It’s not the size of payoff but the size of worst case that drives some entrepreneurs

In the past I wrote about the difference between the mind of an analyst and that of an entrepreneur,

It is impossible for someone who rationally estimates net present value of all options, stress tests their assumptions, meticulously conduct sensitivity analysis, determines market sizes and customer demands to start a new venture. (Dan Ariely calls this Optimism Bias, Gavin Cassar attributes this to selection bias)

Corollary: To start a venture one needs to be risk seeking and at the very least be willing to suspend their  rational mind to make the leap.

A research conducted by Saras Sarasvathy, Assoc Prof at University of Virginia points to evidence on how entrepreneurs evaluate outcomes, that it turns out it is indeed different from the methods of a rational decision maker,

Sarasvathy interviewed 45 successful entrepreneurs, all of whom had taken at least one business public (see caveat at the end of this post).  It was not the planned outcome, carefully constructed from comprehensive business plan and understanding of customer needs that drove these founders. They started with resources they had and imagined the possibilities.  Instead of estimating the size of rewards from a venture from successful outcomes or the likelihood of such outcomes, they asked, “what is the worst that can happen if they failed”.

If the failure was not all that bad they went right ahead.

In fact the failure is indeed not bad. Another research conducted by Pfeffer of Standard GSB, found that

Few of the participants in entrepreneurial activity suffer significant consequences from unsuccessful decisions, and therefore many players have less incentive than one might expect to improve their decision-making  – VCs get guaranteed principal and Entrepreneurs often, although not always, are working with other people’s money, so their financial downside, except in terms of the opportunity costs of their time, are also limited

Since entrepreneurship is already viewed and accepted by all as a high risk activity, failure is not only accepted but glorified as example of risk taking.

It’s not the size of payoff that drives them but imagining what is the worst that can happen. And it appears the worst case is not worst at all.

Caveat: Sarasvathy interviewed 45 successful entrepreneurs whose venture went public and more importantly agreed to talk to her for her study. Clearly there is survivor, selection and availability biases here. The results are also based on the conversations with those entrepreneurs which is prone to hindsight and narrative biases.

Take this for what it is worth.