Entrepreneurship is seen as an inherently risky proposition. The Europe start-up ecosystem in particular has been criticised for being risk-averse in comparison to their American counterparts.
The downside of Entrepreneurship
Wasserman (2013) found that the self-employed tended to have 35% lower earnings compared to if they had been in a paid job. Given that there is diminishing returns to wealth, with a satiation point between ยฃ100,000 to ยฃ120,000, the benefit of earning more that that is often outweighed by the costs of potentially losing wealth.
Proponents of taking the entrepreneurship gamble often egg others on by saying that youโll never get rich working as an employee. What they neglect to tell you is that you might also never go bankrupt as an employee. The downside of startups is capped by bankruptcy procedures, but so is the upside, because of the diminishing amount of utility you receive from wealth.
Entrepreneurship as option theory
Risk aversion can be mitigated if we teach people the benefits of downside protection. It is not always optimal to do an all-or-nothing gambit. This practice of managing your bets, or position sizing, is vastly underrated. After all, if a bet is 51% in my favour, is it not the wisest thing to plonk my entire life savings on the table? Net Interest does an incredible article on position sizing.
What you are forgoing is the ability to make future bets in lotteries down the road, which may be equally or even more favourable odds.
Entrepreneurship is like option theory. As long as you limit the costs you are willing to sink into a venture, that is all you can lose. Downside protection. Meanwhile, the upside is unlimited – though of course statistically a small proportion of startups achieve an incredible amount of financial success.
Is there value to waiting to start as an entrepreneur? Serial entrepreneurs have a higher chance of success, even if they have failed. This has given rise to the notion that entrepreneurship is a sure-win game, where success means financial freedom and failing just means your chances for the next time are increased. The only cost is the years of foregone salary.
As for foregone salary, it’s wholly possible to start a business on the side while maintaining a full-time career as long as you have a decent amount of leisure time outside of work. That way, you avoid the costs of foregone salary as well. That said, it will cost you your leisure time – which arguably, you could have traded for a higher paying job, so it will never be completely cost-free.
We need to stop romanticising entrepreneurship as this massive step that results in epic success. There is no need to go all-in on your first idea. Spend conservatively to test the waters, and allocate more capital to it as you get a positive response.
Conclusion
Hernan Cortes is credited with scuttling his boats to motivate his men into exploring the New World. That might not however, be the ideal strategy most of the time. When you burn the boats, you also risk losing due to a siege, or natural calamity beyond your control. The option to live another day, as long as you know your base threshold and are disciplined to follow this, will be more valuable.
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