Entrepreneurs and capital

Wolves' new owner Steve Morgan is another datapoint corroborating the idea that it is capital, not character, that determines who becomes an entrepreneur:

According to the   Sunday Times Rich List, he has a fortune estimated at £425 million. In 1974, he borrowed £5,000 from his father to buy a struggling civil engineering firm and transformed it into Redrow, a multimillion-pound property business.

This is consistent with this paper (pdf) by Andrew Oswald and David Blanchlower:

The probability of self-employment depends markedly upon whether the individual ever received an inheritance or gift...Childhood personality measurements and psychological test scores are of almost no help in predicting who runs their own business later in life. It is access to start-up capital that matters.

Even in a world of abundant capital, banks are unwilling to lend big sums to people with neither collateral nor track record.
One reason for this is that entrepreneurship often rests upon a hunch, a gut feel for what might work. And this is tacit knowledge, hard to communicate to potential lenders; even good businessmen can fail to anticipate what might sell. Access to capital from family or friends is sometimes necessary to overcome this problem.
In this sense, it's environment, not just pure skill, that is necessary for entrepreneurship.

Comments

[Luis Enrique]

Why not say capital and character? I expect plenty of people could have put their hands on £5000 in 1974 but few could have turned a failing civil engineering company around. It wouldn't harm your conclusion any - environment is still necessary even if it needs combining with character.

Of course necessary is too strong a word - I'm sure there's at least one successful entrepreneur from a very poor background.

[dearieme]

Right then, scrap Inheritance Tax immediately.

[john b]

Dearieme: IHT has bugger all to do with anything - for a start, it arrives too late to drive much entrepreneurship. Far better to incentivise wealthy parents to back their progeny's business plans, rather than delivering them a windfall in their late 50s to buy a second/third house...

[Mark]

I wonder (and hope) that the communications revolution means that this is not as true as it once was - barriers to entry to business being lower in this (increasibly dominant) area than others.

However, it does lead me to wonder whether the government should not allocate more to capitalising and providing management expertise to budding entrepreneurs. In seeking to create wealth, should the government not try to tap as many potential entrepreneurs as possible? And I don't mean those piddling GBP2K grants that some local authorities offer.

[Heraklites]

Apologies for belabouring the heritability theme (this week's topic on the Heraklites blog). But isn't the quote from Oswald and Blanchflower quote a little tendentious?

If it *happened* to be (I am not saying it is) the case that entrepreneurial ability was, say, 90% inherited, and given that it is entrepreneurs who are most likely to end up with capital to bequeathe, wouldn't one expect a high correlation between self-employment and receipt of capital gift?

[Mark Wadsworth]

What Heraklites says.

[guest]

However, it does lead me to wonder whether the government should not allocate more to capitalising and providing management expertise to budding entrepreneurs.

The government could play a positive role by untaxing and de-regulating VC investment. "Capital and management provision" should be left to the private sector, in order to avoid political rent-seeking and other problems.

[Dipper]

the dot com boom seemd to be full of companies run by so-and-so's son or daughter. I assumed this was because they had the financial backing to take a chance whereas normal people have mortgages to pay. Of course, this is just anecdotal evidence and may be skewed.

And on the other hand, its riches to rags in three generations ...

[dsquared]

I think Luis is right. Elvis was bought a guitar by his mother, but that doesn't mean he wasn't really Elvis.

[Justin]

the dot com boom seemd to be full of companies run by so-and-so's son or daughter.

A particularly good example being Martha Lane Fox, who I believe, at the time she left Lastminute.com as one of the most-hyped "entrepreneurs" in the country, had not yet actually managed to turn a penny profit. The financial journalists and City headhunters who talked about how great she was would, I suspect, normally consider the ability to make a profit economically fundamental.

Anyway, her old man has a lot of money which I believe was the source of her start-up capital, no?

As for Elvis - I know what you mean but I'm not sure that the pop music industry is a particularly good place to serch for examples of talent, stil less the link between entreprenuerial talent and success. This is partly because that industry is absolutely packed full of shysters, crooks, hype merchants, bullies, hangers-on and liars. It's also for the associated reason that there's not necessarily a sizeable link between talent and success in that particular field, unless we're to adopt the (not uncommon) circular argument that in a market economy those who succeed have perforce shown themselves to be talented. I don't believe that for a moment.

Moreover, Elvis was a musician, not an entrepreneur (the Colonel was the entrepreneur, I'd have said) and it's not the same thing. It's occasionally forgotten now that there are different routes to becoming rich and they are not identical in nature.

I'm deeply suspicioius of the very term "entrepreneurial ability" (as I am of the even more tendentious term "wealth creation"). What does it actually mean and how much is it simply a a version of the argument I quarrelled with above, to wit "x has done very well economically therefore they must have deserved it"?

[Heraklites]

Justin, surely you wouldn't go so far as to deny there is such a thing as "entrepreneurial ability" (some people take to managing like a duck to water, some couldn't run a whelk stall), or to argue there is no inherited component?
No doubt there is also plenty of luck, string-pulling, networking etc. involved in becoming successful - in business, pop music and any other field one cares to mention.
Question: say the state intervenes to "correct" the failure of the market to generate perfect correlation between ability and success. Will this increase the correlation or decrease it?

[Justin]

"Right then, scrap Inheritance Tax immediately."

This is a remarkably silly comment (though not atypical of contemporary one-dimensional "let's-blame-tax-for-everything" thinking). How many people affected by inheritance tax would, as a result, lack the equivalent of five grand, allowing for inflation, to pass on to their beloved child to pay their start-up costs? None?

I'm in a position to know a bit about this. I spend my waking hours trying to make a loss-making small business work, one founded by my girlfriend two years ago basically on the basis of plunging her life savings into it and hoping for the best. The things we could do, in terms of equipment, advertising and so on, if Mummy and Daddy had money to give us, would quite concerivably transform our chances overnight.

Now that in itself doesn't bother me, since I don't hold the view that the purpose of society or government is to support entrepreneurs in everything they do. What does bother me is that when people talk about both capital and character making a difference, they surely vastly underestimate how great is the "capital" part of that equation. Growing up with money, or inheriting it, changes your life-chances to such an enormous degree that I think it's fair to call it "fundamental". (Of course there are plenty of people, as in comments above, who will say that ability is inherited as so of course the children of the well-off become well-off themselves, but I'll start believing that as soon as they stop buying their children the enormous advantages they currently enjoy.)

It seems to me that the more prominent "entrepreneurship" and meritocracy become in public policy and social discourse, the less they actually apply, because the wider economic inequality becomes, the harder it becomes to mobilise one's merit in order to bridge that gap. Not least because one hasn't got the money to make it possible.

But never mind, because the aforementioned argument comes to our rescue - the people who don't bridge the gap just didn't have sufficient merit, or just didn't try hard enough. It's a good game, if you're on the right side of it.

[Matthew]

£5,000 in 1974 is equivalent to between £36,000 and £56,000 today, so it's a fair chunk of money.

[ejh]

"Justin, surely you wouldn't go so far as to deny there is such a thing as "entrepreneurial ability"

I'd like to have a better idea of what people think it is. Because I think success in business may often involve a number of components (and I don't just mean luck) and some of them aren't really things like "getting the best out of people" or "understanding one's product" or "spotting a gap in the market" or what you will, important though these things can be.

I also think that if you don't have access to capital then your chances of success are enormously reduced to a degree that makes talk of ability almost irrelevant for those in that position. Of course it's more relevant for people who can get hold of money off their parents - nobody's so rich that they can't screw it up completely (except possibly the current President of the United States, but he's an exception).

(Incidentally, ejh is the same as Justin - apologies for any confusion.)

[Matthew]

I should have added that £56,000 in 1974 is clearly nothing like £425m today (in fact I think investing that £5k in the stock market in 1974 would now be worth about £200,000 or so), so clearly he's done something very right.

[ejh]

"so clearly he's done something very right."

Well, clearly he's done something and clearly it's been right for him. But what precisely he has done and whether it's necessarily right for everybody else, those are different questions.

[ejh]

"£5,000 in 1974 is equivalent to between £36,000 and £56,000 today, so it's a fair chunk of money."

But not one that anybody affected by Inheritance Tax is likely to find impossible to get hold of (though most of us might struggle). Still, every little helps eh?

[Jonathan]

'Tacit knowledge' is a very shaky foundation to the argument here. Yes, it's widely cited but try getting anyone to define what it actually is and things become very slippery. Despite, or - more likely - because of this an ever widening set of phenomena are apparently atributed to it even though it's well nigh impossible to see how one could test the explanation. See the links - this is knowledge that can't be codified but apparently is communicated and diseminated within firms and organisations. How? By osmosis?

[dsquared]

This looks like an application for one of those natty Bayesian tables that Chris does.

Given that people with good access to capital will start a lot more businesses than people with bad access to capital, we'd expect to see the majority of successful businesses being owned by people in this category. This would be true even if entrepreneurial ability was completely randomly distributed in the population (actually it could probably be true even if the children of the rich were in general significantly less gifted in entrepreneurial ability). But this being true at the level of broad statistical aggregates would not necessarily mean that any given successful business wasn't successful because of the skills of its owner.

A lot of crap is talked about "entrepreneurs". The skills involved are basically administrative ability, good awareness of what the public will buy, plus (quite a lot of) luck and retrospective halo effect.

[Tim Worstall]

D2, you missed the most important thing an entrepreuneur must have. Stupidity (and I speak as someone who has spent my working life starting and running businesses).

It takes a quite glorious amount of bone headedness to think that as an individual you've spotted something that all other 6 billion of the species have missed and that you've also got the skills to beat all of them when they do wake up to it.

Being an entrepreneur is grossly irrational: the polite way of saying completely idiotic.

[Luis Enrique]

I'm going to stick up for something like entrepreneurial spirit too - only anecdotal I'm afraid.

The couple of friends I know well enough to comment on their 'spirit', who have started successful businesses certainly had a different attitude to life to me - my impression is that they saw life as something to pick and make things happen with, whereas me and most other people I know just go with the flow. They were pretty obssessed and worked hard at it - much harder than other 20 somethings and kept at it for years. For what it's worth I don't think either of them had that much of a capital head start ... one started with a student loan and the other got seed investment from other companies he'd pitched his idea to, and bank loans. One in particular is a serial entrepreneur, always got things on the go (most of them fail) - that's definitely his character - he's not from a well-off background (although he did get the head start of a university place, if you must insist he can't take all the credit).

I agree that wealth, luck and over confidence etc. have as much (more?) to do with it as anything, but don't write off character altogether. There may - heaven forbid - be something to admire about one or two of these people?

[dsquared]

[The couple of friends I know well enough to comment on their 'spirit', who have started successful businesses certainly had a different attitude to life to me - my impression is that they saw life as something to pick and make things happen with, whereas me and most other people I know just go with the flow. ]

again I think that the Bayesian box is useful here; my guess is that people like this start up a lot more businesses, and therefore are a majority of successful business owners; it might or might not be a success factor in itself (ie, conditional on having started up a business, the businesses of get up and go types might be no more likely to succeed).

[Dipper]

anyone who's watched one odf those property invcestment profgrams knows that businee success may be down to luck but business failure often isn't

[Roger Thornhill]

Speaking as an idiotic soul, Banks do not touch such idiots. Vulture Captials only touch idiots if they are well established, have a clear and substantiated prospect and are a dead cert, asset backed and give away equity at dotcom multiples.

The last thing the government should do is get into capital investment. It is bad enough that the State is involved in so much provision, as all that creates is tedious, bureaucratic tendering processes which lock out innovation and hands contracts to "mates" and/or the same tired suspects.