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Opportunity cost when starting a business

I was talking to a friend last night about what I’m currently doing with my life, and discussing whether either of us fancied starting a new business in the teeth of the recession.

He told me – not for the first time – that he was getting itchy feet, and that he felt in a secure enough position to think about starting a business of his own.

I told him I’d love to talk through his plans and help out in any way I could.

But I also suggested, as tactfully as I could, that I thought he was far less likely to start his own company now than when we’d had such discussions in our late 20s.

What’s more, I think there’s no shame in that.

My friend has no kids, and his mortgage is largely paid down, with his girlfriend able to cover the remaining monthly down payments if required. So he doesn’t have the usual dependents excuse that hampers older entrepreneurs.

Yet I still think it will be harder for him to decide to go it alone today.

The reason is opportunity costa common enough term in business, but something that’s rarely considered in even the best books for entrepreneurs.

What are you risking?

My friend is a corporate man through and through. You almost certainly use the products of the company he works for, and after ten years he’s reached a very cozy position where he’s more worried about getting bored than getting bawled at by his boss or being made redundant.

He’s also well rewarded. I have a ballpark idea of his salary, and I know he’s been benefiting from share-based incentive schemes for years.

In short, he has it pretty good.

In contrast, as I wrote recently I’m back where I was five years ago in terms of my income, after a breakeven outing co-founding a new business in 2005.

My start-up experiences also informed my article I wrote on the risks of starting your own business.

As that article hopefully makes clear, I’m pretty level-headed about the chances of success when starting up a new business. (In case you’ve not been following, the chances are low!)

However, while I have no plans to start a business again right now, I think it would actually be a better time for me to do it than it was back in 2005.

I’m not talking here about the experiences I learned the first time, or the contacts I made, though both would be valuable and would help if I did it again.

Rather, I mean I’ve now got much less to lose. It would therefore be an easier decision, and I’d be less plagued by thoughts of what I’d given up.

Opportunity may knock, but it also costs

As 2005 ended I’d just negotiated a great new contract with my main client that meant I was set to earn more than ever before.

This particular gig came with a performance related bonus that added nearly 20% to my income, and which I’d never failed to hit.

Combined with my earnings from elsewhere, it meant 2006 was looking pretty sweet.

However I wasn’t really satisfied. Partly, I felt I’d been doing the same sort of thing for too long, and that trying out a start-up was an itch I had to scratch.

Equally important though was that I was constantly getting approached for new jobs.

It was a great time to work in my area, and I know for a fact I could have increased my income by 50-100%, although I would have had to go full-time to do so. (I’m currently self-employed as a freelancer and consultant).

Perhaps buoyed up by the good times, I decided to try the start-up route.

I don’t regret it, but it decimated my income for two years, soaked up a load of capital that I got by selling down my equities which I only eventually got back at around the value I put in (this when the stock market was booming) – and it left me so emotionally and even physically drained that it took several months for me to get my feet back on the ground.

My situation today is very different, however.

My income never fully recovered after I left the start-up, and then the recession kicked in and started taking out clients, freelance projects, and the jobs’ of friends.

Today I get no bonus-related work, and since Christmas and a further lurch down, only a couple of my gigs represent more than a few day’s work at a time.

As a result, I have to push to make sure I’ve got enough work and money coming in each month – and that monthly amount is meaningfully less than I was earning back in 2005.

When you’ve got nothing, you’ve got nothing to lose

This is why I think now would be psychologically speaking an easier time for me to start a business.

My opportunity cost is lower. The opportunity for me to make money elsewhere, or to develop my career in an interesting fashion, is much less clear than four years ago. I don’t see this changing until the recession abates.

Therefore risking capital and forgoing income for an uncertain project is an easier equation to balance – with less capital and income on the left hand side, the pay-off on the right doesn’t need to be so much.

Now compare that to my friend. He’s approaching a six-figure salary (that’s in UK pounds, so say $150,000), has a wheelbarrow load of incentives and benefits with his name on them, enjoys lots of respect and admiration at work, and, metaphorically speaking, plays golf with his boss.

All of that is worth a lot in the corporate world – and would certainly be part of the negotiations with a potential new employer if he looked to swap full-time jobs.

But none of it translates into start-up success.

My friend would start as the same position as me or any other new entrepreneur, which is to say the first rung of the ladder.

Quite simply, I think the opportunity cost for my friend is just too great. He has too much to lose. If he asked me for my thoughts, I’d tell him to stay where he is, unless he came to me with a truly brilliant idea that I could see he just had to try for his own peace of mind.

This article is certain to annoy any of the entrepreneurial pundits across the Web who read it, particularly in the U.S. where the mantra of endless positivity excludes rationale thought (and utterly ignores survivorship bias).

But I think my point is simple enough.

Don’t pretend giving up a lowly-paid job with no security is the same as leaving comfy corporate life. It’s not.

The opportunity cost of the latter is much greater, and the corporate folk who recognize that and decide to stay where they are and enjoy the benefits aren’t timid and lazy. They’re just able to do the maths.

Of course, I’d suggest they live within their means, save hard and invest wisely so that work is optional altogether. But that’s a different article!

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{ 3 comments… add one }
  • 1 Shannon From New Zealand January 27, 2010, 2:29 am

    First time on this site, first post i’ve read, and I am very impressed and intriqued by the quality of posts on this site, I myself am soon embarking on the big wide world once I have finished my year 13 studies, this most certainly brings things into perspective.
    If you’ve got nothing or next to nothing to lose, than clearly you are more likely to give up the little you have taking the risk that some new business venture may take off, but if your set in your ways and don’t need to bring risk into your life no matter how sure you are of success, there’s no point in changing a seemingly uncomplicated life with the worries of starting your own business in this economic climate.
    Last year, I was offered a decent electrical training job, as it is my second passion next to economics, but I declined in order to remain in my studies, now with the recession it is extremely unlikely I would be able to get that job without 50 other applicants pushing the door down, I chose studying over a job, which would of lead me to financial security, so the opportunity cost was the job, of which is now alot harder to get.
    I would like to make the point that education is ultimately what is important here, that along with life experience will one day lead those to have it in them, to deal with the hassles of their own business, and will stand a much greater chance of success due to learning from lifes mistakes, times are tough, anyone going into business now has a much bigger chance of losing out than before.
    I live in a country where debt is mounting, welfare is rising and even though we are officially out of the recession 4500 people showed up for interviews for 160 jobs in our biggest city, alot of them had degree’s and were simply desperate for work, is such a shame, and on a quick departing note, age also needs to be seriously taken into account as mentioned in this great article, those of in the 40-60 age bracket have much more to lose starting a business if they have left a secure job, as it’s tough getting re-hired if things turn pear shaped, this is a disappointing truth in a ruthless world, a company will choose a young hot-shot straight out of University over a person 30 years in the business, as they have more years to offer to the company, I think that this is a large scale problem which leads to the downfall and demise of many great business men and women, I only hope once out of this recession, I will be able to make the most of my opportunities in life, I’ve got the years to do it, abit of common sense and some good mentoring advice from articles like these, hopefully I can’t go wrong.

    Regards

    Shannon

  • 2 The Investor January 28, 2010, 10:29 am

    @Shannon – Thanks for stopping by and sharing your thoughts so extensively. Good luck with your dreams!

  • 3 Paul March 14, 2014, 3:17 pm

    Good article… I think guys in this situation (I am one of those) have another avenue to leave the corporate life… it’s called LBO. They can just buy a business on their own, which greatly reduces the risk as they are effectively buying a business idea that already works, and generates cashflow. The game here is just to make it better, bigger etc…

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