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THE
ENTREPRENEURIAL
PROCESS
William D. Bygrave
This is the entrepreneurial age. It is estimated that as many as 460 million persons worldwide were either actively involved in trying to start a new ven- ture or were owner-managers of a new business in 2002. 1 More than a thou- sand new businesses are born every hour of every working day in the United States. Entrepreneurs are driving a revolution that is transforming and re- newing economies worldwide. Entrepreneurship is the essence of free enter- prise because the birth of new businesses gives a market economy its vitality. New and emerging businesses create a very large proportion of innovative products and services that transform the way we work and live, such as per- sonal computers, software, the Internet, biotechnology drugs, and overnight package deliveries. They generate most of the new jobs. For example, from 1990 to 1994, small, growing firms with 100 or fewer workers generated 7 to 8 million new jobs in the U.S. economy, whereas firms with more than 100 workers destroyed 3.6 million jobs. In 1998 to 1999, the last period for which data are available, small business accounted for two-thirds of the 2.6 million net new jobs. There has never been a better time to practice the art and science of en- trepreneurship. But what is entrepreneurship? Early this century, Joseph Schumpeter, the Moravian-born economist writing in Vienna, gave us the mod- ern definition of an entrepreneur as the person who destroys the existing eco- nomic order by introducing new products and services, by creating new forms of organization, or by exploiting new raw materials. According to Schumpeter,
2 The Entrepreneurial Process
that person is most likely to accomplish this destruction by founding a new business but may also do it within an existing one. Very few new businesses have the potential to initiate a Schumpeterian “gale” of creation-destruction as Apple computer did in the computer industry. The vast majority of new businesses enter existing markets. In The Portable MBA in Entrepreneurship, we take a broader definition of entrepreneurship than Schumpeter’s. Our definition encompasses everyone who starts a new business. Our entrepreneur is the person who perceives an opportunity and creates an organization to pursue it. And the entrepreneurial process involves all the functions, activities, and actions associated with perceiving opportuni- ties and creating organizations to pursue them. Our entrepreneur’s new busi- ness may, in a few rare instances, be the revolutionary sort that rearranges the global economic order as Wal-Mart, FedEx, and Microsoft have done, and Amazon.com, eBay, and Expedia.com are now doing. But it is much more likely to be of the incremental kind that enters an existing market.
Is the birth of a new enterprise just happenstance and its subsequent suc- cess or demise a haphazard process? Or can the art and science of entrepreneur- ship be taught? Clearly, professors and their students believe that it can be taught and learned because entrepreneurship is the fastest growing new field of study in American higher education. A study by the Kauffman Foundation in 2002 found that 61% of U.S. colleges and universities have at least one course in entrepreneurship. It is possible to study entrepreneurship in certificate, associ- ates, bachelors, masters, and PhD programs. That transformation in higher education—itself a wonderful example of entrepreneurial change—has come about because a whole body of knowledge about entrepreneurship has developed during the past two decades or so. The process of creating a new business is well understood. Yes, entrepreneurship can be taught. However, we cannot guarantee to produce a Bill Gates or a Donna Karan, any more than a physics professor can guarantee to produce an Albert Einstein or a tennis coach a Serena Williams. But give us students with the ap- titude to start a business, and we will make them better entrepreneurs.
- An entrepreneur is someone who perceives an opportunity and creates an or- ganization to pursue it.
- The entrepreneurial process involves all the functions, activities, and actions associated with perceiving opportunities and creating organizations to pur- sue them.
4 The Entrepreneurial Process
con solidations in the pharmaceutical industry, and he had had enough of big business. So he started his own drug packaging business, Waverly Pharmaceu- tical. Tim Waterstone founded Waterstone’s bookstores after he was fired by W. H. Smith. Ann Gloag quit her nursing job and used her bus driver father’s $40,000 severance pay to set up a bus company, Stagecoach, with her brother. They exploited legislation deregulating the U.K. bus industry. For other people, entrepreneurship is a deliberate career choice. Sandra Kurtzig was a software engineer with General Electric who wanted to start a family and work at home. She started ASK Computer Systems Inc., which be- came a $400 million-a-year business. Where do would-be entrepreneurs get their ideas? More often than not it is through their present line of employment or experience. A 2002 study of the Inc. 500 —comprising America’s [500] fastest growing companies—found that 57% of the founders got the idea for their new venture in the industry they worked in and a further 23% in an industry related to the one in which they were employed. Hence, 80% of all new high-potential businesses are founded in industries that are the same as, or closely related to, the one in which the en- trepreneur has previous experience. That is not surprising because it is in their present employment that they get most of their viable business ideas. Some habitual entrepreneurs do it over and over again in the same industry. Joey Crugnale, himself an Inc. 500 Hall of Famer and an Inc. 500 Entrepreneur of the Year, became a partner in Steve’s Ice Cream when he was in his early twen- ties. He eventually took over Steve’s Ice Cream, and created both a national franchise of some 26 units and a new food niche, gourmet ice creams. In 1982, Crugnale started Bertucci’s where gourmet pizza was cooked in wood-fired brick oven and built it into a nationwide chain of 90 restaurants. Then he founded Naked Restaurants as an incubator to launch his innovative dining concepts. The first one, the Naked Fish, opened in 1999 and brought his wood- fired grill approach to a new niche: fresh fish and meats with a touch of Cubanismo. The second restaurant, Red Sauce, opened in 2002, serves moder- ately priced authentic Italian food somewhat along the lines of Bertucci’s. Others do it over and over again in related industries. In 1981, James Clark, then a Stanford University computer science professor, founded Silicon Graph- ics, a computer manufacturer with 1996 sales of $3 billion. In April 1994, he teamed up with Marc Andreessen to found Netscape Communications. Within 12 months, its browser software, Navigator, dominated the Internet’s World Wide Web. When Netscape went public in August 1995, Clark became the first Internet billionaire. Then in June 1996, Clark launched another company, Healthscape, to enable doctors, insurers, and patients to exchange data and do business over the Internet with software incorporating Netscape’s Navigator.
Critical Factors for Starting a New Enterprise 5
Much rarer is the serial entrepreneur such as Wayne Huizenga, who ven- tures into unrelated industries: first in garbage disposal with Waste Manage- ment, next in entertainment with Blockbuster video, then in automobile sales with AutoNation. Along the way he was the original owner of the Florida Marlins baseball team, which won the World Series in 1997. What are the factors that inf luence someone to embark on an entrepre- neurial career? As with most human behavior, entrepreneurial traits are shaped by personal attributes and environment.
Personal Attributes
Two decades ago, at the start of the entrepreneurial 1980s, there was a spate of magazine and newspaper articles that were titled “Do you have the right stuff to be an entrepreneur?” or words to that effect. The articles described the most im- portant characteristics of entrepreneurs and, more often than not, included a self-evaluation exercise to enable readers to determine if they had the right stuff. Those articles were based on f limsy behavioral research into the differ- ences between entrepreneurs and nonentrepreneurs. The basis for those exer- cises was the belief, first developed by David McClelland in his book The Achieving Society, that entrepreneurs had a higher need for achievement than nonentrepreneurs, and that they were moderate risk takers. One engineer almost abandoned his entrepreneurial ambitions after completing one of those exer- cises. He asked his professor at the start of an MBA entrepreneurship course if he should take the class because he had scored very low on an entrepreneurship test in a magazine. He took the course, however, and wrote an award-winning plan for a business that was a success from the very beginning. Today, after more research, we know that there is no neat set of behavioral attributes that allow us to separate entrepreneurs from nonentrepreneurs. It turns out that a person who rises to the top of any occupation, whether it be an entrepreneur or an administrator, is an achiever. Granted, any would-be en- trepreneur must have a need to achieve, but so must anyone else with ambitions to be successful. It does appear that entrepreneurs have a higher locus of control than non- entrepreneurs, which means that they have a higher desire to be in control of their own fate. This has been confirmed by many surveys which have found that entrepreneurs say that independence is their main reason for starting their businesses. By and large, we no longer use psychological terms when talking about entrepreneurs. Instead we use everyday words to describe the characteristics found in most entrepreneurs (see Exhibit 1.2).
Critical Factors for Starting a New Enterprise 7
sell goods on credit to companies with no credit history, and even politicians who are supportive. Role models are very important because knowing successful entrepre- neurs makes the act of becoming one yourself seem much more credible. Would-be entrepreneurs come into contact with role models primarily in the home and at work. If you have a close relative who is an entrepreneur, it is more likely that you will have a desire to become an entrepreneur yourself, es- pecially if that relative is your mother or father. At Babson College, more than half of the undergraduates studying entrepreneurship come from families that own businesses. But you don’t have to be from a business-owning family to be- come an entrepreneur. Bill Gates, for example, was following the family tradi- tion of becoming a lawyer when he dropped out of Harvard and founded Microsoft. He was in the f ledgling microcomputer industry, which was being built by entrepreneurs, so he had plenty of role models among his friends and acquaintances. The United States has an abundance of high-tech entrepre- neurs who are household names. One of them, Ross Perot, was so well known that he became the presidential candidate preferred by one in five American voters in 1992. Some universities are hotbeds of entrepreneurship. For example, Massa- chusetts Institute of Technology has produced numerous entrepreneurs among its faculty and alums. Companies with an MIT connection transformed the Massachusetts economy from one based on decaying shoe and textile industries into one based on high technology. According to a 1997 study by the Bank of Boston, 125,000 jobs in Massachusetts were MIT-related. 2 Nationwide in 1996, 733,000 people working in more than 8,500 plants and offices held jobs that originated with companies founded by MIT graduates. The 4,000 or so firms that MIT graduates founded accounted for at least 1.1 million jobs worldwide and generated $232 billion in revenues. If MIT-related companies were a na- tion, it would be the 24th largest economy in the world. The neighborhood of East Cambridge adjacent to MIT has been called “The Most Entrepreneurial Place on Earth” by Inc. magazine. According to Inc., roughly 10% of Massa- chusetts software companies and approximately 20% of the state’s 280 biotech- nology companies are headquartered in that square mile. It is not only in high-tech that we see role models. Consider these examples:
- It has been estimated that half of all the convenience stores in New York city are owned by Koreans.
- It was the visibility of successful role models that spread catfish farming in the Mississippi delta as a more profitable alternative to cotton.
- The Pacific Northwest has more microbreweries than any other region of the United States.
8 The Entrepreneurial Process
- In the vicinity of the town of Wells, Maine, there are half-a-dozen sec- ondhand bookstores. African Americans make up 12% of the U.S. population, but owned only 4% of the nation’s businesses in 1997. 3 One of the major reasons for a relative lack of entrepreneurship among African Americans is the scarcity of African- American entrepreneurs, especially store owners, to provide role models. A similar problem exists among Native Americans. Lack of credible role models is also one of the big challenges in the formerly communist European nations as they strive to become entrepreneurial.
Other Sociological Factors
Besides role models, entrepreneurs are inf luenced by other sociological fac- tors. Family responsibilities play an important role in the decision whether to start a company. It is, relatively speaking, an easy career decision to start a business when a person is 25 years old, single, and without many personal as- sets and dependents. It is a much harder decision when a person is 45 and married, has teenage children preparing to go to college, a hefty mortgage, car payments, and a secure, well-paying job. A 1992 survey of European high- potential entrepreneurs, for instance, found that on average they had 50% of their net worth tied up in their businesses. And at 45 plus, if you fail as an en- trepreneur, it is not easy to rebuild a career working for another company. But despite the risks, plenty of 45-year-olds are taking the plunge; in fact, the me- dian age of the CEOs of the 500 fastest growing small companies, according to Inc. 500 in 2000, was 40. 4 Another factor that determines the age at which entrepreneurs start businesses is the trade-off between the experience that comes with age and the optimism and energy of youth. As you grow older, you gain experience, but sometimes when you have been in an industry a long time, you know so many pitfalls that you are pessimistic about the chance of succeeding if you decide to go out on your own. Someone who has just enough experience to feel confident as a manager is more likely to feel optimistic about an entrepreneur- ial career. Perhaps the ideal combination is a beginner’s mind with the experi- ence of an industry veteran. A beginner’s mind looks at situations from a new perspective, with a can-do spirit. Robert Swanson was 27 years old when he hit upon the idea that a company could be formed to capitalize on biotechnology. At that time, he knew almost nothing about the field. By reading the scientific literature, Swanson identified the leading biotechnology scientists and contacted them. “Everybody said I was too early—it would take 10 years to turn out the first microorganism from a
10 The Entrepreneurial Process
Fortunately, today there are more organizations than ever before to help f ledgling entrepreneurs. Often that help is free or costs very little. The Small Business Administration (SBA) has Small Business Development Centers in every state; it funds Small Business Institutes; and its Service Core of Retired Executives provides free assistance to entrepreneurs. Many colleges and univer- sities also provide help. Some are particularly good at writing business plans, usually at no charge to the entrepreneur. There are hundreds of incubators in the United States where f ledgling businesses can rent space, usually at a very reasonable price, and spread some of their overhead by sharing facilities such as copying and FAX machines, secretarial help, answering services, and so on. In- cubators are often associated with universities, which provide free or inexpen- sive counseling. There are numerous associations where entrepreneurs can meet and exchange ideas. In the Boston area, for example, the 128 VC Group provides a place where entrepreneurs, financiers, accountants, lawyers, and other profes- sionals meet each month for a two-hour breakfast.
EVALUATING OPPORTUNITIES FOR NEW BUSINESSES
Let’s assume you believe you have found a great opportunity for starting a new business. How should you evaluate its prospects? Or, perhaps more importantly, how will an independent person such as a potential investor or a banker rate your chances of success? The odds of succeeding appear to be stacked against you because, according to small business folklore, only 1 business in 10 will ever reach its tenth birthday. This doesn’t mean that 9 out of 10 of the estimated two million businesses that are started every year go bankrupt. We know that even in a severe recession, the number of businesses filing for bankruptcy in the United States has never surpassed 100,000 in any year. In an average year, the number is about 50,000. In 2001, for instance, there were slightly fewer than 40,000. So what happens to the vast majority of the ones that do not survive 10 years? Most just fade away: They are started as part-time pursuits and are never intended to become full-time businesses. Some are sold. Others are liquidated. Only 700,000 of the two million are legally registered as corporations or part- nerships, which is a sure sign that many of the remaining 1.3 million never in- tended to grow. Hence, the odds that your new business will survive may not be as long as they first appear to be. If you intend to start a full-time, incorporated business, the odds that the business will survive at least eight years with you as the owner are better than one in four; and the odds of its surviving at least eight years with a new owner are another one in four. So the eight-year survival rate for incorporated startups is about 50%.
Evaluating Opportunities for New Businesses 11
But survival may not spell success. Too many entrepreneurs find that they can neither earn a satisfactory living in their businesses nor get out of them eas- ily because they have too much of their personal assets tied up in them. The hap- piest day in an entrepreneur’s life is the day doors are opened for business. For unsuccessful entrepreneurs, an even happier day may be the day the business is sold—especially if most personal assets remain intact. What George Bernard Shaw said about a love affair is also apt for a business: Any fool can start one, it takes a genius to end one successfully. How can you stack the odds in your favor, so that your new business is suc- cessful? Professional investors, such as venture capitalists, have a talent for picking winners. True, they also pick losers, but a startup company funded by venture capital has, on average, a four in five chance of surviving five years— better odds than for the population of startup companies as a whole. By using the criteria that professional investors use, entrepreneurs can increase their odds of success. Very few startup businesses—perhaps no more than one in a thousand—will ever be suitable candidates for investments from professional venture capitalists. But would-be entrepreneurs can learn much by following the evaluation process used by professional investors. There are three crucial components for a successful new business: the opportunity, the entrepreneur (and the management team, if it’s a high- potential venture), and the resources needed to start the company and make it grow. These components are shown schematically in Exhibit 1.3 in the
EXHIBIT 1.3 Three driving forces.
Source: Based on Jeffry Timmons’ framework, as presented in Jeffry A. Timmons, New Venture Cre- ation (Homewood, IL: Richard D. Ir win, 1990).
Resources
Fits & Gaps
Opportunity Entrepreneur
Uncertainty
Uncertainty
Uncertainty
Uncertainty
Evaluating Opportunities for New Businesses 13
capital firm Sevin Rosen Management Company, invested in Compaq. Started initially to make transportable PCs, it quickly added a complete range of high- performance PCs and grew so fast that it soon broke Apple’s record for the fastest time from founding to listing on the Fortune 500. What did Ben Rosen see in the Compaq proposal that made it stand out from all the other personal computer startups? The difference was Rod Canion and his team. Rod Canion had earned a reputation as an excellent manager at Texas Instruments. Furthermore, the market for personal computers topped $5 billion and was growing at a torrid pace. So Rosen found a superb team with a product targeted at an undeveloped niche, transportable PCs, in a large mar- ket that was growing explosively. By 1994, Compaq was the leading PC manu- facturer with 13% of the market.
The Opportunity
Perhaps the biggest misconception about an idea for a new business is that it must be unique. Too many would-be entrepreneurs are obsessed with finding a unique idea. Then, when they believe they have it, they are haunted by the thought that someone is just waiting to steal it from them. As a result, they be- come super secretive. They are reluctant to discuss it with anyone unless that person signs a nondisclosure agreement. That in itself makes it almost impos- sible to evaluate the idea. For example, many counselors who provide free ad- vice to entrepreneurs refuse to sign nondisclosure agreements. Generally speaking, these super-secret, unique ideas are big letdowns when the entre- preneur reveals them to you. Among the notable ones I have encountered were “drive-through pizza by the slice,” “a combination toothbrush and toothpaste gadget,” and “a Mexican restaurant in Boston.” One computer programmer telephoned me and said that he had a fantastic new piece of software. Eventu- ally, after I assured him that I was not going to steal his idea, he told me his software was for managing hairdressing salons. He was completely f loored when I told him that less than a month previously another entrepreneur had visited my office and demonstrated a software package for exactly the same purpose. Another entrepreneur had an idea for f luoride-impregnated dental f loss. Not three months later, on a visit to England, I found the identical prod- uct in Boots—Britain’s largest chain of drugstores and a major pharmaceuti- cal manufacturer.
In entrepreneurship, as in any other profession, luck is where preparation and opportunity meet.
14 The Entrepreneurial Process
I tell would-be entrepreneurs that almost any idea they have will also have occurred to others. For good measure, I point out that some of the most revolu- tionary thoughts in the history of mankind occurred to more than one person al- most simultaneously. For instance, Darwin was almost preempted by Wallace in publishing his theory of evolution; Poincaré formulated a valid theory of relativ- ity about the same time Einstein did; and the integrated circuit was invented in 1959 first by Jack Kilby at Texas Instruments, and then independently by Robert Noyce at Fairchild a few months later. The idea per se is not what is important. Ideas are a dime a dozen. Developing the idea, implementing it, and building a successful business are the important aspects of entrepreneurship. Alexander Fleming discovered penicillin by chance but never developed it as a useful drug. About 10 years later, Ernst Chain and Howard Florey unearthed Fleming’s mold. They immediately saw its potential. Working in England under wartime conditions, they soon were treating patients. Before the end of World War II, penicillin was saving countless lives. It was a dramatic pharmaceutical advance that heralded a revolution in that industry.
Customer Need
Many would-be entrepreneurs call me telling me that they have an idea for a new business and that they want to come to see me. Unfortunately, it is im- possible to see all of them, so I have developed a few questions that allow me to judge how far along they are “with their idea.” The most telling question is, “Can you give me the names of prospective customers?” Their answer must be very specific. If they have a consumer product—let’s say it’s a new shampoo—I expect them to be able to name buyers at different chains of drugstores in their area. If they are unable to name several customers imme- diately, they simply have an idea, not a market. There is no market unless cus- tomers have a real need for the product—a proven need rather than a hypothetical need in the mind of a would-be entrepreneur. In a few rare cases, it may be a revolutionary new product, but it is much more likely to be an existing product with improved performance, price, distribution, quality, or service. Simply put, customers must perceive that the new business or
The idea per se is not what is important. Ideas are a dime a dozen. Developing the idea, implementing it, and building a successful business are the important aspects of entrepreneurship.
16 The Entrepreneurial Process
gather the resources they will need. Rushing to open a business without ade- quate planning can lead to costly mistakes.
The Entrepreneur and the Management Team
Regardless of how right the opportunity may seem to be, it will not make a successful business unless it is developed by a person with strong entrepre- neurial and management skills. What are the important skills? First and foremost, entrepreneurs should have experience in the same industry or a similar one. Starting a business is a very demanding undertaking indeed. It is no time for on-the-job training. If would-be entrepreneurs do not have the right experience, they should either go out and get it before starting their new venture or find partners who have it. Some investors say that the ideal entrepreneur is one who has a track record of being successful previously as an entrepreneur in the same industry and who can attract a seasoned team. Half of the CEOs of the Inc. 500 high- growth small companies had started at least one other business before they founded their present firms. When Joey Crugnale acquired his first ice cream shop in 1977, he already had almost 10 years in the food service industry. By 1991, when Bertucci’s brick oven pizzeria went public, he and his management team had a total of more than 100 years experience in the food industry. They had built Bertucci’s into a rapidly growing chain with sales of $30 million and net income of $2 million. Without relevant experience, the odds are stacked against the neophyte in any industry. An electronics engineer told me that he had a great idea for a chain of fast-food stores. When asked if he had ever worked in a fast-food restaurant, he replied, “Work in one? I wouldn’t even eat in one. I can’t stand fast food!” Clearly, he would have been as miscast as a fast-food entrepreneur as Crugnale would have been as an electronics engineer. True, there are entrepreneurs who have succeeded spectacularly with no prior industry experience. Anita Roddick of The Body Shop and Ely Callaway of Callaway Golf are two notable examples. But they are the exceptions that defi- nitely do not prove the rule. Second to industry know-how is management experience, preferably with responsibility for budgets, or better yet, accountability for profit and loss. It is even better if a would-be entrepreneur has a record of increasing sales and profits. Here, we are talking about the ideal entrepreneur. Very few people measure up to the ideal. That does not mean they should not start a new ven- ture. But it does mean they should be realistic about the size of business they should start. Fifteen years ago, two 19-year-old students wanted to start a
Evaluating Opportunities for New Businesses 17
travel agency business in Boston. When asked what they knew about the indus- try, one replied, “I live in California. I love to travel.” The other was silent. Neither of them had worked in the travel industry, nor had anyone in either of their families. They were advised to get experience. One joined a training pro- gram for airline ticket agents; the other took a course for travel agents. They became friends with the owner of a local Uniglobe travel agency who helped them with advice. Six months after they first had the idea, they opened a part- time campus travel agency. In the first six months, they had about $100,000 of revenue and made $6,000 of profit but were unable to pay themselves any salary. They acquired experience at no expense and at low risk. Upon gradua- tion, one of them, Mario Ricciardelli, made it his full-time job and continued building the business and gaining experience at the same time. In 2001, after many bumps in the road, the business had sales revenue of $22.1 million and was one of the largest student travel businesses in the world.
Resources
It’s hard to believe that Olsen and Anderson started DEC with only $70,000 of startup capital and built a company that at its peak ranked in the top 25 of the Fortune 500 companies. “The nice thing about 70,000 dollars is that there are so few of them, you can watch every one,” Olsen said. And watch them he did. Olsen and Anderson moved into a 100-year-old building that had been a nineteenth-century woollen mill. They furnished it with second-hand furni- ture, purchased tools from the Sears catalog, and built much of their own equipment as cheaply as possible. They sold $94,000 worth of equipment in their first year and made a profit at the same time—a very rare feat for a high- tech startup. Successful entrepreneurs are frugal with their scarce resources. They keep overheads low, productivity high, and ownership of capital assets to a minimum. By so doing, they minimize the amount of capital they need to start their business and make it grow.
Entrepreneurial frugality includes:
- Low overhead
- High productivity
- Minimal ownership of capital assets
Determining Resource Needs and Acquiring Resources 19
its own manufacturing plant and equipment. Nor does it have to worry about re- cruiting and training production workers. Often, it can keep overhead lower by using outside firms to do work such as payroll, accounting, advertising, mailing promotions, janitorial services, and so on. Even startup companies can get amazingly good terms from outside suppli- ers. An entrepreneur should try to understand the potential suppliers’ marginal costs. Marginal cost is the cost of producing one extra unit beyond what is presently produced. The marginal cost of the laborers who gutted Milstein’s building while sheltering from the rain was virtually zero. They were being paid by another firm, and they didn’t have to buy materials or tools. A small electronics company was acquired by a much larger competitor. The large company took over the manufacturing of the small company’s prod- ucts. Production costs shot up. An analysis revealed that much of the increase was due to a rise in the cost of purchased components. In one instance, the large company was paying 50% more than the small company had been paying for the same item. It turned out that the supplier had priced the item for the small com- pany on the basis of marginal costs and for the large company on the basis of total costs. Smart entrepreneurs find ways of controlling critical resources without owning them. A startup business never has enough money. It should not buy what it can lease. It must be resourceful. Except when the economy is red hot, there is almost always an excess of capacity of office and industrial space. Sometimes a landlord will be willing to offer a special deal to attract even a small startup company into a building. Such deals may include reduced rent, deferral of rent payments for a period of time, and building improvements at low cost or even no cost. In some high-tech regions, there are landlords who will exchange rent for equity in a high-potential startup. When equipment is in excess supply, it can be leased on very favorable terms. A young database company was negotiating a lease with IBM for a new minicomputer when its chief engineer discovered that a leasing company had identical secondhand units standing idle in its warehouse. It was able to lease one of the idle units for one-third of IBM’s price. About 18 months later, the data- base company ran out of cash. Nevertheless, it was able to persuade the leasing company to defer payments, because by then there were even more minicomput- ers standing idle in the warehouse, and it made little economic sense to repossess one and add it to the idle stock.
Startup Capital
You have reached the point where you have developed your idea; you have carefully assessed what resources you will need to open your business and
20 The Entrepreneurial Process
make it grow; you have pulled all your strategies together into a business plan; and now you know how much startup capital you will need to get you to the point where your business will generate a positive cash f low. How are you going to raise that startup capital? There are two types of startup capital: debt and equity. With debt you don’t have to give up any ownership of the business, but you have to pay current interest and eventually repay the principal; with equity you have to give up some of the ownership to get it, but you may never have to repay it or even pay a dividend. So you must choose between paying interest and giving up some of the ownership. What usually happens, in practice, depends on how much of each type of capital you can raise. Most startup entrepreneurs do not have much f lexibility in their choice of financing. If it is a very risky business without any assets, it will be impossible to get any bank debt without putting up some collateral other than the business’s assets—most likely that collateral will be personal assets. Even if entrepreneurs are willing to guarantee the whole loan with their per- sonal assets, the bank will expect them to put some equity into the business, probably equal to 25% of the amount of the loan. The vast majority of entrepreneurs start their businesses by leveraging their own savings and labor. Consider how Apple, one of the most spectacular startups of all time, was funded. Steven Jobs and Stephan Wozniak had been friends since their school days in Silicon Valley. Wozniak was an authentic computer nerd. He had tinkered with computers from childhood, and he built a computer that won first prize in a science fair. His SAT math score was a perfect 800, but after stints at the University of Colorado, De Anza College, and Berkeley, he dropped out of school and went to work for Hewlett-Packard. His partner, Jobs, had an even briefer encounter with higher education: After one semester at Reed College, he left to look for a swami in India. When he and Wozniak began working on their microcomputer, Jobs was working at Atari, the leading video game company. Apple soon outgrew its manufacturing facility in the garage of Jobs’ parents’ house. Their company, financed initially with $1,300 raised by selling Jobs’ Volkswagen and Wozniak’s calculator, needed capital for expansion. They looked to their employers for help. Wozniak proposed to his supervisor that Hewlett-Packard should produce what later became the Apple II. Perhaps not surprisingly, he was rejected. After all, he had no formal qualification in com- puter design; indeed, he did not even have a college degree. At Atari, Jobs tried to convince founder Nolan Bushnell to manufacture Apples. He too was rejected. However, on the suggestion of Bushnell and Regis McKenna, a Silicon Valley marketing ace, they contacted Don Valentine, a venture capitalist in the fall of 1976. In those days, Jobs’ appearance was a hangover from his swami
