Creative Class

As one looks around the economic landscape I am struck by the devastation. One number stands out above all others. One in five males between the ages of 25 and 55 is out of work! That is a staggering number. The numbers are not going back to anything “normal” anytime soon according to the IMF. Financial crises followed by recessions do not return to normal levels of employment for over a decade. Why you might ask? The answer I guess is that the levels of debt need to be worked down. Everyone owes everyone money and none pay anyone. Second, the recession destroys real capital. In this situation it was housing. It will take years to work off the excesses of the housing crisis.

So what does entrepreneurship have to do with the recession? If we take what we know today, entrepreneurs and innovation play a vital role in the economy. But can they help us in the great recession? In other words, what policy should we be pursuing to move the unemployment rate below 10 percent and back into the neighborhood of 5 percent? We know that new firms are important. They create most of the net jobs.  However, only a small percent, perhaps 4 percent, create almost all of the jobs in any given four-year period. And this seems to hold up in different times, different countries, and different industries.

So how do we forge a policy? Two stories are told out there. First we know that age and size are important variables. And we know that age appears to be more important than size. In other words, we should target firms based on age not size. The two stories out there are one by Zoltan Acs and the other by Carl Schramm. In a highly influential study, Acs found that the average high impact firm was about 20 years old and came in all sizes, small, medium, and large. Schramm, on the other hand, using a Census Bureau study, found that firms less than five years old created almost all of the jobs independent of size.  They both cannot be right.

However, if we are interested in short-term policy solutions and not real economic growth, we should help stimulate solo self-employed. They have a start-up rate that is three times as large as firms with employees. They start easily but also go out of business quickly. So an effective policy would be to make it easier for them to stay in business longer.

A simple policy would be to cut the self-employment tax, not over 15 percent of all new solo self-employed firms to zero for three years. If they hired any employees we should cut the employer share 7.5 percent for three years also. This would greatly increase the survival rate for these new firms. Of course this is not a long-term solution because many of these firm will contribute very little to productivity, economies of scale, or wealth creation. But they will pull down the unemployment rate.

The impact on the deficit would not be great since many of these people would not have survived to pay payroll taxes anyway. Once the economy picks up the issue of long-run growth can be addressed. But in the short run, let’s get people working.

In her September 3 blog post, “Creative Florida”, Rana Florida asked for thoughts about Florida tourism. As a resident of St. Petersburg, Florida, I thought I should respond.

Tourism has long been the golden goose in Florida but it is also a double-edged sword. We have no state income tax in large part due to the sales tax revenue that tourism provides. When the tourists come, the coffers fill and all is well. When we have downturns in the economy or other disruptions (such as hurricanes or 9/11) our budgets shrink. This volatility prevents us from having a predictable revenue stream which in turn means less long-term planning.

For better or worse, tourism also defines Florida. For many it is great to have that identity but I know a lot of creative class entrepreneurs in high-tech who lament that they can’t attract talent or VC interest because no one takes Florida seriously as a business environment.

But to me the largest impact of tourism is that it has made us lazy (I say this with love, Florida!). Tourism is easy money and we have coasted on that for too long. When the tourists just arrive with bags of money, why innovate? Why invest in our schools or our infrastructure? Why make the hard tax choices when we can raise the bed tax on hotel rooms or local tax on car rentals? We need to rethink tourism and make it a higher value experience, one that leverages the service economy and makes it more creative and innovative.

Florida had a wake-up call last year when, for the first time since WW2, we had a net outflow of population. That is a seismic shift in the underpinnings of Florida’s economy and I hope that it forces us to look at diversifying our economy and making the harder choices of developing industries beyond the beach and theme park.

What, exactly, is entrepreneurial strategy, anyway?

I regularly teach classes on entrepreneurship and new venture development, and more than occasionally drop in to provide my perspective on topics of interest to those forming or funding technology-driven, high-growth companies. Since I have been spending a lot more time up in front of students (and, thus, getting peppered with great questions), I have been giving a lot of thought to what passes for “entrepreneurial strategy” courses (or sections of courses). To me, it seems that the bulk of entrepreneurship pedagogy has, in a relatively brutish way, simply ported over the issues relevant in a typical strategic management class and attempted to convert those topics into material appropriate to the new venture setting. The more I think about it, the less persuaded I am that this is helpful for students; and I continue to have my suspicions that this approach forwards the research frontier.

Why we have decided to believe that the theories and questions in strategic management – relevant to large, established firms – apply equally well to either nascent or newly established firms merits further consideration. What evidence do we have that the same proscriptive advice we give in the case of large-firm strategy applies to nascent or newly established firms? And does that advice apply equally well for both innovative, high-growth firms (the software startup) and replicative entrepreneurship (a neighborhood bakery)?

In Innovation and Entrepreneurship, Peter Drucker notes, “I have not come across any discussion of entrepreneurial strategies. Yet they are important, and they are distinct, and they are different.” Consider that the next time you are perusing your local bookstore seeking insight on how to build a business.

Entrepreneurship seems to be the cure all for almost everything including the common cold. In a recent paper, the Kauffman Foundation found that the number of Fortune 500 companies and Inc 500 companies were founded in bear markets. A bear market is when stock prices are more or less falling and a bull market is one in which they are rising. Now this seems counter-intuitive at first. Would you not start a business when times are good? In bad times, if other firms are having trouble selling goods and services, why would you start another one? However, there is another aspect to this. If you lose your job you might have to start a business (a necessity entrepreneurship). But I do not think many of these would grow up to be Fortune 500 companies.

So how do we explain the Kauffman finding? Well, a quick look at bear and bull markets reveals a very interesting finding. Over the whole of the 20th century we found about three bear markets (the market rising) and about three bull markets (the market falling). Each is about 15 years, give or take a little. Keep in mind that a bear market does not mean recession. Recessions are short, but bear markets can last a very long time. In fact, the current bear market stated about 2001 so we are about halfway through if you take the more or less 15-year average. So it is not surprising if about half of businesses are started in bear markets. In fact, a quick look at the statistics suggests that the start-up rate of new firms is not very sensitive to recessions. They are around eight percent. They never fall by 50 percent and never rise by 50 percent.

So what does this finding tell us? Nothing I am afraid. It is business as usual. In good times and bad times Americans will start businesses. I would suggest that the creative class start-up rate is also very steady in the recession. The regional variation of this might also be very interesting.

As creativity becomes increasingly important to all jobs, existing corporate recruiting and management processes face challenges. Some of these were documented recently by the Conference Board in “Changing Attitudes to Work – What Should HR Do.“  (Subscription may be required to view.)

First, some numbers about employer attitudes and approaches to hiring for creativity:

• 97 percent of American employers agree that “creativity is increasingly important in U.S. workplaces.”
• 72 percent say that hiring creative people is a primary concern.
• 85 percent of employers who seek creative employees state they struggle to find them.
• 25 percent assess creativity from interviewees appearances.
• Less than 20 percent use profile tests to identify creativity.

From the above, it seems that many companies appear lost when it comes to an approach to finding the types of employees they want.

The ways that creative people often want or need to work sometimes challenge traditional HR practices.

• 75 percent of junior to mid-level staff use social networking tools while most senior leaders have never done so and are concerned about privacy.
• Younger people appear to be more entrepreneurial, interested in starting their own ventures at some point. This leaves some HR professionals concerned about hiring them, wanting “lifers,” but in making this preference they may be rejecting some incredibly driven and talented people from contributing to their company.
• Many talented younger people are not interested in the traditional hierarchy of career paths within a company. Creative people often want flexibility, whether to balance work-home life or shift laterally within the company to learn new skills.

What do you think of these stats? Do you feel like you fit in at your workplace as a creative?

… one victim will be entrepreneurship.

I monitor the financial blogs quite a bit and over the last two weeks an amazing transformation has occurred. Initially, many were calling the current wave of government takeovers “socialism.” Now, with the most recent Bush-Dodd-Frank plan to give enormous amounts of U.S. government money to global financial institutions, few believe this has nothing to do with “socialism.” What a canard. This is simply the final act in a long bout of “crony capitalism.”

Socialism is about government ownership of parts of the economy in an effort to transfer some of the gains to the less fortunate in society. For anyone to believe that the last two decades of financial deregulation and the current giveaways of government monies have anything to do with socialism is simply ridiculous. This is about some sort of booty capitalism where theft was legitimated. When the State abdicates its role as an enforcer of rules of the game, things quickly get out of control and outright fraud becomes the rule.

The New Deal was not socialism, though many accused it of being that. It had many components, but one of them was the enforcement of transparency and rules upon the stock market. It was this that made U.S. markets the envy of the world. These have now collapsed as few trust the financial results being reported by U.S. firms or even a day’s trading results, as investment banks are clearly investing in their own stocks for day trading profits. The SEC and the Fed have openly told firms they do not need to report their results truthfully. This is extremely dangerous throwing the major principles necessary for operating markets overboard at the first whiff of a crisis is extreme and dangerous short-termism. Regaining public trust will take a very long time.

How does all of this affect entrepreneurship and creativity? The U.S. entrepreneurial model was to start a firm, build it, and then use public stock markets to raise capital to build the firm further. In the last decade, many of the advocates for entrepreneurship came to think of public markets simply as exits from which the promoters got rich. This type of thinking is a fundamental misunderstanding of the role of stock markets. The initial public offering is meant to raise more capital so that a firm can grow. The EXIT is only a by-product of the raising of capital for further growth.

This mistaking of a private goal for the public good led to the offering of ridiculous firms in the dot.com bubble, which made billions for unscrupulous “entrepreneurs,” venture capitalists, and investment bankers. It also destroyed the public markets. Unfortunately, this most recent meltdown, which is only in its first stages, will be catastrophic for small firms wanting to raise capital.

For Schumpeter’s gales of creative destruction to work, one needs the transparency that can only come from stern and fair regulation. Otherwise, the creativity that creates new value cannot be expressed because of a generalized lack of trust.

I know I have combined two thoughts in this post. We need to sharpen up our vocabulary so that we can discuss the issues clearly and thoughtfully.

What do you think will be the effect of this collapse on entrepreneurship?

For a class to exist – the working class, the capitalist class – it has to inherit something to continue from one generation to the next. Money, or the lack of, was usually the thing that helped define a class. Titles and status also worked pretty well. If a class is defined by intangibles – like drive, character, education, creativity – can it be inherited and, if it cannot, can it be a class?

Think of entrepreneurship. If one cannot inherit the “claw with the prey,” how does the class continue? What holds it together from one generation to the next? This has interesting public policy implications. What should public policy support? Are we still in the Schumpeterian world where the capitalist class invites in the gifted few to revitalize the system from time to time? We seem to invite immigrants and they seem to perform rather well.

The world of venture capital investment can seem murky and opaque, especially for a first-time entrepreneur. Depending on your perspective, the venture capital industry can look like a densely networked set of professionals or the so-hot-right-now party to which you didn’t get an invite.

While the prevailing wisdom is that venture capitalist is in the driver’s seat in the relationship with the entrepreneur, that’s not necessarily so. The relationship is better characterized as one rife with asymmetric information. And, as it turns out, both sides are flying by instruments. For example, an entrepreneur inevitably possesses more knowledge about their business and its prospects than the venture capitalist. It’s pretty easy to imagine an optimistic founder overstating the technology, business environment, or the capability of the management team in order to secure financing or negotiate better terms. A more unpleasant – but unfortunately not uncommon – scenario is outright opportunism where, after receiving financing, the team squanders the invested cash, turning the startup into their own personal ATM.

Venture capitalists invest other people’s money in small teams of unknown (often dubious) quality, shepherding bleeding-edge technology to an unproven market: a truly risky business. A rich literature details the incentives and controls that venture capitalists use to mitigate that risk and align the goals of the entrepreneur and investor (a standout paper on this subject by Thomas Hellmann is available here). Unfortunately, the existing literature tends to focus entirely on opportunism by the entrepreneur, with little or no mention of what happens when venture capitalists start behaving badly (in a forthcoming paper, I have worked with my colleagues to redress this imbalance). The fact of the matter is that a huge, dispersed collection of individuals asking for capital from a small number densely of networked investment professionals seeking an outsized return is bound to go awry for the entrepreneur a good chunk of the time.

Enter TheFunded.com. Launched in early 2007, the site allows entrepreneur-members to rate, review, and discuss their experiences with venture capital firms. By scaling up and enhancing informal entrepreneurial social networks, TheFunded.com provides entrepreneurs with more information about venture capital firm operations, as well as firsthand reports of experiences with investors and board members. It has also generated a firestorm of publicity and controversy. In 2008, the site provided the ability to upload and review term sheets, allowing entrepreneurs to compare deal terms. You can imagine how well that went over on Sand Hill Road.

Initial reaction to the launch of TheFunded.com was pretty predictable: chewed-up or jilted entrepreneurs gleefully celebrating the new state of affairs and venture capitalists trying to game the rating system or even sue anonymous posters. But many venture capitalists are discovering that the benefits of connectedness and transparency outweigh the downside of the sometimes bruising public feedback.

Both entrepreneurs and venture capitalists ultimately benefit when both sides know what’s what. Through TheFunded.com, entrepreneurs may now know a bit more about firms, partners, and deal terms. However, the knife cuts both ways. Perhaps the informal network of venture investment and startup culture will firm up a bit, and a public mechanism for quickly sorting out a capable founder from the mass of cranks, creeps, and bozos will emerge. This would benefit venture capitalists, but also the startup’s early hires, all of whom are signing up to work themselves into the ground for the chance at breakout cash. Imagine anonymous postings detailing tales of management’s goofball antics, inexperience, and malfeasance written by employees, venture investors, and board members. Reputation is an extremely powerful corporate governance mechanism.

It probably feels about as good to be a banker today as it did to be running an Internet startup back in the day. That is, until the other shoe drops. Yves Smith reports on the ennui engulfing this season’s technique-arbitragers, finance professionals with “a narrow skill, like being able to structure CDOs…unable to land jobs” in the imploding financial services industry. Reports indicate that half of the people working in debt sales, trading, or research in NYC at the beginning of 2007 will be fired at the end of the year or won’t get a bonus. For fans of Leveraged Sell-Out and the Banker Method, this is not good news.

The similarities are not lost on those of us who participated in the technology tomfoolery in the early to late 90’s, where those who could hand-code HTML had a skill they could trade – albeit for a very brief period – for 80 large and on-site espresso. Smart people understand the half-life of the trix-y things they know, and act accordingly. Those that miss the phase shift take a more stable job or shift careers, leaping from the back of one hungry crocodile to the next like Pitfall Harry. A few even become entrepreneurs. Some follow the heat and light elsewhere, “…moving west or to Europe, including Russia, or to Dubai” according to Jeanne Branthover, managing director of Boyden Global Executive Search.

Technique without creativity is a commodity, and all that this entails. What’s of interest to me is the crucial intermingling between technique and creativity, and how people use the current foundation of technical work as a mechanism to learn, incorporate, and innovate. There are heaps more places to do that then ever before. It’s a spiky world. Where will innovation in the production of complex, mission-critical software applications, energy and the environment, or finance happen next? I suspect that innovation will go where the people go.

What’s creativity and what’s technique in your line of work? When will the particular tricks-y things you do become automata, or simply routine knowledge that represents the ticket to entry? If the talent in your industry goes elsewhere, will you switch locations, switch industries, or stay put?