Affordable loss

Stuart Read et al. explain the affordable loss principle crystal clear in their book Effectual Entrepreneurship: "Starting up a business is in fact an investment decision. One commonly used tool to make investment decisions is NPV (Net Present Value). While NPV is undoubtedly a useful decision making tool in many situations, because of its sensitivity to uncertainty, you have to be careful how you use it in entrepreneurial situations. Expert entrepreneurs favor thinking through the plunge into a new venture using an affordable loss approach, rather than NPV. Fundamentally, affordable loss is based on things they know and can control, whereas NPV is based on predictions they don't trust and can't control. Expert entrepreneurs make decisions based on what downside risk they find acceptable rather than on what they guess the upsides might be. So instead of calculating up front how much money they will need to launch their project and investing time, effort and energy in raising that money, the effectual entrepreneur tries to estimate the downside and examines what s/he is willing to lose."

The affordable loss principle is thus about reasoning from your life situation, your current commitments, your aspirations and your risk propensity. It is helpful to think of affordable loss as a two-step process. The first step is to ask how much you really need to start your business. Getting creative about different ways of bringing your idea to market using all the means that are available to you and reducing the means you need to launch the venture are key. The second step is to ask what you are really able and willing to lose to start your business. This means actually to think through your available resources and your risk preferences. What can you afford to lose? Well, People tend to mentally account for resources in different ways by putting them into different categories: time, savings, home equity they possess, credit card accounts, loans from family and friends, and so on. Essentially the sum of these is what you have in your hands; they are partly your means. The next thing to decide on is how much of your available resources you are willing to lose. The outcome will be what you can and want to spend on the start-up.

The key take-away of this principle is this: Managing risk like a seasoned entrepreneur means making decisions based on acceptable downside risk rather than on guesses about upside potential for which you don't have the resources. Reasoning through the plunge decision using affordable loss reduces the perceived barriers to starting your business, and helps you see how to get started right now while still managing your risk. Starting a business doesn't have to be over whether the upside is big enough, but whether the downside is life threatening.

Bootstrapping

This principle is also where bootstrapping comes in: bootstrapping means trying to start a business with a minimum of resources, mostly your own, and trying to grow your business with the generated cash-flows while keeping expenses at a minimum.

• Within this context, reading The bootstrapper's bible by Seth Godin will help you a lot. Download this free summary from changethis.com
• "Bootstrap Finance: The Art of Start-Ups" by Amar Bhide is a spot on Harvard Business review article on why bootsrapping is important,
• A Short story on afforable loss in practice