Monday, February 29, 2016

Six Myths About Entrepreneurship

By Rupert Merson & S. Ramakrishna Velamuri

In the rapidly changing world of entrepreneurship, where academic research is struggling to keep up, story-telling has been allowed to fill the gaps. It is, therefore, unsurprising that discussions on entrepreneurship are more dominated by myths and fads than substantial facts. Some of the most worrying myths: 

Myth one: the only entrepreneurial opportunities worth taking seriously are linked to high-tech. The prejudice in favour of the hi-tech comes from an overemphasis on the sort of opportunities favoured by venture capitalists and other institutional sources of private equity. VC firms, by nature, are attracted to software and Internet based opportunities where risks are high, there is tangible potential for fast growth, and there is a demonstrable opportunity to cash-out at many times the size of the original investment. This is because the potential financial return can be significantly greater in a shorter time-frame than in a business that requires capital to be tied up in a production facility or a chain of retail outlets.

Highly educated first generation entrepreneurs may also lean towards technology sectors, which offer them two advantages. First, being knowledge intensive and newer than traditional sectors, tech ventures favour human capital (education and work experience) over social capital (personal or family networks). Second, youngsters can start a business in many technology sectors and achieve the first milestones with very little capital, which then makes it possible for them to attract angel or VC funding. These two advantages, combined with the growth of technology sectors, which now account for about 20% of US stock market capitalization according to Aswath Damodaran, have given the impression that everyone  can become an entrepreneur, and that high-tech is the obvious place to become one.

But the excitement about high-tech tends to push discussion about the disadvantages of the sector, and about lower-tech alternatives, into the shadows. There is greater competition among tech ventures precisely because entry barriers, in terms of financial and social capital, are low. Second, while starting up is possible with bootstrapped resources, scaling technology ventures typically requires raising significant amounts of capital through multiple rounds of fund-raising, leading to dilution of entrepreneurs’ ownership. Third, there is a long road to profitability for technology ventures – Damodaran’s analysis shows that even listed US technology ventures that are less than 10 years old have, on average, negative operating profits.

Meanwhile, there are significant opportunities for entrepreneurs in old as well as new industries – opportunities that they might find themselves more interested in and knowledgeable about and therefore more likely to succeed in. 

Myth two: entrepreneurs in the 21st century do not need business plans. Eisenhower has been credited with saying: “No battle was won without a plan; no battle was won according to plan.” More recently, after a meta-analysis of 51 previous research studies on the effect of business planning on performance, Jan Brinckmann, Dietmar Grichnik and Diana Kapsa concluded that although it takes a lot to gather information about market opportunities and how to use that information to exploit market opportunities, “the benefits outweigh the costs, leading to increased performance of the new and established small firms.” From our experience, business plans are helpful in two ways. First, if the founding team has thoroughly analysed all the important aspects of the business, it is bound to exude confidence when it pitches the venture to customers and resource providers. Second, if the founders want stakeholders to commit their resources to the venture at the seed or early stages, when uncertainty is very high, the business plan can help them have a structured conversation.

Myth three: entrepreneurs are disrupting established companies. If this myth were true, we should have seen an increase in the number of young ventures relative to older ones. In a detailed analysis of US companies between 1992 and 2011 (a period that has coincided with the diffusion of many disruptive technologies such as the Internet, the mobile phone, social media, etc.), Ian Hathaway and Robert Litan show in their paper “The Other Ageing of America” that precisely the opposite is true. They show that firms that were 16 years or older represented 34% of all firms in 2011, versus 23% in 1992; and their share of private sector employment increased to 72% from 60% in the same period. Their results also point to fewer firm foundings and higher failure rates of start-ups; these results hold for all geographic areas of the US and all industries.  

Disruption is an outcome. Only time will tell whether innovations introduced by start-up entrepreneurs end up disrupting larger incumbents. Entrepreneurship is about building new businesses and creating new value, not destroying existing businesses; if the latter happens, then this is ‘collateral damage’ rather than a strategic objective. All entrepreneurs can do is innovate and communicate the benefits of their innovations to potential adopters at a time when getting people’s attention is becoming more and more difficult and costly. They should stop worrying about disruption.

Myth four: innovation is the source of the best entrepreneurial opportunities. This myth confuses inventors with business creators. Inventors invent; entrepreneurs create businesses. Entrepreneurs are just as likely to create a successful business venture with someone else’s idea as with their own. Indeed, replication is a less risky route to entrepreneurship than innovation, as it reduces conceptual risks associated with the quality of the idea, allowing entrepreneurs to focus on mitigating execution risks, which are troubling enough.

In his study of the 1989 Inc. 500 high-growth entrepreneurs, Amar Bhide found that only 12% attributed their success to an innovative idea, whereas 88% cited excellence in execution.

Myth five: everyone wants to be an entrepreneur. When economies turn sour and capable individuals find themselves thrust once more into the job market, some find themselves turning into entrepreneurs out of necessity; but they should not be mistaken for those who have turned into entrepreneurs by choice. Entrepreneurship always has been and, in our view, always will be a minority interest – even for the excited attendees at business school entrepreneurship courses. The incidence of entrepreneurship among MBA graduates at the time of graduation is very low, less than 5% of the graduating class. Studies conducted at different business schools have shown that over the next 15 years, about a third of the graduating class is working full-time in a business that it partially or fully owns. Outside of business schools the incidence is much lower; the rate of non-agricultural self-employment in most developed countries is less than 15%.

Entrepreneurs have to work harder than managers in big businesses, for less return, with less security, and with less certainty as to what the future will hold.

Myth six:  MBA courses are not relevant for entrepreneurs, because they need a different set of knowledge and skills from managers. Jeff Bussgang, a venture capitalist who is on Harvard Business School’s faculty, recently did some data crunching with his students, and found that 33% of unicorns (young companies that have been valued at more than US$1 billion in private or public markets) had at least one co-founder who had an MBA, and a further 49% had at least one non-founder MBA in their top management teams. So, it seems likely that at the very least the MBA has provided a trigger for a career in entrepreneurship, and entrepreneurs are getting something from their MBA investment. Thirty years ago, business school professors had not yet developed much content about the challenges of the start-up phase and how they can be surmounted. The situation is very different today.

In most top business schools, there is a required entrepreneurship course and rich elective offerings. Even finance programmes, whose offerings used to focus on valuation and performance measurement methodologies required by big business, now find room to compare and contrast the very different thinking required to finance and manage start-ups. So in discussions on entrepreneurship, we need to be more evidence based in our approach. Entrepreneurship is a critical force for good but it is not a panacea for all the economic ills of society. Entrepreneurship can provide some individuals with a way of contributing to society that is both exciting and rewarding; but it is difficult, unpredictable, insecure, and demanding. The individuals most likely to enjoy entrepreneurship, and succeed at it, are always likely to be the exceptions rather than the rule.

Rupert Merson is Adjunct Associate Professor of Strategy and Entrepreneurship at London Business School and S. Ramakrishna (Rama) Velamuri is Professor of Entrepreneurship at China Europe International Business School. Between them they have some thirty years of work in entrepreneurship in business schools.

This article was first published by The Economist Intelligence Unit.

Add new comment