Entrepreneurs Should Watch Out for Cognitive Biases and the Curse of Knowledge Understanding the tricks that the mind plays on you is essential in business.

Entrepreneurs face many external challenges in their work, but some of the most treacherous obstacles they may encounter are the tricks played on them by their own minds. The tricks I am referring to are known as cognitive biases. Cognitive biases are mischievous mental gremlins that sabotage our ability to collect the right information, assess it properly and make good decisions.

While cognitive biases ceaselessly affect every facet of one's life, they have an especially detrimental effect on entrepreneurs' probability of success. Entrepreneurs are particularly susceptible, since they are constantly engaged in a high-wire act while juggling many tasks and issues, and any misstep could lead to the downfall of the start-ups they are running. Therefore it is vital for entrepreneurs to be aware of these biases and deal with them resolutely.

While the term cognitive bias has a negative connotation and many negative consequences, cognitive biases do have some heuristic benefits in human lives. Like rules of thumb and educated guesses, they allow humans to make quick decisions in situations of danger or stress when the brain, for efficiency reasons, needs to skip being methodical and reach conclusions quickly. However, this is largely an evolutionary holdover: Now that we are on top of the food chain and rarely need to assume fight or flight reflexes, the reality is that cognitive biases cause significantly more harm than good.

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The purpose of this article is to alert current and future entrepreneurs to the dangers of cognitive biases, so they do not end up finding themselves like the man depicted in a New Yorker cartoon saying to a friend: "I tried being an entrepreneur but found out that the "fire in my belly' was just acid reflux."

The first and most crucial step in fighting the destructive impact of cognitive biases is to be aware of their existence. Although there are over 100 various biases, this article will tackle the two that are most hazardous to the entrepreneurial process.

Confirmation bias

Confirmation bias is defined as the tendency to search for and interpret information in a way that confirms one's own existing preconceptions, beliefs and opinions. We want the external world that we interact with to be congruent with our thoughts, opinions and notions. Any information -- or interpretation of information -- that contradicts our beliefs, views or pre-conceived notions creates dissonance in our minds that leads to mental discomfort. We are programmed to reduce, or if possible, eliminate this mental discomfort, which is where the confirmation bias comes in.

A very basic example of confirmation bias in daily life, in which people look for information that supports their existing notions and views, is the preference of conservatives to watch Fox News and of liberals to watch MSNBC. A more profound example of confirmation bias, which has life-and-death implications, can be found in the world of medical diagnosis. Physicians are known to be prone to confirmation bias when diagnosing patients. After a few short minutes of Q&A with a patient, the physician may reflexively form an opinion of what the diagnosis is, and from that point onward, her questions -- and interpretation of the answers -- will be geared towards confirming her diagnosis. Even Dr. House and his team of ace diagnosticians may claim at times that something is likely wrong with the MRI machine when the image it has generated does not support their current diagnosis.

In the world of entrepreneurship and startups, being subject to the influence of confirmation bias may be equated to driving a car with one eye covered. You see some of what's ahead of you -- but the full picture and depth perspective are lost. Entrepreneurs, generally known to be highly driven people, are intensely focused on their goal and therefore may be extra vulnerable to the destructive effect of confirmation bias

The various areas in which entrepreneurs are susceptible to the confirmation bias include: 1) identifying who the real competitors of the start-up are, 2) methodically and rigorously analyzing what the competition is doing and how it may affect the start-up, 3) understanding what the company's current and prospective customers need and want (it is usually not what one originally thinks), and 4) estimating the resources needed by the company to achieve its stated goals.

In all of the above cases the entrepreneur who is susceptible to the confirmation bias will look for information and analyze it in a way that will yield: 1) fewer competitors rather than more, because it increases the viability of the start-up, 2) underestimation of the capabilities of the competition because stronger competitors will make life harder for the entrepreneur, 3) view of the company's product as fully addressing the needs of the customer because otherwise the start-up is at a weaker position in the marketplace, and 4) need for less resources rather than more because it generally makes raising the money easier.

All of the above misinterpretations of the market are constructed in order to minimize the gap between the entrepreneur's preconceptions about his startup and its relation with the marketplace, and his understanding of reality based on information he collected and analyzed for the purpose of reducing the mental dissonance in the mind. The entrepreneur needs to be aware of the danger of operating under the influence of confirmation bias and devise ways to mitigate the negative effects of that bias.

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The first step in fighting confirmation bias is for the entrepreneur to constantly remind herself of the existence of the bias whenever information is collected, evaluated and interpreted. Such reminders will likely encourage the entrepreneur to act in a less biased way in performing her job.

The second useful tool for fighting Confirmation Bias in the world of a fledgling startup is the creation of a culture of openness, directness and constructive adversarial interaction. Startup team members who productively challenge the prevailing way of thinking in the company should be lauded and possibly rewarded in a public way.

Another way to circumvent confirmation bias is to engage an advisor or mentor to be a no-man (the antidote to a yes-man) whose role is to argue the opposite of what the entrepreneur thinks or believes and to actively look for, and expose, the downside of everything the entrepreneur wishes to do.

Curse of knowledge

The curse of knowledge cognitive bias causes a better-informed person to find it difficult to look at a situation from the point of view of a lesser-informed person. This bias was demonstrated in an experiment at Stanford University in which a group of students was asked to guess the songs tapped by others on a table. The "tappers" expected that about 50 percent of the students will correctly identify the song just tapped. In reality, only 2.5 percent of the listening students identified the correct song. Knowing the song they are tapping, the tappers could not "unknow" it, and therefore could not put themselves in the shoes of those who just heard the tapped rhythm.

One of the areas in which the curse of knowledge may affect the entrepreneur is the pricing of a startups product or service. The entrepreneur knows her product or service better than anyone and may evaluate its advantages and disadvantages differently from the user who is less-informed and will assess its value differently.

The remedy for this is the tried-and-true direct dialogue with the prospective customers either through focus groups with individual consumers or face-to-face meetings with users and purchasing managers within corporate or institutional entities. These interactions allow the entrepreneur to bypass her knowledge about the product or service she is trying to sell, focus on the knowledge of her prospective customers and by that avoid the curse of knowledge when making pricing decisions.

Another example of the potential negative effect of the curse of knowledge on the entrepreneur and her startup is the negotiations for an investment from a venture capitalist (VC). Let's consider the scenario in which negotiations take place with only one VC firm and the startup does not have any other funding options. The entrepreneur knows it but the VC does not. The VC may be thinking that if he does not offer an attractive term sheet to the startup, he will likely lose the deal to a competitor. The entrepreneur thinks that if she is too aggressive with her requirements in the term sheet, she may lose the only funding option currently available to her start-up.

It is very difficult, if not impossible, for the entrepreneur to ignore her knowledge of the criticality of this deal to her startup and see the deal from the VC's viewpoint. This may lead the entrepreneur to negotiate from a mental position of weakness and may result in getting a less attractive deal from the VC than could possibly be available to her. Understanding the negative effect of the curse of knowledge in this context should definitely lead the entrepreneur to make an extra effort to obtain more than one term sheet for funding her startup.

Being an entrepreneur is a risky endeavor and requires many factors to be aligned properly. Startups are often correctly compared to babies in that both are fun to conceive but hell to deliver. The entrepreneur needs to mitigate as many of the hurdles in front of her as possible in order to make her startup a success and cannot afford to be a victim of her own predispositions.

I encourage entrepreneurs and other readers to explore the many cognitive biases that affect their lives in various ways, and find effective tools to mitigate the negative effects of those biases.

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