Why Entrepreneurs Start Companies Rather Than Join Them

If you asked me why I gravitated to startups rather than work in a large company I would have answered at various times: “I want to be my own boss.” “I love risk.” “I want flexible work hours.” “I want to work on tough problems that matter.” “I have a vision and want to see it through.” “I saw a better opportunity and grabbed it. …”

It never crossed my mind that I gravitated to startups because I thought more of my abilities than the value a large company would put on them. At least not consciously. But that’s the conclusion of a provocative research paper, Asymmetric Information and Entrepreneurship, that explains a new theory of why some people choose to be entrepreneurs. The authors’ conclusion — Entrepreneurs think they are better than their resumes show and realize they can make more money by going it alone.  And in most cases, they are right.

I’ll summarize the paper’s conclusions, then share a few thoughts about what they might mean – for companies, entrepreneurs and entrepreneurial education. (By the way, as you read the conclusions keep in mind the authors are not talking just about high-tech entrepreneurs. They are talking about everyone who chooses to be self-employed – from a corner food vendor without a high school diploma to a high-tech founder with a PhD in Computer Science from Stanford.)

The authors’ research came from following 12,686 people over 30+ years. They found:

  1. Signaling. When you look for a job you “signal” your ability to employers via a resume with a list of your educational qualifications and work history. Signaling is a fancy academic term to describe how one party (in this case someone who wants a job) credibly conveys information to another party (a potential employer).
  2. Capable. People choose to be entrepreneurs when they feel that they are more capable than what employers can tell from their resume or an interview. So, entrepreneurs start ventures because they can’t signal their worth to potential employers.
  3. Better Pay. Overall, when people choose entrepreneurship they earn 7% more than they would have in a corporate job. That’s because in companies pay is usually set by observable signals (your education and experience/work history).
  4. Less Predictable Pay. But the downside of being an entrepreneur is that as a group their pay is more variable – some make less than if they worked at a company, some much more.
  5. Smarter. Entrepreneurs score higher on cognitive ability tests than their educational credentials would predict. And their cognitive ability is higher than those with the same educational and work credentials who choose to work in a company.
  6. Immigrants and Funding. Signaling (or the lack of it) may explain why some groups such as immigrants, with less credible signals to existing companies (unknown schools, no license to practice, unverifiable job history, etc.) tend to gravitate toward entrepreneurship. And why funding from families and friends is a dominant source of financing for early-stage ventures (because friends and family know an entrepreneur’s ability better than any resume can convey).
  7. Entrepreneurs defer getting more formal education because they correctly expect their productivity will be higher than the market can infer from just their educational qualifications. (There are no signals for entrepreneurial skills.)

Lemons Versus Cherries. The most provocative conclusion in the paper is that asymmetric information about ability leads existing companies to employ only “lemons,” relatively unproductive workers. The talented and more productive choose entrepreneurship. (Asymmetric Information is when one party has more or better information than the other.) In this case the entrepreneurs know something potential employers don’t – that nowhere on their resume does it show resiliency, curiosity, agility, resourcefulness, pattern recognition, tenacity and having a passion for products.
This implication, that entrepreneurs are, in fact, “cherries” contrasts with a large body of literature in social science, which says that the entrepreneurs are the “lemons”— those who cannot find, cannot hold, or cannot stand “real jobs.”

So, what to make of all this?
If the authors are right, the way we signal ability (resumes listing education and work history) is not only a poor predictor of success, but has implications for existing companies, startups, education, and public policy that require further thought and research.

Companies: In the 20thcentury when companies competed with peers with the same business model, they wanted employees to help them execute current business models (whether it was working on an assembly line or writing code supporting or extending current products). There was little loss when they missed hiring employees who had entrepreneurial skills. However, in the 21stcentury companies face continuous disruption; now they’re looking for employees to help them act entrepreneurial.  Yet their recruiting and interviewing processes – which define signals they look for – are still focused on execution not entrepreneurial skills.

Surprisingly, the company that best epitomized this was not some old-line manufacturing company but Google. When Marissa Mayer ran products at Google the New York Times  described her hiring process, “More often than not, she relies on charts, graphs and quantitative analysis as a foundation for a decision, particularly when it comes to evaluating people…At a recent personnel meeting, she homes in on grade-point averages and SAT scores to narrow a list of candidates, many having graduated from Ivy League schools, …One candidate got a C in macroeconomics. “That’s troubling to me,” Ms. Mayer says. “Good students are good at all things.”

Really.  What a perfect example of adverse signaling. No wonder the most successful Google products, other than search, have been acquisitions of startups not internal products: YouTube, Android, DoubleClick, Keyhole (Google Maps), Waze were started and run by entrepreneurs. The type of people Google and Marissa Mayer wouldn’t and didn’t hire started the companies they bought.

Entrepreneurship. When I shared the paper withTina Seelig at Stanford she asked, “If schools provided better ways to signal someone’s potential to employers, will this lead to less entrepreneurship?”  Interesting question.

Imagine if in a perfect world corporate recruiters found a way to identify the next Steve Jobs, Elon Musks, or Larry Ellisons. Would the existing corporate processes, procedures and business models crush their innovative talents, or would they steer the large companies into a new renaissance?

The Economic Environment. So, how much of signaling (hiring only by resume qualifications) is influenced by the economic environment? One could assume that in a period of low unemployment, it will be easier to get a traditional job, which would lead to fewer startups and explain why great companies are often founded during a downturn. Those who can’t get a traditional job start their own venture. Yet other public policies come into play. Between the late 1930s and the 1970s the U.S. tax rate for individuals making over $100,000 was 70% and 90% (taxes on capital gains fluctuated between 20% and 25%.) Venture capital flourished when the tax rates plummeted in the late 1970s. Was entrepreneurship stifled by high personal income taxes? And did it flourish only when entrepreneurs saw the opportunity to make a lot more money on their own?

Leaving a Company. Some new ventures are started by people who leave big companies to strike out on their own – meaning they weren’t trying to find employment in a corporation, they were trying to get away from it.  While starting your own company may look attractive from inside a company, the stark reality of risking one’s livelihood, financial stability, family, etc., is a tough bar to cross.  What motivates these people to leave the relative comfort of a steady corporate income and strike out on their own?  Is it the same reason – their company doesn’t value their skills for innovation and is just measuring them on execution? Or something else?

Entrepreneurial Education. Is entrepreneurship for everyone? Should we expect that we can teach entrepreneurship as a mandatory class? Or is it calling? Increasing the number of new ventures will only generate aggregate wealth if those who start firms are truly more productive as entrepreneurs.

Lessons Learned

  • Entrepreneurs start their own companies because existing companies don’t value the skills that don’t fit on a resume
  • The most talented people choose entrepreneurship (Lemons versus Cherries)
  • Read the paper and let me know what you think

 

28 Responses

  1. We know that test scores / grades are the major signaling tools for Lemons.

    What are the signaling variables for cherries ? How can we understand them? I strongly believe today’s education test do not measure their skills. Do you think that there is a better way to pick cherries? 😊

    Liked by 1 person

  2. “It never crossed my mind that I gravitated to startups because I thought more of my abilities than the value a large company would put on them.”

    Well, God bless your pointed head, Steve…all I can guess from looking at your abbreviated bio is that you did not spend much time at a large, enterprise-scale company. Dilbert has covered this rich topic — insofar as the “death to innovation” mindsets in such places — far better than anyone.

    A long way of saying that this was a very conscious motivation in my particular case, and I can only hope many others…!

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  3. Steve, this is the best piece ever about clarifying this issue. More is less. Just Brilliant.

    Liked by 1 person

  4. (1) From what I saw of hiring at Google, the qualification they wanted was C++ coding and nothing else.

    (2) A Ph.D. in computer science is not the best qualification for an information technology startup. Applied math is better!

    (3) People in technical fields over 35 need to consider a startup because of severe age discrimination at big companies.

    (4) At most organizations, higher qualifications do NOT increase the chances of a job offer. Instead, people are looking for subservient, obedient, dependent, fungible subordinates.

    (5) Of COURSE large companies are not innovative: Their employees are to do the assigned, routine work from existing operations. Starting something new is not such work. Starting something new is risky, and big companies just want the assigned, routine work done cheaply and reliably, low risk. Besides, anything else is a threat to the careers of everyone else in the company. Besides, an internal innovation is opex and an acquisition is capex.

    Liked by 4 people

  5. Entrepreneurship is an attitude. A state of mind that distinguishes the “business model” of these people. It is only possible to favor the individual discovery of this propensity. Thanks for the post, a continuous stimulus to reflection.

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  6. Thanks for this piece. A very encouraging article particularly for those planning to start their own companies.

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  7. This rings true in my case. In spite of great education, I left corporate American after creating a $1BN unicorn within AT&T. I got a $10K bonus that year, which was in the middle of the “acceptable” range.

    With gratitude,

    Dave Linhardt Founder & CEO InsightStudios.co

    Liked by 1 person

  8. Entrepreneurship was originally defined by Schumpeter as an economic phenomenon. That seems to me still the right way to think about it. If someone offers an innovation (“new combination”) that breaks an economic cycle, they are an entrepreneur because that’s the one way to keep capitalism fresh and growing. Everything else (including attitude, personality, and start-up culture) is noise. If an engineer joins Google and works on autonomous self-driving, they are every bit as entrepreneurial as someone who starts a company to develop autonomous self-driving. And, the Google employee likely will have a much greater impact because she is already embedded in a powerful, creative community. As long as we conflate entrepreneurship with starting a company, and try to assign some kind of special personality traits to entrepreneurs, we come to all the wrong conclusions. Scott Shane is especially good on this; see https://link.springer.com/article/10.1007/s11187-009-9215-5.

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    • Entrepreneurship is not only about what you are doing but in what circumstances are you doing that. That shows your character. As an employee of Google, I will never have the limitations of money, less resources, being on your own. I would say that an entrepreneur working on self driving in his own company is a real entrepreneur and how I define an entrepreneur is being skillful, resourceful, visionary, measured risk taking abilities, and more. The degree of all these is traits is much higher in core entrepreneurship than a big company employee because he doesn’t have very less resources at disposal, he has help from other departments, he doesn’t have full independence mostly on the project, and he won’t necessarily have very severe implications of failing. Entrepreneur has to manage everything in a very balanced way and ensure success for his survival. And he pushed himself to these circumstances, so his belief in himself is much higher than a big company employee.

      Like

  9. the post is flattering for entrepreneurs, but I think it missed the point that when you are inserted into a large organization your value is 1+1= 3 so even if you are a genius “2”, but you do not cope with the organization, you are still delivering less than a simple “1”….

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  10. Is it the dominant trend for entrepreneurs to start a company in spite of getting a job at a larger Corporation, or do more entrepreneurs Branch off on their own after being at a large corporation?

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  11. Great write up, Steve. I think this article misses one point, which is that companies can’t accommodate many entrepreneur type individuals. People are primarily hired for implementation roles, so there’s simply not infrastructure to support too many idea people at any given company.

    Liked by 2 people

  12. Very inspiring Steve. Thank you.

    Like

  13. Steve, have you never before noticed that entrepreneurs are generalists, that our school system creates specialists, and that the corporate jobs expect people to do one?

    Try testing your incoming entrepreneurs with lunarmobiscuit.com/skills to see whose skills are still spiky and whose are round.

    Like

  14. Steve, this is an interesting angle and feels like it has a grain of truth. But there are several other dimensions that I feel also have large truth too:

    I have a PhD in financially lucrative area. But so do others. Thus Google needs to only give me a fraction of the $$$ they can make with my work. EVEN IF THEY FULLY REALIZE MY POTENTIAL.

    On my own I can own all fruits. Notice this does not depend upon asymmetric information, but rather on supply and demand of my specialty — and in a knowledge economy is only takes one.

    BTW a large factor in the other direction: my value at a large company is much higher, since they have access to the market. As an Entrepreneur almost all of my efforts go towards market access, scant little towards solving the problem for the customer! (Still I ain’t running back to IBM anytime soon!)

    love your writings by the way.

    Like

  15. It is a good step toward a successful journey. It is not easy as that but Those who have strength to do something, choose entrepreneurship. It opens job opportunity for people. People in India also started to choose their own business rather thank working for others. It takes time but you win definitely you don’t quit. founder of Geekolive will one of the successful man in those.

    Like

  16. This study is bogus. Comparing a corporate worker income (at 40 hours a week) to an Entrepreneur (60+ hours a week) gives only 7% more income for the latter? So then, hourly wages are more like 30% lower for the Entrepreneur. Which makes sense since they take lower average incomes for the chance of ‘hitting it big’.

    A bigger picture fatal flaw with the study: the ‘cherries’ that clearly have something more valuable (IQ, grit, etc.) than colleagues at a similar education level probably would have also been ‘cherries’ at the corporate job (getting earlier promotions for example and moving up ranks). Harder working, smarter people with adequate people skills get paid much more than 7% more than the average coworker. Therefore, the fact that an entrepreneur has that extra ‘something’ that helps them succeed is proof that income comparison between the average corporate worker and average entrepreneur may just reflect something like IQ or work ethic, rather than where they happen to work.

    Like

  17. Good to know that companies like seedlinktech and cognisess make a great deal out of unfolding the breadth of characteristics and skills that make a difference with big data.

    Like

  18. Armed with degrees from top universities, I started my career at a company known for its innovation. My goal was a VP slot. It didn’t take long to realize that there was no path from where I was to where I wanted to be. And that is why I became an entrepreneur. It was all about the money. I made more money last year than my parents did in their entire lives.

    I disagree with the author.

    The tremendous return I have is not due to my being worth more than my old company was willing to recognize, it has to do with the return on the risk I was willing to take.

    I had provided my old company many ideas to potentially develop. They were always turned down. An established company cannot take the risk necessary to make those big ideas pay off. I stopped giving them ideas.

    The article mentioned Google. Google has who knows how many R&D projects going on, but it will never let them get very far. They aren’t willing to risk the company for anything.

    Look at Apple and Motorola. Motorola was the leader in cell phones. But they refused to risk the company. Apple was headed toward bankruptcy. They had nothing to lose and placed a bet.

    Another example is Amazon and Sears. More than any other company, Sears was positioned to move from mail order to online order. But the company executives were unwilling to bet the company on that.

    Where are Motorola and Sears now? And that innovative company I used to work for named a lawyer as CEO and no longer exists.

    Risk the company and you may lose. Don’t risk the company and you will lose.

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  19. Many talented people become entres because hiring processes do not provide the opportunity to communicate important information that can justify the hiring decision. I know too many unfortunate people who encountered toxic situations at firms that threw them into the “maybe” (read…long term “no”) bucket.

    However, I also know genuinely toxic people who became entres because they were simply found out.

    The advice is this; find out more about why that shingle goes up….and remember, whatever goes around comes around! Co-workers previously thrown under a bus by new owners do not suddenly make the most enthusiastic supporters.

    Like

  20. Excellent article, agree heartedly.

    Like

  21. Your basic thesis looks reasonable; I recall a fellow from my college days who commented “Sun wouldn’t hire be because I don’t have a Master’s degree. So I started a company to compete with their flagship product.”. (His company did make him fairly rich.)

    In general, the bigger a company gets, the more pressure it will have to seek out economies of scale — essentially, “industrialization”. Unfortunately, when that hits the Personnel department, that leaves them looking for Standard Model Workers: Making a list of easily-testable features for new hires, and ignoring anyone who doesn’t pass the checklist.

    Any company which does this may gain something in predictability. but they completely lose out on the diversity of talents which is the true power of humanity.

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  22. Wonderful. Makes me think. Makes me ask all sorts of questions. If signaling is what’s on this side of the coin if we flip it over whats on the other side of the coin? Is the in ability to signal just a polite way of saying prejudice? When we measure a persons inability to get a job is it “really and truly” their inability to signal? or is it really just companies focus on specific things (as in your Google poor grades example) and don’t realize that hiring based “filtering out candidates” will filter out good people. I can’t tell you how many companies [more precisely the practices of a company’s hiring mangers] that screen people based on the “name brands” of their prior companies. Further I’ve seen a huge increase in age-ism (discrimination based on age..above 50, 60 etc..), is that because older people worked for “brick and mortar” mortar companies. And today’s companies only expect “internet brands”?

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  23. I also believe that education tests do not measure the skills. For you can learn some stuff and get good grades. But you cannot tranfer them into the practice unless you test it.

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  24. Great topic for discussion and your insights are always appreciated Steve! My first reaction was – I gotta tweet this: “asymmetric information about ability leads existing companies to employ only “lemons,” relatively unproductive workers. The talented and more productive choose entrepreneurship.” but then I realized that would insult many people I respect and admire…

    Lets admit – there are plenty of lemons amongst entrepreneurs as well, which doesn’t help the stats and analysis. And surely there are cherries in corporate world (see below why I think that is).

    I think a big reason why entrepreneurs (who are truly cherries) choose their own path outside corporate world is a combination of:
    a) It’s not that companies can’t evaluate their worth correctly, there is no means for companies to adjust pay to be adequate to talent. This is VERY obvious for programmers/engineers – a rock start can outperform their peers with x3-10 output, but at most they only get paid 50-100% more – this is why many technologists choose to join startups.
    b) Tolerance for risk (many other commenters touched on this too). Many very smart people I admire and just know could do very well as entrepreneurs choose to have FT jobs because of low risk tolerance. They have families, don’t have support networks (e.g. local family to help with kids) and so the risk tolerance is not aligned with potential and aspirations. I can’t wait to grow my next venture big enough to be able to hire these people and unlock their true worth.

    Like

  25. You get it…

    Like

  26. Fantastic article that describes me!

    Like

  27. Great Article, I think everyone should try business once in their life. I mean it’s a risky business still you should try this. Have a job first and then spend 3-4 hours daily on your business, I’m doing the same thing.

    Like

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