I recently came across and rather enjoyed this talk from a few years ago by William Sahlman, who is a professor emeritus at the Harvard Business School. He discusses the things he has learned over almost 40 years of studying entrepreneurship. Some notes below (for personal reference only, any mistakes in transcription are my own):
When talking about entrepreneurship, lot of things come to mind. For example, people often talk about risk, but he doesn’t know anyone who gets up each morning in search of risk. He knows people who try to find reward and, as it turns out, you can’t get reward without taking some risk. He thinks risk-reward management is a better way to think about it, rather than the extremes of either risk avoidance or risk-seeking behavior.
People also talk about innovation, but great entrepreneurs are often in the execution business – taking ideas, hiring right teams, raising the right money from the right people. They are doing a series of things that you would not describe as particularly innovative. Bill Gates is often regarded as one of the finest entrepreneurs in the history of world, but he didn’t invent the entire suite of Microsoft products. He was a great commercializer and one of his innovations was bundling to create a compelling offering that beat the individual offerings at the time, such as Lotus 123 or Word Perfect.
There is also no single set of personality traits to describe entrepreneurs. Finally, he finds that even founders often have a problematic definition of entrepreneurship – it is relatively easy to start something, but it is hard to build something interesting. You have to have in mind a journey with a beginning, middle and an end. If you only focus on the early processes, you miss out on most of what is interesting about the businesses we would all describe as successful, attractive and important.
His colleague Howard Stevenson defines entrepreneurship as the pursuit of opportunity beyond resources currently controlled. You are looking for a gap between what customers are willing to pay and what it will cost you to deliver that customer value and then figure out the resources you need. It is a different approach that is more opportunity-driven, rather than a process that is focused on existing resources. This definition is liberating because you get out of thinking about entrepreneurship in terms of risk seeking, innovation or personality traits.
All opportunities begin as hypotheses – you have an idea that there will be this potential for creating a sustainable, cash flow positive business. He has read 10,000 business plans but has only ever seen 3 companies meet their plan. It can’t be about planning. Once you have a hypothesis, you want to create a test that is designed to give you some information to validate it. This may involve putting together some human capital, financial capital etc., but it has some end point at which you are able to make a better informed decision. He calls this a value inflection point, where you know whether you are on the right path or heading in the wrong direction. If your test is negative, you sometimes abandon the whole project or you change what you are trying to do. If positive, you step on the gas or run a new test (often a sequence of tests).
Investors similarly stage their commitment of capital – they want to give entrepreneurs just enough to run a test to produce some information, on the basis of which they get to make the next decision (e.g. do they give more money, tweak something etc.). One way to think about it is that entrepreneurs are in the business of producing information, while investors in the business of buying information.
He has been involved in or invested in 205 companies, and 80 have sent him a crash letter. Turns out the distribution of outcomes is pretty constant across time – even if you are a professional VC fund, at least 50% of ventures fail; used to be 35%, now more like 50-60%. Fortunately you can only lose 100% of your money on those investments, but you can earn more on the others. Almost all the action is in the right end tail of the distribution – the very few positive outcomes that can offset all the losses. The entrepreneur’s first objective is to lower the likelihood of a goose egg (and if it is a goose egg, to try and minimize the losses and time commitment). The other objective is to increase the likelihood of achieving a right end of the tail positive event.
He uses a simple framework to understand the process of entrepreneurship – people, opportunity, context (the set of things that can’t be controlled) and deal. You can evaluate each of these things individually, but the real insight comes from asking how they relate to each other – are these the right people for the opportunity, what’s the context (e.g. what are the regulations, what is going on in the capital markets) and so on. To give one recent example, Softbank has become a contextual tsunami in the world of entrepreneurship. They have weaponized finance and so every decision people are making has to reflect that Softbank is prepared to anoint and announce winners, which affects the supply of human and financial capital to everyone else in the market. On deal terms – entrepreneurs are often focused on maximizing valuations, but they don’t often talk / think enough about the terms, which can mean even if you sell your business for a billion dollars, you only end up with a $1.50 and a letter of recommendation.
Another fundamental rule of entrepreneurship is don’t run out of money. It’s not so much about the cash in the bank, because the fundamental rule of entrepreneurship is that you are never going to get enough money to get to the nirvana of cash flow independence. It is more that you run out of trust, where you have produced information about yourself, your team, or the idea that causes people to lose faith. You run out of money when the value inflection points are such that the math doesn’t work – you can’t create and capture enough customer value to pay the people who give you their services as employees or their financial resources.
He also likes to prepare a simple set of related questions – what can go wrong, what can go right, how can I make what can go wrong less likely to occur, how can I make what can go right more likely to occur? Turns out we are pretty good at thinking about what can go wrong, but not so good at thinking about what can go right. But everything in life is about what can go right and then making it happen. So how can you manipulate the team (people inside and outside the organization), change the opportunity (your strategy, tactics, positioning), make sure you have access to money not only today but to run future tests (not giving away too much of the pie, or terms that make it hard to raise money in the next round). Goal is to maximize the likelihood and magnitude of success by changing the team, opportunity or the deal.
Finally, entrepreneurship is a global phenomenon – you can have an idea from anywhere, money from anywhere, sell to markets anywhere, production can be anywhere. We are reimagining how something can get done. An activity that perhaps used to be more concentrated in certain geographic areas has now been democratized across the world. The cost of experimentation is also approaching zero, so we should expect the amount of experimentation and entrepreneurial behavior to increase dramatically. Not small businesses, but high potential entrepreneurship. Case for hope – there are an infinite supply of problems in the world, but entrepreneurs view problems as opportunities.
Q&A:
On business school students today versus 20-30 years ago – it is a much more diverse crowd today, students from 70 countries, 45% women. Students come from lots of industries, they aren’t all from PE or consulting. So the richness of diversity in the classroom has improved. The students used to come from GE, Ford, P&G. Now Google and Facebook have replaced P&G and GE. The risk averse jobs people go to are at Google, Amazon and Facebook. Consultants, investment banks are struggling to hire people. Many more students are also interested in early stage companies or starting their own company. HBS has created the Innovation Lab to give students hands on experience with running the first test, figuring out does this idea make sense, how to get feedback from customers etc. His job is not to have students go start a company, thinks they ought to go learn something first (e.g. problems and opportunities in an industry, experience of how to manage people).
Any characteristics of entrepreneurs that indicate success – all opportunities are based on people and all problems are people problems. Early on in their business education, people imagine if they can only model the financial numbers better that life will be great. Over time, he has learnt it is all about people issues. So looking for folks who can retain, motivate and organize teams to have a strong supportive culture. Looking for entrepreneurs who have a mentality about what they are trying to accomplish, something more than just making money. Another one is curiosity – the willingness to ask why not, question-based approach to find an opportunity. Persistence with a sense of humility. Communication – he has learned over 205 companies that it is not a good sign when companies go radio silent. If you only communicate when times are good, when you deliver bad news, you will be kicked out the game. Need the ability to get trusted and retain that trust, through honesty and non self-interested behavior. 3 of the 205 companies he has backed had integrity issues. That is a very small proportion, but he feels horrible about them. He doesn’t lose sleep about losing money, but does lose sleep about having bad people judgment.
Thoughts on / differences between bootstrapped entrepreneurs vs. those who get VC backing – the best money comes from customers, not from investors. He has enormous respect for folks who are able to create value for customers – could be from pre-selling the product, subscription business model. But the choices are not always yours to make. Some companies have to try and grow more rapidly – in a network effects business, where value grows exponentially as you add customers and suppliers arithmetically, you don’t have the luxury of saying you want to retain control and bootstrap this business, because you will get blown out of water. No requirements for entrepreneurs to have any formal education, only to create and capture customer value. He honors everyone who gets in that journey. ~50% of companies never got institutional capital, lot of success across the country.
Listening to an entrepreneur pitch – anything that makes him say no immediately or want to lean in and listen more? He has a small investment committee – just himself. No limited partners except his wife. Asks her advice about certain products and ideas. Not interested in anyone who suggests they are willing to go close to edge. Always about people who can do something special. Almost always a team, rarely individuals. Next, they have to be realistic about the process and understand that when he invests, he fully anticipates there will be more opportunities to invest, and that they will come sooner than they expect. Ultimately, he is looking for someone he can go on a journey with – through the good, bad and the ugly.