The Entrepreneurial Mind
I still look forward to the beginning of classes each fall. I am excited to see the new groups of faces in each of my classes. I am excited to try out the new materials and new pedagogical approaches I worked on over the summer. I still get a few butterflies in my stomach when I first step in the classroom the first day of classes.
This fall I am teaching two undergraduate classes here at Belmont.
Venture Planning is a class that I teach at least one section every semester. It is the final course that our entrepreneurship majors, minors, and social entrepreneurship majors all have to take before they graduate.
A couple of years ago I made a fundamental shift to make this more of a business modeling class than a traditional business plan class. Although I continue to refine and tweak the new approach, the results of the change to business modeling have been remarkable. The final reports in the class are much stronger and we have more students feeling ready to move ahead with their businesses when they graduate.
Even in the face of what seems to most of them as a permanent recession — it has been the economic reality since this group first entered college in 2008 — this group is excited about the future.
My other class this year is somewhat of a new class for me. I have taught International Entrepreneurship to students studying abroad, but I never have taught it in a classroom on campus before.
We are not just looking at the nuts and bolts of internationalizing an entrepreneurial venture, although that is where we will end up at the end of the term. Instead, we are beginning looking at some big questions and issues.
Our first topic is quite fundamental, yet profoundly important in today’s world. Is market capitalism moral? Does engaging in capitalism corrupt one’s character?
We will then focus on what drives entrepreneurial activity — or in many cases what inhibits it — around the globe. We will explore the role of culture and public policy issues such as taxation, regulation and property rights. We will also look at the role of entrepreneurs in shaping culture through how they conduct themselves in their work.
These are incredibly timely issues given the debate not only here in the U.S., but around the globe.
We will be exploring these issues not from a political viewpoint, but at a policy and cultural level examining what empirical research tells us about each of these issues.
I am so glad to be back in the classroom again this fall. I guess someday this may no longer be the case — I may no longer feel the magic of that first day of classes each year. I have seen this day come for many a colleague over the years.
And when that day comes I know it will be time to walk away from the whiteboard and hang up the shingle for my bait shop!
The late, legendary Silicon Valley attorney Craig Johnson used to say, “The leading cause of failure of start-ups is death, and death happens when you run out of money.”
And the leading cause of running out of money in a start-up is poor financial forecasting.
At the core of unrealistic forecasts is the undying optimism of most entrepreneurs. Their “what could possibly go wrong?” attitude leads to many forecasting disasters. My father used to say that when he looked at investing in an entrepreneurial venture he would always double the start-up costs and triple the time it takes to get to break even.
My rule of thumb is a bit different. I believe that being overly optimistic leads to entrepreneurs making fatal mistakes in estimating revenues, which is at the heart of most forecasting errors. So, my approach when reviewing a business is plan is to cut revenue forecasts in half.
Here are the four most common revenue foresting mistakes I see:
- Assuming an “instant on” button for a new business. Most business plans I read show significant revenues from the beginning of the business, sometimes even for the very first month that they open their doors. The reality is that it takes time to build a customer base for any business. That is why an entrepreneur should have at least six months personal living expenses available to make it through the startup in addition to the money the new business needs.
- The magic of the hockey stick. A common pattern in business plans is to show a relatively slow initial start to revenues, and then assume some that unexplained breakthrough will occur that leads to a sudden and dramatic increase in sales. When you graph this type of revenue forecast it looks just like a hockey stick. The reality is that such sudden growth is just not that common and usually results from specific actions.
- Assuming enough sales to make the business model look successful. In this mistake entrepreneurs forecast their expenses and then they plug in enough revenues to make the business become profitable. When I press these entrepreneurs, their explanation of revenues is “well, these are the revenues I need to make the business work.” The truth is that the market will not give you the sales you need, it will only give you the sales you earn through a well-executed business model.
- The marketing plan tells a different story than revenue forecasts. The marketing plan should specifically explain what you are going to do to achieve the revenues you forecast. Why will customers want what you are selling? Who are these customers? How are you going to communicate to them about your business? The marketing plan should explain in words the numbers shown in the revenue forecast. Most plans just do not make this connection.
To avoid running out of cash before your business model has time to work requires an accurate assessment of how much money you will really need to get the business off the ground. While knowing your costs is important, accurately forecasting your revenues is critical.
It is so sad to see a business model that has real potential fail simply because the entrepreneur was unrealistic about how much money it would take to get to the point of success.
Entrepreneurs cannot achieve success alone.
They need the help and support of a whole host of people who are directly involved in the business, including employees, partners, family members and investors.
Entrepreneurs also need to develop key “partnerships” with people and organizations that are not a direct part of the daily operation. These partners work closely with an entrepreneur in some way that is important or possibly even critical for the operation of the business. Even though they are not as directly involved day-to-day as employees and customers, the support of these key partners can be at least as important for a business’s success.
Let’s look at an example of key partnerships for a simple business model. My students all know that I have one more business start-up in me. I plan to open a bait shop when I retire from teaching. Why a bait shop? My first significant small business experience was running the bait shop for the marina that our family owned in Wisconsin when I was fifteen years old. So it seems appropriate to me that my last business venture should also be a bait shop!
An entrepreneur can use key partners to help reduce risk by sharing that risk with partners. In Dr. C’s Bait Shop, I will seek out suppliers who will help reduce the risk associated with my inventory. Minnows and worms are perishable, so I will work with suppliers that are willing to deliver inventory often and only deliver it when I need it. That reduces the risk that my inventory will go bad if I have a stormy week that would lead to a significant drop in sales.
Dr. C’s Bait Shop will need a space to operate in a good location. I will try to find a landlord who will rent me the right building and offer good service at a fair price even though my business is new. I may even be able to get the landlord to pay to fix up the space I need and add that cost into my rent. So, key partners can help entrepreneurs secure needed resources without actually spending their precious start-up cash to acquire them.
I will seek out counsel from people with more experience in the industry to help serve as advisors. I will talk with bait shop owners in other markets and connect with old timers in the Tennessee fishing community.
Finally, I will build legitimacy for my bait shop among angling enthusiasts by volunteering in local hunting and fishing organizations.
Good networking with key partners is much more than just introducing myself and giving them a business card. I need to earn their support by making the relationships between us mutually beneficial.
So as simple as my bait shop business is to operate, its success depends on building a network of key partnerships. While being an entrepreneur means you do not work for anyone, it does not mean you don’t work with anyone.
The economy continues to languish while the politicians blame each other and business owners continue to wait for signs that things are really going to improve.
The big word for many entrepreneurs is uncertainty. It is not only uncertainty about when a true recovery will begin, but also uncertainty about things such as tax rates, regulation, and global economic instability.
While the Intuit Small Business Index shows continued weak improvement, other surveys show business owners to be more cautious.
The latest report from the NFIB is more of the same.
“July looked a lot like June in terms of job growth—namely, it was negative”. said chief economist for the NFIB William C. Dunkelberg. “On balance, July looks like a repeat of June, few jobs and no change in the unemployment rate. So far, it has turned out to be a cruel summer of dashed hopes for meaningful job creation.”
SurePayroll’s Small Business Scorecard shows that month-over-month, hiring remains flat and the average paycheck is down.
“Small business owners are optimistic by nature and they know that if you have a good idea you can take advantage of the lower costs in this economy and be successful,” said SurePayroll CEO and President Michael Alter. “Still, we need more incentives for investors to back startups and less tax burdens on small businesses.”
Lee Schafer of the Minneapolis Star Tribune called me the other day to see if I had any information on the effectiveness of angel investment tax credits for a story he was writing.
I told him that all that the tax credit programs do is speed up or slow down investments (to take advantage of their timing). There is no evidence that they increase angel investment whatsoever. They are not the job creator politicians claim when enacting these programs. (See my arguments in my editorial at the WSJ).
In his investigation of the program in Minnesota he found strong support among politicians for the program, but very little support from entrepreneurs.
Plymouth-based start-up MetaModix Inc. raised about $1 million earlier in 2012, and its investors got about $254,000 in credits. Co-founder and CEO Kedar Belhe said “most of my investors did not look at it as a requirement, they looked at it as a bonus.” He said any real investor commits to a deal only after first carefully considering the odds of losing everything vs. winning big.
One stated that because the Minnesota program was about to run out, he would have to wait until additional credits were approved to fund raise, since angels will sit on their hands until credits become available. They will invest, but will wait until they can qualify for another check from the government.
Angel investment tax credit are yet another misguided program that may be based on good intentions, but that has none of the desired impact on business formation or on job creation. We just can’t afford ineffective programs like angel tax credits during a time when we don’t have the luxury to give away tax revenues.
Schafer puts it this way:
The Minnesota program is a straightforward, get-a-check-from-the-taxpayers subsidy for purely private business activity, so it’s remarkable that the allocation has lasted this deep into the year. It’s remarkable as well that angel credits have such broad bipartisan support when the economic case remains mostly unproven.
If we are going to use the tax code to help entrepreneurs, just cut taxes and let the market do what it does best.
Something that always gives me pause is when I hear entrepreneurs and their managers refer to their small business as “the company”, or even worse, “the corporation.”
I was talking with an entrepreneur who has two partners and no employees. Their business seemed to be kind of “stuck.” They were not getting some important, and yet basic things done to market their business and take better care of their customers. He kept saying things like “the corporation needs to do this” and “the corporation should do that.” They were spending most of their time trying to determine who should have what title and how to create a well-defined structure.
I finally said, “Wait a minute! There are just three of you! Sit down, make a list of what needs to get done, and divide up the work. You are ‘the corporation’ so get busy!”
In fairness, the entrepreneur and his partners have big dreams and have a business model that could become a big business someday. But they will never reach their dreams if they don’t start running their small business the way it needs to be run.
A key advantage that small businesses have is that they are not big businesses.
Small businesses can be nimble and can react quickly to customer needs and changes in the market. Small businesses can continue to be entrepreneurial and seek opportunity.
As the business grows you will need to add some structure, increase the clarity of people’s roles, and put in some processes and procedures. But all of this should be done judiciously and slowly.
Small businesses that try to act “big” too quickly run the risk of losing their entrepreneurial culture. I can tell you from my own experience that once you lose the entrepreneurial spirit in a business, it is very difficult, if not impossible to get it back.
So how do you start to build an organization while still keeping an entrepreneurial culture?
When you delegate, make sure that you don’t just delegate tasks. You need to delegate the responsibility and the authority to manage the tasks. Give your employees the ability to make improvements and to react quickly to the market. Everyone needs to have a sense of “ownership” of what they do.
When you start to create organizational structure for your business, don’t just create positions and reporting relationships to deal with immediate problems and challenges. Be intentional about the kind of structure you are building and how it will impact your ability to remain entrepreneurial as a business. Too much bureaucracy can kill innovation very quickly.
When you start to create processes and procedures ask yourself one question: Is it critical? While standardized processes and procedures are important to support a growing business, if overdone they can actually inhibit your ability to grow.
When you own a small business don’t be in such a rush act like a “big” business. Your smallness is part of your competitive advantage. Find the balance between building an organization and maintaining your entrepreneurial culture.
New research released today by the NFIB suggests that allowing tax relief on the top individual rates to expire will hurt job creation and the economy.
The report, published by Ernst & Young and authored by Dr. Robert Carroll and Gerald Prante, estimated the effects of the policy advocated by President Obama and some Members of Congress to allow the top tax rates paid by small-business owners to rise sharply starting January 1, 2013. It finds that over time the economy would be 1.3 percent smaller and there would be 710,000 fewer jobs. More than 72 percent of S corporation income is earned by the half-million S corporation owners who pay the top two rates.
Increasing individual rates directly impacts small businesses organized as S corporations, partnerships, LLCs and sole proprietors, also known as “pass-through” businesses. NFIB research shows around 75 percent of all small businesses are organized in such a manner.
Together with the new 3.8 percent tax on investment income introduced in the health care reform law, the study finds that the top tax rate on pass-through business income would skyrocket from 35 to nearly 45 percent.
Other studies suggest that such a 10% marginal tax rate increase will decrease start-up activity by 15-20%.
In case you missed it over the weekend, President Obama said the following about entrepreneurs: “If you’ve got a business — you didn’t build that. Somebody else made that happen.”
Now I am the first to say that entrepreneurs do not build a business alone. They need help from employees, customers, investors, suppliers, family members, and the broader community.
That being said, entrepreneurs are the ones who take the risk to launch the business. They are the ones who do not get paid if money is tight. They are the ones who personally guarantee the business’s loans.
NFIB President and CEO Dan Danner nailed it today when he said, “His unfortunate remarks over the weekend show an utter lack of understanding and appreciation for the people who take a huge personal risk and work endless hours to start a business and create jobs. “I’m sure every small-business owner who took a second mortgage on their home, maxed out their credit cards or borrowed money from their own retirement savings to start their business disagrees strongly with President Obama’s claim.”
Entrepreneurs do not owe any of their success to what politicians do in Washington. They do not owe their good fortune to government.
It is the government that owes its successes to the entrepreneurs who built our once mighty economy through the pursuit of free enterprise.
Amy Payne at the Foundry put it this way: “The slap in the face to hard-working Americans conveyed Obama’s belief that it takes a village—a heavily subsidized village—to create that venture you’re profiting from.”
The word out today on the mood of entrepreneurs in the US and it is not at all encouraging. The NFIB Small Business Optimism Index is down sharply this month.
And who can blame them!
Unemployment remains high and shows to positive growth. Don’t be fooled by the “80,000 new jobs” spin. Due to our population growth in this country we need at least 130,000 new jobs each month just to break even with the added people coming into the workforce. Without jobs, people are not spending. And without spending in our economy, there is no reason for entrepreneurs to become aggressive again and get into a growth mode.
The President is drawing a line in the sand insisting on increasing taxes for those earning over $250,000 a year. Many who fall into this proposed tax increase are entrepreneurs. We know that for every 1% increase in the marginal tax rate that we can expect a 1.5 to 2.0% decrease in start-up activity. Remember that this announcement came after the survey from the NFIB that showed a sour mood among business owners.
And then there is the new healthcare model about to roll forward in this country. Many small business owners are paralyzed by the implications of this law. I have had a couple of friends estimate the costs for their small businesses and it is tens of thousands of dollars for even a modest sized payroll. Obamacare will lead to a huge decrease in employment in small business as it is implemented over the next two years. (By the way, most of what we are hearing from the Republicans is only lip service, so we should all plan for it to move ahead).
So we can see why small business owners are in a foul mood. A weak consumer base, increasing taxes, and increasing labor costs are not going to spur entrepreneurs to help lead the economic recovery.
So why should we care?
Entrepreneurs have led every past recovery. If they are not optimistic they are not going to hire more workers, buy more inventory and increase capital spending.
This economy is dead in the water and we are doing everything wrong when it comes to helping those who can help rebuild economic growth.
Crowdfunding, which uses the Internet to generate small contributions of funding from a large number of people, has been getting a lot of attention lately among entrepreneurs.
Crowdfunding primarily has been used to help raise money to support social causes and to help fund struggling artists. The money received from crowdfunding has to be considered a contribution or a donation. In most cases, something nominal is usually offered in return for financial support, such as a free download from a musician.
Historically, because of securities laws, small businesses have been unable to use crowdfunding. Until recently, entrepreneurs had only been able to seek funding from a limited number of people who meet specific income and wealth criteria.
A few creative entrepreneurs have used a loophole in the rules to raise money through crowdfunding. Rather than treat money raised through a crowdfunding campaign as investments, they offer people something of value in return. For example, a person opening a new brewpub may get people to “donate” to support the start-up by offering free admission to a special opening night event. The contributions would be motivated by the desire of local beer enthusiasts to support a new local brewery. The most commonly used websites that promote traditional crowdfunding are Kickstarter and IndieGoGo.
One instantly legendary crowdfunding campaign was implemented by Eric Migicovsky. He was raising money for his new wrist watch, called Pebble, which pairs with smartphones via Bluetooth. Contributors were promised they would get preference to buy a Pebble when the watches were introduced to the market. Although his initial goal was to raise $100,000, Migicovsky was able to raise over $10 million to help launch Pebble.
The recently enacted Jumpstart Our Business Startups (JOBS) Act of 2012 significantly expands the use of crowdfunding for entrepreneurs. Under the provisions of this bill, those who provide funding through crowdfunding can now become equity investors with ownership in the business. The JOBS Act opens up the funding of start-ups to allow almost anyone to invest in entrepreneurial ventures. Several efforts to create crowdfunding platforms under the JOBS Act are being developed, including one in Nashville called InCrowd Capital, being led by Phil Shmerling.
Attracting investors through crowdfunding requires a different approach than when pursuing funding from angels and venture capitalists, who tend to invest more in the entrepreneurs leading the team than in their ideas.
Crowdfunding investors, on the other hand, are attracted to compelling stories and business ideas they can see themselves using. What led to the success of the Pebble crowdfunding campaign was that people were excited about a completely new technology that they wanted to be the first to own. Not every product can create that kind of passion and excitement.
The JOBS Act certainly broadens the pool of people who can invest in small businesses and offers an exciting new avenue for raising money for start-ups.
However, using crowdfunding also may make the entrepreneur’s work more challenging. If adding just one new partner increases the complexity of running a business, imagine what a crowd of partners can do to complicate an entrepreneur’s life!