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

 

The Difference Between Innovators and Entrepreneurs

I just received a thank-you note from a student who attended a fireside chat I held at the ranch. Something I said seemed to inspire her:

“I always thought you needed to be innovative, original to be an entrepreneur. Now I have a different perception. Entrepreneurs are the ones that make things happen. (That) takes focus, diligence, discipline, flexibility and perseverance. They can take an innovative idea and make it impactful. … successful entrepreneurs are also ones who take challenges in stride, adapt and adjust plans to accommodate whatever problems do come up.”


Over the last decade I’ve watched hundreds of my engineering students as well as ~1,500 of the country’s best scientists in the National Science Foundation Innovation Corps, cycle through the latest trends in startups: social media, new materials, big data, medical devices, diagnostics, digital health, therapeutics, drones, robotics, bitcoin, machine learning, etc.  Some of these world-class innovators get recruited by large companies like professional athletes, with paychecks to match. Others join startups to strike out on their own. But what I’ve noticed is that it’s rare that the smartest technical innovator is the most successful entrepreneur.

Being a domain expert in a technology field rarely makes you competent in commerce. Building a company takes very different skills than building a neural net in Python or decentralized blockchain apps in Ethereum.

Nothing makes me happier than to see my students getting great grades (and as they can tell you, I make them very work hard for them). But I remind them that customers don’t ask for your transcript. Until we start giving grades for resiliency, curiosity, agility, resourcefulness, pattern recognition, tenacity and having a passion for products and customers, great grades and successful entrepreneurs have at best a zero correlation (and anecdotal evidence suggests that the correlation may actually be negative.)

Most great technology startups – Oracle, Microsoft, Apple, Amazon, Tesla – were built by a team led by an entrepreneur.

It doesn’t mean that if you have technical skills you can’t build a successful company. It does mean that success in building a company that scales depends on finding product/market fit, enough customers, enough financing, enough great employees, distribution channels, etc. These are entrepreneurial skills you need to rapidly acquire or find a co-founder who already has them.

Lessons Learned

  • Entrepreneurship is a calling, not a job.
  • A calling is something you feel you need to follow, it gives you direction and purpose but no guarantee of a paycheck.
  • It’s what allows you to create a missionary zeal to recruit others, get customers to buy into a vision and gets VC’s to finance a set of slides.
  • It’s what makes you get up and do it again when customers say no, when investors laugh at your idea or when your rocket fails to make it to space.

Leadership is More Than a Memo

I just read Brotopia: Breaking Up the Boys’ Club of Silicon Valley. It was both eye-opening and cringe-worthy. The book explores the role of gender in the tech industry – at startups and venture capital firms – and the interaction between men and women in the two. While Silicon Valley has grown to have global influence, in many ways the cultural leadership from the venture community has dramatically shrunk in the last decade. Chasing deal flow has resulted in many VCs leading the race to the bottom in startup ethical behavior.

Among other things the book reminded me how important leadership is in setting startup culture – both consciously and implicitly.

Here was the day I got that lesson.

—-

With the reckless and naïve abandon of founders who had no clue what they were about to tackle, we had just started Ardent, a supercomputer company. Ben Wegbreit, the VP of Engineering (one of my mentors and then co-founder of Epiphany), broke his foot skiing just as the company started. So every day Ben hobbled into our very small office nattily dressed in his suit but wearing sneakers over his cast. (Yes, in the dim past of Silicon Valley the execs really wore suits.)

At first the company just consisted of the founders, but Ben soon started to hire his engineering team. Since this was the pre-Hoodie era, they interviewed in various types of then engineering attire – most with jeans, some with khakis, etc. (And back then they were all men.) But as each engineer was hired and started work I began to notice that after a few days they started to wear suits… wait for it… with sneakers. Obviously, this was a pretty bizarre fashion statement – and no one had sent out a memo announcing this as the engineering dress code. After six weeks of furious staffing and recruiting Ben had a team of 10 or so engineers and I have vivid memories of all of them trying to look like Ben.

Yet Ben was oblivious to the suit-and-sneaker clone army he had created.

With my now decades of hindsight, I realize I should have just let the engineers know that Ben had broken his foot and there was no attempt at sartorial innovation. But I remember just being mesmerized by this lesson in implicit leadership unfolding before me.

I knew that the cast was going to come off, and Ben would show up one day wearing regular shoes. What I didn’t know was what would happen to the engineering dress code then– would they all then adopt suits and shoes? Drop the suits all together? Keep their suit and sneaker style?

And how long would the change in engineering dress take? The next day?  A week?

And then it happened. Ben showed up wearing a suit and … shoes.

I’m sure engineering productivity took a big hit that week as cognitive dissonance set in.  Some of the engineers literally went home at lunch and changed – some into shoes, some dropping the whole suit.  Most started wearing regular shoes the next day, and by the second day no one was wearing sneakers.

Decades later Mark Zuckerberg would run the experiment at scale.

Lessons Learned

  • Culture gets set both explicitly with rules and implicitly by example
  • The bro culture of the Valley is a failure of leadership – by VC’s who should know better and CEO’s who need to be taught
  • Ironically, it would take a Los Angeles VC, Mark Suster at Upfront Ventures and the Inclusion Clause to lead the change in venture capital culture

The State of Entrepreneurship

Co-founder magazine just interviewed me about the current state of entrepreneurship – in startups and large companies – and how we got here. I thought they did a good job of capturing my thoughts.

Take a read here.

click here to read the rest of the article

CoinOut Gets Coin In

It’s always fun to see what happens to my students after they leave class. Jeff Witten started CoinOut four years ago in my Columbia University 5-day Lean LaunchPad class. CoinOut eliminates the hassle of getting a pocket full of loose change from merchants by allowing you to put it in a digital wallet.

Jeff just appeared on Shark Tank and the Sharks funded him. We just caught up and I got to do a bit of customer discovery on Jeff’s entrepreneurial journey to date.

What was the Shark Tank experience like?
It was surreal. We were not prepped or told what to expect, and really just thrown into the “tank” like a baby in the deep end. Given the stage and possibility of embarrassment, it was very intimidating. With that came a ton of adrenaline – it felt like a gallon of it was pumped into my veins – and it allowed me to focus and defend the business/myself as if there were no tomorrow. Looking back I can barely remember what went on in there, but just that I went in with a fighter’s mentality of not letting them speak over me, bully me or misrepresent what we are doing.

SHARK TANK – Coverage. (ABC/Michael Desmond)
JEFF WITTEN (COINOUT)

Anything about the Lean LaunchPad class or just being an entrepreneur in general prepare you for pitching on Shark Tank?
The class was almost a mini shark tank – I still remember the very first pitch we did in front of the class. Each time you speak publicly, or even privately for that matter, about your business I believe that you learn something and help improve / sharpen your pitch. Also, as an entrepreneur, you have to fight every single day. Nothing is easy and you need to convince people that your new way of doing something brings value that someone should pay for. That mentality certainly is one I needed to survive the “Tank.”

Coming into the Lean LaunchPad class, what did you know about starting a company?
I knew very little! I had lots of thoughts that turned out to be wildly incorrect and off target. I had a faint idea of how to interact with potential customers, but no real-life experience doing so. I also knew how to write up a great, theoretical proposal and presentation but that was about it!

What was the 5-day LaunchPad class experience like?
The 5 days were still one of the most intense stretches I’ve gone through (even more intense than some law school finals)! I was working with 4 other folks for the first time and we had to slam together as much as possible to come to some legitimate findings by the end of the course. We actually forced our way into a retail conference that was going on in the Javits Center and ran around berating a million different very large companies, half of whom told us to get lost. At the end of the day, we were able to re-focus and come up with half decent findings with the help of the business model canvas and mentoring from our professors. It was a real whirlwind, but when I look back, many of the discoveries still animate the product and company today.

Jeff’s original CoinOut presentation after five days is here

What did you learn in the LaunchPad class?
I learned how to build a Minimum Viable Product (MVP), test it with real customers and ask the right questions to get unbiased feedback. I took those learnings and implemented that immediately in a pilot while still in school. I feel like I’ve done 30 different MVP’s and customer tests over the few years since the course and continue to use the lean methods in all things we look to do for our customers and merchants.

What were the biggest learnings in your first 3, 6, 12, 24 months as an entrepreneur?
The biggest learning was that it’s vital to get out of the building. After getting some data and feedback it’s easy to then say we have enough and know what we need to build. Still today, even after a couple years at this, I have to remind myself that we always have more we can learn from potential and existing customers.

I would say the first 3 months it was to keep asking questions and iterating based on what we were getting. After 6 months, it was learning how to tackle everything with grit and determination as if there were no other option. And in the 12 – 24 months it was to always keep an open mind and never assume a product is right until you truly have product-market-fit. We keep doing pivots to this day. We believe we will always be searching for a better version of product-market-fit!

What are the top three things you wished you knew when you started your company?

  1. I wish I knew how critical good distribution channels are, particularly in the early stages of a company. You can have the greatest product in the world but if it can’t get into customers’ hands efficiently and effectively it is meaningless.
  2. I wish I knew how difficult it is to change people’s perceptions in large companies. Sometimes when you are hot out of the gates with entrepreneurial fever you think you can do anything. I think that is always a valuable feeling to have, but when selling through to larger organizations I’ve learned you need to temper your expectations and do as much as you possibly can to mitigate the risks of partnership ahead of time. Show them why they need to do it rather than why it would be a nice thing to have.
  3. I wish I knew how much fun this was going to be because I would have gotten in sooner! Many people say how hard entrepreneurship is, and I 100% agree. It is incredibly hard. But it is also rewarding like nothing else and when things work out well it is really fun.

See the articles about CoinOut in Forbes and in Columbia entrepreneurship and on Shark Tank episode 23.

While we can’t guarantee an appearance on Shark Tank, the five-day Lean LaunchPad class at Columbia is offered every January and open to all Columbia students.

Hacking for Defense at Columbia University

Over the last year we’ve been rolling out the Hacking for X classes in universities across the U.S. – Hacking for Defense, Hacking for Diplomacy, Hacking for Energy, Hacking for Impact (non-profits), etc.

All are designed to allow students to work on some of the toughest problems the country has while connecting them to a parts of the government they aren’t familiar with. When they leave they have contributed to the country through national service and gained a deeper understanding of our country.

Here is the view from Columbia University.

If you can’t see the video click here.

Innovation at Speed – when you have 2 million employees

Success no longer goes to the country that develops a new fighting technology first, but rather to the one that better integrates it and adapts its way of fighting…Our response will be to prioritize speed of delivery, continuous adaptation, and frequent modular upgrades. We must not accept cumbersome approval chains, wasteful applications of resources in uncompetitive space, or overly risk-averse thinking that impedes change.

If you read these quotes, you’d think they were from a CEO who just took over a company facing disruption from agile startups and a changing environment. And you’d be right. Although in this case the CEO is the Secretary of Defense. And his company has 2 million employees.


In January, Secretary of Defense Mattis released the 2018 National Defense Strategy. This document tells our military – the Department of Defense – what kind of adversaries they should plan to face and how they should plan to use our armed forces. The National Defense Strategy is the military’s “here’s what we’re going to do,” to implement the executive branch’s National Security Strategy. The full version of the National Defense Strategy is classified; but the 10-page unclassified summary of this strategic guidance document for the U.S. Defense Department is worth a read.

Since 9/11 the U.S. military focused on defeating non-nation states (ISIS, al-Qaeda, et al.) The new National Defense Strategy states that we need to prepare for competition between major powers, calling out China and Russia explicitly as adversaries, (with China appearing to be the first.) Secretary Mattis said, “Our competitive advantage has eroded in every domain of warfare.”

While the Defense Strategy recognizes the importance of new technologies e.g. autonomous systems and artificial intelligence – the search is no longer for the holy grail of a technology offset strategy. Instead the focus is on global and rapid maneuver capabilities of smaller, dispersed units to “increase agility, speed, and resiliency .. and deployment … in order to stand ready to fight and win the next conflict.” The goal is to make our military more “lethal, agile, and resilient.”

The man with a lot of fingerprints on this document is the Deputy Secretary of Defense Patrick Shanahan. Shanahan came from Boeing, and his views on innovation make interesting reading.

“The DoD must become less averse to risk” is something you’ve rarely heard in the government. Yet, Shanahan said, “Innovation is messy, if the (defense) department is really going to succeed at innovation, we’re going to have to get comfortable with people making mistakes.”

All of this means that significant changes will be needed in the Department of Defense’s culture and policies.  But now the change agents and innovation insurgents who have been fighting to innovate from the bottom up at Office of Naval Research, National Geospatial-Intelligence Agency, Joint Improvised-Threat Defeat Organization, Defense Intelligence Agency, National Security Agency, Defense Innovation Unit Experimental, Intelligence Advanced Research Projects Activity, etc., will have the support all the way to the Secretary of Defense.

The innovation language in this document is pretty mind blowing – particularly the summary on page 10. It’s almost as they’ve been reading the posts Pete Newell and I have written on the Red Queen Problem and the Innovation Pipeline.

This document, combined with the split of Acquisition and Logistics, (the office responsible for buying equipment for the military), from Research and Engineering will enable the DoD to better connect with private industry to get technology integrated into the defense department. The last time the country mobilized private industry at scale was the Cold War.

As you read the excerpts below from the 2018 National Defense Strategy imagine the shockwaves this would send through any large company.  This is a pretty unprecedented document for the military.

on page 3
“…Maintaining the Department’s technological advantage will require changes to industry culture, investment sources, and protection across the National Security Innovation Base. “

on page 4
“Defense objectives include: …Continuously deliver performance with affordability and speed as we change Departmental mindset, culture, and management systems;

on page 5
Foster a competitive mindset. To succeed in the emerging security environment, our Department and Joint Force will have to out-think, out-maneuver, out-partner, and out-innovate revisionist powers, rogue regimes, terrorists, and other threat actors. We will expand the competitive space while … reforming the Department’s business practices for greater performance and affordability

on page 7
Cultivate workforce talent. … Cultivating a lethal, agile force requires more than just new technologies and posture changes; …it depends on the ability of our Department to integrate new capabilities, adapt warfighting approaches, and change business practices to achieve mission success. The creativity and talent of the American warfighter is our greatest enduring strength, and one we do not take for granted.
…A modern, agile, information-advantaged Department requires a motivated, diverse, and highly skilled civilian workforce. We will emphasize new skills and complement our current workforce with information experts, data scientists, computer programmers, and basic science researchers and engineers…The Department will also continue to explore streamlined, non-traditional pathways to bring critical skills into service, expanding access to outside expertise, and devising new public-private partnerships to work with small companies, start-ups, and universities.

on page 10
The current bureaucratic approach, centered on exacting thoroughness and minimizing risk above all else, is proving to be increasingly unresponsive. We must transition to a culture of performance where results and accountability matter.

Deliver performance at the speed of relevance. Success no longer goes to the country that develops a new fighting technology first, but rather to the one that better integrates it and adapts its way of fighting…. Current processes are not responsive to need; the Department is over-optimized for exceptional performance at the expense of providing timely decisions, policies, and capabilities to the warfighter. Our response will be to prioritize speed of delivery, continuous adaptation, and frequent modular upgrades. We must not accept cumbersome approval chains, wasteful applications of resources in uncompetitive space, or overly risk-averse thinking that impedes change. Delivering performance means we will shed outdated management practices and structures while integrating insights from business innovation.

Organize for innovation. The Department’s management structure and processes are not written in stone, they are a means to an end–empowering the warfighter with the knowledge, equipment and support systems to fight and win. Department leaders will adapt their organizational structures to best support the Joint Force. If current structures hinder substantial increases in lethality or performance, it is expected that Service Secretaries and Agency heads will consolidate, eliminate, or restructure as needed.


Up to now innovation within the Department of Defense has been the province of a small group of insurgents, each doing heroic efforts. Now innovation at speed has become a nation’s priority.  Culture change is hardest in the middle of a large organization. It will be interesting to see how each agency in the Department of Defense (and its contractors) adopts the strategy or whether the bureaucratic middle kills it/waits it out. Time will tell whether it provides real change, but this is a great start.

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