Entrepreneurship Risk

From Summation by Auren Hoffman:

Entrepreneurs tend to be street-smarter than strategy consultants. Entrepreneurs are more practical, more focused on the bottom line, and more attuned to real-world contingencies.

A typical strategy consultant job interview might go something like this:

“I toss a coin. Heads you win $10,000. Tails you lose $6,000. Do you play this game? Why?”

And a typical strategy consultant answer would go something like this:

50% chance I win, 50% chance I lose. So my decision calculation goes something like:

Winnings: (0.5) * $10,000 = $5,000

Loses: (0.5) * $6,000 = $3,000

My net value of this game is $2,000

Therefore, even if I am very risk averse, I’ll still play this game, because I can afford to lose $6K when the payoff is so much higher.

A typical entrepreneur would look at this game totally differently and would ask a series of questions:

1. How do I know the coin is fair? Maybe tails is much more likely to come up. Can I test the coin by flipping it 500 times to see if it is consistent? Do I really want to waste my time performing and recording 500 coin tosses?

2. How do taxes affect my wins and losses? Is Uncle Sam going to take a huge chunk of my winnings but not recognize my losses? Can I only apply my losses to gambling gains? How are state and city taxes affected?

3. Do I have to pay in cash if I lose and do I get cash if I win? If that is the case, are we going to show up at the location with all the money? Will I be secure? Can I pay by credit card to get frequent flyer miles?

4. How can I be sure I will collect from you? Are we going to hold the money in a third-party escrow? How much will that cost?

It’s interesting to note that Nassim Taleb gives a similar example of the coin toss scenario when discussing the thought processes of The Nerd and the street-smart common-sensical Epistemocrat.

Here, however, Auren Hoffman is describing the typical entrepreneur. I’m sure Taleb (and most entrepreneurs) would agree that, despite the typical risk associated with entrepreneurship, creating your own business and liberating your finances—that is, putting your wealth in your own hands—changes the nature of the question so that you have ultimate control over the amount of risk that you choose to take on. Otherwise, your entire stream of income would be dependent on the decisions of the establishment that hired you.

Picture entrepreneurship like a pyramid, a large base and a fine point on the top; the large base represents multiple opportunities for streams of income. A typical job, however, would look like an inverted pyramid, in which you only have one source of income—the point of the pyramid. If that one source fails, the entire pyramid would collapse on you.

Leave a Reply

Your email address will not be published. Required fields are marked *