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Affordable loss Principle

You should only invest as much as you are willing to lose.

Affordable loss is about not risking more than you can afford. To be successful and not end up homeless is about taking calculated risks. Effectuation theory tells you not to focus on the upside but on the downside, focus on what is your maximum loss. What you can lose and what you can get out. Affordable loss is guided by the following: Your time, your effort and your money that you can afford to lose.

The time
This is the amount of time that you can afford to lose by investing it in your startup. If you work and run your startup after work, then that time you are giving up is your affordable loss. Time can be just as important as money because if you have a family, the time with them is what you are sacrificing by spending it on your startup.

The effort
All the effort you are putting in your startup or small business is effort that was taken away from somewhere else, if you were spending your time watching TV then your affordable loss isn’t very high but if you were spending it more productively like studying, the effort you put into your business is worth more.

The money
If you saved up some money that is your affordable loss. If you put your family home up for collateral to fund a startup that is not an affordable loss as if you lose your property will get sold and your family will end up on the street. Now many people have made a lot of money by doing just that, but many more have ended up bankrupt. South Africa is not a country to have an “all-or-nothing” mentality and risk everything, there is a greater chance you will end up with nothing. In South Africa you have a macro environment: government, trade unions and even workers who are openly hostile to business. It is one of the most difficult places to do business with onerous regulation and high taxes. You are very likely to lose your shirt.

If you want to be successful, you need to think on those terms. What could you lose and still come out in a position where you can start again. It doesn’t help you if you were to lose the roof over your head, that will be very hard to start again from.

From the beginning to the end you need to know what you will lose and where you will end up. Yes, you can change your course (lemonade principle) but still stay within the affordable loss. If you lose what you considered your affordable loss, then you lose it and exit. You have designed your exit plan from the beginning.

The affordable loss is similar to a “stop loss” in trading which means that you will only take on a loss till a certain limit. The same thing applies in business, as a startup you need to know this is how much money you will lose, your time and your effort till a certain limit.

Make planning for failure part of your business planning, it does not have to be on your business plan, but you need to be able to say, this is my affordable loss and this is the end. Have an affordable loss, a stop loss from day one. This is what you are able to lose and nothing more. And that is how you will ultimately succeed. You cannot just have an open ended loss; if you fail you need to be able to be in a position to bounce back. It does not help you if you lose your house (money) which will make it harder to start again and it also does not help if your wife leaves you (time, effort) because you were too busy with your startup. If you retain both, you can restart easily again, a roof over your head to work from and your wife for support and even to sustain the household.

With startups it is impossible to predict the future and make accurate predictions, something that can be done with a medium or large business with a history of trading. What you think will happen in a small business often doesn’t. The best way forward is to understand affordable loss.

 

Watch the video below from the 9 minute mark to the 16 minute mark to see the need for an affordable loss: