Is it foreseeable that your bank is going to have a run on it? Thanks to social media connectivity, possibly. 

But is it foreseeable that anything above $250,000 in your bank account is exposed? The answer is a clear yes as well.

The recent collapse of SVB is a great reminder of the importance of understanding all the inherent risk in your business and the different places it’s coming from. For instance, those risks are not limited to banking, it’s also essential to have a very clear understanding of the environment you operate in: customers, clients, regulators, macro-economic environment, etc.

Of course, starting a new business involves taking risks, but understanding risk management is paramount to the success of any business venture. Many business owners, particularly founders of new companies, are so busy trying to perfect their MVP (minimum viable product) and attract customers that they don’t have time to manage all the risks in business, and this is partly due to the new cohort of working people who did not experience the turmoil of the last financial crisis in 2008. Unfortunately, many founders and business owners make critical (but avoidable) mistakes that can be catastrophic. Not all risks will lead to rewards, and it’s crucial to learn from the mistakes of others. 

I’ve put together 5 of the top risk management mistakes that founders and business owners make. Don’t fall victim to these mistakes.

1. Misunderstanding your environment

In today’s rapidly changing business world, misunderstanding your environment is a surefire way to fall behind and eventually fail. Being blind to your business environment can leave you vulnerable to market changes, operational issues, and financial or legal risks.

​​Consider the case of Nokia, once a dominant player in the mobile phone industry. While Nokia was founded as a wood pulp mill in 1865, they successfully expanded into various industries, including rubber, cable, and electronics. But in the early 2000s, they failed to adapt to the evolution of smartphones, losing their market share to competitors like Apple and Samsung. Nokia’s reliance on traditional mobile phone models and outdated operating systems like Symbian, coupled with its failure to anticipate shifts in consumer behavior, led to its downfall. Eventually, Nokia’s mobile phone business was acquired by Microsoft in 2014.

After all, as Clay Christensen aptly said, “Disruptive innovations tend to be produced by outsiders and entrepreneurs, rather than existing market-leading companies.” To avoid meeting a fate similar to Nokia, remain aware of your industry and the potential disruption from new competitors. 

But understanding your environment is not limited to your industry and competitors. Make sure you have a well-thought-out contingency plan to respond to exogenous events like natural disasters, cyber-attacks, or market downturns. Always include backup systems, alternative suppliers, and access to additional funding.

By staying informed, being open to change, and having a comprehensive contingency plan, you can protect your business from unexpected challenges and maintain a competitive edge. Denial is a dangerous luxury that leaders and organizations simply cannot afford today.

2. Over-reliance on debt

The current rising interest rates are leaving businesses vulnerable, particularly when it comes to leveraged positions or floating-rate loans. Within the next 18 to 24 months, there are hundreds of billions of dollars in term debt coming due for many companies. These debts are likely to be repriced or potentially not renewed. Additionally, companies with outstanding floating-rate notes are experiencing significant increases in their borrowing costs, as interest rates have risen considerably compared to a year ago (in some cases, the cost of borrowing has even doubled). This situation puts tremendous financial pressure on businesses, creating an urgent need to address their debt obligations and manage the associated risks. 

Over reliance on debt and being over leveraged can also leave a business vulnerable. Those with high debt-to-equity ratios could find it challenging to secure additional financing or weather financial shocks, leaving them exposed to potential disaster.

The once-popular fashion retailer Forever 21 is a stark reminder of this. As the company aggressively expanded its physical footprint, it amassed a considerable amount of debt. When consumer preferences shifted towards online shopping and more sustainable fashion options, Forever 21 struggled to keep up. Unable to adapt quickly and weighed down by their heavy debt load, the company ultimately filed for bankruptcy in 2019.

Always consider the consequences of taking on too much debt. First, monitor your company’s debt-to-equity ratio and ensure it remains at a manageable level. This will help maintain financial stability and improve your chances of securing additional financing (but always raise capital before you need it!). Additionally, implement a proactive approach to managing debt by regularly reviewing your company’s financial performance and adjusting your repayment strategy accordingly.

Furthermore, reducing dependency on a single type of debt is a smart decision. This may include exploring alternative funding options such as equity financing, grants, or strategic partnerships. By striking a healthy balance between debt and other financing options, you can bolster your company’s financial resilience and safeguard it from the perils of over reliance on debt. 

Debt can be a useful tool for growth and expansion, but excessive borrowing can be the Achilles’ heel that brings your business to its knees.

3. Lack of Diversification

Don’t make the mistake of putting all your eggs in one basket. Most certainly do not put all of your financial resources in one bank account. Business owners who banked with SVB learned that lesson the hard way last month. Due to 0% interest rates we’ve previously had for years, many people didn’t realize that a checking account isn’t meant for storing cash –– it’s just a landing pad for money coming in and going out of your balance sheet. In other words, it isn’t meant to be a proxy for managing your cash. Good risk management is always having more than one account. And don’t just let your money sit there, it would be smarter to invest in risk-free CDs or short-term treasury bonds.

Lack of diversification can be a ticking time bomb for any business, regardless of size or industry. Founders and business owners must recognize the dangers of relying exclusively on a single product, market, team, or customer base. Such over reliance can make a company vulnerable to sudden changes in market conditions, consumer preferences, or unforeseen challenges. Implementing diversification strategies, such as expanding product offerings, entering new markets, building a diverse team, or broadening the customer base, helps to mitigate these risks and protect your company.

Once a leader in the smartphone market, Blackberry failed to diversify its product offerings and adapt to the rapidly evolving mobile landscape. As Apple and Android took the market by storm, Blackberry’s over reliance on its traditional physical keyboard and outdated operating system caused it to lose significant market share. If Blackberry had diversified its product portfolio and invested in innovative technologies, it might have remained a significant player in the smartphone industry.

Remember that diversification is essential for long-term success. By spreading your risks and resources, you will not only protect your company from unforeseen events but also optimize your cash flow and fuel sustainable growth.

4. Clever-looking accounting practices

A clear understanding of your company’s financial health is crucial, and this starts by not letting accounting delude you into a false sense of security. Proper risk management, maintaining accurate financial records, and implementing a robust accounting system can make the difference between a thriving enterprise and a sinking ship.

One of the biggest mistakes businesses make is reliance on pro forma income. This typically involves the use of EBITDA as a key performance indicator. The issue with relying on pro forma income is that it can create a false sense of financial security for both the business and its investors. By focusing on EBITDA, some may be led to believe that economic value is being generated, when the company might actually be incurring greater losses. 

An example of this can be seen in the case of Motorola, a once-dominant mobile phone company, that struggled and declined due to its inability to adapt to changing market dynamics, internal issues, and an over reliance on pro forma income and EBITDA. The company reported pro forma numbers that painted a positive picture of their financial health, but in reality, they were struggling. By focusing on EBITDA, Motorola managed to create an illusion of success that concealed the company’s true financial situation. They were eventually split into 2 companies in 2011.  Motorola Mobility, the mobile phone division, was acquired by Google in 2012 for $12.5 billion.

As we now know, Silicon Valley Bank, once a leading financial institution, also met its downfall due to its questionable accounting practices, particularly the adoption of a “hold to maturity” strategy which was not properly hedged. This approach allowed the bank to avoid marking losses in their investment portfolio, which was mostly long-duration government bonds. Government bonds, while generally low-risk, can still have price fluctuations due to changing market conditions. By classifying these bonds as “held to maturity,” the bank effectively hid their true value, obscuring significant financial losses from investors and regulators. As a result, the bank’s financial position appeared to be far stronger than it actually was and created a false sense of security. This false representation of their financial health eventually contributed to the bank’s demise when the truth about their hidden losses came to light.

The key takeaway? A business that loses its focus of its true financial condition risks severe consequences, damaging not only the company’s reputation, but also its bottom line and existence. Prioritize honesty, transparency, and accuracy in your financial reporting, and you’ll be laying the foundation for a successful, resilient business that stands the test of time.

5. Assuming insurance Will Cover Everything

Trusting insurance as an all-encompassing safety net can be a costly mistake for a business owner. While insurance can mitigate risks, it is not an infallible solution. Understanding the limits and exclusions of your coverage is critical to ensure your business can weather unexpected challenges.

A great example of this is the collapse of Washington Mutual, once the largest savings and loan association in the United States. In 2008, during the global financial crisis, Washington Mutual faced a bank run as panicked customers withdrew their deposits en masse. While the bank had insurance through the FDIC, they only insured individual deposits up to $100,000 at the time, leaving many customers and the bank itself vulnerable to losses. Washington Mutual’s over reliance on insurance coverage and failure to recognize the extent of its exposure to risk ultimately led to its demise and acquisition by JPMorgan Chase. 

In October 2008, the Emergency Economic Stabilization Act (EESA) was enacted. The act temporarily raised the FDIC insurance limit to $250,000 per depositor per insured bank. This increase was initially intended to last until December 31, 2009, but due to the ongoing economic instability, it was made permanent in 2010 with the Dodd-Frank Wall Street Reform and Consumer Protection Act. 

This crisis did not only serve to raise insurance protection –– it made business owners critically aware of how important it is to be more financially astute. Ironically, it also gave everyone a false sense of security –– we seem to have forgotten everything we learned from the great financial crisis in 2008, leaving many in a tough situation.

To protect your business, it’s vital to thoroughly assess your business’s unique risks and obtain comprehensive insurance coverage tailored to your needs. Be proactive in discussing potential scenarios with your insurance agent, and ensure you fully understand the extent and limitations of your policy.

The bottom line

By avoiding these mistakes and implementing effective risk management strategies, entrepreneurs can help ensure the long-term success of their businesses.

Regularly review and update risk management strategies as your business evolves and new risks emerge. Conducting regular risk assessments, staying up-to-date on industry regulations and trends, and seeking advice from experts in the field are all great places to focus.

Take a lesson from SVB –– don’t wait until it’s too late to understand all of the risks inherent in your business and make a plan.