Science Shows Why Broke Founders Make Stupid Decisions
Poor people make bad decisions. It’s not conjecture, it’s science.
While the goal of a disruptive startup is to make it big and cash in, reaching the ramen profitable stage is usually an accomplishment worth celebrating.
There’s also dangerous notion that entrepreneurs need to be as scrappy as possible, and founders should live below the poverty line. This is short-sighted, and potentially disastrous for your business. Cash-starved startup founders make boneheaded decisions because they can’t think straight. Literally.
The effect of financial strain impacts our IQ and the ability to make complex decisions, according to the results of a study by and published in the journal Science. When you’re distracted by money–or the lack thereof–you’re easily confused, Princeton University psychologist Eldar Shafir, and Harvard economist Sendhil Mullainathan found.
At a mall in New Jersey the research team asked people to self report their income. The researchers then asked the participants a question that triggered thoughts about their finances before presenting them with a series of puzzles. Those participants who self-reported higher incomes had less trouble completing the puzzles, than those who self-reported a poor. Performance dropped by as much as one quarter among people who were thinking about money, according to the study.
“Financial constraints capture a lot of your attention,” said Shafir. “Then there’s less bandwidth left to solve problems. Your cognitive ability starts to slow down, just like a computer.” The experiment was also conducted among sugar cane farmers in India who are paid after the harvest, and have to stretch their money for the entire year. With a very different subject population, the results were identical.
[C]onsidering a projected financial decision, such as how to pay for a car repair, affects people’s performance on unrelated spatial and reasoning tasks. Lower-income individuals performed poorly if the repairs were expensive but did fine if the cost was low, whereas higher-income individuals performed well in both conditions, as if the projected financial burden imposed no cognitive pressure. Similarly, the sugarcane farmers from Tamil Nadu performed these tasks better after harvest than before.
Most startup founders whose companies aren’t “crushing it” are living pretty lean. Deferred salaries are one way to stretch funds long enough to grow the team. And if your board has granted you a decent CEO salary, it may still be just enough to cover the basics, without factoring in things like student loans, car payments, a mortgage and other life stuff.
I would venture to guess it’s not just bootstrapped startups whose judgement suffers due to money woes. Any CEO fretting about how his or her company will hit key milestones to reach its next fundraise feels the same pressure. The pressure could even be worse when you have board to appease. VCs regularly fire underperforming founders and replace them with more experienced executives when they like the opportunity, but don’t like a company’s direction.
Suddenly the plight of the Indian farmer doesn’t seem so alien after all.