Feature Story

 

Myths of Entrepreneurship

 

By Jeremy Hanks

 

NOTE!!: Before you read this article, visit http//yalepress.yale.edu/yupbooks/entrepreneurshipquiz.asp and take the entrepreneur quiz.

 

I'm reluctant to admit that I didn't score very well on the above entrepreneur quiz — 45 percent to be exact. Guy Kawasaki, a leading thinker on all things entrepreneurial, scored 40 percent. I'd venture a guess that you scored in the same ballpark.

This quiz and the related book, "The Illusions of Entrepreneurship: The Costly Myths That Entrepreneurs, Investors, and Policy Makers Live By," were written by Scott Shane, a professor of entrepreneurial studies at Case Western University. Shane is also a researcher on new businesses for the Ewing Marion Kauffman Foundation and an angel investor with the North Coast Angel Fund. He's the author or editor of 11 books and more than 60 scholarly articles on entrepreneurship. He knows what he's talking about.

"People start businesses based on the myths we tell ourselves about entrepreneurship and then are hurt when confronted by reality. Investors believe these myths and invest money and they're disappointed when they don't hold true. Policy makers make policy based on these myths and then wonder why the economy isn't growing with all these entrepreneurs now in it." Shane says.

So for my own education (based on my score it seems like I need it) and to help aspiring entrepreneurs here in Utah, here are my favorite 10 myths (written by Shane) that are dispelled in this great book:

 

1.  It takes a lot of money to finance a new business. Not true. The typical startup only requires about $25,000 to get going. Successful entrepreneurs design their businesses to work with little cash. They borrow instead of paying for things. They rent instead of buy. And they turn fixed costs into variable costs by, say, paying people commissions instead of salaries.

2.  Venture capitalists are good place to go for startup money. Not unless you start a computer or biotech company. Computer hardware and software, semiconductors, communication and biotechnology account for 81 percent of all VC dollars, and 72 percent of the companies that got VC money over the past 15 or so years. VCs only fund about 3,000 companies per year and only about one quarter of those companies are in the seed or start-up stage. In fact, the odds that a startup will get VC money are about one in 4,000. That's worse than the odds that you will die from a fall in the shower.

3.  Most business angels are rich. If rich means being an accredited investor — a person with a net worth of more than $1 million or an annual income of $200,000 per year if single and $300,000 if married — then the answer is "no." Almost three-quarters of the people who provide capital to fund the startups of other people who are not friends, neighbors, co-workers or family don't meet SEC accreditation requirements. In fact, 32 percent have a household income of $40,000 per year or less and 17 percent have a negative net worth.

4.  Startups can't be financed with debt. Actually, debt is more common than equity. According to the Federal Reserve's Survey of Small Business Finances, 53 percent of the financing of companies that are two years old or younger comes from debt and only 47 percent comes from equity. So a lot of entrepreneurs out there are using debt rather than equity to fund their companies.

5.  Banks don't lend money to startups. This is another myth. Again, Federal Reserve data shows that banks account for 16 percent of all the financing provided to companies that are two years old or younger. While 16 percent might not seem that high, it is 3 percent higher than the amount of money provided by the next highest source — trade creditors — and is higher than a bunch of other sources that everyone talks about going to: friends and family, business angels, venture capitalists, strategic investors and government agencies.

6.  Most entrepreneurs start businesses in attractive industries. Sadly, the opposite is true. Most entrepreneurs head right for the worst industries for startups. The correlation between the number of entrepreneurs starting businesses in an industry and the number of companies failing in the industry is 0.77. That means that most entrepreneurs are picking industries in which they are most likely to fail.

7.  The growth of a startup depends more on an entrepreneur's talent than on the business he chooses. Sorry to deflate some egos here, but the industry within which you choose to start your company has a huge effect on the odds that it will grow. Over the past 20 years or so, about 4.2 percent of all startups in the computer and office equipment industry made the Inc. 500 list of the fastest-growing private companies in the United States. Conversely, 0.005 percent of startups in the hotel and motel industry and 0.007 percent of startup eating and drinking establishments made the Inc. 500. That means the odds that you will make the Inc. 500 are 840 times higher if you start a computer company than if you start a hotel or motel. There is nothing anyone has discovered about the effects of entrepreneurial talent that has an equally powerful effect on the growth of new businesses.

8.  Most entrepreneurs are successful financially. Sorry, this is another myth. Entrepreneurship creates a lot of wealth, but it is very unevenly distributed. The typical profit of an owner-managed business is $39,000 per year. Only the top 10 percent of entrepreneurs earn more money than employees. And the typical entrepreneur earns less money than he otherwise would have earned working for someone else.

9.  Many startups achieve the sales growth projections that equity investors are looking for. Not even close. Of the 590,000 or so new businesses with at least one employee founded in this country every year, data from the U.S. Census shows that less than 200 reach the $100 million in sales in six years that venture capitalists talk about looking for. About 500 firms reach the $50 million in sales that sophisticated angels talk about. In fact, only about 9,500 companies reach $5 million in sales in that amount of time.

10.  Starting a business is easy. Actually it isn't, and most people who begin the process of starting a company fail to actually get it up and running. Seven years after beginning the process of starting a business, only one-third of people have a new company with positive cash flow greater than the salary and expenses of the owner for more than three consecutive months.

 

Any aspiring or current entrepreneur, investor or policy maker should read "The Illusions of Entrepreneurship." Understanding the realities instead of succumbing to the myths of entrepreneurship can only mean good things for entrepreneurs and entrepreneurship in Utah.

 

Jeremy Hanks is an entrepreneur and founder of several successful technology companies. His most recent venture is Doba, which he co-founded in 2002 and is its current chairman and president.

 

Launch - Summer 2008

 

 

For the full "digital magazine" version of Spring 2008, visit: www.nxtbook.com/nxtbooks/growutah/launch_2008summer/