You should not be surprised if dealing with the money side of your business stirs strong emotions. You should not be surprised if human psychology plays a huge role in not only your approach to business numbers, but also the attitude and actions of potential funders.
Two things reminded me today of the emotional connection to money and numbers.
First, someone close to me is again in personal financial trouble. My perception is that spending and credit have deep rooted, long term psychological issues associated with them. I’m no psychologist so I won’t overanalyze, but it seems like spending is a “feel good” and credit is the path to feeling really good through spending.
Second, I clicked a link to a Youtube video discussion of business metrics as part of Y Combinator’s startup school. At one point the discussion turned to the emotional and psychological attitude towards business metrics. They can be painful if the truth revealed by metrics isn’t pretty. They can challenge a leader’s ability to motivate their team through painting a rosy picture of the future.
These two events stirred up lots of personal memories. Money was interwoven with my parents’ psychological struggles. My own financial aspirations were deeply and complexly psychological and emotional. Most of the poor business choices I made in my a cappella music business (and there were plenty) were more about psychology than financial analysis.
When it comes to business money issues, emotions and psychology matter a lot!
As personal catharsis, and hopefully help to you, I’ve compiled the following litany of ways that business finances and financing are influenced by emotions and human psychology, and vice versa. My hope is that you will recognize some of these, as a first step towards removing or managing emotional and psychological factors in your business financial decisionmaking.
Financial health = Self worth – certainly in American society financial success is deeply tied to perceptions of self worth. That can lead to both positive and negative behaviors including motivation to get better financially, and depression induced by poor financials.
Financing Validation = Personal Validation – many entrepreneurs tie their self-image to their business. That may lead business owners to seek financing (especially equity financing) as a means to validate themselves and their ideas. That can happen even when financing is not the right financial step!
Ego spending – there are numerous opportunities to spend unwisely because the product or service makes you feel superior. I definitely had a period of ego spending which fortunately I stopped before it wiped me out financially.
Hard choice avoidance – when you kind of know there are hard choices to make or hard conversations to have, it’s psychologically easier for lots of people (including me, especially when I was younger) to avoid the conversation. Let the bills pile up. Don’t reconcile the bank statement. For goodness sakes don’t analyze your numbers. There are likely hard choices lurking. That’s avoidance psychology.
Like me – Most people want to be liked. That can lead to the above hard discussion avoidance. But, it also can affect your ability to get financing. As in sales, likability has a huge influence on whether or not you secure financing from angels, venture capital firms and banks. It isn’t just about your numbers!
Fear of math – Poor math teachers can psychologically scar students for life by making them believe they are “not good at math.” If you suffer from poor math self worth, know that you are not alone. And, there are now great free resources to help, if you’re willing to put in the work. Visit Khan Academy and conquer your fear of math!
Fear of debt – The Great Recession drove mortgage foreclosures and bankruptcies to fear inducing levels. And there are many people in the US still burdened by overwhelming student loans, credit card debt, and medical expense debt. Fear of debt emerged as the psychological backlash, and blinds about 13% of small businesses to potential prudent use of debt to finance business growth.
Fear of vulture capitalists – The large, diverse and sometimes lightly regulated US capital markets include both trustworthy funders and unscrupulous opportunists – and plenty in between those extremes. Fear of the unknown can lead to irrational fear of all equity funders. As with pretty much everything in the world of finance, doing a bit of homework will help distinguish the trustworthy from the unscrupulous.
Trust – much of human society depends on trust. Business financing is no different. Some people are challenged to trust anyone; others are far too trusting. Both psychological paths can lead to financial and financing problems. Generally I was too trusting when I was younger. As a consequence an in-house bookkeeper padded her own salary, and I paid too much too long for employees who were not delivering. I’ve grown fond of the Russian proverb popularized by President Ronald Reagan, “trust but verify.”
Jealousy, Envy – when you learn about the positive financial or financing results of others, are you jealous or envious?
Surprise – while some people like surprises, investors and bankers don’t. Regular financial reporting will eliminate most unwanted surprises, and a good line of communications should be used to tell financial stakeholders soon if undesirable financial results surprise you and your team.
Boredom – do you get bored when your accountant tries to explain your numbers to you?
Cognitive bias – the human brain didn’t evolve to be great at business financing… or many other modern activities for that matter! Instead, we have numerous cognitive biases (I love this Wikipedia list of cognitive biases) that can trip us up and keep us from making the most rational choices about financials and financing. These include:
- Anchoring is the tendency to weight too heavily certain pieces of information in our decisions. This bias is frequently exploited in marketing, For example, loans anchor expectations by highlighting low interest teaser rates that mask expensive fees.
- Availability heuristic is the tendency to overestimate the likelihood of something happening that we’ve heard or read or seen about a lot recently. For example, reading lots of stories about venture capital financing might make you think it’s more likely than it actually is.
- Bandwagon effect is the tendency to do things because other people are doing them. Just because lots of other businesses finance their operations a certain way doesn’t mean it’s right for you!
- Confirmation bias is the tendency to filter information in a way that confirms your own preconceptions. This can impact the way you analyze your own financial information as well as the way you think about financing options. Instead, you need to be open to what the numbers tell you!
- Dunning-Kruger effect – paradoxically the unskilled tend to overestimate their own abilities (for example, assessing your business’ financial health?) and experts tend to underestimate.
- Framing effect – entirely different conclusions or decisions can be made depending on how the same information is framed or presented. There are many ways to present numbers, so be careful not to jump to conclusions!
- Hyperbolic discounting – people tend to prefer immediate gratification to future gratification, which can distort choices and make those decisions inconsistent over time. It’s hard to make long term financial plans!
- Illusion of control – people overestimate how much they actually control or influence external events. For example, many entrepreneurs overestimate how much they can impact the decision making process of funders.
- Illusory correlation – it’s not unusual for people to see a relationship or a cause and effect connection between two unrelated events. This can significantly impact your ability to really understand why your cash flow isn’t as good as you would like.
- Insensitivity to sample size is specifically a tendency to think small sample sizes – that is, a small number of the same thing going on – ought to be more consistent. In fact averages and consistencies only emerge with many examples of the same thing. This might impact, for example, the way you think about average customer orders.
- Loss aversion is a well documented tendency to have much stronger negative feelings about losing an object you already have than the positive feelings you get from acquiring the same object. This can lead to the “sunk cost effect,” in which you don’t want to give up on something you’ve spent lots of money on in the past, even though the rational choice is to let it go.
- Money illusion is a tendency for people to focus on the face value of money rather than what it can buy. This can impact both investors’ and employees’ attitudes towards the price per share of stock, as the most important issue is really how much of the company it represents, not the price per share.
- Optimism bias afflicts many if not most entrepreneurs; we tend to be too rosy in our projections of the future, which can show up in financial projections among other places.
- Ostrich effect is a tendency to ignore an obviously negative situation, such as overdue bills or diminishing cash in the bank.
- Overconfidence effect is the inclination to think our answers to questions are far more likely to be correct than we ought to believe rationally. If someone asks you what your gross margins are and you don’t have good financial reporting, might you be overconfident in your answer?
- Planning fallacy is a variation on optimism: people tend to think tasks will be completed sooner (and for less expense) than they usually take.
- Post–purchase rationalization is a tendency to justify the decision making process of something that has been purchased in order to convince yourself it was a good value.
- Survivorship bias shows up in many press accounts of financings and financial success. We tend to focus on those who have survived or succeeded, and forget about all those who didn’t. In the process we may think that, for example, equity financing is easier than it is, and it’s more positive in its impact than it is.
- Zero-risk bias is an interesting tendency of people to prefer reducing a small risk all the way to zero, rather than making a much bigger risk significantly smaller even though some risk still remains. This is not a rational way to manage financial risks!
Wow, that’s a long list! Did we miss anything? Which of these emotions or psychological twists are issues for you? And, what are you going to do about it?