Risky Business?: Small Business Best Practices for Assessing Risk
by Jen Hickey.
Small business owners are usually well acquainted with risk. After all, starting a business is one of life’s most momentous decisions and often requires a leap into the unknown. However, you can improve the odds for your business by identifying those risks early on and devising a plan to eliminate or minimize their impact. While it’s probably not healthy to think about all that could go wrong, asking “What if?” when it comes to every aspect of your business is key to its survival.
Lay the right foundation
Even before your business opens its doors, there are important points to consider. “First, you need to decide how to set up your company,” says Barbara Weltman, tax and business attorney and author of Small Business Survival Book. “If you’re a corporation or an LLC, creditors can only look to business assets to satisfy claims. Personal assets, like your house, car and savings, are protected.” But these assets are exposed when a business is a sole proprietorship or partnership. Weltman urges anyone thinking of starting a business to meet with a legal advisor to see if your business type requires such entity protection. “If your business deals with the public, it faces potential liability,” notes Weltman. “These require legal steps.”
Match risk mitigation to your specific business
Next, you should select an insurance agent to help you determine what kind of coverage your business needs. “Every business owner should have a business owners’ policy (BOP), which includes protection for property in case of storm and fire damage, as well as liability coverage to protect against claims from customers and creditors,” advises Weltman. Purchasing a packaged policy like a BOP, which typically includes coverage for property, business interruption, and liability, is generally more affordable than purchasing individual policies.
Depending on the industry your business is in, as well as its location, you may also need specialized coverage in addition to a BOP. “A basic liability policy doesn’t cover professional action or inaction,” says Weltman. “A professional liability policy covers errors and omission.” It protects professional businesses, such as consulting firms, ad agencies, law offices, and medical practices, against lawsuits for negligence or malpractice.
By law, any business with employees must pay for workmen’s compensation, unemployment and, in some states, disability insurance. If your business requires the use of vehicles to transport your products or services, you will not be able to register or operate your vehicle without commercial auto insurance. Businesses that manufacture or sell certain products may also need product liability insurance to protect against lawsuits resulting from injury due to a defective product.
Because some risks are unique to a particular business and often depend on type, industry, and location, assessing your business’s risks might involve taking steps not listed here. To perform a more thorough risk assessment, consult an insurance agent, as well as your attorney and accountant to make sure all regulatory and tax obligations for your business have been fulfilled.
Prepare for the unexpected
While the chances of a natural disaster may seem remote, if affected by one, your business will not likely recover if you don’t have property or business interruption insurance. According to the Red Cross, 40 percent of businesses that experience a disaster will never re-open. As seen when Hurricane Irene hit the Northeast coast last year, but caused the most damage to interior regions, violent weather can wreak havoc in the unlikeliest of places. So, this is not an area where a small business would want to cut corners.
While insurance enables a small business to transfer some risks to a third-party, should a loss occur, it needs to consider out-of-pocket costs. “A way businesses can manage their costs is to pay a high deductible,” notes Mitchel D. Weiss, adjunct professor of finance at the University of Hartford and author of Business Happens, set to publish in December 2012. “You want to be sure to have the cash set aside to cover them.”
You also need to assess the risks to your business you can control, such as operational and human resources. “You can protect your business against internal risks through checks and balances,” Weiss explains, “by having stated policies and procedures and segregation of responsibilities.” For example, the accounting department or your bookkeeper should keep track of expenses incurred by your employees. “One way to protect against internal risks, fraud in particular, is to have good, solid controls in place, so that the person that benefits from something is not the same person that authorizes the receipts.”
Your employees are your greatest assets. But they also can be a significant source of risk without proper policies and procedures in place. “One of the biggest areas for legal action are claims by employees for discrimination, sexual harassment, and wrongful termination,” Weltman points out. “Having an employee manual that sets forth procedures for reporting harassment and reasons for termination, for example, will help thwart such action.” Requiring all employees to read and sign a release that they’ve read the manual can help minimize unwarranted claims.
Hiring the best people and creating a work environment so they can thrive can also help reduce risk. “If you’re not investing in your people and putting the right people in the right places, that’s a risk that could translate into a potential failure of your business,” notes Weiss. “In addition to paying them fairly, one of the most effective ways to hold onto your best talent is to invest in their training, so they’re [worth] more tomorrow than they are today.”
Safeguard your business information
Next to its people, your business’s data is what keep it running. Look at possible threats to your company’s computer and network security. Assess the risk for viruses, malware, or outsiders hacking into your system. Your business’s reputation is at risk if you have to notify your customers their personal information and/or credit card numbers have been stolen.
While property insurance will cover the cost of replacing equipment destroyed by fire or flood, it won’t bring back all your business records. “The loss of data could put you out of business really quickly,” says Weltman. “Backing up your data or working from the cloud” can eliminate that risk.
Be systematic to avoid missing trouble spots
Take a look at each of your business operations for risk exposure and assign each a probability of loss and cost. Weiss recommends creating a four-way grid to assess risk: “Those that have the highest probability and the highest impact; those with low probability but high impact; those with high probability but low impact; and those with low probability and low impact.” Then, devise a plan to eliminate or minimize those with the highest impact or costs based on probability first, and then work down the list.
Once you’ve identified, assessed, and eliminated or minimized the most likely and costly risks to your business, “rinse and repeat,” says Weiss. “Risk management is not a once-and-done kind of thing. It’s something you need to revisit to make sure you’re on target. Did you identify all the things that could go wrong or have other things happened you didn’t think about?” It’s important to review and revise your risk management plan (download the SBA’s Insurance and Risk Management Guide here) at least yearly to add any new risks and re-prioritize old ones. Think of it as an anniversary present to your business, one that actually saves you money in the long run.