the same thing: certainty.

To be as close as possible to a sure thing, investors look for a combination of positive metrics, acceleration, sizeable market, and clear, enduring competitive advantage. Many investors will say they’re not actively looking for deals, but show them an opportunity with all four of these characteristics and you may be surprised by how many suddenly find some spare cash.

The best founders want the same thing. They’re not just good at convincing people they’re right, they do what’s necessary to be genuinely sure of success. And they do this before committing resources they can’t afford to lose.

What does the evidence say?

Arguably the most reliable study on this topic is research published in 2013. Researchers Joseph Raffiee and Jie Feng asked:

When people start a business, are they better off keeping or quitting their day jobs?

They followed more than five thousand Americans in their 20s, 30s, 40s, and 50s who became entrepreneurs. The cohort was divided into two groups – those who ran headlong into a business, quitting their job to do so, and those who appeared more risk averse, who started a business while remaining in their day job.

The result? The entrepreneurs who didn’t quit their day jobs had 33 percent lower odds of failing than their risk-taking counterparts.

Examples of high-risk entrepreneurs.

Of course, there are plenty of well known risk takers who’ve made it. High-profile examples of such startup founders include:

  • Elon Musk, who founded and runs multiple companies concurrently. These include SpaceX and Tesla. As if that weren’t sufficient, Musk recently acquired Twitter. Arguably the most famous (or infamous) entrepreneur of our time, Elon Musk is known for his ambitious goals and willingness to take on risks.
  • Mark Zuckerberg, the co-founder and CEO of Facebook, has placed some very large bets over the last decade. Zuckerberg was at college when he started Facebook, so you could easily argue he had nothing to lose back then. Since that time, however, he has shown a significant appetite for risk. The apparently expensive acquisitions of Instagram and WhatsApp seemed like extraordinary bets, for example, although since then they’ve turned out to look very smart, if not defensive. Will Zuckerberg’s more recent bet on the Metaverse turn out to be equally prescient? Only time will tell.
  • Jeff Bezos, the founder and former CEO of Amazon, is both a risk taker and a strategic thinker. Formerly on Wall Street, Bezos took on significant financial risks to start and grow his company. Having said that, as his shareholder letters show, Bezos has always had a firm eye on the tradeoff between growth and return on capital, which suggest he is anything but rash.

Examples of risk averse entrepreneurs, who stayed employed when launching their startups.

There are, of course, plenty of successful founders who are considered to be risk-averse. Adam Grant points out several in his book, Originals: How Non-Conformists Move the World:

“Phil Knight started selling running shoes out of the trunk of his car in 1964, yet kept working as an accountant until 1969. After inventing the original Apple I computer, Steve Wozniak started the company with Steve Jobs in 1976 but continued working full time in his engineering job at Hewlett-Packard until 1977.

And although Google founders Larry Page and Sergey Brin figured out how to dramatically improve internet searches in 1996, they didn’t go on leave from their graduate studies at Stanford until 1998. “We almost didn’t start Google,” Page says, because we “were too worried about dropping out of our Ph.D. program.” In 1997, concerned that their fledgling search engine was distracting them from their research, they tried to sell Google for less than $2 million in cash and stock. Luckily for them, the potential buyer rejected the offer.”

Other examples of risk averse entrepreneurs include:

  • Pierre Omidyar, the founder of eBay, who despite the almost immediate success of his marketplace, remained employed in his day job until the business was generating enough revenue to sustain him.
  • Sara Blakely, founder of Span and, at one time, the world’s youngest self-made billionaire, took a big risk by investing her entire savings of $5,000. However, instead of going all-in, she remained employed for a further two years, building her prototype in the evenings and at weekends. She even wrote her own patent application to save spending money on lawyers.
  • Mark Pincus, the founder of video game developer, Zynga, who is known for his focus on data-driven decision making. Pincus has a reputation for prioritising his company’s stability over speculation and risk taking.
  • Reed Hastings, the CEO of Netflix, who is known for his focus on long-term growth and strategic planning. The volatility in Netflix’s share price is more indicative of an overheated market than it is of Hastings’ management style.
  • Brian Chesky, the CEO of Airbnb, is also known for his long-term thinking. The tactics Chesky and his cofounders dreamt up to help bootstrap the early stages of their startup have become the stuff of legend – particularly their repackaging and sale of politically-charged breakfast cereal.

What strategies can founders use to avoid taking large risks?

The risks founders will face during the lifespan of their startups will be as varied as they are plentiful. The strategies they adopt to overcome those risks will be equally diverse. Some such strategies may include:

  • Staying employed. Many would argue that the benefits of keeping your job far outweigh the distractions of running a side hustle. By ensuring your loved ones’ basic needs are taken care of, and ensuring there’s money to pay the bills, founders escape the pressure to take large leaps of faith, build unvalidated software products, and release untested features.
  • Starting small. To begin with focus on a specific niche market, with limited competition. This can help founders to refine tactics, understand what does and doesn’t work, and grow gradually rather than sustaining large financial cost.
  • Staying lean. Avoid unnecessary investments and expenses, don’t hire employees too early – especially sales people. This is a classic error many startup founders make, long before they have proven what and how to sell themselves.
  • Emphasising simplicity. Avoid complexity and adding features to your core product. Instead focus on the one or two core features that truly offer your users value. Make it user-friendly and easy to navigate, or you’ll run the risk of users not engaging with your product.
  • Focusing on customer service. Place a strong emphasis on customer service. This will help to build trust among users, may drive referrals and organic growth, and should reduce the risk of negative reviews or customer complaints.
  • Building a community. Creating a movement around your product or brand can help foster a sense of loyalty among users, provide a competitive moat that makes life difficult for copycats, and deliver a powerful, unpaid marketing channel through which you can reach new customers.
  • Focusing on a small number of core products. Rather than spreading resources thin by trying to develop too many products at once, a tight focus on a small subset of high-performing products can help reduce the risk of failure.
  • Prioritising return-on-capital over revenue. As navigated brilliantly by Jeff Bezos, there is a delicate balance between revenue growth and profitability. Return-on-capital is arguably the most important indicator of a business’s long-term potential, as it indicates how effectively the company turns capital (usually in the form of debt or investment by shareholders) into profits. Many companies in recent years have focused heavily on revenue, despite sometimes having suspect underlying unit economics. While in the short term they were rewarded with ballooning paper valuations and media coverage, it looks likely in 2023 that many will suffer, with large down rounds if not bankruptcy.
  • Using data-driven decision making. Make informed decisions about product development and marketing strategies by looking more closely at metrics and analytics to understand what’s truly going on in the business.
  • Building a diversified revenue stream. Depending on what you’re building, it may be worth considering a diversified revenue stream to reduce your reliance on a single source of income. Amazon has done this extremely well. Alongside its core e-commerce business, the company has added cloud computing, subscriptions, licensing video content, third-party selling services, physical stores, and its most profitable segment of all – advertising.

These strategies have helped the likes of Omidyar, Blakely, Pincus, Hastings, Chesky, and Bezos to minimize the risk of failure and build some of the most successful businesses in the world.

In summary.

Good founders are not defined by rash decisions and taking unnecessary risks. Over time they become known for proficiency at testing assumptions, avoiding unpleasant surprises, and minimising potential losses. Unlike investors, founders are risking far more than just money. They also bet their time (and with it opportunity cost), careers, reputation, relationships, and mental health.

As founders and investors we shouldn’t glorify risk taking. We should try to be more risk averse.

Image credits

– Featured railway image by Foundry Co from Pixabay.
– Elon Musk image by Bulu Patel.
– Amazon image by Christian Wiediger.
– Breakfast cereal by Nyana Stoica.
– Tight rope image by Loic Leray.

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