Between 2006 and 2009, I borrowed $100,000 from friends, vendors, and banks (at high interest rates) to launch what I thought would be a world-changing company.
Instead, the company died a slow, painful death whose shadow I deal with to this day.
It took me years to pay off those debts, and I had to make big personal sacrifices in my late 20s and early 30s to do so: turning down good business opportunities and lowering the living standards of my family.
For that entire three-year period, as I poured in thousands of hours, the results were mixed. I kept on doubling down, hoping that new features could make it take off.
What happened instead is that each push forward dug a deeper hole.
Ten years later, I have two consolations...
First, I learned how to avoid the sunk cost bias. This is the cognitive bias that causes us to keep investing our time, energy, and money once we've already made an investment, even if we don't get the results we anticipated. Instead of facing reality, we have a tendency to come up with rationalizations: "If only I ...."
Second, I learned that I was not alone. Everyone deals with the sunk cost bias, even the best entrepreneurs in the world. It's how we're wired. Warren Buffett, Richard Branson, and other top entrepreneurs attribute their largest business mistakes to it.
So how do you know whether you're facing a hurdle to overcome or if you just need to cut your losses? Here are seven foolproof ways to overcome the sunk cost bias in all of its guises.
1) Know The Minimum Return On Investment You Need To Keep Moving Forward
Even the seemingly infallible Warren Buffett has admitted to making mistakes and letting emotion get in the way when letting go of sunk cost biases. He estimates that one, in particular, cost him $100 billion.
In a Fortune interview, Buffett acknowledges that "the dumbest stock I ever bought was--drum roll here please--Berkshire Hathaway."
Before Berkshire Hathaway was Buffett's investment-holding company, it was a struggling textile company -- one that he aimed to use to turn a quick profit. The management did offer to buy the stock back. However, their offer was lower than what Buffett had agreed to and he took it as a slight. Instead of selling the stock back, he set on a campaign to take control of the company.
Buffett held on to the textile company for two decades. It became a heavy financial burden, even as the company merged with more successful ventures. He continued to throw good money after bad in the hopes of turning around the company's textile mills. By increasing the investment in a losing deal, Buffett fell into an escalation of commitment trap. This trap is caused by our psychological tendency to make decisions that are consistent with our past ones. This tendency is considered by some researchers to be one of the core motivators of human behavior.
Eventually, he sold the textile mills, but by then Berkshire Hathaway had become an "anchor" to the rest of his insurance investments.
"For 20 years, I fought the textile business before I gave up," Buffett says. "If, instead of putting that money into the textile business originally, we just started out with insurance, Berkshire would be worth twice as much as it is now."
Now when Buffett makes investments he sticks to analyzing their hurdle rate, or the minimum acceptable return for investment projects. The riskier the investment, the higher the expected rate of returns and the greater the hurdle rate to make the risk and return worthwhile.
For Buffett, using the hurdle rate to assess the opportunity for a project's return means he brings a 50 percent return on a $1 million investment.
2) Challenge Rationalizations
When Richard Branson began his entrepreneurial career in 1972 by opening a chain of record stores known as Virgin Megastores, he had no idea he'd have a ringside seat to the music retail industry being revolutionized just after he had conquered it.
In the early 2000s, digital music hit the scene. The need for a physical music retail store was completely negated at a time when Virgin Megastores had 287 stores globally.
"Once you could start downloading, once the iPod was available, the writing was already on the wall for music retailing. I stuck with it longer than I should have done, and it cost us a lot of money," Branson says in an interview with Joe Polish. "So, I think cutting one's losses is something which is often tough to do, but it's important to do early on."
Branson had rationalized keeping the stores because he didn't want to lose their flagship stores' presences in Times Square and on Oxford Street: he viewed these as paramount to brand recognition and as a " link with the past." Branson's rationalization reflects the psychological tendency to keep assets that have reduced value, because we regret our mistakes and don't want to admit the loss to ourselves and others.
And that leaves the rest of us with a lesson: to be aware of and challenge the rationalizations we make about why we can't afford to stop investing in the project. Rather than "chasing a dying industry" like Branson says and watching your money waste away, you should be proactive and reinvest that money in creating new jobs elsewhere.
3) Ask Yourself This Question To Keep Yourself Honest
Ultimately, staying ahead of the sunk cost bias comes down to a simple question. Dhru Purohit, partner at Dr. Hyman Enterprises and co-founder of Clean Program, a wellness regimen that tripled its sales revenue in 2014, simply asks himself:
"If I wasn't already invested in this business, would I invest in it today, knowing what I know?"
The same question works when looking at a business, a relationship, a project, or a friendship.
"The beauty of this question is that it cuts through the rationalization tactics that our mind uses to deal with our fear of loss," Purohit says.
"It's too easy to think, "But we've been together for four years... But I've already put in so much money into this project... But I've spent so much time working on it..." Purohit says. "And sometimes we're so scared of losing something, or admitting that it isn't working, that it's easier to pretend that it isn't an issue than it is to deal with it."
This mistake just prolongs the inevitable pain of having to make a decision. You will also lose time, and it will be even more difficult to turn things around when you are finally forced to examine the problem, he says.
Letting go is never easy, Purohit acknowledges. But holding onto something primarily because you're afraid of losing it is never a good answer.
4) Reevaluate The ROI Of Standing Meetings And Other Employee Habits
Most entrepreneurs are good at evaluating the return on investment (ROI) of large financial investments. However, they're terrible at evaluating the ROI of their employees' smaller activities on a day-to-day basis.
Employees are often an entrepreneur's biggest investment. Yet, we rarely analyze their performance on individual tasks and see if they produce the optimal ROI, says Cameron Herold, author of Double Double and a CEO coach to high-growth businesses.
Take, for example, the standing meeting you have had every week for the last six months. Perhaps there are some team members who no longer need to be there. Or instead of an hour long, it could be 30 minutes long. The unexamined habit may be wasting resources that could be better spent somewhere else, Herold explains.
"We often just say, 'Well, we'll just keep doing it.' Instead, we need to get better at saying, 'We have other resources we want you to work on,' or 'I value your expertise being used somewhere else."
Herold recommends calculating people's hourly cost from their yearly salary and using that to determine the real cost of how people spend their time. For example, if you ask seven people to attend a weekly meeting who all make $50 an hour, that one-hour meeting costs the company $350. In a year, the company has now spent more than $18,000.
"I think we often just get sloppy. That can be equally as dangerous as throwing a lot of money at something," he concludes. "Instead, you need to think every day, or every week, what return do I want to get on these people? What return do I want to get on my time? What return do I want to get on my money?"
5) When The Results Are Mixed, Remove Obstacles That Obscure The Truth
You spend a lot of time courting a new client. They seem interested and you're excited too. So, you spend still more time creating a fancy proposal. Suddenly, they fall off the face of the planet. One follow up. Two follow ups. Do you go for three?
Dorie Clark, CEO of Clark Strategic Communications found herself in just such a conundrum.
"Once I submitted the proposal--which I'd spent at least a full business day or two working on--I heard nothing. No response whatsoever," Clark explains in an interview with me. "I was getting good signals initially that they were interested in the project, so I felt fine investing the time upfront."
Ultimately, the client never responded. Clark took it as a lesson and has come up with an approach that has worked in similar situations.
"It is definitely easier for prospects to just dodge you or blow you off, rather than explain in a mature manner why they don't want to pursue things further," Clark says. She likens it to how people don't like declining an invitation to a party they know they can't attend. They don't want to take responsibility or commit to an answer--especially if it's a negative one, she says.
The best course of action is to have a direct approach that shines a spotlight on the truth, Clark advises. If you haven't heard from the prospect in a while, Clark recommends reaching out and saying something along the lines of: "I wanted to check in on the status of the proposal. If you have questions or would like to move forward, I'd love to set that up. If it looks like it won't be a fit, I understand and would appreciate hearing more, for my future reference, about what pieces didn't work for you."
This way, they understand that talking to you won't subject them to a 'hard sell' that they're looking to avoid, and you might get a more honest response.
6) Keep Learning Your Market (Even If You Know It Well)
"Sometimes you know a market so well, you forget to step back and see the larger picture. The market may be changing direction under your feet, but you don't even realize it," says Jason Duff, founder and CEO of multimillion dollar company COMSTOR Outdoor.
Among the tenants in the buildings he owns are gyms, restaurants, manufactures, banks, retail stores and malls. He rightfully considers himself attuned to the local business community.
But when a local manufacturer in one of his buildings relocated out of state, he learned he might be more attached to his vision for his investment than he was attuned to the reality of the market.
Duff could not find another manufacturer to take its place and rent it for a similar price. After it sat vacant for a year, he finally came to terms with the fact his assumption was false.
When he dug into the root cause, he discovered that the community was moving away from manufacturing to service based industries, he says.
"I've lived in this community for my whole life. I feel like I know it like the back of my hand, and that was my mistake," Duff says. "Because of my overconfidence and of having invested in the building with the idea that I was going to get a certain return, it took me a while to come to terms with the fact that I was blinding myself to the situation at hand."
"The financial cost was actually the least expensive part; it's the mental energy and loss of confidence that takes the biggest toll," Duff says.
To protect himself from future biases along these lines, Duff has made changes to the way he keeps his pulse on the community.
"Today, we use Facebook to understand where the demand is before we even open the space to potential tenants," Duff says. For example, the company's Facebook page, Mainstreet Marketplace Mall, shares a before/after picture of a proposed building makeover and asks for direct feedback.
In general, sometimes the only way to remove ourselves from a bias is to get an outside perspective from someone who does not have the burden of a sunk cost.
7) When There Is A Large, Sudden Change In Your Market, Do An Honest Reevaluation
Early in his career Rohit Anabheri, founder of the firm Circa Ventures ($10M+ revenue), was setting up to export a pharmaceutical drug to Uganda. All told, the company invested a total of $1.5 million to export the drug, and one year later it fell apart.
"When we started--there was a huge demand for the pharmaceutical drug. But then six months later, the Ugandan government began offering incentives for local investors to start a pharmaceutical plant in the country," Anabheri says.
Despite his awareness of the changes in the country's political and business landscape at that time, Anabheri took a year and four months to finally decide to pull the plug on his venture. They simply couldn't compete with the price offered by local manufacturers. The delay in his decision cost his company $700,000.
Now Anabheri reminds himself to be proactive in analyzing the political and business landscape and to react accordingly, even if it means facing a harsh reality. He asks himself: "Okay, what truly makes sense for our business as a result of this change?" And he answers himself without fearing it may mean a big change.
Given that Warren Buffett alone feels he lost $100 billion as a result of the sunk cost bias, it's reasonable to say that businesses have cumulatively lost trillions of dollars to it over the years.
It's caused entrepreneurs to lose their life savings. It's bankrupted huge companies and resulted in the loss of thousands of jobs.
We should not underestimate its importance or how difficult it is to solve.
Awareness of the subconscious bias is just the first step.
But, it is not enough. Nobel Laureate Daniel Kahneman finds little evidence that being aware of biases actually increases decision making at an individual or organizational level in the real world.
How are you going to combat the sunk cost bias?
Billionaire and longtime Warren Buffett's partner, Charlie Munger, has spent much of his 70-year career thinking of answers to this exact question.
Special thanks to Rachel Zohn, Sheena Lindahl, Austin Epperson and Ian Chew who volunteered their time to edit this article and do research.
Also thank you to Jessica Newfield, Rachel Mathis, Krystal See, Shizuka Ebata, Antonia Donato, Luke Murray, Jeehan Jawed, and Mustafa Nalwala for reviewing the article and providing insightful feedback.
Disclosure: Some of the contributors featured in this article are members of Seminal, a selective council that distills research-backed, actionable insights from world-class entrepreneurs and leaders.