Chapter 2: Financial Capital vs. The Entrepreneurs

More than often, when I try to motivate undergraduate, and executive students toward entrepreneurship, they complain about the lack of capital, which they argue is necessary to start a business. Asking for capital without experience, without necessary execution skills, without a workable idea, etc., is like asking for a sports car, without knowing how to drive (in traffic in particular), and without knowing where to go. Even a layman can anticipate what would happen eventually. My doctoral research, my experience of working with entrepreneurs, and previous literature suggest that access to capital from an institutional investor, in particular, can do more harm than good for inexperienced entrepreneurs (angle investment is a better option, but please wait for a moment). This may sound counterintuitive, particularly when traditional textbooks on entrepreneurship tell you to make a business plan to convince a bank or a VC when the government. initiatives exclusively talk about the investment to promote entrepreneurship, and when every incubation center incubates its start-ups to make them look attractive to potential investors. Money is generally believed to be the most important ingredient of an entrepreneurial process.

Experience and recent research on real entrepreneurs suggest otherwise. The availability of cash coupled with inexperience or immaturity often leads to unproductive expenditure. Wasting money on lavish office space and unnecessary staff are common examples. It typically requires sufficient experience, emotional maturity, and wisdom to see which of the running or fixed expenses can lead to positive cash flow. Even if the expenses are meticulously managed, customer behavior is often unpredictable, so major changes in the imagined-value-proposition are often required to find the correct sweet spot. So the cash flow may not emerge as mentioned in the business plan, this may increase the chance of failure if a chunk of investment money is already spent on unnecessary ego-boosting stuff. Every act which may end up inflating the ego, like impressing investors or setting up a nice office space, can reduce the possibility of success.

Contrary to inflating their ego, entrepreneurs need the humility of a Level Five Leader (see Jim Collins), and agility to quickly adapt to changing market scenarios or new market insight. Traits like Humility, and agility unfortunately do not emerge when you take a route toward institutional investment with a business plan in your hand. Humility can be misinterpreted as a sign of weakness by the investors. Further, an investor’s overarching influence may even cripple the ability to rapidly adapt to developing scenarios. Agility is dependent on strong intuition (see Ricardo Semler, and Nick Hauner), as there is often not enough time to scientifically gather data, and perform complex data analysis before making a decision (let alone the accuracy of the scientific process). However, using intuition is also counterintuitive for institutional investors who only understand the language of scientific analysis. Therefore, there is a heavy unquantifiable price to pay to attract investment, which often cripples an entrepreneur’s ability (humility to accept mistakes, agility, and intuition to quickly adapt) to walk on an unpredictable-nonlinear spiral-like path of establishing a venture.

What to do?

Sara Sarasvathy, Carl Schramm, Ricardo Semler, Jim Collins, Alexander Osterwalder, Steve Blank, David Gerber (just to name a few), my doctoral research, and experience with entrepreneurs in Pakistan suggests an alternative route. To begin with, it is fundamentally necessary to gain industry experience, execution skills, emotional maturity, and wisdom. Or start something which one can manage with an available set of skills. The best way to gain the necessary experience according to Jack Ma (Founder Alibaba) is to work for a few years for a small or medium-sized business under a good boss. Carl Schramm, entrepreneur, and former chairman of Kauffman Foundation, also shares his similar observation in his book ‘Burn the Business Plan’. This is a standard practice among Ethnic Entrepreneurial Communities (EEC) like Memon, Delhiwala, Chinioti, Bohri, or Ismaili. So before worrying about finding investment at first, potential entrepreneurs need to worry about how much experience they have. If more than one partner intends to start a business, some of them need to have the necessary market experience and execution skills.

It is interesting to note that the age of successful entrepreneurs in the USA is between 42 to 46 years (Ref. World Economic Forum). By this time they have already worked for someone, developed their network (another fundamentally important resource), gained necessary skills, and experience, gained market knowledge, industry insight, and realized a potential market gap that needs to be filled. Carl Schramm even argues that big firms are the best incubators for new start-ups, while actual incubators in Schramm’s view have done more harm than good to the growth of entrepreneurship. Real growth requires real stressors according to Nassim Nicholas Taleb, which an entrepreneur experiences in real market conditions, while a cozy, and protective atmosphere inside typical business incubation centers may do otherwise.

So it is best to grow organically (slow, and steady) while getting exposed to the heat in a real market environment, while bootstrapping, reinvesting your profits, or at the least involving an angel investor only after you have stabilized the new venture. For example, if you want to locally manufacture UPS, and have the necessary technical skills at hand, but no market experience or capital, it is better to start with offering a repair service in a freelancing capacity. Establish a customer base gradually, and add the option of retailing an already available product to your clientele, if you don’t have space to open a shop, selling online would do. The goal is to expand your customer base and establish trustable relationships with them. Once there are enough customers, you may think of backward integration by assembling the UPS, and then proceed toward manufacturing components one by one. This entire process may take 5 to 10 years. So the idea is to start simple, move slowly, while gaining experience, just like a plant grows naturally, spreading its roots deep in the ground, and gradually increasing in the complexity of operations as your experience, skills, maturity, market knowledge grows. Community networks with high social capital (typically found in EEC) are perhaps the best natural, and conducive environments to grow a venture through bootstrapping.

It is good to have a mentor to seek advice to avoid major pitfalls during a bootstrapping process; however, mentors have their limitations. Can an experienced driver give you instructions on the phone every second about how to drive a sports car in traffic, when you don’t have much experience yourself? Would you be successful in reaching your destination? It is not very difficult to answer this question. If you are lucky enough to find an honest-concerned-mentor, he or she may give you some broad guidelines, help you set your direction, and align your steps. But you will have to figure out the micro details in your daily routine yourself, and it is in these details where you see the dance of the devil (referring to the idiom: ‘the devil is in the detail’). Mentors advise, or advice from books on entrepreneurship, etc. can help to an extent. How many books will be required to learn the skill to survive in the wild like Bear Grylls (host of the Discovery TV show: Man vs. Wild)? According to Richard Branson, it is better to work for an expert as a helper to learn the desired skills. Once the skills are acquired, books my help.

Mentors are often busy people, you will be lucky to catch an hour every week with them. However working for a boss who is interested in developing your skills is a better alternative, as mentioned above. There is a saying in Urdu that ‘kharbooza kharboze ko dekh ke rung pakarta hai’, so if you have five friends for example, who are entrepreneurs, then your chances of ending up as an entrepreneur are high. I believe that members of EEC are not born entrepreneurs, it’s just they see so many entrepreneurs around them while they grow up, and when they see a few failures in their circle, their orientation often shifts towards building a career as a professional, working for someone else.

Your immediate, and extended circle is perhaps a greater resource than capital. As from this network, if you have the right kind of connections, you do not just take aspirations, and advice, but also find your first customers, suppliers, employees, even angel investors. Such utilization of resources in one’s network is common in EEC. If your network does not give you access to such stakeholders it is better to work hard in upgrading your network, even if you have sufficient capital in your pocket. Your network in actual is your net worth (see Porter Gale). Building it however takes years, as people who would like to become your first customers, suppliers, or even angel investors must already consider you a credible person having sufficient potential. That’s where spending time in the market becomes fundamental, which should start at the age of 14, and above so that when you complete your education you already have sufficient experience, and connections with the right people to start something on your own. This practice is already common among members of EEC, where children spend their free time in their father’s or relative’s business particularly during their summer vacations. Contrarily job oriented families see it as a hindrance in receiving a proper education to secure a job that may not exist. (Space constraints limit me to share more, please see my articles on LinkedIn for further discussion)

Financial Capital vs. Innovative Ideas

To experiment with any new kind of innovation, one must already have a running business. Contrarily, what Mark Zuckerberg did is not normal. One has to be extremely lucky to hit a jackpot as 99.9999% entrepreneurs who start their business, do not follow the route which the likes of Zuckerberg have been able to take. Unfortunately most people in the modern start-up culture attempt to follow the line. The trend is even endorsed by financial markets resulting in start-ups that are only created to be sold to an investor or attract multiple series of investments. The value proposition is created less for the end-user, and more for the investors. It is typically the IT-based ventures which focus on gathering as many users as possible by providing something of entertainment value (FaceApp is a recent example). The number of users on their app or website thus determines the worth of their venture. Often the service is provided free of cost or at subsidized rates to get as many customers as possible. The money is not made through selling a product or a service, but by finding the next series of investments. Every new investor bails out the previous one. Uber and Twitter for example are still not in profit as of now, while their shareholders earn through capital gains only. Such unicorns blur the difference between a stock market, and a casino. The trend, unfortunately, has corrupted new venture creation according to Tim O’ Reilly (the man behind the terms ‘Open Source’, and ‘Web 2.0’) as many start-ups now focus on creating a huge user base without providing meaningful value. As a result, impending societal problems that prevail in our food chain, health care industry, or global problems like climate change, etc. remain ignored by typically by new entrepreneurs or investors. Chamath Palihapitiya, CEO of Venture Firm ‘Social Capital’ is another concerned voice, who now only invests in ventures which create genuine value for the public by addressing the impending societal issues.

Pakistan’s emerging entrepreneurial ecosystem is also not free from the potentially-corrupting influence of venture funds. Almost every incubation center in the country expects its start-ups to exit after being acquired by an investor. Acquisitions are often celebrated; despite they lead markets toward a more monopolistic, and less competitive environment (example: Careem’s acquisition by UBER). While many entrepreneurs seek investment after stepping into the bandwagon, without realizing that in the USA less than 0.1% of ventures receive VC (as per a report on Forbes). One can imagine if the trend to seek venture funds is further ingrained in the minds of aspiring Pakistani entrepreneurs, the short supply of funds (let alone its possible corrupting influence) will do more harm than good in promoting the culture of entrepreneurship in the country. This trend has hijacked even the meaning of the term entrepreneurship, so much so that those who create ventures delivering superficial value to their users just to make an exit or getting hooked with a VC, are now only referred to as entrepreneurs. The influence of financial capital has shifted the focus of entrepreneurs from innovating for the end-users to innovating for the financial market only (see Tim O’ Reilly’s book ‘What’s the Future’, and Jaron Lanier’s ‘Who Owns the Future’ for details). This trend must not continue.

Entrepreneurs must create real value for real users. This perhaps is only possible if entrepreneurs keep a distance from the influence of financial markets. Staying away from the institutional investment is also beneficial for operational reasons as well as explained earlier. Growing organically while bootstrapping, and gradually increasing the complexity of the operations is perhaps the appropriate way. Innovative ideas emerge from the combination of real-time interaction with the customers, market intelligence, and intuition grounded in a real-time experience. But for that, one should already be operating in the market for a few years. It is perfectly alright to start a traditional business as the goal should be to establish oneself in the market with the available resources. Once a cash-cow has been developed, you have the luxury to experiment on an innovative idea.

But why innovate in the first place. If the goal is to attract more customers, then please note that winning customers in the Pakistani market can be best done through superior customer service, as Pakistani customers typically fancy respectful treatment. By making your customer feel special you can beat the competitors in almost every market domain. Interestingly, to make customers feel special, and give them due respect doesn’t cost a dime. You just need to know how to talk respectfully and deliver a little more than you promise. Employees can be won likewise.

Innovation must only be pursued if an entrepreneur is genuinely interested in improving a certain aspect of customer experience or solving an unsolved problem in society. Carl Schramm argues that innovators are mission-oriented, and do not do it for money. They have an urge to create a better world by contributing their bit. They are rewarded nevertheless by customers for creating value. So to innovate, you must genuinely consider the wellbeing of your target audience as supreme, and your self-interest as secondary. That doesn’t imply giving products or services for free. You can sell for a profit to ensure the sustainability of your venture, and improve your capacity to take your proposition to a wider audience.

Nassim Nicholas Talib argues that creating a genuine innovation takes years of customer or user feedback; often it takes decades of refinement which results in the creation of a better solution to a prevailing problem, more so if multiple entrepreneurs compete in the process. This is seldom possible while ensuring interest in financial markets for the reasons mentioned above. There are hidden costs or side effects behind innovations that sometimes surface after many years, like the influence of burning fossil fuels on the climate or impact of plastics on the food chain. These side effects or their costs eventually decide the future of innovation. However, if the interest of the financial market gets hooked with an insidious innovation, they try their level best to obscure the knowledge of side effects or suppress innovations. Genuinely beneficial innovations with no hidden costs therefore can come from competing entrepreneurs engaged with real customers under no influence of financial markets. That’s the kind of entrepreneurial environment we need to produce in Pakistan.