The True Cost of Entrepreneurship

I’ve noticed that it’s pretty easy for me to convince myself that a task I’m doing is easier/faster/simpler than it really is. Especially once I’m already deep in the task. This is a natural psychological trick we play on ourselves I think. A form of sunk-cost fallacy.

This is a huge problem because if you’re expected to weigh the costs and benefits of a certain decision, yet you’re unable to accurately determine the costs, then you could be led down the wrong path.

The Awesome Coach

Here’s a simple example. Let’s say you meet an amazing business coach. She offers to give you a personalized coaching session for $300 that will tell you exactly what you need to know. Alternatively she has a $20 book on the subject that you can purchase. Which would you choose?

If you’re like most people, you’d go with the $20 book. The reasoning being that for $20 you can learn what the $300 would otherwise teach you. But here’s where the cost-benefit analysis is flawed. The true cost isn’t $20. The true cost is $20 + the amount of time it takes to read the book. Assuming it takes you five hours to read the book, it’s probably best to just get the $300 coaching session, and spend the extra 4 hours doing something else (maybe applying the teachings and actually growing your business).

Well, you could say that it’s enjoyable to read that $20 book. Then that’s fine as well. As long as you factor it into the overall cost-benefit analysis of the decision.

Making It On Your Own

Here’s another more concrete example. Say you’re deciding between two different paths: stay at your current job that pays $10,000 per month. Or start a new freelance job where you reasonably expect to start at zero and then grow by $500 additional per month. At what point would you be break even after quitting your job? The answer seems to be 20 months (20 months * $500/month/month = $10,000/month).

But in reality, to be truly break even (all other things being equal) it would take you 39 months, almost twice as long.

Why? Imagine you had stayed at the job for all those 20 months. You would’ve earned a total of $200,000. Meanwhile, doing freelancing at month 20 you would’ve earned a total of $105,000. At month 20 you’d start earning as much as in the salaried job, but you still would’ve missed out on almost $100,000 in earnings. It’ll take you an additional 19 months to earn back all that lost income.

Here’s a chart illustrating the total earnings over time:

Luckily in this scenario all the variables can easily be estimated with simple math. And even then it wasn’t totally obvious in the beginning. Now if you factor in other factors such as financial freedom, being your own boss, work-life balance, stress etc, then the potential for miscalculating benefits and costs grows exponentially.

Don’t Overlook Any Factors

No one can know for sure what’s ultimately the best decision in every crossroads. But being at least aware of as many factors as possible will increase your chances of coming up with the best direction.

  • Thanks for bringing reason to the table of entrepreneurship. So long as someone adds up all their factors and understands their “cost of entrepreneurship”, then they can know if they are in fact taking a calculated risk. Good read.