Risk appetite

I grew up in a social milieu where no one had any exposure to running a business. That world, full of hard-core salaried employees of modest means, considered “businessmen” a strange species. (When you have absolutely zero exposure to a species, you form opinions from movies and books. And Hindi movies in the 70s and 80s did not exactly cover businessmen with glory — every movie had a “Seth Kirorimal”, and no businessman ever had a surname. Sub-consciously, it was all very alienating.)

Thanks to strange twists of fate, I became an entrepreneur. And over the next decades, I learned to appreciate this species — I became one of them. One of the impressions we had when we were in college was that businessmen are great risk takers. The picture became much more nuanced after I engaged with the entrepreneurial and business community. It’s not easy or simple to summarise the risk appetite of the businessman.

Creator and operator

The term “businessman” is a blanket term which hides two very different profiles: the business creator and the business “runner”. The former is not interested in Y-o-Y 10% growth and details of compliance and optimisation — she wants to explore new frontiers. She bets whatever she can to create a business from scratch, then grows it at a blistering pace. She is bored with “stable”. The business runner is keen to “run” the business, and is exactly the opposite.

Needless to say, the first profile has high risk appetite and the second profile, which is the overwhelming majority, has very little of it. No right or wrong here, just different.

Sometimes, in family owned businesses, entrepreneurs who grow their businesses show high risk appetite but their children switch to operate-and-maintain mode. This is more true if the parent succeeds in building a “sizeable” business.

Various profiles of risk taking

We are beginning to get the nice and warm feeling that we’ve understood these two buckets of business leaders: the “growers” and the “operators”. But I will bring in a twist: not all business-growth leaders are great risk takers either.

We’ve already said that those business leaders who prioritise stability over rapid growth do not show much risk appetite. But I have also seen that those who grow their businesses also often have very “measured” risk appetite. They often start from zero, grow their business to a certain size and depth, and then switch to operate-and-maintain mode. I find this more common in business creators who come from the traditional business communities, than in those who come with no prior business exposure and become business creators due to passion or circumstances. It is as if the culture and traditions of the business communities give many of these business creators an innate sense of “grow to a healthy point, then consolidate.”

Growth spurt, then comfort

Why does the risk appetite of a business creator suddenly taper off?

I have a theory. I feel that each businessperson has a deeply embedded subconscious image of what “a good sized business” means. This very often has to do with what he or she has seen as “good businesses” in his or her childhood, growing up. (This is why these mechanisms work on members of traditional business communities, who have seen businesses all around them, who have 90% of their uncles running businesses.)

I feel that a deep impression becomes imprinted in each person’s mind of what a “big business” is like in tangible terms. They do not want to be JRR Nabisco or Reliance Industries — they find those sizes fantastical. They relate to the businesses they have seen closely, in chats around the dinner table, in chats with their college classmates who are children of business families.

So, some young entrepreneur will start out to build a business and will think that owning a certain amount of wealth (three apartments, a Mercedes car) is a “big business”. Someone else will start with the impression that setting up a factory, or having a sales network in all regions of the country, indicates a “big business”. They will rarely have seen anyone in their family or community circles attain these milestones, so they internalise these markers as milestones to aim for. And if they see a relative grow his business to 10x the “normal” size of their community, they will snigger at the relative’s “greed” or “arrogance”. They’ll say “He thinks he’s a big man — he has no time for us now.”

So, most business owners from traditional business communities work very hard to reach their internal markers, then they suddenly feel they have “arrived”, and take their foot off the accelerator. As one dear friend once told me, “We all plant our stakes in the sand on the beach at some point or other. Some plant their stake early, at the high-water mark, some are more daring, they go right to the water’s edge and plant their stake. Some wade into knee-deep water, lose their nerve, and quickly plant their stake. Those who build big are those who don’t feel afraid to get into deep waters. There is no shortcut — each of us wades in as far as our fear lets us.” I still keep wondering about this.

Therefore, each business builder builds as big a business as her fears and her capabilities allow, and then takes her foot off the gas pedal.

What about those like me who became entrepreneurs due to twists of fate without any in-built idea of what the “right size” of a business should be? We keep learning, and we keep changing our idea of what we can do. In some sense, we are totally unprepared for the challenges of business growth, and in another sense, we are blessed because we are free from any preconceived notion about “right sizes”. Like ignorant or innocent fools, we wade deeper and deeper into the water, stake in hand, taking our lives one day at a time. Fear is our daily companion. Some of us drown. C’est la vie. Those who watch from the shore call us fools or visionaries depending on where we reach. We ourselves cannot relate to either label.

A “risk budget”

One thing I’d have expected to see in the CEO or owner of a mature business would be a risk budget. But I don’t see it.

Imagine a business owner who operates a business with a topline of USD 100m and a bottomline of USD 15m. Imagine that about USD 5m gets added to the balance sheet in some form or other every year, and this has been going on for a few years.

What would such a business be willing to risk in an entirely new line of business without destabilising their existing cash cows? I’d say that USD 5-10m is practically zero-risk. This is what I’d call a risk budget — a budget to risk on a new venture with near-zero risk. Even a risk-averse business head, doing cold-blooded calculations, should not hesitate to bet this amount.

But I’ve seen business heads failing to do this. In the context of our hypothetical company, they balk at investing USD 2m.

I cannot understand this. It seems that many businesspersons, who have all the backing of wealth which one could hope for, have inexplicably low risk appetite.

Keep the personal out

Why is there this hesitation in allocating a risk budget? I see a strange pattern.

Owners of family-run businesses often keep pulling money out of the free cash flow generated by their business and invest this in personal assets. In India, this often takes the form of real estate or shares of listed companies. Note that these go into the owner’s personal balance sheet, not in the business’ balance sheet.

Businesspersons who drive their businesses hard on the growth trajectory rarely do this — they keep ploughing back generated cash to fund their growth. I sense that this hard pursuit of growth is frowned upon by the traditional business communities — they feel that one needs to keep taking money out of the business in the good years in order to have capital to fall back on in bad times. Most sensible and non-controversial.

But I have seen that somewhere, something changes in this process. A catch develops when there should be none.

I have found that some of these businesspersons, even when starting a new line of business, strongly resist liquidating even 20% of their acquired personal assets to fund their new business. Let’s say that the business owner’s family has quietly pulled money out over the last few decades and invested in ten apartments in various parts of the country, and these together have a market value higher than the annual revenue of their existing, stable business. They’re starting a new line of business, which has the potential to double or treble their overall revenue. However, they refuse to sell two out of the ten apartments to fund this venture.

It’s as if, once they convert accrued cash reserves into long-term personal investments, they refuse to consider those assets as sources of liquidity for new ventures. I do not understand where this risk aversion comes from. Imagine my confusion — our founding team has taken unsecured personal loans from banks and NBFCs on multiple occasions, standing guarantee with our apartments as collateral. Yes, we have received nasty calls from collection agencies when we’ve missed an EMI date. And these business owners, sitting on balance sheets of a dozen apartments, warehouses and plots, cannot sell one apartment to fund their own business.

Corporate risk appetite

I have been focusing on the risk appetites of individual business owners, not on fully professional corporate organisations with boards, independent directors, institutional investors, real CFOs, and so on.

However, even when I look at such large blue-chip organisations, I find a wide variation in risk appetite. The Tata group acquired Corus for USD 11 billion in the largest cross-border acquisitions in India’s history. The Aditya Birla group acquired Novelis for USD 6 billion, making them the world’s largest aluminium rolling entity. Both of these were high risk. (I refuse to get drawn into discussions about whether they were wise or otherwise — let’s stay on point.) I find that both these were driven by a person — a business leader who put his sign and seal on the deal, taking a risk I have not seen a purely professional board with a salaried professional CEO take. (There may be many such cases of professional-board-driven risk appetite too — my knowledge is very limited.)

Therefore, however large and professionalised a giant enterprise may be, when I see this sort of risk appetite, I see a person behind it. This is the nature of risk appetite. It seems to come ultimately from the human gut, after all the spreadsheets have been studied.

It’s complicated

Like the old Facebook status, I find the story of business owners and their risk appetite a complicated and nuanced one. As a student of organisations and organisation builders, I feel there is a lot to learn. And I no longer believe that all business owners from traditional business communities are great risk takers.