In the process of searching for a self-sustaining and successful business model, success is not only uncertain, but is likely to involve both small successes and failures. Knowing how much money, time or other resources that one is willing to invest in this process does not take away the uncertainty, but it ensures that the impact of this uncertainty is managed. The affordable loss principle is what turns entrepreneurs from reckless risk seekers into smart risk managers.

The affordable loss principle forces people to only choose resources that are cheap or for free. The difference between managers and entrepreneurs is that managers have budgets, while entrepreneurs don’t. Since entrepreneurs don’t have any resources, they cannot spend it, and so they have to manage all their decisions in a way that they do not spend or lose any money. This is precisely the reason why entrepreneurs always look for investors, so that the entrepreneurs can draw a salary for building the venture. By not spending any money, they make the risk of failure, and hence any losses, affordable. The affordable loss principle could therefore have been called the “not spending any money” principle.

While success is uncertain, one can predict how much one is willing to lose. By sinking the cost of (potential) failure in advance, entrepreneurs can operate with much more focus on what needs to be done to develop the business. Instead of being afraid to fail, they know that they can carry the cost of a (potential) failure. Fear is often bad company in decision making, and so managing the emotions involved in this process is important. Next, one can focus all one’s efforts on building the venture.

During the process of developing a business, choices have to be made about the opportunities and approaches followed for the venture. While in predictable environments one can use financial methods to optimize these decisions, such as the calculation of the “Net Present Value” of these decisions, and choosing the best option between them, future revenues are often unpredictable in startups. As a result, this method is difficult to use in startups. In order to apply some rigour to the decision process, the affordable loss principle allows the entrepreneur to base their decisions on what IS controllable, ie - the amount of time and money that one is willing to dedicate to a decision. This doesn’t mean that these decisions cannot change, nor that other solutions can be found to solve resource constraints (by partnering with others for example), but at least they offer a method to make decisions for the entrepreneur.