Cardiff de Alejo Garcia

How entrepreneurs differ, and how they don't

My cover story in this month's APS Observer looks at some of the research on entrepreneurial psychology. For those in too much of a hurry to read the whole thing, here's the conclusion (with a few typos fixed):

In some ways, the Schumpeterian view of entrepreneurs — as ruthless, risk-defying capitalist superheroes with ambitions as big as their outsized egos — persists. For the latest example of this approach, one need look no further than how Mark Zuckerberg is fictionally portrayed in The Social Network, a new movie about the origins of Facebook: He is brilliant, backstabbing, arrogant, and innovative. And certainly some entrepreneurs do fit this mold.

But with more than 550,000 new firms opening in the US each year, it’s obvious that only a tiny percentage of startups ever become global phenomena like Facebook — and most entrepreneurs are nothing like the Zuckerberg of the movies. As Shaver has labored to prove, it’s time to do away with much of the stereotypical personality sketch.

That doesn’t mean, however, that we should ignore all personal characteristics in evaluating potential entrepreneurs. It is just that the relevant characteristics have more to do with how equipped someone is to endure the rigors of entrepreneurship than with personality. Consider what the studies have found, beginning with how entrepreneurs are similar to everyone else. Entrepreneurs are no more likely to care about money. On average, they are no more ruthless than non-entrepreneurs, or any more spontaneous. They should not be portrayed as either gooey optimists or control freaks. They do not crave risk more. They’re not more outgoing or agreeable. And they don’t have a magical problem-solving approach that’s denied to the rest of us.

Shaver likes to emphasize how important it is for more people to realize this. Psychological perceptions matter. A young college grad with a big idea who thinks he lacks the personality to create a business should reconsider. So should venture capitalists and financiers who think they can instantly distinguish a winner from a loser during a first meeting. This is nonsense, as the ways in which entrepreneurs differ are mostly unrelated to the kinds of personality features that can be observed in such a manner.

But (and this is a large but) the few psychological differences that entrepreneurs do have are crucial ones. The PSED found that entrepreneurs are more willing to sacrifice other parts of their lives for their ventures. Their lives are less balanced and more heavily oriented towards their work. They care a lot less what others think of them. Shaver believes this is because entrepreneurs find their primary validation in the success of their businesses. No wonder that entrepreneurship attracts people who both expect to succeed and are better able to cope with the stress and rigors it brings. Starting a business can be grueling and full of uncertainty, and it will exact too heavy a cost on people unable or unwilling to throw themselves at the process.

Maybe, then, the right lesson to draw from the research is that more people than we think are capable of starting and running new businesses, but there are good reasons why not all of them will — or should — try.

Taleb, debt, young people, and entrepreneurship

We currently learn in business schools to engage in borrowing (by the same professors who teach the Gaussian bell curve, that Great Intellectual Fraud, among other pseudosciences), against all historical traditions, when all Mediterranean cultures developed through time a dogma against debt. Felix qui nihil debet goes the Roman proverb: “Happy is he who owes nothing.” Grandmothers who survived the Great Depression would have advised the exact opposite of debt: redundancy; they would urge us to have several years of income in cash before taking any personal risk—exactly my barbell idea of Chapter 11, in which one keeps high cash reserves while taking more aggressive risks but with a small portion of the portfolio. Had banks done that, there would have been no bank crises in history. ...

Debt implies a strong statement about the future, and a high degree of reliance on forecasts. If you borrow a hundred dollars and invest in a project, you still owe a hundred dollars even if you fail in the project (but you do a lot better in the event you succeed). So debt is dangerous if you have some overconfidence about the future and are Black Swan blind, which we all tend to be. And forecasting is harmful since people (especially governments) borrow in response to a forecast (or use the forecast as a cognitive excuse to borrow). My Scandal of Prediction (i.e., bogus predictions that seem to be there to satisfy psychological needs) is compounded by the Scandal of Debt: borrowing makes you more vulnerable to forecast errors.

That's from a new essay in the second edition of Nassim Taleb's The Black Swan. 

Provocative stuff, and Taleb's rationale against debt at the macroeconomic level is interesting.  Globalization---the increased flow of goods, capital, and people across borders---has already levered up the world economy in a sense, by making it vastly more efficient.  But this interconnectedness has also made it highly susceptible to the kinds of acute, negative shocks that would be contained locally in a less connected world.  So, for instance, a sovereign debt crisis in Greece might contribute meaningfully to a double-dip recession in the US (maybe). 

Fine. He takes this a bit too far, but his basic point about the systemic dangers of excess leverage seems correct---and it's an old lesson we keep forgetting.

But I think Taleb's advice that individuals should have big savings before taking personal risk has to be qualified.  Specifically, young people with an entrepreneurial bent should ignore it completely, as that kind of caution leads to worse outcomes both for them and for society.

Taleb is no fool: he's a proponent of experimentation and entrepreneurship, which is similar to book publishing in that it's impossible (or nearly impossible) to predict either which idea will be a big hit or the extent of its impact.  In other words, the whole point is to make it possible to capitalize on a positive Black Swan.  It's just that Taleb wants this kind of personal risk to be taken with a small part of an individual's portfolio so that he or she is "robust" to failure.  

Unfortunately, this would eliminate most people in their early twenties from the pool of potential entrepreneurs.  These are people who tend to finish college without a whole lot in the bank.  They can't take personal risk with only a small part of their portfolio because they have no portfolio.

But look.  If a bunch of 23-year-olds with few personal assets choose to max out their credit cards while starting a company in their garage, the worst thing that happens if the project fails is they get wiped out and declare bankruptcy.  In the meantime, they've picked up some valuable skills and remain young enough to bounce back from whatever damage was done to their credit rating, reputation, etc..

This kind of risk-taking, even when it involves debt, is good for young people, especially in an ideas-based economy where the commodified jobs of the past are less safe than they used to be.  As Paul Graham, who invests in companies founded by twenty-somethings for a living, writes:

Your early twenties are exactly the time to take insane career risks...it's not necessarily a mistake to try something that has a 90% chance of failing, if you can afford the risk. Failing at 40, when you have a family to support, could be serious. But if you fail at 22, so what? If you try to start a startup right out of college and it tanks, you'll end up at 23 broke and a lot smarter. Which, if you think about it, is roughly what you hope to get from a graduate program.   

More often than not, starting a company means incurring debt.  And a society that fosters this kind of risk-taking, for instance through lenient bankruptcy laws, makes for a more dynamic economy.  Nor does it increase the "fragility" of the young people who borrow the money, as Teleb worries; in many cases, quite the opposite. 

So for these kinds of ventures, I think the primary responsibility to diversify and be cautious belongs to the institutions doing the lending and investing, as they would be wise not to expose too much of their portfolio to any single risky project.  Which is something they already know anyway, or should know.

There are no entrepreneurs, only people who do entrepreneurial things

That's the conclusion I take away from Tim Harford's column in last week's FT:

There is some evidence that personality matters, although the data do not always reinforce the entrepreneurial stereotype. Djankov and his colleagues find that entrepreneurs tend to be more patient and more intelligent. There was no evidence that entrepreneurs were more confident than non-entrepreneurs, and entrepreneurs actually seem to be more averse to taking risks. Separate research by Djankov and different colleagues suggests that low taxes and efficient regulations are hugely important in encouraging the overall prevalence of new businesses.

Other variables associated entrepreneurial careers are access to capital and a tradition of entrepreneurship within one's family.

Women, tech companies, and startups

Women own 40 percent of the private businesses in the United States, according to the Center for Women’s Business Research. But they create only 8 percent of the venture-backed tech start-ups, according to Astia, a nonprofit group that advises female entrepreneurs.

That disparity reaches beyond entrepreneurs. Women account for just 6 percent of the chief executives of the top 100 tech companies, and 22 percent of the software engineers at tech companies over all, according to the National Center for Women and Information Technology. And among venture capitalists, the population of financiers who control the purse strings for a majority of tech start-ups, just 14 percent are women, the National Venture Capital Association says.

That's from this article in the New York Times, which links to a lot of interesting research.  Here's another example:

Research indicates that investing in women as tech entrepreneurs is good for the bottom line. Venture-backed start-ups run by women use, on average, 40 percent less capital than start-ups run by men and are increasingly involved in successful initial public offerings of stock, according to a recent white paper by Cindy Padnos, a venture capitalist who compiled data from 100 studies on gender and tech entrepreneurship.

Two types of startups

From Paul Graham, whose irregularly published columns are always worth reading:

There are two types of startup ideas: those that grow organically out of your own life, and those that you decide, from afar, are going to be necessary to some class of users other than you. Apple was the first type. Apple happened because Steve Wozniak wanted a computer. Unlike most people who wanted computers, he could design one, so he did. And since lots of other people wanted the same thing, Apple was able to sell enough of them to get the company rolling. They still rely on this principle today, incidentally. The iPhone is the phone Steve Jobs wants.

Our own startup, Viaweb, was of the second type. We made software for building online stores. We didn't need this software ourselves. We weren't direct marketers...

There is no sharp line between the two types of ideas, but the most successful startups seem to be closer to the Apple type than the Viaweb type. ...

So if you want to come up with organic startup ideas, I'd encourage you to focus more on the idea part and less on the startup part. Just fix things that seem broken, regardless of whether it seems like the problem is important enough to build a company on. ...

Don't be discouraged if what you produce initially is something other people dismiss as a toy. In fact, that's a good sign. That's probably why everyone else has been overlooking the idea. ...

Read the whole thing here.