The popular perception of the entrepreneur is as something of a swashbuckling type who is prepared to ignore the status quo and make their own way in pursuit of their dreams and ambitions.
This image is perhaps typified by Richard Branson, with his adventurous lifestyle sitting squarely alongside his courage and verve as an entrepreneur.
Such people seem to be a breed apart from the rest of us because they seem to be devoid of any sense of loss aversion. Loss aversion is one of the more common psychological biases that results in many people preferring to avoid making a loss rather than try to make a gain.
A recent study (pdf), led by Professor John Morgan from the University of California at Berkeley alongside Dana Sisak, from Erasmus University in Rotterdam, has explored the link between entrepreneurship and loss aversion. The research made the fascinating finding that the dashing entrepreneur is not so much driven by their love of risk taking as they are by their own particular brand of loss aversion.
"There is a view that entrepreneurs are often overconfident gamblers, who thrive on risk, yet there is little evidence to support this view," the researchers said. "Entrepreneurs aren’t Steve Jobs. They’re just ordinary people who want to start a business. I wanted to try to understand a little better what motivated those individuals."
What makes entrepreneurs different?
The study was born out of the belief that entrepreneurs are not really so different to everyone else, but the researchers nevertheless wanted to understand what prompts someone to leave the comfort of a secure job for the relative uncertainty of start-up life.
They suggest that every entrepreneur has a certain reference point, by which they define things such as their salary or happiness levels when comparing themselves to others. That reference point is then used to gauge just how much the entrepreneur is prepared to sacrifice when starting up their new venture.
Loss aversion = effort
The research discovered that the concern the entrepreneur had around loss aversion was directly correlated with the amount of effort they devoted to their start-up. In other words, the bigger the loss involved in starting up their business, the greater the effort they put into making it work.
The researcher derived its conclusion via a winner-takes-all style of framework. This is commonly found in the startup world, where a single company can often grow to dominate a market, much as the likes of Facebook and Google have in the online world.
"For every Facebook, there were hundreds of failed ventures," the researchers say. "We model this aspect of entrepreneurial markets explicitly. This research can help entrepreneurs gain self-knowledge so they make better decisions and have a clear understanding of why they’re doing what they’re doing."
The study provides a fascinating insight and perspective into the kind of mentality underpinning entrepreneurial verve. They are careful to point out however the flip side of loss aversion, which often involves sunk costs. This suggests that people are often reluctant to ’cut their losses’ when they’ve made a big investment into something, which typically sees the losses escalate.
"One of the most important traps entrepreneurs fall into is when they’re not experiencing success and they become increasingly willing to take risks because of where they are psychologically," the researchers concluded. "One lesson from the research is to be careful when you are behind. It’s not necessarily the best decision to double down."
The different angles of entrepreneurship
The study might support more enlightened policy making from officials looking to encourage entrepreneurial innovation within their societies. Despite the popular misconception of entrepreneurs, many are sole traders, with little prospect of expanding to thus recruit more staff and grow the economy substantially. A better understanding of the motivations involved, may therefore prove crucial in supporting those with the best chance of truly expanding their enterprise.
It could also provide valuable insights into our own motivations should we wish to venture into the start-up world ourselves.
Have you started a new business yourself? Let us know your motivations in the comments below.