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Risk, Reward, and Entrepreneurship

Are you a base hitter or do you swing for the fences?


Are you a Hank Aaron or a Ty Cobb? A Barry Bonds or a Hugh Duffy? Do you consistently get on base or do you swing for the fences? The answer will tell you a lot about whether entrepreneurship is right for you, and if so, what style will best suit you. Understanding your attitude towards risk and reward is essential for a happy life as an entrepreneur.

Hank Aaron is the Major League Baseball career home-run leader, and Barry Bonds holds the single-season record. Ty Cobb has the highest career batting average, and Hugh Duffy holds the single-season record. Interestingly, for batting average, Hank Aaron isn't even in the top 100. Barry Bonds isn't in the top 100 for the single season. But Aaron and Bonds are both in the top 100 all-time for striking out. When you swing for the fences, you strike out more than when you just try to get consistently get on base.

So are you a slugger or a base hitter? What's your tolerance for risk vs. reward? Employees tend to be base hitters, and entrepreneurs tend to swing for the fences. That's not a hard and fast rule, of course.

The underlying question has to do with your tolerance for risk and desire for higher reward. For all the talk about the high salaries of corporate CEOs, the reality is that most millionaires are self-employed professionals or entrepreneurs. Yet most strike out a few times. As Barry Moltz says in his book, You Need to Be a Little Crazy, "It is not a question of whether you will fail as an entrepreneur, it is simply a question of when and how."

Consider the following scenario: we're going to flip a coin 100 times. I'll give you $100 for every heads, and if it's tails, you win nothing. You figure you've got nothing to lose and probably $5,000 or so to gain, right?

Let's say instead that you have to pay me $100 for every tails. Do you still do it? Maybe. 50-50 chance. Low risk, low reward.

Now, consider two versions: Version 1: Heads, you win $100; Tails, you lose nothing. Version 2: Heads, you win $300; Tails, you lose $100.

In version 1, you can expect to win about $5,000, give or take, and you've got no risk. In version 2, you can expect to win about $10,000 (500 x $30 = $15,000; 500 x $10 = $5,000; $15,000 - $5,000 = $10,000). But you could lose as much as $10,000 -- unlikely, but possible. There's a fairly good chance, though, that you might lose something.

How much risk are you willing to tolerate for the expected reward? Or, flip it around... how much reward does it take to justify the risk?

There's no right answer. To make matters worse, it's not exactly like flipping a coin. What are the odds that your business is going to be successful? Of course, you believe that you have something that makes your odds better than the average. Every successful entrepreneur has thought that. So have most of the ones who've failed, too!

If you swing for the fences, entrepreneurship may be your best choice. If you prefer a consistent batting average, perhaps you should reconsider. However, if you do decide on entrepreneurship, you may want to consider a lower-risk business.

Lower risk, though has two factors: how much you are risking and what the odds are. For example, at one extreme, a low-risk business might mean doing something like starting up a web-based business for $20 a year for a domain name and hosting. So long as you have other income to pay your basic bills, your risk is trivial.

On the other hand, if you have the cash or credit available to do it, opening a franchise of a major chain might be the right low-risk approach for you.

"But wait," you say, "it takes more than a hundred thousand dollars to start up a franchise. That's a huge risk!"

That's true, but the structure of the franchise program helps ensure success. You have a lot of support from your franchisor. Also, the high barrier to entry helps make sure that only those with adequate capital and planning even enter into it in the first place. As such, the failure rate of franchisees is only about 15-20% of that of independent businesses.

Again, there's no right answer, but you have to have a realistic idea of the risks involved, and the level of risk you're comfortable with, before you step up to the plate and start swinging.

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