Comments on: Entrepreneurs Are Not Overconfident

By: Rolf Nelson

Rolf Nelson — Mon, 23 Nov 2009 20:52:06 +0000

Yes, restaurants et al are terrible industries to startup in compared with high-tech, see Scott Shane’s work for an overview.

The narrowing to only analyzing VC-funded firms therefore greatly skews the sample. VC-funded firms are primarily in favorable industries, and furthermore I believe entrepreneurs in favorable industries that are not VC-funded are more likely to fail.

By: samantha

samantha — Fri, 19 Dec 2008 07:46:24 +0000

If money wise on average an entrepreneur breaks even with less adventuresome folks then it seems there is nothing to lose and much to win. It has been said that the path of the start up is like compressing all the effort of an entire career as an employee into a mere three years in the hopes of gaining all that income much sooner.

But actually I think this piece misses the point. To me being an entrepreneur is about having a “fire in the belly”, having something inside that one fervently wishes to see born into the world and that can only be born through business. Sometimes it is possible to bring one of these to life as an employee, but not so often. Then the choice is whether to give birth to this thing inside or not. Making a lot of money is secondary.

Besides, it is a lot more intense.

By: Sonnie Bailey

Sonnie Bailey — Thu, 18 Dec 2008 01:41:20 +0000

An article by Mark Simon, Susan Houghton, and Karl Aquino entitled ‘Cognitive Biases, Risk Perception, and Venture Formation: How Individuals Decide to Start Companies’ was published in the Journal of Business Venturing a few years back. It doesn’t talk about VC specifically, but it is probably relevant to your discussion.

To quote: “The study’s findings tentatively suggest that individuals start ventures because they do not perceive the risks involved, and not because they knowingly accept high levels of risk.”

The specific cognitive biases they investigated were overconfidence, illusion of control, and belief in the law of small numbers. In contrast to the latter two, they did not find a statistically significant relationship between overconfidence and perceived level of risk.

By: Grant

Grant — Tue, 16 Dec 2008 14:27:54 +0000

Venture capitalists typically fund businesses after they’ve gotten started (though they still may not be at all profitable). Angel investors (or in the case of bootstrapped businesses, the entrepreneur’s own judgment, spouse, etc) already do some “idea screening”.

Terren, most of the questionable “Web 2.0″ businesses I’ve seen were self-funded. The increasing productiveness of web development tools means more and more people can start a web-based business without needing as much outside help (and opinion, expertise, etc) as before.

By: Douglas Knight

Douglas Knight — Tue, 16 Dec 2008 06:40:57 +0000

Eric Falkenstein,
looking at the paper, the median is low, but it’s dominated by returns of 20-50MM, not 1B. They claim that they use standard utility functions. The only think I can point to that is a clear error is trusting VC data. That’s probably not enough to discard the paper, but I’m going to assume that they make some other error I didn’t find.

By: David Balan

David Balan — Tue, 16 Dec 2008 04:05:09 +0000

Eric Falkenstein,
The paper cannot distinguish the quality of the ideas, and so treats all ideas as equal (meaning all ideas are of average quality). And the results the authors get seem to show that you would not have to be particularly overconfident to want to be an entrepreneur with an average quality idea. You are certainly right that the marginal idea is going to be of lower quality than the average idea, meaning that the guy with the marginal idea may well have to be overconfident to want to go ahead with it (otherwise he/she would have to be either really rich or really risk tolerant). So the title of the post is really too strong. But the result does, I think, put a bound on how much overconfidence exists among potential entrepreneurs. If there was really massive overconfidence, you would expect a finding where even the average quality idea wouldn’t make sense to do (again, unless you were remarkably rich and/or risk-tolerant).

By: Eric Falkenstein

Eric Falkenstein — Tue, 16 Dec 2008 02:26:10 +0000

If the mean is $4.4MM, but the payouts top out over $1B, the median is probably well under $1MM. Give standard utility functions and the opportunity costs, I don’t see how this can work without some sort of delusion. Of course, there are non-standard utility function, but they have their own problems.

Given Sturgeon’s Law as applied to any innovative effort (ie, 90% of everything is crap), it’s a wonder we do it (eg, write books, songs, create business plans).

By: Chrissy

Chrissy — Tue, 16 Dec 2008 00:22:13 +0000

Me, being an 'underconfident' entrepreneur needs help. I found some help reading, "The Expert's Edge" by Ken Lizotte. It was time well invested. The Expert's Edge book gave me a clearer focus on concepts I knew, served as a refresher in other areas, and introduced me to new ideas that will lead me closer to not only becoming a Thoughtleader in my subject field, but also a "Thoughtleader of Choice".

By: Don Geddis

Don Geddis — Mon, 15 Dec 2008 23:09:06 +0000

That “average” is the tricky part. The study concludes that the average funded company is worth it for most founders (in terms of expected value), compared to salaried jobs. But that’s not a choice most entrepreneurs considering jumping from a safe job to founding a company get to make. Their decision to leave their safe jobs only gets them in the pool of all startup companies, not the much smaller pool (10%?) of successfully-funded VC-backed companies.

By: Lord

Lord — Mon, 15 Dec 2008 21:55:27 +0000

The VCs have already drummed some reality into them. Those that haven’t made it that far, not so much.