Conservative entrepreneurs

I want to hate Malcolm Gladwell, but then he writes something interesting enough that I have to grudgingly like  his work again. As with all of his work, though, the good and important stuff needs to be parsed out of his articles, which share with his books the tendency to over-inflate a point, or keep making it with the wrong examples.

In this case, I’m talking about his piece in the January 18 edition of the New Yorker (not yet online, but there’s an abstract available) called “The Sure Thing.” His thesis is that entrepreneurs are not the swashbuckling risk-takers that they’re believed to be in the popular culture. They’re actually quite conservative, minimizing risk wherever possible and carefully exploiting their greater expertise or knowledge in deal-making. Gladwell’s point, I believe, is that it’s important to understand these behaviors from a public-policy perspective because if policy makers (and boards of directors, managers and educators) want to increase entrepreneurialism, they shouldn’t incentivize risk-taking per se to get it.

Where Gladwell goes wrong in his article is using John Paulson, the hedge-fund manager who famously bet on the housing price collapse in 2007 and 2008, as a prime example of his thesis. Paulson is no entrepreneur: he’s a trader who made a very successful bet with a strategy that had better downside protection than most short, negative-carry bets. He didn’t build a business, create new value or new job or add to the sum of wealth in the economy–he transferred money from losers on the trade to his investors and himself.

But he’s dead on with the story of Ted Turner, and how he built his media empire not through high-stakes gambles, but by having a vision of how to build his business, picking the battles to fight and going into those battles with as much certainty of the outcome as he could create.

Gladwell’s article would have been much stronger and more prescriptive if he had defined what he meant by “entrepreneur” and extended his observations to the less visible entrepreneurs in the economy. That would have helped with his diagnosis of what went wrong with Wall Street and banks, how CEOs should be compensated, and would have let him make even better recommendations for encouraging true, productive entrepreneurship in the economy.

So what is an entrepreneur? I like Wikipedia’s definition with one important caveat:

a person who has possession of a new enterprise, venture or idea and assumes significant accountability for the inherent risks and the outcome.

The key terms are “possession,” “new” and “significant accountability,” with the stipulation that the last point should explicitly include the risk of significant financial and/or reputational losses. The entrepreneur needs real skin in the game! I also believe that the new “enterprise, venture or idea” should be one that creates new wealth and value in the economy, including adding new jobs.

This definition excludes John Paulson (who was already wealthy, didn’t have his personal wealth on the line in the trade, and didn’t create new wealth in the economy) but includes everyone from Ted Turner to those who build a new chain of restaurants. It also excludes sole proprietor and small family businesses, which I’d count as “self-employment” rather than true entrepreneurship. I also don’t count most of Silicon Valley startups and their leaders as entrepreneurs for reasons I’ll elaborate on in another post.

So what does this mean for people setting public and managerial policies? Entrepreneurs create new jobs; presumably so does entrepreneurial management within larger companies. How do you get more of that? Here’s my first cut as some prescriptions.

  1. Get out of the way: Neither government, boards of directors or even distant managers should try to overdetermine outcomes. Entrepreneurs need latitude to find advantage and opportunities in a marketplace where commercial value can be found and exploited. Goal-setting works; “industrial policy” rewards game-playing.
  2. Give them something to work with…: As Gladwell observes, undercapitalized businesses, startups (vs. acquiring and improving an existing business) and poor planning result in failure–in unsuccessful entrepreneurs. Policy makers should make sure entrepreneurs have what they need without being too prescriptive (see point 1). Education is important, for sure. But what about making it easier to pass on a family business to an ambitious member of the next generation? In lieu of estate taxes that might be paid on a business being passed down to heirs, the Federal government (via the SBA) could provide personal loans to children who have worked in the business for at least five years and want to continue to operate it. The interest on the loan would balance out the loss from the estate tax and the company stays with a knowledgeable, ambitious operator.
  3. …but make sure there’s skin in the game: As I said, entrepreneurs must have something to lose–that makes them conservative about the downside and work hard for the upside. The advantage of the personal loan in lieu of estate tax scheme in point 2 is that the child is making a personal commitment and is on the hook for the loan. This also applies to corporate managers. Rather than issue stock options to CEOs (all upside reward, no downside risk) or restricted stock (which is still a grant of value, even if it declines), CEOs should be required to invest a significant portion of their personal wealth into any company they run. The board can juice the upside with matching options or warrants, but the CEO should have a lot to lose.
  4. Don’t throw money at the problem. Trying to make another Silicon Valley doesn’t work. Frankly, Silicon Valley doesn’t work as well as it used to, or as well as people think it does now as an engine of transformative wealth and value creation. Yes, amazing companies come out of the Valley and it’s the envy of the world. But I’d argue (and will, like I said) that the venture-backed startup culture is very different from an entrepreneurial one, so investing in that model is doomed to fail.
  5. Mitigate the catastrophic personal consequences of failure: Entrepreneurs (and CEOs, companies and entire industries) should be allowed to fail and go bankrupt, fortunes can be lost. Our culture in the US does a very good job of supporting this failure and these consequences keep the entrepreneurs focused on good risk assessment. But public and managerial policy can reduce some of the worst outcomes so entrepreneurs can focus on the business. Failed entrepreneurs shouldn’t lose their kids’ access to health care, so whether that means portable, affordable non-employer based insurance, a buy-in to Medicare or some comparable policy, there needs to be some way to minimize that kind of personal collateral damage.

That’s my first whack at entrepreneurial public policy. In the future, I’ll elaborate and extend on some of these points, particularly around creating incentives for good performance.

One thought on “Conservative entrepreneurs

  1. Pingback: How to Fix Executive Pay: Get Skin in the Game « El Jefe readMedia

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