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Hamblin Brown

Preparing for your startup to fail

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In his latest Reluctant Entrepreneur column, Dr DJ Hamblin-Brown explains why the blindness of business startup entrepreneurs is a double-edged sword.

What’re the chances that your startup is going to succeed?

If you, like me, are a digital or MedTech entrepreneur (or perhaps a more traditional startup business owner) your answer will likely be: about 80 per cent.

If so, you are utterly wrong. Based on averages, your answer should be Pareto-like: about 20 per cent.

This is based on government numbers from the USA, and it depends on your sector, but there is little reason to believe this is not repeated elsewhere. In fact, many commentators put the number of failures at 90%. Although I can’t find reliable evidence for that number.

Any reasonably honest autobiographical business book will provide you with plenty of horror stories, to which I could add my own, about mistakes and hubris. Personally, I like the first few chapters of Steve Blank’s Four Steps to the epiphany which, describe beautifully one of the most spectacular failures of the dot com boom.

However, such tales of entrepreneurial failure will tell you only the mechanism by which your business might fail. ‘I hired the wrong team’; ‘I didn’t know my market’; ‘I spent too much time playing golf’. As descriptions of near-causal effects, these are reasonable explanations. But it doesn’t really tell you why that happened.

A habit of thinking

With your tolerance and, building on rule number one, it may be helpful to use a medical analogy.

All businesses terminate when the cash runs out, which is to say the blood stops flowing. This is the final common pathway. However, doctors will rarely suggest the cause of death is  ‘lack of circulating blood to the vital organs’, they will usually provide a near-term cause.

‘Myocardial infarction’ is a description that will help. However, even on death certificates, doctors are expected to provide some context. Adding ‘Atherosclerosis’ may be enough to satisfy a coroner.

In business terms, we can easily find lists of such near-term causes for business failures: not investigating the market; business plan problems; too little financing; bad location or marketing; remaining rigid; expanding too fast; the wrong market; lack of research; bad partnerships; lack of expertise…the list is in fact endless.

What a death certificate won’t say, however, is ‘a diet high in trans-fats and too little exercise’. Such distant causation relies too much on conjecture for the legal profession. And yet, we all know that cardiovascular disease is the primary cause of premature death in the developed world and that this is primarily driven by lifestyle choices.

What is relevant, including to our discussion about business failure, is not what causes heart disease, but what drives people to eat too many doughnuts and sit on the couch for most of their life. This cannot be for lack of understanding that these are unhealthy habits. Such information is readily available; even from the doctors who populate the daytime TV schedule.

The answer, of course, is a habit of thinking. The average couch potato believes: ‘It won’t happen to me.’

So too with startup entrepreneurs. We think we’re invincible.

Kahneman and overconfidence

This blindness of business startup entrepreneurs is a double-edged sword. Without the optimism that averts our mind from the awful reality, we would (like the vast majority of people) do nothing. But it is also the state of mind that will most likely lead our business over the precipice.

Nobel laureate Daniel Kahneman, in his seminal work Thinking Fast and Slow dedicates almost a quarter of the book to overconfidence – and an entire chapter to the bias of optimism, which he describes as perhaps one of the most significant of the many psychological biases to which humanity is prone.

He suggests that optimism is the ‘engine of capitalism’. Optimists drive most change that happens in society, including politics. And he believes that it bestows a significant benefit on those it infects:

“If you are allowed one wish for your child, seriously consider wishing him or her optimism. Optimists are normally cheerful and happy, and therefore popular; they are resilient in adapting to failures and hardships, their chances of clinical depression are reduced, their immune system is stronger, they take better care of their health, they feel healthier than others and are in fact likely to live longer.”

More specifically, Kahneman recognises that optimism creates a level of self- belief that can be misguided but nonetheless useful:

“The evidence suggests that an optimistic bias plays a role, sometimes the dominant role, whenever individuals or institutions voluntarily take on significant risks. More often than not, risk takers underestimate the odds they face, and do not invest sufficient effort to find out what the odds are. Because they misread the risks, optimistic entrepreneurs often believe they are prudent, even when they are not. Their confidence in their future success sustains a positive mood that helps them obtain resources from others, raise the morale of their employees, and enhance their prospects of prevailing. When action is needed, optimism, even of the mildly delusional variety, may be a good thing.”

However, optimism is not always useful. It is also potentially fatal to businesses. Kahneman posits a few ways in which this takes shape:

  • Competition Neglect: simply ignoring that fact there are others in the same market or space in which you operate (I know I am culpable of this).
  • Inside View: relying too much on your own organisation and your own network to reinforce what you think. This has surely become more prevalent even for small companies inside the bubbles caused by social media algorithms.
  • Overconfidence: the willingness to ‘bet the house’ (sometimes literally) on a long-shot. The belief that if fortune is to play a part, that lady luck, lady luck will be on your side.
  • The Planning Fallacy: the belief that you’ll get more done in less time than is either likely or, sometimes, even humanly possible. This is a trait that is made worse by investors and accelerators egging on startups to provide hockey-stick growth charts and over-ambitious valuations. In my view, this is the most pernicious and certainly the most common mistake made by optimists – myself included. It probably warrants an entire “rule” to itself

I won’t do justice to one of the world’s most influential academic thinkers by elaborating any further. If you think it worth exploring, I strongly recommend reading the book, and Part 3 on Overconfidence in particular.

My point is that all of the pitfalls outlined in magazine articles and business books about startups that I have read fall into one – sometimes more – of these four broad categories of what might be called the psychological errors.

To my mind it is these psychological errors that are the metaphorical equivalent of our desire to lounge on the sofa and eat chips. We know it’s bad for us, but the craving to be excessively optimistic is just too tempting.

So, what to do?

We can’t abandon optimism altogether. And yet we must rein in our excesses. As taught by the sages, we need to steer a middle way: not too much realism, not too much hubris. This much is clear. The question is how.

Taking these four psychological errors in turn, we can perhaps see ways in which we can temper our own optimism with useful antidotes that don’t kill our enthusiasm.

  • Undertake a thorough competition analysis 

I hate this. I find it physically quite upsetting to look squarely at the competitive field. I have often wondered if this is because it feels like competition in the more personal aspects of our lives: sexual jealousy, sibling rivalry and the like. Even if it’s uncomfortable, you just need to do it.

  • Seek contrarian help 

Your team are following you and your friends are…well, they’re your friends. You need someone who will speak truth to power. You need someone knowledgeable of your area of business – not necessarily the expert that you are – who is going to tell you what you need to know, not what you want to hear.

  • Look at the odds

For my part, I’m a lousy gambler. In backgammon, I love to play the back-game. When it works out, it’s lovely, but I’ve lost too many times to make it a worthwhile strategy. You need to know (especially if you’re playing with other people’s money) what you’re actually betting on. Work out the odds and try to improve your chances.

  • Write a modest business plan

Ignore the exhortations of your VC colleagues to be the next unicorn and plan for a business that won’t set the world on fire; that won’t achieve the billion-dollar valuations. Understand that 5% growth compounded on a reasonable start will get you a perfectly adequate business in 10 or 20 years. I know this sounds boring. But boring may be better than dead. Trying to grow too quickly will starve you of cash. What would it be like to be moderately successful? Try it.

Kahneman writes that optimism, when identified as a problem, is pretty intractable – much like a sedentary lifestyle. He has only one suggestion, namely that you isolate yourself and write down, as a memoire, the story of your business failure and the lessons you learned. We can use fantasy to break the armour of optimism just for a moment and seek some lessons before they are taught to us more painfully. This is he describes as a pre-mortem.

This is probably the most sensible, but also the hardest suggestion for an entrepreneur since it runs so obviously against the grain of our essential optimism. Nonetheless, any or all of these suggestions may help to curb pernicious overconfidence.

In summary, then, we could do worse than prepare for failure.

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  1. Pingback: Health tech's reluctant entrepreneur: How to have purpose

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