Creating Entrepreneurs: Deliberately seeking uncertainty

I contributed an article to the latest edition of Money Magazine which focusses on innovative business and entrepreneurship

It is based on 25–30 hrs of research on the topics of creative entrepreneurship and ecosystem building from renowned authors on the subject

The feature discusses key pillars that contribute to “Creating Entrepreneurs”:

  • seeking uncertainty as a path to profit
  • ecosystem building through public/private measures
  • entrepreneurs working with peers through cohort groups
  • successful entrepreneurs become lighthouses

https://bemags.com/magazines/money
Issue 71: pgs 34–37

Further thanks goes to Julian Pace Ross from Altaro for contributing his thoughts on the lighthouses argument

Profit through Uncertainty

Early explorers may have had no way to predict what was across the ocean, but once they sailed there, they knew. But if you’re like most people, you aren’t going out looking for uncertainty, per se, you are looking at an idea you like and trying to figure out why no one else has tackled it. You’ll either find that they haven’t because it’s a bad idea, or that they haven’t because there’s some major uncertainty preventing them from knowing whether it’s a good idea or not. If it’s the latter, great! Now figure out how to overcome the uncertainty.

If you want the knowledge, you have to go out and create it — Jerry Neuman

According to Jerry Neuman, entrepreneurship lecturer at Columbia University, novelty uncertainty is when there are things you just don’t know, even after doing all your research and thinking things through to their logical conclusions. It is especially common when someone does something for the first time. Doing the thing creates the knowledge, so this kind of uncertainty is mitigated through doing things.

This is how you mitigate uncertainty, by creating new knowledge. This may include observation, deduction, and induction, but often has at its core the generation of new facts through trial and error. You do it and see what will happen. If it is about how to reach a desirable state of the world, you try different things and see if they get you closer to it, if they don’t you try something else.

The uncertainty should be about something that would provide some tangible benefit to the company or its customers if it ends up resolving in a certain way. A startup takes on uncertainty, but must then manage so that it eventually dispenses with the uncertainty but ends up with a clear competitive edge. It must brave the uncertainty to build a company.

Neuman explains, when Steve Jobs was raising venture capital for Apple Computer, he envisioned every household in America would own a personal computer. There was no way to know — even in a probabilistic way — if this goal was achievable. He couldn’t even know if the problem, “who will own a personal computer?”, even made sense because the industry was still defining what a personal computer was.

The entrepreneur is a person who is continually pursuing economic value through growth and as a result is always dissatisfied with the status quo. Entrepreneurship is aspirational and risk-taking is intrinsically contrarian. Risk is intrinsic to entrepreneurship because an entrepreneur engages in an activity which will only generate value, if any, later.

Individual Characteristics of Entrepreneurs

Entrepreneurs, in the broadest economic sense, buy inputs low, transform them through risk, and sell them high. The key is having great challenges to solve. Underdeveloped or expanding economic regions present great challenges when it comes to education, health, finances, agriculture and environment. These challenges, rather than problems, are opportunities for entrepreneurs. Technology adoption provides the natural habitat for tech companies to emerge, finding their way by providing access to convenience or better services in core economy sectors. No one is better qualified to find a solution than the individuals who live amongst the problems.

The individual characteristics of entrepreneurs are considered a significant factor affecting start-ups’ success, which is closely related to the entrepreneurial process and output. In academic journal discussing “Nature or Nurture”,It was held that self esteem and a proactive personality, combined with either a family entrepreneurial background or a healthy attitude towards entrepreneurship education creates entrepreneurial intention. That is, the intrinsic willingness to challenge the adversity of entrepreneurial endeavor. Yet, it is the entrepreneurial ecosystem that those individuals are surrounded by is what spurs them into entrepreneurial behavior.

Entrepreneurial Ecosystems

The typical problem with entrepreneurs in weak ecosystems looks like this: I do this business alone, and I don’t know about other startups in town. I don’t know investors here, and there is only old money from family corporations, so I go to London to find an investor. The investors themselves say: ‘I don’t find any prospective startups in this region, so I go to London to find companies to invest in. Weak entrepreneurial ecosystems are characterized by high entropy, the infamous “silo” effect, where lack of teamwork among public, academic and private entities prevails.

From the entrepreneurial “supply side,” there are large numbers of talented people eager, in principle, to try out interesting ideas in the marketplace, but who don’t have the resources or knowledge base. When you dig deeper, they invariably complain that they need seed financing (or human resources, or customers) and no one is willing to give them time, let alone finance them. The private investors are nervous, or make rapacious demands, getting small government grants or loans takes forever, and the SME teams in the banks won’t lend to them because they can’t provide sufficient collateral. So startups typically go on to become service providers rather than bolt onto new technologies and scale globally.

To establish a market, which is essential for sustained involvement by the providers of finance, the deal flow quality must undergo a natural selection mechanism where the market distinguishes between the deserving and the undeserving. The policy objective should not be to have a high venture survival rate, but to have high potential ventures survive, and low potential ventures to fail, the sooner the better.

The geography of entrepreneurship is “spiky”, meaning that from region to region there are significant variations in rates of start-ups and, in particular, “scale-ups” — new businesses that are evolving into larger enterprises.This can be explained by the fact that successful entrepreneurship occurs in “fertile soil” — economic and social environments conducive to entrepreneurial activity. And in some places these environments — or ecosystems — are much better at generating and supporting entrepreneurial activity than others.

Yet, the real world is messy. The diversity of entrepreneurs and their changing needs on the entrepreneurial journey means that there also has to be a diversity of support available for these ecosystems to be effective. Local funds struggle to reach critical mass and although they are the best positioned to support the entrepreneurs especially in the earlier stages, many do not have enough capital to allocate to several financing rounds.

Development banks and government players will need to step up to help develop the venture industry. In South America multilateral institutions such as the regional development bank took on a strategic role, by establishing an investment fund, to start investing in seed/early stage ventures back in the 90’s. The objective was to support first-time fund managers to build a successful track record, and jointly develop a local venture industry for companies without access to conventional financial services. In Israel,”Yozma” leveraged public money to attract private investment, transforming the country into a global research and development hub. Between 1993 and 1998, the government offered to provide 40% of the money offered by private investors in combined funds, supporting more than 40 companies. The value of Yozma increased from $100 million in 1993 to $250 million by 1996, and the project is regarded as a rare example of government venture capital success. Eventually, the government was out, with a $50 million gain, to boot.

In Europe approximately €1 out of every €3 comes from government agencies. Key to growing the industry in Southern Europe and the MENA region is to have the big family offices, pension funds and insurance companies allocate a portion to venture capital. The industry would have an incredible growth in the region if pension funds and insurance companies would allocate even a minimum of 1–2% of AUM to venture capital.

Entrepreneurial Cohorts

Social Capital amongst entrepreneurs is a critical element. Entrepreneurs arrive at the resources through the relationships and interactions of their networks. What matters more for entrepreneurs is the density of connection within the mass of entrepreneurs. These interactions created an environment in which they not only could learn from their peers, but also support each other emotionally through the rough and uncertain journey they, as entrepreneurs, were facing. Creating an ecosystem means constantly talking to new people about your project, making them understand your ambition well before needing their help or services.

An entrepreneurship ecosystem should present a mixture of nascent and experienced entrepreneurs. Secondly, it must foster interaction between the cohort of entrepreneurs. Entrepreneurs learn from other entrepreneurs, and from mentors who have entrepreneurial experience.

The policy implication is that any public venture funds should distribute smaller prizes, so that a group of entrepreneurs can become a cohort and learn from one another.This should then be supported by a host of activities, meetups, fairs and conferences, focussed on entrepreneurial events to encourage cohort interaction. Quality resources will then tend to become concentrated locally and attract each other: human, capital, information, and markets will begin to gravitate to one another. In addition, the signal effects are more potent when they are proximal, and the spillovers into the wider economy are stronger as well. At the seed stage, investors would increase their expected return by broadly indexing into every credible deal within a cohort.

If you had to choose between being in a position to see great deals and then picking randomly, or coming across average deals and picking expertly, choose the former.” — Jack Altman, investor and CEO of Lattice

Lighthouses

Successful entrepreneurs become leaders, or lighthouses. These leaders create and shape the various cultural, social and material factors that make up an ecosystem. Their example helps entrepreneurs to find a route through the dangerous waters of business venturing and to make their start-up a success. Moreover, their success radiates beyond a region to attract additional resources and human capital. If you have one case in the media that people talk about, that influences, motivates people, inspires people to do the same.

This supports the idea that legitimacy is contagious and that the legitimacy of successful startups can foster that of their affiliates. Among entrepreneurial cohorts leaders will emerge. These are then in an ideal position to help the emergence of further startups similar to the lighthouses they helped create. Lighthouses also strengthen and reinforce organizations that have helped them, such as incubators and academic institutions and therefore create ideal conditions for startups with a similar focus to flourish.

According to Daniel Isenberg, entrepreneurship researcher, Lighthouses play a role in building a reputation for what makes a good investment. Based on this reputation, investors with a focus on related business models are attracted to the region. The most significant spillovers stem from the fact that most successful entrepreneurs like to create more entrepreneurship. Entrepreneurship, it turns out, when successful becomes like a hobby or sport which entrepreneurs pursue for a mix of motives, often for the challenge or the adrenaline rush long after their material needs are taken care of many times over. It becomes a positive addiction, one in which the venture junkie likes to get others hooked as well. So entrepreneurship “addicts” become angel investors, or advisors, or venture capitalists, or board members, and likely a combination, feeding back their experience and wealth to generate more entrepreneurship. They become public speakers or guest lecturers inspiring others to follow in their footsteps.

Successful entrepreneurship thus has broad spillover effects on the economy, strengthening all of its domains. Human capital is upgraded through training and experience, success stories inspire new generations and make society more tolerant of risk and failure and wealth creation.

When we started out in 2008 as we described the business model of Altaro to the industry, we were met with the mindset that innovation is something that happens somewhere else. Most companies were service providers and resellers of imported products…with one exception: for us a massive and monolithic lighthouse was GFI. I’m not sure what would have happened had GFI not existed in the first place, but there’s a good chance we would have been too apprehensive to take the plunge. I’m sure (and hopeful) that Altaro are now acting as lighthouses to others, so in a way I feel indebted and obliged to support others that are in the early stages by sharing the highs and lows of my experiences, in the hope of increasing their chances of success.

– Julian Pace Ross, co-founder of Altaro Software (now acquired)

The existence of one tangible, local visible success can be a powerful root cause, and in most societies in which there is a step change in the level of entrepreneurship, you will find one or two successes that ignited the imagination of a generation of entrepreneurs.

Author profile:

Adrian Galea is a professional in venture capital and portfolio management for early stage startup investors. He also manages a facebook group called Malta Startup Space that inspires startup culture in Malta. For more information: www.clutchplayadvisors.com

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AdiG

www.clutchplayadvisors.com Early stage company advisory and startup fund raising. Human connections that build relationships, add value and move the needle