The concept of Loss Aversion has been well studied. It came out of the 1979 work by Daniel Kahneman and Amos Tversky and is encapsulated in the expression “losses loom larger than gains.”1 Essentially, people feel pain from losses much more intensely than they feel pleasure from gains of the same size. Kahneman and Tversky performed an experiment which resulted in an example of human bias towards losses. The experiment involved asking people if they would accept a bet based on the flip of a coin. If the coin came up tails the person would lose, and if it came up heads, they would win. The results of the experiment showed that on average people needed to win about twice as much as they were willing to lose to proceed forward with the bet (example: I need to win $200 for every flip of heads and lose $100 for every flip of tails).
If you’re reading this article, it’s my opinion that you’re someone who has limited Loss Aversion in their life. Many people on this email list are entrepreneurs and business owners who have gone against Loss Aversion in their career. Entrepreneurship often involves taking a bet: on yourself, your team, your industry. It’s much safer to practice Loss Aversion and work inside a BigCo. If you have a job, you know what you’re doing, right? It’s much less ambiguous. It’s the “paint-by-numbers” approach to life. Going out on your own is a blank canvas. It’s a lot more ambiguous. Where do I start? What colors do I use? What kind of painting do I want to make?
So, to those on this list that have taken that leap and built a business congratulations on fighting against loss aversion. As a former operator of a business, I understand how hard that can be sometimes (on a daily basis even).
When it comes to a sell-side transaction of a business, it is my opinion that Loss Aversion can show back up. An individual who has spent years, decades even, working against Loss Aversion to build a great business, is suddenly faced with Loss Aversion when it’s time to monetize their life’s work with a sale.
This is of course, COMPLETELY NORMAL. It is a natural human tendency. But that is where the right investment banker comes in. By working with an investment banker, a seller has someone in his/her corner to be their Loss Aversion Regulator. There is a myriad of circumstances that come up in a transaction, and having the right banker in your corner to determine “is this Loss Aversion warranted” can make all the difference: is this the right time to sell? The right buyer? The right deal structure? The right thing for my family, employees, city?
At RKCA, we like to get involved with clients years before a transaction is complete. Why? Because it helps us to prepare that business and its owner for sale when there is limited to no threat of Loss Aversion. In a “hurry up and sell now” scenario, the Loss Aversion is far greater. In the RKCA “Build to Sale” model, we spend years working alongside the owner and the business to think through all the scenarios of where Loss Aversion could occur and DISCUSS them with the owner. This involves asking the right questions, not being prescriptive. It’s the owners life’s work, and their decision.
Two tips from our Build to Sale Strategy on Loss Aversion:
- Framing
- Make sure you frame up each decision as a loss or a gain. It helps to shift your focus to highlight the potential gain of the decision and not the loss.
- Take it to the Extreme
- This is an exercise we’ve borrowed from behavioral market research. By asking a series of questions, we can run out the outcome to the worst possible. Usually this helps the owner put loss into perspective.
- The easy real-work example is: if I don’t send my kid to the right pre-school, they won’t learn, won’t get into college, won’t get a job, will live with me in my basement forever. Framing it that way, is that loss of selecting the “wrong” school really that accurate? No. This is a decision on pre-school, there are decades to course correct, so pick the pre-school and move on.
- This is an exercise we’ve borrowed from behavioral market research. By asking a series of questions, we can run out the outcome to the worst possible. Usually this helps the owner put loss into perspective.
Would you be interested in learning more of our Build to Sale Strategies for Loss Aversion? If so, email me: nursic@rkca.com
1. Kahneman, D., & Tversky, A. (1979). Prospect theory: An analysis of decision under risk. Econometrica, 47, 263-291.
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