Models of Entrepreneurship and the Entrepreneur

I've been meaning to write this post for a while. Part of this blog is going to be space for me to put down ideas that get kicked around in my head, hopefully a bit more coherently than I find them there.

This post has been simmering for a while and has to do with entrepreneurship, and more generally the concept of being self-employed.

The entrepreneur is a distinctly American archetype. It traces its roots back to the pioneers moving westward, pushing through hardships unimaginable to most of us today. It is the idea that by hard work and determination, an individual can carve out an existence on his own terms, rather than having his livelihood subject to existing structures out of his control. It is possible to argue to what extent these ideals exist and are achievable in the real world, but we will take them for granted in this discussion.

It is useful to think of three different paths of entrepreneurship, each with its own advantages and disadvantages. While these categories are generally more distinct in theory than in practice, they provide a useful way of understanding the concepts. Here are the three approaches:

* Franchise method. Simplest approach. Takes an existing business model and copies. May add some unique elements but in general can be described as "cookie-cutter." E.g. McDonalds.

* Bootstrap method (BM). Organic approach. Builds a business model from the ground up based on constantly changing environment. Relies primarily on growth to finance expansion. Describes the majority of small and medium sized businesses.

* VC method (VC). VC is most common in hi-tech arenas that require large amounts of startup capital (e.g. biotech). Can be used at various stages of a business as well. Primary focus is the exit strategy.

I want to concentrate more on the BM and VC methods, as I see the Franchise method as pretty much self-explanatory.

BM ventures are grown from the ground up. While there usually is (and should be) a business plan, a bootstrapped venture tries to respond to changes in the business environment in real time.

The VC venture is similar in this respect has a small but critical constraint that a BS venture does not: Time. Rather a lack thereof.

Most firms that get VC funding started out as BM venture, and grew to the point where VC was a viable option. When firms reach this level, there are some crucial decisions to be made about the future of the business. These decisions are about more than just the direction of the business, they are also of existential import to the entrepreneur himself.

Here’s why: At the point in time where venture capital enters the picture the game changes drastically.

A typical venture cap fund is financed by a group of large, institutional investors. The fund is run by a handful of partners, usually entrepreneurs previously successful in the field.

A typical VC fund has a 10-year lifespan. This means that a company getting venture cap funding has 3-7 years to generate the large returns necessary to generate a profit.

Put another way, a venture cap fund looks to profit off its investment at the end of a set time frame, not necessarily when the business itself is viable or has intrinsic value.

While the entrepreneur clearly cares about making money, by going the route of a VC he abdicates his position as the sole decider of the direction of the business. Part of the venture cap deal is that the funding does not come in a vacuum. Fund managers are former entrepreneurs and operational experts for a reason, and they exist to help manage the companies in their portfolio. They'd be crazy not to.

However, the recent phenomenon of tech companies that are essentially worthless by traditional valuation being sold for fortunes has changed the strategy of venture cap funds over the last 5-7 years (think Google's acquisition of Youtube). These massive paydays have encouraged VCs to position companies in their portfolio for one-time acquisitions rather than build a diversified portfolio of performing companies that develop truly breakthrough technologies. This phenomenon is well documented by Carl Schramm and Harold Bradley over at BusinessWeek (hat tip to Ade).

This critique isn’t meant to completely discount the VC approach, but I do think there is something personally fulfilling for the entrepreneur to be free to pursue the company as an end in itself, rather than as an entry in someone else’s ledger. I think there is also plenty to say on how to refocus venture cap, but I'll leave that for another day.