10 April 2023
Startups and Investing

Escalating Commitment to a Losing Strategy - Why Founders Refuse to Quit

As a startup founder, shutting down your business will be one of the hardest decisions you'll ever have to make. However sometimes it's also the smartest option. Especially if you're able to close things down gracefully, give folks a good severance package and potentially return some unused funds to investors; not to mention gaining back some valuable time. Unfortunately, many entrepreneurs refuse to admit defeat and keep pouring resources into a failing endeavour. The tendency for people to double down in the face of growing negative evidence is known in behavioural psychology as "escalating commitment to a losing strategy". In this short article I highlight a few of the common cognitive biases that help make this happen.

Why Startup Founders May Not See the Writing on the Wall

There are several reasons why startup founders struggle to see when things things are heading in the wrong direction. For one, being a successful founder requires a strong belief in one's vision and the ability to ignore setbacks and naysayers. You wouldn't be here today if you'd have listened to everybody telling you to give up, so you've been trained and socialised to filter out negative signals. Additionally, social proof from sophisticated investors can give founders extra confidence that they are on the right track. Optimism bias, which makes people believe that they will be the exception to the rule, can also contribute to this phenomenon. Finally, the endowment effect can make founders believe that their product is worth more than it actually is, leading them to hold onto an idea for longer than is workable.

Why Founders Continue to Plow Forward Despite Setbacks

Once things start to go wrong, founders may continue to plow forward for a variety of reasons. Sunk cost fallacy—the tendency to keep investing in a losing venture because of the resources already invested—can make it difficult for founders to pull the plug. Promises made to staff and investors can also create pressure to keep going, as can pressure from investors who want to see a return on their investment. While getting some of their stake back might be important to angel investors, institutional investors might have already discounted the investment—so it's in their interest for you to keep plugging on in the chance you might be able to pull something off at the last minute. Finally, media stories of successful startups turning things around at the last minute can create a false sense of hope that things are likely to get better. Even if we're aware of the dangers of survivor bias, society tells us that it's noble to keep going to the very end, like the Captain going down with their ship.

Challenges of Letting Go and Shutting Down

Even when it becomes clear to others that the party is over, founders may continue to hold on for longer than is sensible. One reason is that the people around you don't want to upset you—especially if their job or relationship might suffer as a consequence—so they'll couch their feedback in softer terms. As such the founder is often the last one to realise things are coming to an end. This can be exacerbated by the concept of "motivated reasoning," where we effectively come up with the rational that most benefit us.

Even once we've seen the writing on the wall, there's a tendency to want to hold off for as long as possible. This is often due to a sense of identity and purpose that is tied to being a founder, as well as the social stigma attached to failure. Additionally, making the decision to shut down can be difficult and emotionally fraught, especially when it means letting go of employees and facing the uncertainty of what comes next. As such, keeping going until you run out of money means that the decision gets made for you. This is a great way to subconsciously protect one's ego and externalise fault. We didn't fail. We just ran out of money. If we'd just been able to raise another round, things would have been different.

The Importance of Overcoming Cognitive Biases and Cutting Losses Early

The phenomenon of escalating commitment to a losing strategy is a real and significant problem for startup founders. Overcoming cognitive biases and recognising when it is time to cut one's losses and move on is a difficult but essential task for those in the startup world. By acknowledging the signs of failure and making the decision to shut down early, founders can minimise the damage to themselves, their employees, and their investors, and move on to new and better ventures.