Yearly Archives: 2013

Entrepreneurs and global wealth since 1850 – Part II

Entrepreneurs are the “missing gap” in the analysis of national wealth and innovation, according to Geoffrey Jones’s book, in which he suggests that current dominant explanations of global wealth and poverty tend to focus more on deficient institutions, poor human capital development, geography, and cultureAlthough these factors should not be minimized,

Entrepreneurs were also actors and not simply responders to institutions and resource endowments.  They could train their own workers and introduce investor protection into their own bylaws.

Professor Jones writes that the modern economic growth wrought by the Industrial Revolution diffused from its origins in the North Sea region to the rest of Europe, the US, and (later) Japan, but was slow to gain traction elsewhere because the “societal and cultural embeddedness of the new technologies posed significant entrepreneurial challenges.”  One such example would be deficient or broken institutions.

Institutions “provide the incentive structure of economies” and the author cites a handful of other authors in order to offer a fairly broad definition:  they’re a combination of formal rules (constitutions, laws, property rights) and informal constraints (sanctions, taboos, customs, traditions, codes of conduct); a system of rules, beliefs, norms and organizations that together generate a regularity of (social) behavior.

In practice, the primary focus of attention has been on systems of property rights.  It has been asserted that societies that provide incentives and opportunities for investment will be richer than those that fail to do so, and that the protection of property rights was an essential incentive behind such investment.  By reducing transaction costs and facilitating potential gains from exchange, institutions fuel productivity and growth.  The literature has particularly favored the use of three proxies in particular for “institutions”:  risk of expropriation, government effectiveness and constraints on the executive.  North famously identified the Glorious Revolution in England in 1688 as providing the institutional arrangements which explain why that country had the Industrial Revolution.

Some countries were more fortunate than others in the institutions they inherited:

“(T)he legal tradition countries inherited or adopted in the distant past has a long-term effect on financial development… which in turn can be assumed to have impacted the nature and speed of economic development.”  Countries with common law systems had on average better investor protections than most civil law countries, and within civil law countries some were worse than others.

Colonialism transmitted European institutions around the world, with mixed results.  In regions with soils and climates that provided a comparative advantage in extracting resources and/or growing crops, and with prosperous and densely settled areas, Europeans introduced or maintained extractive institutions to force people to work in mines and plantations.  In more sparsely settled areas, with soils and climates that favored mixed farming and livestock with limited economies of scale, Europeans settled and created institutions of private property across a broad cross-section of society.

Jones has much to say about the impact of colonialism and the importance of ethnic minorities in each culture – which will be the subject of our 3rd installment in a few days.

(Here is Part I, which summarizes the author’s framework of 3 economic eras that followed the Industrial Revolution.) 

Entrepreneurs, Firms, and Global Wealth since 1850

We are working our way through a fascinating book published just last month by Harvard Business School professor Geoffrey Jones:   Entrepreneurship and Multinationals: Global Business and the Making of the Modern World. Once we’re finished it could become the most recent addition to The Library in St. Pete.

Professor Jones asks why, after the Industrial Revolution in the West, “the Rest” struggled to catch up.  He does not delve into the causes of the Industrial Revolution nor the reasons it began where it did.  Instead he explores the role entrepreneurs and firms played in the modern economic growth since, and posits theories about the policies at the national level which encouraged them.  In our mind, it’s akin to the Jared Diamond’s treatment of the development of civilizations in Guns, Germs, and Steel – albeit with a narrower focus.

Discussing his book at HBSWK, Professor Jones argues that the current dominant explanations of global wealth and poverty focus too much on deficient institutions, poor human capital development, geography, and culture, with too little credit given to the “missing gap” between these factors:  the entrepreneurs and firms which create wealth and innovation.

In this post we’ll be summarizing his definition of 3 economic eras that followed the Industrial Revolution:  The First Global Economy, The Era of Constrained Globalization, and The Second Global Economy.  In subsequent posts over the next few days we’ll offer brief synopses of the national-level factors he explores:  institutions, the effects of colonialism, human capital, culture, and geography.

The first global economy (1850-1914) locked in the less developed countries (LDCs) as resource providers and reinforced institutional constraints on domestic entrepreneurship.  Characterized by:

  • The LDCs suffered from a “lack of cognition” about “the pace of change” and the opportunities offered by the new global economy.
  • Faced with colonialism, local politicians often chose strategies to enrich themselves and prevent the empowerment of rivals.
  • The multinational entities (MNEs) were “disappointing diffusers” of entrepreneurial skills and practices.

The era of constrained globalization (1914-1980) was characterized by two World Wars and the Depression, and the revolt of peoples who had not done so well in the previous decades.  Characterized by:

  • Import substitution regimes of this era resulted in inefficient industries which were sheltered from international markets.
  • State-led industrialization programs disrupted local firms, blocked or discouraged foreign investment, and were burdened by webs of planning regulations.
  • Local firms had the incentive to build skills in political contacts rather than technology.  This led to corruption rather than innovation.
  • Capacities were created, albeit inefficient ones.

The second global economy (1980 to the present) has a singular feature:  the growth of powerful globally active MNEs from the Rest.  Characterized by:

  • The changing nature of the global economy
  • Returning diaspora from the West to the Rest
  • New sources of knowledge acquisition provided by business schools and management consultants
  • Smarter state capitalism

Jocks and Bonds – similarites between entrepreneurs and pro athletes

Arian Foster for NVSEWriting at Grantland Katie Baker discusses the proposed Arian Foster (Houston Texans, University of Tennessee) IPO and compares entrepreneurs to professional athletes:

When you think about it, many entrepreneurs share a number of similarities with professional athletes (and not just a predilection for hoodies or the phrase “at the end of the day”).  A breakout success early in life — say, spending $6.7 million on a stake in eBay that would be valued at $5 billion two years later, or having a 1,600-plus-yard rushing season at age 24 — can be the platform that launches a career.  But it can also become, for better or worse, the only thing that defines you.  For every hit, there are multiple soul-crushing misses. Hard work and luck have a chicken-and-egg relationship, and the distinction between being the best and just being the best-positioned is often hard to spot.

Her focus on the similarities in career arcs is a bit ‘meta’ but that is an excellent point about luck and elsewhere in the piece she makes more practical comparisons:  both have to be nimble and adaptable to their environments, and, like a pro athlete, an entrepreneur is (quoting Randall Stross) “the person who is afflicted by a monomaniacal fever, who cannot not be an entrepreneur.”

San Francisco start-up Fantex is seeking to issue 1,055,000 shares of Arian Foster tracking stock at $10 apiece – with $10 million of the $10.55 raised going to Foster, who, in turn, will owe Fantex 20 percent of his future income (with a few exceptions).  They’re trying to apply the concept of Celebrity Bonds to a professional athlete – in this case, a “trailblazer” (their idea of his brand) like Arian Foster.

Celebrity bonds were pioneered in 1997 by David Bowie, who, faced with financial pressures that could have ultimately cost him the rights to his songs, chose to securitize the future cash flows from his catalogue.  These “Bowie Bonds” received investment-grade ratings from the bond agencies because they were backed by assets:  an “established portfolio of songs that generated mostly reliable, known cash flows.”  Other asset-backed securitization had been done, but “not with what was essentially intellectual property.”

A better analogy for Fantex’s deal would be if a musician were to attempt to securitize the songs he planned to compose in the future.  Baker again:

That’s because, when you look closer at the company’s SEC filing, you start to realize that at its root this isn’t really about Arian Foster, nor is it a more high-stakes version of fantasy football exactly. Buying a slice of the running back at the $10 IPO price does not give you any more ownership than buying his jersey would. (There are currently no plans, for example, for Foster to meet with investors or appear on quarterly earnings calls, and shareholders won’t have any voting rights.)

What it does get you is one share of a “Fantex Series Arian Foster Convertible Tracking Stock” that theoretically will benefit from his future earnings stream. Except that any actual distributions are at the discretion of Fantex, which will also take a 5 percent cut. If you want to buy or sell shares, you need to do so on Fantex’s proprietary exchange, for a brokerage commission. The stock that you own can be abruptly converted, at any time, into basic company stock. (And, again, at the discretion of Fantex.) I’d love to listen in on the customer service calls on the day that a bunch of fans with cash to burn wake up to find out that they’re now proud minority shareholders of an unlisted Silicon Valley venture capital–backed marketing firm.

Baker also mentions the challenge of conducting due dilly in these circumstances:

We all love Arian Foster, but just like the running back himself, things can turn on a dime. In his 2007 piece about Protrade, Lewis wrote: “Tiger Woods is a prime candidate to launch the new market. But Tiger Woods’ financial future is secure; he’s the sports equivalent of a blue-chip stock.” (He would soon turn into more of a … speculative investment.) The “Risks” section of the SEC filing on Foster makes mention of his recent admission that he received money while at the University of Tennessee as an example of where Fantex’s diligence failed to turn things up.

Tower Cloud named to Inc. 500 List of Fastest-Growing Private Companies

With 3-Year Sales Growth of 964%, the BPV portfolio company ranked #478 on the 2013 Inc. 500 List of America’s Fastest-Growing Private Companies.

The 2013 Inc. 500, unveiled in the September issue of Inc., is the most competitive crop in the list’s history.  To make the cut, companies had to have achieved a staggering minimum of 918.59% in sales growth.


Tower cloud inc500 profile

“We are honored to be recognized by the 2013 Inc. 500 for the tremendous growth Tower Cloud has achieved over the last three years,” said Ronald Mudry, Tower Cloud’s founder and CEO. “Our placement as the 7th fastest growing telecommunication company in the nation, and the fastest growing wireless backhaul provider is a testament to all the hard work, dedication and customer focus of the Tower Cloud team.”

Forget passion. Goals are for losers. Suffer defeat.

dogbertScott Adams, creator of Dilbert, discusses his new book – How to Fail at Everything and Still Win Big – in both print and video at the WSJ.

Mr. Adams provokes a bit with his trademark jaded humor (of which we are fans), but he also provokes fresh thinking on passion, failure, goals, and the role of luck.

We can’t quite endorse every piece of advice he offers – not everyone enjoys the sinecure of an established syndicated cartoonist – but we can recommend the article and the interview.  And perhaps after we’ve finished it, the book.

Don’t follow your passion because your passion might not be very rationalSuccess creates passion, not the other way around:

My boss, who had been a commercial lender for over 30 years, said that the best loan customer is someone who has no passion whatsoever, just a desire to work hard at something that looks good on a spreadsheet. Maybe the loan customer wants to start a dry-cleaning store or invest in a fast-food franchise—boring stuff. That’s the person you bet on. You want the grinder, not the guy who loves his job.

For most people, it’s easy to be passionate about things that are working out, and that distorts our impression of the importance of passion. I’ve been involved in several dozen business ventures over the course of my life, and each one made me excited at the start. You might even call it passion.

The ones that didn’t work out—and that would be most of them—slowly drained my passion as they failed. The few that worked became more exciting as they succeeded.

Goals are less important than having a system or process for success:

To put it bluntly, goals are for losers. That’s literally true most of the time. For example, if your goal is to lose 10 pounds, you will spend every moment until you reach the goal—if you reach it at all—feeling as if you were short of your goal. In other words, goal-oriented people exist in a state of nearly continuous failure that they hope will be temporary.  If you achieve your goal, you celebrate and feel terrific, but only until you realize that you just lost the thing that gave you purpose and direction. Your options are to feel empty and useless, perhaps enjoying the spoils of your success until they bore you, or to set new goals and re-enter the cycle of permanent presuccess failure.

If you have a choice, success is better than failure, but failure is a great teacher.  In the real world, luck is a huge part of any success story:

You can’t control luck, but you can move from a game with bad odds to one with better odds. You can make it easier for luck to find you. The most useful thing you can do is stay in the game. If your current get-rich project fails, take what you learned and try something else. Keep repeating until something lucky happens. The universe has plenty of luck to go around; you just need to keep your hand raised until it’s your turn. It helps to see failure as a road and not a wall.

Small Brains, Big Problems; Or, It’s Complicated

complicatedWe came across this item today, which makes for a nice addendum to yesterday’s post about the indispensability of human judgment even (or especially) with today’s complex and detailed decision-making models.

Kevin D. Williamson writes about a research fellow in applied mathematics and complex systems who is bumping up against the limits of mathematical modeling:

Having made the switch from physics to social systems, Mr. DeDeo discovered that the complexity of the data describing human action is so vast that modern mathematics does not have the tools to deal with it. Like many scholars of complex systems, he believes that a new discipline within mathematics — probably entailing an intellectual revolution on the order of the invention of calculus — is needed before scientists can even begin to get a handle on the relationships between  variables in the systems they are studying.

We’re limited by Bonini’s Paradox:  As our models become more complete and more accurate, they become as difficult to understand as the underlying reality they are meant to represent; as they become easier to understand, they become less accurate and less complete.

Or in Paul Valéry’s words:  “Everything simple is false. Everything complex is unusable.”

This sounds very similar to BoE Director of Financial Stability Andrew Haldane, quoted in yesterday’s post, who warned that “fundamental limitations of the human mind” thwart increasingly complex (and sometimes frivolous) attempts at regulation.

This belief is new, and not helpful. As the authors note, “Many of the dominant figures in 20th century economics—from Keynes to Hayek, from Simon to Friedman—placed imperfections in information and knowledge centre-stage. Uncertainty was for them the normal state of decision-making affairs.”

Is good old-fashioned intuition out of date?

intuition2Is There Still a Role for Judgment in Decision Making?  Harvard Business School Professor James Heskett wonders if recent advice to eliminate decision-making biases might have gone too far in an effort to supplant independent judgment with data and probabilities and decision trees:

The replacement of customs and biases with data, “big” or “small,” has been intended, at least in part, to drive out such things as tradition, habit, and even superstition in endeavors ranging from child rearing to professional sports.  After all, wasn’t the book and film, Moneyball, at least in part a glorification of the triumph of statistics and probabilities over intuition and managerial judgment in professional baseball?  …

In fact, if there is a sense that one gets from all of this work, it is that we are our own worst enemies when it comes to making and implementing good decisions.  We need tools to correct the errors and biases of our own judgment.  This is puzzling, because we are frequently reminded that the ability to exercise judgment is what sets humans apart from other forms of life.  (Perhaps judgment is what leads us to adopt recommendations such as those of these authors.)

Every leader has internal biases, some of them subconscious or hidden, which can create especially tricky traps that complicate sound decision making.  So it is important to think systematically and design the decision-making process to account for the zoo of biases managers face.  Astute management of the social, political, and emotional aspects of decision making can help account for the underlying biases of the participants.

On the other hand qualities such as judgment, engagement and strong communication skills are critical attributes because interpersonal chemistry plays a role in any decision involving more than one person.  What we’ve oft said about boards is true of any team:  processes and best practices may be important, but great teams rely on ‘robust social systems’ and mutual accountability among its members to ensure that they function properly.

As we argued in Thinking consciously, unconsciously, and semi-consciously:  the best results often come from a combination of deliberation and intuition.  Too much deliberation can become analysis paralysis; and studies show that those who rely on intuition alone tend to overestimate its effectiveness.  (They recall the times it served them well and forget the times it didn’t.

Furthermore, the more complex and detailed the process the greater the likelihood managers will mistake process for purpose and manage to the rules without exercising any judgment.  In the wake of the last financial crisis, BoE Director of Financial Stability Andrew Haldane argued that this had been precisely the case with regulators, who tiptoed right up to the hot red line at which a crisis can be triggered.

Mr. Haldane deployed an analogy about a Frisbee-catching dog to explain how increasingly complex (and sometimes frivolous) attempts at regulation push the limits of data or modeling or even the nature of knowledge itself.  The dog can catch the Frisbee despite the complex physics involved because the dog keeps it simple:  run at a speed so that the angle of gaze to the Frisbee remains roughly constant.

So while we still do value “good old-fashioned intuition,” it’s also unwise to rely only on one’s instincts to decide when to rely on one’s instincts.  The dog’s doing just fine, but if it involves more than a Frisbee he might want to crunch some numbers too.

What is growth equity?

Two recent publications do a very nice job of describing “growth equity” and distinguishing it from early-stage venture capital and buyouts.

This piece at explains that due to Sarbanes-Oxley young high-growth companies are delaying IPOs, staying private longer, and seeking other sources of capital to fuel their growth:

What makes a growth-stage company? Generally, it has its first product or service in the market and is getting traction. At this stage, investors like to say that the dogs are eating the dog food.  Product development continues to be very important, but sales, marketing and customer service are now center stage. The founding management team is still in place, but new faces and skill sets are needed. The amount of money needed to maximize the company’s opportunity outstrips the company’s ability to generate free cash.

Growth investors cover a wide spectrum. Some growth-stage investors prefer the early stage of expansion. This investor generally has been rooted in the venture capital industry, or he or she may be a successful entrepreneur-turned-investor. These investors tend to be active and more hands-on. They will make available their extensive networks and years of experience. You may want seasoned growth-capital investors as board members or advisors, as they will be able to open doors and help you solve problems that may be new to you but that they’ve seen repeatedly.

At the other end of the field are the financial engineers. They tend to be passive investors who engage much later in the growth cycle, when a big exit is not too far over the horizon. Most will write jumbo checks — $50 million and up — to be well-positioned for an IPO. They generally will have no interest in being on your board or offering operational assistance…

Similar to your hunt for early-stage investors, compatibility with your aspirations and personal chemistry are essential ingredients.  If your company is doing well, you should have the luxury to pick and choose whom you work with.

This report from Cambridge Associates argues that growth equity has developed into its own unique asset class:

If you were seeking to locate growth equity on a spectrum of private investment strategies, you would most likely place it somewhere between late-stage venture and leveraged buyouts—established companies that can benefit from additional capital to accelerate growth…

It is instructive to contrast growth equity deals with buyout and venture capital transactions. Leveraged buyouts, for example, also typically involve companies with a stable earnings stream, perhaps growing less aggressively, and in this case used to facilitate the assumption of debt, which is expected to be a material contributor to the investment return. Venture capital investors, meanwhile, generally receive preferred equity positions similar to those given to growth equity funds, but because of the nascent stage of most venture-funded companies, the downside protections outlined above are typically lacking.

Further, venture investors usually share control with a syndicate of other institutional investors that can have conflicting interests and priorities—a situation that growth equity investors often avoid…

In summary, while growth equity shares some characteristics with both venture capital and leveraged buyouts, it should be viewed as a separate strategy with its own risk-reward profile, distinguishable by its minimal use of leverage and portfolio companies with strong organic growth. Simply put, growth equity offers a similar return profile to leveraged buyouts but without the leverage, and could also be viewed as a low-octane venture proxy,with far less dispersion among company returns given the lower risk of loss, but also little chance for the fabled ten-baggers integral to venture’s long-term success.

Both these pieces describe fairly accurately the strategy that BPV has pursued since our founding:  our investment is a “growth accelerator” for companies at or nearing profitability and in the early stages of rapid expansion.  Our entrepreneur partners benefit from our network and experience with high growth companies, and our limited partners benefit from the fact that our strategy entails a lower risk of loss of capital and is not reliant on a frothy IPO market for an attractive exit.  We have pursued this investment approach since the founding of our predecessor firm, South Atlantic Ventures, over thirty years ago. and we are pleased that Cambridge Associates has recognized the unique aspects of this asset class.

growth accelerator

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UF’s incubator honored again (again)

Congratulating David Day and his team at UF’s Office of Technology Licensing is becoming a habit:  they’ve been ranked 4th nationally for the number of start-ups formed, and 11th for the number of licenses and options granted for university research.  (In a yearly audit conducted by the Association of University Technology Managers.)

This represents the 3rd time in under six months we’ve had the pleasure to give David & team a shout-out.  Last April they were named the 2013 Incubator of the Year by the National Business Incubation Association, besting much larger competition from all around the globe, and just this past July they were named World’s Best University Biotechnology Incubator by the Sweden-based research group UBI.

The university’s OTL, Innovation Hub and incubator are vital parts of the hodge-podge of scientists, institutions and funding that make up Florida’s entrepreneurial ecosystem, all of whose members share great regional pride in their accomplishments.  We’ll cut & paste this post into another draft and save it for re-use a couple months from now…

Worry less about the idea, more about the execution

Patron saint of bad ideas?

As reported in The 10 rules of entrepreneurship, the best products don’t always win.  Compelling ideas can and do fail after launch:  before the iPod and Facebook there were MPMan and Mirror Worlds, and enjoyed no shortage of funding or publicity.  (Although selling below cost and making it up on volume might not qualify as a great idea…)

Wil Schroter, writing in Forbes, advises entrepreneurs to fret a little less about confidentiality in “Why Investors Don’t Sign NDAs.”

Investors want entrepreneurs, not ideas.  Anyone can come up with a great idea, but very few can actually pull them off

If your idea is so easily stolen that just hearing the concept is enough to allow anyone to replicate it and launch it better than you, then you’ve already lost.

There is little protection in just a concept, so unless you’ve got a secret recipe behind it, signing a NDA doesn’t do you much good anyway…  since as soon as you launch everyone will have a taste of it anyhow.  [Therefore] you’re more likely to be explaining why you can defend this concept once it’s launched.

We made a similar point last year on Columbus Day:  he was not the first to think the earth was round, but he was the one willing to act on it.  An earlier Forbes piece had made clear that the King & Queen were more interested in the entrepreneur than the idea:

The second time Christopher Columbus pitched Ferdinand and Isabella (two years after his initial presentation – raising money has always taken patience and persistence), he did not need to convince them that locating a shortcut to the spice routes of India was a good idea.  Rather, he had to belie their primary concerns:  was he honest, tenacious and competent enough to execute the journey [N.B. – Furthermore, he failed and had to go to market with a different idea altogether.]

While we do retain some interest in hearing about the idea – the details in the pitch reveal important things about the entrepreneur  – we agree about the primacy of some of the intangibles:   integritytransparency, trustworthiness, enthusiasm and tenacity, self-awareness, and flexible persistence.

The issue of NDAs ripples throughout the entire entrepreneurial ecosystem: angels will tell you they waste limited resources and never get used in anger, and code jockeys won’t sign “the poor man’s patent.”  As one software developer puts it:

If someone’s out to screw you, they’ll screw you with or without an NDA…  In short, don’t waste your time building straw houses, just stay away from wolves.

Given the ubiquity and overlap of ideas, asking for an NDA is a rookie mistake that only slows the process and undermines your pitch – unless you have patented IP and not just a legally un-protectable thought.

Growing the acorn into a mighty oak is a long-term project that will eventually include adding partners who share the vision and can bring additional resources – financial, expert, and network – to bear.  Choosing partners who best fit requires as much rigor and thoughtfulness as any decision an entrepreneur makes.

So forget the NDA, and instead just conduct a little due diligence before trusting us with your idea.

(For additional illustrations of how today’s trendy idea can become tomorrow’s punchline, you can check out our Vintage Future series.)

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