RL106: Risk & Reward in Business & Life

Weighing the risk of an opportunity with its potential reward is something we do every day.

When we’re crossing a street and the flashing hand sign is on, we’re weighing the risk/return of trying to make it across the street.

• Risk: Getting hit by a bus or car.

• Return: Faster to get to my destination, don’t have to wait a full cycle of the lights.

Professionally, we make these calculations more deliberately. Consider the following professional opportunities:

1. A post-MBA job at Goldman Sachs

   1. Risk to my career: Low. It’s unlikely the firm will go out of business, it’s a known quantity in the business world that will be helpful in future pursuits, has a helpful network, and I can learn a great skillset.

   2. Return: Capped - there’s a strong cash compensation, but limited ability for wealth creation in the entry level roles.

2. Starting a company

   1. Risk to my career: High. It’s unlikely that the company will succeed. It can be difficult to explain time spent as a founder on the resume / in job interviews.

   2. Reward: Unlimited upside potential. An opportunity to create inter-generational wealth.

3. Leadership Role at a Turnaround Company

   1. Risk to Career: Relatively high. If things don’t go well, it can be challenging to explain in a future interview.

   2. Reward: Relatively high - long term incentives can create significant wealth.

4. Investor at a VC Fund

   1. Risk to Career: Relatively low, though it depends on the fund. Most first-time funds do not successfully return capital. Job security/performance is tied to the performance of portfolio companies.

   2. Reward: Can be lucrative if there is carried interest involved.

Today’s RL post is about risk -

• How Risk and Return are Correlated

• The types of risk we encounter in business

• How founders and investors should think about risk mitigation

Risk and Return Are Correlated

The amount of risk is directly correlated with the returns that are possible for an asset.

Higher-risk investments have the potential to have outsized returns, whereas lower-risk assets have lower return profiles.

Source

In the graphic above, bank deposits have the lowest risk as they are insured by the FDIC. They also have the lowest returns.

Early-stage companies are on the top right - very high risk, but the returns can be extraordinary.

The correlation between risk and return is well known, but I see founders and investors make mistakes when they think about risk.

Dialing up the risk does not automatically dial up the returns.

Risk is not something to be sought after - rather, it is our job to mitigate and reduce risk in our careers, businesses, investments, and life.

Risk is not good because it means returns can be higher. Ideally we can keep the returns high while mitigating risk to the maximum extent possible.

In the next section, I’ll explain some of the types of risk that we face in business. For the founders and investors who are reading this, we’ll dive into your role in mitigating risk in the following section.