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Are Entrepreneurs Less Risk-Averse than the Common Man?

Entrepreneurs are in many ways an enigma that current business-management scholars are trying to solve. One of the most researched subjects is entrepreneurs’ attitude toward risk. According to a University of Tennessee study, only 37 to 58 percent (depending on the industry) of new businesses are still operating after four years. This means that even if you start a business in the most entrepreneurship-supportive industry, there is a 42 percent chance you will fail within four years.

One would think that these rates, which are known to every entrepreneur, would lead many to rethink their new business ventures; however, this is not the case. In light of this, researchers assumed that entrepreneurs are simply less risk-averse then the common man. However, much to their surprise, that wasn’t the case either.

So what is it? Cognitive biases.

Three researchers from Oakland University and Georgia State University examined the relationship between three cognitive biases (overconfidence, illusion of control, and belief in the small-number law), risk perception, and the decision to start a new venture.

They found that two cognitive biases directly influence the decision to start a new business. The first is Illusion of control. This bias refers to people’s tendency to overestimate their ability to control a certain event, while the situation is in fact primarily determined by chance. When faced with uncertainty, a common experience in the entrepreneurial process, people tend to overestimate their ability to predict and prepare for future events. The second cognitive bias is belief in the small-number law, which refers to a situation in which a person forms a firm conclusion on an issue after gathering information from only a limited number of sources. This bias may be relevant to a nascent entrepreneur when assessing a new idea, business opportunity, or potential market, just to name a few.

What can you do to overcome these biases? The answer is easy. Hire a professional consultant who will impartially assess your business plan. Understand that you might have to invest in your idea to accurately analyze whether it has the potential of becoming a success. There is also some good news: These biases are not necessarily bad, at least in the beginning stages of the entrepreneurial process. They allow entrepreneurs to explore and develop their ideas freely without being crippled by the fear of failure.

Based on: Simon, Mark, Susan M. Houghton, and Karl Aquino. “Cognitive biases, risk perception, and venture formation: How individuals decide to start companies.” Journal of Business Venturing. 15.2 (2000): 113-34. Web. 24 Mar. 2013.

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