a class?
Two different sets of resources and two different philosophies emerge to answer these questions. Resources are deployed either as entrepreneur development or venture development. Entrepreneur development seeks to train and prepare the entrepreneur for the road ahead. Entrepreneur Development Organizations support the entrepreneur with community, networks, and training independent of their venture.
Venture Development Organizations support companies, usually who have defensible Intellectual Property or market traction, with resources needed to quickly scale their operations. Resources might include grants, investment, or consulting services designed for startups.
Each of these resource providers will likely have a philosophy about how resources should be allocated. The first philosophy is the “tough love” approach. Entrepreneurship is brutal and hard. Resources should only go toward entrepreneurs who demonstrate ability typically by gaining customer traction without the need for resources. The convertible note is a good example of how investors seek to mitigate risk by requiring small businesses to have ongoing customer traction to access resources.
The second philosophy is the “market” approach. Resource providers see entrepreneurs acting within a capital market. The entrepreneur, perhaps based on previous success or the strength of their idea, can command pre-revenue investment for their startup. The investor views speed as the competitive advantage. If resources are deployed quickly, the entrepreneur has a better chance of success in a competitive global economy. Providing pre-seed grants to startups or pre-revenue equity investments are good examples of this philosophy. The SAFE investment contract is a good comparison to the convertible note.
Each set of resources or philosophies is not better or worse though many practitioners believe strongly in their chosen philosophy. However, the differences drive regional divergence and local economic development strategies. For example, some regions are heavily against a market approach to entrepreneurship. Decision-makers feel strongly that entrepreneurs should not receive grants or pre-revenue equity investments.
The needs of entrepreneurs are largely driven by broader economic logics related to the startup, creative, and digital economies and much different than other industries such as agriculture or manufacturing.
Creativity and “Agro-Industrial Production”
In the 20th century, agriculture and manufacturing dominate the economy. Agricultural supply chains are regional and distributed. Manufacturing supply chains have broader distribution but are vertical and typically hierarchal within a regional economy. A major constraint on both agricultural and manufacturing production is transportation costs and durability.
In the manufacturing economy of the 20th century, successful entrepreneurs embodied a tough and rugged approach. Success was earned and won with little financing and incremental growth. The ability to presell to buyers was a better approach than raising debt financing from a limited supply of local commercial banks. Through an entrepreneurial force of will and expanding markets, some manufacturers grew to operate as prime or second tier manufacturers. Larger firms contracted regionally with third, fourth, and lower tier specialized suppliers due to high transportation costs.
A small manufacturer might grow over time, but growth is always incremental. Manufacturing accounting is pragmatic. Firms that try to grow too fast get into big trouble. Every manufacturer can tell a story, either from personal experience of a friend, who took too much debt at the wrong time. A downtown development plan failed and took years to recover.
Shipping costs also provide a bound to production. Aspiring manufacturers cannot grow as rapidly as a tech company can today. Taking too much debt or attempting to grow too fast represents an embarrassing failure for the gritty entrepreneur. The 20th century economy is dominated by the entrepreneur with humble beginnings, who is clever in their ability to presell, and demonstrates long-term persistence and incremental growth.
The values of 20th century entrepreneur should be present in any successful ecosystem. Though some aspects of growth, production, and speed are changing, success still requires determination, persistence, and pragmatic accounting.
The 21st century entrepreneur operates in a few distinct ways compared to their 20th century counterparts. The first difference is speed to market. Entrepreneurs in the new economy sell equity so they can reach the market faster, a concept literally devilish in the 20th century economy. Equity finance in the form of private equity and venture capital play much larger roles in economic production as evidenced by significant growth in investment volume over the past four decades. Differences do not apply to all sectors, but many industries are shifting their model to reach the market as quickly as possible.
Some key features of the 21st century digital and creative economies include low distribution costs, more product and market variety, and in some cases lower barriers to entry. Film and media exemplify these logics as they can distribute their product across the world with negligible cost. The production from film and media companies are infinite in their variety and differentiation. Today’s media companies are plagued by low barriers to entry as amateur news producers, filmmakers, and musicians gain market share.
Global competition also forces the hand of capital in the 21st century. Many firms that operate in industries closer to the 20th century model find themselves needing capital at earlier and earlier stages. One challenge that drives American economic divergence is the differences in investor philosophies and access to capital between larger and smaller metros.
If investors in one part of the country are giving capital with less constraints, these startups will reach market faster than counterparts in other regions. If other regions are slow in their approach, they will lose. Complicating matters is that some regions do not have the discretionary resources to place riskier bets on early stage firms. In any case, these tensions drive how resources are deployed at the local level.
Capital requires a byzantine understanding of industry categories and investment philosophies. Pre-IPO financing or financing for the privately held economy is no different. The relationship between debt and equity capital is long studied in academia. However, publicly traded companies and privately held companies are operate in a different enough landscape that challenges a common understand between large companies and small business.
For example, an insightful theory that explores a firm’s relationship between equity and debt financing is called the Mogdiliani-Miller Theorem. The theory holds that in an efficient market, the cost to a firm of debt and equity financing remains the same [2]. However, the theory applies to publicly traded firms with enough real time data to validate.
The limitation in market and firm-level data and information drives major differences in how public and private markets operate. For example, disclosure requirements are different between small businesses and publicly traded firms. Publicly traded firms must disclose material impact to their firm’s valuation to existing and potential investors alike. Privately held firms with investors disclose information through Board-level Governance.
To any accountant or attorney these differences seem obvious and slightly trivial, but they lead to massive differences in how society supports and monitors publicly traded and privately held firms.
Domains of research associated with small business ownership, entrepreneurship, and local economies fall under economic development as opposed to finance. At the local level, aggregate firm-level or economic data is largely unconsidered.
Even the terminology related to positions within a company are different. We refer to the small business owner as managing partner or owner. We refer to a similar role in a growth company as “founder” because of the numerous exit options available that might include acquisition or replacement as CEO.
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