Understanding How Businesses Start and Grow
Prepared by the National Commission on Entrepreneurship , March 2001

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Part Three: What Does Public Policy Have to Do With Entrepreneurial Growth?

A Precarious Transition

Understanding the different stages that most successful EGCs go through is essential to developing effective public policy. Most of the popular media attention towards entrepreneurs has focused on their efforts during the later stages, when they are transitioning from one type of company into another. The early stages of development have gone virtually ignored, and any policy program intended to support entrepreneurship will have to address the needs of entrepreneurs in both stages.

None of this means that entrepreneurs who reach the later stages are out of danger and have no need for support. Having started a successful company is no guarantee of its survival, much less its prosperity. In fact, growth companies remain in a particularly precarious position even after they have enjoyed a series of early wins. And in many ways, building a company past its initial success is even harder than getting the initial business off the ground. It is for these reasons that the vast majority of new businesses fail within ten years. Most close their doors entirely or become the walking dead – remaining small and being quickly surpassed by others. Many of those that do survive the initial stage cease fighting for long-term viability on their own and are often bought out by larger competitors. And entrepreneurs who have decided to enter areas such as the Internet or biotechnology face tremendous hurdles within the first few months.

Because the motivations and characteristics of a successful later-stage entrepreneur are so different from those at the earliest months, growth companies are particularly vulnerable during this transition. The transition from initial entrepreneurial success to long-term growth requires comprehensive changes in many attributes of successful EGCs, according to Bhidé. Only the very few entrepreneurs who can reinvent themselves into ambitious, strategy- minded risk-takers will continue to grow. To make this transition successfully, growth companies have to find new employees, customers, and sources of capital, according to Bhidé.

Given what Bhidé calls the limited correlation between these attributes and those initially required, it is no surprise that many founders decide to sell their firms or remain local, regional, or niche players. For many entrepreneurs with one set of highly developed skills who are facing a whole new set of challenges as they enter the later stages of development, it can make more than just financial sense to consider selling the business. The passage from a fledgling business to a large company requires entrepreneurs to develop new skills and perfect new roles, writes Bhidé. At these later stages of development, a successful entrepreneur must do almost the opposite of what has been successful in the past in order to prevail. And here again, outside investors often play a key role in facilitating this transition by setting conditions that require entrepreneurial growth companies to adopt new behaviors.

Facilitating Conditions and Policy Implications

If anything is clear from recent and limited research on entrepreneurship, it is that many policies that have been adopted to spur entrepreneurship may be based on misunderstandings about entrepreneurship and may fail to meet the real-world needs of growth companies. Moreover, the needs of growth companies are not a uniform set of conditions, but rather a range of economic and social structures that differ, depending on the stage of development of the company.

Despite the current prominence of entrepreneurs, social pressures against risk-taking remain strong. Without an environment supporting entrepreneurship, critically needed resources – money, people, technology, and suppliers and customers – may be diverted away from risk-taking EGCs. The following is a brief description of several policy considerations that may warrant further investigation. This is by no means a comprehensive or detailed set of ideas.

1. Shared Risks and Rewards

EGCs need others to share their risk – employees, investors, suppliers, and even customers. This requires an education system that produces both employees with the basic skills (analytical, communications, and creative problem-solving skills) and employees with the right technical skills. Immigration policy is relevant if there is a shortage of technical staff. Regional policies that support networks of suppliers (lawyers, accountants, landlords, etc.) that are entrepreneur-savvy can also help. Bankruptcy laws that do not overburden or stigmatize entrepreneurs who take risks but fail are another critical element. Finally, regional political and community leaders can celebrate the success of EGCs and encourage a culture where working for or working with an entrepreneurial company becomes an exciting, honorable calling.

Shared rewards are also key, at both the earliest and later stages of entrepreneurial growth. Those who do take risks and succeed with entrepreneurs must be rewarded with a piece of the value created and grown by the entrepreneur. Early employees, early investors, suppliers, and even customers must have access to stock ownership or options in the EGCs they work with.

For those who succeed to the later stages, rewards for the success of the business should be maximized. First, an array of exit strategies – such as an initial public offering or an acquisition by another company – must be available to realize their gains. And these exit strategies require a vibrant new issue market (e.g., NASDAQ), reasonable securities regulations at federal and state levels, accounting standards that truly reflect the nature of the new business, and a reasonable anti-trust policy that sees acquisitions of EGCs as generally a good thing for the economy. Finally, tax policy should reward investment in EGCs.

2. Fostering and Protecting Innovation

At a regional level, universities should do more to encourage spin-out of commercial applications of their technologies, by their own professors or otherwise.

Intellectual property policy is another policy issue of critical importance to entrepreneurship. However, constructing an effective approach requires a delicate balancing act. For early-stage entrepreneurial growth companies, entrepreneurs need access to ideas that can be modified and executed successfully. Intellectual property laws that over-protect certain innovations would be a problem. For later-stage businesses, the enterprise seeking institutional capital and professional management needs enforceable legal rights to an innovation as a key asset of the company.

Entreprenuerial growth depends on sustaining levels of public investment in research and development and technology transfer laws that allow researchers and their institutions to commercialize their discoveries. At a regional level, universities should do more to encourage spin-out of commercial applications of their technologies, by their own professors or otherwise.

3. Expertise

Clearly, an analysis of the early stages of entrepreneurship suggests policies that better prepare individuals with the skills to be successful entrepreneurs. That probably means education that is excellent in both a general skills sense (analytical, communications, and creativity) and also some specific training in the requirements of entrepreneurship and business. On a regional level, public policy should encourage extensive networks of entrepreneurs and professionals who can advise and mentor these entrepreneurs – a support infrastructure that will help minimize the mistakes of youthful entrepreneurs.

Later-stage entrepreneurship requires policies that will encourage industry experts and managers to join EGCs. Again, the availability of stock, stock options, and favorable tax treatment is important. Making sure that personal liability for corporate actions is severely restricted is important too (securities litigation, for example). From a regional perspective, an education, transportation, communications, and lifestyle infrastructure attractive to managers is another key. And if there are a number of growth companies in the same region or area, then the risks for experienced managers who are considering relocation are lowered even further. If things don't work out with one company, there are others nearby that might be in search of skilled professionals.

4. Planning and Strategy

The adaptiveness that is the hallmark of early-stage entrepreneurship further emphasizes the need for education, entrepreneurship and business training, and critical support networks described above. Moreover, public policy and the agencies that implement it need to give the entrepreneur the flexibility to make decisions quickly. Overly onerous regulations and regulatory agencies (especially at the local level) that are ponderously slow and unduly delay the implementation of an entrepreneur's move are not helpful. Entrepreneurs need more forgiveness than permission in this phase.

The changes that EGCs face during these early stages also require the flexibility of capital and labor. Capital must be equity capital during this phase, without all the covenants, conditions, and security that accompany debt instruments. Policies that make such equity capital abundantly available are critical. Labor regulations must be flexible during this tumultuous phase too. The more that employees have access to portable health and pension benefits, the better they will be able to endure the necessary hirings and firings of the early stages.

5. Capital

Perhaps the most significant policy contribution over the last 30 years to U.S. entrepreneurship has been the creation of a vibrant capital market to finance entrepreneurial growth companies.

Perhaps the most significant policy contribution over the last 30 years to U.S. entrepreneurship has been the creation of a vibrant capital market to finance entrepreneurial growth companies.

Early-stage EGCs require an abundance of non-institutional equity capital. Policies that enable credit cards and second mortgages – at low interest rates – to be used to fund EGCs are important. Policy should encourage the reinvestment of earnings during the early growth stages of an EGC. Securities regulation, at the federal and state levels, must allow friends and family to invest in these companies. And regional policy should enable the formation of angel networks and seed capital funds to support entrepreneurial growth companies at the $300,000 to $3 million level. Good exit strategies for these early investors, in the form of vibrant public offering and acquisition markets, are obviously critical.

For EGCs, the policies that have supported the extraordinary development of the venture capital industry in the United States must be continued. This includes key provisions in ERISA that helped foster venture capital investments. We must also sustain the securities regulation, accounting standards, and initial public offering market regulations that have fostered robust exit strategies for these investors. Acquisitions of venture capital-backed companies must continue to be favored in anti-trust policy.

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