Entrepreneurship

Information Communications University
Entrepreneurship 2017
Contents
STUDY UNIT 1: INTRODUCTION TO ENTREPRENEURSHIP......................................... 7
1: THE ENTREPRENEURIAL REVOLUTION.................................................................... 7
1.1: LEARNING OUTCOMES........................................................................................ 7
1.2: LEARNING CONTENT............................................................................................ 7
1.2.1: THE ENTREPRENEURIAL REVOLUTION....................................................... 7
1.2.2: ENTREPRENEURSHIP: AMERICA'S SECRET ECONOMIC WEAPON..........8
1.2.3: THE ENTREPRENEURIAL REVOLUTION ACCELERATES AND

BROADENS.............................................................................................................. 10
1.3: SELF-ASSESSMENT QUESTIONS...................................................................... 10
2: THE ENTREPRENEURIAL PROCESS........................................................................ 11
2.1: LEARNING OUTCOMES....................................................................................... 11
2.2: LEARNING CONTENT.......................................................................................... 11
2.2.1: ENTREPRENEURSHIP: DEFINITION............................................................ 11
2.2.2: ENTREPRENEURSHIP IN ITS DIFFERENT FORMS.................................... 11
2.2.3: THE ENTREPRENEURIAL PROCESS........................................................... 13
Study Unit 2: THE ENTREPRENEUR.............................................................................. 20
3: The ENTREPRENEUR................................................................................................ 20
3.1: READING.............................................................................................................. 20
3.2.1: INTRODUCTION............................................................................................ 55
3.2.2: ACQUIRABLE ATTITUDES AND BEHAVIOURS OF ENTREPRENEURS......55
3.2.3: UN-ACQUIRABLE ATTITUDES AND BEHAVIOURS...................................... 58
3.2.4: ENTREPRENEURIAL APPRENTICESHIP..................................................... 59
STUDY UNIT 3: THE OPPORTUNITY............................................................................. 60
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4: CREATING, SHAPING, RECOGNISING, AND SEIZING an opportunity......................60
4.1: Reading................................................................................................................. 60
4.3.1: THE ROLE OF IDEAS.................................................................................... 77
4.3.2: PATTERN RECOGNITION.............................................................................. 78
4.3.3: IDEAS AND OPPORTUNITIES....................................................................... 79
4.3.4: SCREENING OPPORTUNITIES..................................................................... 81
4.3.5: GATHERING INFORMATION......................................................................... 86
5: SCREENING VENTURE OPPORTUNITIES................................................................ 89
5.2.1: THE FOUR CORNERSTONES OF VENTURE OPPORTUNITIES.................89
5.2.2: QUICK SCREEN............................................................................................. 89
5.2.3: VENTURE OPPORTUNITY SCREENING GUIDE (VOSG)............................91
STUDY UNIT 4: RESOURCES FOR THE new VENTURE............................................ 100
6: RESOURCE REQUIREMENTS................................................................................. 100
6.1: Reading............................................................................................................... 100
6.2: LEARNING OUTCOMES..................................................................................... 144
6.3: LEARNING CONTENT........................................................................................ 144
6.3.1: IDENTIFYING RESOURCES........................................................................ 144
6.3.2: OUTSIDE PEOPLE RESOURCES............................................................... 158
7: ENTREPRENEURIAL FINANCE................................................................................ 163
7.2.1: VENTURE FINANCING: THE ENTREPRENEUR'S ACHILLES HEEL..........163
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7.2.2: THE FINANCIAL STRATEGY FRAMEWORK............................................... 167
7.2.3: FUND RAISING STRATEGIES..................................................................... 168
7.3: SELF-ASSESSMENT QUESTIONS.................................................................... 168
STUDY UNIT 5: DIVERSE ISSUES IN ENTREPRENEURSHIP: THE

ENTREPRENEURIAL MANAGER................................................................................. 169
8: THE ENTREPRENEURIAL MANAGER..................................................................... 169
8.2.1: INTRODUCTION........................................................................................... 169
8.2.2: PRINCIPLE FORCES AND VENTURE MODES........................................... 170
8.2.3: STAGES OF GROWTH................................................................................. 171
8.2.4: MANAGING FOR RAPID GROWTH............................................................. 172
8.2.5: KNOWLEDGE AND SKILLS REQUIRED OF ENTREPRENEURIAL

MANAGERS........................................................................................................... 173
STUDY UNIT 6: DIVERSE ISSUES IN ENTREPRENEURSHIP: the new venture team 179
9: THE NEW VENTURE TEAM...................................................................................... 179
9.1: Reading............................................................................................................... 179
9.3.1: THE IMPORTANCE OF THE TEAM.............................................................. 210
9.3.2: FORMING BUILDING TEAMS...................................................................... 210
9.3.3: COMMON PITFALLS.................................................................................... 215
9.3.4: REWARDING THE TEAM............................................................................. 216
STUDY UNIT 7: DIVERSE ISSUES IN ENTREPRENEURSHIP: THE BUSINESS

PLAN............................................................................................................................. 219
10: THE BUSINESS PLAN............................................................................................. 219
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10.1: LEARNING OUTCOMES................................................................................... 219
10.2: LEARNING CONTENT...................................................................................... 219
10.2.1: DEVELOPING THE BUSINESS PLAN....................................................... 219
10.2.2: A CLOSER LOOK AT THE "WHAT"............................................................. 222
10.2.3: PREPARING A BUSINESS PLAN............................................................... 223
10.3: SELF-ASSESSMENT QUESTIONS.................................................................. 236
11: OBTAINING VENTURE AND GROWTH CAPITAL................................................... 237
11.2.1: COVER YOUR EQUITY.............................................................................. 237
11.2.2: INFORMAL INVESTORS............................................................................ 237
11.2.3: VENTURE CAPITAL.................................................................................... 238
11.2.4: OTHER EQUITY SOURCES....................................................................... 241
STUDY UNIT 8: DIVERSE ISSUES IN ENTREPRENEURSHIP: THE START-UP AND

AFTER........................................................................................................................... 243
START-UP AND AFTER................................................................................................. 243
12: MANAGING RAPID GROWTH................................................................................ 244
12.1: Reading............................................................................................................. 244
12.3.1: INTRODUCTION......................................................................................... 291
12.3.2: GROWING UP BIG..................................................................................... 291
12.3.3: THE IMPORTANCE OF CULTURE AND ORGANISATIONAL CLIMATE .. 292
12.3.4: ENTREPRENEURIAL MANAGEMENT BREAKTHROUGH........................294
12.3.5: THE CHAIN OF GREATNESS.................................................................... 295
13: THE ENTREPRENEUR AND THE TROUBLED COMPANY.................................... 296
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13.2.1: WHEN THE BLOOM IS OFF THE ROSE.................................................... 296
13.2.2: CAUSES OF TROUBLE.............................................................................. 296
13.2.3: THE GESTATION PERIOD......................................................................... 298
13.2.4: PREDICTING TROUBLE............................................................................ 299
13.2.5: THE THREAT OF BANKRUPTCY............................................................... 299
13.2.6: INTERVENTION......................................................................................... 299
14: THE HARVEST AND BEYOND................................................................................ 303
14.2.1: LEARNING CONTENT............................................................................... 303
14.2.2: BUILDING A GREAT BUSINESS................................................................ 303
14.2.3: HARVEST OPTIONS.................................................................................. 304
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STUDY UNIT 1: INTRODUCTION TO

ENTREPRENEURSHIP
0 THE ENTREPRENEURIAL REVOLUTION
1.1: LEARNING OUTCOMES
After completion of this chapter, you should be able to:

0 Discuss the entrepreneurial revolution;
1 Why are entrepreneurs the engine of job creation?
1.2: LEARNING CONTENT
1.2.1: THE ENTREPRENEURIAL REVOLUTION

The new generation of entrepreneurs, referred to as the E-Generation has permanently
altered the economic and social structure of the world. A study has shown that nearly 40
per cent of the top 1 per cent of the wealthiest Americans got there by building a small
business. Small business has become extremely popular and the number of small
businesses is growing rapidly. The following are some reasons for the increased interest
in small business:
0 Most new private employment is generated by small firms;
1 The public favours small business;
2 There is an increasing interest in small business entrepreneurship at high schools

and colleges;
3 There is a growing trend towards self-employment;
4 Entrepreneurship is attractive to people of all ages.
The value of goods and services that small businesses produce and the new jobs they
generate make the small business sector one of the greatest economic powers in the
world. The number of small businesses in America is growing by three quarters of a
million each year. Most of these businesses remain successful. In a recent census of 250
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000 small businesses it was found that "almost 70 percent of all firms that started in 1985
were still around in 1995".
Examples are:
Richard Branson Virgin Group
Anita Roddick The Body Shop
Fred Smith Federal Express
Bill Gates Microsoft
1.2.2: ENTREPRENEURSHIP: AMERICA'S SECRET ECONOMIC

WEAPON
Entrepreneurs are the prime generators of job opportunities worldwide. According to the
US Departments of Commerce and Labour, small-business-dominated industries
produced an estimated 64 per cent of the new jobs created in 1996. In 1994 business
establishments with less than 500 employees employed 80 per cent of all employees.
Women are playing an increasing role in entrepreneurial ventures. The 1980's were called
the "decade of women entrepreneurs". In the last twenty years female entrepreneurs have
been the fastest growing segment of the small business sector creating firms twice as fast
as men. 90 per cent of small business women started the business for themselves,
bought a business or bought a franchise — mostly to prove that they could succeed, to
earn more money or to control their work schedule. Most of these women are highly
educated. Problems facing women entrepreneurs include getting loans, dealing with male
employees and clients, getting moral support in the industry and dealing with female
employees and clients.
Innovation forms the heart of entrepreneurship. Innovation means to introduce new things.
Small business firms produce 55 per cent of all innovations and twice as many
innovations per employee as large firms. They are responsible for 95 per cent of all radical
innovation in the United States. This trend is especially true in the computer field.
The E-Generation was instrumental in the generation of new industries such as:
23 personal computers;
24 internet publishing and shopping;
25 convenient foods superstores;
26 cellular phone services.
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Venture capitalists form an integral part of the entrepreneurial process working as

coaches and partners with entrepreneurs. Venture capital firms have been partnerships
composed of wealthy individuals who make equity investments in small firms with
opportunities for fast growth especially businesses with new high-tech products. Two
thirds of all venture capital goes into existing businesses rather than to start new ones.
Venture capitalists act as business incubators and hands- on advisors. In addition to
money the capitalists provide management skills and business contacts. They are
successful entrepreneurs themselves who bring experience, wisdom, networks and
maturity to fledgling companies. Venture capitalists invest in a firm with the expectation of
eventually selling the company.
Examples of fast growing companies backed by venture capitalists are:
5888 Apple computers;
5889 Lotus Development Corporation;
5890 Yahoo.
Entrepreneurs are often involved with their communities. There are several areas in which
small firms participate like educational and medical assistance, urban development and
renewal and the arts, culture and recreation.
In America most new classrooms, athletic facilities, etc. are funded by business ploughing
resources back into the community. These entrepreneurs are community leaders that
devote their money, time and creative leadership to community institutions such as
hospitals, churches, museums, schools, etc.
Ewing Marian Kaufman was treated badly by the president of the company that he worked
for. He earned more money than the president did so the president cut back on his
commission. Despite this Kaufman still earned more than the president in the next year so
the president cut back on his sales area. Kaufman decided to quit and started his own
business. He has built his company on three principles:
23 Treat people as you would want to be treated;
24 Share the wealth with those who contribute to its creation;
25 Give back to the community.
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1.2.3: THE ENTREPRENEURIAL REVOLUTION ACCELERATES

AND BROADENS
Since the 1970's vast progress was made in the presentation of study programs on
entrepreneurship. Entrepreneurship and small business management have become
respected academic disciplines in many high schools, colleges and universities. Many of
them offer majors in entrepreneurship or entrepreneurial studies.
In 1994 the United Nations General Assembly passed a unanimous resolution endorsing
and encouraging all emerging and developed nations to pursue entrepreneurship as a
policy.
Major international media such as CNN and leading business publications now cover the
entrepreneurial beat regularly. A large number of magazines on small business and
entrepreneurship are available.
Polls show an unprecedented level of interest in entrepreneurship among young people of

all races.
Capital markets for new and emerging companies are exploding with record public
offerings and trading levels. The poorer get richer due to the entrepreneurial process.
Entrepreneurship is the great equalizer and mobilizer of opportunity. It is indifferent to
race, religion, sex or geography. It rewards performance and punishes shabbiness and
ineptness. Equal opportunity is what counts not equal income. What you make of the
opportunity will determine your income.
Building an entrepreneurial society for the 21st century is a high priority for the E-
generation.
1.3: SELF-ASSESSMENT QUESTIONS

1.1) Who is the E-generation?
1.2) Why is there such an interest in small business?
1.3) Explain why the small business sector has become one of the greatest economic
powers in the world?
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5888 THE ENTREPRENEURIAL PROCESS

23 Define entrepreneurship;
24 Describe the various forms and paradoxes of entrepreneurship;
25 Describe the entrepreneurial process.
2.2.1: ENTREPRENEURSHIP: DEFINITION

Entrepreneurship is a way of thinking, reasoning and acting that is opportunity obsessed,
holistic in approach and leadership balanced.
Entrepreneurship is the investing and risking of time, money and effort to start a firm and
make it successful. These are calculated risks to shift the odds in your favour so that you
can reap the rewards.
At the heart of this process are the creation and/or recognition of opportunities followed by
the will and initiative to seize these opportunities.
Entrepreneurship is grasping an opportunity that occurs to satisfy the needs of

consumers, coming up with an idea that will satisfy those needs, establishing a form of
enterprise from which to satisfy those needs and using the available resources to satisfy
those needs.
Entrepreneurship occurs in new as well as old, small and large, fast and slow growing,
profit and non-profit organisations.
2.2.2: ENTREPRENEURSHIP IN ITS DIFFERENT FORMS
2.2.2.1: CLASSIC ENTREPRENEURSHIP
In classic terms, the new start-up company is an innovative idea that catapults as a high
growth company; innovative ideas that become legends such as Amazon.com and
McDonald's; They are characterized by being funded by ingenious funding schemes and
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other resources; Success usually involves entrepreneurial leadership qualities, building a

team with complementary skills and talents, and the ability to work as a team.
2.2.2.2: BEYOND START-UPS: BRONTOSAURUS CAPITALISM
Many industrial giants were knocked off their pedestals by new competitors.
Examples are:
IBM — unseated by Microsoft (In 1961 Ross Perot one of IBM's employees suggested to
IBM that they emphasize software rather than hardware. After being turned down by top
management for the second time, Perot left and founded EDS which he later sold to GM
for several million dollars.)
AT &T- unseated by MCI
Sears - unseated by Wall-Mart
These giants were characterised by layers of management red tape and being "over-
managed" and "under-led".
The giants were unprepared for attack by smaller entrepreneurial ventures.
Managers keep doing what has worked in the past, while the market requires a different
approach.
Some of the "giants" have woken up and started to change. They are implementing
strategies to recapture their entrepreneurial spirit and instill the culture and practices
characterising entrepreneurial ventures.
2.2.2.3: Paradoxes (statement that seems self-contradictory but may be

true) of entrepreneurship
The entrepreneurial process is full of contradictions and paradoxes. Some examples are:
5888 An opportunity with no or very little potential can be an enormously big

opportunity. One of the most famous examples is Apple Computer Corporation.
The founders approached their employer, Hewlett-Packard Corporation, with the
idea for a desktop personal computer and were told this was not an opportunity for
HP, so they started their own company;
5889 In order to make money you have to first lose money. A start-up, venture-
backed company typically loses money, often millions of dollars, before becoming
profitable and going public, usually at least five to seven years later;
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23 In order to create and build wealth, you must relinquish (give up) wealth. By
rewarding and sharing the wealth that owners make with the people who
contribute significantly to the creation of the business, they motivate them to
expand the pie.
2.2.3: THE ENTREPRENEURIAL PROCESS

There are general lessons and principles underlying the successes of entrepreneurs.
These lessons can be learned and studied by aspiring entrepreneurs.
The entrepreneurial process can be described as "getting the odds in your favour". There
are several opinions to describe this process.
The Timmons Model of the Entrepreneurial Process
The key factors in the Timmons model (see below) are the entrepreneur and the founding
team, the opportunity, and the resources that are mustered to start the new organization.
Put simplistically, the Timmons model is normative. The key ingredient is the entrepreneur.
If the entrepreneur has the right stuff, he or she will deliberately search for an opportunity,
and upon finding it, shape it so that is has the potential to be a commercial success, or
what Timmons calls a high-potential venture. The entrepreneur then gathers the resources
that are necessary to start a business to capitalize on his or her opportunity. Explicit in the
Timmons framework is the notion that the entrepreneur and the provider of capital will be
rewarded with profits, and that both are commensurate with the risk and effort involved in
starting, financing, and building the business. The entrepreneur usually risks career,
personal cash-flow, and some or all of his or her net worth. In an ideal situation, all this is
quantified in a business plan before the business is operational.
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The layout for this module follows three study units, in line with the above schematic
layout of Timmons, namely:
Study Unit 2: The entrepreneur
Study unit 3: The opportunity
Study Unit 4: Entrepreneurial resources
Study Unit 5: Some general aspects of entrepreneurial behaviour
We can briefly explain the three components of the Entrepreneurial model as follows:
Study Unit 2: The entrepreneur and founder
The entrepreneur is broadly seen as someone who exercises initiative by organizing a

venture to take benefit of an opportunity and, as the decision maker, decides what, how,
and how much of a good or service will be produced.
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An entrepreneur supplies risk capital as a risk taker, and monitors and controls the
business activities. The entrepreneur is usually a sole proprietor, a partner, or the one
who owns the majority of shares in an incorporated venture. According to economist
Joseph Alois Schumpeter (1883-1950), entrepreneurs are not necessarily motivated by
profit but regard it as a standard for measuring achievement or success. Schumpeter
discovered that they (1) greatly value self-reliance, (2) strive for distinction through
excellence, (3) are highly optimistic (otherwise nothing would be undertaken), and (4)
always favour challenges of medium risk (neither too easy, nor ruinous).
Read more:
http://www.businessdictionary.com/definition/entrepreneur.html#ixzz1lHPFMS00
Study Unit 3: The opportunity
The opportunity is the heart of the business, and forms the basis for a sustainable future
for a business. Successful entrepreneurs know that a good idea is not always a good
business opportunity. For every 100 ideas presented to investors, only 4 get funded. More
than 80% of those business ideas submitted, get rejected within the first few hours and a
further 10-15% get rejected after the would-be investors have read the business plan
carefully. Therefore countless hours and days are wasted chasing ideas that would go
nowhere.
A good business opportunity can be described as an opportunity to create income, wealth

and profit over a sustainable period of more than 10 years
Study Unit 4: Resources:
Business resources are anything and everything that helps a business operate and do
business. This can include the use of human capital, natural resources, tangible resources
such as property or production machinery, intangible resources such as brand image and
knowledge, financial resources and anything else a particular business may use to make
a profit. Every business resource used to produce goods or to serve customers has an
economic value.
Read more: Business Resources Definition | eHow.com

http://www.ehow.com/about_5089164_business-resources-
definition.html#ixzz1lHU6WipE
Study Unit 5 and onwards: Diverse topics in entrepreneurship
 The business plan 44
 Managing rapid growth 60
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 The entrepreneur and the troubled company 64
5888 The harvest and beyond
5889 Entrepreneurship and culture Chapter 8
Before going any further, you need to have a better understanding of the entrepreneurial
model and its behaviour
The behaviour of the entrepreneurial model
Fit and balance plays a constant role throughout the entrepreneurial process.
Fit and balance is the rounding of the three forces of the entrepreneurial process. Look at
the model below. Imagine the founder, entrepreneurial leader of the venture standing on a
large ball, grasping the triangle over her head. The challenge is to balance the balls above
her head, without toppling off.
The balanced position is the most ideal position. In this position, the three components,
namely Entrepreneur, opportunity and resources are each in balance. However, in the
practical world this seldom happens.
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2.2.3.1: An unbalanced process
Mostly the opportunity outbalances the resources and team. For example, the Internet
was a huge opportunity. The founder had no significant capital or other resources to
speak of. There was no team.
Refer to the models below that show the entrepreneurial process of Netscape-an internet
browser software company.
Exhibit 3 shows that the opportunity outweighs the team on resources.
In exhibit 4 the resources and team catches up.
In exhibit 5 the process is balanced.
In exhibit 6 the model is out of balance again. The company must now either re-invent or
become a target of entrepreneurial competitors.
Exhibit 3
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Exhibit 4
Exhibit 5
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Exhibit 6
Decisiveness in recognising and seizing an opportunity makes all the difference.
Quite often new businesses run out of money before they can find enough customers and
the right team to exploit an opportunity.

2.1) Define entrepreneurship.
2.2) Identify 2 forms of entrepreneurship.
2.3) Explain the Entrepreneurial process.
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STUDY UNIT 2: THE ENTREPRENEUR
23 THE ENTREPRENEUR
3.1: READING
Article 1
Education and Training as Non-psychological Characteristics That Influence

University Students' Entrepreneurial Behaviour
by Juan Hernangomez Barahona , Natalia Martin Cruz , Ana Isabel Rodriguez Escudero
THEORETICAL APPROACH AND RESEARCH OBJECTIVES
In recent years, public institutions such as education centers and other European
institutions have become aware of the importance of developing an efficient business
structure, which is capable of discovering and exploiting opportunities in an increasingly
dynamic, complex and uncertain environment (Ronstandt, 1985; Scott et al., 1998; Meyer,
2003; Snijders & Vander Horst, 2002).
The European Union (EU) is developing an active strategy of promoting entrepreneurship.

Thus, the current strategy is reflected in policies such as the Multi-annual programme for
Enterprise and Entrepreneurship for 2001-2005, Euro Info Centres and Innovation Relay
Centres.
The emphasis on young people is particularly noteworthy, although hardly surprising,

since this group contains the largest proportion of entrepreneurs in the EU (CEEDR,
Middlesex University, 2000). By analysing the characteristics of this group of
entrepreneurs in detail, we find that a large proportion of these individuals have taken
courses up to degree level at university. In Spain, a higher proportion of entrepreneurs are
young university graduates than the European average: 40.5% compared to 35%
(Reynolds et al., 2002).
Given this positive outlook for entrepreneurship among young graduates, the responsible
authorities should design useful educational policies (Henderson & Robertson, 1999). It is
also clearly advisable to further our understanding of the elements that promote
entrepreneurial inclinations. Thus, before teaching people how to start entrepreneurial
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activities, they must be induced with the desire to do so. Little is known about this aspect
(Henderson & Robertson, 1999).
Following Shane's (2003) reasoning, the attributes or features of individuals that influence
their ability to evaluate and subsequently exploit the opportunities that emerge can be
classified into two groups: psychological and non-psychological factors. This research
focuses on the non-psychological features of individuals that favor the exploitation of
business opportunities. Among the main non-psychological factors we are interested in
the demographic characteristics considered by the upper-echelon literature, such as age
and gender, and the sociological variables, specifically those regarding education and
work experience.
We consider that age has an inverted U-shaped relationship with entrepreneurship. On

the one hand, it includes the positive effect derived from the individual's maturity, but on
the other hand, there is the negative effect of the opportunity cost and uncertainty. The
opportunity cost increases with age insofar as this latter variable is positively associated
with income. However, uncertainty increases because life expectancy declines (Reynolds
et al, 1994; Bates, 1995). Consequently, age has a positive effect on entrepreneurship for
younger individuals, but after a certain age the relationship between age and
entrepreneurship becomes negative.
Another feature, which is no less important, but rarely studied, is the gender variable.
Studied in the context of modern society, which is characterized by equal opportunities for
men and women, it is of interest to researchers on entrepreneurship (Hisnichet et al.,
1996; Duchénant & Orhan, 2000; Orhan and Scott, 2001).
Researchers have shown that women's motivation to engage in business activities is very
varied and can originate from diverse factors, such as the influence of the environment
and the necessity or desire for self-realisation (Orhan & Scott, 2001). According to Peters
(2004), the role women play in the economy is one of the most significant phenomena of
the early 21st century. In the US, the number of women running a company increased
from 9 million in 1997 to around 10.6 million in 2004 (Center for Women' s Business
Research, National Numbers, 2004). In spite of these figures, it seems that nowadays
men are still more prone to set up their own company and take on the risk involved in any
new venture.
From the sociological perspective, another set of variables affecting the decision to set up
a firm comprises the individual's education and previous work experience (Bates, 1990;
Cressy, 1996). Education and experience in other business activities provide individuals
with information (about the market, the workforce, etc.) and skills (in sales, planning,
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decision-making, etc.) that improve their ability to combine the resources, develop a
strategy, organise business activities and, in short, exploit opportunities more successfully
(Corman et al, 1988; Lee, 1999; Shane & Khurana, 2001).
Specifically, researchers have found that one of the main characteristics of individuals
running small enterprises is a higher educational level (Smith, 1967; Robinson & Sexton,
1994; Lorrain & Dussault, 1998). In particular, among the determinant factors of
entrepreneurship, university education has been found to be very influential. Henderson
and Robertson ( 1 999) observe that students who have participated in postgraduate
education programmes are more likely to set up their own firm. Researchers have also
found a positive relationship between education and the firm' s growth aspirations
(Davidson et al, 2003; Matos, 2003).
Education at all levels plays a key role in the development of an entrepreneurial society.
However, it is necessary to develop education in the most fundamental dimensions
associated with the definition of personality and the learning of leadership skills (Fillion,
2004). In this vein, universities play an important role in training entrepreneurs as
individuals of multiple characteristics (Lazear, 2003; Pleitner, 2003; Fayolle et al, 2004).
Entrepreneurs, unlike specialists, possess a more harmonious education in all the areas
of knowledge required to successfully exploit opportunities and manage the attitudes and
tasks of individuals (including the specialists) who will go on to help them successfully
develop their new business (Lazear, 2003). Greater knowledge, together with a higher
level of information and skills, provides the individual with a greater capacity to undertake
entrepreneurial activities and to assume or demonstrate entrepreneurial attitudes.
New entrepreneurs, apart from their higher educational level, also stand out for their
increased work experience (Lorrain & Dussault, 1998; Smith, 1967). The individual's
experience is one of the variables that researchers have most frequently found to be
significant in distinguishing between successful and unsuccessful entrepreneurs (Cooper
et al, 1994; Gimeno et al, 1997; Burke et al., 2000 and 2002; Capelleras et al., 2004;
Fayolle et al, 2004). Moreover, if the first experience has something to do with starting a
business activity during the individual's youth, this makes the individual more likely to start
another entrepreneurial activity later on (Ikei, 1997; Dobrev & Barnett, 1999; Wandosell &
Garcia, 2004). To this we should add that entrepreneurs with some managerial experience
acquired previously tend to create firms that grow faster compared to inexperienced
individuals (Henderson & Robertson, 1999; Capelleras et al, 2004). Also, people with a
more varied previous experience are more likely to start their own business (Littunen,
2002) because they have been able to develop networks of influence and
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contacts. In this respect, an important finding is that the majority of European

entrepreneurs have related past positions as specialist workers or managers in other
firms. Thus, all of them had considerable knowledge and some previous business
experience (Reynolds et al, 2002).
The current research (see Figure 1) has the aim of studying the influence of the
abovementioned variables (age, gender, education and work experience) as fundamental
determinants of the propensity to set up firms by university students close to graduation.
In other words, we apply the general approach of the literature on entrepreneurship to an
analysis of entrepreneurial orientation among university students.
METHODOLOGY
The information that we used to test the empirical model proposed here was provided by
the General Foundation (www.funge.uva.es) of the University of Valladolid (Spain). The
Foundation has initiated a study called the "Professional Observatory of the University of
Valladolid", whose aim is to conduct an exhaustive analysis of the current situation and
problems of the academic degrees/studies and educational areas taught by the University
of Valladolid with regards to their professional development, as well as to identify
complementary education that would help graduates to adapt more closely to current
labour-market needs.
In order to achieve this objective, various data collection tools have been developed that
are directed at different students. One of these tools consists of a questionnaire directed
at students from cycles 3-5 of the various degrees/studies (The Spanish university system
offers students the possibility of choosing either 3-year or 5-year studies. Students
successfully completing a 3-year degree ("first cycle") are awarded diplomas. These can
then optionally continue for two more years ("second cycle") to complete a 5-year degree,
whereupon they graduate). This is the source of information used in the current study.
2017 completed questionnaires were collected for the year 2004. The sample consists of
59.6% engineering students, 25.7% social sciences students and 14.6% humanities
students.
The means of the age and gender variables show that more than half of the students
surveyed are women, and that their average age is around 23 years. The group of
education variables includes the acquisition of knowledge complementary to the university
studies themselves, such as the level of foreign language ability, the number of stays
abroad, the level of computer skills, and receiving other types of complementary non-
university education (for instance, courses for developing job search skills, courses for
developing teaching skills, sports training, musical training, among others). To evaluate
Page 23
the students' previous work experience, we considered firms' internships, voluntary/social

work, work with a contractual work (in a position either related or unrelated to the
student's speciality), work without a non-contractual work, and previous experience as a
freelancer. The dependent variable of the study is a dichotomous variable measuring the
students' orientation to create their own firm after graduating. 63% of students in the
sample do not want to become entrepreneurs and 37% desire to set up a new company.
Table 1 provides more information about the variable measurements and their average
values for the sample individuals. Before we tested the hypotheses, we examined the
correlation matrix (see Table 2). The signs of the bivariate correlation appear to be
consistent with the hypothesized relationships.
The analytical methodology used was binary logistic regression, in which the dependent
variable was the students' propensity to set up their own firm. Logistic regression analysis
is well suited when the dependent variable is non-metric and consists of just two groups.
Compared to discriminant analysis, choosing logistic regression is justified by the fact that
the multivariate normality assumptions do not need to be met. Logistic regression is much
more robust when these assumptions are not met. But even if they are met, many
researchers prefer this methodology to discriminant analysis, because the interpretation
of the results is similar to that of regression analysis results.
Logistic regression also tests the hypothesis that a coefficient is different from zero as is
done in multiple regressions, where the t value is used to assess the significance of each
coefficient. Although logistic regression uses a different statistic, the WaId statistic, it also
provides the statistical significance for each estimated coefficient so that hypothesis
testing can occur just as it did in multiple regressions.
Specifically, we used a hierarchical logistic regression. This methodology allows us to

sequentially introduce different blocks of variables and to check their respective
explanatory capacities. Firstly, we included the block corresponding to the main effects of
all the independent variables (Model 1). Finally, we add the variable age squared to these
variables, to test for the existence of an inverted U-shaped relationship (Model 2). The
relevance of the inverted U-shaped effect cannot be rejected if the corresponding Wald-
statistic is significant.
We used three global goodness-of-fit indices. Firstly, we use the log-likelihood (-2LL), for
which low values indicate a better model fit. This index is similar to the residual or error
sums of square values for multiple regressions. Secondly, we use the Hosmer and
Lemeshow test, which measures the correspondence between the observed and
expected results of the dependent variable. A non-significant value indicates a good fit.
Page 24
Finally, we apply the Nagelkerke R2, which is interpreted similarly to the R 2 of any multiple
regression model. In logistic regression, there is no true R 2 value as there is in OLS
regression. However, because deviance can be thought of as a measure of how poorly
the model fits (i.e., lack of fit between observed and predicted values), an analogy can be
made to the sum of squares residual in ordinary least squares. The proportion of
unaccounted for variance that is reduced by adding variables to the model is the same as
the proportion of accounted for variance, or R2. An index that reflects this basic idea has
been developed by Nagelkerke.
RESULTS
Table 3 presents the results from the regression. The logistic regression conducted on the
entire sample has suitable adjustment indexes. An important number of variables are
significant in explaining the students' entrepreneurial orientation.
With regards to gender, our expectations are met (-0.36, p <0.01). Women are indeed
less likely to start businesses than men. Age, however, does not have an effect on
entrepreneurship, neither when we consider the positive and linear effect, nor when we
consider the quadratic effect. When the 'age' variable is included the -2LL index barely
changes and the Nagelkerke R2 does not change. This may be because the sample
individuals show little variability in this variable. 98% of the sample is under 30 years old.
With regards to complementary education, computer skills (0.39, p <0.01) and education
(0.10, p <0.05) in other areas are both important. We do not find foreign language ability
to be relevant, but stays abroad are (0.30, p <0.05). However, both variables -foreign
language ability and number of stays abroad-are highly correlated (0.28, p <0.01). This
result can indicate that the first condition is necessary but not enough to motivate
entrepreneurial behaviour. Foreign language ability during stays abroad has a much more
positive effect on entrepreneurship than when it is put into practice without travelling from
home.
Previous work experience also has an important role in explaining the propensity to set up
firms. Specifically, the uncertainty that is related to non-contractual work (0.50, p <0.01)
seems to stimulate students to create their own professional environment. We might
interpret internships (0.28, p <0.01) and volunteering (p <0.37, p <0.01) that way.
However, contractual work experience is not associated with the desire to create firms.
This may be because once students have experienced the absence of risk in contractual
work they will adapt to this or look for a similarly comfortable situation, rather than
contemplate starting their own firm.
Page 25
Finally, among all these results perhaps the most noteworthy is the strong propensity to
create firms among individuals that have already had experience as
entrepreneurs/freelancers (0.82, p <0.01). The extent of the effect is much larger than that
observed for the rest of the variables.
DISCUSSION AND CONCLUSIONS
In general, the factors recognized in the entrepreneurship literature as determinants of a

stronger entrepreneurial orientation are highly significant in the present study. In other
words, university students' propensity to create firms is explained by demographic,
educational and work experience variables.
Women continue to show lower entrepreneurial behavior compared to men, however

nowadays the situation has improved. This conclusion is consistent with the results of
previous international literature. In particular, in Spain this reality can be explained by our
historical and cultural heritage. Our results have to be assessed by universities while
discussing new and specific policies to promote entrepreneurial behaviour among
members of this institution.
Education is one of the strongest engines of entrepreneurial orientation, especially, if it is

associated with the opening of minds brought about by travelling and confronting the
individual's knowledge with that of other countries. Initiatives such as exchange
programmes are fundamental for producing enterprising students. At the same time,
complementary education that is not part of their formal degree gives students the
possibility of interrelating their specialized knowledge with that of other areas, which will
be the seed of entrepreneurial ideas. Thus, these extra areas should complement formal
education in order to foster entrepreneurship.
This is particularly the case with computer ability, since fast technological development
means that this skill is essential in almost all business projects. Our findings show that it
catalyses students' entrepreneurial initiatives.
On the other hand, work experience in firms helps to turn students into entrepreneurs.
This is particularly true when the job is not too formal. Thus, rather than the flexibility of
the labour market achieved through temporary work agencies, what helps the most is to
design internships during which students face varied experiences in an organisation, in
either a for-profit or non-profit context. Thus, universities should encourage university-firm
collaboration, or the creation of groups of entrepreneurs that support and advise students
about how to exploit their ideas and set up their own firms. We can suggest the
Page 26
following recommendations for university authorities wishing to foster entrepreneurship

among their students:
5888 Since students with computer skills are more likely to start firms than others,
this type of education should be essential in all degrees. University teaching should
incorporate this technology as part of normal teaching routines, so that all students are
assumed to have such knowledge when they graduate, just as correct use of language
and the ability to express oneself well are assumed nowadays.
5889 Students who have previously created their own business or participated in a
start-up are more likely to repeat the experience. This result helps us to claim that
Universities should promote courses in which students are faced with the creation of a
new venture. This can be done both by trying to create real new businesses and by
participating in simulation exercises.
5890 Another possible way of generating entrepreneurs would be to make it easier

and quicker for students to set up their own firms in practice, by establishing
collaborations between the university and the public institutions responsible for fostering
entrepreneurship. These collaborative agreements can lead to the simplification of the
bureaucratic procedures prior to the start of business activities.
5891 Although the situation has improved, women still show fewer propensities to
create firms than men. This situation should be evaluated carefully by universities, which
should then establish policies for promoting entrepreneurship specifically for potential
female entrepreneurs.
LIMITATIONS AND FUTURE RESEARCH
This paper has some limitations. However, the identification and correction of these
limitations could give rise to new streams of future research. Firstly, the low value for the
Nagelkerke R2 indicates a limited explanation of the variance by variables included in this

research. We think that other individual-related variables, like the psychological profile of
students risk-aversion, autonomy or self-confidence-could improve the explanation of
entrepreneurial behaviour. Risk-aversion is negatively related to the exploitation of new
business opportunities. Taking risks is an essential part of entrepreneurial activity (Van
Praag & Cramer, 2001; Stewart & Roth, 2001). Students' independent behaviour could
have a positive relationship with the need to create their own business. We claim that
independent individuals have difficulties in accepting rigid organisations and procedures
and are averse to hierarchical structures. Thus, they will be willing to make their own
decisions and to initiate their own ventures, independently of other peoples ' beliefs (Koh,
Page 27
23 996; Douglas, 1999). Finally, self-confidence is positively related to entrepreneurial

behaviour. This psychological feature means that the individual will trust in his own skills
and abilities to control the environment in which his business will grow (Davidsson, 2001;
Matos, 2003).
These psychological variables could be used in an enlarged model to explain the

entrepreneurial propensity to create new ventures. Other than that, it could be interesting
to evaluate the potential interactions and synergies among these individual-related
characteristics and the non-psychological ones. By identifying these effects, we could
focus the institutional efforts more efficiently to increase the number of new businesses
created by university graduates.
Another limitation of our research is related to the cross-sectional data. We cannot

observe with our data if students with a high entrepreneurial propensity will indeed
become new entrepreneurs. Thus, we suggest longitudinal research in which we follow
the students once they finish university. This information will allow us to find out if students
with an entrepreneurial inclination finally became entrepreneurs and then, we could
identify those individual-related variables that are more persistent and determinant of
entrepreneurial propensity.
Questia, a part of Gale, Cengage Learning. www.questia.com
Publication Information: Article Title: Education and Training as Non-psychological

Characteristics That Influence University Students' Entrepreneurial Behaviour.
Contributors: Juan Hernangomez Barahona - author, Natalia Martin Cruz - author, Ana
Isabel Rodriguez Escudero - author. Journal Title: Journal of Entrepreneurship Education.
Volume: 9. Publication Year: 2006. Page Number: 99+. © 2006 The DreamCatchers
Group, LLC. Provided by ProQuest LLC. All Rights Reserved.
Article 2
Entrepreneurial Characteristics, Optimism, Pessimism, and Realism-correlation or

Collision?
by Chyi-Iyi (kathleen Liang , Paul Dunn
INTRODUCTION
There has been and is a discussion among researchers about entrepreneurial optimism,
and if optimism relates to other characteristics of entrepreneurs. The purpose of this
article is to explore and examine the relationships between entrepreneurial characteristics
Page 28
and optimism, realism, and pessimism. For many years, researchers have identified
unique characteristics of entrepreneurs such as confidence, independence, being in
control, risk taking, and creativity. The literature has also discussed optimism and its
relationship to other entrepreneurial characteristics, how optimism impacts venture
performance (success and failure) and decision making, and different levels of unrealistic
optimism leading to various consequences in venture development (Liang & Dunn, 2008a;
Liang & Dunn, 2008b; Schneider, 2005).
Looking at economic issues today, many people do not have a strong positive outlook for
the future. However, the creation of new ventures during an economic downturn may help
to stimulate the economy. Some research evidence shows that optimistic entrepreneurs
seem to perform better and more competitively in certain environments and organizations
(Manove, 2000). If results from previous literature are accurate, it would be reasonable to
assume a strong positive relationship between entrepreneurs' decisions, their unique
characteristics, and optimism. These factors can influence savings and investment rates,
which might boost overall economic activity (Manove, 2000). This assumed relationship
between entrepreneurial characteristics and optimism is the underpinning theory for this
article.
Unrealistic optimism, identified as a common human trait, has appeared in psychology

literature within the last twenty years. Psychologists' explanations of optimism and
personal characteristics have often been gathered in case-specific experiments (Taylor,
1989; Weinstein, 1980, 1982). Most of the arguments presented in entrepreneurship and
economics literature remain in the conceptual stage (Aidis, Mickiewicz, & Sauka, 2008).
Even though optimism turns out to be common among entrepreneurs, it should not be
inferred from this that realism and pessimism do not exist among entrepreneurs.
Therefore many questions remain unresolved in the literature due to lack of empirical
evidence. How closely does optimism relate to other entrepreneurial characteristics? If not
all entrepreneurs are optimistic, are there relationships between entrepreneurs'
characteristics and their perceptions of realism or pessimism?
There are a number of reasons why this is an important area for research. First, realism
and pessimism have not been studied thoroughly in entrepreneurship and economics.
There is a lack of understanding of what realism and pessimism mean and how they
impact entrepreneurs (Liang & Dunn, 2008a; Liang & Dunn, 2008b). A second reason to
examine the relationships between entrepreneurial characteristics and optimism, realism,
and pessimism is the need to examine some questions presented in previous literature
regarding who entrepreneurs are and their behaviors in decision making (Liang & Dunn,
Page 29
2008a; Liang & Dunn, 2008b). Optimism is included in the set of entrepreneurial
characteristics in many studies. However, not all entrepreneurs are optimistic all the time,
especially given the volatile economic and financial situations we are dealing with today. A
third reason to examine realism and pessimism is that there are some gaps between
theoretical frameworks and empirical findings in entrepreneurship. A rich inventory of
literature in psychology has provided numerous case studies in clinical experiments to
test how optimism influences recovery or treatments for patients. Optimism might be
positively correlated with the attitudes and characteristics of many successful
entrepreneurs. It would be equally important to explore if realism and pessimism might be
correlated with other entrepreneurial characteristics such as risk taking, being in control,
seeking independence, and creativity. If unrealistic optimism could become a barrier for
success, realism or pessimism might also contribute to unpredictable outcomes in new
venture creation.
LITERATURE REVIEW, RESEARCH HYPOTHESES, AND ANALYTICAL

FRAMEWORK
General profiles of entrepreneurs often include optimism and other entrepreneurial

characteristics such as self confidence, independence in decision making, creativity, and
willingness to accept risks. Each of these characteristics has been explored in previous
studies. Researchers in psychology have investigated optimism as an attribute that
governs positive thinking and future outlook and may relate to better outcomes, better
performance, better personal well-being, and better coping strategies. There has not been
sufficient research directly relating entrepreneurial characteristics to realism or pessimism
We shall examine these entrepreneurial characteristics to assess the way in which they
relate to optimism, realism, and pessimism.
Entrepreneurial Characteristics, Optimism and Realism in Entrepreneurship Literature
Much of the work on entrepreneurial characteristics has discussed drive for achievement,
action orientation, internal locus of control, tolerance for ambiguity, moderate risk taking,
opportunism, initiative, independence, commitment/tenacity, creativity, and optimism
(Crane & Sohl, 2004; Liang & Dunn, 2003; Liang & Dunn, 2008a; Malach-Pines, Sadeh,
Dvir, & YafeYanai, 2002). These researchers seem to agree that optimism links to other
entrepreneurial characteristics when we identify who entrepreneurs are.
Several researchers have claimed that optimism is associated with positive outcomes in
entrepreneurs, their success, and their contributions to the economies in which they
operate. Kuratko and Hodgetts (2004) suggest that optimism among entrepreneurs, even
in bad times, is an important factor in their drive toward success. Researchers have
Page 30
identified optimism as a stimulator for persistence and commitment to new venture

creation (Litt, Tennen, Affleck, & Klock, 1992; McColl-Kennedy & Anderson, 2005;
Seligman & Schulman, 1986). It is often assumed that optimists have a positive outlook
for their future. Optimism enables entrepreneurs to downplay uncertainty or setbacks and
focus on what is doable and good in a situation.
However, optimism is also characterized as a negative factor in entrepreneurship. Being

overconfident and unrealistically optimistic drives entrepreneurs to overestimate the odds
that they will succeed (Baron & Shane, 2005; Hey, 1984). Optimism has also been linked
to risk tolerance and high expectations (Petrakis, 2005). Optimists often delude
themselves into becoming entrepreneurs with high risks of failure (De Meza & Southey,
1996). An experiment conducted by Coelho and De Meza (2006) discovered that irrational
expectations (also interpreted as unrealistic optimism) led entrepreneurs to behave in
ways that were contrary to their interests and that resulted in a loss of well-being.
Optimism and overconfidence seem to be interpreted in the behavioral finance literature
as causes of the high failure rates of new ventures in the initiation stage (Brocas &
Carrillo, 2004). Puri and Robinson (2004), in a large scale study, linked optimism to
significant work/life choices and entrepreneurship. Puri and Robinson (2004) also found
that entrepreneurs were more optimistic than non-entrepreneurs and were more risk
tolerant than non-entrepreneurs. Optimistic cognitive biases may lead entrepreneurs
undertaking pioneering activities to overestimate demand, underestimate competitive
reaction, and misjudge the need for complementary assets (Simon & Houghton, 2002).
Researchers have mixed views on unrealistic optimism, but they generally agree that it
has both positive and negative impacts on entrepreneurs' well-being. Unrealistic optimism
(or overestimated optimism) can lead to a misallocation of resources and a reduction in
welfare, but it can also stimulate saving and investment and provide added incentives for
hard work (Manove, 2000). Manove (2000) is among the first researchers to demonstrate
the coexistence of optimists and realists. He explored the interaction between optimists
and realists regarding their self evaluated productivity and competitiveness. Fraser and
Greene (2006) developed an occupational choice model in which entrepreneurs are
identified as learning from experience. According to the results of their study, both
optimistic biases and uncertainty diminish with experience; the more entrepreneurs learn,
the more realistic they become. However, none of these researchers provided measures
of optimism or realism.
Entrepreneurial Characteristics and Optimism from the Psychological/Clinical Perspective
Page 31
The psychology literature contains a great deal of information on optimism. According to

the Centre for Confidence and Well-being (2006), an optimist is "someone who sees the
silver lining in every cloud and views the world through rose-tinted spectacles (or a glass
that's always half full)." The optimism discussed in the entrepreneurship literature is
similar to "dispositional optimism" in psychology. Dispositional optimism is the bias to hold
positive expectations across time and situations. Individuals who are dispositionally
optimistic believe that, in general, their goals will be met in any situation (Sujan, 1999).
"Thus, dispositional optimism is a very general tendency, a disposition that reflects
expectations across a wide variety of life domains" (Wrosch & Scheier, 2003, p, 64).
Chang (2001) suggests that dispositional optimism results in expectations that good
things will happen and pessimism results in expectations that bad things will happen.
Haugen, Ommundsen, and Lund (2004) suggest that general expectancy is a fruitful
concept in central personality dispositions, encompassing both positive and negative
expectations associated with optimism and pessimism.
Jackson, Weiss, Lundquist, & Soderlind (2002) suggest that optimists:
1024 Feel they are in control of their activities
1025 Believe their activities will give them satisfaction
1026 Believe they have a significant role in initiating projects
1027 Believe they have adequate control and time to carry out their projects
1028 Believe they can make progress toward their goals
1029 Expect the outcomes of their projects to be successful
Optimists rated their personal projects as more congruent with their values and identities,
which also reflected positively on their sense of self and other goals (Jackson, Weiss,
Lundquist, & Soderlind, 2002).
Psychologists have also discovered that optimism is related to psychological well-being

and coping behaviors. Optimism results in a sense of subjective well-being as it "fosters
self-esteem, relationship harmony, and positive perceptions of financial conditions"
(Leung, Moneta, & McBrice-Chang, 2005, p. 335). Psychologists have also suggested
that optimists believe in good luck, which was associated with better psychological well-
being (Day & Maltby, 2003). Wrosch and Scheier (2003) conclude that optimists,
compared with pessimists, more frequently used active coping tactics when confronted
with aversive situations and adaptive emotion-focused coping tactics when important life
goals were blocked. People who are able to disengage from unattainable goals and re-
engage elsewhere seem able to avoid accumulated failure experiences so as to achieve
Page 32
higher quality of life. Optimists also use a strategy of acceptance/resignation, but they do
so only in circumstances in which this strategy is most adaptive (Scheier & Carver, 1987).
On the other hand, Schulman (1999) suggests, as have some entrepreneurial

researchers, that "[e]xcessive optimism at the wrong time and in the wrong situation can
blind us to the costly consequences of certain actions" (p. 36). Strong optimism is helpful
in that it encourages people to expect success and focus on the activities needed to
achieve that success, but there may be negative consequences when things do not go as
expected (Niven, 2000).
Optimism may link many different concepts between entrepreneurship and psychological
theories. Barbera (2004) indicates that over the long haul, "one needs to recognize that
persistent optimism, the signature characteristic of American entrepreneurs, provides the
dynamism that delivers growth for the U. S. economy" (p. 22). While many
entrepreneurship researchers have discussed optimism and have indicated that optimism
generates both positive and negative influences on personal and business development,
there is a need to quantify the relationships between optimism, realism, pessimism, and
common entrepreneurial characteristics such as independence, creativity, being in control,
and willingness to take risks.
Hypotheses
The assumed relationship between optimism and entrepreneurial characteristics becomes

the foundation of this study. Following the literature review, several hypotheses have been
developed to determine if entrepreneurs are optimistic, realistic, or pessimistic when they
examine their own characteristics. To develop these hypotheses, we followed Baron's
(2000) suggestion that "from both a scientific and a practical perspective, applying the
principles and findings of psychology to the study of entrepreneurs seems to hold great
promise" (p. 18).
We hypothesize the following:
H1: Independence has a strong positive correlation with optimism among entrepreneurs.
H2: Being in control has a strong positive correlation with optimism among entrepreneurs.
H3: Creativity has a strong positive correlation with optimism among entrepreneurs.
H4: Willingness to take risks has a strong positive correlation with optimism among
entrepreneurs.
H5: Realistic entrepreneurs do not have a strong tendency to be independent, in control,

creative, or risk taking.
Page 33
H6: Entrepreneurs who are independent, in control, creative, and risk taking do not have a
strong tendency to be pessimists.
Conceptual Framework of Analysis
A conceptual framework has been designed based on the literature reviews and the
hypotheses of this research. This conceptual framework interprets the relationships
between optimism, realism, pessimism, and entrepreneurial characteristics in a two-
dimensional diagram (Figure 1). The vertical axis represents the valence of the
entrepreneurial characteristics between -1 and +1, where -1 represents extremely
negative self-assessed value in entrepreneurial characteristics (not independent, not in
control, not creative, and not willing to take risks) and +1 represents extremely positive
self-assessed value in entrepreneurial characteristics. Given the theories presented in
many entrepreneurship and psychology studies, we can assume a strong positive
relationship between entrepreneurial characteristics and optimism. This implies the values
of correlation coefficients between measurements of entrepreneurial characteristics and
optimism would situate in the larger values of the (+, +) quadrant.
Based on the information noted prior regarding realism and its relationship with
entrepreneurial characteristics, realistic entrepreneurs would be more conservative in
assessing their characteristics and their situations. This leads to weaker positive values of
the correlation coefficients between entrepreneurial characteristics and realism
measurements, as represented by the lower values of the (+, +) quadrant. The
relationship between pessimism and entrepreneurial characteristics is assumed to be
negatively correlated in theory. Pessimistic entrepreneurs are assumed to be contrary to
entrepreneurial characteristics, implying that they are not independent, not in control, not
creative, and not willing to take risks. Thus the correlation coefficients between self
assessed pessimism and entrepreneurial characteristics should reside in the (-, +)
quadrant.1
RESEARCH METHODOLOGY
Questionnaire Design and Sampling Frame
The first step in conducting this research was to design a questionnaire. There were five
sections in the survey: 1) Demographics and characteristics, 2) Optimism assessment, 3)
Realism assessment, 4) Expectations from the venture, and 5) Outcomes of the new
venture creation. To serve the specific purpose of this article, we used the first three
sections for our analysis. (This is a study of entrepreneurs who are already in business.)
Page 34
Demographics reported gender (male or female), age (younger than 30, between 30 and
50, or older than 50), ethnicity, family composition, education, type of business, and
location of the business (rural or urban). Characteristics included independence, control,
creativity, and risk acceptance. The answers were on a Likert-type scale anchored by (1)
Strongly Agree to (4) Strongly Disagree. To elicit more specific answers from
entrepreneurs, we omitted the "Neither Agree Nor Disagree" option.
Statements for optimism assessment were adopted from the Life Orientation Test-Revised
(LOT-R). The original LOT-R has three positive statements (optimism measurements),
three negative statements (pessimism measurements), and four non-scored items as filler
statements. We used the three optimism statements and three pessimism statements for
our questionnaire. The three positive statements were: "In uncertain times, I usually
expect the best," "I am always optimistic about my future," and "Overall I always expect
more good things to happen to me than bad." The three negative statements were: "If
something can go wrong for me, it will," "I hardly ever expect things to go my way," and "I
rarely count on good things happening to me." Carver (n.d.) indicates that "[t]he LOT-R
has good internal consistency (Cronbach's alpha runs in the high .70s to low .80s) and is
quite stable over time" (p. 6). The LOT-R procedure has been recognized and used by
many psychologists as a sufficient and robust tool to measure optimism. Psychologists
have conducted research using the LOT-R to explore personal control in sports; to
investigate the relationships between optimism and depression, coping, and anger; to
analyze effects of optimism on career choice and well-being; and to examine the impact of
optimism on changes of environment and circumstantial situations (Burke et al., 2006;
Burke, Joyner, Czech, & Wilson, 2000; Creed, Patton, & Bartrum, 2002; Perczek, Carver,
Price, & Pozo-Kaderman, 2000; Puskar, Sereika, Lamb, Tusaie-Mumford, & Mcguinness,
1999; Sydney et al., 2005). Clinical researchers have also utilized the LOT-R to explore
how optimism affects patients dealing with various health problems and treatments
(Walker, Nail, Larsen, Magill, & Schwartz, 1996). A few entrepreneurship studies have
adapted the LOT-R to verify the relationship between optimism, realism, and pessimism
(Liang & Dunn, 2008a; Liang & Dunn, 2008b). The LOT-R is available online and is free
for researchers to use (Centre for Confidence and Well-being, 2006). As in the original
LOT-R, the responses to the optimism statements were on a five-point Likert scale
anchored by (1) I Agree a Lot to (5) I Disagree a Lot.
A measure for realism could not be found in the literature. After thorough review of
psychological research and consultations with entrepreneurs and entrepreneurship
educators, we designed seven statements to capture the essence of realism: "I usually
Page 35
set achievable goals," "I usually look before I leap," "When planning, I usually consider
both negative and positive outcomes," "I usually try to find as much information as I can
before I make decisions," "I am always realistic about my future," "I try to be reasonably
certain about the situation I face when starting an important activity," and "I usually weigh
the risks and rewards when making decisions." Entrepreneurs responded on the same
five-point scale used to test the optimism statements.
Using the reliability test on the responses received from our sample entrepreneurs, the
Cronbach's Alpha statistic was 0.81 for the realism statements, 0.73 for the negative
optimism (pessimism) statements, 0.60 for the positive optimism statements, and 0.72 for
the entrepreneurial characteristics (see Table 1). These test results seem to support the
reliability of various statements included in the survey.
Administration of the Survey
After the questionnaire was designed and pre-tested, in-business entrepreneurs were
contacted by a research contact person and asked to complete the questionnaire. After
permission was granted, the entrepreneur was given the questionnaire and allowed to
complete it in private. After completion, the questionnaire was returned to the research
contact person. The collection was done during business hours; however, it was
sometimes necessary to administer the questionnaire while the business was closed or at
a time that was convenient for the business owners' schedules. The questionnaire was
administered to a convenience sample of business owners who started their businesses
in the Mississippi River Delta region between the fall of 2007 and the spring of 2009.
There was no direct personal or familial relationship between the interviewers and the
respondents. However, it is possible that the interviewers were acquainted with the
respondents through other connections. A total of 354 entrepreneurs responded to the
survey.
Method of Analysis
We chose to use the Pearson Correlation Coefficients to analyze the degree of

association between entrepreneurial characteristics, optimism, realism, and pessimism.
The correlation between the graphs of two data sets is the degree to which they resemble
each other. However, correlation is not the same as causation, and even a very close
correlation may be no more than a coincidence. Mathematically, a correlation is expressed
by a correlation coefficient that ranges from -1 (never occur together), through 0
(absolutely independent), to 1 (always occur together).
FINDINGS OF THE STUDY
Page 36
Using the original LOT-R and the newly designed realism statements, we were able to
gather information from over 300 entrepreneurs already in business to reveal if they were
optimists, realists, or pessimists. A summary of the respondents' personal profile and
business profile is included in Table 2. Approximately two thirds of the respondents were
male (63.6%). A majority of the respondents were White (79.6%). Some of the
respondents were Asian (15.9%). Almost 64% of the respondents were married with
children. Forty-eight percent of the respondents were between 30 and 50 years of age.
Another 34% of the respondents were over 50 years old. Most respondents had at least a
high school education, with almost 62% having a college education. Two thirds of the
respondents had their businesses in urban areas. A large group of respondents had fewer
than five full time employees (68.1%). A few of them had no full time employees (4.2%).
Almost 64% of the respondents had fewer than five part time employees, and 20% of the
respondents had no part time employees. Many of the respondents' spouses worked full
time (20.6%) or part time (21.6%) in the businesses. Most of the respondents did not have
children who worked in the business.
Table 3 reports the correlation coefficients of each entrepreneurial characteristic

corresponding to the optimism and pessimism statements. In most of the cases,
entrepreneurial characteristics seemed to relate to strong, positive assessments of
optimism based on our sample. However, independence did not appear to have a strong
positive correlation with the optimism statement "In uncertain times, I usually expect the
best"; neither did being in control. Interestingly, not all entrepreneurial characteristics were
negatively related to pessimism statements. Most of the entrepreneurial characteristics
were weakly negatively related to pessimism statements. The only statistically significant
negative relationships were creativity related to "If something can go wrong for me, it will,"
creativity related to "I hardly ever expect things to go my way," and risk acceptance
related to "I hardly ever expect things to go my way." Contrary to what we expected,
independence and being in control actually had a very weak positive correlation with the
pessimism statement "If something can go wrong for me, it will."
It is also interesting to see how entrepreneurs responded to realism statements since

there is not much discussion of this concept in the literature. There seemed to be a mixed
relationship between entrepreneurial characteristics and realism assessment based on
our sample (Table 4). Most of the entrepreneurial characteristics related to realism
statements positively, except in one case. Independence, being in control, creativity, and
risk acceptance seemed to be strongly positively related to "I usually set achievable
goals." But these four entrepreneurial characteristics did not show a strong positive
relationship to "I usually look before I leap." Being in control seemed to even have a
Page 37
negative relationship to the statement "I always look before I leap." Independence seemed
to have a strong positive relationship with "I am always realistic about my future" and "I try
to be reasonably certain about the situation I face when starting an important activity."
Being in control did not seem to have any statistically significant positive relationship with
most of the realism assessments. Creativity and risk acceptance exhibited the strongest
significant positive relationship with realism.
To verify our findings with the proposed analytical framework of this research, we plotted
the values of the correlation coefficients in a two-dimensional diagram. Using the two-
dimensional diagram we could also see the valence of the one-dimensional interpretation
of the correlation coefficients for each pair of variables.
Figure 2 represents the relationships between each entrepreneurial characteristic and

each optimism statement. All of the values of the correlation coefficients between each
pair of the variables are located in the (+, +) quadrant. This finding is similar to prior
research findings that entrepreneurial characteristics are positively correlated with
optimism assessments. What has not been described in the literature is the strength of
the correlations between entrepreneurial characteristics and optimism. In our sample,
creativity seemed to have a much stronger positive correlation with optimism than did
other characteristics. Independence seemed to have a weaker positive correlation with
optimism. Being in control also had one of the lowest positive correlation coefficients with
the optimism statement "In uncertain times, I usually expect the best."
Realism, as a concept, is relatively new in entrepreneurship literature. We created our

own statements to assess realism among entrepreneurs. We also hoped to explore how
entrepreneurial characteristics corresponded to realism. Figure 3 shows the relationship
between each pair of the entrepreneurial characteristics and realism statements, using a
two-dimensional diagram. By looking at the orders of the characteristic symbols in the
graph, we have identified new information that has not been explored thoroughly in
existing literature. Most of the values of the correlation coefficients were in the (+, +)
quadrant, except one. Being in control seemed to have the lowest correlation coefficients
with all of the realism statements. Furthermore, being in control had a slightly negative
correlation with the statement "I usually look before I leap." Risk acceptance seemed to
have the strongest positive correlation with most of the realism statements. The
correlation coefficients between entrepreneurial characteristics and realism statements
were not as strong as the relationship between entrepreneurial characteristics and
optimism.
Page 38
Pessimism is something that has never been studied in entrepreneurship literature. Is it

true that entrepreneurs are most likely to be optimistic? Is it possible for entrepreneurs to
be pessimistic? In our sample, some entrepreneurs seemed to have certain pessimistic
characteristics. Being in control was one of the characteristics that showed a positive
correlation with the statement "If something can go wrong for me, it will." Being
independent also had a slightly positive correlation with the statement "If something can
go wrong for me, it will." Creativity seemed to have the strongest negative correlation with
pessimism (see Figure 4).
CONCLUSIONS AND IMPLICATIONS
In general researchers have believed optimism is an entrepreneurial characteristic, along

with independence, being in control, creativity, and risk acceptance. The actual influence
of optimism on entrepreneurial decisions in relation to other entrepreneurial
characteristics has seldom been analyzed. Realism and pessimism also deserve further
research. This article examines the relationships between entrepreneurial characteristics,
optimism, realism, and pessimism. The most important contribution of this article is to
report differentiated levels of optimism, realism, and pessimism and how they relate to
entrepreneurial characteristics.
Based on the results of this study, we can conclude findings associated with our
hypotheses.
H1: Independence has a strong positive correlation with optimism among entrepreneurs.
This hypothesis is supported in two cases. Independence relates to two out of the three
optimism statements, "I am always optimistic about my future" and "Overall I always
expect more good things to happen to me than bad." The desire for independence is often
given as a reason for starting a new venture.
H2: Being in control has a strong positive correlation with optimism among entrepreneurs.
This hypothesis is supported in two cases. Being in control relates to two out of the three
optimism statements, "I am always optimistic about my future" and "Overall I always
expect more good things to happen to me than bad." The desire for control is a force
among entrepreneurs.
H3: Creativity has a strong positive correlation with optimism among entrepreneurs.
This hypothesis is supported in three cases. Creativity relates to "In uncertain times, I
usually expect the best," "I am always optimistic about my future," and "Overall I always
expect more good things to happen to me than bad."
Page 39
H4: Willingness to take risks has a strong positive correlation with optimism among
entrepreneurs.
This hypothesis is supported in three cases. Risk acceptance relates to "In uncertain
times, I usually expect the best," "I am always optimistic about my future," and "Overall I
always expect more good things to happen to me than bad."
H5: Realistic entrepreneurs do not have a strong tendency to be independent, in control,

creative, or risk taking.
This hypothesis got mixed results based on our sample. Independence was positively
related to "I usually set achievable goals," "I am always realistic about my future," and "I
try to be reasonably certain about the situation I face when starting an important activity."
Control was positively related only to "I usually set achievable goals." Creativity was
positively related to "I usually set achievable goals," "When planning, I usually consider
before I make decisions," "I am always realistic about my future," "I usually weigh the risks
and rewards when making decisions," and "I try to be reasonably certain about the
situation I face when starting an important activity." Risk acceptance, like creativity, was
positively related to "I usually set achievable goals," "When planning, I usually consider
before I make decisions," "I am always realistic about my future," "I usually weigh the risks
and rewards when making decisions," and "I try to be reasonably certain about the
situation I face when starting an important activity." Realists tended to be more inclined to
view themselves as creative and risk-accepting.
H6: Entrepreneurs who are independent, in control, creative, and risk taking do not have a
strong tendency to be pessimists.
This hypothesis is supported by our sample. Two characteristics, independence and being
in control, actually show slightly positive, though not significant, correlations with "If
something can go wrong for me, it will." In other cases, most of the entrepreneurial
characteristics relate to the pessimism (negative optimism) statements negatively.
Much speculation and many assumptions have been made about entrepreneurial
characteristics, but not many attempts have been made to measure those characteristics
and their relationships to entrepreneurial behavior. This article represents one of the first
attempts to measure and analyze the relationships between entrepreneurial
characteristics, optimism, realism, and pessimism. Optimism, realism, and pessimism
have not been studied thoroughly in entrepreneurship and economics, and these
Page 40
variables are definitely contributors to decision making. There is a need to understand

what optimism, realism, and pessimism mean, how they impact entrepreneurs, and how
that impacts entrepreneurs' decision making in changing the economy. Whether the
decision regards the size of the new firm or the scale of the operation, entrepreneurial
characteristics corresponding to optimism, realism, and pessimism become critical factors
that influence firm performance and the entrepreneurial team (Barkham, 1994; Herron &
Robinson, 2002).
Gartner (1989) argued that focusing on personality traits and characteristics would not
lead to a definition of the entrepreneur nor offer further understanding of the phenomenon
of entrepreneurship. The scope of entrepreneurship research is a combination of actors
and actions. It is important to examine the relationship between entrepreneurial
characteristics and optimism, realism, and pessimism as one way to understand some of
the issues presented in the literature regarding who entrepreneurs are and their behaviors
in decision making. Optimism alone will not stimulate new venture creation. There is a
combination of certain characteristics and environmental factors that motivate
entrepreneurs, especially given the volatile economic and financial situations we are
dealing with today. Being realistic or pessimistic might be a better attitude to avoid
unnecessary financial loss when economic factors are not in favor of new venture
creation.
There are still missing links between theoretical frameworks and empirical studies in
entrepreneurship regarding trait and behavioral theories. This article presented a new way
to examine differentiated levels of optimism, realism, and pessimism related to other
entrepreneurial characteristics. The next step is to explore and analyze entrepreneurial
actions, expectations, and outcomes given the differentiated levels in characteristics.
As many researchers have agreed, the study of entrepreneurship is multi-dimensional,

encompassing personality, traits, skills and training, decision making, organization
creation, team building, management science, and resource allocation. Characteristics
affect behavior, behavior leads to decisions, decisions lead to consequences, and
consequences lead to changes in the economy as well as the behavior of entrepreneurs.
Understanding this flow requires an empirical study of the individual dimensions and their
relationships.
Publication Information: Article Title: Entrepreneurial Characteristics, Optimism

Pessimism, and Realism-correlation or Collision?. Contributors: Chyi-Iyi (kathleen Liang -
author, Paul Dunn - author. Journal Title: Journal of Business and Entrepreneurship.
Page 41
Volume: 22. Issue: 1. Publication Year: 2010. Page Number: 1+. © 2010 Association for
Small Business and Entrepreneurship. Provided by ProQuest LLC. All Rights Reserved.
Article 3
Entrepreneurial Human Capital and New Venture Performance: in Search of the
Elusive Link
by Madhushree Nanda Agarwal , Gurgaon Leena Chatterjee
INTRODUCTION
"Economic circumstances are important; marketing is important; finance is important;

even public agency assistance is important. But none of these will, alone, create a new
venture. For that we need a person, in whose mind all of the possibilities come together,
who believes that innovation is possible, andwho has the motivation to persist until the
job is done. Person, process, and choice: for these we need a truly psychological
perspective on new venture creation ". - Shaver and Scott (1991:39)
Although the positive role of new ventures is widely acknowledged, it is also accepted
that many new ventures go through a period of premature decline (Kimberley and Miles,
1980). This is also evident in the recent dotcom "bust". The population ecology school of
organization theorists have identified this phenomenon as 'liability of newness'
(Stinchcombe, 1965), or the higher propensity for failure among young firms.
Understanding how and why certain entrepreneurs succeed presents an enormous
challenge for the entrepreneurship research community (Aldrich and Martinez, 2001).
Thus, within the population of new and young firms, there is a wide variation in terms of
performance and growth that has to be accounted for.
Cooper, Woo and Dunkelberg (1989) point out that while the majority of new jobs
created are by only 15% of new firms, it is still not possible to predict which companies
will be part of that 15%. Predicting the performance of new ventures has therefore been
a challenge for researchers and investors. At a time when names of start-up firms like
eBay, Google and Infosys are almost household names, why do so many new
businesses close down every day? The outstanding success stories of some start-up
businesses, coupled with the high failure rate of new ventures, generate many
interesting questions about identification of key success factors among new ventures.
Although literature suggests that the entrepreneur is an important resource of the

entrepreneurial firm; attempts at finding relationships between entrepreneurial
personality traits and performance of ventures have been largely unsuccessful.
Anecdotal literature focuses almost exclusively on the role of the entrepreneur, but this
is not supported by empirical research (Sandberg and Hofer, 1987). As Sandberg and
Hofer (1987) point out, one of the most important factors that a venture capitalist
assesses at the time of financing a new venture is the entrepreneurial potential. At the
same time, their model of NVP shows an insignificant effect of the entrepreneur. A
search for the elusive link between the entrepreneurial capabilities and new venture
performance which will allow us to predict with greater accuracy which new businesses
will succeed, has presented a challenge to policy makers, venture capitalists, as well as
entrepreneurship researchers.
Page 42
A REVIEW OF CURRENT RESEARCH
NVP research
Early models of venture performance could be represented by NVP = f(E), where E

represented the entrepreneur. These models tested for direct relationships between
entrepreneurial characteristics and NVP. However, very few of these studies were able
to demonstrate empirically any significant association between entrepreneurial
characteristics and venture performance. On the other hand, Sandberg and Hofer
(1987) tested a model of NVP, where they found significant effects of industry structure
and business strategy, but no significant effect of the personal characteristics of the
entrepreneur. However, they were still reluctant to drop the entrepreneur from their
model of NVP, because this did not agree with anecdotal evidence that the entrepreneur
is able to influence the performance of the new venture significantly. Moreover,
Sandberg and Hofer (1987) also found that venture capitalists emphasize certain
behavioral traits of the entrepreneur qualitatively, while evaluating venture proposals.
Although these are mostly subjective assessments, it emphasizes the importance of the
entrepreneur in the creation and future behavior of the entrepreneurial firm. Although
resource based theories have led to many researchers trying to identify correlates of
successful start-ups in terms of the financial and social capital of the entrepreneur, NVP
models have not been very successful in tracing the link between NVP and
entrepreneurial human capital.
This leads us to suggest that the operationalization of the entrepreneur as an empirical

construct may be one of the issues that leads to the insignificant and inconsistent
empirical linkage between NVP and entrepreneurial human capital.
Recent researchers have tried to identify predictors of success for new ventures, which
typically link success/failure of these firms to certain initial or founding conditions like the
entrepreneur's background, the venture strategy, environmental considerations, or some
combination of these (Stevenson and Jarillo, 1990). The unit of analysis in this branch of
entrepreneurship studies is the organization, and these studies have largely been
conducted by researchers in strategic and entrepreneurial management. The variables
that have been researched for effect on NVP can be broadly listed as (i) The
Entrepreneur, (ii) New Venture Strategy, (iii) The Environment, (iv) Industry Structure,
and (v) Organization structure. However, NVP research has suffered from the following
limitations:
While the entrepreneur is widely accepted to be an important element in a model of

NVP, much of the research trying to find a link between the individual entrepreneur and
the performance of the venture has focused on specific entrepreneurial "traits", which
has turned up results that are inconclusive or insignificant. Trait research, or studies
attempting to explore links between entrepreneurial traits and organizational outcomes,
can at best make conclusions about the particular traits under study.
These inconclusive results of entrepreneurial trait research led some researchers to

drop the entrepreneur from their models. However, this is not consistent with theory or
with anecdotal evidence, which points to important effects of the entrepreneur on small
and young firms (Miller, 1983 ; Sandberg and Hofer, 1987). Moreover, the use of
combinations such as Strategy and Industry structure to explain performance fails to
take into account the effect of entrepreneurial human capital. The inclusion of the
Entrepreneur in NVP models is what distinguishes entrepreneurship research from
mainstream organizational behavior, and dropping it adds little to the already existing
Page 43
body of knowledge.
Although Gartner (1985) pointed out that there may be different types of entrepreneurs,
there are no widely accepted, consistently defined typologies. Operationalizations of the
entrepreneurial construct have been weak and inconsistent.
It is also suggested that this may be because of the failure on the part of most
researchers to consider mediation paths and moderating variables like skills, motivations
and strategy (Baum, 1995; Herron and Robinson, 1993) rather than testing for direct
effects of variables. This may have led to results that are not very significant. Models
using interaction terms have been more successful than those testing for direct effect of
variables.
The Entrepreneur
Most research in the area of entrepreneurship till as late as the mid and late '80s
focused on the differences between entrepreneurs and non-entrepreneurs. Researchers
in this area tried to distinguish the entrepreneur from the non-entrepreneur, based on
psychological, sociological, environmental or educational characteristics (Hornaday,
1982; Brockhaus, 1980). Research in this area examined the founder's traits such as
need for achievement, internal locus of control, or tolerance for ambiguity, demographic
variables like age, education and work experience, and sociological variables like
networks and contacts, parents' background etc.
The results of empirical studies in this area produced mixed and inconclusive results
(Stevenson and Jarillo, 1990; Low and MacMillan, 1988; Gartner, 1990). The
assumption behind studies differentiating between entrepreneurs and non-entrepreneurs
was that entrepreneurs were more or less a homogeneous set. This issue was later
addressed by Gartner (1985), who suggested that differences between entrepreneurs
are more significant than their commonalities, and hence the emphasis of
entrepreneurship research should shift towards studying variations among
entrepreneurs rather than between entrepreneurs and non-entrepreneurs.
Given that differences between entrepreneurs exist, it becomes important to study the
causes and effects of such diversity. Typically, the method adopted by researchers has
been to group entrepreneurs by some common, meaningful, characteristics (Woo,
Cooper and Dunkelberg, 1991). This serves as a useful middle ground between the
anecdotal style of treating every individual entrepreneur as a unique case, and trying to
generalize over a diverse group of entrepreneurs as a whole. Following Gartner (1985)'s
lead, there have been a number of studies that try to differentiate between types of
entrepreneurs.
The earliest work in this area came from Smith (1967), who isolated two types of
entrepreneurs, based on their personal characteristics and work motivations. 'Craftsman'
entrepreneurs came from blue-collar backgrounds, relatively lower levels of education,
and had been associated with operations rather than management in the past. In
running their firms, they were typically paternalistic, used personal finances or relatives
and friends for financing, used personal relationships in marketing, and adopted rigid
strategies. Opportunistic' entrepreneurs, on the other hand, had middle class
backgrounds, were more educated, had a greater variety of work experience, and had
some past experience with management. They were more aware of and sensitive to the
market, and better oriented towards spotting opportunities and growth. Their
management style was more professional, they delegated more, looked for more
Page 44
financing options, adopted more innovative competitive strategies, and led adaptive and
faster growing firms.
Other researchers have tried to build upon Smith's (1967) craftsman-opportunistic

typology (Filley and Aldag, 1978; Smith and Miner, 1983; Cooper and Dunkelberg, 1986,
Lafuente and Salas, 1989). Broadly, three types of entrepreneurs have been identified,
5888 the craftsman entrepreneurs, who are strongly motivated to do what they
enjoy doing, and value their independence, 2) managerial entrepreneurs, who are
motivated by economic gain or building an organization, and are more concerned with
administrative details and control systems, and 3) opportunistic entrepreneurs who can
exploit the market conditions by spotting a particular need (Smith, 1967; Smith and
Miner, 1983; Lafuente and Salas, 1989; Cooper and Dunkelberg, 1986; Woo, Cooper
and Dunkelberg, 1991).
Further studies by Filley and Aldag (1978), Cooper and Dunkelberg (1986), and
Laftiente and Salas (1989) have also identified different types of entrepreneurs based on
different sets of initial classificatory variables like education, previous work experience,
the process of ownership, work expectations etc, and related these classification
variables to growth rates or type of firm created.
As Gartner (1985) pointed out, there are significant variations among entrepreneurs and
the firms they create. Smith (1967) found opportunistic entrepreneurs' chances for
survival and growth to be higher than that of craftsman entrepreneurs. Garland et al
(1984) differentiated between entrepreneurs and small business owners based on the
firm's growth orientation. Birch (1987) has discussed two types of small firms, income
substitutors and entrepreneurs, and noted the difference in growth orientation between
them. Westhead and Wright (1988) have distinguished between novice, portfolio, and
serial entrepreneurs, based on the entrepreneur's experience in new venture creation,
and conclude that portfolio and serial entrepreneurs are significantly associated with
higher job creation rates.
LIMITATIONS OF RESEARCH IN THIS AREA
The operationalization of the entrepreneur as a construct has been inconsistent. Either

personality, personal characteristics, or motivations have been used in isolation, often
without conceptual or theoretical explanations of why they have been used. This has led
to lack of generalization across different studies. Most of these studies have not been
able to report significant association between the entrepreneur, and growth or
performance of the venture. One reason for this could be that the basis for
categorization is by itself not enough to serve as a strong predictor of behavior in new
ventures.
Although many studies have assumed, a priori, the presence of the craftsman-
opportunistic dimension among entrepreneurs, few researchers have tried to validate
the typology empirically. While Woo, Cooper, and Dunkelberg (1991) have suggested
that a two-way classification may not be wide enough to describe a varied sample of
entrepreneurs, there have been few empirical tests for a wider and more clearly defined
typology.
Even when an empirical verification has been attempted, the variables used for
classifying entrepreneurs have been different. For example, Lafuente and Salas (1989)
have used only work motivations to classify entrepreneurs, while Smith's (1967) original
classification was based on the background, education, training as well as attitude to
Page 45
work. This has led to lack of clarity at the construct level, leading to lack of
generalizability across research findings.
Although skills of an entrepreneur have implicitly been part of Smith's original definition,
it has not explicitly been used to differentiate between entrepreneurs.
A SYNTHESIS
Entrepreneurs create new ventures for a variety of reasons, and satisfying a variety of
personal objectives. Motivational structures will be very different for the entrepreneur
who wants challenging work, and for one who chooses self employment as "a more
desirable form of earning a living" (Chell, Haworth, and Brearley, 1991). This is expected
-to have a significant effect on the behavior of the entrepreneur, and hence the future
performance of the ventures created by them. Kolvereid (1991, cited in Gundry and
Welsch, 1997) found that higher levels of growth aspirations were related to
entrepreneurs who started businesses as a means of personal achievement. Similarly,
Amit and Muller (1996) found that "Pull" entrepreneurs had significantly higher chances
of success than "Push" entrepreneurs. Thus, reasons for starting a business may be
related to the growth orientation of the entrepreneur.
Moreover, although entrepreneurship is a situational phenomenon, combinations of

circumstances cannot create a new venture by themselves. The entrepreneur as an
individual has to employ his own skills to "shape a new organization out of complexity
and chaos" (Herron, 1990, quoted in Herron and Sapienza, 1992: 50). Entrepreneurs
come from different social backgrounds, have varied education, training and work
experience, all of which result in the development of different skill sets. These
differences may impact their decisions and be another source of variation between the
ventures they create.
Moreover, it is suggested that personality is manifested in knowledge, skill and ability

(Baum, 1995). Herron and Robinson (1993) conceptualize 'skills' as a function of
aptitude and training. Hence, skill sets of entrepreneurs will capture the effect of the
knowledge and abilities acquired by them through their education, training and work
experience.
One of the major problems with entrepreneurship research is that mediating and
moderating paths between variables have often not been examined (Herron and
Robinson, 1993). Studies which have tried to link personality traits and other
demographic characteristics of the entrepreneur directly to outcomes, instead of testing
contingent sets of relationships, have not reported significant findings. Baum ( 1995)
suggests that the limited effect of entrepreneurial personality on performance may be
explained by analysis of mediation paths through competencies, motivation, strategy,
and structure. Herron and Robinson (1993) suggest that personality traits do not have a
strong direct effect on behavior and performance, but are mediated by motivations and
moderated by abilities, or skills of the entrepreneur. This is consistent with literature on
psychological job testing which suggests that the relationship between traits and
performance is not a direct one, but is moderated and mediated by other variables
(Herron and Robinson, 1990).
Thus, personality, background and experience of the entrepreneur, which are used more
often in entrepreneurship research, may not have a direct impact on organizational
outcomes, but may be mediated by a combination of skills and motivations.
Page 46
Gartner, Shaver, Gatewood and Katz (1994) advocate the use of a combination of work
ability and motivation to capture the effect of the entrepreneur on the performance of his
venture. They suggest the use of measures of specific knowledge and skills rather than
general measures like number of years of experience in industry ornumber of years of
education. Although Smith's (1967) early categorization of entrepreneurial types
implicitly included skill dimensions, no other empirical study has explicitly incorporated
the skills of individual entrepreneurs in defining a typology. Thus, a combination of
motivations and abilities of individuals may yield a more robust basis for differentiating
between types of entrepreneurs.
Many researchers have studied the associations between the characteristics of senior
managers and the strategies they adopt (Miller and Toulouse, 1986; Miller, Kets de
Vries, 1982; Hambrick and Mason, 1984).
The upper echelon theory propounded by Hambrick and Mason (1984) suggests that the
choices made by executives are representative of the characteristics of its managers.
Managers take decisions based on their interpretation of the objective environment, and
their own values and experiences. Bamberger (1983, cited in Kotey and Meredith, 1997)
goes further by stating that business strategies are products of managers' visions which
in turn originate from their personalities. After the initial decision to launch a new
venture, the entrepreneur is faced with many other decisions about the nature of
industry, nature of entry, competitive strategies and operational decisions. Considering
that in small businesses, the owner's goals "become intricately entwined with the
strategies of the business" (Chaganti, DeCarolis, Deeds, 1995: 9), it may be expected
that the entrepreneur would take strategic decisions based on how he perceives the
environment through the lens of his own beliefs, values and attitudes (Wiersema and
Bantel, 1992). Moreover, strategies are particularly likely to reflect the orientations and
priorities of the founder in small and new ventures (Kisfalvi, 2002). Thus it can be
expected that the strategic decisions taken, and hence the early strategies adopted by
the entrepreneurial firm will be related to the type of entrepreneur who makes those
decisions. Specifically, using the arguments above, these decisions will be associated
with the entrepreneurial skill-motivation sets.
Feeser and Willard's (1990) research studies the effect of founding strategies on
performance. The researchers have defined founding strategies to include the
characteristics and experiences of the entrepreneurs, as well as the decisions taken by
them regarding markets, technologies, and competitive postures. Moreover, Timmons,
Smollen, and Dingee (1977) advocate the need for different sets of skills for different
types of entrepreneurial ventures. Keeping in mind that the entrepreneur as an individual
is one of the most important assets of the new venture, a combination of the
entrepreneur's skills and motivations, and the resource allocation decisions he makes,
may have implications for the growth and performance of the firm. Hence both the
entrepreneur and the strategy of the venture may have implications for performance.
Thomas, Litschert and Ramaswamy (1991) point out that if the argument that
managerial characteristics are associated with strategic decisions is true, then a match
or congruence between the two must have performance implications. They argue that
absence of this alignment would result in a "conflict between the distinctive
competencies of the organization and managerial decisions... (leading to) suboptimal
resource deployments, failure to build on organizational strengths, and alack of clear
direction, all of which would have a negative impact on performance" (Thomas, Litschert
and Ramaswamy, 1991, p511 ). Naman and Slevin (1993) argue that fit implies 'efficient
allocation of managerial resources', and hence misfit would be associated with
Page 47
inefficiency. Govindarajan (1989) presents the following rationale for matching

managers to strategies:
23 A different set of behavior, knowledge and skills will be effective in different

strategies.
24 Mangers may have different sets of behavior, knowledge and skills based on their
personalities, background, education, experience etc.
25 Managers can change their styles, but to a limited degree only. Managers whose
behavior, knowledge and skill sets are congruent with the requirements of the particular
strategies will be more effective than others (: 252).
Many studies have attempted to find a link between the entrepreneurial human capital
(i.e., the knowledge, skills and abilities of the entrepreneur), and the new venture
performance (Ucbasaran, Westhead and Wright, 2001). However, resource based
theories of organization recognize that resources alone cannot generate sustainable
competitive advantage, and hence entrepreneurs must select strategies that best exploit
the resources that they have access to (Ucbasaran, Westhead and Wright, 2001).
Chandler and Hanks (1994) suggest that a fit between the available resources and the
venture strategy should enhance performance of the venture. Hence the alignment of
the characteristics of the entrepreneur to the requirements of the strategy will have
implications for the performance of the new venture.
From the above arguments it may be concluded that:
5888 Founders can have a significant influence on organizational outcomes.
5889 Certain organizational decisions may be associated with certain

entrepreneurial characteristics.
5890 The skill-motivation combination of the entrepreneur, as well as the strategic

decisions taken by the entrepreneur, may have associations with NVP.
5891 Congruence or alignment of entrepreneurial characteristics with the

requirements of the strategy may lead to effectiveness of the venture.
CONCEPTUAL FRAMEWORK
Research Questions and Propositions
The arguments outlined earlier generated the following research questions:
23 Are certain combinations of skills and motivations associated with certain

entrepreneurial "types"?
24Are these skill-motivation sets associated with certain competitive strategy decisions
taken by entrepreneurs?
25 Does the entrepreneur-strategy alignment lead to higher performance?
An operationalization of the entrepreneur as a combination of his skills and motivations

has not been attempted in earlier studies. Hence the first part of the study is exploratory
Page 48
in nature, and the propositions will reflect the exploratory nature in that they will state the
relationships that are expected to be found, based on constructs and dimensions from
previous literature.
Based on earlier research on the subject (Smith, 1967; Smith and Miner, 1983; Filley
and Aldag, 1978; Cooper and Dunkelberg, 1984), the following types of entrepreneurs
can be defined: The 'craftsman' entrepreneur is likely to be technically skilled and his
primary entrepreneurial motivation would be the need to enjoy freedom at work, and a
desire for independence. In today's context, the software engineer who branches out on
his own to indulge his creative skills and do his work the way he wants to, can be
described as a craftsman entrepreneur. It seems intuitively probable that he would like
technical jobs and dislike administrative ones, would rate comfortsurvival higher than
growth-profitability, and enjoy technically challenging work.
The managerial/administrative entrepreneur is likely to possess excellent conceptual

skills and a welfare-growth orientation. Such an entrepreneur would be interested in
growth and the opportunity to 'build' an organization. He is likely to be a non-technical
administrator, preferring to expend his energies in planning and organizing. Growth
orientation may be highest for organizations created by this kind of entrepreneur.
The opportunistic/promoter/risk entrepreneur would have strong networking/ opportunity

skills and a profitability orientation. His reason for starting a business would be the ability
to spot an attractive market or opportunity more easily than others. He would be likely to
have a relatively shorter planning time frame, use marketing techniques rather than
product innovations, and be oriented towards profits rather than growth.
From earlier research on skills (Katz, 1974, Pavett and Lau, 1983; Szilyagi and
Schweiger, 1984, Herron and Robinson, 1990; Baum, 1995; Chandler and Jansen,
1992) and motivations of an entrepreneur (Cooper and Dunkelberg, 1986; Amit and
Mueller, 1996; Birley and Westhead, 1994; Scheinberg and MacMillan,1988; Shane,
Kolvereid and Westhead, 1991), the following patterns of entrepreneurial skills and
motivations are proposed in Table 1.
Proposition 1: A combination of skills and motivations of entrepreneurs will yield certain

patterns of skill-motivation sets which will define a typology of entrepreneurs.
As argued earlier, the strategic decisions taken by entrepreneurs are likely to be

associated with entrepreneurial characteristics.
The craftsman entrepreneur is likely to have a high level of technical knowledge and skill
in his focus area. A combination of high need for independence and technical skills is
likely to make him break away from his previous employment to start a business in a
closely related area. His high need for personal development, as well as his expertise
would give him a strong technical orientation and product focus. He would be
comfortable with using sophisticated tools and techniques to differentiate his product.
Since he is not driven by growth or profit motivations, his business strategy would more
likely be differentiation or focus and not an expansion oriented, undifferentiated one. He
is unlikely to have strong human and conceptual skills and hence would be more
product than marketing oriented. Using Carter et al.'s (1994) classification of new
venture strategies, craftsman entrepreneurs could be associated with Technology Value
strategies.
With a high level of conceptual and administration skills, a managerial entrepreneur
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would be most likely to pursue an undifferentiated strategy, driven by growth rather than
profitability motivations. His strong conceptual skills and knowledge of the business and
industry would allow him to have a product as well as a marketing focus. Hence
managerial entrepreneurs may be associated with ventures following Quality Proponent
/ Super Achiever strategies (Carter et al., 1994).
An opportunistic entrepreneur would have the ability to take advantage of environmental

opportunities. Therefore he is more likely to spot niche markets. He is also likely to use
innovative marketing practices rather than product superiority. His strong networking
skills would allow him to understand the needs of his target markets and tailor his
product/service to these needs. Thus opportunistic entrepreneurs may be associated
with Niche purveyor / Price Competitor strategies (Carter et al., 1994). Hence, the
following proposition can be formulated regarding the association of entrepreneurial
skill-motivation sets and competitive strategy of the venture.
Proposition 2: New ventures with dissimilar competitive strategies will be associated

with founders possessing different skill-motivation sets.
Consistent with findings from earlier research (Smith, 1967; Filley and Aldag, 1978;
Lafuente and Salas, 1989; Westhead and Wright, 1998), it can also be expected to find
performance differences across types of entrepreneurs.
Craftsman entrepreneurs have been associated with comfort-survival motivations rather

than growth and profitability (Smith, 1967; Smith and Miner, 1983). Opportunistic
entrepreneurs, associated with desire for financial returns, are likely to be associated
with higher profitability, and managerial entrepreneurs, who are associated with a desire
to build, are likely to be associated with higher growth (Filley and Aldag, 1978; Smith,
1967). Hence we may expect to find different performance orientations among ventures
formed by entrepreneurs with different skill-motivation sets
Proposition 3: Skill-motivation sets of entrepreneurs will be associated with different

levels of performance.
Similarly, new venture strategy literature (Macmillan and Day, 1986; Sandberg and
Hofer, 1987; Birley and Westhead, 1990) suggests that there may exist an association
between new venture strategy and performance.
Proposition 4: New ventures with dissimilar competitive strategies will be associated

with different levels of performance.
The argument for matching entrepreneurial characteristics with the requirements of the
strategy for effectiveness of the venture has been presented earlier. A closer look at the
strategy types established by Carter et al (1994) shows us that:
Super achievers try to exploit all the competitive postures identified, by offering quality
products and services at reasonable prices, and trying to retain flexibility and
responsiveness to the market. Hence a broader view of the organization and its
elements, or administrative skills may be required for this kind of strategy. Skills like
business and industry knowledge will be needed to identify customer needs and ensure
quick responses to changes in the market. Internal skills like leadership and
administrative skills will also be needed to integrate diverse areas of operation like
production, customer service etc. Hence we can expect that a managerial/
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administrative type of entrepreneur to be most successful in this kind of strategy.
Technology Value firms use innovative or new technology or a price competitive product
as a differentiator. Carter et al (1994) suggest that this strategy seems likely for
entrepreneur who have previously been employed in related industries and have hence
been able to successfully transfer their knowledge and skills into the new venture. It
seems fairly clear that technical knowledge of the product/service will be essential skills
for this area in order to be able to offer leading edge technology. The craftsman
entrepreneur who is motivated by technical work and uses his technical skills to excel at
his work may be most likely to outperform others using this strategy.
Niche Purveyors emphasize unique products and services for their identified niche, and
couple this with convenience value, locational advantages, etc. to create value for their
customers. Since this type of strategy demands opportunity recognition skills, the
opportunistic entrepreneur is likely to be a niche player. However, the craftsman
entrepreneur could also be a niche player if his product/service is specialized and aimed
at a narrow target market. This type of strategy would need a strong customer
orientation and relationship management with the small market segment. Thus we
expect opportunistic entrepreneurs to be more successful in this kind of strategy.
Moreover, we also see that a lack of market responsiveness is also a feature of this kind
of strategy. As opportunistic entrepreneurs are more likely to be responsive to changing
market conditions than other types, we would expect them to perform better than the
other types adopting this strategy.
Quality proponents rely on the quality of their products, superior service and better
technology. The required skills would include both actual product/service skills as well as
leadership and business skills to ensure that the organization as a whole is oriented
towards quality. Moreover, there is a strong element of service in the value offering in
this type of strategy. Craftsman entrepreneurs can be expected to be less service
oriented and hence we may expect managerial entrepreneurs to perform better.
Price competitors use a combination of marketing/advertising, service and low price.

This needs knowledge of the industry, and good networking skills. Moreover, a price
competitive strategy by definition is a short term strategy. As the opportunistic
entrepreneur is likely to be more marketing oriented than product oriented, and would be
motivated by short term profits, we would expect this type to perform better.
Equivocators adopt ambiguous strategies where they fail to emphasize any of the
strategy dimensions mentioned. Given the lack of a coherent strategic orientation, we
expect opportunistic entrepreneurs, who are strongly motivated by short term results
and personal achievement rather than long term growth plans, to perform best in this
strategy type.
From the arguments above, we may expect that "fit" between the entrepreneur and the
strategy of the new venture will have performance implications for the venture.
Proposition 5: New ventures where the type of entrepreneur is aligned with the
requirements of its strategy will perform better than ventures where such an alignment
does not exist.
Research Framework and Suggested Methodology
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The model is of the form NVP =f(E, S, Ex S), where
E = Type of Entrepreneur
S = Type of Strategy, and
E x S defines the interaction term.
The variables under consideration are the Entrepreneur (E), New Venture Strategy (S),
and New Venture Performance (NVP). The entrepreneur as an empirical construct is
operationalized by a combination of skills and motivations. Multidimensional scales can
be used to measure skills and motivations. Clustering methods may be used to identify
specific skill-motivation sets. This would empirically validate the craftsman-opportunistic-
managerial typology. It is expected that personality, background, experience etc will not
have direct effect on performance, but will be mediated by skills and motivations, and
moderated by strategy.
The typology identified is expected to impact strategic decisions as well as the

performance of new ventures. Moreover, the type of entrepreneur and strategy are
expected to have weak direct effects on NVP, and the interaction term is expected to
have a strong effect. Contextual variables like Environment and Industry Structure are
assumed to be controlled for.
Analysis Plan
The first part of this study attempts an operationalization of the type of entrepreneur,
based on skills and motivations. Skills and motivations can be identified from literature
and operationalized into a multidimensional questionnaire. Since the initial objective is to
reduce and summarize the data collected on skills and motivations to a smaller number
of common dimensions, the first step in the process will be Factor Analysis. Skills and
motivations can be factor analyzed separately using an R-mode Principal Components
Analysis (PCA) to reduce the items into a smaller number of independent orthogonal
components. PCA is to be used since the component scores are to be further used in a
clustering technique which is sensitive to intercorrelations (Green and TuIl, 1990).
Although the dimensions of skills and motivations can be identified through factor
analysis, the objective of the research is to examine the "combinations" of these that
actually exist. As has already been argued, entrepreneurs are a heterogeneous group in
terms of their skill-motivation sets, and the attempt here is to identify homogeneous
subgroups within a heterogeneous sample. Everitt (1980) recommends the use of
cluster analysis under these circumstances.
The factor scores obtained from the earlier factor analysis can be used as inputs for the
subsequent cluster analysis to identify entrepreneurial "types". It is expected that the
cluster analysis would yield clusters similar to the craftsman-opportunistic-administrative
types defined in literature. The methodology has the disadvantage of a loss of detail, but
makes up for it by helping generalization (Birley and Westhead, 1994). Moreover, given
the exploratory nature of this research, the use of this method is useful in constructing
"mid-range theories" (Pinder and Moore, 1979), which help in the process of theory
building.
The study then proposes to test whether the competitive strategy choices made by the
entrepreneur differ systematically with the "type" of entrepreneur. This is consistent with
researchers in organization behavior who study associations between managers and
Page 52
strategy (Miller, Kets de Vries and Toulouse, 1982). Unlike in larger organizations,
causality is not complicated by the possibility of executives being chosen for a particular
position because of their personal and background characteristics (Hambrick and
Mason, 1984), and any association between entrepreneurial characteristics and strategy
can be assumed to be directional. Moreover, by using cluster analysis, strategy is
treated as a multidimensional construct which reflects the differential emphasis that each
firm places on each dimension of competitive strategy. The hypotheses can be tested
using contingency coefficients, as both the data are category data, and hence nominal in
nature. Other nonparametric tests available for association between nominal data eg.
Phi and Cramer's V can also be used.
The last part of the study then proposes to examine the performance implications of a
strategy-entrepreneur matching relationship. Since the use of mediating and moderating
variables is recommended rather than examining direct effects of variables, and models
incorporating interaction terms have generally been found superior in explaining
NVP(Sandberg and Hofer, 1987), it is expected that the interaction between type of
entrepreneur and type of strategy would have performance implications.
Controlling for industry, it is proposed that NVP = f (E, S, E ? S), where NVP=New
venture performance, E = Type of entrepreneur, S = Type of strategy, ExS = Interaction
term. It is proposed that E and S will have independent weak effects on performance,
and the interaction term will have a strong effect. This can be tested by using a set of
'matching' hypotheses, which test the argument that "fit" between type of entrepreneur
and type of strategy would have association with the performance of the new venture.
These propositions could be tested using non-parametric statistical tools. The framework
for the analysis is presented in Figure 2.
Implications of the Model
The model derived here has important implications for entrepreneurship researchers,
practicing entrepreneurs, and venture capitalists.
The model derived in the paper integrates research on the individual entrepreneur and
the performance of the venture in an attempt to find the elusive link between the two
streams of research in this area.
Firstly, the operationalization of the entrepreneur as a combination of his skills and

motivations has not been attempted earlier. Although the choice of variables for
categorization is strongly grounded in theory, no empirical research has been carried out
with this operationalization. Since the derivation is strongly grounded in theory, empirical
testing of the model will validate the existence of a typology that has been studied but
not validated earlier.
The derivation of the model is based on strong theoretical antecedents deriving from
areas like psychological job testing, behavioral theories of organization, and strategic
management literature. It is supported by the fact that testing for direct effects of traits
on outcomes has not yielded significant results. A model using mediation and
moderation paths of the relevant variables is expected to have higher explanatory
power. This could be a significant contribution to the area of research which has tried to
identify which behavioral characteristics of the entrepreneur are associated with
success.
The new operationalization of the entrepreneur could form the basis for a stable
Page 53
typology for further empirical research, This would help the process of theory building in
the area of entrepreneurship, by allowing the comparison and generalizability of
research findings.
Trying to determine which new ventures are likely to succeed has traditionally been a
challenging problem for venture capitalists. When a venture capitalist is approached by
an entrepreneur for financing his venture, he often faces the problem of adverse
selection (Amit and Muller, 1996). Since venture capitalists do try to evaluate the ability
of the entrepreneur by trying to assess certain traits and behavioral characteristics of the
entrepreneur (Sandberg and Hofer, 1987; Amit and Muller, 1996), they are hampered in
this evaluation by the absence of any clear theory which predicts which characteristics
will increase chance of success. The subjective assessments and psychological or trait
measures used by venture capitalists to assess entrepreneurial capabilities may be
replaced by instruments measuring actual skills and motivations of the individual
entrepreneur. As explained earlier, traits may not have direct effects on outcomes, but
may rather be mediated by a combination of the entrepreneur's skill-motivation set,
which capture the effects of personality traits as well as other commonly tested variables
like education, background and work experience. Any government policy to encourage
employment growth by encouraging new venture creation has to take into account
differing attitudes, managerial styles, and hence, varying incubation needs of different
types of entrepreneurs (Lafuente and Salas, 1989).
Finally, based on the finding that certain types of entrepreneurs outperform others,
founders and potential founders should analyze their own skills and motivations.
Knowing which behavioral aspects are linked to performance can help them either to
supplement their skills in certain areas, or balance their own shortcomings with a
complementary founding team.

1024 Attitudes and behaviours that are distinctive in entrepreneurs and that can
be acquired;
1025 Attitudes and behaviours in entrepreneurs that cannot be acquired;

Introduction
The entrepreneurial mind
Successful entrepreneurs work hard, are driven by an intense commitment and

determined perseverance, strive for integrity, burn with a competitive desire to excel and
will use failure as a tool for learning and believe they can personally make a difference;
Successful entrepreneurs cannot be identified through any psychological model;
Successful entrepreneurs do not only possess creative and innovative flair but also solid
general management skills business know-how and sufficient contacts;
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The entrepreneur is opportunity driven whilst the manager is driven by the need to
conserve resources.
The lead entrepreneurs who find and seize opportunities and grow higher potential do
things differently.
3.2.1: INTRODUCTION
There are two principles for achieving entrepreneurial greatness:
5888 Treat others as you would want to be treated;
5889 Share the wealth that is created with all those who have contributed to it at
all levels.
There is no single model of entrepreneurship.
However the eventual success of a new venture will depend a great deal upon the talent
and behaviour of the lead entrepreneur and of his or her team.
Leadership therefore mostly makes the difference. Leaders are made not born. In earlier
era's rulers were royal and leadership was the prerogative of the aristocracy. This notion
has not stood the tests of time. It is widely accepted today that leadership depends more
on the interconnection among the leader, the task, the situation and those being led than
on inborn or inherited characteristics alone.
Managers can be distinguished from leaders. The main distinctions between managers
and leaders are found amongst the following:
Creating an agenda: management plans and budgets, leadership establishes direction;
Developing a human network for achieving the agenda: management is responsible for
organising and staffing and leadership for aligning people (communicating direction);
Execution of the agenda: management control and solves problems, leadership

motivates and inspires;
Outcomes: management produces a degree of predictability and order and producing

key results, leadership produces change.
3.2.2: ACQUIRABLE ATTITUDES AND BEHAVIOURS OF

ENTREPRENEURS
Merely possessing the characteristics of an entrepreneur do not necessarily make an
Page 55
entrepreneur. Many successful entrepreneurs have emphasized that while successful

entrepreneurs have initiative and take charge, are determined and persevere, and are
resilient and able to adapt, it not just a matter of their personalities, it is what they do.
Certain attitudes and behaviours can be acquired through experience and study.
Some attitudes and behaviours are common in most entrepreneurs such as:
← The ability to respond positively to challenges and learn from mistakes;
← Taking personal initiative;
← Great perseverance and determination.
3.2.2.1: Commitment and determination
A committed and determined entrepreneur can overcome incredible obstacles and also
compensate enormously for other weaknesses;
Commitment and determination are vital because the entrepreneur lives under constant
pressure;
Entrepreneurs are not relentless in their attack on a problem. They are realistic about
unsolvable problems;
Nothing can take the place of persistence - not talent, genius or education.
3.2.2.2: Leadership
Successful entrepreneurs are experienced;
They are knowledgeable in their field and have sound general management skills;
They are patient leaders;
They are visionary dreamers;
They are supporting and nurturing and able to make "heroes" out of the people they
attract to the venture by giving them responsibility and sharing credit for
accomplishments;
They can exert influence without formal power;
They are not lone wolves, but have highly developed interpersonal skills.
3.2.2.3: Obsession with opportunity
Entrepreneurs are totally immersed in the opportunity;
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This obsession is what guides how an entrepreneur deals with important issues;
They are oriented to the goal of pursuing and executing an opportunity for accumulating
resources or money.
3.2.2.4: Tolerance of risk, ambiguity and uncertainty
Entrepreneurs manage paradoxes and contradictions;
Entrepreneurs risk money and their reputations. They are not gamblers, they take
calculated risks. They get others (partners and investors) to share financial and
business risks with them;
Entrepreneurs are able to tolerate ambiguity and uncertainty and are comfortable with
conflict;
Successful entrepreneurs maximize the good higher performance results of stress and
minimise the negative reactions of exhaustion and frustration.
3.2.2.5: Creativity, self-reliance and adaptability
Successful entrepreneurs believe in themselves. They believe that their

accomplishments lie within their own control and influence and that they can affect the
outcome;
They are traditionally viewed as highly self-reliant innovators and champions of the free
economy (market) system;
They have a tendency to take responsibility for the success or failure of the operation
and prefer to be measured on their ability;
Mostly their ability to achieve is measured through the profitability of their ventures;
They are not afraid of failing and use failure as a way of learning. They are more intent
on succeeding, counting on the fact that "success covers a multitude of blunders;"
They understand their own roles but also the roles of others in their failures and thus are
able to avoid similar problems in the future.
3.2.2.6: Motivation to excel
Entrepreneurs are self-starters who appear driven internally by a strong desire to

compete against their own self-imposed standards and to pursue and attain challenging
goals;
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They are driven by a thirst for achievement rather than status or power. Status and
power are a result of their activities;
They derive motivation from challenge and excitement of creating and building
enterprises;
They are selective in sorting out opportunities.
3.2.3: UN-ACQUIRABLE ATTITUDES AND BEHAVIOURS
3.2.3.1: Energy, health and emotional stability
Each of these has strong genetic roots but can be fine-tuned and preserved by careful
attention to eating and drinking habits, exercise and relaxation.
3.2.3.2: Creativity and innovativeness
Traditionally thought of as an inherited quality but there is a growing school of thought

that believes creativity can be learned.
3.2.3.3: Intelligence
This includes street smarts (i.e. a nose for business) gut feel, instincts and special kinds
of intelligence;
Many times entrepreneurs do not excel in formal learning programs (school). Colonel
Sanders of Kentucky Fried Chicken dropped out of school.
3.2.3.4: Capacity to inspire
Vision is that natural leadership quality that is charismatic, bold and inspirational. An
entrepreneur's vision is conveyed by the style of leadership;
Goals and values of entrepreneurs normally establish an atmosphere within which all
activity will take place and his or her inspiration, regardless of the form it takes, will
shape the venture.
3.2.3.5: Values
Personal and ethical values reflect the environments and backgrounds from which
entrepreneurs have come and are developed early in life;
These values are an integral part of an individual.
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3.2.4: ENTREPRENEURIAL APPRENTICESHIP

Most successful entrepreneurs have acquired 10 years or more of substantial
experience;
Mostly acquired intimate knowledge of a particular industry;
They have found and nurtured relevant business and other contacts that contribute to
their success;
These experiences dramatically improve the chances of success.

3.1) What are the main differences between managers and leaders?
3.2) Describe 6 characteristics of successful entrepreneurs.
Page 59
STUDY UNIT 3: THE OPPORTUNITY
← CREATING, SHAPING, RECOGNISING, AND

SEIZING AN OPPORTUNITY
4.1: Reading
Article 1
Business opportunity Screening
Idea or Prime Opportunity? a Framework for Evaluating Business Ideas for New
and Small Ventures
by Sherrie E. Human , Thomas Clark , Melissa S. Baucus , Andrew C. Eustis
INTRODUCTION
Entrepreneurship scholars, practitioners, and educators define the field in terms of

opportunity focus (Brodsky, 2000; Bygrave, 1989; Gartner, 1985; Kamm & Nurick, 1993;
McGrath & Hoover, 2001; Stevenson & Gumpert, 1985; Timmons & Spinelli, 2004;
Weinzimmer, Fry & Nystrom, 1996). For scholars and practitioners, an important question
regarding opportunity recognition and evaluation is how do potential entrepreneurs, small
business owners, or informal investors determine if an idea is a good business
opportunity. This is particularly important given the often high uncertainty, low information,
and rapid decision making surrounding start-up ideas. In addition, entrepreneurship
educators look for efficient and effective tools for teaching students opportunity
recognition and evaluation skills. In the formal venture community, sources of funding
such as venture capital firms, banks, and more recently, angel investor groups have
access to sophisticated, often proprietary, investment analysis tools and models. They
often receive thoroughly researched, even professionally prepared, business plans upon
which these groups apply their analytic tools. These more formal sources of financing
represent a relatively small percentage of new and small business funding, unless the
business opportunity meets stringent growth or asset requirements. The more common
sources of funds for new and smaller businesses, such as family, friends, informal
investors, and the entrepreneurs themselves (Shulman, 2004), often do not have access
to the same level of analytic tools as formal investors and may not receive thoroughly
prepared business plans early on in their discussions regarding a start-up concept.
Page 60
Consequently, these more typical funding sources for new and small business ideas can
benefit from access to systematic and easy-to-use approaches for determining initial
feasibility of a business idea, short of investing the time in the full-blown business
planning process. In addition, students of entrepreneurship can benefit from new
pedagogical tools that allow them to easily practice opportunity evaluation and critical
thinking regarding new venture concepts.
Scholars suggest that "simplifying heuristics may have a great deal of utility in enabling
entrepreneurs to make decisions that exploit brief windows of opportunity" (e.g.,
Ucbasaran, Westhead, & Wright, 2001, pg. 59). This article describes such a simplifying
heuristic designed to be a framework to examine important Product/service, Resource,
Individual, Market, and Economic characteristics when initially investigating a start-up
concept. This framework, using the acronym PRIME, prompts users to ask key questions
regarding a venture or growth concept's merits.
In the following section we describe selected leading models for business concept
assessment, illustrating how our framework builds on these models. We then explain our
model for evaluating business opportunities, how it fits key criteria for such a framework,
and following the format of Weinzimmer et al. (1996), we describe applications of the
model.
EXISTING TOOLS FOR EVALUATING BUSINESS OPPORTUNITIES
While not comprehensive, our discussion of the selected models in this section provides a
wide range of topics identified by entrepreneurship scholars and practitioners as important
for evaluating business ideas. The Timmons Model of the Entrepreneurial Process
(Timmons & Spinelli, 2004) continues to be a leading framework for evaluating business
opportunities. It focuses attention on the fit among three elements critical for evaluating a
start-up: the team, the resources, and the characteristics of the opportunity. Potential
entrepreneurs and investors can use this model to determine if, like a three-legged stool
(Timmons, 1999), the business opportunity has achieved a critical balance among the
three elements. Timmons further outlines a Venture Opportunity Profile, which details
multiple key topic areas and specific benchmarks and yardsticks for evaluating business
opportunities such as Industry and Market, Economics, and Personal Criteria. The
Timmons frameworks are designed to allow investors to evaluate a business idea against
high potential and low potential venture criteria, with a goal of helping investors identify
high potential opportunities while screening out low potential ones.
With two other frameworks, the New Venture Decision Making Model and the Opportunity
Search Model (Kamm & Nurick, 1993; Weinzimmer et al., 1996, respectively), the
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entrepreneur or business owner takes center stage. The New Venture Decision Making
Model emphasizes idea generation and business concept evaluation as important first
steps in new or small venture decision making, including topics such as social networks
and resource supplies available to the founding team. With the Opportunity Search Model,
the start-up entrepreneurs or small business owners are influenced by three sets of
factors in their search for opportunities: environmental attributes, owner characteristics,
and strategy factors.
Finally, some entrepreneurs perform an analysis of the Strengths, Weaknesses,

Opportunities, and Threats, or SWOT analysis, for a firm, its industry ,and its environment
(e.g., Bernrolder, 2002). However, in practice SWOT is more often applied to existing
ventures, as it implicitly assumes an existing business looking for ways to identify new
strategies (Warnaby, 1999).
We designed the PRIME framework as an extension to and integration of these and other
models, specifically to help address the needs of the substantial and growing number of
new and serial entrepreneurs, informal investors, students of entrepreneurship, as well as
formal investors who favor an additional opportunity-screening model to recommend or
use. As recent studies indicate, the environment for start-up businesses consists of
heightened awareness and increasing documentation of entrepreneurial activities,
increasing speed with which venture opportunities are often evaluated, growth in types
and numbers of entrepreneurship education programs, and a continuing likelihood that
informal funding sources such as families, friends, and the entrepreneurs, themselves, will
be primary sources of start-up funding (Penley, 2000; Reynolds, 2000; Reynolds,
Bygrave, Autio, Cox & Hay, 2002). Thus, the PRIME analysis was designed to help
entrepreneurs, investors, and students of entrepreneurship screen and evaluate venture
opportunities. Further, our goal was to structure the PRIME analysis as an easily
remembered heuristic guiding opportunity search and evaluation in the typical
entrepreneurial contexts of high uncertainty and low information. Figure 1 shows the
overall PRIME analysis framework.
DEVELOPMENT OF THE PRIME ANALYSIS FRAMEWORK
We identified four key criteria for application-oriented models to help guide our
development of an efficient opportunity evaluation framework, building on previous work
in this area (e.g., Gorry, 1971; Timmons & Spinelli, 2004; Weinzimmer et al., 1996). The
four criteria we identified stipulate that the framework be easy to recall, educative and
prompting, comprehensive, and useful in helping identify personal relevance. We briefly
discuss these four criteria and the importance of each.
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Easy to Recall
An important characteristic of any framework is the ease with which users can remember
and apply it when evaluating a potential business opportunity. As Figure 1 illustrates,
PRIME integrates key opportunity evaluation factors from prior models, using a mnemonic
device to remind the user of key questions, similar to the purpose of SWOT analysis.
Thus, the PRIME framework was not intended to identify new characteristics for
evaluating business opportunities, but was designed to help easily recall established
business evaluation criteria when out in practice or in the classroom. We adopted this
easy to recall design based on recent scholarly and practitioner findings that mnemonic
frameworks were positively associated with user recall in training and marketing (Nestor,
2000; Smith & Phillips, 2001). Consistent with concerns in the literature related to memory
aides (Campos, Gonzalez, & Amor, 2003; Hill & Westbrook, 1997; Panagiotou, 2003;
Ullius, 1997), the acronym PRIME did not drive our inclusion of particular content
characteristics. Rather, all of the framework's characteristics were first drawn from well-
established opportunity recognition and evaluation models and literature, from which we
then developed relevant acronyms.
Educative
Similar to the content in a full-blown business plan, our framework educates users
regarding key information they need to obtain about the opportunity and prompts them to
uncover issues that might not have been considered without the model. For instance, in
Figure 1, the topic Resources, with subtopics of Defined, Accessible, Minimized, and
Sustainable Advantage, reminds the user to explore whether key resources such as
suppliers, advisors, and customers are defined or accessible (e.g., does the founding
team have relevant industry networks?). Thus, while new venture economic forecasts are
understandably uncertain, identifying whether key resources have been approached or
assembled by the team can be more certaincither the team has contracts, contacts or not-
and reminding the PRIME user to ascertain this level of resource definition and
accessibility can help users understand the overall timing and readiness, for instance, for
a particular opportunity.
Comprehensive
Ultimately, a model for evaluating opportunities must help the user ask questions covering
a full range of issues well documented as important for opportunity recognition. To be
comprehensive, yet parsimonious, we identified major opportunity evaluation criteria
discussed in leading entrepreneurship literature for practitioners, (e.g., Abrams, 2003),
educators (e.g., Kuratko and Hodgetts, 2003; Timmons & Spinelli, 2004) and scholars
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(Shane, 1997). For instance, as Figure 1 under Economics illustrates, the PRIME
framework uses the mnemonic FRESH to prompt users to examine a wide range of
economic issues including Forgiving, Rewarding, Enduring, Stability, and Harvest
characteristics. Will the venture suffer a fatal blow if an early mistake is made due to high
fixed costs early on? Is this a short or long window of economic opportunity? While not a
complete set of all economic factors to evaluate, this set covers a wide range of relevant
and important business opportunity characteristics discussed in the literature.
Helps Identify Personal Relevance
By incorporating an individual rating system, the framework helps users identify important
individual assumptions or personal relevance regarding PRIME topics (e.g.,
Product/service), subtopics (e.g., Superiority, Uniqueness, etc.), and the business concept
as a whole. That is, new venture success criteria may not have equal weighting for
different entrepreneurs or investors, and particular aspects of business concepts may be
more or less attractive to individuals or teams. The PRIME framework, incorporated into a
worksheet provided to users, outlines a rating system of simple plus-zero-minuses that
allows users to consciously consider the relevance or importance of each topic and
subtopic for themselves (see Table IV). Thus, one user might rate the subtopic Availability
of resources as a zero (O), representing a "me too" aspect of the opportunity, neither
positive nor negative, while another individual might rate resource Availability for the same
idea as a double-minus ( - ), indicating this is a fatal flaw for the opportunity as far as this
particular individual assumes. The PRIME analysis ratings also include double-plus ( +
+ ), indicating the user perceives that the topic or subtopic represents a major competitive
advantage that could be validated and emphasized in a business plan, a single-minus
( - ), suggesting potential areas to eliminate or minimize through reworking the original
concept during the business planning process, and a single-plus ( + ), indicating a positive
characteristic but not a major advantage over competitors.
The PRIME analysis worksheet also prompts users to provide an overall rating for each
major topic (e.g., Product/service) and the business concept as a whole and to write/type
in key facts known or needed to continue opportunity evaluation. Thus, the PRIME
analysis allows for an individually weighted examination of venture concept
characteristics, including highlighting characteristics to be emphasized, minimized, or
further investigated. For instance, answers to PRIME questions on the Rewards of the
business concept (under Economics) might be overshadowed by answers to the Ethicality
questions (under Product/service) when examining the "payday lender" industry and its
attractive gross margin opportunity, which for some would not be compelling enough to
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overcome potential ethical or legal issues (ClassActionAmerica.com, 2004). The following

section describes topic areas of the PRIME framework and selected literature on which
each topic and subtopic was based.
COMPONENTS OF PRIME ANALYSIS
The following descriptions illustrate relevant questions PRIME prompts users to ask within
key topic and subtopic areas and highlights selected literature supporting the use of these
questions. Table IV illustrates one topic and selected subtopics on a PRIME analysis
worksheet used to guide users through the opportunity evaluation thought process.
Product/Service Evaluation
Understanding the entrepreneur's product or service idea continues to be at the heart of

the opportunity recognition process (Abrams, 2003; Scholhammer & Kuriloff, 1979;
Vesper, 1990). The mnemonic for Product/Service Evaluation is SUPERB (see Figure 1).
Superiority. Is the product or service idea demonstrably superior in some way to

competing products or services, as of the current information? Can the superiority be
quantified on a dimension meaningful to potential customers? Informal and formal
investors use a number of screening criteria for evaluating the sustainable competitive
advantage of an idea, including characteristics such as superiority, uniqueness, and
protection (see below) of the product or service (Roberts, Stevenson, & Morse, 2000;
Zider, 1998).
Uniqueness. Scholars and practitioners often list uniqueness as a key characteristic for a
new business concept. Importantly, uniqueness can encompass a wide range of product,
service, process, and systems applications (Bhide, 1996; Kuratko & Hodgetts, 2003).
Moderately high levels of uniqueness may be most desirable. Extremely unique concepts
often require massive public education, an expensive undertaking for a start up, and can
tend to result in huge success or rapid failure, with failure relatively common. However,
concepts without some uniqueness rarely create significant competitive advantages.
Protection. To what extent can the product or service concept be protected from
competitors who may possess better financing and market-place connections and strong
motivations to copy a good idea quickly? Having or creating barriers to entry such as
patents, licensing agreements, specialized knowledge, or secret formulas is not only
important to strategic management scholars (e.g., Fahey & Randall, 2000; Thompson &
Strickland, 2003), but is also of interest to entrepreneurship scholars and practitioners
(Bhide, 1994; Fry, Stoner, & Weinzimmer, 1999).
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Ethicality. Does the product or service make a positive social contribution in the eyes of
the entrepreneur or investor for a particular niche market, or are there ethical or even
legal considerations regarding the founders' actions in the opportunity (e.g., employment
contract issues)? Organization and entrepreneurship scholars suggest that ethicality plays
an active role in organizational decision-making (Grant, 1992; Dees & Starr, 1992; Paine,
1994). Indeed, leading entrepreneurship textbooks include entire chapters devoted to
topics such as "Personal Ethics and the Entrepreneur" (e.g., Timmons & Spinelli, 2004, p.
327).
Readiness. How long before the new venture will likely have its first customer, generate
revenues, or become profitable? Does a business plan exist yet, or is the idea still in the
mind of the entrepreneur? Kourilsky and Carlson (2000) discuss the relevance of
entrepreneurship readiness in curriculum development, maintaining that students need to
be ready to start a business. Timmons and Spinelli's (2004) concept of timing in
evaluating opportunities also encompasses the aspect of product or service readiness for
the market.
Business model. How does the overall product or service offering look to the PRIME
user? For instance, what are the ongoing revenue generation and customer attraction
processes as compared with other business models in the industry? Is this explicit or can
it be easily implied? While business models have received increased attention in recent
years, the issue of what an idea might look like in the real world has long been of interest
to those evaluating new venture opportunities (Vesper, 1990; Wiltbank & Sarasvathy,
2002).
Resource Evaluation
The mnemonic for Resource Evaluation is DAMS (see Figure 1). Key resources for new
venture opportunities include financial, social, human, physical, technological, and
organizational (Ucbasaran et al., 2001). Resource acquisition has been a pivotal issue in
evaluating opportunities for well over a decade. For instance, Vesper's New Venture
Checklist (1990) asked entrepreneurs to evaluate new ventures in terms of key resources
such as financing, staffing, suppliers, and equipment. Practitioner-oriented books on
preparing business plans include extensive worksheets to help identify key resource
requirements when evaluating new ventures (e.g., Abrams, 2003). And, scholars have
identified resources as an important component for creating organizational and new
venture sustainable competitive advantage (Alvarez & Busenitz, 2001; Barney, 1991).
Defined. Vesper's New Venture Checklist (1990) suggests that the evaluation of start-ups
should include questions regarding who will have to be hired and when, and how will they
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be found and recruited. We refer to these types of questions as defining the resources for
the new venture. Indeed, in addition to labor, questions should also include to what extent
the small business owner or entrepreneur knows exactly what and how much is needed in
other key resource areas such as suppliers, funding, and equipment.
Accessible. Does it appear that the founding entrepreneurs have not only defined the
resources required, but also have access to them, such as solid relationships with
important suppliers or funders, are there backup sources of supply identified, favorable
trade terms available? Vesper's New Venture Checklist (1990) asks these questions, in
addition to Kamm and Nurick (1993), who discuss "resource supply decisions" (p. 20) in
new venture formation, and Timmons and Spinelli (2004), who identity access to
resources as a part of the entrepreneurial process.
Minimized. On the one hand, has a real effort been made to eliminate the "nice, but not
necessary" expenditures, and on the other hand, have resources been minimized to a
point that suggests unrealistic expectations or that might be harmful to the success of a
particular opportunity? Concerns over the need to minimize or bootstrap start-up
resources is a common issue in the entrepreneurship literature (Bhide, 1992),
incorporating tools and models for bootstrapping (e.g., Smith & Smith, 2004) and case
studies that illustrate how successful entrepreneurs initially bootstrapped their new
enterprises (e.g., Hofman, 1997).
Sustainable advantage. Do the resources defined and accessible by the entrepreneur

appear to help build sustainable advantage for the new venture, or do they allow an initial
advantage that may be lost early on to competitors? Barney (1991), Alvarez and Busenitz
(2001), and others argue that organizations, in general, and entrepreneurs, in particular,
must develop a sustainable competitive advantage through resources that are rare or of
value to the market or competitors, are difficult to imitate, or have little to no substitutes in
the market.
Evaluation of the Individual Entrepreneurs
The acronym for Individual Evaluation is STARS (see Figure 1). This section focuses on
the entrepreneur or founding team, leaving the evaluation of key employees as part of the
resource evaluation. Human capital resources (Becker, 1964) in organizations and new
ventures have been of interest to scholars for decades. Studies suggest that while
"person variables" (Shaver & Scott, 1991, p.25) are not totally predictive of
entrepreneurial success, there are key personal characteristics that continue to be of
interest to scholars and practitioners when evaluating new venture opportunities (McCline,
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Bhat, & Baj, 2000; Robinson, Stimpson, Huefner, & Hunt, 1991; Timmons & Spinelli,
2004; Weinzimmer et al., 1996).
Skills. While not comprehensive, the following illustrate a range of skills often attributed to
new venture success by scholars and practitioners (Basadur, 2001; Bhide, 1994; Grant,
1992; Pickle, 1964; Zider, 1998): a) business skills including functional, technical, and
persuasion/motivation skills, b) interpersonal skills, including communication, listening,
conflict management and networking, and c) creative problem solving and change
management skills.
Traits/attributes. The literature identifying entrepreneurial traits or attributes, while not

conclusive, suggests that successful entrepreneurs typically exhibit certain types of traits,
including achievement and opportunity orientation (Hornaday & Aboud, 1971 ), a strong
sense of personal responsibility and control (Durand & Shea, 1974), tolerance for risk
(Bhide, 1996) and ambiguity (McMullen & Shepherd, 2001; Weinzimmer et al., 1996),
persistence (Shaver & Scott, 1991), proactiveness and innovativeness (Covin & Slevin,
1986; Miller, 1983), and resiliency, energy, and good health (Adebowale, 1992; Boyd &
Gumpert, 1983). For instance, some people find the idea of enlrepreneurship or starting
one's own business appealing until they discover the personal investment, sacrifices, and
other commitments necessary for success.
Aspirations. Does the founding team communicate vision and passion for the idea?
What have they done to show commitment to the success of the concept? Kamm and
Nurick (1993) and Ronstadt and Shuman (1988) refer to this as the alignment of the
founding team's interests with the start-up's mission. Roberts, Stevenson and Morse
(2000), Sahlman (1997), and others describe commitment to the venture as a key
personal attribute for new venture success.
Relevant experience. For a start-up opportunity, three kinds of experience are often
examined: previous entrepreneurial/leadership, industry, and educational experience (Hall
←Hofer, 1993; MacMillan, Siegel, & Narasimha, 1985; Roberts et al., 2000). Ideally, the
entrepreneur or team will possess all three types of experience, since that increases the
probability of success. Experience in the industry, or knowledge and experience with the
technology used to produce or provide the product or service, has been commonly
associated with success and often builds important credibility early on.
Synergy. Does the founding team have complementary skills that offset each member's
weaknesses, and does there appear to be a clear understanding of team member roles?
If an individual proposes the concept, does he or she show enough understanding to
identify key roles or skills needed for a balanced founding team? This dimension
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incorporates our knowledge of criteria for successful founding teams used by informal and
formal sources of funding for new ventures (Hall & Hofer, 1993; Kamm & Nurick, 1993;
MacMillan et al., 1985) and our knowledge of high performing teams (Katzenbach &
Smith, 1993; Slevin & Covin, 1992).
Market Evaluation
The mnemonic for Market Evaluation is STRONG (see Figure 1). This segment of the
PRIME focuses the user's attention on fundamental issues for new business concepts,
market, and marketing (Lodish, Morgan, & Kallianpur, 2001).
Size and structure. Market size and structure are consistently of interest to scholars in
evaluating new venture or growth opportunities (Roberts et al., 2000; Timmons, Smollen,
← Dingee, 1977; Zider, 1998). Large, mature markets dominated by a few companies
may be difficult for start-ups to penetrate, unless the entrepreneur can focus on a clearly
defined market niche; smaller markets may be more approachable, but may have
limitations in overall potential.
Targeted customers. Does the entrepreneur know specific customer demographics,

psychographics, buying decisions, and other key market segment characteristics (Hills &
LaForge, 1992; Vesper, 1990)? When evaluating whether someone has a good venture
opportunity, scholars suggest asking the entrepreneur to name specific customers or
relevant market research data that can illustrate whether the idea is far enough along to
start determining actual potential (Bygrave & Zacharakis, 2004).
Reachability. Does the founding team know how it will reach targeted customers
(Sahlman, 1997; Vesper, 1990)? Can the team use niche marketing techniques to reach
the primary markets, or will it have to use potentially more expensive mass marketing
approaches? Targeted or niche marketing can be much more desirable for smaller
companies and start-ups (Abrams, 2003; Hills & LaForge, 1992). \
Other choices (the competition). What does the founding team appear to understand
about its direct and indirect competition? Can the team communicate specific strengths
and weaknesses competitors possess in the marketplace and the nature of the
competition's current and anticipated strategies (Porter, 1980; Sahlman, 1997;
Schollhammer & Kuriloff, 1979)? The assessment of other choices should also include
consideration of firms operating in different niches or markets that might move into the
proposed market if it appears highly lucrative. In recent years distinctions among
suppliers, distributors, customers and competitors have blurred so a firm in any of these
groups could move into the firm's market (Davis & Meyer, 1998).
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Needs. Is the market need or want clearly identified and understandable (Baty, 1974; Hills
← LaForge, 1992)? Is the product or service a compelling purchase to the market
(Longenecker, Moore, & Petty, 2003; Sahlman, 1997)? For typically resource-slim small or
new ventures, identifying a product or service already perceived as a need may help
avoid expensive and/or time-consuming learning curves.
Growth prospects. How much growth is occurring in the relevant market and industry
(Roberts et al., 2000; Zider, 1998)? What major market and industry changes might
impact the venture idea's marketplace (Kunkel & Hofer, 1993; Weinzimmer et al., 1996),
and could the proposed new company be ahead of the change curve? Entrepreneurs
entering a market experiencing rapid growth should recognize these market opportunities,
even as they anticipate challenges such as larger firms entering the market. On the other
hand, entering a slowing or maturing market can present serious growth problems unless
the entrepreneur successfully identifies and appeals to an untapped market niche.
Economic Evaluation
The mnemonic for Economic Evaluation is FRESH. This analysis directs the user's
attention to the potential outcomes associated with the new venture (Human & Matthews,
2004; Ucbasaran et al., 2001). Since the PRIME is designed to prompt users for
information they need to obtain as well as information they already have, the economic
analysis used with the framework can range from sophisticated financial forecasting
(Smith & Smith, 2004) to (more likely) back-of-the-envelope analyses to arrive at
approximations for early decision making on whether to pursue the concept at all (e.g.,
Hesseldahl, 2004).
Forgiving. Can a few early mistakes be made without killing the business? Positive
indicators include a high gross margin and a high ratio of variable to fixed costs
(Longenecker et al., 2003; Sahlman, 1984). Unique technology opportunities can be less
forgiving due to the market's learning curve, often requiring heavy and lengthy investment
in marketing and education long before revenues occur, and capital intensive ideas (e.g.,
manufacturing) may also be less forgiving opportunities, unless the founding team has
industry experience to help mitigate risks.
Rewarding. Can the PRIME user perform back-of-the-envelope analysis or ROl

estimates to obtain an early determination of economic potential? What information is
needed for further economic analysis, and what is the upside potential of the idea given
the risks estimated (Roberts et al., 2000; Sahlman, 1997)? How would forecasted
economic rewards for this venture compare to industry benchmarks or yardsticks
(Chandler & Hanks, 1993; Smith & Smith, 2004)?
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Enduring. Will the window of opportunity likely remain open for some time, or does the
opportunity depend on a temporary market trend that must be exploited quickly
(Ucbasaran et al., 2001; Vesper 1990)? An opportunity with a longer time frame or larger
window may offer advantages for a new venture, as it allows the entrepreneur more time
to make necessary adjustments when gearing up operations. Pursuing a short-term trend
(e.g., a fad) can also be an opportunity as long as the team can obtain sufficient resources
and develop a clear strategy for moving in quickly, capitalizing on demand, and then
exiting without getting left with expensive equipment, investments in inventory, or other
resources.
Stability. How cyclical, seasonal, or uncertain is the financial pattern, and would the
business generate sufficient financial resources to keep cash flow positive for a year or
two if profits do not materialize (Vesper, 1990; Zacharakis, 2004)? These types of
instabilities in the economics of the idea can create serious cash flow problems,
particularly if the Individual segment of the PRIME indicates little industry experience for
handling relevant cash flow cycles.
Harvest options. What are the likely exit or harvest options for the small business owner,
founding entrepreneur/team, and investors, such as strategic sale, merger, or taking the
company public (Birley & Westhead, 1993; Petty, 2004; Ronstadt, 1986)? Is the business
idea considered a potential "cash cow" to fund other ventures (Timmons & Spinelli, 2004)
or a family business that could be passed down to successive generations? While the
exact mode of harvest or exit cannot often be guaranteed, this long term look at the
venture concept allows potential investors, scholars, practitioners, and students to explore
the long-term thinking of the founding team.
APPLYING THE PRIME ANALYSIS TO EVALUATE OPPORTUNITIES
To illustrate the application of the PRIME framework for evaluating venture ideas early in
the process, in this section we include data and application examples. First are survey
data collected from two of our MBA courses on New Venture Creation, both of which
focused on opportunity recognition and evaluation using the PRIME analysis and the
business plan. Over 95 percent of the MBA students work full-time while pursuing their
degree, and most have 3plus years of work experience upon entering our applied MBA
program. Thirty-seven (77%) of the 48 MBAs in the two New Venture creation classes
surveyed were male. Assignments in both courses required students to use the business
plan and the PRIME frameworks to evaluate new venture ideas, with all students
completing one business plan on a new venture idea, four case analyses evaluating
business plans, and four PRIME analyses evaluating new venture ideas.
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The survey was administered to the students at the completion of the assignments, asking
questions about the use of the two frameworks, the PRIME and the business plan, for
evaluating business concepts. When asked, "If you were presented with a start-up
business idea to evaluate, to what extent do you see benefit in using both the PRIME
analysis and the business plan to evaluate the concept (i.e., are the two frameworks
different enough to use both?)." On a five point scale from 1 = to no extent to 5 = great
extent, respondents' mean rating was 3.9. Respondents were also asked an open-ended
question regarding, "If both frameworks (the business plan and the PRIME analysis) were
to be used to evaluate a start-up concept, how would you suggest using both frameworks
for opportunity evaluation and why do you say this? For instance, would you use one
before the other, or both simultaneously, or would you use them for different specific
purposes?" Thirty-eight of the 48 (78%) indicated they would likely use the PRIME
analysis before the business plan for reasons including: "The PRIME analysis is good as
a first pass evaluation of a business idea. The business plan would follow up as a detailed
look at the business opportunity." "The PRIME would be first, to evaluate initial feasibility.
The business plan would be to prove the case," "1 would use the PRIME first to have a
general idea of the business, and the business plan to get more in depth analysis if the
general idea panned out," and "PRIME seems good for first blush analysis and evaluation.
Gives a good full picture overview of an opportunity. The business plan gives more detail
to see whether an idea really holds together and whether or not it is well thought through."
It is worth noting that none of the MBAs responded that the business plan should be
completed before the PRIME analysis, and several suggested that the two frameworks be
used in unison due to prompting for complementary issues (e.g., ethicality, readiness). In
addition, when asked, "How useful was PRIME as a classroom tool for learning the
process of opportunity recognition and evaluation?", the mean response was 4.2 (on a 5
point scale, where 5 = extremely useful). Finally, when asked, "How useful are the
mnemonics (i.e., spelling out words for each set of major headings and subheadings) of
the PRIME analysis in evaluating venture ideas?", respondents' mean rating was 4.0
Consequently, the survey evidence from one application context, the MBA
entrepreneurship classroom, helps validate our intended use for the PRIME analysis as
an early stage, easy-to-use, comprehensive screening tool that helps prompt users to ask
key questions regarding a new venture concept.
A second approach for illustrating the usefulness of the PRIME analysis is to briefly
describe actual applications, one using PRIME as a teaching tool in entrepreneurship
education, and one using the framework as a tool for professional consultants. Below are
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brief applications in these two contexts, highlighting processes, outcomes, interpretations,

and conclusions.
USING THE PRIME AS A TEACHING TOOL IN ENTREPRENEURSHIP EDUCATION
Process
The instructor assigns a start-up business case to be read and analyzed by students
using the PRIME analysis worksheet provided to the class as a Microsoft Word document
into which they can type their comments, ratings, etc. (see Table IV). The assignment
includes students reading the case, which describes an actual start-up idea by two brand
managers at an international consumer products company who learn that their employer
wants to sell, within 90 days, one of its brands that does not meet the company's new
strategic directions. The brand has slipped from an $80MM brand to a $6MM one in less
than two years, since the company no longer markets the brand. Students must review
each PRIME topic and subtopic for its relevance to the case, and come to class with a
completed PRIME analysis worksheet in which they have written short bullets of facts
known and/or needed for each subtopic with a rating (plus, minus, etc.) for each topic and
subtopic in terms of what it adds or detracts from the feasibility of the idea. Finally,
students must be prepared to discuss, "Given your PRIME analysis, would you invest in
this start-up idea; why or why not?"
Before the class in which the case analysis will be discussed, the instructor writes six
column headings across the classroom board, one for each of the five PRIME topic
headings (e.g., Product/services, Resources, etc.), and one for "Facts Needed" (see
Table IV). Directly below each of the five PRIME topic headings on the board, the
instructor writes the relevant subheadings (e.g., below the Product/Service heading are
rows for the subtopic headings Superiority, Uniqueness, etc. with space to the right of
each). The instructor's class discussion is guided by students' comments and ratings that
are written on the board next to the appropriate subtopics or under the Facts Needed
column.
Outcomes
By the end of the class discussion, a full set of student comments, ratings, and facts
needed have been posted on the board for all to consider. For instance, in a recent class
discussion on the case described above, some students argued for a double plus (strong
competitive advantage) for the Protection of this Product/service idea (e.g., trademarked
brand), for the Sustainable Competitive Advantage of the Resources (e.g., valuable brand
equity that could be recovered in the market), and for Skills and Synergies of the
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Individuals (e.g., two managers with direct brand and industry experience and
complementary business skills). On the other hand, some students viewed the company's
"pulling the plug" on the brand's marketing as a fatal flaw or double-minus for the
Reachability in the Market section (e.g., without the large corporation's supply chain the
consumer product brand would never get to supermarket shelves), they viewed the 90-
day timing as a double-minus for Readiness in the Product/service section, and they
viewed the Relevant Experience of the Individuals and Accessibility of Resources as
single minuses or characteristics that needed re-working or improving, if a plan were
developed, since the two managers had no entrepreneurial experience and while well-
connected in their corporate and industry community, were not at all connected in the
entrepreneurial community. Also, Other Choices in the Market segment were rated zero
(neither positive nor negative), since the brand, while still having some revenues, was
also considered to have "a dated image" with respect to competition.
Interpretation
As a class, how do we interpret our PRIME analysis after a case discussion? A classroom
board of facts known, facts needed, and student ratings allows the instructor to engage
the students in a final discussion on the challenges in collecting and assessing accurate
information on start-up ideas and on the potential subjectivity and therefore differences of
opinion in rating new venture characteristics. The classroom discussion also allows
students to hear others' perspectives on what is perceived as positive or negative in a
start-up concept, which often helps clarify or even change an individual student's own
perspective. For instance, in this case, after a detailed class discussion on how "the pulled
marketing-plug" could be overcome through some innovative strategic partnerships within
the consumer products supply chain, the double-minus rating was changed to a single-
minus, meaning the issue could be reworked through further attention in a business plan.
Thus, given the doubleplusses described above and the potentially restorable revenues of
the brand, the venture concept was rated overall as a good potential for a business plan
and for investors.
Conclusions
The final conclusion for the PRIME analysis class discussion is that a) if no fatal flaws
(double-minuses) continue to be identified after discussion and fact finding, and b) at least
one compelling major competitive advantage (double-plus) is identified, then a business
plan with fully articulated financial analysis can be worth pursuing.
USING THE PRIME AS A TOOL FOR PROFESSIONAL CONSULTANTS
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One of the co-authors frequently consults with small businesses and start-up
entrepreneurs on their new business ideas. Indeed, the original development of the
PRIME framework was to meet this co-author's needs for a systematic and
straightforward way to walk a potential new business owner through the thought
processes of evaluating a business opportunity. It allowed the co-author a means of not
missing anything fundamental in the early analysis process with his clients. The process,
outcomes, interpretation, and conclusions of the PRIME analysis when used in this
context are similar to those described in the teaching tool application above, except not
done in the classroom with a reading assignment. Instead, the consultant provides the
PRIME analysis worksheet to the start-up entrepreneur so that an actual business
concept can be analyzed before discussing it in detail with the consultant. Or, the
consultant and start-up entrepreneur can walk through the PRIME framework together,
making notes on facts needed, ratings of the PRIME characteristics, and overall
interpretations regarding whether the idea is worth further pursuing in a business plan.
Indeed, instead of a classroom board full of comments, ratings, and facts needed, the
entrepreneur can talk with his or her family, friends, consultants or business advisors to
outline the same issues done in the classroom setting. A special case of the consulting
application would incorporate the PRIME framework as a tool for approaching a venture
capitalist requiring fully articulated financial analyses and forecasts. An initial estimate of
firm valuation would likely follow from the PRIME analysis, which can be a useful tool for
the entrepreneur prior to contacting venture capitalists.
CONCLUSIONS AND IMPLICATIONS
The PRIME analysis framework builds upon the entrepreneurship and strategy literature
and has benefited from use by successful entrepreneurs, small business owners,
investors, and students of entrepreneurship. Of course, the framework is not without its
limitations, including not being inclusive of all venture opportunity evaluation criteria, not
offering brand new criteria for evaluating opportunities, and using a mnemonic structure
that, while shown to increase recall of important topics in practice, can raise concerns
regarding structure driving content in the framework. We have attempted to minimize
these limitations by emphasizing the purpose of the framework as an easy-to-recall tool
using well-adopted criteria in the literature and incorporating user suggestions and survey
benchmarking into the design of the framework.
One of the major implications of the PRIME analysis involves allowing potential users to
perform an initial reality check on a business idea prior to or as they develop a business
plan. As some entrepreneurs resist developing a formal business plan, the PRIME
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analysis offers them a comprehensive, quick way of ensuring that the business plan "in
their heads" includes consideration of major issues and problems facing the new venture.
A second implication of the PRIME analysis is that once the PRIME is initially completed,
users can review their subjective ratings and conclusions to identify areas for which they
need more information, areas in which the concept needs to be modified, and key
characteristics that can become the cornerstone of a business plan. A third implication for
small business owners, entrepreneurs, and consultants is that the ratings of each
subcategory can be used as a validity check across potential or practicing team members
who complete and then compare their individual PRIME analyses.
Entrepreneurship educators can use the PRIME analysis as a framework for teaching
students how to evaluate business ideas and a tool in class for evaluating business case
assignments. PRIME has proven to be useful for introducing a comprehensive range of
issues from the literature of which students should be aware when evaluating
entrepreneurial ideas.
Finally, the PRIME analysis' integration of key topic areas from the literature on new
venture evaluation provides implications for scholars. For instance, the use of a simple
subjective rating system provides an opportunity for scholars to examine how the
backgrounds, attributes, and skills of entrepreneurs and professionals working with
entrepreneurs may affect individual ratings, which can further scholars' understanding of
related issues, such as tolerance for risk and ambiguity and differing perceptions of risk
and rewards in start-ups.
Publication Information: Article Title: Idea or Prime Opportunity? a Framework for

Evaluating Business Ideas for New and Small Ventures. Contributors: Sherrie E. Human -
author, Thomas Clark - author, Melissa S. Baucus - author, Andrew C. Eustis - author.
Journal Title: Journal of Small Business Strategy. Volume: 15. Issue: 1. Publication Year:
2004. Page Number: 61+. © 2004 Small Business Institute Directors' Association.
Provided by ProQuest LLC. All Rights Reserved.

← The role of ideas;
← The recognition of patterns;
← When an idea becomes an opportunity;
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← How to screen opportunities;

← How to gather information on ideas and opportunities.
4.3.1: THE ROLE OF IDEAS
4.3.1.1: An idea is not always an opportunity
← Ideas as tools
A good idea is nothing more than a tool in the hands of an entrepreneur. Finding a good
idea is only the first step in converting an entrepreneur's creativity into an opportunity;
The new business that simply bursts from an idea is rare;
What is usually necessary is a series of trial-and-error repetitions before a promising

product or service fits with what the customer is really willing to pay for.
← The mousetrap
Ralph Emerson created what is called the mousetrap fallacy by saying: "If a man can
make a better mousetrap than his neighbour, though he builds his house in the woods
the world will make a beaten path to his door;"
It is often assumed that success is possible if an entrepreneur can just come up with an
idea;
Most ideas are inert and worthless.
Contributors to the mousetrap fallacy are:
Oversimplified accounts of the ease and genius with which ventures such as Xerox and
Microsoft became a success.
Investors are prone to the mousetrap myopia (short-sightedness).
They may underestimate what it takes to make a business succeed.
There is tremendous psychological ownership attached to an invention. The focal point

needs to be the building of the business, not just one aspect of it, the idea.
Better does not always constitute bigger. An entrepreneur and his brother founded a company to
manufacture truck seats. The entrepreneur's brother had designed a new seat that was a definite
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improvement over other seats. When they needed more manufacturing capacity, the brother
rather wanted to concentrate on new ideas and designs but the entrepreneur decided to
manufacture more of the first seat. If he had listened to his brother they would probably have
become a small custom shop. Instead their company has sales of several million dollars.
Concentrate on making a profit not just on trying to better an already successful product.
4.3.2: PATTERN RECOGNITION

Ideas are only building blocks for opportunities. There are decided patterns in superior
opportunities. Recognising these patterns is a skill that entrepreneurs need to develop.
4.3.2.1: Experience
Since opportunities follow a pattern, experience is vital when considering new venture
ideas. Those with experience have been there before;
The process is often intuitive, involving the creative linking of two or more in-depth
"chunks" of experience, know-how and contacts. It takes 10 years to accumulate enough
"chunks" of experience to be highly creative and recognise patterns;
The process of sorting through ideas and recognising a pattern can be compared to the
process of fitting a jigsaw puzzle. It is impossible to assemble a puzzle by looking at it as
a whole. One needs to be able to fit together seemingly unrelated pieces before the whole
is visible;
Recognising ideas which have the potential to become opportunities stem from a capacity
to see what others do not.
4.3.2.2: Enhancing creative thinking
The notion that creativity can be learned or enhanced holds important implications for
entrepreneurs who need to be creative in their thinking;
Due to various circumstances creativity is stifled in most people. A child's life becomes
more structured after the formative years. The development in school of intellectual
discipline and rigor in thinking, and beyond school the stressing of logical, rational mode
of orderly reasoning and thinking, takes on greater importance;
The Synectics were one of the first organisations to investigate the process of creative
thinking and to conduct training sessions in applying creative thinking to business.
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4.3.2.3: Approaches to unleash creativity
Creativity visualisation can be enhanced by using the following 10 brainstorming rules:
← Define your purpose;
← Choose participants;
← Choose a facilitator;
← Brainstorm spontaneously, copiously;
← No criticism, no negatives;
← Record ideas in full view;
← Invent to the "void";
← Resist becoming committed to one idea;
← Identify the most promising ideas;
← Refine and prioritize.
The understanding of how the brain works helps understand unleashing natural creativity.
The left side performs rational, logical functions, while the right side operates the intuitive
and non-rational modes of thought.
4.3.2.4: Team creativity
Teams of people can generate creativity that may not exist in a single individual.
4.3.3: IDEAS AND OPPORTUNITIES

An idea is not an opportunity;
An opportunity has the qualities of being attractive, durable and timely and is anchored in
a product or service which creates or adds value for its buyer or user;
To achieve this the following must exist:
The window of opportunity is and remains open long enough;
Market entry is feasible and the management team is able to achieve it;
The venture must be economically rewarding and allow significant profit and growth
potential.
Most successful entrepreneurs start with what the market and customers want and they
do not lose sight of this.
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4.3.3.1: The real world
Opportunities are created or built, using ideas and entrepreneurial creativity. The process
is like the collision of particles in the process of a nuclear reaction;
When ideas interact with "real world conditions", an opportunity is created around which a
new venture can be created;
The business environment in which a product is launched is given and cannot be altered.
Dealing with suppliers, production costs, labour, distribution and a positive cash flow are
critical to the health of all organisations.
4.3.3.2: Spawners and drivers
Opportunities are spawned when there are changing circumstances, chaos, confusions,
inconsistencies, information gaps and other vacuums in an industry or market. Constant
vigilance for changes is a valuable habit. An entrepreneur with credibility, creativity and
decisiveness can seize an opportunity while others study it;
Opportunities are situational. Some conditions under which opportunities are spawned are
entirely idiosyncratic, while at other times, they can be applied to other industries,
products or services;
The following are some examples that illustrate how vacuums spawn opportunities:
← Microcomputer hardware in the early 1980's far outpaced the development of

software. The development of the industry was highly dependent on the
development of software, leading to aggressive efforts by IBM, Apple, and others
to encourage software entrepreneurs to close this gap;
← Many opportunities exist in fragmented, traditional industries that may have a craft
character and where there is little appreciation or know-how in marketing and
finance. For example fishing lodges, inns, flower ships, auto repairs.
4.3.3.3: Big opportunities with little capital
Many entrepreneurs attribute their success to discipline from limited capital resources.
Estee Lauder was started by Josephine Esther Mentzer with an initial investment of $100.
After convincing the department stores rather than the drug stores to carry her products,
Estee Lauder was in its way to a $3 billion corporation.
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4.3.3.4: Real Time = Timing
For an entrepreneur to seize an opportunity the window must be opening, and remain
open long enough;
Markets grow at different rates over time and as a market quickly becomes larger, more
and more opportunities are possible — the window opens;
As the market becomes larger and established, conditions are not as favourable — the
window closes;
Business failures are higher in circumstances where the window of opportunity is shorter.
Venture capital backed firms that ripen in less than 3 years are the lemons while the firms
that take 7 to 8 years to ripen are the pearls;
The ability to recognise a potential opportunity when it appears and the sense of timing to
seize it is critical.
4.3.3.5: Balance and fit
It is important to remember than an opportunity can only be successful in balance and fit
with entrepreneurial leadership and adequate resources.
4.3.4: SCREENING OPPORTUNITIES
4.3.4.1: Opportunity focus
Opportunity focus is the most fruitful point of departure for screening opportunities. The
screening should not begin with strategy, financial and spreadsheet analysis, or with
estimations of how much the company is worth and who will own what shares. Over the
years, those with experience in business and in specific market areas have developed
rules to guide them in screening opportunities.
4.3.4.2: Screening criteria
The criteria are based on plain good business sense that is used by successful
entrepreneurs, private investors and venture capitalists.
← Industry and market issues
This includes the following:
Nature of the market. The product meets the customer’s needs, customers are
reachable and receptive to the product/service, payback to the user is one year or less,
the company is able to expand beyond a one product company.
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Market structure. A fragmented, imperfect market or emerging industry often contains

vacuums that create unfilled market niches. Industries where information gaps exist and
where competition is profitable are also attractive.
Market size. An attractive new venture sells to a market that is large and growing.
Growth rate. An attractive market is large and growing without being threatening to
competitors and where a small market share can represent significant and increasing
sales volume.
Market capacity. There must be a demand that the existing suppliers cannot meet.
Timing is all important here as the entrepreneur must fill the demand before the other
players decide to increase capacity.
Possible market share. The potential to be a leader in the market and capture at least a
20 percent share of the market is important.
Cost structure, i.e. low cost produce. The firm that can become the low cost provider is
attractive. Attractive opportunities boast of low costs of learning by doing.
← Economics
Profits after tax. High and durable gross margins (i.e. the unit selling price less all direct
and variable costs) usually translate into strong and durable after-tax profits. Attractive
opportunities have potential for durable profits of at least 10 - 15 percent and often 15 - 20
percent or more.
Break-even and cash flow. Breakeven and positive cash flow for attractive companies
are possible within two years.
Return on investment. Attractive opportunities have the potential to yield a return on

investment of 25 percent or more per year. High and durable gross margins and after-tax
profits usually yield high earnings per share and high return on stockholder's equity, thus
generating a satisfactory "harvest" price for a company.
Capital requirements. Ventures that can be funded and have capital requirements that
are low to moderate are attractive. Most higher potential businesses need significant
amounts of cash to get started — several hundred thousand dollars or more.
Internal rate of return potential. Is the risk reward relationship attractive enough? The
most attractive opportunities often have the promise of — and deliver — a very substantial
upside of 5 to 10 times the original investment in 5 to 10 years. A 25 percent or more
annual compound rate of return is considered very healthy.
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Free cash flow characteristics. Free cash flow is a way of understanding a number of
crucial financial dimensions of any business: the robustness of its economics; its capital
requirements, both working and fixed assets; its capacity to service external debt and
equity claims, and its capacity to sustain growth. The potential for high and durable gross
margins is important. It means that a venture can reach breakeven earlier — it should
occur within the first two years. It provides a cushion that allows for error and more
flexibility to learn from mistakes. New businesses that can quickly achieve a positive cash
flow and become self-sustaining are highly desirable.
← Harvest issues
Value-added potential. New ventures that are based on strategic value in an industry
such as valuable technology, are attractive, while those with low or no strategic value are
less attractive. For example, a product technology of strategic value to Xerox was owned
by a small company with about $10 million in sales and showing a prior-year loss of $1,5
million. Xerox purchased the company for $56 million. A characteristic of businesses that
command a premium price is that they have high value-added strategic importance to
their acquirer.
Valuation multiples and comparables. There is a large spread in the value the capital
markets place on private and public companies. The historical boundaries for the
valuations placed on companies in the area you intend to pursue need to be identified.
(See par. 4.2 — Screening Criteria).
Exit mechanism and strategy. Businesses that are eventually sold or acquired are
usually started and grown with a harvest objective in mind. Planning is critical because it
is much harder to get out of a business than to get into it. Giving serious thought to the
options and likelihood that the company can eventually be harvested is an important initial
and on-going aspect of the entrepreneurial process.
← Competitive advantage issues
Variable and fixed costs. An attractive opportunity has the potential for being the lowest-
cost producer and for having the lowest costs of marketing and distribution. Being unable
to achieve and sustain a position as low-cost producer shortens the life expectancy of a
new venture. For example, Bowmar was unable to remain competitive in the market for
electronic calculators after the producers of large-scale integrated circuits, such as
Hewlett-Packard, entered the business.
Degree of control. Attractive opportunities have potential for a moderate-to-strong

degree of control over prices, costs and channels of distribution. Fragmented markets
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where there is no dominant competitor, have this potential. These markets usually have a
market leader with a 20 percent market share or less. A market where a major competitor
has a market share of 40 — 60 percent, usually implies a market where power and
influence over suppliers, customers and pricing create a serious barrier and risk for a new
firm. Such a firm will have a few degrees of freedom.
Entry barriers. Having a favourable window of opportunity is important. Having or being

able to gain proprietary protection, regulatory advantage, or other legal or contractual
advantage, such as exclusive rights to a market or with a distributor, is attractive. Having
or being able to gain an advantage in response/lead times is important since these can
create barriers to entry or expansion by others. Possession of well-developed, high-
quality, accessible contacts acquired through years of building a top-notch reputation and
that cannot be acquired quickly is advantageous.
← Management team issues
Entrepreneurial team. Attractive opportunities have existing teams that are strong and
contain industry superstars. The team has proven profit and loss experience in the same
technology, market and service area and members have complementary and compatible
skills.
Industry and technical experience. A management track record of significant

accomplishment in the industry, with the technology and in the market area, with a proven
profit and loss of achievement where the venture will compete is attractive. A top
management team can become the most important strategic competitive advantage in an
industry.
Integrity. Having an unquestioned reputation is a major long-term advantage for

entrepreneurs and should be sought in all personnel and backers.
Intellectual honesty. There is a fundamental issue of whether the founders know what
they do and do not know, as well as whether they know what to do about shortcomings or
gaps in the team and the enterprise.
← Fatal-flaw issues
A fatal flaw relates to one or more of the above criteria, for example, markets which are
too small, which have overpowering competition, where the cost of entry is too high, etc.
Attractive ventures have no fatal flaws.
← Personal criteria
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Goals and fit. There must be a good match between the requirements of business and
what the founders want out of it. Dorothy Stevenson pinpointed the crux of it by saying:
"Success is getting what you want. Happiness is wanting what you get."
Upside and downside issues. An attractive opportunity does not have excessive
downside risk. If the entrepreneur's financial exposure in launching the venture is greater
than his or her net worth, the deal may be too big. An entrepreneur needs to be able to
absorb the financial downside in such a way that he or she can rebound without becoming
bound to debt obligations.
The cost of pursuing the opportunity. In pursuing any venture opportunity, there are
also opportunity costs. The entrepreneur needs not only to asses benefits that may accrue
in pursuing an opportunity but also account honestly for any cut in salary that may be
involved. Building a venture takes a lot of time and it is important to consider alternatives
while assessing an opportunity.
Desirability. A good opportunity is attractive and desirable. The desire for a certain
lifestyle is an intensely personal criterion which may mean that certain opportunities may
be opportunities for someone else. The founder of a major high-technology venture in the
Boston area was asked why the headquarters of his firm were located in downtown
Boston, while those of other such firms were located on the famous Route 128 outside of
the city. His reply was that wanted to live in Boston because he loved the city and wanted
to be able to walk to work. He said, "The rest did not matter."
Preparedness to take personal and financial risk. Successful entrepreneurs take

calculated risks or avoid risks they do not need to take. A country and western song puts it
like this: "You have to know when to hold 'em, know when to fold 'em, know when to walk
away and know when to run." Overly risk averse entrepreneurs on the one hand and
gamblers on the other hand are unlikely to sustain any long-term successes.
Stress tolerance. President Harry Truman said: "If you can't stand the heat, then stay out
of the kitchen." There are stressful requirements of a fast-growth high-stakes venture.
← Strategic differentiation
The fit of the driving forces. To what extent is there a good fit among the driving forces
(founders and team, opportunity and resource requirements) and the timing, given the
external environment?
The distinctiveness of the team. There is no substitute for an A-quality team, since the
execution and the ability to adapt and to devise constantly new strategies is so vital to
survival and success. If the team can bring to the venture a culture of superior learning,
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teaching skills, high standards, delivering results and constant improvement they will be
unstoppable.
The ability to provide after sales service. A survey done in Boston showed that 70
percent of the customers who stopped using a product or service did so because of bad
service.
Timing. Timing can make a significant difference. Being to early or too late can be fatal.
The crux is to row with the tide, not against it.
Availability of the required technology. A breakthrough, proprietary product is no

guarantee of success, but it does create a greater competitive advantage.
Flexibility to adapt to changing circumstances. Maintaining the capacity to commit

and de-commit quickly and to abandon if necessary is a major strategic weapon. Larger
firms can take six or more years to change basic strategy and 10 to 20 years or more to
change the culture.
Alertness to opportunities in the chosen market. There should be a continual search

for opportunities. An entrepreneur said: "Any opportunity that just comes in the door to us,
we do not consider an opportunity. And we do not have a strategy until we are saying no
to lots of opportunities."
The amount of margin available to compete on price. One of the most common
mistakes of new companies in a growing market is to underprice. A price slightly below to
as much as 20 percent below competitors is necessary to gain market entry.
The nature and availability of distribution channels. New channels of distribution can
leapfrog and demolish traditional channels; for instance, direct mail, infomercials, etc.
Having access to the distribution channels must not be taken for granted.
Room for error. Can I survive if I make a mistake? How wrong can the team be in
estimates of revenue, costs, cash flow, timing and capital requirements? High leverage,
lower gross margins and lower operating margins in a small company are signals for
fatality.
4.3.5: GATHERING INFORMATION
4.3.5.1: Finding ideas
The following are sources of information:
Existing businesses. Purchasing an ongoing business is an excellent way to find a new

business idea. Such a route to a new venture can save time and money and can reduce
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risk as well. Investment bankers, business brokers and trust officers know of such
businesses for sale but the real gems are usually bought by individuals or firms closest to
them, such as management, directors and customers.
Franchises. Buying a franchise can give access to all types of information. This is a
fertile area. Franchisors account for well over $300 billion in sales annually and nearly
one-third of all retail sales.
Patents. Patent brokers specialise in marketing patents that are owned by individual
inventors, corporations, universities or research organisations to those seeking new
commercially viable products.
Subscribing to an information service.
Research institutes and universities. Research institutes do research and development

of new products and processes that can be licensed to private corporations for further
development, manufacturing and marketing. A number of universities are active in
research in the physical sciences and seek to license inventions that result from this
research. A number of very good ideas developed in universities never reach formal
licensing outlets so it is a good idea to become familiar with the work of researches in an
area of interest.
Industry and trade shows. Trade shows can be an excellent way to examine the
products of many potential competitors, meet distributors and sales representatives, learn
of product and market trends and identify potential products.
Professional contacts. Ideas can be found by contacting such professionals as patent

attorneys, accountants, commercial bankers and venture capitalists who come into
contact with those seeking to license patents or to start a business using patented
products or processes.
Using consultants. A method for obtaining ideas that has been successful for technically
trained entrepreneurs is to provide consulting and one-of-a-kind engineering designs for
people in fields of interest. These kinds of activities often lead to prototypes that can be
turned into products needed by a number of researchers.
Networking. Networks can facilitate and accelerate the process of making contacts and
finding new business ideas. Examples of networks established in Boston are: the Babson
Entrepreneurial Exchange, the Smaller Business Association of New England and the
Boston Computer Society.
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4.3.5.2: Research
Existing information is available, for example using published resources. Own research
can also be useful such as finding out about competitors' sales plans, capacity of their
plants and technology used in them, who their principal suppliers and customers are and
about new products.
The internet is becoming the most common source of information with powerful search
engines.
4.3.5.3: Reverse engineering
Reverse engineering can be used to determine costs of production and sometimes even
manufacturing methods. This requires stripping a competitive product or ordering parts of
it to determine costs.

4.1) Describe in a nutshell the difference between an idea and an opportunity.
4.2) How can an entrepreneur recognise patterns in opportunities?
4.3) Name 3 requirements for an idea to become an opportunity.
4.4) Discuss 2 points that you think are important under each of the eight screening
criteria.
4.5) Name 5 sources of information for finding ideas.
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← SCREENING VENTURE OPPORTUNITIES

← Describe the four cornerstones of venture opportunities;
← Describe two screening methodologies i.e. Quick Screen and VOSG;
← Apply the two techniques in practice.
5.2.1: THE FOUR CORNERSTONES OF VENTURE

OPPORTUNITIES
Superior businesses have four anchors:
They create or add significant value to a customer or end user;
They do so by solving a significant problem, or meeting a significant want or need, for

which someone is willing to pay a premium;
They have robust market, margin and moneymaking characteristics. They are large
enough (at least $50 million), have high growth (at least 20 percent), high margins (at
least 40 percent), strong and early free cash flow (recurring revenue, low assets and
working capital), high profit potential (at least 10 — 15 percent after taxes) and offer
attractive realisable returns for investors;
They are a good fit with the founder(s) and management team at the time and in the
marketplace and with the risk/reward balance.
5.2.2: QUICK SCREEN

The ability to quickly and efficiently reject ideas is a very important entrepreneurial skill.
Quickscreen is a method that should enable you in an hour or so to conduct a preliminary
review and evaluation of an idea. Unless the idea has the four anchors, you will waste a
lot of time on a low-potential idea. Quickscreen is based on four principles:
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← Market and margin related issues
← Has the need/want/problem been identified?
← Are the customers reachable and receptive?
← Is the payback to users less than one year?
← Realizable returns for investors should be 40 percent or more.
← The market size should be $50 - 100 million.
← A market growth rate of +20 percent.
← Gross margin of 40 percent and durable.
← Competitive advantages
← Fixed and variable costs lower
← Degree of control stronger
← No barriers to entry
← Service chain
← Contractual advantage
← Contacts and networks in place
← Value creation and realization issues
← Profit after tax 10 - 15 percent more and durable
← Time to break even less than 2 years
← Time to positive cash flow less than 2 years
← Return on investment potential 40 — 70 percent + and durable
← High strategic value
← Capitalization requirements low to moderate and fundable
← Exit mechanism defined
← Overall potential
← Margins and markets
← Competitive advantages
← Value creation and realisation
← Fit: "0" + "R" + "T"
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← Risk/reward Balance
← Timing
← Other compelling issues: must know or likely to fail
5.2.3: VENTURE OPPORTUNITY SCREENING GUIDE (VOSG)

The VOSG is based on the screening criteria discussed in Unit 3. This effort is reserved
for the two or three very best ideas you have at this time. Completing the VOSG may take
20 to 30 hours or more.
STEP 1
Briefly describe your vision, the opportunity concept and strategy. What is your vision for
the business? What is the value creation proposition? What is the significant problem
want or need that it will solve? Why is this important enough that a customer or end-user
will pay an above average to a premium price for it? Why does this opportunity exist, now,
for you? Can you describe the concept and your entry strategy in 25 words or less?
STEP 2
Evaluate the following criterion given in Par 4 of Study Unit 3 on a scale of 1 — 10 to

indicate your best estimate of where your idea stacks up.
STEP 3
Assess the external environment surrounding your venture opportunity. Include the
following:
← An assessment of the characteristics of the opportunity window, including its

perishability;
← A statement of what entry strategy suits the opportunity, and why;
← A statement of evidence of and/or reasoning behind your belief that the external
environment and the forces creating your opportunity, described in Step 1 and the
venture opportunity profile, fit;
← A statement of your exit strategy and an assessment of the prospects that this
strategy can be met, including a consideration of whether the risks, rewards and
tradeoffs are acceptable.
CHECKPOINT: Be sure the opportunity you have outlined is compelling and you can
answer the question, why does the opportunity exist now. The amount of money and time
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needed to get the product or service to market and to be open for business may be
beyond your limits.
STEP 4
Assess the attractiveness of your venture opportunity by applying screening criteria.

Include the following:
← What is the critical problem, want or need your product or service will solve?
← Why is this a critical problem?
← Who will pay a premium price, compare with alternatives, if you can address this
problem or want?
← What is the underlying value creation proposition: how and why will it pay for itself,
yield major benefits, etc.
← A brief description of the market(s) or market niche(s) you want to enter.
← An exact description of the product(s) or service(s) to be sold and, if a product, its

eventual end use(s).
← An estimate of how perishable the product(s) or service(s) are, including if it is

likely to become obsolete and when.
← An assessment of whether there are substitutes for the product(s) or services(s).
← An assessment of the status of development and an estimate of how much time

and money will be required to complete development, test the product(s) or
service(s) and then introduce the product(s) or service(s) to the market.
← An assessment of any major difficulties in manufacturing the product(s) or

delivering the service(s) and how much time and money will be required to resolve
them.
← A description of the necessary customer support, such as warranty service, repair

service and training. An assessment of the strengths and weaknesses, relative to
the competition, of the product(s) or service(s) in meeting customer needs,
including a description of payback of and value added by the product(s) or
service(s).
← An assessment of your primary customer group.
← List the main reasons why your customers will buy your product or service
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← Draft 5 — 10 crucial questions you need to have answered to identify good

customer prospects
← Give an indication of how customers buy products or services, e.g. direct

sales, wholesale, etc.
← Provide a description of the purchasing process.
← An assessment of the market potential for your venture's product or service, the
competition and what is required to bring and sell the product or service to the
customer.
← An estimate, past, present and future, of the approximate size of the total
potential market.
← An assessment of the type of market in terms of price, quality and service;

degree of control; and what approaches are necessary to enter, survive
and win.
← An assessment based on a survey of customers, of how your customers do

business and of what investigative step are needed next.
← An assessment of how your product or service will be positioned in the market.
← A statement of any proprietary protection and what this means in the way
of a competitive advantage.
← An assessment of any competitive advantages you can achieve in the level

of quality, service and so forth, including an objective description of any
strengths and weaknesses of the product or service.
← An assessment of your pricing strategy versus those of competitors.
← An assessment of where competitors in your industry or market niche are

in terms of price versus performance/benefits/value added.
← An indication of how you plan to distribute and sell your product or service.
← A distribution plan for your product(s) or service(s) and any special

requirements such as refrigeration and the percentage of distribution costs
of sales and total costs.
← Map the value chain for your product or service.
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← A realistic estimate of approximate sales and market share for your product or
service for your market area which your venture can attain in each of your first five
years.
CHECKPOINT: Consider whether you suffer from mousetrap myopia or whether you lack
enough experience to tackle the venture at this stage. If you were unable to respond to
many of the above questions, or do not have much of an idea of how to answer them, it is
possible that you need to do more work.
← An assessment of the costs and profitability of your product or service.
← An assessment of the minimum resources required to "get the doors open and
revenue coming in," the costs, dates required, alternative means of gaining control
of these, and what this information tell you.
← A rough estimate of requirements for manufacturing and/or staff, operations,

facilities, including:
← An assessment of the major difficulties for such items as equipment, labour

skills and training and quality standards in the manufacture of your
product(s) or the delivery of your service(s).
← An estimate of the number of people who will be required to launch the

business and the key tasks they will perform.
← An assessment of how you will deal with these difficulties and your
estimate of the time and money needed to resolve them and begin
saleable production.
An identification of the cash flow and cash conversion cycle for your business over the
first 15 months.
← A preliminary, estimated cash flow statement for the first year.
← An estimation of (1) the total amount of asset and working capital needed and
peak months and (2) the amount of money needed to reach positive cash flow and
the amount of money needed to reach breakeven, and an indication of the months
when each will occur.
← Create a break-even chart.
← An estimate of the capital required for asset additions and operating needs to
attain the sales level projected in five years.
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← A statement of how you intend to raise capital, including all types, when and from
whom.
← A statement of whether you intend to harvest your venture, how and when this
might occur, and the prospects.
← An assessment of the sources of value, such as strategic, to another firm already

in the market or one contemplating entry and an indication if there is a logical
buyer(s) of your venture.
← An assessment of how much it would take to liquidate the venture if you decided
to exit and whether this is high.
CHECKPOINT: Reconsider if your venture opportunity is attractive. Are you and others
convinced that the amount you need to raise is reasonable with respect to the venture's
potential and risk. Your preliminary estimates of financial requirements need to be within
the amount that an investor, venture capitalist, or other lender is willing to commit to a
single venture or that you can personally raise.
← An assessment of competitors in the market, including those selling substitute

products.
← A profile of the competition.
← A ranking of major competitors by market share.
← A Robert Morris Associates statement study.
← An assessment of whether there are economies of scale in production and/or cost

advantages in marketing and distribution.
← An assessment, for each competitor's product or service, of its costs and

profitability.
← An assessment of the history and projections of competitors' profits and industry

averages.
← A ranking of competitors in terms of cost.
← A profile for the current year of your competitors in terms of price and quality and
of market share and profitability.
← An assessment of the degree of control in the market and the extent to which you
can influence these or will be subject to influence by others.
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← An assessment of current lead times for changes in technology, capacity, product

and market innovation and so forth.
← An assessment of whether your venture will enjoy cost advantages or

disadvantages in production and in marketing and distribution and an indication of
whether your venture will have the lowest, average or highest costs of production,
marketing and distribution.
← An assessment of other competitive advantages which you have or can gain, how
you would secure these and what time and money is required, including:
← An indication of whether your product or service will benefit from, or be

subject to, any regulations and of the status of any copyrights, trade
secrets, or patents or licences and distribution or franchise agreements.
← An indication if you enjoy advantages in response and lead times for

technology, capacity changes, product and market innovation, and so forth.
← An indication if you enjoy other unfair advantage such as strategic

advantage, people advantage, and so on.
← An assessment of whether you think you can be price competitive and

make a profit, or other ways, such as product differentiation, in which you
can compete.
← A ranking of your venture in terms of price and quality and of market share and
profitability relative to your competitors.
← An assessment of whether any competitors enjoy competitive advantages, such

as legal or contractual advantages.
← An assessment of whether any competitors are vulnerable, the time period of this
vulnerability, and the impact on market structure of their succumbing to
vulnerabilities.
CHECKPOINT: Do you have sufficient competitive advantage. Remember, a successful

company sells to a market that is large and growing, where capturing a small market
share can bring significant sales volume, where it does not face significant barriers to
entry, and where its competition is profitable but not so strong as to be overwhelming.
Further, a successful company has a product or service that solves significant problems
that customers have with competitive products and a sales price that will enable it to
penetrate the market.
An assessment of your partners and/or management team, including:
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← Commitment
← Industry knowledge
← Vision and zest
← Trust
← Roles, responsibilities and tasks
← Contributions
← Salaries, benefits, ownership share
CHECKPOINT: Remember, the team is a primary force driving successful entrepreneurial

ventures. It is important to question the assumptions on which your team has been
shaped.
STEP 5
Include any other vital issues or considerations that are unique to your venture
opportunity and that have not been covered in the VOSG. For example, a location
analysis is necessary for retail establishments.
STEP 6
Assess whether your venture opportunity has any fatal flaws.
STEP 7
List significant assumptions including:
← A consideration of significant trade-offs that you have made.
← A consideration of the major risks.
STEP 8
Rank assumptions according to importance.
STEP 9
Evaluate the downside consequences, if any, when your assumptions are proved invalid;
how severe the impact would be; and if and how these can be minimized, including:
← The cost and consequences of (1) lost growth opportunities and (2) liquidation or
bankruptcy to the company, to you, and to other stakeholders.
STEP 10
Rate the risk of the venture as high, medium or low.
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STEP 11
List chronologically the 10 to 15 most critical actions you need to take during the next six
months and the hurdles that need to be overcome in order to convert your idea into a real
opportunity.
STEP 12
Make a week-by-week schedule of key tasks to be performed, when they are to be

performed and by whom.
CHECKPOINT: It is important to take a hard look at the assumptions you have made and
to assess the risk of the venture. Do not overestimate sales and delivery dates and
underestimate costs, effort and time required to execute the opportunity and to reach a
positive cash flow. Difficulties need to be identified as soon as possible so they can be
eliminated or their impact minimized.
STEP 13
Return to steps 1 and 2 to refine your opportunity summary and make any adjustment to
your venture opportunity profile.
CHECKPOINT: Your responses to the "venture opportunity screening guide" will help you
to determine whether you want to continue with your venture and develop a complete
business plan. Ask yourself: "What do I want to get out of the business?" The venture
must have a strong fit with your personal goals. Remember you are what you do.
STEP 14
Four anchors revisited. You should have a much sharper sense of the extent to which
your good idea exhibits the four anchors. As you proceed you need to constantly consider
the following, since creative insights that can make a significant difference can occur at
any time:
← How can the value proposition be enhanced and improved?
← What can be changed, added, modified or eliminated in order to improve the fit?
← What can be done to improve the value chain and the free cash flow
characteristics?
← What can be done to enhance the risk/reward balance?
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5.1. How do businesses create or add value to a customer?
5.2. Read through the VOSG and using the knowledge that you acquire write down an
opportunity that you have identified, and provide at least 5 explanations of why you think
this is an opportunity and not just a good idea.
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STUDY UNIT 4: RESOURCES FOR THE NEW

VENTURE
← RESOURCE REQUIREMENTS
6.1: Reading
Article 1
Avoiding the Black Hole of Business Start-Ups: "Even When the Person Has Done
All the Homework, Is an Expert in the Field, Has Researched the Marketplace, and
Understands the Strengths and Weaknesses, the Resources Required-In Time and
Money-Almost Always Are Much Greater Than First Imagined.".
by Kenneth Sweet
IT IS THE GREAT AMERICAN DREAM to start your own business and become your own
boss. It is not that complicated, either. Simply invest everything you own and as much as
you can borrow, paint a rosy picture of how successful your product or service will be,
grossly underestimate the cost in time and money, then sit back and watch the business
fold in less than a year. Oh, and do not forget to rain your credit rating, personal
relationships, and health along the way.
You say no one deliberately sets out to fail in business. Perhaps not, but four out of every
10 start-ups will go under within the first year, six within the first five years. It seems that
nothing succeeds like failure. Yet, many of the missteps and disasters that befall a new
business are avoidable.
It is an idea that has been simmering in the mind of Carla, a pastry and dessert chef, who
has been told her cupcakes are second to none. At the urging of friends and coworkers,
and with some credibility and success under her belt working at reputable restaurants,
she finally feels she has the resources to follow her dream. The idea is to open a small
shop--a bakery boutique--that will feature her singular cupcakes. The real business,
however, will be in supplying stores and retail outlets and establishing a name brand a la
"Famous Amos" chocolate chip cookies.
A viable idea, sound financial management, and hard work all are important, but first and
foremost is the need for a well thought out strategic plan, the big picture of the business. It
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starts with the vision, mission, values, and operating principles. In addition to these
basics, the plan will include financial data, market research, positioning information,
competition review, and market description. This plan addresses the nuts-and-bolts issues
of how to grow the business--it is a map for traversing the business jungle.
As part of this process, it is important to decide exactly what it is the company will be
selling, whether it is a product or a service and, more importantly, to whom it will be sold.
In other words: identify the market. A company can offer the finest, most affordable and
efficient air-conditioning system known to man, but if the target market is only north of
Alaska, the company will not last the summer.
Define the market and the market will help to define the product or service. As such, it is
critical to ask and answer these basic questions: Where are the prospective customers
located? Who are they? What is their demographic? What are they looking for and what is
missing in the marketplace? What is the company's unique selling proposition?
The factors that will set a new company, product, or service apart from the competition not
only will help determine the future marketing approach, but will act as a barrier to entry for
future competition. Without this kind of thought process and planning, a new venture is
vulnerable to being co-opted and imitated by the more established competition, thereby
diluting its place in the market.
In Carla's case, the upswing in cupcake sales indicating something of a trend is what
helped her decide this might be the right time to start her business. In her mind, the
market already is defined. One of the challenges or opportunities is to build a brand that
cannot be imitated and takes on a certain cache in the marketplace. (Using the Famous
Amos model, a cookie is a cookie, except when branded as "the" cookie.)
"We will not be undersold" is a popular war cry, but if the company's pricing is not
sustainable, this statement only will apply because the company will not be in business. If
the sole competitive advantage is lower pricing, a competitor with deeper pockets may
price you down and eventually out of the market.
A common mistake start-ups make is setting prices according to the competition. It is

better to start by calculating the profit margin needed to stay in business. What will the
operating costs be? It is particularly important to shop for the best prices on equipment
and materials and estimate labor costs by surveying what the competition pays or by
checking regional and industry averages.
Once costs have been determined, decide if pricing is where the new company will make
its stand. Perhaps not. Quality of service or product may be the unique selling proposition
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that sets the company apart from the pack. If so, though costs may prevent the company
from being the lowest priced offering, there still may be a niche that will attract the desired
target market. In some cases, where prestige and status are the qualifying factors, a price
that is too low may send the wrong message and actually lower market appeal.
While the mantra "location, location, location" is what drives real estate, it also could apply
to any new start-up. After defining the target market, take into consideration where the
business will be located. For example, if the intent is to open an overnight shipping
service, an airport, rail station, or industrial area locale, where large space is available for
lower costs, would be important. On the other hand, selling high-end furniture or designer
fashion might be easier in an upscale mall or boutique shopping area despite the higher
cost per square foot. Perhaps the business entity needs little or no square footage at all.
Is the business better suited for e-commerce, or does the target market require the old
bricks-and-mortar, or a combination of both?
Other considerations as to the where and how of large physical operations depend on
how much the company plans to do in-house and how much the business will rely on
strategic alliances and outsourcing for support operations such as shipping, printing,
manufacturing, accounting, communications, etc.
The strategic plan also should include something few bother to consider when entering a
business--an exit plan. The excitement and energy of starting a business leaves little
room for looking many years down the road. Most may have some vague idea that once
the business is successful, they will sell it and retire to their own private island. If the
business should happen to beat the odds and succeed to the point where retirement or
selling becomes a real issue, it may be very late in the game to take the needed steps
crucial to a positive outcome.
The sell-the-business" exit strategy contains the basic assumption that someone will want
to buy it. Buyers look for more in a business than the mere fact of survival. They look for a
sustainable income stream, verifiable assets, and an experienced management team or
key employees who will guarantee that survivability. These all are considerations to be
aware of right from the start.
With every "can't miss" business idea, there are a few more nagging questions that may
arise between the first blush of inspiration and successful retirement on that private island.
Questions such as: What form should the business be set up as--a corporation, sole
proprietorship, or partnership? Will you need to establish merchant accounts and banking
services? What about insurance, payroll, tax liabilities, workmen's compensation, etc?
These are areas where expert advice from outside professionals is vital before the
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business opens its doors. Thinking that you will be able to "figure it out as you go along" is
akin to inventing the parachute after you have jumped from the plane.
Carla may dream of opening the doors on her first day of business to a cheering throng of
eager customers climbing all over themselves to buy her cupcakes. Her smartest
business decision here would be to wake up. Even if her product does sell well initially,
this is by no means an assurance of long-term success. Many popular products and
services fail to make it, not because there is anything wrong with the idea, manufacturing,
or marketing, but simply because the business did not have the resources to support its
own success.
Another way to guarantee failure is to undercapitalize. The fixed costs and working capital
needed usually are quite apparent. There is rent or a lease to pay, equipment costs,
payroll, insurance, etc. Some costs, however, are not apparent at first and allowing for
them might be the difference between a new venture having the chance to find its footing
or falling immediately into financial quicksand.
Under the best of circumstances, it takes time to develop and build a customer base.
During this period, the fixed costs and working capital needs remain the same. Put
another way, money starts leaving the moment you open those doors, and it will be some
time before any of it makes the return trip.
It is, of course, a relief when the theoretical finally becomes real and orders start coming
in, but it is a trap to mistake orders tot cash flow and a stronger than anticipated initial
response may have a dangerously negative effect. In addition to that steady stream of
cash going out the door from day one, suppliers must be paid and, if orders are strong,
there may be overtime and other added labor costs.
Add to this shortfall the fact that, with some exception, these accounts receivable will
remain outstanding until work is complete, invoices are sent, and payment is returned. A
new start-up probably has no established credit with suppliers and must pay as it goes.
Customers, on the other hand, particularly linger companies, have payment schedules
and procedures that may delay the actual payment for weeks, perhaps months. Even in
retail or food service there may be a lag between the time a credit card is charged and
funds am released to the account. If them is any kind of dispute, even a month later, those
funds may be held, or charged back, until the matter is resolved. For these reasons, it is a
good role of thumb to have a set-aside of at least three to six months of total operating
costs before starting any new business.
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Carla's Classic Cupcakes starts off well, with good word-of-mouth buzz and interest from
a local chain of food stores. The first supplies to the food stores sell out, and they double
the next order. Carla had not anticipated this rapid growth and now not only must order
twice as many supplies, but add labor and transportation costs. In addition to finding help,
her costs for workmen's compensation, insurance, payroll tax, and office support increase.
If she takes too long to adjust and cannot re-supply the stores on time, she runs the risk of
destroying her credibility and brand from the outset.
Most entrepreneurs who stall, a new business are not driven simply by the desire to make
money. If they were, there certainly are easier ways. Divide the financial return by the
amount of hours needed to get a business off the ground, and working behind a fast-food
counter probably pays more--especially when many would-be Donald Trumps neglect to
take into account their own living expenses or forget to add themselves to the payroll.
The lure of financial independence is there of course, but only as a function of the desire
for self-management. Sometimes it is the wish for creative freedom, for finding a full use
of personal skills and knowledge that fuels this drive. Ironically, the same skill and
expertise in a particular field that leads someone to the conclusion they can and should
do better on their own may limit their success in a start-up.
A case in point can be found in the construction industry. A skilled general contractor most
likely will have knowledge and expertise in every area of construction he oversees. The
reverse is not necessarily true. An excellent plumber, carpenter, or electrician may have
the technical skills to master any or all of these areas, but lack the business savvy
necessary to make a profit.
Though Carla has had to eat. sleep, and breathe cupcakes, she has managed to take her
business to the next level. Now the retail boutique has a steady stream of regulars, and
the food chain has decided to expand her product to stores citywide. However, to handle
the increased orders, she has had to rapidly increase her capacity (and overhead), and
now needs to spend more and more time finding new customers and selling the product
and less time doing the actual baking (which is what the product is known for, alter all).
Carla has hit the classic start-up glass ceiling. "When I am selling, I do not have time to do
the work, and when I am working, I cannot go out and find new business."
Whether it is because delegating is difficult or there is a need to keep labor costs to a

minimum, many small business owners end up trying to do it all themselves, and the burn
out factor is high.
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While Carla, and her cupcakes, may be fictional, the problems of starting and growing a
new business are all too real. A common trait of most, if not all, self-made success stories
is the willingness to take a risk. The upside can be financially and personally rewarding if it
succeeds, but the cold facts are that only a small fraction actually will survive. Even when
an individual has done all the homework, is an expert in the field, has researched the
marketplace, and understands the strengths and weaknesses, the resources required--in
time and money--almost always are much greater than first imagined. A hard and realistic
look at what is needed, along with a solid strategic plan, can help a start-up avoid early
catastrophe and literally beat the odds.
Kenneth Sweet is executive director of Consulting Services at International Profit

Associates, Inc., Buffalo Grove, Ill.
Publication Information: Article Title: Avoiding the Black Hole of Business Start-Ups: "Even
When the Person Has Done All the Homework, Is an Expert in the Field, Has Researched
the Marketplace, and Understands the Strengths and Weaknesses, the Resources
Required-In Time and Money-Almost Always Are Much Greater Than First Imagined.".
Contributors: Kenneth Sweet - author. Magazine Title: USA Today. Volume:
← Issue: 2730. Publication Date: March 2006. Page Number: 62+. COPYRIGHT 2006
Society for the Advancement of Education; COPYRIGHT 2006 Gale Group
Educating Entrepreneurs on Angel Venture Capital Financing Options
by Jason B. Brinlee , Geralyn McClure Franklin , Joseph R. Bell , Charles A. Bullock
INTRODUCTION
Entrepreneurs have several options available when it comes to financing their ventures.
Initially, an entrepreneur must understand what pre-initial public offering (pre-IPO) stage
(when an organization has not made a public offering) the business represents and what
type of expansion strategy will be needed in order to identify the type of investor to seek
for additional capital. It is equally important for entrepreneurs to understand the roles
investors may play in their businesses. To accomplish this, entrepreneurs must make the
distinction between business angels and venture capitalists as well as know where to find
and how to approach each type of investor. Understanding where to look provides the
means of searching for needed capital.
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What are angel investors? What are venture capitalists? How are they alike? How are
they different? Broadly, angel investors are those individuals that "save struggling firms
with both finance and know-how when no one else will" (Van Osnabrugge & Robinson,
2000, p. 4). Bradley, Benjamin, and Margulis (2002, p. 9) describe venture capitalists as
those that create a "highly institutionalized investment process, designed to bring together
those with massive amounts of money to invest with those whose ideas are promising
enough to warrant its receipt." Historically, it was appropriate to say that angel investors
were willing to accept more risk than venture capitalists (Amis & Stevenson, 2001;
Bradley, et a.. 2002: Gutner, 2000; Lipper & Sommer, 2002; May & Simmons, 2001; Sohl,
2003; Thompson, 2000: Van Osnabrugge & Robinson, 2000). But, is this changing?
These issues will be discussed in more detail shortly.
Matching entrepreneurial ventures with appropriate investors is important to the health of

the United States economy because such ventures make a considerable contribution to
the labor force and the country's Gross Domestic Product (GDP). The entrepreneur
seeking outside funding should always enter the venture with the end or exit in mind,
never losing sight of that objective. Funders are in the deal for a return on investment.
Thus, the entrepreneur must be aware that there are various aspects in the due diligence
process where angel investors differ from venture capitalists. The optimistic entrepreneur
must recognize these disparities in order to make a successful match with an investor.
Moreover, the equity seeker must present the criteria investors analyze in a visionary yet
realistic representation. The entrepreneur must also understand that both business angel
and venture capital investors look for similar, yet not identical, criteria in a prospective
business venture.
ENTREPRENEURIAL VENTURES AND THE UNITED STATE ECONOMY
Between 1992 and 1997, 50 percent of GDP was contributed by small and entrepreneurial
businesses (Popkin & Company, 2001). Additionally, small businesses "represent about
99 percent of employers, employ about half of the private sector workforce, and are
responsible for about two-thirds of the net new jobs" in the economy (U.S. Small Business
Administration, 2003, p. 3).
Locating investment money for start-up and early-stage businesses is a difficult task, but it
is necessary for many entrepreneurs. The market presents a problem for business owners
looking for investment capital that will nurture their firms into mature entities. After
exhausting their own financing resources, start-up entrepreneurs usually seek additional
financing from family, friends, and colleagues (also known as family, friends, and fools or
FFF). Most entrepreneurs then search for additional financing through lending agencies,
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the United States Small Business Administration, or venture capital firms, only to be
turned away because of the high risk involved in early-stage business ventures.
Angel investors may provide the money that these early-stage businesses need in order
to grow. In fact, they "play a critical role in early-stage finance . . . providing 80% of the
seed and start-up capital" for small businesses in the United States (Wessner, 2002, p.
353). In addition, Van O snabrugge a nd R obinson (2000, p. 5) s tate," Business a ngels
fund t hirty t o forty t imes more ventures each year than venture capitalists, their better-
known counterparts." Interestingly, in 2001, only 400,000 of the two million individuals that
have enough net worth to invest in early-stage companies actively participated in the
market (Benjamin & Margulis, 2001).
Finding completely accurate numbers for angel investing is difficult. Most angels want to
remain anonymous so not to be overwhelmed with too many requests for capital. Lack of
documentation along with "the very high number of transactions; the smaller and therefore
less visible investments; and the high degree of confidentiality demanded by high-net-
worth angels upon engagement" has made angel information hard to find (Bradley, et al.,
2002, p. 7). Still, according to Sohl (1999), 400,000 angels are currently investing
between $30 billion and $40 billion per year in approximately 50,000 ventures in the
United States.
In contrast to angels, venture capitalists prefer investing in ventures that involve laterstage
businesses. Efficiency is the main reason for this tendency. It is more efficient for formal
investment institutions to make fewer large investments rather than multiple smaller
investments (Van Osnabrugge & Robinson, 2 000). The costs of having a portfolio
manager t ake c are o f several small deals would easily outweigh the benefits of making
each investment. Therefore, it is more sensible and efficient for venture capital firms to
make larger investments in fewer business deals in order to maintain the manageability of
each portfolio by a single venture capitalist.
Venture capital investments for 2002 were $21.2 billion, almost a 50 percent decline from
the $41.3 billion in 2001 (PricewaterhouseCoopers, 2003). With the previous spike in
venture capital investment in 2000, it is obvious the "dot-com" bubble and the recent
strains on the economy have decreased investments. However, Tracy Lefteroff of
PricewaterhouseCoopers believes "this level of investing is more realistic and more
sustainable" for the market (PricewaterhouseCoopers, 2003). Although Venture Capital
investors play an important role in the economy, they "are funding less than 0.5 percent of
the deal flow they receive" (Benjamin & Margulis, 2001, p. 20). Even though the numbers
are not outstanding, PricewaterhouseCoopers (2003) reports that if improvement in the
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public markets and liquidity opportunities occur in 2003, then venture capital investments
will stabilize. Still, in the second quarter of 2003, 442 firms received venture funding
(Ernst & Young, 2003). Yet, annually, 3.5 million new ventures are launched (Timmons,
1999).
Liquidity events come in the form of initial public offerings (IPOs), major buyouts, and
mergers or acquisitions. Since only three IPOs occurred in the second quarter of 2003
(Westenberg & Gallagher, 2003), the current focus is upon mergers and acquisitions.
Because the number of exit vehicles has become more limited, it is now even more
problematic for venture capitalists to exit an investment. This generally limits the dollar
amount one company is willing to pay for another and makes it more difficult for large
investors to get out of very large deals. Thus, the playing field has changed significantly
over the past few years, making lower dollar angel investment very appealing. However,
there is still the need for an exit strategy. Interestingly, angels appear to be focusing on
exits coming through mergers or acquisitions rather than venture capital participation and
subsequent IPO. Mergers and acquisitions do address some of the issues surrounding
restricted stock, making them attractive. However, in a declining economy, the upside
valuation of a venture may be limited, since fewer buyers may be vying for the venture.
The high risk avoidance of venture capital firms and other lending agencies creates a
"capital gap" in the entrepreneurial investment market which represents the sought after
investment money of between $250,000 and $2 million (Wessner, 2002). Angel investors
are the solution to the capital gap. Additionally, networks of angel investors have the ability
to push toward and beyond the $2 million threshold. In fact, it has been noted that the
"angel capital market may account for $100 billion annually" in the U.S. economy (Bradley,
Benjamin et al.., 2002, p. 7). This money funds small and entrepreneurial businesses that
create "55 percent of all technological innovation..., [which is] twice that of larger
corporations" (Benjamin & Margulis, 2001, p. 13).
Angel investors usually follow right behind the venture capitalists in terms of investment
intensity. In one report from the first quarter of 2003, 38 angel investor organizations
invested $7.1 million in 14 deals ranging from $11,000 to $4 million (EMME Consulting,
LLC, 2003). At the same time, venture capital investment increased 14 percent from the
prior quarter, reaching $4 billion (Ernst & Young, 2003).
STAGES OF DEVELOPMENT AND GROWTH OF ENTREPRENEURIAL VENTURES
It is obvious that there are stages of development for entrepreneurial ventures. Van
Osnabrugge and Robinson (2000) categorize the four stages of a pre-IPO firm as seed,
start-up, early-stage, and later-stage. Bradley, et al. (2002) identify nine stages of
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development including seed, research and development, start-up, first stage, expansion
stage, mezzanine, bridge, acquisition/merger, and turnaround.
In the seed and research and development stages, the entrepreneur usually utilizes
his/her own personal savings and wealth including lump sum retirement distributions,
second mortgages, severance pay, and credit card debt along with money provided by
family, friends, and colleagues to fund the firm's development. Once the business
becomes operational, leasing, factoring, and accounts payable may be utilized to finance
the early-stage venture. When the business is past the research and development stage
but not quite to the expansion stage, it has usually exhausted all funds from the
entrepreneur's savings, family, friends, and colleagues. Now, the entrepreneur is in need
of other capital, most likely angel capital. After the business angel provides the equity to
bridge the gap between the research and development and expansion stages, the
entrepreneurs will often exit or harvest the business, or the new venture will fail. Should
the firm aspire beyond this stage, the entrepreneur will typically seek follow-on money
from other angel investors and/or venture capital from institutional investors.
Ultimately, businesses have four stages left after reaching the expansion stage of
development: mezzanine, bridge, acquisition/merger, and turnaround. Invariably, these
directly connect to the management strategy of the entrepreneur. At mezzanine stage, the
firm is breaking even or possibly making a small profit but has a need for more capital for
expansion, marketing, etc. Businesses in the bridge stage need additional capital to gain
or maintain stability with the near-term intension of an IPO. The acquisition/merger and
turnaround stages are simply what they imply-capital is needed in order to sell, merge, or
change the firm's strategy (Bradley, et al., 2002), or even possibly to survive.
The definition of "entrepreneur" is often based on the type of business the individual
enters. Typical classifications include the hobby business, lifestyle business, family
business, small business, expansion-minded business, entrepreneurial business, or
corporate venturing. These same classifications often overlap with the growth strategy
descriptions for firms. The growth strategy describes the entrepreneur's strategy for
expansion andean be c ategorized as lifestyle (low growth), middle-market (modest
growth), and high-potential (high growth) ventures (Hisrich & Peters, 1998; Sohl, 1999;
Van Osnabrugge & Robinson, 2000).
Timmons (1999) contends that there is a significant difference between low-growth

potential, or what he terms lifestyle businesses, and modest- and high-growth potential
ventures, which are more entrepreneurial in nature. Initially, a business owner looking to
operate a business with little risk and make enough profit to suffice his/her desired living
Page 109
standard probably has a hobby, lifestyle, family, or small business with a low-growth
strategy. According to Sohl (1999), these firms are classic small businesses, with five-year
revenue projections under $10 million. Firms in this category are rarely attractive to
investors; thus, the owner must rely on internal rather than external financing. Next are
the middle-market firms with a modest-growth strategy that forecast growth of more than
20 percent per year along with expectations of $10 to $50 million in revenues within five
years (Van Osnabrugge & Robinson, 2000). Ventures in this category are often appealing
to angel investors, even though they often depend upon bootstrapping to fund initial
growth (Sohl, 1999). Middle-market firms may also be attractive to venture capital
investors.
Ultimately, high-potential strategy firms are those businesses that have high aspirations of
vast growth through remaining innovative, adaptable, and venturesome. In most cases,
they project having more than 50 employees in five to 10 years. Unlike the modest growth
firms, the high-potential firms foresee a growth rate above 50 percent each year along
with a revenue forecast of more than $50 million within five years (Sohl, 1999).
Organizations that have a service or product with prospective high market demand in
conjunction with a high-potential strategy are "diamonds in the rough" for any investor
(Van Osnabrugge & Robinson, 2000).
BUSINESS ANGELS AND VENTURE CAPITALISTS DEFINED
Making a distinction between investors is one of the most important tasks an entrepreneur
must make when searching for capital. Understanding the differences will allow the
entrepreneur to use his/her time more efficiently and prepare the appropriate materials
required by each type of investor. At one end of the spectrum are unsophisticated angel
investors. At the other end of the spectrum are venture investors like venture capitalists or
institutional investors (refer to Figure 1). All types of investors provide capital to
entrepreneurial firms. However, business angels and venture capitalists usually finance at
different stages of the pre-IPO business cycle, although this may be evolving.
One may speak of an angel investor or venture capitalist, but like the term entrepreneur,
that seemingly encompasses hobby venturing through corporate venturing, these two
terms are often distorted. Earlier, we defined angel investors as those individuals that
"save struggling firms with both finance and know-how when no one else will" (Van
Osnabrugge & Robinson, 2000, p. 4). But, how have angel investors evolved to how we
know them today?
The term "angel" comes from the practice in the early 1900's of wealthy businessmen
investing in Broadway productions (Kautz, 1998-2003). The seed-capital financing system
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for companies "operates like it was 200 years ago," contends Vicki Rellas, CEO of the
online financing service PriCap (Bunn, 1997). Doctors, lawyers, and high net worth
individuals would sit around and talk about "deals" friends and associates were embarking
upon. Many times, funding was put together, and an investment was made. Little or no
due diligence was performed, and investments were made based upon the trust of the
others involved in the deal. Along this line would be the family member, friend, or fool that
invests in a venture solely on the basis of his/her relationship with the entrepreneur.
Undoubtedly, both types of investments still occur today. Collectively, this first category of
angel investors is unsophisticated angel investors. Yet, in order to truly grow a business,
an entrepreneur must find a sophisticated investors) who can add both money (up to $5
million) and value to the venture (Mitchell, 19982003).
In contrast, the second category of angel investors is made up of sophisticated investors.

Traditionally, this term has been applied to the knowledge base of the investor and/or a
minimum net worth/income requirement. Though there is extensive discussion that net
worth or income alone should not determine sophistication, this along with investor
knowledge base establishes an ability to adequately invest minimum amounts of dollars in
multiple ventures to make the ventures self-sustaining or built-up to a point of being able
to attract additional outside investment (e.g., venture capital). Knowledge base refers to
the ability of the investor to understand the financial impact and terms of their investment
(Leshchinskii, 2002). Arguably, in the world of angel investing, knowledge base would
extend to an understanding of the industry of the venture.
It should be noted that the term "sophisticated investor" differs from the term "accredited
investor." Accredited investor is a legal term specifically defined by the federal securities
laws (Securities Act, 1933) while sophisticated investor is a term of art that has no legal
definition (U.S. Securities and Exchange Commission, 2003). B oth terms typically refer to
aninvestor who has such a high degree of financial knowledge and ability that he/she
does not need the protections afforded by registration with the Securities and Exchange
Commission. Yet, an investor who may be considered "sophisticated" may not meet the
definition of an accredited investor (U.S. Securities and Exchange Commission, 2003).
The third category of angel investing is a hybrid that falls somewhere between
sophisticated angel investors and a venture capitalists and may be referred to as venture
angels. Venture angels usually exhibit one or more of the following characteristics
(Cooper, 2003):
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← Comprised of a small number of external investors. Traditionally, the total dollar

amount raised is far less than major venture funds, and the source is private money rather
than institutional resources.
← Have an ability to invest greater amounts of money than individual angel investors.
They may or may not have the ability to totally fund the venture through exit.
← Investment portfolio is run by professional management though the staff, if any; tends
to be much smaller than a venture fund team.
The final category of angel investors is angel networks, and there are two types of these
(Wainwright & Horvath, 2002). One is the informal network represented by groups like the
Rockies Venture Club, a Colorado group where open monthly meetings are held with the
intent of trying to introduce individuals with money to individuals in need of money. The
second is the formal angel investor network. Formal networks have been founded around
entrepreneurial hotbeds around the country. As an example, Band of Angels was formed
in Silicon Valley followed by groups in Austin, Boston, North Carolina, and Colorado, just
to name a few. In this article, the term "angel networks" refers to formal angel networks.
Formal angel networks may be no cost or fee related (Magids, 2001). On one hand,
angels may be required to pay a fee to participate in the network and/or a fee may be
assessed to entrepreneurs to submit or present business plans to the angel network.
An angel network brings together diverse backgrounds of investors in order to increase

deal flow quality, reduce risk, and increase the total potential dollar investment amount
(May, 2002; Wainwright & Horvath, 2002). The diverse backgrounds of the investor group
allow each individual investor to draw upon the trusted expertise of a co-member. By
relying on a co-member's expertise, an investor that would not invest in a particular deal
due to a lack of individual expertise may now collectively invest with others in the group.
In general, investors have numerous deal opportunities, but very few merit investment. By
increasing the number of contacts an individual investor has, the pool of quality deals will
also increase. By having other investors share in the investment, i.e., putting less
individual capital into a deal, the individual investor reduces his/her risk exposure.
Ultimately, a network with 75 or more members has the investment capability to eliminate
venture capital money (except in extremely high dollar deals) later in the deal. This
reduces angel investor dilution in subsequent rounds and makes angel money a one stop
shop. This issue will be addressed in greater detail shortly.
Finally, there are venture capitalists. Venture capitalists were defined earlier a s t hose
individuals that create a "highly institutionalized investment process, designed to bring
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together those with massive amounts of money to invest with those whose ideas are
promising enough to warrant its receipt" (Bradley, et al., 2002, p. 9). Obviously, there are
degrees within the venture capital industry. There are those that may invest billions of
dollars such as SoftBank along with smaller venture funds like Vista Ventures with $60
million dollars in total investment capital in its current fund (Ford, 2003). Here, the term
"venture capitalists" will be used broadly, keeping in mind that the investment criteria,
amount to invest, and area and stage of investment may vary.
DISTINGUISHING BETWEEN BUSINESS ANGELS AND VENTURE CAPITALISTS
Seeing the broader picture that encompasses all pre-IPO investments provides a better
understanding of the business cycle and where entrepreneurs should seek capital.
Benjamin and Margulis (2001, p. 19) capture this connection by stating that "active
business angel investors in the United States provide early-stage companies with 90
percent of all rounds of financing under $1 million and 80 percent of all dollars.
Meanwhile, venture capital resources provide later-stage financing in growing companies
that are originally financed by the founders, family, friends, and angel investors." These
facts present the continuum for the pre-IPO business cycle stages and the gradual
change in which type of investor an entrepreneur should approach (see Figure 1).
Before hopeful entrepreneurs try approaching an angel, they must have at a minimum an
idea with modest-growth potential and the vision to market that idea to the investors).
Most angels want to participate in deals with a high probability of success-modest-growth
or highpotential firms-along with those deals that require operational assistance. If the
business deal meets these criteria, then angels are willing to wait for the possible high
returns (Wetzel, 2002).
Angel investors' interests often reside in the entrepreneurial experience. Angels are
looking for a deal where they can participate by consulting with the entrepreneur or sitting
on the board of directors. This is where, if the entrepreneur has found the right angel, the
angel adds value to the early-stage firm. Most often, business angels "have extensive
small business experience, and over 80 percent of them...have started a company of their
own" (Benjamin & Margulis, 2001, p.22). As might be expected, most angel investors are
comfortable in the industry where they have been successful themselves. According to
the National Venture Capital Association (2003), high technology investment makes up
most of the venture investing in the United States. Regardless, angels are in the venture
to make money.
Adding value is an important quality business angels bring to a venture. In the early
stages of a firm's existence, there are many obstacles to overcome for the business to
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succeed. Angels may provide solutions to a number of these problems either through
external contacts or their own previous experiences. They may also assist with strategic
management issues in operations, marketing, human resources, etc. For angels to
provide such operational assistance, they want the deal to be "reasonably close to where
they live, within 300 to 500 miles" (Benjamin & Margulis, 2001, p. 23). A survey conducted
by Elango, Fried, Hisrich, and Polonchek (1995) illustrates investor attitudes toward
involvement. The sample population felt that those investors adding value to a deal also
placed more importance on being the entrepreneur's confidant than the less active
investors. This research indirectly illustrates the value-adding relationship between the
entrepreneur and the business angel by presenting the hands-on activity of most angel
investors.
Venture capitalists are searching for ventures that require larger amounts of capital with
lower levels of risk. Venture capitalists "are looking for later-stage deals in which
investment sizes are larger, risk is reduced, and the time frame to harvest is shrinking"
(Bradley, et al., 2002, p. 9). Investors in this category are using money they received from
larger corporations, pension funds, etc. They are not investing their own money; instead,
they are investing someone else's money. Reduced levels of risk, achieved in later stages
of development, are the key factors for venture capitalists. Firms in the later stages of the
business cycle are more suited for venture capital investors. With this said, the rule of
thumb for venture investing in 10 companies will breakdown as follows: s ix or seven will
tank, two to three will make some money, and one investment results in a home run (10
times the invested amount is returned) (Popper, 1999).
Disproportionate rewards are the key to attracting high-risk money (Frezza, 2002).
Venture capitalists have less interest than angels in the true entrepreneurial experience
because of the need to secure and maintain a good reputation. In order to finance their
own operations, these investors must maintain an impeccable reputation with their
financiers. The only way to keep a sharp reputation is to finance ventures with a
risk/return assessment that will provide "annual returns of 30 to 40 percent or more and a
total return of five to 20 times their original investment" (Arundale, 2002) over the life of
the portfolio.
Venture capitalists also lend industry experience and connections. Most venture
capitalists specialize in specific industries or even segments within an industry. Many
have large teams of highly skilled personnel on staff to assess the venture prior to
investment and then track the progress of the venture on an ongoing basis. Venture
capitalists often identify or attract professional management to take the venture to the
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next level. Frequently, venture capitalists prefer a team that has acquired IPO funding in
the past to seek IPO funding for their latest venture. As might be expected, they seek to
add value through their experience in investing in hundreds of firms. Some venture firms
are successful by creating synergies between the various companies where they have
invested. For example, one company that has a great software product but does not have
adequate distribution technology may be paired with another organization or its
management team in the venture portfolio that has better distribution technology.
Although both angels and venture capitalists participate in entrepreneurial ventures,

angels usually spend more face-to-face time with the firm's management team. They
spend more time with the company since it is a start-up firm trying to reach the expansion
stage of the business cycle. Additionally, investments made by a number of individuals
through an angel network are usually connected to the venture through a single lead
investor from the group. On the other hand, venture capitalists often fill board of director
positions in order to monitor their investments. Still, the involvement of venture capitalists
in the business operation is usually not as hands-on as angel investors. Most often,
investors "that provide a high level of assistance should invest in early-stage companies
and those that provide a low level of assistance should invest in later-stage companies"
(Elango, Fried, Hisrich, & Polonchek, 1995, p. 159).
With the advent of a greater number of sophisticated angels and rapid growth in the
number of angel networks, a similarity between business angels and venture capitalists
has developed, though their participation level in the business deal and primary reasons
for involvement are different. Both types of investors involve themselves in the ventures
they select to finance. On the one hand, angel investors are active in their investments in
order to help the firm progress through the business cycle stages. On the other hand,
venture capitalists participate in order to make sure the company performs well enough to
provide the projected returns determined in the business valuation. Angels have their own
skin or "money" in the game whereas venture capitalists invest "other people's money"
("OPM") and are driven by return on investment, a slight but significant difference.
Of course, there are reasons why business angels prefer to invest in early-stage firms and
venture capitalists like to invest in later-stage firms. Early-stage firms are in need of
consultants whose knowledge can help the venture grow and prosper. Not surprisingly, a
preliminary study by several of the authors of this paper found that 100 percent of 26
angels polled personally and actively participate in ventures in which they invest. Later-
stage firms, in contrast, usually already have personnel with skill 1 evels necessary to
maintain their current position or grow. Thus, venture capitalists add value to ventures
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through participation in later-stage firms, but their primary purpose is still to obtain the
forecasted return on investment (Bradley, et al., 2002; Benjamin & Margulis, 2001; Freear,
Sohl, & Wetzel, 1994: Van Osnabrugge & Robinson, 2000).
Customarily, it was appropriate to say that angel investors were willing to accept more risk
than venture capitalists. But, that may be changing. Today, there is a movement on the
part of angels to later-stage investment (Lipper & Sommer, 2002; May, 2002; May &
Simmons, 2001: Sohl, 2003). Part of this is, no doubt, a result of the furious investment
activity during the dot-boom and then the impending dot-bomb. This is also driven by the
ability of angels to co-invest in networks. As a result, much larger dollar amounts are
available, rivaling small venture capital funds. Recently, through personal experience, one
of the authors witnessed 20 angels and seven venture capitalists accusing each other of
invading their traditional investment spaces. Thus, it appears angels are moving to the
right on the venture capital continuum to later-stage deals while venture capitalists are
beginning to move to the left in search of quality and complementary deal flow (see Figure
1).
UNDERSTANDING DUE DILIGENCE EXPECTATIONS OF BUSINESS ANGELS AND

VENTURE CAPITALISTS
The unsophisticated angel investor spends a miniscule amount of time on due diligence,
unlike the venture capitalist who spends most of his/her time on due diligence. Due
diligence is the time and effort taken by the investor to evaluate the worthiness or
potential of an entrepreneur and all aspects of the venture. The different emphasis each
type of investor places on due diligence inversely relates to his/her risk characteristics.
Today, sophisticated angel investors perform background checks on all management

team members, take months to assess the state of the business prior to investing, and
use stepped investments tied to specific milestones. Abrams (2003, p. 226) states, "A
milestone list allows you and your financing sources to see what you specifically plan to
accomplish, and it sets out clearly delineated objectives." Failure to meet these
milestones could harshly impact the ownership interest of the entrepreneur.
Term sheets, the initial agreement between the entrepreneur and angel, are detailed
documents that provide the provisions for the investment agreement. Over the years,
these documents have evolved in regard to content and complexity. Interestingly, they are
sometimes skewed to the interest of the angel. As a result, for protection, the
entrepreneur must have legal representation in this process.
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The venture capitalist accepts an average return rate for less risk, while the angel will
accept more risk in hopes that he/she has found an entrepreneur with a winning idea. This
conclusion follows the financial theory that investors "should expect higher returns from
higher risk investments" (Elango, et al., 1995, p. 159). However, disappointment may arise
when the angel realizes the business idea is not a winner, and the return on investment is
diminutive.
Although there are differences between the timing and dollar amount preferences of
business angels and venture capitalists, both look for specific criteria for a potential
investment. The basic criteria are: entrepreneur and management team, product and
market potential, financials, and the business plan (Van Osnabrugge & Robinson, 2000).
The most important criterion for all investors is the enthusiasm, trustworthiness, first
impression, and expertise of the entrepreneur. Or, simply stated, has he/she been there
and done that? In fact, these key attributes are what most encourages business angels
and venture capitalists to invest in a deal, even if the management team is incomplete. As
might be expected, venture capitalists place more importance than business angels on a
complete management team. Not surprising, business angels are hoping to be active in
the venture and help the entrepreneur construct an appropriate management team.
Evaluating the product and market are important to both types of investors. The
entrepreneur must know the product and the market completely and realistically before
approaching either type of investor. Both angel and venture capital investors want to see a
niche product; however, venture capitalists need a modest to high growth potential before
considering the deal, which contrasts to the market growth angels typically require. If
entrepreneurs know there is no growth potential, then they "should not...consider
approaching a venture capitalist" (Van Osnabrugge & Robinson, 2000, p. 128). Angels
and venture capitalists want to invest in ventures with a product niche and growth
potential, management with knowledge of the industry, and competition protection (Van
Osnabrugge & Robinson, 2000).
Providing financials and a business plan are important to investors (Benjamin & Margulis,
2001; Freear, Sohl, & Wetzel, 1994: Jensen, 2002; Seglin, 1998; Van Osnabrugge &
Robinson, 2000: Wetzel, 2002). These criteria are important in the due diligence process
because they provide the information an investor needs in order to roughly determine the
risk involved in the deal. However, business angels are ambiguous with these measures.
Some angels are very subjective when evaluating deal flow and may not require a full-
blown business plan; even their concern with financial ratios may be lenient.
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Consequently, some angels start with the financials of a business plan and value them,
while others may also begin there but by literally ripping them out and creating their own.
The financials in a business plan tend to be one of the greater points of contention with
entrepreneurs and investors, since these numbers play a key role in the valuation of the
venture and the resulting amount of ownership the external investor will receive. On the
contrary, venture capitalists place strict emphasis on the financials and business plan, and
they make sure the financial numbers (like return on investment) are as precise and
accurate as possible.
IDENTIFYING BUSINESS ANGELS AND VENTURE CAPITALISTS
Angel investors are elusive so it takes some effort on the entrepreneur's part to find them.
In general, angels prefer a personal introduction rather than receiving an unsolicited
business plan. Often, unsolicited business plans go unread. Therefore, the best way to
contact an angel investor is through personal contacts such as friends, family, bankers,
accountants, attorneys, business colleagues, etc. These individuals might have personal
relationships with angels and may provide the entrepreneur with a personal introduction.
Networking with these individuals to find a business angel gives the entrepreneur a little
more credibility. Steier and Greenwood (2000) illustrate networking strategy with a story of
an entrepreneur who found angel capital by simply networking through people he knew.
This triggered an event where those individuals networked through another layer of
people until the entrepreneur identified an angel.
If such networking fails, the next best attempt is to search the World Wide Web for angel
investors. Usually, multiple links will appear on a meta-crawler like Google.com. Taking
this route will lead to many websites matching entrepreneurs with angels, generally for a
registration fee. These links also provide additional information on investors and
entrepreneurial entities. Such information may lend valuable insights as to what type
venture in which they might be interested in investing (e.g., technology) or the type of
information they would require to be submitted for investment consideration. Some of the
more popular sites are http://www.ace-net.sr.unh.edu and http://www.investorscircle.net.
Once an angel is identified and expresses an interest in the venture, negotiations will
begin. This may be a very difficult process for all involved and may fall apart even at the
last moment. Since early-stage ventures have little, if any, sales, many traditional
valuation models (e.g., discount cash flow) are speculative at best. Therefore, the
valuation of the venture, especially a very early-stage one, will rely almost solely upon the
negotiating skills of the parties. With that said, entrepreneurs have a tendency to think
their venture is worth more than the perceived value held by the investor. Should an
Page 118
agreed upon valuation not be found, no deal will occur. In the end, should investment
terms be agreed upon, other angels may enter the picture through the networking efforts
of the initial angel.
A growing, high-potential business in the later stages of the business cycle might seek
venture capital to significantly grow the business. The ability of such a venture to attract
these additional investment dollars is further enhanced through the prior participation of
an angel investor. Much as the referral network works for entrepreneurs in approaching
angels, the same is true with ventures as they approach venture capitalists. Many venture
capitalists have worked with angel-funded businesses in the past and thus the credibility
of the venture increases due to the investment and knowledge contribution of the angel.
The angel is a known commodity to the venture capitalist. At this point, its probability of
acceptance by additional investors is enhanced. As soon as the entrepreneur attaches to
an angel and the business is successful, the credibility of the company in general
becomes noticeable by other investors. Take, for example, the situation described earlier
where an entrepreneur found an angel through networking. After finding the first angel
and making a deal, other venture capitalists were willing to invest in his company (Steier
& Greenwood, 2000).
Seeking equity from venture capitalists is not such a mysterious process as finding angel
investors. These institutions are built on their reputations with the public. Since this is the
case, they are looking for deals that will prove themselves in terms of earnings and have a
high growth potential. As a result, venture capitalists are easier to identify than angels.
Simply using a webcrawler will provide a long list of venture capital websites that have
listings of top-rated venture capital firms. An accountant or banker will probably know
many notable institutions such as Acacia, JP Morgan, Morgan Stanley, etc. V enture c
apitalists may also be found through the National Venture Capital Association at
http://www.nvca.org.
Entrepreneurial firms that have proven themselves and are in later stages of the business
cycle might receive funding from venture capitalists. For example, 3Com, Apple
Computer, Cienna, Cisco Systems, Digital Equipment Corporation, Federal Express,
Genentech, hotmail, Intel, iVillage.com, Lotus, Microsoft, Oracle, Vitesse Semiconductor,
and Yahoo! are all companies that successfully reached the later stages of the business
cycle and received financing from venture capitalists (National Venture Capital
Association, 2003; Van Osnabrugge & Robinson, 2000).
CONCLUDING REMARKS
Page 119
Identifying sources for investment capital without clearly understanding the purpose of the
business or the preferences and investment criteria of the equity providers is an
unnecessary mistake made by many entrepreneurs. Since entrepreneurial activities are
significant to the health o f t he U nited S tates e conomy, further r esearch i s n eeded as
w ell as b etter m ethods o f documenting activities of angel investors. Entrepreneurs,
investors, and researchers need this information in order to educate the populace on
investment opportunities and the steps entrepreneurs and financiers must take to create
successful investment transactions. Educating entrepreneurs on the differences of
investor types will allow them to better organize their equity searching efforts along with
the due diligence criteria that investors use to analyze deal flow. With this in mind,
entrepreneurs should first be willing to give 110 percent to their ideas before considering
other financing options. Without a doubt, such dedication by entrepreneurs to their
business ideas will be quite appealing to angel investors and venture capitalists that are
making decisions to finance ventures.
The process to acquire outside investment begins with an outstanding idea that is then
reduced to paper in the form of a business plan. That plan will detail the "winning"
opportunity and provide for a modest- to high-growth market strategy. Contained within
that document are the foundations for an exceptional team to lead the venture forward.
Unfortunately, the reality is that most ventures will not possess the necessary attributes to
attract outside investment. Of the 3.5 million businesses begun each year, few will be
candidates for either angel or venture capital funding. But, those entrepreneurs in
ventures that do fit the profile for external investors and begin the long and arduous
growth journey are what legends are made of. The founders of such ventures become
subjects of admiration and study, our business heroes, our civic leaders, and ultimately
our philanthropists. They create a class unto themselves: entrepreneurs.
Publication Information: Article Title: Educating Entrepreneurs on Angel Venture Capital

Financing Options. Contributors: Jason B. Brinlee - author, Geralyn McClure Franklin -
author, Joseph R. Bell - author, Charles A. Bullock - author. Journal Title: Journal of
Business and Entrepreneurship. Volume: 16. Issue: 2. Publication Year: 2004. Page
Number: 141+. © 2004 Association for Small Business and Entrepreneurship. Provided by
ProQuest LLC. All Rights Reserved.
Page 120
Article 2
Money Matters: Using Sound Resources, You Can Find Capital for Your Business.
by Carolyn M. Brown
FASHION DESIGNER KARA SAUN GARNERED NATIONAL praise as runner-up on the

first season of Bravo's reality competition series Project Runway. Showing her styles at
the 2005 New York Olympus Fashion Week, Saun not only wowed television viewers, she
also inspired an angel investor from Connecticut to help launch her Fall 2006 clothing line
at Los Angeles Fashion Week.
"He and his wife saw me on Project Runway," says Saun. "He liked my work and
personality." Over the course of six to eight months from their initial meeting, a contract
was drawn whereby Saun's investor (who provided an amount in the low six figures)
would get an equity percentage, but she would retain fun creative and operational control.
[ILLUSTRATION OMITTED]
Having a solid business plan is what helped seal the deal, says the 39-year-old Los
Angeles-based designer. "Even though he sought me out, I still needed a strong
presentation," says Saun on what investors expect. "I worked with two business writers
and my accountant. I had a full budget and marketing plan. They want to see what the
profits are going to be and the return on their investment."
Saun's line of gowns and cocktail dresses, starting at $1,500, is sold in boutiques
throughout California, New York, Texas, and Connecticut and at www.karasaun.com. She
still designs custom clothing for celebrity clientele and does costume design for television
shows. Next, Saun wants to secure second-round financing to sell her line in high-end
retail stores such as Nordstrom and Saks Fifth Avenue.
A shortfall of capital is one of the most commonly cited reasons businesses fail, says Todd
McCrackin, president of the National Small Business Association (NSBA), a small-
business advocacy group based in Washington, D.C. These days, it is tougher than ever
for entrepreneurs to raise money.
According to the NSBA, small businesses in 2007 were less likely to obtain adequate
financing than they were 10 years ago. For America's smallest businesses, credit cards
are a primary source of financing, followed by earnings of the business and then private
loans. Larger companies rely much more on bank loans. New companies, however,
generally don't have access to commercial bank loans because they lack operating
Page 121
experience and solid credit history, says McCrackin. "It doesn't matter if an entrepreneur
is asking for $10,000 or $1 million, bankers require the same information."
Capital Resources
← Angel Investors: Typically among the earliest sources of funding for budding
entrepreneurs. Such investors are available to finance your business and believe in your
vision just as much as you do. They provide seed capital ranging from a few thousand
dollars to as much as $1 million. Angel Capital Association,
www.angelcapitalassociation.org
← Interpersonal Funding: Private monies from friends and family, a fast and easy
source. Terms are usually more lax than with other forms of borrowed capital. Receipts
should be drawn up to show the exchange and any stipulations for repayment. Circle
Lending, www.circlelending.com
← Loans: The Small Business Administration offers various loan programs. Its
Community Express Program grants loans from $5,000 to $50,000 in conjunction with
preferred lenders (www.blxonline.com/Products_Community_Express.cfm). Small
Business Administration, www.sba.gov
←Microlending: For start-ups without access to traditional financing. Regional and

national nonprofit groups make loans from as little as $500 up to $35,000, and repayment
terms are less stringent. Lenders may also offer financial and business workshops. Each
organization has its own lending requirements. ACCION USA, www.accionusa.org
← Venture Capitalists: The least likely source of funds for startups, according to NSBA
president Todd McCrackin. He says venture capitalists tend to shy away from very new
businesses and rarely invest less than $5 million at a time. National Association of
Investment Companies, www.naicvc. corn; National Venture Capital Association,
www.nvca.org
Where to go for help:
← Association of Small Business Development Centers, www.asbdc-us.org
← National Business Association, www.nationalbusiness.org
← SCORE (Service Corps of Retired Executives), www.score.org
← The Minority Business Development Agency, www.mbda.gov
Books
Page 122
Raising Capital for Dummies by Joseph W. Bartlett and Peter Economy (For Dummies;
$24.99)
Publication Information: Article Title: Money Matters: Using Sound Resources, You Can
Find Capital for Your Business. Contributors: Carolyn M. Brown - author. Magazine Title:
Black Enterprise. Volume: 38. Issue: 4. Publication Date: November 2007. Page Number:
← COPYRIGHT 2007 Earl G. Graves Publishing Co., Inc.; COPYRIGHT 2007 Gale
Group
Article 3
Working Capital Financing and Cash Flow in the Small Business
by Leo R. Cheatham , J. Paul Dunn , Carole B. Cheatham
INTRODUCTION
Cash flow problems create what is probably the most unexpected hurdle on the road to
success for the small business. Being able to sell merchandise at prices that are higher
than costs does not insure survival. Perhaps one of the most dangerous misconceptions
is the common belief among entrepreneurs that adequate profits will automatically result
to adequate cash inflows.
Profit, as identified in the income statement, is the product of an accounting system in

which revenues and expenses are recorded on an accrual basis to reflect the point in time
when these events occurred, and not the flows of cash associated with them. This
process does not distinguish between liquid assets (those that are in the form of cash or
that can be easily converted to cash) and non-liquid assets. Bills and debt obligations
cannot be paid with profit. They must be paid in cash. Creditors can force a profitable
business into bankruptcy if it does not pay its bills on time.
Managers of large corporations began to notice the discrepancy between the two
concepts to the 1970's as interest rates began to soar to double digit figures. Executives
began to realize that a lack of cash, not profits, prevented their firms from surviving and
growing (7). As a result, financial managers in most large corporations now investigate all
the underlying factors controlling and influencing cash flows to discover ways of reducing
the amount of cash required as well as to find ways to speed up the cash conversion
cycle.
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A survey conducted by Greenwich Associates to 1988 revealed an extremely high level of

cash management activity among large companies. Of the surveyed firms, 90 percent had
made changes to their cash management systems in the past 12 months, 41 percent had
set up programs to review bank costs, and 32 percent had increased cash management
services (3).
A GREATER CONCERN FOR THE SMALL FIRM
While the financial rules for the small business may differ from those of corporate giants,
evidence indicates cash management is even more important for the small firm (10).
Executives of large corporations first became interested to this topic because of their
concern over the opportunity cost of idle cash balances. However, in recent years cash
flow problems have become more commonplace, and cash management focus has
shifted more in the direction of developing procedures to deal with cash shortages rather
than surpluses. Managers of large firms are now having to deal with the same types of
cash flow problems that have always plagued small firms. Consequently, cash flow
management tools have been developed by large organizations to deal with their
problems, thereby creating opportunities for small business to adapt and benefit from the
latest technology.
Even though large and small firms share common types of liquidity problems, there is no
comparison of the impact these have on the different sized firms. Corporate giants in need
of additional cash have several options. A typical choice to meet short-term liquidity needs
is to sell commercial paper. If a firm needs more permanent capitalization, it can sell
stocks and/or bonds in national and international markets. Neither of these options is
available to small firms, many of which are already undercapitalized (8).
Often the only alternative for the small firm is to rely heavily on short-term sources of
financing such as accounts payable, accruals, and lines of credit. By their very nature
these sources tend to create their own set of liquidity problems because they provide
funds for only a very short period of time and require quick generation of cash for
repayment. Funds from these sources are used to finance a portion of working capital (5)
which includes all funds invested to current assets. This investment shows up on the
balance sheet primarily in the inventory and accounts receivable balances. As
merchandise is sold, cash is generated to repay debt obligations. However, this
generation process is conditionally based on the ability to produce sales and then collect
the accounts receivable.
The process of spending cash to purchase raw materials and/or finished goods which are
eventually sold and converted back to cash is referred to as the cash conversion cycle.
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This process is far more critical to the small firm because a larger percentage of its
working capital is likely to be financed with current liabilities requiring prompt repayment;
on the other hand, the large corporation tends to have a larger percentage of working
capital financed by long-term debt in the form of bonds and permanent equity as stocks.
CASH FLOW AND NET WORKING CAPITAL
Cash flow is primarily the result of the investment to and eventual liquidation of current
assets, especially inventories and accounts receivable. These items require the
expenditure of cash. When current assets are sold to and paid for by the customers, cash
is made available to pay off current liabilities. The dollar amount by which current assets
exceeds current liabilities is referred to as net working capital. In this definition, the
amount of net working capital is equal to the amount of long-term or permanent financing
of the current assets. This amount is an important risk measure to commercial bankers
and other lenders when a small business applies for a loan. Net working capital
represents a safety cushion for the lender to those current assets can be liquidated for
less than book value, and current debt obligations can still be paid on schedule. The
portion of current assets equal to net working capital does not mandate prompt liquidation
and generation of cash as do current assets financed with current liabilities such as
accounts payable. Consequently, a small business that has a large amount of net working
capital is perceived by lenders as a lower risk borrower and will receive preferential
treatment in terms of availability of loans and lower interest rates on those loans.
In spite of its importance, working capital management is one of the areas often neglected
by small business entrepreneurs. A survey of 120 small firms revealed inadequate control
of receivables, payables, and inventories as well as laxities in accountability for tax
receipts and disbursements (9). Such oversights can be more devastating for firms to
start-up and growing phases than for firms with established, stable sales. A firm that has
survived start-up has probably learned that current assets use up investable funds the
same as any other assets; the new entrepreneur often makes no financing provisions for
funding inventories and accounts receivable. Likewise, the management of a growth firm
seldom makes provisions for the increase in these asset items that must occur when sales
increase.
INCREASED SALES REQUIRE MORE CASH
The amount of current asset items is directly proportional to the level of sales. To support
an increase to sales, average inventory must build up, accounts receivable must increase,
and larger cash balances are required to pay for larger purchases. From a financing
perspective, accounts receivable is essentially the same as inventory, with the only
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difference being that accounts receivable is inventory that has been removed from the
premises and is closer to being converted to cash. Just as inventories are necessary to
make sales, trade credit is offered to attract customers. Similarly, both groups of current
assets use up real dollars just the same as purchases of plant and equipment.
Even though the level of sales is the dominant factor determining the required investment
to working capital, there are several other considerations which cause the percentage
relationship between these two variables to differ from business to business. A
manufacturing firm may not have the same working capital-to-sales ratio as a retailer or a
wholesaler. Also, a manufacturing firm with a lengthy production process will automatically
have higher levels of inventories because it takes longer for products to be completed and
moved to the sales floor.
Management attitude toward the risk of being out-of-stock affects the levels of current
assets carried. Conservative management wishing to avoid this risk will carry larger
Inventories (11). Regardless of the sizes of inventories and current assets maintained,
working capital must increase as sales levels increase.
Increases in these sales-related assets occur almost spontaneously. In order to make

more sales, larger purchases are necessary. This also means that financing from
accounts payable, accruals, and lines of credit are also spontaneous; that is,
management does not have to negotiate financing arrangements as it would if arranging a
new loan. However, because accounts payable increase, the firm must carry larger cash
balances resulting to an increase to this current asset item as well. More sales
simultaneously create a larger volume of accounts receivable. Inventories, accounts
receivable, and cash balances to pay current debt obligations must all increase. However,
the total increase required to current asset funding is partially offset by the spontaneous
financing provided by increases in current liabilities.
A TECHNIQUE TO HANDLE THE PROBLEM
Richards and Laughlin's cash conversion cycle concept can be converted to a framework
for determining the net amount of cash investment required for varying sales levels. This
technique is based on the concept of identifying the number of days of sales that are
represented by inventories and accounts receivable. This approach considers timing
(length of time the investment funds are tied up in working capital) as well as the amount
of funds required (6).
Offsetting effects of accounts payable and other deferred expenses on cash requirements
are included so the cash cycle reflects only cash demand. Using the example, inventories
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and accounts receivable represent a combined expenditure equal to enough inventory to

supply 70 days of sales. In terms of investment, it makes no difference if inventory is still
on hand or is held by customers who have not yet paid in cash. However, the total amount
of cash invested by the business is only an amount necessary to finance inventory for 50
days because financing from spontaneous current assets is sufficient to finance
inventories for 20 days of sales.
It is, therefore, the length of time between the actual cash expenditure for current assets
and the point to time to which the inventories and accounts receivable are converted back
to cash.
Table 1 illustrates the events in the cash conversion cycle and how they are related.
Without the payables deferral period that is primarily the result of accounts payable, the
cash conversion cycle would be equal to the number of days sales units are in inventory
and accounts receivable combined. However, because cash is actually paid on a delayed
schedule after raw materials are purchased, the amount of cash that must be invested by
the firm is the amount needed to finance inventory and accounts receivable for sales for
50 days.
How can the management of a firm like Little, Inc. translate this information into dollar
figures so they will know the amount of funds that must be provided to finance their
inventories and accounts receivable? Suppose the firm manufactures and sells 100
widgets per day at a price of $11.25. Production cost per unit is $9.00 to produce the
widgets. Gross profit per unit is $2.25. Each day the investment to inventory increases by
$9.00 X 100 units = $900.00. If this inventory is sold it will produce cash inflow of $11.25 X
100 units = $1,125.00. Cash is needed to finance a 50-day inventory supply and will be
$900.00 per day X 50 days = $45,000.00. When liquidated, this inventory will provide
$1,125.00 X 50 days = $56,250.00 of cash inflow. However, the firm must provide
$45,000.00 in cash at present to be able to realize the larger cash inflow to the future that
produces the profit. This cash must be provided from non-spontaneous sources. Even
though each dollar is recovered after 50 days, $45,000.00 is a permanent investment
because this amount has to be continually reinvested.
Elements to the cash conversion cycle reveal the key role of sales levels in determining
the amount of cash necessary to finance working capital. The inventory conversion period
is computed by using inventory turnover which is a functional relationship between total
annual sales and average inventory balances. The receivables conversion period is
computed by using average daily sales. Consequently, the product of the cash conversion
equation reflects the sales levels used when making the calculation.
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THE ROLE OF TIMING OF CASH FLOWS
Timing of cash flows is equally as important as the size of average inventories and
accounts receivable in its impact on the amount of cash required for current asset
financing. Cash flow planning is complicated because all accounting records are kept on
an accrual basis which recognizes revenues and expenses at the point in time at which
they occur and not at the point to time at which cash flows to or out. Table 1 illustrates the
problem. When finished goods are sold, accounting records will record the sales
transactions and report profits on all units sold. However, it will actually be an additional
30 days before cash is received. From a cash perspective, accounts receivable are
nothing more than inventory that has been sold. This discrepancy between profit and cash
inflow is one of the main reasons why small business owners who only look at profits and
do not analyze cash flows can face bankruptcy while showing a profit. Bills must be paid
with cash, not with profits.
Fluctuating sales create havoc to the timing of cash flows. Sales are made from
inventories produced to earlier periods based on levels of future sales anticipated when
production took place. Consequently, a small business is forced to produce or stock for
future sales levels and must forecast what those levels will be. Forecasts occur even if
they are implicit and involve no formal planning. Two types of errors can result from
inaccurate forecasts:
← Insufficient inventories can cause loss of sales because of the inability to fill orders.
← Excessive inventories can create an exorbitant investment of cash that could have
been used for other purposes.
An unexpected sales decrease for Little. Inc. provides an illustration of the cash flow
effect of such a decrease. If Little has a 40-day supply of inventory ready to sell when
daily sales fall from the forecasted rate of 100 units per day to 80 units per day, there will
be an unintentional build-up of inventories. Furthermore, any sudden decrease to sales is
usually discounted by the management of small firms who assume it is random
fluctuation, and therefore they do not adjust their production accordingly. As a result it is
very likely that Little. Inc. will continue to produce 100 units per day for some period of
time after sales rates have actually declined to 80 units per day. Consequently, average
inventory continues to increase because the company is producing 20 more units per day
than it is selling. This unintentional inventory build-up is illustrated in Table 2.
As a result of overproducing by 20 units per day the inventory balance has increased by
600 units. Investment to inventory now stands at 57.5 days X 80 units/day X $9.00 =
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$41,400.00 rather than 40 days X 100 units/day X $9.00 = $36,000.00 as it was when
sales were stable at 100 units per day. The small business manager should note the
importance of adjusting production to a level compatible with current sales as quickly as
possible after sales have declined. Further production adjustment delays will intensify the
problem. If the manager waits two months, the unintentional build-up will be 1,200 units.
While the $5,400.00 increase in investment due to the additional 600 units is significant,
this figure understates the net impact of a sales decline on the timing of cash flows. The
decrease to sales volume aggravates the problem because cash inflow is reduced at the
same time the amount of cash outflow has increased. Table 3 shows how the process
affects the other three variables to the cash conversion cycle.
Once the cash conversion cycle has been determined, a few simple calculations let the
entrepreneur know how much additional cash is required to finance inventories and
accounts receivable. When sales were stable at 100 units per day, the cash required was
50 days X 100 units X $9.00 = $45,000.00. With the decline in sales to 80 units per day,
the cash required increases to 67.5 days X 80 units X $9.00 = $48,000.00. The difference
of $3,000.00 is the amount of additional cash required to finance working capital until
Inventory levels can be readjusted back to a 40-day supply. Actually the investment to
inventory went up by the larger amount of $5,400.00 but this need for funding was
partially offset by the decreased investment to accounts receivable because of decrease
in sales. The most important advantage of using the cash conversion cycle concept is that
all of the affected variables are considered simultaneously when computing the cycle.
The $3,600.00 additional cash required represents only the cash outflow side of the
problem. Cash inflow is declining simultaneously because sales have decreased from 100
units X $ 11.25 = $900.00 per day instead of $ 1.125.00 per day. Cash needs are
increasing while the ability to supply them has decreased.
Growth situations also cause increases in cash needed to finance working capital. The
main reason is the build up of inventories and accounts receivables before the sales
benefits of the increased volume begin to generate cash flow.
These effects on working capital financing emphasize the importance of good sales
forecasting. If the management of Little, Inc. had foreseen the decline to sales before it
occurred, it could have actually reduced the amount of inventory and lowered its cash
investment to 50 days X 80 units X $9.00 = $36,000.00, $ 12.000.00 less than the level
that would otherwise result. On the other hand, if management realistically expects the
sales level to return to 100 units per day to the near future, it would be a mistake to cut
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production back to 80 units per day because sales are made from previously produced
goods, and insufficient inventory would result to opportunity losses.
USING CASH FLOW PLANNING INSTRUMENTS
The importance of realistic sales forecasts to cash flow management cannot be

overemphasized because the link between sales and working capital requirements is so
vital. In turn, the investment to inventories and accounts receivable is the major factor
altering the cash conversion cycle.
A second instrument that follows the sales forecast, but which is of equal importance, is
the cash flow forecast. It should detail projected cash inflows and outflows as accurately
as possible. Because inflows and outflows do not always follow the projected path of
forecasts, a firm's survival may depend on being able to detect unexpected changes
quickly (2).
One authority states that cash flow projections should extend at least three years into the
future and should provide monthly details for the first year and quarterly figures for the
next two years. This frequency enables management to detect problems before it is too
late to correct them. Maturi provides a simple approach that can be used by small
businesses to prepare cash forecasts. He emphasizes why this process is even more
critical for the small firm than for the large firm (4).
Forecasting is both a planning and a controlling tool. Control is the feedback element that
results in alteration of plans. There are other devices to assist managers to projecting
cash flow. The statement of changes to financial positions is well documented in the
literature for the useful cash flow information it provides. Byrd and Byrd explain how the
small businesses can use this information for both planning and control (1). New
accounting provisions requiring historical cash flow statements should also help.
Traditional ratio analysis techniques, especially those using liquidity ratios, should not be
overlooked. Both trend analysis, which reflects historical changes in the firm's liquidity
practices, and cross sectional industry comparison with the liquidity status of other
competing firms help the firm assess its cash flow position.
WHAT ABOUT START-UP FIRMS?
The technique of using the cash conversion cycle will work well for established firms who
have accounting data to provide information on inventory, accounts receivable, and
accounts payable balances. But how does a new firm deal with the problem of estimating
the amount of cash required for working capital investment since it does not have this
type of historical information? Maturi emphasizes that cash management is more crucial
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to the start-up firm than to the established firm because most initial cash flows to the start-
up firm will be in the outward direction with a long delay before sales begin to generate
significant inflows (4).
Probably the best solution is a simple one. Management can use working capital data
from similar firms. Such information is readily available in financial statement studies
services provided by Robert Morris & Associates and Dun & Bradstreet. There are
sufficient balance sheets and income statement data to compute the average cash
conversion cycle for similar competing firms operating to the same markets and
environments as those of the start-up firm. The start-up firm of comparable asset and
sales size will likely have to maintain inventories of comparable size, offer similar credit
terms, and buy from the same suppliers. Consequently, this process provides an effective
starting estimate of the amount of cash investment that should be set aside for working
capital.
An alternate approach could consist of using the industry data for the same sized firms to
calculate the percentage relationships between the variables to the conversion cycle and
sales. These Industry standard percentages could then be applied to any projected sales
level of the start-up firm to produce estimates for inventories, accounts receivable, and the
current liability financing sources. From these estimates the net amount of the cash
conversion cycle could be computed and an estimate of cash required determined. After
the new firm has been in operation for a period of time, management can begin to
investigate the possibility of some of the fine-tuning effects that were discussed earlier to
this paper.
SUMMARY AND CONCLUSIONS
Small business managers can benefit from some of the cash management developments
and techniques used by large corporations. Unlike a decade ago when large firms were
trying to decide on ways to invest idle cash, these same firms are now trying to determine
how to make ends meet in managing cash flow. Managers of small firms have long been
encountering this problem, but a lack of awareness or knowledge of what action to take
has caused techniques of cash management to be overlooked.
Once firms have acquired the necessary plant and equipment to begin operation, cash
flow management becomes almost synonymous with working capital management. Most
operating cash outflows are reflected In the current asset items of inventories and
accounts receivable on the balance sheet, and all cash inflows are the result of liquidating
these two asset items to the form of sales. Because a portion of working capital is
financed with accounts payable, accruals, and other spontaneous sources, the net
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amount of cash investment required for the firm is less than the total amount of
inventories and accounts receivable depicted on the balance sheet.
The cash conversion cycle concept provides an ideal framework for determining the
actual amount of cash that must be provided by the firm to finance working capital. This
technique focuses on the timing of cash flows as well as on the dollar amounts invested.
Timing, reflected in the length of time products stay in inventory or accounts receivable,
provides the key to finding ways to reduce the amount of cash investment without
jeopardizing sales levels.
The value calculated for the cash conversion cycle is the number of days of sales
inventories that must be financed with cash. This value is found by adding the inventory
conversion period to the accounts receivable conversion period and then subtracting the
payables deferral period. Consequently, the cash conversion cycle simultaneously
considers all the working capital variables that affect cash flow. The cycle is useful not
only for determining the amount of current investment, but also for providing a means for
quickly estimating the effects on cash investment requirements if sales fluctuate in either
a favorable or unfavorable direction.
Changes to sales affect inventory levels, accounts receivable, and accounts payable. The
cash conversion cycle reveals the net effects of what are sometimes offsetting changes
and what are sometimes cumulative effects to the variables. The cycle quickly reveals
why an unexpected decrease to sales or any increase in sales creates an immediate net
outflow even though it may be offset by later inflows.
Cash flow analysis cannot be conducted without information provided by other planning
and control instruments. Sales forecasts are essential because of the link between current
asset investment and actual sales. Because of the importance of timing of cash flows,
cash flow projections for frequent intervals help avoid surprises. Liquidity ratio analysis,
historical cash flow statements, and the statement of changes to financial position
complement the process.
New firms that do not have historical financial statement data from which to compute cash
needs can use industry data from comparably sized firms. This provides a good proxy
because the start-up firm will likely offer similar service on products supplied, as well as
similar credit terms and will be buying from some of the same suppliers. Once the firm
establishes its own data base of working capital information, it can then begin to fine tune
its cash investment levels in inventories and accounts receivable.
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Publication Information: Article Title: Working Capital Financing and Cash Flow in the
Small Business. Contributors: Leo R. Cheatham - author, J. Paul Dunn - author, Carole B.
Cheatham - author. Journal Title: Journal of Business and Entrepreneurship. Volume: 1.
Issue: 2. Publication Year: 1989. Page Number: 1+. © 1989 Association for Small
Business and Entrepreneurship. Provided by ProQuest LLC. All Rights Reserved.
Reality Check for Your Muses: Creativity and Business Innovation Resources
by David Mattison
You're never too old for a good idea.
This roundup of web resources focuses on creativity and innovation, not so much the
how-to as a sampling across a wide range of online assets, most of them freely available.
If you're stuck for ideas, blocked for inspiration, or need some channeling for your creative
muses, these websites might help you discover and create something different and new -
and hopefully good.
When It Comes to Ideas, Big and More Are Better
"Creativity consists of coming up with many ideas, not just that one great idea."
-Charles "Chic" Thompson, What a Great Ideal (1992)
The growth of social networking, the creation of Creative Commons licenses, the
propagation of "open" (shared, collaborative) approaches to problem- solving, software
development, intellectual findings, and business innovation; the shift from analog to digital
content - the last reinforced by the internet itself - have all led to some extraordinary
personal connectivity and audio-visual collections. Blogging in general falls into these
phenomena and Twitter [http://www.twitter.com] for mobile phone microblogging via text
messaging, syndicated content (news) feeds, and newsfeed reading tools; Technorati
[http://www.technorati.com] for tracking the popularity of blogs by their readership; Flickr
for photographs and video [http://wwwflickr.com];YouTube [http://www.youtube.com] for
videos; SoundBoard for audio [http://www.soundboard.com]; and the Internet Archive for
historic video, audio, texts, software, and websites [http://www.archive.org]. Writers may
find no greater source for ideas than places such as Wikipedia and its family of sites
[http://www.wikipedia.org] andFreeBase [http:// www.freebase.com] .
Page 133
Where can you find your next big idea? Businesses and services that specialize in trying
to recognize the "next big thing" include the well-known IT consulting and research
company Gartner, Inc. [http://www.gartner.com], which began hosting a Web Innovation
Summit in 2007. Founded in 2002 by Reinier Evers, the Dutch
companyTrendwatching.com [http: //www trendwatching.com] has an idea-spotting
network called Springspotters [http://www.springspotters.com] that, in turn, feeds into the
database -driven Springwise.com [http: //spring wise.com]. TrendHunter.com
[http://www.trendhunter.com], founded in 2005 by Jeremy Gutsche, operates on the same
principle as the Springspotters Network. You can search the TrendHunter database of
more than 22,200 trends without registering for a free account. Established in 2006,
BuzzFeed [http: //buz zfeed.com] combines social networking with trend watching by the
masses.
The Belgian company CREAX NV has assembled more than 840 categorized links to
sites "about creativity and innovation" at CREAX.net [http://www.creax.net]. Creative
Clusters [http:// www.creativeclusters.com], a U.K. company established by Simon Evans
in 2001, has hosted conferences since 2002 and maintains a good set of international,
mainly European, and English-language resources on the creative industries sector.
Web 1.0 subject portals and gateways to creativity and innovation include the Creativity
Portal [http: / /www.creativity-por tal.com], established in 2000 by Chris Dunmire and
geared to writers, teachers, and arts and crafts enthusiasts. But the Web 1.0 outlets are
giving way to Web 2.0 applications centered around blogging, wikis, and social
networking, all better tools to promote a freer exchange of ideas. The upside and main
advantage of the gatekeeper approach, especially in the howto arena, is quality control.
When a Bad Idea Spells Innovation
"Innovation is the central issue in economic prosperity."
-Michael E. Porter, Harvard Business School (unsourced and attributed by various

websites and publications)
One of the most famous "bad idea = innovation" tales from the 20th century is the story of
how 3M Post-it Notes came to be. You can read up on this at Snopes.com [http: /
/www.snopes.com/busi ness/origins/post-it.asp] or on 3M's Post-it Brand gateway
[http://www.3m.com/us/office/postit/pastpresent/history.html]. Striving to find something
very sticky, 3M researchers found something that would pull off. Came the dawn! Light
bulb appears over researcher's head!! Sometimes people want to pull things off.
Page 134
ness stack up against "The World's Most Innovative Companies," an annual study
[http://www.businessweek.com/magazine/
toc/08_17/B4081best_companies_at_innovation.htm]? Since the boss knows you already
play games on company time, why not go for the gold at the BusinessWeek Arcade
[http://business week.com/innovate/bwarcade], "a collection of some of the web's best
free, independently produced games," some of which might help your own creative
processes.
Other worthwhile magazines with online content related to business innovation are Wired
[http://www.wired.com], Fast Company [http://www.fastcompany.com], Fortune [http://
money.cnn.com/magazines/fortune] , RedHerring [http://www. redherring.com], Forbes
[http://www.forbes.com], Business 2.0 [http://money.cnn.com/magazines/business2] , and
the Massachusetts Institute of Technology's Technology Review [http://
www.technologyreview.com]. Some management consulting companies also publish
regular, free reports or white papers on business innovation such as the Boston
Consulting Group's "Innovation 2008: Is the Tide Turning?" [http://www.bcg.com/
impact_experfise/publications/fUes/ tonovation_Aug_2008.pdf].
Awards can help pinpoint good ideas based upon design and innovation. The Industrial
Designers Society of America (IDSA) sponsors the annual IDEA (International Design
Excellence Awards) competition [http://www.idsa.org/idea2008/index. html] with results
publicized by Business Week. The 2008 IDEA ceremony was held Sept. 13 in Arizona.
Called the Oscar for inventors, the $500,000 Lemelson-MIT Prize [http://web.mit.
edu/invent/a-prize.html] is part of a series of cash awards for U.S. inventors and student
innovators. The Lemelson-MIT Program site includes an Inventor of the Week
[http://web.mit. edu/invent/i-main.html] , where you can search for inventors by their last
name or browse by inventor name, category, or name of the invention. For those who
need a good challenge, I've seen many websites run by educational institutions promoting
competitions and challenges in various fields but typically around business management,
engineering, math, and the sciences. In the field of information technology, one of the best
known is the international Stockholm Challenge [http://www.stockholm challenge.se],
which started in 1995 as the Bangemann Challenge. Challenge sites are a great way to
find out how others have tackled similar problems.
Patent databases are a great inspiration and innovation tool. You can see what's worked
in the past and what others are working on in the present. English-speaking countries that
offer historic and contemporary patent databases freely available over the internet are
Australia (AusPat) [http://www.ipaustralia.gov. au/auspat], Canada (Canadian Patent
Page 135
Database) [http://pat ents.ic.gc.ca/cipo/cpd], and the U.S. (USPTO Patent Full-Text and
Image Database) [http://patft.uspto.gov]. The European Patent Office's trilingual database
esp@cenet [http://ep.espace net.com] offers patent applications from around the world,
including Great Britain, but result sets are limited to 500 per search. The World Intellectual
Property Organization (WIPO) also operates an international, multilingual database of
patent applications with close to 1.5 million records called PatentScope
[http://www.wipo.int/pctdb/en]. James Ryley, an ex-patent searcher, has created an easy-
to-use database of U.S., European, Japanese, and WIPO-registered patents at
FreePatentsOnline. com [http: / /www.freepatentsonline.com] . You must register for a free
account to view any PDF images of patent documents.
Look for universities, research centers, and government programs built around academic
research into and the teaching of innovation management. Don't forget the funding of
management innovation and the R&D (research and development) sector by government
jurisdictions. Here are a few English-language sites to help sharpen your innovative wit:
← The U.S.'s lead in science and technology was established early in the nation's life
when the National Academy of Sciences was incorporated under federal legislation in
1863. Today, the National Academies [http://wwwnationalacade mies.org] advise the
government on science, engineering, and medicine. It also operates a National Research
Council. The National Academies offers a look at selected research projects, close to 400
when I visited in early August 2008, through a database called the Current Projects
System (CPS) [http://www8.nationalacademies.org/cp]. One of the great inspirational
treasure-troves you can unlock at no cost are thousands of free books published by the
National Academies Press [http://www.nap.edu], many of which are also available for
purchase as PDF files or in hardcopy For more current content, check out the full-text
content of the weekly Proceedings of the National Academy of Sciences [http://www.
pnas.org], which began publication in 1915.
← Closely related to the mandate of the National Academes, the U.S. National Science
Foundation (NSF) [http://www.nsf. gov], created in 1950, funds national and multinational
scientific research projects, promotes science education, and recommends national
policies for research and innovation. As a source of potential inspiration, the NSF offers its
illustrated Discoveries database [http://www.nsf.gov/discoveries] featuring activities and
results from the 10,000 research projects it funds annually. You can likewise search the
Awards database [http://www.nsf.gov/awardsearch] to see who's researching what with
your tax dollars.
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← InnovationCanada.ca [http://www.innovationcanada.ca] was created by the Canada

Foundation for Innovation [http://www.innovation.ca], a national government agency for
"showcasing research excellence in Canada."
← National Research Council of Canada [http://wwwnrc-cnrc.gc.ca], "active since 1916,"

has a broad legislated mandate to deal with scientific and industrial research activities.
The NRC also operates Canada's national science and technology library, the Canada
Institute for Scientific and Technical Information (NRC-CISTI), which offers a current
awareness and document ordering subscription service called CISTI Source.
← The European Union has embraced a practice called Open Innovation

[http://www.openinnovation.eu], a term coined by University of California-Berkeley Haas
School of Business professor Henry Chesbrough in his book Open Innovation (2003).
Chesbrough is also the director of the university's Center for Open Innovation
[http://openinnovation.haas.berkeley.edu].
← National Endowment for Science, Technology and the Arts (NESTA)

[http://www.nesta.org.uk] was established in 1998 as a beneficiary of national lottery
funds. It is the U.K.'s current attempt "to make the UK more innovative" according to the
site's FAQ page. This independent organization funds and works with other academic,
private, and public sector entities on a wide array of activities. One of its key projects is
the Innovation Index [http://www.innovationindex.org.uk] to develop a set of innovation
metrics. A July 2008 research report, "The New Inventors: HowUsers Are Changing the
Rules of Innovation" [http://www.nesta.org.uk/assets/Uploads/pdf/Research-
Report/new_inventors_report_NESTA.pdf] , is an example of its commissioned work with
academic research centers.
Blogs and Social Networks of Creative Thought
Most but not all creativity and management innovation consultants get it when it comes to
blogs, social networking, and other kinds of Web 2.0 technology. You can't, however,
judge a consultant on the look and feel of their website, only on their past performance. If
you're checking out someone's credentials, you should also find out if that person belongs
to any professional or "better business" organizations.
The field of creativity and innovation management consultants has far too many blogs to
list them in full, so I've limited this list to ones that had a little extra something - the oomph
factor - as well as strong links to their peers. Both the Google Directory and Yahoo!
Directory will help you find more, though here again, as with any "crowdsourcing," it's
buyer beware and you get, usually, what you pay for.
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Creative Think
http://blog.creativethink.com
Roger von Oech is best known for his book A Whack on the Side of the Head (1983;
republished in 2008 as a 25th anniversary edition). It has a special place for me since his
was the first work on business creativity and innovation I have ever purchased.
The Heart of Innovation
http://www.ideachampions.com/heartofinnovation
This blog comes from the innovation and creativity company, Idea Champions. The
principal writer appears to be the company's president and co-founder, Mitch Ditkoff. This
just happens to be one of the wittiest blogs on this topic I have encountered.
The Hub for Productive Thinking
http://thinkx.ning.com
Created in late May 2008 on the Ning social networking system by Canadian Franca
Leeson, as of mid-July 2008 it had just over 100 members from around the world. Many of
the members appear to be associated with a multinational "productive thinking" company
called think^sup x^ intellectual capital.
FutureLab's Marketing & Strategy Innovation Blog
http://blog.futurelab.net
This blog has a rich archive extending back to December 2003. Both the incoming blog
feeds and the list of blogs followed should keep you filled with good ideas and well
inspired for a long time. Another excellent blog from a creativity and innovation consulting
firm is that of PSFK [http://www.psfk.com].
SparkBugg
http://sparkbugg.wordpress.com
SparkBugg calls itself "a blog about sharing smart ideas, inventions, and innovation."
You'll find two kinds of postings here: Ones entitled Bright Idea depict an existing
prototype or existing new product, and ones entitled IdeaSpark are new ideas or ideas for
improving existing products. An IdeaSpark may also appear as a comment below a Bright
Idea. More inspiration than you can shake a blog at and conceptually similar to the
MoreInspiration database from CREAX.com described elsewhere.
In the area of blogs highlighting technology and gadgetry (one kind of innovation focuses
on improving existing products), some of the outstanding blogs you should at least
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sample for their variety and commentary include the group blog BoingBoing, A Directory of
Wonderful Things [http://wwwboingboing.net], a truly eclectic mix of gadgetry and social
commentary with a sub-blog called BoingBoing Gadgets [http://gadgets.boingboing.net].
Even if you get distracted by the incredible wealth of information going back to January
2000, there is always real inspiration in here somewhere. TechCrunch
[http://www.techcrunch.com], created in 2005 and the second-most-popular blog "by
authority" on Technorati's Top 100 list, calls itself "a weblog dedicated to obsessively
profiling and reviewing new internet products and companies."
Another example of this kind of trend-watching blog, coupled with witty observations on
the real and digital worlds, is Neatorama [http://www.neatorama.com]. Last but certainly
not least is ReadWriteWeb [http://www.readwriteweb.com], founded in 2003 by Richard
MacManus, that covers the gamut of IT trends and products with a sub-site called Alt-
SearchEngines [http://www.altsearchengines.com] edited by Charles Knight.
ReadWriteWeb also utilizes Predictify.com [http://www.predictify.com], "a prediction
platform where users can predict the future and build a reputation based on their
accuracy, and marketers can post questions to collect actionable, forward-looking data
'from the crowd' ... Predictify is an effective way to create interactive advertisements by
posting a question related to your product or service." In other words, you can
"crowdsource" questions about your latest innovation via Predictify.
Giving Some Back
I was struck by a number of these websites, some from businesses, others from the
nonprofit sector, that encourage the sharing of knowledge about creative and innovation
processes.
Global Ideas Bank tp://www.globalideasbank.org
A project of the Nicholas Albery Foundation, a U.K. charity, this site was launched in 1995
and calls itself "part suggestion box, part networking tool, part democratic think-tank and
part inspirational entertainment!" This site thrives on ideas that contribute to the social
good.
Creativity Pool
http : //www. creativitypool .com
← bulletin-board system of user-contributed ideas organized into an ideas topics

taxonomy. You're only as good as your next idea.
Morelnspiration
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http://www.moreinspiration.com
Maintained by CREAX.com, this fascinating database carries information on more than

2,200 innovative products and technologies. By registering, you can contribute feedback
and keep in touch with what's new through this site. You can also subscribe to the CREAX
monthly innovation email newsletter.
All the News From All the Citizens
Back at the beginning of the 21st century, when blogs were beginning to receive some
attention, the Idea of using them for more than reflections on your daily life or tracking
visits to websites began to evolve into a notion of participatory or citizen journalism. A
Canadian company, NowPubllc [http://www.nowpubllc.com], one of Time magazine's Top
50 Web Sites of 2007, calls Itself "a crowd-sourced, participatory news network ... the
largest news organization of Its kind with contributing reporters in more than 5,500 cities
and 160 countries." In July 2008, NowPubllc purchased Nononina, Inc.'s Truemors
[http://truemors.nowpublic.com]. Truemors is another crowdsourced real-time content
aggregator that also features a Twitter News Network (TNN). Nononlna was founded by
former Apple evangelist Guy Kawasaki [http://www.guykawasaki.com] and two cohorts.
Nononina's newest venture is called Alltop [http://www.alltop.com], an aggregator of "news

websites and blogs for any given topic" (Alltop About page). There are lots of topics
covered at Alltop, but it does have some drawbacks. Even though It's timely and trendy,
Alltop has no RSS or Atom feeds, meaning you have to visit each site if you want to
subscribe to its content. Nor does Alltop have archives of past content or site-search
capabilities and, as the site and number of topics grow, the taxonomy might become
unwieldy. If you miss the top five items at any given time under each blog or syndicated
website, It's back to Google, which is Ironic given Alltop's promotion of Dan Roam's
cartoon explanation of Google versus Alltop [http://alltop.com/about/ nuggets. php].
In addition to getting Instant Inspiration from IT-centric, user-driven famous sites such as
Slashdot [http://slashdot.org], "news for nerds," and Kuro5hin [http://www.kuro5hin.org],
"technology and culture, from the trenches," other citizen news sites with trendy stories
Include the South Korean OhmyNews International [http://engllsh.ohmynews. com],
GroundReport [http://www.groundreport.com], NewsVine [http:// www.newsvlne.com]
owned by MSNBC, and Human Times [http:// humantimes.com]. Through its SourceWatch
project [http://www. sourcewatch.org], the Center for Media and Democracy maintains a
List of citizen journalism websites [http://www.sourcewatch.org/lndex. php?
title=List_of_citizen_journalism_websites].
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Organizing Creative and Innovative Bodies
Success in business is all about Innovating to remain competitive and retain or grow
market share. So it's not surprising that a number of organizations exist to legitimize the
field of creativity and Innovation management and provide accredited educational
opportunities. In addition to major multinational and International groups, several national
associations exist, such as the American Creativity Association
[http://www.amcreatlvltyassoc.org], the South Africa Creativity Foundation [http://www.sa
creativity.com], the Gesellschaft für Kreativität (German Association for Creativity)
[http://www. kreativ-sein.de], and the KreaNET Foundation In the Netherlands
[http://www.kreanet.net]. If you want to get up close and personal with your creativity, the
Creativity Coaching Association [http://www.creatlvltycoachlngassoclatlon.com] can help
you find a coach. It also offers an online training program.
Creative Education Foundation (CEF)
http://www.creativeeducationfoundation.org
This foundation was established in 1954 by Alex Osborn, who also coined the term
"brainstorming" and in the 1950s along with Sidney J. Parnes developed the Osborn-
Parnes Creative Problem Solving Process. The CEF sponsors an annual International
conference, possibly the oldest around, called the Creative Problem Solving Institute
[http://www.cpslconference.com].
European Association for Creativity and Innovation
http://www.eaci.net
EACI hosts a European conference on creativity and Innovation. If a proposal by the

European Commission is ratified by the EU Council and Parliament, 2009 may be
celebrated by the European Union as the European Year of Creativity and Innovation.
International Center for Studies in Creativity (ICSC)
http://www.buffalostate.edu/creativity
Located at Buffalo State College, N.Y., and founded in 1967, ICSC offers undergraduate
and graduate programs in creative studies. The college claims it is the only academic
Institution in the world that offers a graduate degree in creative studies. Many of Its theses
from the 1990s to at least 2006 are available as full-text documents from the site.
International Society for Professional Innovation Management (ISPIM)
http://www.ispim.org
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ISPIM was established in Norway in 1983 as outgrowth of work by professor Knut Holt at
the University of Trondheim beginning on 1973. Its mission is the "connecting of
academics, business leaders and consultants In the field of Innovation." ISPIM has hosted
an International conference in various countries since 1974. A few publications are online
for public access and the site carries a good selection of links to other organizations and
resources on Innovation management.
Product Development and Management Association (PDMA)
http://www.pdma.org
PDMA has more than 3,500 members. In September 2008, it held Its 32nd annual
conference in Orlando, FIa. The PDMA certifies practitioners through its New Product
Development Professional (NPDP) program. One of Its serial publications, Visions:
Insights into Innovation [http://www.visionsdigital.com], is available without membership.
Two academic journals in the field of business Innovation and creativity stand out: the
bimonthly Journal of Product Innovation Management, edited by C. Anthony Di Benedetto
and published by the Product Development and Management Association (ISSN 0737-
6782, online ISSN: 15405885, 1984-present) and Creativity and Innovation Management
(ISSN 0963-1690, online ISSN: 1467-8691, 1992-present), edited by Petra de Weerd-
Nederhof, Olaf Fisscher, and Klaasjan Visscher and published by Blackwell Publishing.
“The latter gives managers insights into introducing innovation within their organizations
and accelerating the development of creative performance in their staff” (Blackwell
Publishing).
Mycoted
http://www.mycoted.com
The site for this U.K. creativity company offers a wealth of creativity tools through its wiki
site, including an A-Z of creativity techniques.
Win Wenger's Project Renaissance
http://www.winwenger.com
Go to the excellent roundup of CPS Techniques (Creative Problem Solving)

[http://www.winwenger.com/mind.htm] for use in solo or group settings. His most famous
technique is called image-streaming, a purposeful kind of daydreaming.
Smashing Magazine
http://www.smashingmagazine.com
Page 142
Created in September 2006 for designers and web developers by Vitaly Friedman and
Sven Lennartz, this ezine is filled with all manner of visual inspiration, including a best-of-
the-month roundup and a selection of monthly desktop wallpaper calendars submitted by
graphic artists. Much of the work here is geared to Mac computers.
The Function Database [http://function.creax.com] and the Attribute Database

[http://attributes.creax.com], also from CREAX.com, let you explore knowledge relating to,
in the case of functions, actions that can change or affect a solid, liquid, gas, or field, and,
in the case of attributes, changing, decreasing, measuring, increasing, or stabilizing the
attributes of energy and mass as expressed through their physical nature and
measurement modes. Measure your creativity with the CREAX Creativity Self-
Assessment Test [http://www.creax.com/csa]. (Note: You must have Flash Player installed
in order to access the questionnaire.)
If you love to surround yourself with current marketing images for goods and services and
take inspiration from them all, Ads of the World [http://adsoftheworld.com] from
Jupitermedia Corp. should be your first stop. When I stopped by in early August and
reviewed the Research beta page, there were "2,225,014 ads, spanning 5 types, 39
countries, and 25 languages." The ads cover print, video, audio, internet, and outdoor
ads. You can search or browse through them right down to the ad agency and brand. The
Respect page contains a long, illustrated list of other sites about advertising, chiefly blogs.
You can also admire a selection of best ads from around the world dating back to
November 2007. For 19th- and 20th-century ads from the U.S., one of the best overall
resources comes from the Duke University Special Collection Library John W. Hartman
Center for Sales, Advertising & Marketing History's digital collections and databases of
print and outdoor advertising [http://library.duke.edu/specialcollections/hartman].
Conclusion
"I searched into myself."
-Roger von Oech, Innovative Whack Pack, card no. 19, inspired by Heraclitus (fl. 500
BCE)
All the texts and sites I've consulted preach one central tenant: the ability to have the
freedom within you to be creative. Should you want further motivation, make a New Year's
resolution to go out and celebrate World Creativity and Innovation Day andWeek
[http://creativityday.org], which happens every April 15 to 21. (April 21 is Leonardo da
Vinci's birthday.) You don't have to be a genius to be creative or innovative, you just need
to possess or cultivate the desire to bring forth ideas that might come true.
Page 143
Publication Information: Article Title: Reality Check for Your Muses: Creativity and
Business Innovation Resources. Contributors: David Mattison - author. Magazine Title:
Searcher. Volume: 16. Issue: 10. Publication Date: November/December 2008. Page
Number: 16+. © 2008 Information Today, Inc. Provided by ProQuest LLC. All Rights
Reserved.

← Examine the successful entrepreneur's unique attitudes about and approaches to
resources - people, capital and other assets;
← Identify the important issues in the selection and effective utilisation of outside
professionals, such as members of a board of directors, lawyers, accountants and
consultants;
← Examine decisions about financial resources;
← Discover the ways in which entrepreneurs turn less into more.
6.3.1: IDENTIFYING RESOURCES

Resources are those elements that are required to make a success of a venture.
THIS COURSE HAS A FUNDAMENTAL APPROACH TOWARDS RESOURCES NAMELY

THAT AN ENTREPRENEURSHIP IS THE PROCESS OF CREATING OR SEIZING AN
OPPORTUNITY REGARDLESS OF THE RESOURCES CONTROLLED.
The decisions on what resources are needed, when they are needed and how to acquire
these are strategic decisions that fit with the other driving forces of entrepreneurship.
Entrepreneurs should seek to control resources rather than owning them.
The advantages of this approach are:
← Capital. Capital required is smaller thus reducing financial exposure and the
dilution of the founder's equity.
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← Flexibility. Entrepreneurs who don't own a resource can commit or decommit

quickly. Response times need to be short if a firm is to be competitive. Decision
windows are small and elusive most of the time.
← Low sunk cost. Sunk costs are lower if the firm exercises the option to abort the
venture at any point.
← Costs. Fixed costs are lowered but variable costs may rise.
← Reduced risk. Risks such as the obsolescence of the resource are lower.
The following types of resources are required:
Human resources such as:
← The Board of Directors;
← Attorneys;
← Bankers and other lenders;
← Accountants;
← Consultants.
Financial resources
6.3.1.1: Bootstrapping (minimizing resources)
Article 4
Bootstrapping Techniques and New Venture Emergence
by John T. Perry , Gaylen N. Chandler , Xin Yao , James A. Wolff
Financial bootstrapping in new ventures refers to a variety of techniques that business

founders use to raise funds from nontraditional business funding sources (e.g., spouses,
friends and family) and limit business expenses (e.g., by utilizing used machinery,
delaying salaries) (Bhide, 1992; Payne, 2007; Winborg and Landstrom, 2001). For the
founders of new ventures, bootstrapping is a particularly important source of financing
because they often do not have access to traditional sources of business funding such as
bank loans, venture capital financing, and public equity (Stouder, 2002).
Although researchers have documented the types of bootstrapping techniques founders

use (Carter and Van Auken, 2005; Ebben and Johnson, 2006; Van Auken, 2004; Van
Auken, and Neeley, 1998), the literature is silent regarding the effectiveness of different
types of financial bootstrapping techniques. Are certain types of bootstrapping techniques
Page 145
more effective in helping a venture become operational? Are the founders who focus on
raising funds to support the venture more successful than those who focus on limiting
expenses? Are the founders who focus on obtaining money and free services from
individuals outside the venture more successful than those who focus on obtaining money
and free services from insiders? Research identifying and validating bootstrapping
techniques that facilitate new venture launch has significant implications for nascent
entrepreneurs.
In this research we provide answers to these questions. To do so, we review and integrate
the bootstrapping and organizational emergence literature. We build on earlier
categorizations of bootstrapping techniques to parsimoniously investigate differences in
effectiveness (Payne, 2007; Winborg and Landstrom, 2001). We utilize arguments
grounded in the resource-based view of the firm and institutional theory to develop
testable hypotheses regarding the effectiveness of different categories of bootstrapping
techniques. Subsequently we describe our sample, discuss the construction of the
variables, and describe the analytical method employed. Finally, we present the results of
our analysis and discuss our findings.
Theory Development
Our research model stipulates that different types of bootstrapping techniques have
different influence on whether a nascent venture emerges as an operational venture. We
use institutional theory and the resource-based view to develop hypotheses. Our
arguments are founded on a belief that acquiring resources that either increase cash or
decrease monetary costs from external sources helps build the social legitimacy of the
nascent business and leads to an increased probability of successful emergence. In this
section of the article, we define the constructs relevant to our arguments and develop
hypotheses.
This research is designed to focus on the relationship between bootstrapping and

organizational emergence. The creation of business organizations is a central issue in
entrepreneurship research. Hence the demarcation of organizational emergence is
important in spite of significant challenges in determining the point of emergence (e.g.
Gärtner and Carter, 2003). Our dependent variable, organizational emergence, is defined
as the transition point at which a nascent venture becomes an operational organization
(Carter, Gärtner and Reynolds, 1996;Tornikoski and Newbert, 2007). Although it is
recognized that organizational emergence is a process, there has been significant
discussion in the literature regarding the point in time at which a new venture can be
deemed a viable venture (Carter, Gärtner, and Reynolds, 1 996; Gärtner and Carter,
Page 146
2003). Of the researchers who have used the first Panel Study of Entrepreneurial
Dynamics (PSED I) to study organizational emergence (Lichtenstein, Carter, Dooley, and
Gärtner, 2007; Newbert, 2005;Tornikoski and Newbert, 2007), many have operationalized
organizational emergence as occurring when the venture's revenues exceed expenses.
Although arguments for other points in time could be constructed, we posit that the point
in time when revenues exceed expenses provides an indicator of a successful initial
experiment and provides a base for future development. Thus, building on this logic and
previous research, we also use positive cash flow as the indicator of when a venture
becomes operational.
The term "bootstrap "has been part of the business lexicon for decades. However, one of
the earliest uses of bootstrap in the academic literature was in a 1992 Harvard Business
Review article titled "Bootstrap finance:The art of startups" (Bhide, 1992). Bootstrap
finance was defined in this article as "launching ventures with modest personal funds"
(Bhide, 1992: 110). More recently, bootstrap finance has been defined as "the use of
methods for meeting the need for resources without relying on long-term external finance
from debt holders and/or new owners" (Winborg and Landstrom, 2001 : 235-236), and
described as a method by which entrepreneurs can "extend the runway" from which to
launch their business (Payne, 2007). Entrepreneurs often use bootstrapping techniques
because they lack access to traditional sources of capital, or because they wish to
maintain full control and ownership of their ventures, or both (Stouder, 2002). Specific
techniques include practices such as continued regular employment, investment of
personal savings, borrowing from family members, using personal credit cards, bartering
for needed goods and services, state and local government grants, and making pre-
agreements with suppliers and customers. (See Payne, 2007 and Winborg and
Landstrom, 2001 for a full listing of bootstrapping techniques.)
Research on bootstrapping has been largely descriptive. (See Table 1 for a summary.)
Early work in the area examined the types of bootstrap techniques that have been used
and the degree to which managers of companies (not just new ventures) have used them
(Van Auken and Neeley, 1 998). This is a necessary first step in the examination of any
important area. Researchers must first understand the "what' of an area before tackling
the "why" and "how." The descriptive work indicates that sole proprietorships and firms
outside the construction and manufacturing sectors are more likely to employ
bootstrapping techniques. In addition, research that examines the degree to which
entrepreneurs use bootstrap financing versus traditional forms of capital acquisition finds
that bootstrap finance usage is related to market size, perceived firm risk, recent funding
search (Van Auken, 2004), and the managers' assessment of their own ability (Carter and
Page 147
Van Auken, 2005). Moreover, the use of particular bootstrap techniques (e.g., delaying
payment to suppliers, customer related bootstrapping) is positively related to perceived
firm risk (Van Auken, 2004) and organizational age (Ebben and Johnson, 2006). Though
some contingent relationships have been part of the above work (e.g.VanAuken, 2004;
Ebben and Johnson, 2006), extension of the research from descriptive to normative is the
next step in the development of the bootstrap finance area as it relates to
entrepreneurship.
Cash-Increasing versus Cost-Decreasing Techniques
Bootstrap finance techniques can be categorized as cash increasing or cost-decreasing

(Payne, 2007). Cash-increasing techniques include continuing to work for others while
starting a new venture; obtaining funding from spouses, friends, family, and current
employers; obtaining a second mortgage; utilizing credit cards and personal financing;
and founders investing their own money in a venture. The assumption of these techniques
is that the money raised from using these techniques will be used to fund the venture.
Cash-increasing techniques add value by bringing cash to a venture that can be used for
multiple purposes. Cash-increasing techniques, therefore, are direct substitutes for
traditional forms of financial capital.
Cost-decreasing techniques include delaying payments to suppliers, deferring salaries,

utilizing used machinery, and obtaining professional services for free. Cost-decreasing
techniques add value to a venture by reducing the need for cash. Cost-decreasing
techniques are specific to tasks (e.g., free advice, deferred salaries) and they are not
transferable across tasks. They are not direct substitutes for traditional forms of financial
capital. Thus, the byproducts of cash-increasing and cost-decreasing techniques differ.
The byproduct of a cashincreasing technique is cash. The byproduct of a cost-decreasing
technique is a cost saving.
The resource-based view of the firm (RBV) contends that some resources are superior to
other resources and superior resources are more likely to serve as sources of competitive
advantage (Barney, 1991; Peteraf, 1993). Within an industry or competitive environment
(e.g., a pool of new ventures), the resources that organizations possess are
heterogeneous. Therefore, some organizations possess marginal resources and some
organizations possess superior resources. Superior resources allow an organization to
either produce goods or services more economically or incorporate elements that enable
premium pricing. Producing goods or services economically or incorporating elements
that enable premium pricing allows an organization to generate superior returns. Superior
returns then allows the organization to enjoy a competitive advantage (Peteraf, 1993). For
Page 148
new ventures, the successful utilization of bootstrap financing techniques can provide
them with potentially important resources, namely, cash and cost savings.
Because of the substitutability of cash, and the lack of substitutability of cost savings, we
view a cash-increasing technique as a means of obtaining a more valuable resource (i.e.,
a superior resource) than a cost-decreasing technique. We view the successful
employment of cash-increasing techniques as more likely to increase a venture's
likelihood of becoming operational (e.g., an indicator of organizational performance) than
the successful employment of cost decreasing techniques. Therefore we believe that the
founders of new ventures who successfully employ more cash-increasing bootstrapping
techniques than cost-decreasing techniques will be more likely to have their venture
become operational.
Hypothesis 1: Among nascent ventures, those whose founders successfully employ a

higher percentage of cash-increasing bootstrap finance techniques versus cost-
decreasing techniques will be more likely to become operational.
Internal versus External Bootstrapping Techniques
The bootstrap financing techniques of new venture founders can be categorized as being
internally oriented (within the direct control of the founders) or externally oriented
(requiring intervention from stakeholders outside the new venture). Building on new
venture research that has examined ventures' resources that derive from internal
capabilities and external networks (Lee, Lee, and Pennings, 2001), we extend the study of
internal and external resources to founders' financial bootstrapping efforts. Internal
bootstrapping techniques include founders' continuing to work for others while starting a
new venture, deferring salaries to themselves, obtaining a second mortgage, utilizing
credit cards and personal financing, investing their own money in a venture, utilizing used
machinery, and providing free services to the venture. External techniques include
obtaining funding from friends, family, and current employers; delaying payments to
suppliers; and obtaining professional services for free from outsiders.
Within the institutional theory-based organizational emergence stream, researchers have

found that ventures in which founders undertook actions designed to legitimize their
nascent venture to prospective customers and suppliers (e.g., they developed a model or
prototype, purchased materials, bought or rented facilities and equipment, hired
employees, and began promotional efforts) were more likely to have made a sale than
those that did not engage in these activities (Newbert, 2005). Researchers have also
found that legitimization activities undertaken with respect to a broader context of
business community institutions (e.g., marketing or promotion efforts, projecting financial
Page 149
statements, opening a bank account, becoming listed in a telephone book, becoming

listed with Dun and Bradstreet, asking for funds, and establishing credit with suppliers)
improved a venture's likelihood of being perceived as an operating organization
(Tornikoski and Newbert, 2007). Neither of these research streams, however, have
addressed whether founders' financing choices, in particular, their bootstrapping
practices, have affected their ventures' ability to become operational.
To be successful, internal bootstrapping techniques do not require external validation.

Therefore they are not dependent on conforming to institutional norms. On the other hand,
to be successful, external bootstrap finance techniques do require external validation. This
means that whereas the successful employment of internal techniques include cash and
cost savings, which are valuable to a new venture, the successful employment of external
techniques include cash, cost savings, and a greater sense of social legitimacy. Greater
legitimacy can then help generate more resources for a venture. Therefore, we believe
that ventures that successfully employ greater levels of externally oriented techniques will
be more institutionalized and have a greater sense of legitimacy than the ventures that
employ more internal techniques; and a greater sense of legitimacy will provide these
ventures with a greater likelihood of becoming operational.
Institutional theory contends that stakeholders in organizational fields have preferences

and values that firms ignore at their peril. Stakeholders are comfortable with these
preferences and values and subtly coerce organizations to conform to them by rewarding
the conforming organizations with resources and punishing the nonconforming
organizations by withholding resources. The resources they offer motivate organizations
to conform, and thus the preferences and values become institutionalized (Perrow, 1986).
For new ventures, the resources offered to conforming ventures also include social
legitimacy, which is crucial to a new venture's likelihood of survival (DiMaggio and Powell,
1983; Meyer and Rowan, 1977; Tornikoski and Newbert, 2007).
The process of conforming to institutional norms (i.e., stakeholders' preferences and

values) implicitly involves an externalization process, a process of conforming to and
validating with external stakeholders' preferences and values rather than internal firm
preferences and values (Perrow, 1986). Once an organization conforms to institutional
norms, external stakeholders then provide resources to the organization, including a
greater sense of organizational legitimacy and increased capital. Institutional theory
suggests the greater sense of legitimacy and resources will improve the organization's
likelihood of survival compared to other organizations that do not receive external
resources (Meyer and Rowan, 1977). For new ventures, the successful utilization of
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bootstrapping techniques that appeal to external stakeholders may provide ventures with
greater legitimacy and resources.
Hypothesis 2: Among new ventures, those whose founders successfully employ a higher
percentage of externally oriented bootstrap financing techniques versus internally oriented
bootstrap finance techniques will be more likely to become operational.
Methods
To test our hypotheses, we used data from the PSED I dataset. The PSED I dataset is
composed of 830 individuals who were in the new venture process when the study began
and 431 comparison individuals. (For more information about the PSED, see Gärtner,
Shaver, Carter, and Reynolds, 2004.) To limit our sample to only new ventures, we used
kscleans (Shaver, 2006), a publicly available SPSS syntax file, to reduce the sample. In
using kscleans, we eliminated the comparison individuals and six ventures that should
have been screened out of the dataset because they did not qualify as new ventures (i.e.,
at the beginning of the study, these ventures had positive cash flow). Finally, we
eliminated ventures that were spin-offs of other companies (i.e., nonpersons owned more
than 50% of the venture). This resulted in a sample of 817 new ventures. Excluding
ventures with missing data further reduced the sample size. The final sample consisted of
207 ventures at time 1 (one year after the beginning of the PSED study) and 157 ventures
at time 2 (two years after the beginning of the study). Although PSED data were collected
annually for three years after the beginning of the study, data were not collected from all of
the ventures in the sample for all three years. In particular, data were collected from
ventures started by minority groups for only two years (Gärtner et al., 2004). Therefore, in
the interest of producing generalizable results, we did not examine data from the final
PSED wave.
Measures
Organizational Emergence
Items R621 and S621 from the PSED asked, does the venture's monthly cash revenue
exceed monthly expenses? If the respondent answered yes, this variable was coded as 1
. Otherwise it was coded as O. R621 and S621 were items collected in the second and
third waves of the PSED (i.e., one and two years after the initial data collection). Following
the advice of Schaubroeck (1990), we used lagged dependent variables as a means of
showing that our independent variables, which were collected in the initial data collection
wave, were related to later organizational performance.
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In terms of independent variables, the PSED dataset contains information about founders'
use of 10 bootstrapping items: continuing to work for others, employer financing, family
and friend financing, owner investing, spousal financing, using a second mortgage, using
credit cards, using free helper-provided services, using free owner-provided services, and
using personal financing,
To test our hypotheses we separated bootstrapping items into four categories represented
by a 2x2 matrix.
Percentage of Techniques Used that Are Cash Increasing and External This variable
represents the percentage of all the bootstrapping techniques that a venture used that
were cash-increasing and external. These included spousal financing, family and friend
financing, and employer financing.
Percentage of Techniques Used that Are Cash Increasing and Internal This variable
represents internally oriented cash-increasing techniques. It is operationalized as the
percentage of all of the bootstrapping techniques used that fit these categories and
included using a second mortgage, using credit cards, using personal financing, owner
investing, and continuing to work for others.
Percentage of Techniques Used that Are Cost Decreasing and External This variable
represents externally oriented cost-decreasing techniques. It includes using free helper-
provided services.
Percentage of Techniques Used that Are CostDecreasing and Internal This variable
represents internally oriented cost-decreasing techniques and includes using free owner-
provided services.
To control for other explanations of why new ventures become operational, we included
several control variables.
Entrepreneurial Experience. Within the knowledge based organizational emergence

stream, founders' entrepreneurial experience (the number of new ventures an
entrepreneur or entrepreneurial team has helped start) and industry experience has often
been used as an indicator of knowledge-based resources available to the firm.
Entrepreneurial experience, as measured by the number of new ventures an entrepreneur
or entrepreneurial team has helped start, has been shown to be positively related to a
new venture's likelihood of survival (Delmar and Shane, 2006; Klepper, 2001; Stuart
andAbetti, 1990; Taylor, 1999). Therefore we control for entrepreneurial experience by
using PSED item Q200 for solo entrepreneurs and PSED item Q214 for teams.
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Industry Experience. The startup team's industry experience has been shown to be
positively related to a new venture's likelihood of survival (Bates and Sevron, 2000;
Bosnia, van Praag, Thurik, and de Wit, 2004; Bruderl, Preisendorfer, and Ziegler, 1992;
Bruderl and Preisenforfer, 1998; Gimeno et al., 1997;van Praag, 2003;Wicker and King,
1989). Therefore, we control for industry experience (the number of cumulative years of
experience of all team members in the venture's industry) by using PSED item Q 199 for
solo entrepreneurs and PSED item Q213 for teams.
Total Amount of Money Raised. Arguing from a resource-based perspective, new venture
researchers have suggested that the amount of money provided to a startup will relate
positively to the likelihood that the venture will be successful (Bruderl et al., 1992; Brush,
Greene, and Hart, 2001; Shane and Stuart, 2002). The amount of money provided can
include money raised by bootstrapping, but it can also include money raised from
traditional funding sources (i.e., loans and investments from parties not associated to the
venture or its founders). Traditionally, the founders of new ventures have experienced
difficulty raising funds from traditional sources (Stouder, 2002;Winborg and Landstrom,
2001). Nevertheless, for those ventures that do receive funding from traditional funding
sources, this funding may increase their likelihood of becoming operational. Therefore we
control for the amount of money that a venture has or will receive in funding from
traditional funding sources. This amount includes money that a venture has or will receive
from bank loans, Small Business Administration loans, and venture capitalists.
Growth Propensity. New venture research has found that the performance of a new
venture, including whether a venture successfully becomes an operational company,
depends, in part, on the threshold performance level of the venture (i.e., the level of
performance that the venture's founders view as acceptable; Gimeno et al., 1997). This
finding suggests that a lower threshold performance level would allow a venture to exist
for a longer period of time, which may increase a venture's likelihood of becoming an
operational company. A way of capturing a founder's threshold performance is by
determining his or her ambitions for the future size of the venture. If the founder wants the
venture to grow as large as possible, then his or her threshold performance might be low.
That is, the founder may not be willing to allow the new venture to flounder for a long
period of time without becoming operational. Conversely, if the founder wants the venture
to be a size that is manageable by a few key employees and him or her, then the
founder's threshold performance may be higher. That is, the founder may be willing to
allow the venture to grow slowly and take a while before becoming operational. We used
PSED item Q322 to capture this variable. The item asks for the respondent's preference
for the future size of the venture. We coded this variable as O if the respondent answered
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that he or she "wants a size I can manage myself or with a few key employees," and we
coded it as 1 if the answer was "I want it to be as large as possible."
Industry. Lastly, new venture research has suggested that in some industries in which
large barriers to entry exist (e.g., biotechnology industries), attaining successful
performance (e.g., becoming operational) may take a longer time than in other industries
(Stouder, 2002). To control for industry effects, we coded each venture's industry using the
PSED item SUSECTlO to identify a venture's industry. This item categorizes a venture's
industry into 11 categories. We excluded the industries that were not represented in the
sample (i.e., mining and other). Eight dummy variables were then used to represent
whether the venture is in a given industry. They are (1) agriculture, forestry, or fish
industries; (2) construction; (3) manufacturing; (4) transportation, communication, or
utilities industries; (5) wholesale trade; (6) retail trade; (7) financial, insurance, or real
estate industries; and (8) public administration. Services was the omitted industry.
Results
Descriptive statistics and correlations of the study variables are displayed in Table 2. The
correlations show that the four independent variables, the percentages of techniques used
that are cash increasing and internal, cash increasing and external, cost decreasing and
internal, and cost decreasing and external, are significantly and negatively correlated
(r=.42, r=-.4l, r=-.54, r=-.l4, r=-.ll, and r=-.28).This is expected because the categories are
interdependent in such a way that collectively they sum to 1.00. Therefore, an increase in
one variable will often be related to decreases in other variables.
Table 3 displays the results of hypothesis testing. Because of the binary nature of the
dependent variable in the two time periods examined, we used binary logistic regression
to test the hypotheses. Also, following the counsel of the PSED architects (Gärtner et al.,
2004), we used weighted items in our analyses.
Hypothesis 1 stated that among new ventures, those that have founders who successfully
employ a higher percentage of cash-increasing bootstrapping techniques versus
costdecreasing techniques will be more likely to become operational. Significant results at
Time 2 indicate that the ventures of founders who use a higher percentage of techniques
that are cash-increasing and external are more likely to become operational than the
ventures of those who use a lower percentage (b=3.12,Wald=5.6l,p <.05).AtTime 1 ,
however, the results do not indicate that cash-increasing techniques influence which
ventures obtain positive cash flow. Taking into account the results of both cash-increasing
independent variables in both periods, it appears that the results are inconclusive.
Therefore, hypothesis 1 is not supported.
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Hypothesis 2 stated that among new ventures, those that have founders who successfully
employ a higher percentage of external bootstrapping techniques versus internal
bootstrapping techniques will be more likely to become operational. As noted above,
significant results at Time 2 indicate that the ventures of founders who use a higher
percentage of techniques that are cash-increasing and external are more likely to become
operational than the ventures of those who use a lower percentage (b=3.12, Wald=5.6l, p
<.05). Additionally, significant results at Time 1 indicate that the ventures of founders who
use a higher percentage of techniques that are cost-decreasing and external are more
likely to become operational than the ventures of those who use a lower percentage
(b=1.53, Wald=4.03, p <.05). Taking into account the results of all the external techniques,
we find that in both time periods, a higher percentage of external techniques is related to
a venture's positive cash flow. Therefore, hypothesis 2 is supported
Note that we used cumulative measures of the entrepreneurial experience and industry
experience variables. That is, to measure these items, we looked at the cumulative
number of companies that all founders had helped start and the cumulative number years
of industry experience by all venture founders. We did so because we argued that the
cumulative experience of all founders would matter more to organizational emergence
than the mean experience of each founder. This argument, however, suggests that
founder teams should have greater success at bringing a venture to organizational
emergence than solo founders, because founder teams will generally have greater
cumulative experience than solo founders. To challenge this argument, we performed
supplementary analysis in which we recalculated entrepreneurial experience and industry
experience to equal the team means, and we then used these means in our analysis
instead of the cumulative it ems. The results did not significantly change the results.
Discussion
Our major finding is that external bootstrapping techniques, both cash-increasing and
cost-decreasing, are positively linked to successful organizational emergence. This study
adds to the nascent entrepreneurship literature that is increasingly showing that
institutional forces that increase a venture's social legitimacy play large roles in
determining whether ventures become operational (Delmar and Shane, 2004;Tornikoski
and Newbert, 2006). For new ventures seeking to become operational, resources
provided externally are more valuable than resources provided internally This may be
because external parties can provide a sense of legitimacy to new ventures that they do
not obtain from internal resources - and this legitimacy may contribute to a venture's
becoming operational.
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Conversely, internal bootstrapping techniques are not significantly related to a venture's

becoming operational. The key difference between external and internal techniques that
may allow external techniques to be significantly related to the likelihood of a venture's
becoming operational may be largely due to the greater sense of legitimacy that
successfully employed external techniques offer.
In drawing conclusions from this study, our evidence suggests that the use of external
bootstrapping techniques at least partially meets the requirements of explaining causality.
That is, to try to show a causal link between bootstrapping techniques and organizational
emergence, we lagged the collection of the dependent variable. In addition, we included
several control variables. The relationship between external bootstrapping practices and
organizational emergence remain significant after control variables are entered into the
equation. However, there may be other factors that we have not considered that might
offer a competing explanation.
The study does have some limitations. First, it is somewhat limited because the PSED
collected data related to only 10 bootstrapping variables, and previous bootstrapping
research has identified 32 bootstrapping techniques (Winborg and Landstrom, 2001). In
addition, our theoretical framework is partially derived from institutional theory, but we did
not directly examine conformity to institutional norms. Instead we examined the
successful result of external bootstrapping (i.e., whether founders were able to obtain
resources from outside the venture). We assumed that if founders successfully employed
external techniques, they must have conformed to institutional norms.
We suggest three ways in which this study could seed future research. First, it would be
useful to verify if the internal/external and cost-decreasing/cash-increasing schema we
used to categorize bootstrapping techniques is adequate when using the 32 bootstrapping
techniques previously identified (Winborg and Landstrom, 2001). Second, future research
should include measures of legitimacy-seeking behavior in order to confirm our argument
that external techniques are more efficacious because they conform to institutional theory
arguments. Third, the study could be broadened to analyze other legitimacy seeking
behaviors. For example, one way that founders may attempt to gain legitimacy is by
managing the impression of their ventures in the eyes of important stakeholders and
potential stakeholders (Elsbach, 1994). Thus, future research could examine whether the
successful employment of certain impression management techniques influences external
stakeholders, and consequentially, a venture's likelihood of becoming operational.
This research has some obvious implications for practice. Our results indicate that
ventures moving toward emergence are more likely to be successful by employing
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externally oriented bootstrapping techniques that both increase cash and decrease costs.
Reliance on internally oriented techniques is not significantly associated with
organizational emergence.
In conclusion this research makes some significant contributions. First, it provides new
insights into bootstrapping, an important facet of venture emergence that has not received
a great deal of research attention. Second, it goes beyond simply describing
bootstrapping by showing that external techniques are more efficacious with respect to
the successful emergence of a new venture than internal techniques. Third, it is able to
provide some evidence for causality by examining relationships across multiple time
periods. Finally the results are not likely to be influenced adversely by recall bias because
the PSED data were collected during the process of organizational emergence at multiple
time periods.
Publication Information: Article Title: Bootstrapping Techniques and New Venture

Emergence. Contributors: John T. Perry - author, Gaylen N. Chandler - author, Xin Yao -
author, James A. Wolff - author. Journal Title: New England Journal of Entrepreneurship.
Volume: 14. Issue: 1. Publication Year: 2011. Page Number: 35+. © 2011 College of
Business, Sacred Heart University. Provided by ProQuest LLC. All Rights Reserved.
A strategy of multistage commitment of resources with a minimum commitment at each

stage or decision point.
Thus at each step, the entrepreneur accomplishes more with a little less.
Amar Bhide explained, "For the great majority of would-be founders, the biggest challenge
is not raising money but having the wits and hustle to do without it."
6.3.1.2: Using other people's resources (OPR)
The key is to control resources, not own them;
Techniques in modern day refer to "outsourcing" — or using them when you need them;
Other people's resources can include money invested or loaned from friends, relatives,
and so on. Also people, space, equipment or other material loaned or provided
inexpensively or free by customers or suppliers, or secured by bartering future services;
Use social assets such as friendship, trust, obligation and gratitude to secure resources at
prices far lower than the market price.
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6.3.2: OUTSIDE PEOPLE RESOURCES
6.3.2.1: The board of directors
The decision of whether to have a board of directors is influenced first by the form of
organisation chosen for the firm.
Certain investors will require a board of directors. Venture capitalists almost always
require boards of directors and that they be represented on them.
Outside directors can provide relevant experience, know-how and networks.
Having a board of directors will necessitate greater disclosure to outsiders of plans for
operating and financing the business. The board of directors also elects officers for the
firm, so the decision to have a board of directors is tied to decisions about financing and
ownership of voting shares.
The expertise that members of a board can bring to a venture can far outweigh any of
these negative factors.
Once the decision to have a board of directors has been made it is important to be
objective and to select people who are known to be trustworthy.
The process involves finding the right people to fill the gaps discovered in the process of
forming the management team.
New ventures are finding that for a variety of reasons, people who could be potential
board members are increasingly cautious about getting involved:
Liability: In South Africa, directors can be held liable for the debts of a company ("reckless
trading"). A director can be held liable for bad decisions unless he can prove he acted in
good faith.
Harassment: Outside stockholders who have unrealistic expectations about the speed at
which a return can be realised are a source of continual annoyance for boards.
Time and risk: It takes more time and intense involvement to work with an early-stage
venture with sales of R1.5 million or less, than with one having sales of $25 - $50 million
or more. The former is also riskier.
An informal group of advisors can be used instead. This has certain advantages, mainly
that such informal groups have no "formal authority" which can cause the entrepreneur
difficulties.
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6.3.2.2: Attorneys
Almost all businesses need the services of an attorney at some stage. Attorneys can fill
many gaps and needs, depending on the nature and size of the business.
The following are areas of the law that entrepreneurs will most likely need to get
assistance with:
← Incorporation. The form of ownership chosen is important. Issues such as

forgivable (e.g. when interest on debts can be exchanged for warrants or direct
equity) and unforgivable liabilities of founders, officers and directors are also
important.
← Franchising and licensing. Innumerable issues concerning future rights,

obligations and non-performance by either a franchisee/lessee or a
franchiser/lessor require specialised legal advice.
← Contracts and agreements. Firms need assistance with contracts, licenses, leases
and other such agreements.
← Formal litigation, liability protection and so on. Sooner or later most entrepreneurs
will find themselves as defendants in lawsuits and require counsel.
← Real estate, insurance and other matters. All entrepreneurs are involved in various
kinds of real estate transactions, from rentals to purchase and sale of property.
← Copyrights, trademarks, patents and intellectual property protection. Products are

hard to protect. An entrepreneur facing a loss of a $2,5 million sale of his business
if his software was not protected obtained the services of a lawyer who devised
powerful protections such as internal clocks in the software that shut down the
software if they were not changed.
← Employee plans. Benefit and stock ownership plans have become complicated to
use effectively and to administer. They require specialised know-how.
← Tax planning and review. Entrepreneurs who worry more about finding good
opportunities to make money, rather than tax shelters are better off.
← State and other regulations and reports. Violations of state and other regulations
often can have serious consequences.
← Mergers and acquisitions. There is specialised legal know-how in buying or selling

a company.
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← Bankruptcy law. If a company that has not paid various State taxes in order to use
that cash in their business goes bankrupt, then the owners, officers and often the
directors are held personally liable for those obligations.
← Other matters. These can range from collecting delinquent accounts to labour
relations.
← Personal needs. As entrepreneurs accumulate net worth, legal advice in estate,

tax and financial planning is important.
In securing an attorney it is essential to make sure that the attorney has the necessary
skills, knowledge and infrastructure to handle the requirements of the business.
Small attorney practices are normally limited in their available services and capacity
infrastructure to handle large and complex matters.
Corporate practices normally have a broad scope of services available in-house, but they
are also more expensive.
Choose the right legal advisor for the right reasons.
6.3.2.3: Bankers and other lenders
Most companies will need the services of a banker or other lender at some time.
The decision to have a banker can also involve how a banker or lender can serve as an
advisor. The banker or lender needs to be a partner and the entrepreneur will therefore be
well advised to pick the right banker or lender although picking the right bank or institution
is also important.
6.3.2.4: Accountants
The accounting profession has changed from being merely "bean counters" to more
professional business advisors.
The right accountant is an invaluable source for the entrepreneur who needs objective
advice regarding a range of services provided by the profession.
In selecting accountants the entrepreneur will need to address several factors:
← Service. Levels of service offered and the attention likely to be provided need to
be evaluated. Both will be higher in a small firm start-up firm than a big one.
← Needs. Both current and future needs have to be weighed against the capabilities
of the firm. Larger firms are able to handle highly complex or technical problems,
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while smaller firms may be preferable for general management advice and
assistance.
← Cost. Most big firms will offer cost-competitive service to start-ups with significant
growth and profit potential. Services of a larger firm are more expensive if the
attention of a partner is needed.
← Chemistry. Always an important consideration.
The right accountant is competent, does not need to look up information often and is
interested in and informed on managerial issues.
6.3.2.5: Consultants
Specialists hired to do a specific job or to solve a specific problem not filled by the
management team.
Start-ups normally require help with critical one-time tasks and decisions that will have a
lasting effect on the business. Compare for instance machine placement and factory
layout, or employment agreements.
Consultants are employed by start-ups for 3 main reasons:
← To compensate for a lower level of professional experience.
← To target a wide market segment (possibly to do market research for a consumer

goods firm).
← To undertake projects which need a large start-up investment in equipment.
Consultants often offer unbiased and fresh views of problems and possible pitfalls.
Consultants are expensive and care should be exercised in choosing the right balance of
skill, knowledge and style.
There are certain qualities that one should look for before engaging the services of a
consultant:
← A shirtsleeve approach to the problems.
← An understanding attitude toward the feelings of managers and their subordinates.
← A modest and truthful offer of services and an ability to produce results.
← A reasonable and realistic charge for services.
← A willingness to maintain a continuous relationship.
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← Always ensure that the consultant is exactly sure of what is expected. This will not
only ensure that the desired result is achieved, but also that unnecessary expense
is incurred.
Please refer to Chapter 11 of this reading module for more information on financial
resources for the new venture
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← ENTREPRENEURIAL FINANCE

0 Examine critical issues in financing new ventures;
1 Study the difference between entrepreneurial finance and conventional
administrative or corporate finance;
2 Examine the process of crafting financial and fund-raising strategies and the
critical variables involved, including identifying the financial life cycles of new
ventures and a financial strategy framework.
7.2.1: VENTURE FINANCING: THE ENTREPRENEUR'S ACHILLES

HEEL
There are three core principles of entrepreneurial finance:
6912 More cash is preferred to less cash
6913 Getting cash sooner is preferred to getting cash later
6914 Less risky cash is preferred to more risky cash
Financial analysis is of vital importance and strategic and financial decisions must be
linked. There is a complex interplay between financial management and business
strategy.
7.2.1.1: Critical financing issues
The central issues in entrepreneurial finance are:
0 Creation of value
1 How the value pie is sliced and divided among those who have a stake
or have participated in the venture
Handling of the risks inherent in the venture
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Exhibit 8
Developing financing and fund-raising strategies, knowing what alternatives are available
and obtaining funding are tasks vital to the survival and success of high potential
ventures.
As a result, entrepreneurs face certain critical issues and problems, which bear on the
financing of entrepreneurial ventures, such as:
0 Creating value: For whom value must be created or added to achieve a positive
cash flow and to develop harvest options?
1 Slicing the value pie:
2 How are deals structured and valued and what are the tax consequences of the
structures?
3 What is the legal process and what are the key issues involved in raising outside
risk capital?
4 How do entrepreneurs make effective presentations of their business plans to

financing and other sources?
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0 How can entrepreneurs apply the micro-computer and applications software to the
financial analysis and evaluation that flow from the above questions?
1 What are some of the pitfalls that need to be anticipated?
2 How critical and sensitive is timing in each of these areas?
3 Covering risk:
4 How much money is needed to start or expand the business and where, when and
how can it be obtained on acceptable terms?
5 What sources of risk and venture capital financing are available and how is it
obtained?
6 Who are the financial contacts and networks that need to be accessed and
developed?
7 How do successful entrepreneurs marshal! the necessary financial resources to

seize and carry out opportunities and what pitfalls do they manage to avoid and
how?
7.2.1.2: Entrepreneurial finance: the owner's perspective
It is important to note that there are absolute and subtle differences between
entrepreneurial finance (private emerging firm) and corporate (large established
company) firm. Consider the following:
0 Cash flow and cash: Cash flow and cash are king and queen in entrepreneurial
finance. Earnings per share, the use of tax codes and rules of the Securities and
Exchange Commission are not.
1 Time and timing: Entrepreneurial financing is more sensitive and vulnerable to

the time dimension. Time is shorter and financing moves are subject to wider more
volatile swings from lows to highs and back.
2 Capital markets: Capital markets for entrepreneurial finance are relatively

imperfect because they are often inaccessible, unorganised and often invisible.
3 Emphasis: Capital is one of the least important factors in the success of higher
potential ventures. Entrepreneurs seek know-how, wisdom, counsel and help
rather than just the best deal or share price.
4 Strategies for raising capital. Venture capitalists commit money for a 3 to 18

month phase followed by subsequent commitments based on results and promise.
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This decreases the risk for them but on the other hand entrepreneurs may refuse
excess capital when they believe the valuation will rise substantially in the future.
0 Downside consequences: Consequences of financing strategies are much more

personal for owners of new emerging ventures than for managements of large
companies since personal guarantees of bank or other loans are common.
1 Risk/reward relationships. While the high-risk/high-reward (and the opposite)

relationship works well in mature and relatively perfect capital markets, just the
opposite occurs all too often in entrepreneurial finance. Some of the most
profitable venture investments have been quite low- risk propositions from the
outset.
2 Valuation methods. Established company valuation methods favour the seller

rather than the buyer of entrepreneurial companies. These methods can be
grossly misleading for valuation of smaller private firms.
3 Conventional financial ratios. Current financial ratios are misleading when

applied to most private entrepreneurial companies. Entrepreneurs often own more
than one company at once and move cash and assets from one to another. Also
many of the most important value and equity builders in the business are off the
balance or are hidden assets, e.g. the best scientist.
4 Goods. Financial strategies are geared to build value, often at the expense of
short-term earnings. The growth required to build value is often heavily self-
financed, thereby eroding possible accounting earnings.
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7.2.2: THE FINANCIAL STRATEGY FRAMEWORK
The opportunity leads and drives the business strategy, which in turn drives the financial
requirements, the sources and deal structures and the financial strategy. Once the core of
the market opportunity and the strategy for seizing it are well defined, an entrepreneur
can then begin to examine the financial requirements in terms of:
0 Operating needs i.e. working capital for operations (salaries, rent, electricity)
1 Asset needs i.e. for startup or for expansion facilities, equipment, research and
development and other one-time expenditures (vehicles and equipment)
Free Cash Flow: Burn Rate, OOC and TTC
The core concept in determining the external financing requirements of the venture is free
cash flow.
0 Burn rate. The rate at which cash is absorbed in the business.
1 OOC. Out of cash (time span before you will run out of cash).
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0 TTC. Time to clear (closing the financing deal and have the cheque cleared
through the bank). These are critical because they have a major impact on the
entrepreneur's choices and bargaining power with sources of capital. Ideally, raise
money when you do not need it.
7.2.3: FUND RAISING STRATEGIES
7.2.3.1: Critical variables
Factors that affect the availability of the various types of financing and their suitability and
cost:
0 Accomplishments and performance to date.
1 Investor's perceived risk.
2 Industry and technology.
3 Venture upside potential and anticipated exit timing.
4 Venture anticipated growth rate.

7.1) Briefly describe the advantages of controlling but not owning resources for the
entrepreneur.
7.2) Briefly describe how the entrepreneur can turn less into more by using OPR.
7.3) When would entrepreneurs make use of consultants?
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STUDY UNIT 5: DIVERSE ISSUES IN

ENTREPRENEURSHIP: THE ENTREPRENEURIAL
MANAGER
0 THE ENTREPRENEURIAL MANAGER

0 Know why an entrepreneur can be both entrepreneur and manager;
1 Explain the stages of growth of an entrepreneurial venture;
2 Identify specific skills required by entrepreneurs.
8.2.1: INTRODUCTION
The growing enterprise requires that the founder and his team develop competencies as
entrepreneurial managers.
Conventional theory states that a good entrepreneur is not a good manager because he
or she lacks the necessary management skill and experience. It is also assumed that a
manager is not an entrepreneur because he or she lacks some intense personal qualities
and the orientation required to launch a business from scratch.
However, recent evidence suggests that entrepreneurs can be successful managers and
that most successful entrepreneurial ventures succeed beyond start-up because the
founder entrepreneurs also have effective management skills.
A 1983 survey by Inc. magazine of the heads of the top 100 ventures showed that the
majority of these companies had founders who were still chief executive officers after
several years and after their companies had attained sales of at least $10 million.
There are three reasons that founders have to adapt to make their ventures succeed:
0 Shift from creation to exploitation;
1 Shift from passionate commitment to dispassionate objectivity;
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0 Shift from direct personal control over organizational action to indirect impersonal
control.
In summary, one should conclude that there is a balance between entrepreneurial skills
and management skills but growing a higher potential venture requires management
skills.
8.2.2: PRINCIPLE FORCES AND VENTURE MODES

Companies, new, growing or mature, occupy a place in either an administrative or an
entrepreneurial field, an area influenced by certain principle forces and characterised by
ways of acting called venture modes.
0 A new venture in start-up stage which is characterised by high change and

uncertainty, is mostly in entrepreneurial (venture mode). These firms will be new,
innovative ventures led by a team, driven by their founders' goals, values,
commitment, and perception of the opportunities and will minimise the use of
resources (driving forces);
1 A mature firm, one which is in the maturity stage and characterised by low change
and uncertainty, one which is stable and led by an administrator or custodian,
(venture mode) and driven by resource ownership and administrative efficiency
and is reactive (driving forces).
The managerial skills in the various modes where the business finds itself in, will differ:
0 Firms in the entrepreneurial domains require creativity and comprehensive

managerial skills. Entrepreneurial managers need to cope effectively with high
levels of change and uncertainty. Their management skills can be affectionately
labeled MBWA (management by wandering around). As the firm enters the high
growth stage, this changes.
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8.2.3: STAGES OF GROWTH
There is no doubt that a business follows this process. The stages may not always be this
exact in reality, but will be characterised by jagged ups and downs. These are the crucial
transition phases of a business and the different management requirements of each
stage.
8.2.3.1: Start-up
This stage usually covers the first two or three years but can be as many as seven. It is by
far the most perilous stage and requires exhaustive drive and energy of the founder(s).
The critical mass of people, market and financial results, and competitive resiliency are
established. Investor, banker and customer confidence is earned. Sales range between
$2 and $20 million dollars.
8.2.3.2: High growth
The most difficult challenge for a founding entrepreneur occurs during this stage, when he
or she finds it is necessary to let go of power and control over key decisions and
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responsibilities have to be delegated with abdicating leadership and responsibility. The

length of time it takes to go through this stage varies greatly but can take six to eight
years.
8.2.3.3: Maturity
The key issue now is no longer survival but one of steady, profitable growth. This stage
can take five to 10 years.
8.2.3.4: Stability
A period of steady sales growth is experienced
8.2.4: MANAGING FOR RAPID GROWTH

This requires a management orientation not found in mature and stable environments.
0 Results usually require close collaboration of a manager with other people than his
own subordinates;
1 Managers have responsibilities far exceeding their authority. The belief that one's
responsibility must equal one's authority can be counterproductive irapid-growth
venture;
2 Everyone is committed to making the pie larger and power and influence is
derived not only from achieving one’s own goals, but also a contribution towards
the achievements of others;
3 Successful entrepreneurial managers understand their inter-dependencies and

have learned to incorporate mutual respect, openness, trust and mutual benefit
into their management style;
4 The awareness and practice of give and take for mutual gain is fundamental to a
progressive style of management.
8.2.4.1: Entrepreneurial transitions
Growing ventures face different circumstances and probable crises such as the erosion of
founder creativity, confusion and resentment over roles, responsibilities and goals and the
desire for control;
In the high growth stage the following are found:
0 Change;
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0 Ambiguity;
1 Uncertainty;
2 Risk;
3 Shrinkage of time.
The venture must cope with new customers, new technologies, new competitors, new
markets and new people. Where technological change is an issue, time is extremely
important. In the computer business it takes only 9 to 12 months for technology
obsolescence to set in.
0 Entrepreneurial management is characterised by nonlinear and nonparametric

events. Events do not follow straight lines or even appear related. They occur in
bunches and in leaps. For example a firm may double its sales force in 15 months
rather than over eight years.
1 The management team may be relatively inexperienced because the unique

events that lead to the birth and growth of such a business cannot be replicated.
2 There are counterintuitive unconventional patterns of decision-making. A traditional

approach to developing and introducing new products in an uncertain marketplace
may not always be the best approach. Most rapid growth companies have many
excellent alternatives that can be very successful.
3 These businesses defy conventional organisational patterns. If an organisational

chart does not exist it does not mean casualness or sloppiness, rather it translates
into responsiveness and readiness to absorb rapid changes.
4 There exists a common value system which is difficult to articulate and measure,
and is evident in behaviour and attitudes. The team has the attitude of "being in
this thing together" and they are unconcerned about personal power and status.
This entrepreneurial climate also exists in larger businesses. Such a climate
attracts and encourages entrepreneurial achievers and it perpetuates the intensity
and pace characterised by high growth businesses. Applying entrepreneurial
principles to the traditional corporation is known as the postentrepreneurial
revolution.
8.2.5: KNOWLEDGE AND SKILLS REQUIRED OF

ENTREPRENEURIAL MANAGERS
Traditional business education emphasises the administrative domain of business;
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Modern approaches concentrate on the skills required in the domain of entrepreneurship

such as:
0 Managing conflict;
1 Resolving differences;
2 Balancing multiple viewpoints and demands;
3 Building teamwork and consensus;
4 Midsized high growth companies are practicing opportunity driven management.

They achieved success with a unique product or distinctive way of doing business
and became leaders in the market by delivering superior value to customers rather
than through low prices;
Some of the effective fundamentals practiced by team-builder entrepreneurs are also

found in successful effective middle managers.
8.2.5.1: Management competence required of the entrepreneurial

managers
Most successful entrepreneurs are also good managers;
Entrepreneurs seldom have strengths in all areas, mostly only in a single area with limited
skills in other areas;
Entrepreneurs who have a technical background are weakest in marketing, finance and
general management while those who do not have a technical background are weakest in
the technical or engineering aspects, manufacturing and finance;
What is important is the concept of fit and having a management team whose skills are
complementary.
8.2.5.2: Skills required to build an entrepreneurial culture
These interpersonal skills can be called entrepreneurial influence skills since they have a
great deal to do with the way these managers exert influence over others.
0 Leadership/vision/influence. These managers are able to create clarity out of

confusion, ambiguity and uncertainty. They do it in a way that builds motivation
and commitment and in a genuine effort to clarify roles, tasks and responsibilities
and make sure there is accountability and appropriate approvals.
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0 Helping/coaching and conflict management. They are creative and skillful in

handling conflicts, generating consensus decisions and sharing their power and
information.
1 Teamwork and people management. They encourage creativity and innovation

and take calculated risks. They help where needed but allow others to be in the
limelight. They do not punish or criticize failure and have the capacity to generate
trust because they are open and honest.
8.2.5.3: Other management competencies
0 Administration
0 Problem solving: anticipate problems, analyse them for causes, plan
action to solve them and to follow through.
0 Communications: ability to communicate effectively and clearly to media,

public, customers, peers and subordinates.
0 Planning: ability to set realistic and attainable goals and to develop plans
to achieve them.
0 Decision making: ability to make decisions on the best analysis of

incomplete data.
0 Project management: skills in organising project teams, setting project

goals, defining project tasks and monitoring task completion in the face of
problems.
0 Negotiating: ability to negotiate effectively and to balance value given and

value received. Recognising once-off versus ongoing relationships.
0 Managing outside professionals: ability to identify, manage and guide

appropriate legal, financial, consulting and other necessary outside
advisors.
0 Personnel administration: ability to set up payroll, hiring, compensation

and training functions.
1 Law and taxes
0 Corporate and securities law: familiarity with the uniform commercial

code and with Security and Exchange Commission, state and other
regulations concerning the securities of your firm and the advantages and
disadvantages of different instruments.
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0 Contract law: familiarity with contract procedures and requirements of

government and commercial contracts, licenses, leases and other
agreements.
0 Law relating to patent and proprietary rights: skills in preparation and

revision of patent applications and ability to recognise a strong patent,
trademark, copyright and privileged information claims.
0 Tax law: familiarity with state and federal reporting requirements.
0 Real estate law: familiarity with leases, purchase offers, purchase and
sales agreements necessary for the rental or purchase and sale of
property.
0 Bankruptcy law: knowledge of bankruptcy law, options and the forgivable

and nonforgivable liabilities of founders, officers and directors.
1 Marketing
0 Market research and evaluation: ability to analyse and interpret market

research study results including knowing how to design and conduct
studies.
0 Marketing planning: planning skills in planning overall sales, advertising

and promotion programs and deciding on distributor or sales
representative systems and setting them up.
0 Product pricing: ability to determine competitive pricing and margin

structures and to position products in terms of price and ability to develop
pricing policies.
0 Sales management: ability to organise, supervise and motivate a direct

sales force and to analyse territory and account sales potential.
0 Direct selling: skills in identifying, meeting and developing new customers

and in closing sales.
0 Service management: ability to perceive service needs of products and to

determine service and spare-part requirements, handling customer
complaints and create an effective service organisation.
0 Distribution management: ability to organise and manage the flow of

products from manufacturer to customers.
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0 Product management: ability to integrate market information, perceived

needs, research and development and advertising into a product plan and
to understand market penetration and breakeven.
0 New-product planning: skills in introducing new products.
1 Operations/production
0 Manufacturing management: knowledge of the production process,

machines, manpower and space required to produce a product and skill in
managing production.
0 Inventory control: familiarity with techniques of controlling in-process and

finished goods inventories of materials.
0 Cost analysis and control: ability to calculate labour and material costs,
develop standard cost systems, conduct variance analyses, calculate
overtime labour needs and manage/control costs.
0 Quality control: ability to set up inspection systems and standards for

control of quality of incoming to finished materials.
0 Production scheduling and flow: ability to analyse work flow and to plan
and manage production processes, manage work flow and to calculate
schedules and flows for rising sales levels.
0 Purchasing: ability to identify appropriate sources of supply, to negotiate

suppliers’ contracts and to manage the incoming flow of material into
inventory and familiarity with order quantities and discount advantages.
0 Job evaluation: ability to analyse worker productivity and needs for

additional help and to calculate cost-saving aspects of temporary versus
permanent help.
1 Finance
0 Raising capital: ability to decide how best to acquire funds, to forecast

funds needs and prepare budgets, and familiarity with sources and
vehicles of short- and long-term financing.
0 Managing cash flow: ability to project cash requirements, set up cash

controls and manage the firm's cash position and to identify how much
capital is needed, when and where you will run out of cash and breakeven.
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0 Credit and collection management: ability to develop credit policies and

screening criteria, to age receivables and payables, an understanding of
the use of collection agencies and when to start legal action.
o Short-term financing alternatives: understanding of payables

management and the use of interim financing, such as bank loans and
familiarity with financial statements and budgeting/profit planning.
0 Public and private offerings: ability to develop a business plan and an

offering memo that can be used to raise capital, a familiarity with the legal
requirements of public and private stock offering and the ability to manage
shareholder relations and to negotiate with financial sources.
0 Bookkeeping, accounting and control: ability to determine appropriate

bookkeeping and accounting systems.
0 Other specific skills: ability to read and prepare an income statement and
balance sheet and to do cash flow analysis and planning.
1 Technology
0 Microcomputers: spreadsheet analysis and knowledge of word

processing, e-mail and so on.
0 Technical skills unique to each venture

8.1) Can entrepreneurs be managers and vice versa? Substantiate your answer.
8.2) Name and describe the 4 stages of entrepreneurial growth.
8.3) Name 5 skills that would be useful to an entrepreneur and what the solution is to
entrepreneurs who don't have all these skills.
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ENTREPRENEURSHIP: THE NEW VENTURE TEAM
0 THE NEW VENTURE TEAM
9.1: Reading
Article 1
Adding Value or Adding Cost?
by Christopher Jones
All of us in business today are seeking to enhance profitability, to maximize the added
value of our operations and minimize costs. We would like to believe that we expend
resources only on operations which are essential to the delivery of our 'product'. and
which add value. However, in addition to this basic 'cost of doing business' we constantly
incur 'cost of quality'. The cost of quality is the cost of the activities which we undertake, in
addition to those of our basic 'production' processes, which add no value and exist to deal
with the failure of people and systems.
A 'real world' definition of quality is 'conforming to agreed customer requirements' ie

fulfilling our commitments to internal users and external clients. The cost of ensuring that
commitments are fulfilled, and of coping with the consequences when they are not, can be
alarming, the more so because they are seldom exposed to management attention.
Identifying, analyzing and monitoring cost of quality provides a powerful tool for driving
business performance improvement.
Experience has shown that cost of quality absorbs 15-40 per cent of revenue. Companies
such as Unisys, IBM, Xerox and British Telecom have experienced levels equivalent to 40
per cent of revenue and more. Xerox Corporation, amongst others, has demonstrated that
a company-wide improvement process can halve cost of quality over a period of 3-5
years. In any business halving cost of quality significantly improves financial performance.
A practical approach to reducing the cost of our 'non-value-added' activities, i.e. our cost
of quality, begins with identifying and costing these activities. Identification is made easier
if we analyze cost of quality using the following categories of activity:
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0 Conformance: those things which we do to ensure that we meet our customers'

requirements:
--Prevention activities: Planning, training, systems development, market research etc.
'Prevention' activities are the one aspect of cost of quality on which businesses seeking
performance improvement increase investment. The return in terms of reduction in errors,
corrective actions, customer complaints, process lead times, etc. provide ample
justification for the time and cost involved.
--Appraisal activities: the 'checking and chasing' we do because we know our products,
our business processes and our people can fail. Is this a necessary evil or an opportunity
to reduce the cost of checking by improving the capability of systems, suppliers and
employees?
0 Non-conformance those things which we do when we have failed to meet our internal or
external customers' requirements.
--Internal failure: rectifying errors, scrap, unused software, work due to late design,
excess or obsolete inventory, etc.
--External failure: warranty, product recall/field rectification, penalty payments, invoicing

errors, etc.
--Exceeding requirements: doing more than is required to meet the user's needs eg
unused product features, unread reports, excess detail etc.
0 Lost sales opportunities the margin on sales lost through poor performance.
Cost of quality (CoQ) information is useful for a number of purposes:
--creating an awareness among senior managers of the opportunities for improvement
--targeting major improvement projects
--providing a focus for work group
improvements --tracking company cost of quality
Typically the business management team requires an assessment of opportunities and a

focus for improvement. With good support this can be achieved over one and a half
working days:
--An initial meeting: the managing director, operations director, personnel director, finance
director and facilitator develop an understanding of CoQ, identify the key business
processes, 'brainstorm' the associated CoQ activities and categorise these as
'high/medium/low' cost.
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(Staff prepare a more detailed assessment of costs.)
--A follow-up meeting: the team agrees costings, selects the priority improvement
opportunity and sets up an improvement project team.
Cost of quality assessment by individual work groups follows a similar pattern but
generally requires more time. The more detailed information generated can be used in a
cost of quality monitoring system.
IT is a fertile field for anyone interested in using cost of quality as a tool for identifying and
reducing the cost of non-value added activity. Both IT departments and IT users have little
difficulty in identifying and prioritizing the costs arising from the ineffective use of people
and systems and shortcomings in the 'product' itself.
In the wider world of business, invoicing and debt collection are frequently interesting
areas for cost of quality analysis. Consider the cost to your business, through unclear or
incorrect invoices, of:
--dealing with customer queries
--dealing with customer complaints
--chasing non-payment of disputed invoices
--raising credit notes
--re-invoicing
--financing higher levels of receivables (debtors)
--lost business due to customer dissatisfaction.
Your business will have its own cost of quality priorities but you can be assured that they
exist and that they are significant. In a one day session a senior management team will,
typically, identify CoQ equivalent to 15-20 percent of revenue rising to 20-30 percent after
more detailed analysis.
Cost of Quality can be used by any business, at any level, to improve financial
performance, customer satisfaction and competitive position.
Publication Information: Article Title: Adding Value or Adding Cost?. Contributors:

Christopher Jones - author. Magazine Title: Management Services. Volume: 38. Issue: 3.
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Publication Date: March 1994. Page Number: 20. © 1994 Institute of Management
Services. Provided by ProQuest LLC. All Rights Reserved.
'The Business of Adding Value'
the management realities of 1997 are harsh but challenging. Gone are the cosy `jobs for
life' and the time honoured `decision deflection' routine. Managers and the new breed of
professionals who support them are now expected to take responsibility and add value to
their organisations. This requires a dynamic, technology paced mindset and an ongoing
commitment to maintaining and developing personal competence.
In order to address these challenges the IMS Financial Sector Specialist Group (FINSEC)
chose The Business of Adding Value' as the theme for its 18th Annual Conference. Seven
presentations by those at the sharpest end of the sharpest industry explained how
modern management techniques are being applied to add value to their organisations.
The techniques include Business Excellence SelfAssessment, Benchmarking and

Process Improvement, the so-called `Balanced Scorecard' approach, and the home grown
`Continuing Professional Development' scheme developed by the IMS to assist its
members.
Add to this the practical aspects of business recovery planning, which may not on the
surface appear to add much value until havoc strikes, as in the case of last year's
notorious `Manchester bomb' or the yet to come `Millennium IT bomb'. The ingredients
were there for a significant learning event, from which Quality Matters has selected the
following four papers for review: `What NatWest has learnt from Business Excellence
Self-assessment' by David Watts, Head of Corporate Development for NatWest Life;
Transformation through benchmarking and process improvement' by Derrick Sheppard of
the Financial Processes Redesign Team of Allied Domecq plc; `Building a Balanced
Scorecard' by John Geanuracos of Renaissance Solutions Limited; and `Business
Recovery Planning in Action: lessons from last year's Manchester incident' by Angus
Jordan, Group Risk Controller for Royal & SunAlliance Insurance.
Adding value through self-assessment
NatWest Life is a relatively new addition to the NatWest group, launched in 1993 as a
brand new life assurance company which was designed and built in 15 months. Already
its record is impressive; however, rising to become the twelfth largest company in its
industry, as ranked by new business income, within a year of its formation, and, as has
been previously reported, becoming a finalist in both the European and UK Quality
Page 182
Awards in 1996. How did they do it? The paper explains how, by continuously adding
value, they have been able to capitalise on the fact that they are a relatively new entrant:
"Starting out from scratch meant that we were able to benefit from detailed research into
customer attitudes. Extensive pre-launch research revealed that of the 200 or so products
we sold to our customers in our previous position as independent financial advisers just
twelve would meet 95 per cent of all customers' needs. That allowed us to put together a
focussed
portfolio of products which today includes term assurance, bonds, mortgage related
products and personal pension plans". The speaker explained how the EFQM Business
Excellence Model had further helped the company to be "action oriented and focus on
delivering results in order to meet or exceed promises".
"The Vision drives our strategy and annual Business Plan which is structured jointly
around the Balanced Business Scorecard approach and the Business Excellence Model.
From the Corporate Plan each Division of the company develops its own objectives which
form the basis of departmental and individual action plans. But these are not imposed on
people. Through a comprehensive Performance Management System objectives for the
year are agreed through open discussion between each member of staff and their
manager. Everyone has a Role Profile which defines their job and their key
accountabilities and core competencies required to achieve them".
The Performance Management System is supported with Personal Learning and

Development Plans for all employees who record training needs both for current jobs and
potential future needs. In addition an annual staff satisfaction survey supports People
Management, with each Division developing action plans through working groups using
the results obtained, and there is annual rather than three yearly assessment to the
Investor in People (IIP) standard. Particular attention is paid to the salesforce:
"In order to provide the right level of service, it is vital that we know how they view us. So
we carry out regular surveys of sales force satisfaction. Our first survey in October 1992
(just before our launch) showed that 46 per cent of NatWest's sales force rated the
service they were then receiving as excellent. By April 1993 that figure had risen to 76 per
cent - and during the first quarter of 1995 it had reached 93 per cent."
The Business Excellence Model demands a stringent approach to customer satisfaction

and readers will note that there is far more to this at NatWest Life than the mere
processing of complaints and indeed there are no targets for a so-called `acceptable level'
of complaints:
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"We aim to measure every area of our business and every conceivable point of contact
between NatWest Life and its customers. After all if you do not measure satisfaction how
do you know whether or not it's improving? We also publish a Customer Satisfaction
Index, which is effectively a monthly index tracking the different measures we take. This
enables us to monitor overall trends and to assess the impact of our actions on customer
satisfaction".
A description of the 1996 European Quality Award submission, which generated 176
areas for improvement, is followed by an outline of the 1997 application which was
submitted in March:
"Rather than sit back and wait for the assessors' feedback report, this year we have
immediately conducted our own assessment of the full document and this has
immediately prompted a number of areas for improvement which we can do something
about straight away".
The author explained how each of the nine Business Excellence criteria has a sponsor,
usually at Executive level, who then own action plans relating to their field:
"Collectively the nine sponsors form the Business Excellence Council whose responsibility
is to set up a challenge process between its members, to prioritise action, to ensure that
positive progress is being made and to really drive Business Excellence throughout the
company. This works well because it also enables members to provide mutual support for
each other in difficult areas".
The author chairs the Business Excellence Council which he says gives him "the rare
privilege of being the boss over the Executive team".
The presentation prompted a number of questions including how the organisation

measured the performance of administrative services and the relative cost of quality. In
response the speaker explained how a series of internal service standards have been
developed as part of an ongoing internal measurement of customer satisfaction, and how
quality had no budget, no manager and no director, just a strategy of "mid market pricing".
Transformation through benchmarking and process improvement
In a presentation with the above title Derrick Sheppard enlightened delegates about how
the value added through benchmarking and business process improvement can be used
as a foundation for total transformation. He explained how in 1993 and 1994 he had
chaired the Pensions Administration Large Scale network (PALS) administration expenses
surveys. He concluded that the administration and development of the PALS system from
1996 would be best outsourced to Arthur Anderson (consultants).
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The PALS system surveys were limited in that there were no costs analyses over major
activities, concerns over data integrity, little correlation with business practices, and only
broad indicators available on account of organizational complexity, different quality and
levels of service, and the varying scope of pensions services.
Benchmarking of pensions industry best practice was undertaken with a search for people
inside and outside the industry of around the same size as Allied Domecq. A
Benchmarking Partnership was established in 1995 consisting of Allied Domecq, Grand
Metropolitan, Guinness, Lloyds Bank, and Unilever, the objectives of which were to
assess business practices in all areas of the pensions business. Activity based costs
analyses were used to cover all major in-house activities and enable valid comparisons to
be made, and a high degree of integrity and consistency in data was achieved.
Two major reports resulted, covering business practices and costs analysis respectively,
and in June 1996 a Business Process Review (BPR) was introduced. This had a two year
timescale involving flowcharting of key processes and the establishment of performance
measures. The speaker believed "this worked well giving sound results, thorough and
significant efficiency improvements, allowed benchmarking to be undertaken at process
level. It also helped to develop multi-skilling and to be an agent for continuous
improvement".
Attendance at the European Benchmarking Forum in 1996 provided several important

lessons. These included the need to communicate a (forward looking) Corporate Vision as
was the case with Shorts plc.’s Focus 2000, and how to incorporate simple benchmarking
questions to selected Annual Benchmarking Reviews. The event also highlighted the
Business Excellence Model as a form of benchmarking.
A revised approach to (their termed) BPR has followed in 1997 with, in particular, more
selective use being made of process mapping and use of Octave software flowcharting
metrics. Delegates were cautioned about the potential for obsessive process mapping to
generate `huge wall charts of things to map' which do not add value and serve merely to
confuse.
In the questions which followed the speaker was asked about how confidentiality issues
were approached, and he referred in his answer to the now established rules of
benchmarking protocol. He was then asked about whether with regard to pensions
industry best practice the best he could hope for was the best in the group. He agreed in
principle, but pointed out that benchmarking was continual, and that his organisation was
already `looking out'.
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Building a Balanced Scorecard
John Geanuracos outlined the concept of the Balanced Scorecard approach which has
been used to transform Cigna Insurance, a troubled US full service underwriter. The
technique was noted particularly for its ability to successfully target knowledge
management investments in key processes in what has been one of the first major
applications of knowledge management concepts to the American financial services
sector.
The author argues that corporations which are using the Balanced Scorecard are
breaking through implementation barriers. These are defeating other organisations and
that the clear articulation in a Balanced Scorecard of business unit strategic objectives,
with links to associated performance drivers, has enabled many individuals to see often
for the first time, the links between what they do and the organisation's long term
objectives:
"The Balanced Scorecard is like a prism, taking the thousand points of light being
generated around the organization and focusing them on the critical few targets with the
intensity of a laser. The results achieved by such strategically aligned organisations can
be dramatic". (Not physics but the idea is understood -Ed).
Use of the Balanced Scorecard is supported by means of a Balanced Management

System. This is defined as "a governance system which uses the Balanced Scorecard as
the centerpiece in order to communicate an organization’s strategy, create strategic
linkage throughout the organisation, develop business planning, and provide feedback
and learning against the company's strategy".
Their case study of National Insurance shows how by adding value the approach may be
used to completely turn around a company by shifting its focus from 'generalised' to
'specialist' business. It is explained how Balanced Scorecards were established at
Corporate, three Divisions and 20 SBUs. These led to a $441 million reduction in annual
operating losses in 1994 and a uniformly positive Net Operating Income (NOI) in 1995
with most recent data available (November 1995) showing a 232 per cent increase in NOI.
The paper points out such turnarounds are extremely rare in the property and casualty
world.
If there is a catch it could only be that a good Balanced Scorecard has to be tailored to the
situation, there is no `best answer' that will work for all companies. However, once in place
it clarifies the vision throughout the organization, gains consensus and ownership by the
executive team, provides a framework to align the organization, integrates the
Page 186
strategic planning and implementation process, focusses human resources strategy and
drives the capital and resource allocation process. Most of the companies which have
adopted the approach have used it to determine incentive compensation:
"A recent poll of 60 large corporations that had introduced the Balanced Scorecard in
recent years discovered that forty of these companies used the Balanced Scorecard to
determine incentive compensation and that another ten companies planned to do so
shortly".
It should be noted that the approach usually demands a complete reappraisal of a

company's rewards structure:
"Organisations that use a Balanced Scorecard to successfully align the board room with
the back room will find themselves dissatisfied with traditional incentive compensation
models. Such structures are typically linked to short term financial results, not the long
term strategic performance of a Balanced Scorecard. The question is not whether a
corporation must change its reward structure, but when and how".
Adding value through disaster recovery planning
Manchester city center on the morning of Saturday June 15th 1996 was the scene of one
of the largest peace time explosions the UK has ever experienced as a 1.5 tonne bomb
concealed in a parked van exploded causing massive devastation and millions of pounds
worth of damage. Royal & SunAlliance's Manchester offices experienced the full force of
the blast yet were able to recover a 300 million turnover business thanks to added value
through disaster recovery planning.
The paper by Angus Jordan and Julia Graham, of Royal & SunAlliance, explains the
immediate reaction to this catastrophe which left 34 staff injured. It explains how a Crisis
Team was assembled and business subsequently resumed:
"Our recovery plans began within an hour of the blast with initial contact being made
between the company's local and head office managers and our disaster recovery
consultants Comdisco. Experts from our Group Risk Management, Information
Technology and Facilities Management departments arranged to meet local managers
and Comdisco representatives early on Sunday morning within 24 hours of the explosion
at a hotel in Manchester".
The role of the Control Group which met daily at 8.30 am in the immediate aftermath is
outlined:
"The number of different business requirements meant that no fewer than four separate
but parallel recovery plans were put into action, but with a number of common issues.
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These included switchboard messages for customers and staff, communication with
Manchester-based staff at home, electronic mail messages across the company's
systems and transportation for essential employees to reach emergency locations".
The paper concluded with a list of lessons learned from an event which is described as
'as educational as it was challenging'. These included:
0 ensure plans are in place
1 ensure key data is accessible
2 only bring staff in when they can work or help
3 operate a clear desk policy
4 ensure key staff take time off after the initial process
5 don't assume staff will be as willing to relocate as you might think
6 don't assume you will automatically have staff support for more than two weeks
7 don't expect sympathy from customers for more than a few days.
The Millennium `IT Bomb
In a change to the advertised schedule Graham Briscoe of Royal & SunAlliance outlined
some of the potential pitfalls which could await from a disaster yet to come, namely the
`Millennium Bomb'. He explained his role in The British Computer Society Working Party
on the Year 2000 Problem and presented a far from attractive picture in terms of the
losses which certain organizations might expect to incur as a result of date changes in
computer software and so called `legacy systems'. Amongst the practical examples cited
were a major oil company who currently have 85 seabed installations which rely on
embedded chips which the manufacturer cannot guarantee will be Year 2000 compliant
The result is that they now expect to have to spend 125,000 in modification costs for each
installation. Another possible problem concerned automated traffic lights
[remember the chaos in the film The Italian Job'? - Ed].
Graham advised delegates to seek contract guarantees for Year 2000 compliance, and to
check particularly for new ranges of machines which have the ability to process old
program codes, and any embedded chips which are over five years old.
In a supporting paper, reproduced from The British Journal of Administrative

Management, a simple `Timebomb Test' is presented to examine whether one's own pc is
Year 2000 compliant.
Page 188
"Reset your computer clock to 23.58 pm, 31 December 1999. Then - and this is vital -
power off the machine and take a break for a few minutes. Reboot, and see what time and
day the machine thinks it is. If you are lucky or have a reasonably new pc you should see
the time indicated as a few minutes past midnight on New Year's Day 2000. If you are
unlucky you will see any one of a range of weird dates - and some of your software might
have started acting peculiarly".
The same paper describes how bad things could get, as well as how to 'defuse' the so-
called 'bomb':
"Average sized companies in Britain may have to spend as much as 25 to 30% of their IT
budget to resolve the problem. And many large companies will find they just don't have
the time to update all their systems before the year 2000."
Continuing Professional Development
In concluding the day Graham Briscoe also outlined the components of the recently
launched IMS Personal Career Portfolio which he has helped to develop along with
Geoffrey Yeomans of the IMS Education and Training Committee.
Essentially the Portfolio has three subsets for professional development: a body of
knowledge with seven modules, a re-launched Management Charter Initiative which
includes new Level Four NVQs in quality and environmental management and an
appendix of `suggested actions' which cover various aspects of personal and work-related
activities. These are shown in diagrammatic form in the conference literature, where there
is also a brief description of the scheme.
Further information
Copies of the conference literature (20) and further information relating to the Institute's
'CPD' scheme (10 to Students and Associates - 20 to Members and Fellows) may be
obtained from Karen Gee at IMS head office, 1 Cecil Court, Enfield, EN2 6DD. Telephone:
01813661261.
Details of the activities of the Financial Sector Specialist Group may also be obtained
from the above address.
Acknowledgements also to Neville Clark for kindly providing this report and Quality
Matters Newsletter where it originally appeared.
Spire City Publishing offer a substantial discount to IMS members so if you wish to
subscribe to QMN apply for a group subscription to Spire City Publishing, PO Box 81,
Abingdon, Oxford OX14 2PJ.
Page 189
Publication Information: Article Title: 'The Business of Adding Value'. Magazine Title:
Management Services. Volume: 41. Issue: 8. Publication Date: August 1997. Page
Number: 28+. © 1997 Institute of Management Services. Provided by ProQuest LLC. All
Rights Reserved.
Article 2
How to Make Customer Service Work
by Christine Gibbs
If the 1960s were the era of marketing and the 1980s the era of quality initiatives, then the
1990s are the era of customer service. While the emphasis and evaluations of success
may have focused on the private sector, local government approaches also are ongoing.
Beginning well before the quality movement, through the training of front-line employees,
the customer now has become the focal point for more systematic approaches to
improved management and service levels.
Given the slogans, speeches, ad campaigns, and annual reports, it seems that there is
not an organization in the United States or perhaps the world that has not rededicated
itself to or launched some program oriented to the customer over the past several years.
In the public and nonprofit sectors, continuous management improvement and reinvention
initiatives often have focused on the community as a customer or on identifying and
effectively responding to internal customers.
In spite of this passion for reinvention, research suggests that in general the consuming
public is becoming less satisfied with many of the products and services it receives--
particularly from local government. The reason government service generally is perceived
to be poor, with a few notable exceptions, is simple: it is not necessary for government
entities to give good service. No such survival factor exists for managers of public
enterprises, as exists for managers of commercial ones. If a hotel gives lousy service, the
customer will stay elsewhere. But seldom does a government organization, regardless of
its charter, have any compelling reason to serve.
In most cases, with government there is no elsewhere, even at a time when contracting
out and privatization of services have become real implements in the local government
manager's toolbox. Anyone who considers the far-reaching consequences of
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government's permanent guarantee of existence, the lack of any force in its environment
that might threaten its survival, will begin to grasp how completely this sense of
indifference penetrates all the nooks and crannies of many cities and counties. It
becomes an all-pervading cultural norm to which all but the most highly motivated and
idealistic employees succumb eventually. Getting a city or county to be customer-driven
and service-oriented is rather like teaching an elephant to dance.
Short- and Long-Term Payoffs
Yet the opportunities, the responsibilities and the payoffs of providing service-oriented
operations are enormous, and they are increasing. There are short-term payoffs in
terminology and measurement when the time comes to respond to or evaluate
privatization proposals. There also are longer-range payoffs if we are to believe, as the
private sector does, that simply satisfying customers is no longer enough.
Frederick Reicheld (1993) and others have found that between 65 and 85 percent of
customers who switch from one product or service to another will state that they were
satisfied with the product or service from which they switched. A corollary response may
have been expressed by voters on November 8, 1994, when they failed to reelect two of
the most popular governors ever to have held office, Mario Cuomo and Ann Richards.
The prospect that all levels of government could put service first is not only exciting from a
citizen's point of view but also tricky from a manager's standpoint. After all, systems often
are the enemies of service. Many of the problems of poor or mediocre service originate in
the systems, procedures, policies, rules, and regulations that government is in the
business of providing to ensure consistency and constancy. As Edwards Deming has
preached, too often front-line people are blamed for poor service when the real problem is
the system itself.
To improve customer service, cities and counties must be willing to rethink the system to
determine how to provide exceptional, equitable, and reliable services. But what does
"rethinking the system" mean? How are customer service initiatives really working in cities
and counties? To find out, the author surveyed 97 local government managers in Arizona
and asked them how their organizations had approached improving internal and external
customer service. Respondents were asked what had been successful and unsuccessful
in their efforts to improve customer satisfaction. They also were asked to name one thing
they would do to improve customer service in their organizations.
Managers' Conclusions
Page 191
The results of the survey were discussed at the midwinter conference of the Arizona
City/County Management Association. Following is a summary of the conclusions that
were reached.
Customer satisfaction as an important organizational value. Regardless of the size of the

organization or community, 85 percent of the managers felt that customer service was
extremely important, and 68 percent believed that their organizations were effective but
not necessarily exceptional in this area. Managers who felt that customer satisfaction was
a function of either budget or workforce size were small in number, as were those who felt
that customer satisfaction could be achieved simplistically by "moving a few citizens to
another town."
How important is customer service to the success of a local government or a manager?

Very, according to almost everyone. In the words of Pat Sherman, city manager of Show
Low, Arizona, "The greatest technician or most professional manager cannot successfully
implement a city's mission without having good customer relations skills."
Responding rapidly to citizen complaints and providing citizens with good information
were seen as the most important ways to improve customer service. In fact, 38 percent of
managers had in place systems that responded to complaints at the time of service.
Important to the ability to respond rapidly with good information is the capacity of front-line
employees to:
0 Deal with one person at a time.
1 Resolve customer complaints by offering immediate results.
2Tell customers what can be done for them and not what cannot be done for them.
3 Let customers be in charge of their own situations by offering several options to choose
from.
4 Use policy and procedures as guides to resolving the complaint, not as excuses to say
"no."
Providing rapid responses and good information depends upon well-trained, well-
informed, and empowered front-line employees. The front-line worker must be committed
to providing positive customer service and to constant improvement, and the worker
constantly must be trained and retrained, not simply in technical skills but in dealing with
customers. Unfortunately, Arizona managers felt that in these areas their programs
faltered.
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When asked about the one thing they would change about the way their organization
approached customer service, respondents mentioned the need to improve employee
attitudes about customers and to provide workers with the tools to do their jobs.
Most managers cited the need to train employees to value differences and customers and
to be problem solvers; the need to develop systems that allow employees actually to
solve problems; and the need to listen better and to make employees respect citizens as
customers and as owners.
Not just training but the right kind of training. In the words of one small-town manager,
"We need to spend more resources on training staff and fewer on dealing with
unnecessary complaints." The kinds of training provided were viewed as important to the
effort yet lacking in substance. "Smile" training was mentioned time and time again as an
example of the kind of customer service training that is ineffective either in changing
employee behavior or in improving customer satisfaction.
This may be because those training programs are too simplistic or are outdated in today's
environment. Or it may be because effective customer service requires front-line
employees to weigh options, discriminate among complaints, and be resourceful. Just as
author Shoshana Zuboff, in her book In the Age of the Smart Machine, painted a
remarkable picture of supervisors who were having difficulty with the idea of workers
looking at computer terminals and thinking, so too did city and county managers
sometimes find it hard to accept that adding value to a service requires workforce
engagement. Workers need to know how to define customer satisfaction within the
context of a request, how to say "no" as well as "yes" to unreasonable requests, and how
to use humor to diffuse difficult situations.
The logic of front-line worker improvement is plain. In an environment that is constantly

changing, no organization simply can pass the papers up and down, back and forth, again
and again, and still keep up with demands. Technology can help with keeping up, but the
human side of the equation is even more demanding and time-intensive than the
technological. And yet training must be justified. In the words of Pat Sherman, city
manager of Show Low, "Training may not be as effective as simply hiring the right people.
The most important thing for a smaller, rural community to do is to hire people who have
customer service skills to start with."
Changing attitudes through management support. While it is true that managers do not
control the quality of the product when the product is a service, service improvement
starts at the top, and managers must "walk the talk." As one manager urged, "Put into
action all the words we say." In Arizona, local government managers, like senior
Page 193
managers in the private sector, do not always follow through in their support for what must
be done to improve customer service programs in terms of program changes, training, or
employee incentives. The customer-city/county relationship is essentially a human one in
which managers can affect the quality of service only indirectly, by inspiring and
motivating the people on the front line.
Many managers do not realize how important their behavior is to outcomes. Research and
practical experience demonstrate that a universal commitment to high-quality service
does not ignite spontaneously in the organization. It must originate from the center of
influence, which is usually the manager as well as the elected officials. If these personnel
believe in service as an artform, they will demonstrate that belief in more ways than simply
talking about it. Managers agreed with Karl Albrecht when, in his 1988 book At America's
Service, he counseled: "I am occasionally asked: What does it take for a government
organization to become really service-oriented? Who or what can supply that incentive? I
always answer: Somebody in charge has to care! Because the government organization
typically has no competitive wolves at its heels, it has no internalized compulsion to make
a hit with its customers. Therefore, the only way to wake it up and put it on the right track
is for the person in charge to become obsessed with the idea of service and service
management and to take concerted, aggressive, long-term action to transform the
culture."
Not just answers but organizational approaches. With restricted budgets, multiple
responsibilities, and programs staffed increasingly with volunteers and part-time
employees, it is no wonder that customer service initiatives often fail to connect internal
with external improvement programs into an organization-wide effort. Nor is it surprising
that managers become discouraged, letting both internal and external efforts languish and
later quietly noting that the efforts have faded away as failures.
Local governments in Arizona may have done a good job of tracking customer satisfaction
(60 percent) and following up with customers (35 percent), but they rarely integrated the
feedback into their briefing of the management team (20 percent) or used it to alter the
program or service (22 percent). And they were far less likely to use such feedback to
update their strategic plans (1 percent). Cities and counties indicated that they tended to
focus their efforts on external customers (58 percent), with few respondents linking
effective customer service to both internal and external efforts.
Today, many local governments are beginning to understand that without an overall
organizational focus and without total commitment to the customer, customer service
initiatives soon grow stale. This means looking at organizational values and calibrating
Page 194
them to the customer, as compared with other priorities that may have become dominant.
In the private sector, this "other priority" may be short-term profit. In local government,
other priorities may involve maintaining last year's service levels across the board in
terms of the number of full-time employees.
"While moving toward exceptional customer service is always a long, slow process, many
communities know that there are high expectations for services to be delivered not only
competently but creatively," noted John Little, organizational effectiveness administrator
for the city of Scottsdale. In these cities and counties, citizen innovation leads the way,
and the challenge to the manager becomes that of exploring ways in which both the
quantity and quality of services can be improved. For Scottsdale, having a City Hall on the
Mall is working, and, most important, the idea originated with a citizen's suggestion.
It is up to the manager and the community to decide what kind of an organization, in

terms of customer satisfaction, everyone wants to be part of. Is it one that is simply
present and accounted for? One that is making a serious effort at rethinking its image with
customers and the organizational focus that must follow? Or an organization that sees
service as an artform in which there is an obsessive, unrelenting commitment at all levels
to the doctrine of maximum positive customer impact? For those who want to do more
than simply show up, Gary Brown, deputy city manager of Tempe, summarized the advice
that Arizona managers found important:
0 "Go beyond looking simply at one department's response to customer needs. Look at
how the whole system reacts to community needs.
1 "Keep track not only of complaints but also of customer needs, wants, and vision.
2 "Design reward systems for employees so that those who do well are identified and
rewarded." For everyday behavior, this does not mean meeting unrealistic demands. But
it does mean greeting the customer positively, using direct eye contact, listening intently,
being assertive about what can be done, being sensitive to the customer who has
difficulty in communicating, and not passing the buck!
For organizational behavior, greater customer satisfaction means creating and expanding
programs like the city of Tempe's Cash Bonus System. In Tempe, any employee who finds
a better way, whether through customer service or innovative program design, can be
nominated by a fellow employee to receive recognition and cash rewards. In the final
analysis, as Tempe's Gary Brown suggests, we need not only to serve our customers but
also to work with them in designing solutions for our communities' problems.
Page 195
Christine Gibbs is on the faculty of the College of Public Programs, Arizona State
University, and she is president of Red Tape, Ltd., Tempe, Arizona.
Publication Information: Article Title: How to Make Customer Service Work. Contributors:
Christine Gibbs - author. Magazine Title: PM. Public Management. Volume: 77. Issue: 8.
Publication Date: August 1995. Page Number: 14+. © 1995 International City
Management Association. Provided by ProQuest LLC. All Rights Reserved.
Article 3
Fusion: Linking Strategy, Technology, and Design to Implement Your Customer

Experience
by Carol Moore
In the contemporary marketplace, a well-designed brand experience is the way an

organization distinguishes itself from competitors. Translating this reality into action, Carol
Moore believes, means delivering maximum value at minimum cost, exploiting technology
to distill and respond to customer needs, and devising and integrating multi-channel
experiences that reinforce customer satisfaction and loyalty.
Every consultant understands that clients have initial questions and Real Questions. For
example, among the IBM clients with whom I work, initial questions often involve one-off
technical solutions, such as how to develop an online supply-chain management system.
Real Questions, on the other hand, are your basic bet-the-business issues-what they're
really getting at. Frequently, the Real Question is: How can my business become more
competitive?
The answer is often some variation on these three themes:
0 First, build your business from the outside in-that is, start with the needs of your
customers, not with the internal needs of your organization.
1 Next, build an integrated, holistic enterprise, in which major business operations are
aligned cross-organizationally and deployed on the network.
2 Finally-the focus of this article-differentiate your brand. How best to do that? Not
necessarily with the lowest price or even the highest quality, but with the superior
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customer experience your business provides-every time your customers interact with
you.1
Actually, a superior customer experience is one of the few traditional brand differentiators
that are not eroding.
0 Product or service features don't accomplish long-term differentiation. Features can be

copied quickly and easily, and products are becoming more and more commoditized.
1 Given the popularity of vehicles like multibrand marketing channels and "best-value"
Web sites, brands are frequently disintermediated, or at least experienced far outside the
contexts that marketing directors so carefully construct.
2 The global economy, ironically, has constricted the playing field. Today there can be only
one "low-cost provider," one brand leader, and one "world's largest."
3 Information technology (both infrastructure and applications) is not a differentiator

anymore, since the heavy hitters in any industry all run pretty much the same stuff.
4 And "quality," or even "excellence"-which used to be the golden gateway to

differentiation-is only the price of entry to today's markets.
As has often been noted in these pages, the customer experience has long been
suspected of being important. Way back in 1955, economist Lawrence Abbot wrote,
"What people really desire are not products, but satisfying experiences. ... People want
products because they want the experience-bringing services which they hope the
products will render."2
Today, a half-century later, research by Dr. Gerald Zaltman, chair of Harvard Business
School's Laboratory of the Consumer Mind, has confirmed that the customer experience
is the single most important customer-facing variable. He says, "Total customer
experience is, in fact, more important than product or service attributes in determining
future customer behavior"-even more important than price.3
Researchers have even drilled down to discover which aspects of the customer
experience contribute most to customer satisfaction. In a survey of about 1,000 customers
of 10 major retailers, the IBM Institute for Business Value discovered that the two most
important satisfaction drivers in the retail shopping experience are person-to-person
experience (interactions with employees that exceed customer expectations) and store
experience (a well-designed, well-maintained, well-stocked space). These two factors
ranked above price and perceived product value, marketing and communications, and the
use of data and analysis to create personalized marketing.4
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The importance of the customer experience, then, can hardly be overestimated. In fact,
experience is becoming nothing less than the personification of the brand and the ultimate
conveyer of the brand's value proposition.
It follows that understanding more about customer experience makes eminent sense.
Taking it a step further-actually setting out to engineer customer experiences toward a
desired result-seems like a logical or even a necessary strategy.
Businesses that engineer customer experiences want to deliver them efficiently and
effectively across all their marketing channels. The problem is, how to get started? I'd like
to suggest a blueprint to provide a consistent customer experience throughout your
enterprise-a blueprint that eventually enables unprecedented leverage of your brand, with
design at its center.
The Fused Implementation Model: A blueprint
Creating this blueprint requires a fusion of skills: an alliance of business strategists,

technologists, and experience designers from several design disciplines (these include all
the usual suspects in the interactive visual design field, plus specialists like architects and
engineers). By this time, any organization with a successful Web site has learned-
probably the hard way-to work in partnership across these skills. But implementing the all-
out transformation that accompanies a high-level commitment to consistent customer
experience is something else again.
The good news is that handling huge change is mostly a matter of scaling up the lessons
learned from small change (that is, a Web site). In other words: You can do this.
The goal of the strategy-technology-design team is to align all the capabilities of the
organization-from staff functions and CRM through business processes and training-
around a consistent customer experience. On a day-to-day level, the specific roles of
these partners are:
0 Strategy: to devise and drive a win-win strategy for the customer and the business-that
is, to drive maximum customer value at minimum cost to the business
1 Technology: to enable this strategy via "customer-centric" integrated systems and

applications-making the needs of the customer the design point for technology
2 Experience design: to provide a customer experience that delivers the desired behavior
(usually a purchase). Ideally, experience design affects every customer touch-point, from
building architecture through the process flow of a call center to the design of a kiosk
interface.
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Let's take a closer look at each of these roles.
First, strategy-charged with delivering maximum customer value at minimum cost to the
business
By definition, most top businesses in any industry already produce products and services
effectively. The differences lie in how well they "go to market"-how well they develop and
maintain distribution or marketing channels. (For the sake of this article, let's define a
channel as a distribution medium for products or services, such as a retail store, a Web
site, a mobile phone application, or even a repair truck.)
Most businesses employ more than one channel, which is considered fundamental good
business today. First, customers use and demand more than one channel to interact with
significant businesses. Then, too, using many channels enables targeted marketing,
leverages technology investments and operations costs, and lowers the costs of sales
and service. Finally, channel use is extremely efficient for specialized purposes: checking
a bank balance by telephone, for example, or checking a Web site to chart a stock price
over the course of a day. (And let's not forget the most popular application for mobile
phones-actually making calls!)
And yet, businesses don't use channels as well as they could, even when the channels
deliver a benefit like lower cost of sales. (In fact, more than half the customers surveyed in
an IBM retail study5 indicated that they didn't know how to get product information without
going to the store.) In other cases, channels are so badly designed-the "call-center menu
from hell," for example-they actually discourage business. Finally, relatively few
enterprises have implemented cross-channel management. Nor have they figured out
how to drive fact-based insights back into core management processes in near-real time,
making their organizations highly adaptive to the marketplace.
The point is, while consumed with internal issues like the five-year plan or who gets the
corner office, businesses seem to forget that the customer experiences only the channel,
and nothing else of the company. You may get the Aeron chair, but all he gets is the
telephone loop.
Interactive channels are especially important. Not only do these channels enable brands
to create preference (the best that traditional channels can do), but they also have the
unique power to transform brands into emotional propositions.
Interactive channels engage us in a way impossible before. For instance, the Web taught
us that you can get astonishingly angry at a site that doesn't work, or you can have a
Wow! moment when the site works well. Somehow, the extra dimension that interactivity
Page 199
supplies gets loaded with emotion (who hasn't noticed how gamers act while they're, uh,
gaming?). It's in your interest to tap into that space.
Imagine a "neutral" Web site-not bad or good, just okay. Chances are you know how
you'd improve it, creating a better user experience with improved information architecture,
more efficient navigation, classier graphic design, slicker applications, and so forth. By
adding those desirable mechanical and emotional "clues" to give the user a better
experience, your business is creating, and then tapping into, that mine of emotion. You
have created an emotional proposition from the brand experience.
And then, having roused all that emotion, interactive channels provide an immediate
opportunity to use it (unlike print, say, or TV advertising). Now, by providing interactivity,
your brand can become functional. Your customer can act.
Consider: Everyone remembers the first time he or she tried Amazon.com. For millions of
people, it was their first e-commerce experience. Probably the sequence went like this:
0 "I'll try Amazon.com" (manifestation of brand awareness).
1 The Amazon.com Web site (the channel) is easy and fun to use, creating a pleasant
emotion toward the brand (the experience enabled the brand to elicit emotion).
2 This emotion leads to a decision to buy, which is supported by a well-designed

transaction application (the experience enabled the brand to become functional in real
time).
3That decision to buy is the manifestation of brand preference ...
4 ... which allows Amazon.com to make money.
Of course, successful e-commerce sites don't get that way by throwing their cards in the
air and noting where they land. They tweak and prod and polish their sites every day.
They don't just use a channel-they exploit the hell out of it.
"Exploit" is a word with unpleasant connotations. You shouldn't exploit your customers or
employees. But exploiting channels is a good thing. Exploited channels more dependably
lead customers to desired behavior (usually a purchase) than channels that just sit there.
And, don't forget: You can't force customers to buy. Purchase happens only when
customers perceive superior value.
How to start exploiting channels?
The most important step is to move away from the laissez-faire "availability" attitude
prevalent in the 1990s-every channel available for every transaction or service, working
Page 200
the same way for every customer. Businesses need to move toward tougher
segmentation. Tougher segmentation:
0 Originates with more-relevant market-research methodologies and measurements, such

as cost-to-serve per customer group (and even per individual customer), and results in
actionable information
1 Identifies the business's profitable and valuable customers to retain, encourage to

become more loyal, and increase
2 Identifies profitable customers who could spend more to increase share and cross-sell
3 Identifies low-profit and less-valuable customers to reduce the cost-to-serve, limit the
product/service mix available to them, or stop serving them altogether
Once segments are identified, choosing appropriate channels to carry out the various
strategies is critical. For example, one major online investment company adopted tough
customer segmentation from the earliest days of its Web site. It crossed demographic
information with three segments of investors, the last segment representing its "profitable
and valuable" customers:
0 Less than $100,000 invested, fewer than 12 trades per year
1 More than $100,000 invested, more than 24 trades per year
2 More than $100,000 invested, more than 48 trades per year
The first two (less profitable and variable) categories' activities were dissected by data
mining and analytics to model their segments and behaviors, which allowed common
scenarios to be launched automatically. Result: High-cost employees spent relatively little
time with less-profitable customers, who used the self-service sections of the Web site.
The third investor segment, however, deserved high maintenance. A special online
services program was developed for these investors, complete with a personal
representative at the firm. For the fortunate upper-upper segment of this category, another
even more privileged program, called Velocity, was created, with even more personal
service involved. Result: High-cost employees spent most of their time with highly
valuable and profitable customers.6
IBM made a similar decision when it stopped selling its personal computers in stores in
the late 1990s. The reason: to lower the cost of selling a low-or-no-profit product (the PC).
We migrated from a high-cost channel (a food chain of IBM sales reps, middlemen, and
retail stores) to the lower-cost direct channels of telesales and a self-service Web site.
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Today, if you as a consumer want to buy an IBM PC or ThinkPad from us, those channels
are your choices.
To summarize the role of strategists in the fused implementation model:
Strategists drive maximum customer value at the least cost to the business. They:
0 Determine the brand differentiator
1 Segment customers across the marketing channels
2 Determine the offerings and transactions to be offered over each channel
3 Determine the degree of integration for each channel with the rest of the business
The second role: technology, which enables the business strategy with seamless, invisible
technologies designed from customer needs.
A recent cartoon from the New Yorker shows a business meeting with the leader saying,
"We have lots of information technology. We just don't have any information."
Wait! I've been in lots of these meetings with clients, and this situation is almost always
the result of a massive change effort in which the technologists (instead of the strategists)
took the lead role. Look at the global infrastructure spend pre-recession, and you can see
the enormous faith businesses placed in simply having the hardware onboard and some
sort of network deployed. All too often, though, the technology worked in isolation, and,
like the cartoon characters, the folks responsible for the results were left asking, "So
what?"
Complicating the situation, in the last few short years, technology itself has become a
commodity. Within any industry, the top players have more or less the same infrastructure,
network capability, middleware, and applications. Computer science people are no longer
in short supply. Technology, generally speaking, is just not special anymore.
Using technology well, however, is still special-relatively rare, in fact. Success lies in
integrating technology strategically with the rest of the business, and in designing it "from
the outside in" to begin with.
Digital customers are tough cookies. They come to channels with specific tasks that they
want to complete in a single session. They want, above all, for that experience to be easy.
They also want it to be:
0 Invisible, transparent, and seamless-all words to describe the blissful unawareness of

the technology behind the experience ("Error 404", anyone?)
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0 Personalized-which, for the technologist, means database-driven
1 Consistent-no moods; looks and acts the same each time
2 Convenient-24 x 7 x 365
3 Real-time-reflects transactions immediately, coordinated across all channels
4 Portable-a characteristic of hardware design, as well as interface design
5 Private and safe-still the primary concerns for transaction users
6 Expandable-not everybody likes to buy new equipment when new software is

introduced!
7 Relevant-otherwise, what's the point?
Sapient Inc., an international business and technology consultancy, helped an office

supplies client integrate technologies across its channels a few years ago, when such an
initiative was a new thing. A four-phase program was deployed to connect the Web site to
the enterprise's back-end system, remodel the retail stores, reengineer the Web site (with
emphasis on linking real-time inventory to suppliers), and integrate kiosks into retail stores
to extend the Web site, stores, and catalog operations. Of course, integrating the
technologies quickly spread to including a revamp of business processes, fulfillment
operations, and other areas of the company. The project had become much more than a
technology overhaul.
These changes empowered the client's customers to interact with the company in the way
they wanted-across channels, in an integrated fashion. The results were dramatic:
Customers who purchased supplies from both the retail store and the catalog spent about
2.5 times more money than those who shopped at the store alone; and customers who
were able to purchase from the store, catalog, and Web site spent about 4.5 times more.7
After the transformation, the office supplies client reported higher revenue, improved
efficiency, improved browse-to-buy on its Web site, and increased traffic on all its
channels.
A study of 22 multi-channel retailers and customers this year for Shop.org, a knowledge
exchange site for e-retailers, confirmed the trend of these findings. Multi-channel
shoppers are the businesses' most valuable customers, shopping with 12 percent more
frequency and spending 32 percent more on average. In addition, tri-channel shoppers
(store, catalog, and online) demonstrate greater loyalty to a single retailer, making 73
percent of similar purchases with one business.8
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To summarize: The role of the technologist is to enable the business strategy with
integrated, "customer-back" technologies (that is, designed with customer needs, rather
than the internal needs of the company, as the starting point). Technologists must:
0 Provide secure, reliable access to the business
1 Develop and deliver applications in conjunction with experience designers
2 Integrate channel capabilities with the rest of the business IT architecture
The third role in the fusion model is that of the experience designer and his or her team-
the multi-disciplinary group of designers who create an experience on a channel, which
leads to the desired customer behavior.
To design a customer experience is to build the start-to-finish interaction between a

customer and a product or service, which takes place on one or more channels.
(Interactions span the continuum, from advertising awareness, to using a Web site, to
unpacking and setting up a product, to customer support.)
As we've already discussed, on an emotional level, experience design shapes our current
and future involvement with the brand, enabling the brand to become an emotional
proposition. On a mechanical level, experience design determines how we interact with
any given channel ... and how well we do it. Thus, it is experience design that largely
determines a channel's value to us, ideally enabling the brand to become a functional
proposition.
Alas, if only it were so easy. To channel usability guru Don Norman: Around the world at
any given moment, millions of people are trying to use, do, or communicate something
that is confusing, frustrating, difficult, or just plain impossible. Take probably the most
common dimension of experience design: interaction with a product. If, for example, I
gave you the cue "a problem with plastic wrap," who wouldn't describe the frustration of
picking at a fused edge of film, unable to get the roll up and running again? (Why is that
problem still around after so many years?) What about the pain involved with simply
opening things: CD cases, boxes of kitty litter, those plastic coffins they put around printer
cartridges (a machete works)?
Of course, brand manifestations have greatly evolved over the decades-from these stand-
alone products to lifestyle metaphors (think Marlboro)-and now, with the advent of digital
channels, to immersive experiences. Ironically, these experiences are all but invisible, yet
they are increasingly functional. And it is these experiences that can develop
unprecedented opportunity for a brand.
The evolution of experience design
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Figure 1 shows the four levels of experience design (brand presence, the crudest, through
brand transformation, the most evolved) through which the digital brand evolves. (In these
illustrations, a Web site is the chosen channel.)
The horizontal axis represents increasing cost and complexity as the experience design
for the Web site becomes more sophisticated. The vertical axis represents increasing
business value as the capabilities of the Web site grow. The three "chasms" are critical
delivery points for security, reliability, and customer value.
Brand presence
The first level of experience design for a Web site is brand presence. This is where many
sites begin-as a "placeholder," or a site with no interactive capabilities except, perhaps, a
simple search function and email. Essentially, the site is static. The respective roles of
strategy, technology, and experience design are detailed in figure 2.
The brand presence stage is a time of assessment for the online brand: What are the
opportunities? Looming ahead is a "security chasm"-the certitude that, to succeed, the
site's more-complex activities will require a secure infrastructure and privacy guarantees.
Brand interaction
The second level in experience design is brand interaction-the point at which the business
is actively exploring ways in which the channel can support or complement its activities
(figure 3).
This stage is immediately more complex than its predecessor, brand presence. For
example, if a Web page contains a toll-free telephone number for contacting the company,
there must be a person at the other end of that phone-and, one hopes, not only from 9 am
to 5 pm, US East Coast time! Business processes, operations, and communications must
be extended to the Web. And the impact of the new channel will reach even deeper into
more complex organizations, which must create a management system around it.
At the brand interaction level, the strategists are looking to save money and drive revenue
on the site. If they've begun to exploit the lower costs of doing business on the Web,
they'll also want to drive business to the Web from more-expensive channels, like call
centers. The technologists will be working on personalization so that customers are
served relevantly, and on Web-only initiatives. The team of experience designers will be
focusing on usability; ideally, they're working side-by-side with the technologists as
applications are developed.
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At the same time, everyone will be struggling with legacy applications and processes.
Basic metrics are being developed, and the capability for more-advanced data mining is
being built into new applications. A reliability chasm lies ahead, because now the business
must ensure that everything about the new channel-from the infrastructure to the business
processes-works optimally all the time.
Because the brand is becoming functional, the brand interaction level is where the
relationship between brand perception and the customer experience first becomes
apparent. (You may remember that in the days before digital, branding gurus used to
advise businesses to brand at the point of interaction-the point at which the benefit is
transferred. Now, that is literally possible.)
For example, in 1999 IBM was dissatisfied with the revenue driven by the e-commerce
section of the IBM Web site. We researched our customers, radically redesigned the
shopping experience, and relaunched the site-but with-out one word of announcement or
promotion (okay, we were scared). Still, revenue went up 400 percent in the week
following the relaunch, as customers reacted to the easier-to-use site by ordering at a
record level.
Brand transaction
The third level of experience design is brand transaction (figure 4), the point at which the
site is a well-oiled machine integrated with the rest of the business. Coordinated intranets
enable the business, literally, to live on the internal and external networks. While strategy
refines ways to generate low-cost online revenue and increase customer self-service,
technologists tackle the need for content management. If the business is successful, it will
be starting to realize substantial operating efficiencies as more customers choose to
interact with the brand online.
At this third level, the enterprise's experience designers will be working on creating brand
differentiation. They'll start with their own brand research, as well as sophisticated primary
research on customer needs. Working with the technology team, they'll translate their
data into relevant transactions.
But looming ahead is a value chasm. Many businesses run excellent transaction sites.
What will make your brand's customer experience deliver more value than that of your
competitors?
In the world of brand management, the transaction level is also the "moment of truth" in
which you find out how far your brand will let you go. How much trust has been developed
between your brand and your customers? "What I'd like to know about our brand," says
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John D. Zeglis, chairman and CEO of AT&T Wireless, "is whether people trust it to take
them the next step, to the next device, to the next connectedness application and when
it's time for them to take that step. [One study found] that people think AT&T Wireless is
the wireless innovator. That's great, we'll take that. But it's proving to them that they can
trust us to take them, hand in hand, into the future-that's ultimately how we deliver on our
promise."
Brand transformation
The fourth and final stage of experience design is brand transformation (figure 5), the
point at which the business is fully exploiting its Web channel. The strategic direction for
the business is firmly rooted in its brand value, which in turn is derived from carefully and
continually researched customer needs. Continuous data mining has led to advanced
customer segmentation and one-to-one marketing. Customers can complete important
transactions on more than one channel, and the results are apparent in real time. The
customer experience, consistent across channels, is value-packed. Because costs are
declining at the same time, the business realizes a sustainable competitive advantage:
the most value to the customer at the least cost to the business. The business culture
becomes one of constant change as the transformation goes forward day to day.
To summarize: The role of the experience design team is to provide the experience that
delivers the desired customer behavior. The team must:
0 Drive the brand manifestation from presence to transformation, across all channels
1 Bridge the gap between strategic intent and actual delivery with a functional and
rewarding customer experience
2 Deliver an experience based on customer needs that differentiates the business
3 Drive toward channel exploitation for maximum brand opportunity-in other words, get the
channel to the point at which a holistic business drives toward the desired customer
behavior
Fusion creates brand opportunity________
The fusion of business strategy, technology, and experience design to forge customer
experiences creates unprecedented opportunity for brands. Brand managers can seek an
enhanced mission. Rather than build the brand as a set of communications and images
that associate a company and its products with emotional values, leading-edge firms will
be focused on delivering the brand as an experience that incorporates them.9 The brand
and the customer experience will merge into one and the same thing.
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As a practical matter, using the vision of customer experience to transform a business

means developing an experience of architecture that is integrated across channels and
across the enterprise.
Read figure 6 from the bottom up to understand the primary steps involved.
0 First, determine your brand value and what differentiates it from others in your industry.
Segment your customers.
1 Next, determine how your differentiator translates into your desired customer
experience.
2 Integrate your plan for customer experience across the business, ensuring that the
management system supports it, and that the processes, operations, training, and
technologies are in synch across the enterprise.
3 Based on your customer segmentation work, plan and deliver the customer experience
for each customer group on each channel-from retail stores and Web sites through mobile
services, business partner operations, call centers, and so on.
4 The result should be a customer experience that is consistent across the enterprise and
across channels, supported by an integrated, holistic business.
Over time, every successful customer experience delivers two fundamental results, one
for the customer and one for the business:
0 Customers who are met on every channel, every time, with an experience that works
(that is, fulfills their need for value) will forge a progressively deeper involvement with the
brand.
1 Businesses that can exploit their customer knowledge to deliver value will improve their
competitive positions and enjoy related gains.
The strength of brands will increasingly depend not upon the distancing of one result at
the expense of the other, but upon their alignment, as manifested in the customer
experience.
In other words, the test of a successful customer experience is whether it achieves the
"win-win" strategy suggested at the beginning of this article: maximum customer value at
the least cost to the business.
"Maximum customer value" translates as consistently excellent experiences across

channels, personally tailored solutions, and needs and wants filled beyond expectation.
"Least cost to the business" translates into such proof points as these:
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0 Increased customer retention at less cost (the accepted ratio is that it costs $1 to retain
a customer versus $11 to recruit a new one). Moreover, increasing retention by only 5
percent has an enormous impact on customer lifetime value: from 35 percent in the
software industry to 75 percent in the credit-card industry to a whopping 90 percent in the
life insurance business.10
1 A higher return on investment for technology and operations costs
2 A lower cost of sales as customer retention increases
3 A higher closing rate (because segmentation pre-qualifies customers), leading to more

revenue per customer
4 Increased market share
5The ability to charge premium prices for greater perceived customer value
The final watchword is integration. The more thoroughly you integrate the customer
experience into your business, the more your brand is personified, the more difficult it is
for competitors to duplicate the value you offer, and the more expensive it is for customers
to switch.
The more thoroughly you integrate with the individual customer through the customer
experience, the more loyalty your business will generate. Even a business that has lost
the ability to differentiate itself in the general marketplace can differentiate itself to
individual customers if it makes itself increasingly indispensable. That's the power of the
experience. And while implementing customer experience is a powerful opportunity in
itself, early adopters have even more advantage.
The customer experience message is one of the few genuinely optimistic messages in
business today. It works like nothing else. It's still early in the game. And-forgive the
assumption-your business is probably ready. What's not to try?
Publication Information: Article Title: Fusion: Linking Strategy, Technology, and Design to
Implement Your Customer Experience. Contributors: Carol Moore - author. Magazine
Title: Design Management Journal. Volume: 14. Issue: 2. Publication Date: Spring 2003.
Page Number: 65+. © 2003 John Wiley and Sons, Inc. Provided by ProQuest LLC. All
Rights Reserved.
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0 Identify and examine the role and significance of teams in building successful new
ventures;
1 Examine the successful entrepreneurial philosophies and attitudes which can
anchor vision in forming and developing effective new venture teams;
2 Identify the critical issues, hurdles and common pitfalls in forming and building
new venture teams;
3 Explain how to reward teams;
4 Develop a reward system for your own business.
9.3.1: THE IMPORTANCE OF THE TEAM

The connection to success:
A management team can make quite a difference in venture success, and a quality team
is often the difference between a typical family business and a high potential venture;
It is extremely difficult to build a high-growth venture without a good team;
The lone wolf entrepreneur may make a living, but the team builder creates an
organization and a company. (Of course there are exceptions);
A study of 104 high-technology ventures launched in the 1960's showed that 83.3 percent
of high- growth companies which achieved sales of $5 million or more annually, were
launched by teams, while only 53.8 percent of the 73 discontinued companies had several
founders;
The existence of a team is important, but so is the quality of the team;
Venture capital investors have become even more active in helping to shape and reshape
management teams to improve their quality;
9.3.2: FORMING BUILDING TEAMS

Entrepreneurs face loneliness, stress and other pressures so finding the right partner can
help to lessen these pressures.
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9.3.2.1: Anchoring vision in team philosophy and attitudes
The most successful entrepreneurs anchor their vision of the future in certain
entrepreneurial philosophies and attitudes about what a team is, what its mission is and
how well it will be rewarded;
This vision concerns what the founder(s) are trying to accomplish, the unwritten ground
rules, the character, and purpose guiding how a team will succeed, make mistakes, and
realise a harvest together;
This fundamental mind-set is often evident in later success;
The capacity of the lead entrepreneur to craft a vision and then to lead, inspire, persuade
and cajole key people to sign up and deliver the dream makes an enormous difference
between success and failure;
There are numerous blends and variations, but the following are the key characteristics of
a good team:
0 Cohesion. Members of a team believe they are all in this together, and if the
company wins, everyone wins. No one wins unless everyone wins and if one
loses, everyone loses.
1 Teamwork. The team that works as a team rather than one where individual
heroes are created, may be the single most distinguishing feature of the higher-
potential company. Efforts are made to make others' jobs easier and to motivate
people by celebrating their successes.
2 Integrity. Choices and trade-offs are made regarding what is good for the
customers rather than on narrow personal or departmental needs and concerns.
There is a commitment to getting the job done without sacrificing quality, health or
personal standards.
3 Commitment to the long haul. Members of a committed team believe they are
playing for the long haul and that the venture is not a get-rich-quick scheme.
4 Harvest mind-set. Eventual capital gain is viewed as the scorecard, rather than
the size of a monthly paycheck, the size of an office, a certain car, and so on.
5 Commitment to value creation. Team members are committed to making the pie
bigger for everyone, including adding value for customers, enabling suppliers to
win as the team succeeds and making money for the team's various stakeholders.
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0 Equal inequality. Democracy and blind equality generally do not work very well
and diligent efforts are made to determine who has what responsibility for the key
tasks. Stock is usually not divided equally among the founders and key managers.
The contribution of each one to the venture will be a deciding factor.
1 Fairness. Rewards for key employees and stock ownership are based on
contribution, performance and results over time.
2 Sharing of the harvest. This sense of fairness can be extended by the more
successful entrepreneurs to the harvest of a company although there is no legal
obligation to do so. As much as 10 to 20 percent of the "winnings" is frequently set
aside to distribute to key employees.
9.3.2.2: A process of evolution
0 There is no blue-print for team development;
1 The new venture does not have to plunge into a full-blown team;
2 It is a process of evolution, trial and error and careful progress;
3 Preparation is an insurance policy. Thinking through team issues and team

building concepts in advance is a very inexpensive insurance policy;
4 The whole is greater than the sum of the individual parts, (i.e. 1 + 1 = 3);
5 The odds for highly successful venture teams is thin and even if the venture
survives, the turnover among team members during the early years is exceedingly
high;
6 There are a multitude of ways in which venture partners come together. Some
teams form by accident of geography, common interest or working together;
7 There are two distinct identifiable patterns, namely:
0 One person has an idea and is later joined by three or four associates over
the next one to three years as the venture takes form;
0 An entire team forms at the outset based on a shared idea, a friendship, an

experience and so forth.
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9.3.2.3: Filling the gaps
0 Successful entrepreneurs search out people and form a team based on

requirements of the opportunity;
1 Team members will add high value to the venture if they complement and balance
the lead entrepreneur and each other;
2 The nature and demands of the venture, the capabilities, motivation and interests
of the lead entrepreneur signal gaps to be filled by the team. For example, if the
strengths of the lead entrepreneur or a team member are technical in nature, other
team members need to fill voids in marketing, finance and so on;
3 The process of evaluating and deciding who is needed is a dynamic process and
not a one-time event;
4 This framework can guide the formation of new venture teams:
0 The founder. The lead entrepreneur needs to first consider whether the
team is necessary and whether he or she wants to grow a higher potential
company. Secondly he or she needs to assess what talents, know-how,
skills, track record, contacts and resources have been acquired. The lead
entrepreneur then needs to consider what the venture has to have to
succeed, who is needed to complement him or her and when. The lead
entrepreneur needs to ask questions such as:
0 What relevant industry, market and techno-local know-how and

experience are needed to win, and do I bring these to the venture?
1 Are my personal and business strengths that are critical to success

in the proposed business?
2 Do I have the contacts and networks needed?
3 Can I attract a team of all-star partners and can I manage these

people effectively?
4 Do I know what sacrifices and commitment will be needed and am I

prepared to make them?
5 What are the risks involved and am I prepared to take them?
6 What are my goals and income aspirations?
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0 The opportunity. What is needed in the way of a team depends on the match
between the lead entrepreneur and the opportunity and how fast he or she plans
to proceed. If a venture is looking for venture capital, the more it has the team in
place in advance, the higher will be its valuation and the smaller the ownership
share that will have to be parted with.
0 Some questions that need to be considered are:
0 Have I considered how and with whom the venture can make
money in this business?
What the company is selling makes a difference in the need for

different team members.
1 What are the critical success variables in the business and what or
who is needed to influence these variables positively?
2 Do I have access to critical external relationships with investors,

lawyers, bankers, customers, suppliers and so on that are
necessary to pursue my opportunity.
3 What competitive advantage and strategy should I focus on.
1 Outside resources. Gaps can be filled by accessing outside resources, such as

boards of directors, accountants, lawyers, consultants and so on.
0 Some questions are:
0 Is the need for specialised, one-time or part-time expertise

peripheral or on the critical path?
1 Will trade secrets be compromised if I obtain this expertise

externally?
2 Additional considerations
0 Values, goals and commitment. A team must be well anchored in terms

of values and goals. In successful companies the personal goals and
values of team members align well and the goals of the company are
championed by team members as well.
0 Definition of roles. Responsibility for key tasks must be determined. A

loose, flexible structure with shared responsibility is desirable for utilizing
individual strengths, flexibility, rapid learned and responsive decision
making.
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0 Peer groups. The support and approval of family, friends and co-workers
can be helpful especially during the bad times. Peer group support for each
team member should be in place (e.g. whether or not a team member's
spouse is in favour of his or her decision to pursue an entrepreneurial
career).
9.3.3: COMMON PITFALLS
0 Practical implementation of these philosophies and attitudes may prove to be

difficult, and the business can become unglued before starting up;
1 The team often lacks skill and experience in dealing with such difficult startup
issues and does not take the time to go through an extended "mating dance"
during the phase prior to actually launching the venture or seek advice of
competent advisors. As a result the team may be unable to deal with sensitive
issues such as who gets how much ownership;
2 Early discussion among team members sometimes leads to a premature

disbanding of promising teams;
3 In the rush to get going or due to a lack of funds to pay for help in these areas a
team may neglect these issues;
4 Critical issues such as who is in charge can be neglected in an attempt to

demonstrate equality. This can lead to destructive conflict at a later stage;
5 Failure to recognise deficiencies in the lead entrepreneur and adding appropriate

team members to compensate for them;
6 Over fascination or over-commitment to a product idea so that the entrepreneurial

requirements are neglected;
7 Failure to recognise the dynamic process of team-building. Initial agreements are

likely not to reflect actual contributions of team members over time;
8 Failure to recognise the possible change in composure of the team over time;
9 Failure to provide for "graceful divorce". Mechanisms must be put in place that will
facilitate and help structure graceful divorces and that will provide for internal
adjustments required as the venture grows;
10 Destructive motivations in investors, prospective team members and lead

entrepreneurs spell trouble. Examples are an early concern for power and control
by a team member;
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0 Taking trust for granted. The world is as full of sharks, crooks and frauds as it is of
people with integrity and ethics.
9.3.4: REWARDING THE TEAM
9.3.4.1: Slicing the founder's pie
How much ownership should go to whom?
Jed, a former student is in serious negotiations with John Doerr of Kleiner, Perkins,
Caulfield & Byers, to raise funding for a new Internet company. The advice for Jed, and all
others is the same: Start with a philosophy: share the wealth with those who help to
create it; realise a harvest at a price 5 to 10 times the original investment and up; make
the venture happen and future opportunities will be boundless.
9.3.4.2: The reward system
A reward system should include both material (financial), such as stock, salary and fringe
benefits and realisation of personal achievement components.
Attracting an efficient and successful team and keeping that team depends both on
financial and psychological rewards.
The rewards available to an entrepreneurial team vary somewhat over the life of the
venture. Rewards such as opportunity for self-realisation may be available throughout but
financial rewards are more or less appropriate at different stages of the venture's
development.
Because these rewards are so important and because a venture has limited rewards to
offer in its early stages, the total long-term reward system over the long term must be
thought through carefully.
9.3.4.3: Critical issues
A good reward system reflects the goals of the particular venture. For example if a goal is
to realise a substantial capital gain from the venture in the next 5 to 10 years, then the
reward system needs to be aimed at reinforcing this goal and encouraging the long-term
commitment required for its attainment.
Issues that should be considered do not always contribute equally. Different team
members rarely contribute the same amount to the venture and the reward system needs
to recognise these differences.
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Performance - the relative contributions of the team members can change dramatically
after several years and the rewards should change as well.
Flexibility - the performance of a team member may be more or less than anticipated or a
team member may have to be replaced. Setting aside a portion of the stock for future
adjustments can help to provide a sense of justice.
9.3.4.4: Timing
Allocating different rewards during different stages.
Division of rewards will most likely be made very early in the life of the venture and may
be a way of attracting early contribution.
Performance over the life of the venture needs to be rewarded.
Should a team member have to be replaced due to non-performance, death, quitting, then
the question of what will happen to the stock held by the team member will have to be
faced.
The stock was intended as a reward for performance over the first several years but the
team member will not perform over this period.
A buy back agreement is useful in these cases. Stock can be returned to its treasury at
the price at which it was purchased.
In the case where the member has earned some but not all of the stock a mechanism
called a stock-vesting agreement can be useful. The venture can then place stock
purchased by team members in escrow (money, property, deed or bond put into custody
of a third party until certain conditions are met) to be released over a two or three year
period.
The vesting agreement establishes a period of year — usually four or more. The founding
stockholders can "earn out" their shares during this period. If a founder leaves before this
period is up he leaves with no stock. In other cases, founders may vest a certain portion
each year, so they have some shares even if they leave.
In the early months of a venture, salaries will be low and bonuses and fringe benefits are
out of the question.
After several years of profitability is achieved, salaries can become competitive and
bonuses and fringe benefits awarded.
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9.3.4.5: Value considerations
The following factors influence the value of the contribution of different team members:
0 Idea. The originator of the idea, particularly if trade secrets or special technology
for a prototype was developed or if product or market research was done, needs
to be considered.
1 Business plan preparation. Preparing an acceptable business plan, in terms of

dollars and hours expended, needs to be considered.
2 Commitment and risk. A team member may have put a large percentage of his or
her net worth in the company and thus be at risk if the company fails, have to
make personal sacrifices, put in long hours and major effort and so on.
3 Skills, experience, track record or contacts. If these are of critical importance to

the new venture and not readily available, they need to be considered.
4 Responsibility. The importance of a team member's role to the success of the

venture needs to be considered.

9.1) Discuss the characteristics of a good team.
9.2) Why is it important to have the "right" team?
9.3) How does the founder decide whether a team is necessary or not?
9.4) Explain the common pitfalls.
9.5) "Share the wealth with those who help to create it." Discuss briefly.
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ENTREPRENEURSHIP: THE BUSINESS PLAN
0 THE BUSINESS PLAN

0 Determine what a business plan is;
1 Determine what needs to be included in the plan, why and for whom;
2 Identify some of the do's and don'ts in the business plan preparation process;
3 Conclude what has to be done to develop and complete a business plan for your
proposed venture.
10.2.1: DEVELOPING THE BUSINESS PLAN

The business plan is the culmination of the raw idea, carefully articulating the merits,
requirements, risks and potential awards of the opportunity.
It will demonstrate how the four anchors noted in Chapter 4 will reveal themselves to the
founders and investors by converting all the research, thought and creative problem
solving from the Venture Opportunity Screening Guide into a thorough plan:
0 They create or add significant value to a customer or end user.
1 They do so by solving a significant problem, or meeting a significant want or need

for which someone is willing to pay.
2 They have robust market, margin and money-making characteristics.
3 They are a good fit with the founder(s) and management team balancing time,
market space, risk and reward.
The business plan is not only a management tool, but is also used by investors and
bankers.
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10.2.1.1: The plan is obsolete at the printer
Due to technological advances (like the Internet), the business environment changes so
quickly that by the time the plan is printed it should start to be reviewed.
10.2.1.2: Work in progress
The business plan is like a cross-country flight plan. Many unexpected changes like
thunderstorms and fog can occur along the way and one has to be prepared to continually
adjust course to minimize risk and ensure successful completion of the journey.
10.2.1.3: The plan is not the business
The business plan forms the blueprint, strategy, allocation of resources, etc.
Without such a document it is exceedingly difficult to find capital.
The plan does not guarantee success.
Don't go to the negotiating table unprepared. The following are some tips from an
entrepreneur:
0 Be vague when talking to venture capitalists about what other venture capitalists
you are talking to.
1 Don't meet with an associate or junior member twice without a partner.
2 Stress your business concept in the executive summary.
3 The economics of the plan e.g. value proposition and business model are more
important than the numbers.
4 Make the business plan look and feel good.
5 Prepare lots of copies of published articles, contracts, market studies, etc.
6 Prepare very detailed resumes and reference list of the key players.
7 Make sure your current investors are as desperate as you are.
8 Create a market for your venture.
9 Never say no to an offer price.
10 Use a lawyer who has closed lots of venture deals.
11 Don't stop selling until the money is in the bank.
12 Make it a challenge — never lie.
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0 Fundraising is much harder than you ever thought it could be.
The founder(s) will rarely succeed in raising money if he or she is not effective at selling. It
is important, however, not to be so obsessed with selling that you fail to ask questions that
will give you great alternatives about the opportunity and strategy that you have not
thought of. Asking investors questions will help you to ascertain just what value they might
add to the venture.
Do's and do not's about the business plan.
Do's:
0 Involve the management team in the preparation of the business plan.
1 Make the plan logical, comprehensive and readable.
2 Demonstrate commitment to the venture by investing time and money in preparing

the plan.
3 Define the critical risks and assumptions and how and why these are tolerable.
4 Disclose any problems in the venture.
5 Identify alternative sources of financing.
6 Spell out the proposed deal — the price of ownership shares and how investors
will win.
7 Be creative in attracting the attention and interest of investors.
8 Remember that the plan is not the business.
9 Accept orders and customers that will generate a positive cash flow even if it
means postponing the writing of the plan.
10 Know your targeted investor group, what they want and what they dislike.
11 Let realistic market and sales projection drive the assumption made in the financial
spreadsheets.
Do not’s
Do not have unnamed people on the management team.
Do not make vague or unsubstantiated statements and estimates.
Do not describe technical products or processes using jargon that only an expert will
understand.
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Do not spend money on developing fancy brochures, etc.
Do not waste time writing a plan when you could be closing sales and collecting cash.
Do not assume you have a deal until the money is in the bank.
10.2.1.4: The dehydrated business plan
This is a summary form of the business plan. It is information about the heart of the
business opportunity, competitive advantages the company will enjoy and creative
insights that an entrepreneur often has. Many investors prefer the dehydrated business
plan in the initial screening phase.
10.2.1.5: Who develops the business plan
The business plan should not be left to outsiders but should involve the entire
management team. For example, one entrepreneur discovered while preparing his
business plan that the market for his biomedical product was in nursing homes and not in
hospital emergency rooms as he had previously thought. This changed the focus of the
entire marketing effort and would never have been discovered if an outsider had done the
preparation.
10.2.2: A CLOSER LOOK AT THE "WHAT"
10.2.2.1: The relationship between goals and actions
A key aspect of the business plan is to indicate how goals are going to be achieved.
This requires critical thinking about issues such as problems involved in launching the
enterprise, long-term profit prospects, future financing and cash flow requirements, facility
location, marketing and price strategies.
The plan must serve the very practical purpose it is needed for. It should be a "can-do"
plan.
10.2.2.2: Segmenting and integrating information
The only way to effectively organise the business plan is to segment the information into
sections.
This makes information digestible.
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10.2.2.3: Establishing action steps
Segmenting information. An overall plan for the project needs to be devised and
must include priorities, who is responsible for each section, the due dates of the
first draft and of the final draft.
Creating an overall schedule. A detailed list of specific tasks, their priorities, who is
responsible for them, when they will be started and when they will be completed
needs to be made.
Creating an action calendar. Tasks on the do list must be placed on a calendar.
Doing the work and writing the plan. The work must now be done and the plan
written. Adjustments can be made to the do list and the calendar as the need
arises.
10.2.3: PREPARING A BUSINESS PLAN
10.2.3.1: A complete business plan
There is a great difference between screening an opportunity and developing a business

plan.
The business plan requires that detailed data be gathered, interpreted and presented.
10.2.3.2: Table of contents of a business plan
a) Executive Summary
Description of the business concept and the business.
The opportunity and strategy. Summarise what the opportunity is and the entry
strategy planned to exploit it.
The target market and projections. Identify and briefly explain the industry and
market, who the primary customers are, how the product or service will be
positioned and how you plan to reach and service these groups.
The competitive advantages. Indicate the competitive advantages you enjoy or can
create.
The economics, profitability and harvest potential. Summarise the nature of the
economics of the venture (e.g. gross and operating margins, expected
profitability), time frames to attain breakeven and positive cash flow, and so on.
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The team. Summarise the relevant knowledge, experience, know-how and skills of
the lead entrepreneur and team members.
The offering. Briefly indicate the amount of equity and/or debt financing needed, how
much of the company you are prepared ,to offer for the financing, what principal
use will be made of the capital and how the investor, lender or partner will achieve
its desired rate of return.
b) The Industry and the Company and its Product(s) or Service(s)
Include a description of the industry.
The current status and prospects for the industry.
Market size, growth trends and competitors.
0 New products, new markets that can affect the venture's business.
Include a description of the company and the concept.
0 What business your company is in and the product(s) or service(s) you will
offer.
1 Include some background like the date the venture was incorporated and
the development of products.
A description of the product(s) or service(s).
0 A detailed description of each product or service.
The application thereof.
Unique features.
Possible drawbacks.
Present state of development.
Any head start you may have in the industry.
Advantages of the product that may give it an advantage over competitors.
0 Opportunities for expansion of the product line.
Entry and growth strategy.
0 Indicate key success variables in your marketing plan and your pricing,
distribution, advertising and promotion plans.
Summarise how fast you intend to grow and to what size.
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0 Show how the entry and growth strategy is derived from the opportunity.
Market Research and Analysis
This section of the business plan should be prepared first.
Other sections of the business plan depend on the market research and analysis
presented here.
Customers
Discuss who the customers for the product(s) or service(s) are or will be. If
customers are from different market segments, the discussion needs to
reflect this.
Show who and where the major purchasers are in each market segment.
Indicate whether customers are easily reached and receptive, how
customers buy (wholesalers, representatives), where in their organisations
buying decisions are made, how long the decisions take, what they base
their decisions on and why they might change current decisions.
0 List any orders, contracts or letters of commitment that you already have,
potential customers who have shown an interest and those who have not
shown an interest, why and how you can overcome the negative reaction.
Indicate how fast you believe your product or service will be accepted in
the market.
Market size and trends
0 Show for five years the size of the current total market and the share you
will have for the product or service you will offer in units, money and
potential profitability.
Describe the potential annual growth for at least three years of the total market
for each major customer group, region or country.
0 Discuss the major factors affecting market growth
Competition and competitive edges
0 Make a realistic assessment of the strengths and weaknesses of

competitors. Assess substitute/alternative products and services and list
the companies that supply them.
Compare competing and substitute products or services on the basis of market

share, quality, price, delivery, service, warranties, and so on.
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Compare the fundamental value that is added or created by your product or

service in terms of economic benefits to the customer and competitors.
Discuss the advantages and disadvantages of these products and services

and why they are not meeting customers’ needs.
Indicate any knowledge of competitors' actions that could lead you to new or
improved products.
Review the strengths and weaknesses of the competing companies in terms of

market share, sales, and so on.
Review the financial position, resources, costs and profitability of the

competition.
Indicate who are the service, pricing, performance, cost and quality leaders
and also who has entered or dropped out of the market in recent years.
Discuss the three or four key competitors and why customers buy from them
or leave them.
0 Explain how you could capture a share of the competition's business. Find
out where they may be vulnerable.
Estimated market share and sales
0 What is it about your product or service that will make it saleable despite
competition? What value is added or created by the product or service?
Identify major customers who are willing to make commitments. Discuss why
they will make the commitments, to what extent and who will be major
purchasers in future.
Estimate the share of the market and the sales in units and money that you will
acquire in each of the next three years.
0 Show how the growth of the company sales in units compares to the
growth of the industry.
On-going market evaluation
0 Explain how you will continue to evaluate your target markets so as to

assess customer needs and service and to guide product improvement
programs and new product programs, plan for expansions of your
production facility and guide pricing.
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d) The Economics Of The Business
Gross and operating margins
0 Describe the size of the gross margins (i.e. selling price less variables) and
the operating margins for each of the products and/or services you are
selling.
Profit potential and durability
0 Describe the size and durability of the profit stream the business will
generate before and after taxes.
1 Describe how perishable or durable the profit stream appears to be and

give the reasons why, such as barriers to entry you can create, and so on.
Fixed, variable and semi-variable costs
0 Provide a detailed summary of these costs in rands and as percentages of

the total cost and the volume of purchases and sales upon which these are
based.
Months to breakeven
0 Show how long it will take to reach a unit breakeven sales level.
1 Note any changes in your breakeven that will occur as you grow and add
substantial capacity.
Months to reach positive cash flow
0 Show when the venture will attain a positive cash flow.
Show if and when you will run out of cash.
0 Note any changes in cash flow that will occur as you grow and add
capacity.
Marketing Plan
The marketing plan describes how the sales projections will be attained.
Overall marketing strategy
Discuss the kinds of customer groups that you already have orders from, how
to identify and contact potential customers, which features of the product
will be emphasised to generate sales and if any innovative
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marketing concepts such as leasing where only sales were previously

attempted, will be used.
Will products be introduced nationally, internationally or regionally and why.
Will the cash conversion cycle be influenced by seasonal trends and what can
be done to promote sales out of season.
0 Describe plans to obtain government contracts.
Pricing
0 Discuss the prices to be charged and compare with those of the

competitors as well as payback in months to the customer.
Is the profit margin large enough to pay for warranty, training, service and so
on and still allow a profit.
Show how the price will get the product or service accepted, maintain the
market share and produce profits.
Justify price differences to those of competitors in terms of payback to the

customer and value added.
If prices are lower than competitors explain how profitability will be maintained.
0 Describe discount allowance for prompt payment or mass purchases.
Sales tactics
0 Describe methods used to make sales and distribute the product or

service.
Discuss the margins to be given to retailers, wholesalers, and so on and

compare them to those given by the competition.
How will distributors or sales representatives be selected, when they will start
to represent you, in which areas and expected sales to be made by each.
If a direct sales force is to be used, indicate how it will be structured.
If direct mail, magazines or other media are to be used, indicate the specific
channels and expected response rate and yield.
Present a selling schedule and a sales budget that includes all marketing
costs.
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Service and warranty policies
The importance of service and warranties to the purchaser's buying decisions

must be discussed.
Describe the kind and term of the warranty and who will handle the service.
Indicate the proposed charge for service calls (profitable or break-even).
0 Compare your policies and practices to those of the competition.
Advertising and promotion
0 How will the company bring its product or service to the attention of
purchasers?
For industrial products indicate plans for trade show participation, trade
magazine advertisements, direct mailings and use of advertising agencies.
For consumer products indicate what kind of advertising and promotional

campaign is on the cards to introduce the product.
0 Present a schedule and approximate costs of promotion and advertising.
Distribution
0 Describe the methods and channels of distribution you will employ.
Indicate how sensitive shipping cost is as a percent of the selling price.
Note any special issues or problems that need to be resolved.
0 Note how international sales will be handled, if applicable.
Design and Development Plans
Development status and tasks
Describe the current status of each product or service and explain what
remains to be done to make it marketable.
Describe the expertise that your company has or will require to complete this
development.
0 List customers who are participating in the development, design, testing of

the product or service. Indicate results to date and expected results.
Difficulties and risks
0 Identify major possible design and development problems and how they
can be solved.
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1 What possible effect can these problems have on costs and time.
Product improvement and new products
0 Discuss any ongoing design and development work that is planned to keep
products or services competitive and to develop new related products or
services.
Costs
0 Present and discuss the design and development budget.
1 Discuss the impact on cash flow projections of underestimating this budget.
Proprietary issues
0 Describe any patent, trademark, copyright or property rights you are

seeking.
Describe contractual rights or agreements that give you exclusivity or

proprietary rights.
0 Discuss the impact of any unresolved issues or existing actions pending

such as disputed ownership rights.
Manufacturing and Operations Plan
Operating cycle
Describe lead/lag times that characterise the fundamental operating cycle in

your business.
0 Explain how any seasonal production loads will be handled (like using part-
time help).
Geographical location
0 Describe the location of the business.
1 Discuss any advantages or disadvantages of the site in terms of labour,

closeness to customers, access to transportation and so on.
Facilities and improvements
0 For an existing business describe the facilities such as plant and office
space, storage and land areas, tools, machinery and whether they are
adequate.
For start-up, describe how the facilities will be acquired.
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Will equipment and space be leased or acquired and how much of the
financing will be devoted to plant and equipment?
Explain future equipment needs in the next three years.
0 Discuss how and when, in the next three years, plant space and equipment
will be expanded to capacities required by future sales projections as well
as plans to improve the facility.
Strategy and plans
0 Describe the manufacturing processes involved in production of your

product and any decisions with respect to subcontracting of parts.
Justify your proposed make-or-buy policy in terms of inventory financing,

available labour, as well as production, cost and capability issues.
Who are the subcontractors/suppliers likely to be?
Present a production plan that shows cost/volume information at various sales

levels of operation with breakdowns of material, labour, components
purchased and factory overheads.
0 Describe your approach to quality control, production control and inventory

control and what measures and inspection procedures the company will
use to minimise problems.
Regulatory and legal issues
0 Discuss any relevant state or foreign requirements unique to your product,

process or service such as health permits and zoning permits.
Note any pending regulatory changes that can affect the nature of your
opportunity and its timing.
0 Discuss any legal or contractual obligations that are pertinent as well.
Management Team
Organisation
Present key management roles in the company and the individuals who will fill
each position.
If it is not possible to fill each executive role with a full-time person, indicate
how these functions will be performed, e.g. using consultants.
Indicate when key individuals will join the board if not from the start.
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0 Discuss current or past situations where key management people have

worked together that could indicate how their skills complement each other
and result in an effective management team.
Key management personnel
0 Describe in detail career highlights, relevant know-how, skills and track

record that show his or her ability to perform the assigned role.
Describe the exact duties and responsibilities of each of the key members.
0 Complete resumes for each key management member must be included.
Management compensation and ownership
0 State the salary to be paid, stock ownership planned and amount of their
equity investment.
1 Compare the compensation of each member to that of his or her last

independent job.
Other investors
0 Describe any other investors in your venture, the number and percentage
of outstanding shares they own, when they were acquired and at what
price.
Employment and other agreements and stock option and bonus plans
0 Describe any existing or future employment or other agreements with key

members.
Indicate any restrictions on stock and vesting that affect ownership and
disposition of stock.
Describe any performance-dependent stock option or bonus plans.
0 Summarise any incentive stock option or other stock ownership plans

planned or in effect for key people.
Board of directors
0 Discuss the company's philosophy about the size and composition of the
board.
1 Identify any proposed board members.
Other shareholders, rights and restrictions
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0 Indicate any other shareholders in your company and any rights,

restrictions or obligations associated with these.
Supporting professional advisors and services
0 Indicate any that will be required.
1 Indicate the names of the legal, accounting, advertising, consulting and

banking advisors selected and the services each will provide.
Overall Schedule
Step 1: Lay out the cash conversion cycle in the business to capture for each product
or service the expected time from an order to shipping and collection.
Step 2: Prepare a month-by-month schedule that shows the timing of activities with
sufficient detail to show the timing of the primary tasks required to accomplish an
activity.
Step 3: Show deadlines or milestones critical to the ventures success.
Step 4: Show the number of management personnel, the number of production and
operations personnel and plant or equipment and their relation to the development
of the business.
Step 5: Discuss the activities most likely to cause schedule slippage, how they can be
corrected and the impact of slippages on the operation.
Critical Risks, Problems and Assumptions
Discuss assumptions and risks implicit in your plan.
Identify and discuss any major problems and other risks.
Indicate what assumptions or potential problems and risks are most critical to the
success of the venture and describe your plans for minimizing the impact of them
in each case.
k) The Financial Plan
Actual income statements and balance sheets
0 For an existing business prepare these for the current year and for the
prior two years.
Pro forma income statements
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Using sales forecasts and the accompanying production or operations costs,

prepare pro forma income statements for at least the first three years.
Fully discuss assumptions made in preparing them.
0 Highlight major risks that could prevent the venture's sales and profit goals
from being attained.
Pro forma balance sheets
0 Prepare them semi-annually in the first year and at the end of each of the
first three years of operation.
Pro forma cash flow analysis
0 Project cash flows monthly for the first year of operation and quarterly for
at least the next two years.
Discuss assumptions made like trade discounts, planned salary increases, etc.
0 Discuss cash flow sensitivity to a variety of assumptions about business

factors.
Breakeven chart
0 Calculate breakeven and show when breakeven will be reached.
1 Discuss whether breakeven will be easy or difficult to attain.
Cost control
0 Describe how you will obtain information about report costs and how often,
who will be responsible for the control of various cost elements, and how
you will take action on budget overruns.
Highlights
0 Highlight important conclusions such as maximum amount of cash

required, amount of debt and equity needed, and so on.
Proposed Company Offering
Desired financing
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How much of the capital requirement will be obtained by offering securities to

investors and how much will be obtained by terms loans and lines of credit.
0 What percentage of the company will investors hold.
Capitalisation
0 Present in tabular form the current and proposed number of outstanding

shares of common stock. Show the number of shares that will be held by
key management people.
1 Indicate how many shares of your company's common stock will remain
authorised but unissued after the offering and how many of these will be
reserved for stock options for future key employees.
Use of funds
0 Investors like to know how their money is going to be spent. Provide a brief
description of how the capital raised will be spent.
Investor's return
0 Indicate how your valuation and proposed ownership shares will result in
the desired rate of return for the investors you have targeted and what the
likely harvest will be.
m) Appendixes
Include information here that is too extensive for the body of the business plan but
which is necessary, e.g. lists of references, product specifications or photos, and
so on.
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10.2.3.3: Financial life cycles
In early stages, personal savings, friends and other informal investors are the only
sources of funds available.
A company only gets outside capital after its early growth stages.
Equity capital and risk funding is only available to high growth and medium growth
types of business.

10.1) Explain the 3 critical issues in financing new ventures.
10.2) Explain 5 differences between entrepreneurial finance and corporate finance.
10.3) Why will the following factors affect the availability of financing?
Accomplishments and performance to date
Investors perceived risk
Venture anticipated growth rate
Venture age and stage of development
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OBTAINING VENTURE AND GROWTH CAPITAL

Identify informal and formal investment sources of equity capital;
Learn how to find, contact and deal with equity investors;
Discover how venture capital investors make decisions.
11.2.1: COVER YOUR EQUITY
Any young company must balance its need for capital with the preservation of equity.
Hold on to as much as you can for as long as you can.
There are three central issues to consider when beginning to think about obtaining risk
capital:
Does the venture need outside equity capital?
Do the founders want outside equity capital?
Who should invest?
11.2.2: INFORMAL INVESTORS
11.2.2.1: Who are they
Wealthy individuals are an important source of capital.
They are nicknamed "angels".
Characteristics
They have made it on their own
They have substantial business and financial experience
Age group 40 — 50
Well educated
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They invest alone or in syndicates.
Demand high equity stakes.
They have different motivations.
Their evaluations and decision-making processes are informal, less thorough and
often based on experience, instinct and risk-based.
11.2.2.2: Where to find informal investors
Mostly through contacts, networks and informal associations.
Often attorneys and accountants have valuable contacts due to the nature of their
work.
11.2.2.3: Contacting investors
Mostly a referral is required.
Be sure to make a concise presentation of the key features of the proposed venture.
Avoid meeting with more than one informal investor at the same time.
Try to obtain the names of other potential investors.
11.2.2.4: Evaluation
Be sure to be able to provide information that can be reviewed by the potential investor.
11.2.3: VENTURE CAPITAL

A venture capital provider should bring more to the business than mere cash. The venture
capitalist should add value to the deal.
11.2.3.1: Definition
Venture capital involves a degree of risk and even an element of gambling.
The venture capital industry provides capital and other resources to entrepreneurs
with high growth potential businesses in the hopes of achieving a high rate of
return on invested funds.
The process involves many stages:
Conception of a target investment opportunity
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Written proposal to raise a venture capital fund
Generating deals to crafting and executing harvest strategies
11.2.3.2: The venture capital industry
The industry credits Ralph E. Flanders, the then president of the Federal Reserve
Bank of Boston with the idea.
The venture capital industry did not experience a growth spurt until the 1980's.
11.2.3.3: The venture capital process
The availability and cost of this capital depends on a number of factors:
Perceived risk
Upside potential and downside risk
Industry and market attractiveness
Anticipated growth rate
Age and development stage
Amount of capital required
Founder's goals for growth, control, liquidity
Strategic fit with investor
Relative bargaining positions
Mission
Build a highly profitable and industry-dominant company
0 Go public or merge within four to seven years
Complete management team:
0 Led by industry "superstar"
Possess proven entrepreneurial and general management skills
Have leading innovator or technologies/marketing head
Possess complementary and compatible skills
Have unusual tenacity, imagination and commitment
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0 Possess reputation for high integrity
Proprietary Product
0 Has significant competitive lead and "unfair" advantages
Has product or service with high value-added properties resulting in early

payback to user
0 Has or can gain exclusive contractual or legal rights
Large and rapidly growing market
0 Will accommodate a $50 million entrant in five years
Has sales currently at $100 million+ and growing at 25% per year
Has no dominant competitor now
Has clearly identified customers and distribution channels
0 Possess forgiving and rewarding economics
Deal Valuation
0 Has "digestible" first-round capital requirements
Able to return 10 times original investment in five years
0 Has possibility of additional rounds of financing at substantial markup
The characteristics of investors should be:
0 Investors who seek new financing proposals and can provide the required
level of capital.
Investors who are interested in certain companies at a certain stage of growth.
Investors who have a preference for a particular industry.
Investors who can provide good business advice.
0 Investors who are reputable and ethical with successful track records.
Red lights in potential investors:
0 The wrong attitude: Entrepreneurs need to be wary if they keep getting

handed off to a junior associate or if the investor thinks he or she can run
the business better than the lead entrepreneur or team.
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Over-commitment: Entrepreneurs need to be wary of investors who already

sit on the boards of six to eight other start-up companies or who are busy
raising money for a new fund.
Inexperience: Entrepreneurs need to be wary of venture capitalists with no

hands-on experience in new and growing companies and have a
predominantly financial focus.
Unfavourable reputation: Entrepreneurs need to be wary of funds that have

a reputation for early and frequent replacement of founders or where one
quarter of the portfolio companies are in trouble.
11.2.3.4: Dealing with venture capitalists
Keep in mind that venture capitalists only invest in one out of three proposals;
Obtain a personal introduction;
Never lie;
Seek signs that the investor is interested in your strategies.
11.2.3.5: Due diligence
A due-diligence is an investigation into the business, its management, concept processes,

weaknesses and strengths;
This may take weeks, or months, depending on the complexity and size of the
transaction;
Remember to also investigate your investigation fund.
11.2.4: OTHER EQUITY SOURCES
11.2.4.1: Development corporations
These institutions are promoting small businesses by guaranteeing long-term loans.
11.2.4.2: Private placements
An attractive source of capital for a private company that has ruled out the possibility of
going public. The company offers stock to a few private investors, rather than to the
public. It requires little paperwork and can take a small amount of time.
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11.2.4.3: Mezzanine capital
Mezzanine financing refers to capital that is between senior debt financing and common
stock.
11.2.4.4: Public stock offerings
An initial public offering raises capital through federally registered and underwritten sales
of the company's shares.
11.2.4.5: Employee stock option plans
A program in which the employees become investors in the company, thereby creating an
internal source of funding.

11.1) How would you find and contact investors?
11.2) Describe 4 aspects that investors would regard as requirements of a "superdeal".
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ENTREPRENEURSHIP: THE START-UP AND
AFTER
START-UP AND AFTER
After conditions of rapid growth, entrepreneurs face unusual paradoxes and challenges as
their companies grow and the management modes required by these companies change.
Whether they have the adaptability and resiliency in the face of swift developments to
grow fast enough as managers and whether they have enough courage, wisdom and
discipline to balance controlled growth with growing fast enough to keep pace with the
competition and industry turbulence will become crystal clear.
There are enormous pressures and physical and emotional wear and tear that
entrepreneurs will face during the rapid growth of their companies. It goes with the
territory. Entrepreneurs after start-up find that "it" has to be done now, that there is no
room to falter, and that there is no "runner up". Clearly, those who have a personal
entrepreneurial strategy, who are healthy, who have their lives in order, and who know
what they are signing up for are better than those who do not.
Among all the stimulating and exceedingly difficult challenges entrepreneurs face — and
can meet successfully — none is more liberating and exhilarating than a harvest. Perhaps
the point is made best in one of the final lines of the musical "Oliver". "In the end all that
counts, is in the bank, in large amounts".
Obviously, money is not the only thing, or everything. But money is the vehicle that can
ensure both independence and autonomy to do what you want to do, mostly on your
terms, and can significantly increase the options and opportunities at your discretion. In
effect, for entrepreneurs, net worth is the final score card of the value creation process.
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MANAGING RAPID GROWTH
12.1: Reading
Article 1
Prepare Your Company Now for the Perils of Rapid Growth
by James A. Buckenmyer
The most perilous period in a company's development is when it starts to succeed wildly,
enjoys high earnings and shows rapid sales growth. This period of peril is not limited to
small businesses. Parallel perils have been observed in small, rapidly growing, not-for-
profit organizations as well. Almost any small, rapidly growing organization faces the same
perils.
The observations for this article were made over a number of years in numerous
organizations including businesses, governmental and not-for-profit agencies and
departments.
Consistent patterns of development were observed in all of the organizations. Three case
studies will illustrate the consistent patterns of growth and eventual problem development.
These patterns will be identified, and some methods of recovery will be illustrated.
THREE CASE STUDIES
Case I A sport cap wholesaler--A moderate volume screen printer of sport caps (imported
"baseball" caps) discovered that the supply of various colored caps was inconsistent.
Many of the most desired colors were not available when needed, delivery was slow, and
quality was extremely variable. He decided that a wholesaler who stocked a wide variety
of colors, maintained consistently high quality and promised 24 hour shipment could
capture a profitable segment of the market. He was right! He developed his own style cap,
had dies made and secured an overseas supplier. He preordered and stocked many
caps. For three years sales more than doubled each year. In the fourth year, troubles
started to develop. His overseas supplier could not deliver all of the caps needed. Another
supplier was found. As demand increases the quality from both suppliers slipped. Existing
employees were unable to handle the influx of orders, and additional ordertakers, pickers
and shippers were hired. Orders were mixed and lost. Prices were repeatedly increased
to cover additional cost, then cut to stimulate sales. Sales fluctuated wildly. High "stock
outs" occurred. Eventually sales declined steadily.
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Case 2: An oak office furniture manufacturer--Two young men started to make oak office
furniture on a relatively small scale. (A $60,000 SBA loan was used to start the business.)
After about four years of steady growth, distributors were added and the business began
to expand rapidly. To meet the demand, new employees and equipment were added.
Space became a premium but sales continued to grow. To meet expansion needs an
additional $600,000 SBA loan was obtained and a warehouse across the street was
purchased. But production facilities were taxed to the limit. Production slowed. Shipping
schedules were missed. Pricing was not related to costs. Bills accumulated. Because of
limited cash, oak was purchased from retail lumber yards rather than wholesalers. The
cash flow crunch grew. Despite their booming sales success, the company was nearing
bankruptcy.
Case 3: An alcohol rehabilitation center --A reformed alcoholic, with some assistance from
the local united fund, started an alcohol rehabilitation center. His unique method had
better success than most other institutional settings. His reputation grew. His facility
became over committed. A second facility was opened after several years. It too became
overcrowded. With state help a third facility was opened. The facilities were so successful
that income and local funding could not maintain the facility nor sustain the growth. State
operating funds were added. Then success rates began to decline. Applications dropped.
The program began to falter. The founder could no longer give the recovering alcoholics
his special form of attention.
Each of these three cases, and the other cases mentioned above, all follow the typical
lifecycle of an organization. Typically, organizations start with a period of slow growth,
have a period of rapid growth, begin to slow, and then begin to decline. At the point of
decline in the cycle one of two things can happen. First, the causes of decline can be
recognized and eliminated. The business begins recovery and has a period of slower,
"planned" growth. Second, the causes of decline:
are not recognized and, therefore, not corrected;
are recognized and the corrective actions are too late to bring about recovery; or
are recognized and the individuals do not know how to correct the problems.
In any of these latter instances, decline continues and the operation becomes severely
troubled, is sold or goes out of business.
PRECONDITIONS FOR RAPID EXPANSION
The three preconditions to rapid expansion seem to be the following:
* a committed, often over-involved founder;
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an organization with commitment to quality, customer service and satisfaction; and
a customer/client awareness of the organization's commitment to customer satisfaction.
MANAGERIAL COMMITMENT
Authors of the book "In Search of Excellence" identified one of the hallmarks of
excellence of a corporation as a corporate leader who was dedicated and charismatic. In
the above mentioned rapidly expanding small businesses (agencies or departments)
there was also one individual who was the driving force of the success. Typically all
activities revolved around this individual. He (in all of the cited cases it was a he) was the
idea man, the resource person, the decision maker and the total authority figure.
Subordinates rarely performed up to his expectations and yet, in several cases, he was
generous with "managerial" bonuses. Despite generally low wage scales he was able to
elicit commitment and dedication from all of the employees. He knew all of the employees
and their families. Esprit-de-corps was generally quite high. There was a fairly large
percentage of long term employees.
All of the long term employees knew what the business was about. They were daily
involved in the organization's mission of quality, service and customer satisfaction. In each
case, the organization had some distinctive service that separated it from its competitors.
All of the leaders insisted on quality, the type of quality that is not merely a label, but is an
integral part of the operation. As one owner put it, "If we do not provide our customers
greater value than our competitors, the customers will not return." New employees who
did not quickly show a dedication to the quality/customer satisfaction mission of the
organization were not retained.
ORGANIZATIONAL COMMITMENT
The organizational commitment was evident as each employee helped the other maintain
quality and shipping expectations. Over time, the employees became experienced
working together. They became aware of expectations and "standards" for each position.
In essence, job responsibility, operating procedures, methods, standards and working
systems were understood by all. These were seldom written or formalized in any way.
It is the organization's quality/customer satisfaction mission that retains customers and

fosters repeat business. Additionally, satisfied customers "spread the word," which
spawns a geometric expansion of orders. The expanded orders propel rapid growth which
leads to the perils of rapid growth.
As the customer's orders expand, the resources of the organization are extended to the
breaking point. The proprietor makes adjustments to keep up. Employee hours are
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expanded. New employees are added, a few at first, in larger numbers later. New
equipment is added, often with excess capacity for growth. The new equipment, larger
inventories and more work-in process make space a premium and some physical
rearrangement takes place. Later, as space needs become so critical that expansion
becomes necessary, the resources of the organization become stretched to their limit. The
"squeaky wheel" principle is applied. Space, equipment and people are added wherever
the pressure is felt at the moment. They are installed quickly to solve a problem. In
essence, everything is over extended and the need to relieve the pressure is felt
throughout the organization.
CASH FLOW AND CASH SHORTAGE
Despite growing profits, a cash flow problem begins to appear. Additional inventories,
accounts receivable, equipment, wages and space almost invariably cause a cash
shortage. Cash flow problems in expanding small businesses are well documented. Poor
cash flow has been identified as one of the major causes of small business failure (SBA).
The cash flow and cash shortage problems become epidemic in a rapidly expanding
business.
EQUIPMENT AND FACILITIES
The crush for space almost always become critical. In retail operations new and/or
expanded lines are desired to sustain the growth. A new outlet may be opened. In
wholesaling, the inventory demands are expanded, and often lines are also extended
here. In manufacturing, inventories are increased to handle the increased production and
prevent stock outs. Equipment is added. In service organizations, room is needed to serve
additional clients. All of these require additional space. Even those organizations that
started with excess space and capacity are soon overextended.
Most manufacturing firms start with minimal, general purpose equipment. As orders and
production increase dramatically, more and more specialized equipment is added. The
specialized equipment usually exceeds the production output of the old equipment, thus
increasing the production capacity but also the required inventory space and the break-
even point. The more specialized equipment may also limit the flexibility of the operation
and require specialized materials handling equipment.
The expanded operations obviously require more people. New people are hired. They do
not know the operating systems and procedures nor the equipment. Most of all, they do
not know the internal relationships nor the quality/customer service mission of the
operation. They are not part of the pride and dedication of the growing business. The new
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employees have not internalized all of the evolved working relationships, procedures,
standards and systems of the business. Usually they are hired in a period of stress and
are thrust into the work situation without much indoctrination and familiarization. This
becomes a critical omission. In retailing, they are often hired for a remote site not under
the direct observation of the manager.
In all of the cases listed in Table 1, the original "management" teams were not managers.
They were hands-on, get involved doers. They knew the operations and what it took to
get the job done. They were deeply involved in the day-to-day operations. The operating
managers were on the floor addressing crises for nine to ten hours a day. As the output
increased, the crisis demands increased and made it impossible for these managers to
keep up. The managers, as well as the workers, were overwhelmed and overextended. It
became necessary to "manage" the organization and the doers were limited in their
management experience.
It was noted earlier that the experienced workers understood their "job responsibilities,
and the operating procedures, methods, standards, and working systems." The
experienced employees knew what made the operation tick. They knew how to get things
done in the way the proprietor wanted them done. But the new employees are not aware
of all of the "ins and outs" of the operation. When they are hired there is little time to
integrate them into the operation. They often learn only the mechanics of their jobs. The
managers hesitate to weed out the weak ones because their output is needed and it
would take too long to obtain and train new employees. As the numbers of new
employees grow as a proportion of the work force, more and more errors begin to appear
in the work flow and the final product. The "understood" work responsibility (and
assignments) and comprehensive operating procedures, methods, standards and working
systems are not a part of the work patterns of the new employees. The new employees
are less efficient.
The new equipment is not as efficient as it was expected to be. None of the employees
are familiar with it. Changes in input and output handling may cause work flow problems,
which further reduce the output per manhour.
New equipment often does not fit into the existing work flow and systems. The physical
expansion of the operation causes disruption of the existing systems. But the interruption
of the work flow and systems caused by the physical changes may be only the tip of the
iceberg.
Actual systems may also be flawed.
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Purchasing activities and suppliers that were satisfactory at one volume may not be
acceptable at a higher volume. Material store age and flow, work flow, order handling and
other systems may all be disrupted by the larger volume. Some processing methods may
have to be changed.
For retailers, merchandising systems may not work for new products nor generate enough
sales. Order handling may have to be changed. Credit practice and customer complaint
systems may not work.
Decision making seems more difficult. Communication seems to be lacking. Often the
right hand does not seem to know what the left hand is doing. Decisions are made and
things are done before the manager finds out about them.
Things just do not seem to work the way they had been working.
THE PROBLEM
All of the organization cases mentioned above had some cash shortage and cash flow
problems. But the cash flow problems were symptomatic; they were not the base cause of
the organization's problems. Other symptoms of the problems were increased scrap;
improper work; delayed orders; increased rework; increased customer/client complaints;
lost orders; increased manufacturing time; lost customers or clients; and other evidence of
inefficiency and ineffectiveness. Note that in the list of problems above, all contribute to a
reduction of cash flow. These reductions in cash flow, when added to the increased
demands for cash caused by expansion, magnified the cash flow problem. The
inefficiencies and ineffectiveness caused by malfunctioning systems and ill-informed
employees are a greater contributor to the cash flow crunch than is generally recognized
By taking precautionary steps, the systems and employee problems can be reduced thus
reducing the cash flow and cash shortage problems.
Suggested remedies require the managers to prepare before actions are taken. The
suggestions revolve around considering what kind of effect the additions or changes are
likely to have in respect to all systems related or connecting to the change to be made. In
other words, the actions require some analysis and planning. Analysis is necessary to
predict the variety of effects of the changes. Planning is necessary to handle the ripple
effect throughout the other systems.
EQUIPMENT AND FACILITIES
When there is a need to add equipment or enlarge facilities, there is a tendency to go first
class. After all, profits are up and sales are expanding. The thought is "We might as well
go first-class because we will need the capacity in the near future." Caution: Do not
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expand beyond the reasonably predictable future. This is especially true when
considering a new building or an expensive piece of specialized equipment. The cost of
the excess capacity will have to be carried by the present volume.
New buildings usually cannot be purchased for near the same cost per square foot as the
existing building. Often the cost per square foot more than doubles. This reduces profit.
Paying for the new building plus interest will increase the demands on cash, further
causing a cash flow crisis. But there are also some hidden or not readily observable
costs. Moving costs and loss of production during the move will heighten the cash flow
crisis. Reestablishing utilities may be costly. There will be more insurance and other costs.
Reestablishing the production system and process will be costly. With proper planning,
some of these costs may be reduced but they will still exist. One of the case study owners
spent nearly $200,000 rearranging storage shelves, inventory and moving part of their
operations, only to relocate some of the storage and return some of the operations six
months later. Caution: If your business warrants a move to new and larger quarters , do it
during what is normally a slack period and provide space only for foreseeable expansion.
It might be wise to buy land for further expansion and to arrange your physical layout to
accommodate that expansion but do not build a high cost building that will stand idle.
Over expansion of equipment will cause the same cash flow difficulties. But any new
equipment will bring with it additional problems. The new, larger capacity equipment will
be installed at the tightest bottleneck. It will usually produce more units, which will require
changes in input handling equipment and changes on the output handling equipment. It
will usually require the acquisition of new supporting equipment. It may also cause
changes in other equipment.
EXAMPLE:
The silk screen specialty manufacturer mentioned earlier purchased two new die cutters
to replace three old die cutters (which had been jerry-rigged conversions from old printing
presses). The smaller of the two new presses would have had more than adequate
capacity had the base stock size been increased and the number of items on the sheet to
be diecut been increased (which the press was easily able to handle). However, that
action would have caused changes in layout, printing, drying, storage and packing. The
owner did not want to make all of those changes, which would have also required many
additional changes.
He tried to operate with the original die and stock size. He used the three old die cutters
as back-up. He soon learned this was inadequate. He had to change. He almost doubled
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the number of items to be cut. This brought about changes in the stock sizes, dies, layout,
printing, drying, storage and packing. The three old die cutters were no longer adequate
for back-up. The larger of the new die cutters, the Cadillac of the industry, stood idle. It
was too sophisticated to use as back-up. An additional problem developed. The increased
blank stock size was difficult to handle for the operators of the printer and die cutter.
There was more scrap which required more overruns. The time spent adjusting to the
input and output requirements of the new die cutter and other changes severely reduced
the expected gains in productivity. The new die cutter caused severe cash drain beyond
its own cost because it required so many changes in operation to fit it into the overall
operation.
Caution: When adding new space or equipment, be sure to review the work flow changes
that will be required to make the new equipment work. Be sure that the equipment you
have will support the changed work and work flow requirements. Do not expand beyond
the foreseeable needs of your operation. Do not increase your costs beyond what the
change will support.
THE PEOPLE
During a boom, new employees are added quickly. They are taught to do "their" job and
turned loose. Since their jobs are often either new jobs or have been carved out of
another job, there is usually no job description available to detail the work of the job. The
new job relationship to other positions is not clear. Also, all of the "known" systems and
procedures are not detailed.
As a result of no job description and the rush to make the new employee productive, only
the bare essentials of the job are described. Often the job instructor is too familiar with the
job so that details are assumed to be understood. Or, the instructor may not be familiar
enough with the job so that job details are overlooked. In either case, the importance of
that job is not impressed upon the trainee and the inter-relationship of that job with other
jobs is not stressed. The resultant employee is an individual who "does the job" but does
the job in a rote and simplistic manner.
Caution: Plan for the addition of new employees before the conditions arise where new
employees need to be hired. Since it is unlikely the jobs will be studied once the decision
to hire has been made, several steps should be taken before the hiring begins. The first
step would be to identify where the next two, three, or four employees are likely to be
added. The second step would be to identify all of the aspects of each job: the
requirements for each job, the place of each job in the overall work structure, and the
inter-relationships for each job with other jobs. Third, a check list should be prepared for
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each job. The check list should be used to assure that adequate training has taken place
and that the employee is aware of his/her direct contribution to the business.
Note that neither new support staff nor new management positions should be exempted
from the check list preparations. Since the support staff's and management's positions are
more mental than physical, the check list preparation and indoctrination procedures are
more important. During the indoctrination of these employees, do not sluff-off questions,
particularly questions like "Why do you do it that way?" Such questions can lead to
improvement in systems. Such questions, if not answered, can lead the employee to take
short cuts, which could contribute to inefficient operations or ineffective control. It is
inestimably more important that support staff and management know what they are to be
doing and why than it is for the operating staff.
A well informed and well trained staff is one of the company's most important assets. Do
not rely upon the staff learning from experience. They may learn the wrong things from
experience. Guide their training and their learning. This is more important for a small
company than it is for a large company where there are more internal checks and
controls.
OPERATING AND SUPPORT SYSTEMS
Often increased orders and production will cause strain on the order procession,
production planning and control, customer complaint, service, inventory and accounting
systems. These systems were usually designed to handle lesser volume. The increased
volume overwhelms them. Changes will be made to accommodate the increased volume.
But, a change in one part of the operation will cause a ripple of change throughout the
entire operation. A change in one part of a system will force changes in other parts of that
system and often changes in other systems.
Refer back to the silk screen specialty manufacturing die cutter example used earlier. The
enlarged blank stock size needed to make the die cutter efficient caused changes in the
printing, quality control, drying, inventory, purchasing, materials handling, set-up, packing
and delivery. These changes caused other changes throughout the organization. There
are numerous systems that can be changed by a significant increase in volume. Systems
that are adequate at a lower volume simply cannot absorb the pressure of significantly
increased volume.
Marketing system failures can occur in a number of areas. The system may not be
capable of supporting the heavy increase of sales. The established distribution system,
from packing to shipping to shipper, may not be equipped to handle the increased
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volume. The customer related system of credit, service and complaints may not be
adequate to support the larger sales. All of these marketing systems may need to be
revised, expanded or revamped to accommodate a significant increase in sales.
The internal processing system will also require some revision. The order processing
system may need to be revised. The production scheduling and control will undoubtedly
need to be expanded. The layout and production flow will need change, particularly at the
bottleneck operations. The purchasing system may need change. Inventory layout, space
and flow will often require expansion. Almost assuredly the quality control system will
require some change and expansion.
Organizational systems will need upgrading. The hiring, training and indoctrination system
will need to be expanded or one will have to be developed. Problem solving, decision
making and planning systems will be required or should be expanded, especially since the
manager will need to delegate more. With the increased delegation, better communication
and organization control systems will be required. Accounting systems, particularly cost
accounting, cash flow projections and capital equipment acquisition handling, will need to
be improved. Cost and fiscal control systems will need strengthening.
Until these systems are adjusted they will slow processing. Expanding, revising and
rebuilding the systems will take time and a cash drain. If the systems are not revised, they
can also cause a cash outlay. These system problems can cause a reduced cash inflow or
cause an increased cash outflow further straining an already anticipated cash flow
difficulty.
SUMMARY
As an organization expands, it often experiences cash flow problems. The most frequently
identified causes of these problems are the financing from profits of the expanded
accounts receivable and inventories. There are other drains on the cash flow of an
expanding business. The influx of new people who do not know the business, their jobs
nor standard operating procedures can increase the drain on cash flow. New facilities and
equipment can cause operating problems, which will add to the cash flow problems.
Inadequate marketing, internal processing and organizational systems, can also
dramatically increase the drain on cash flow.
The manager of a small business can prevent some of these cash drains and reduce cash
flow problems with an awareness of the potential problems and some careful analysis and
planning. If the manager is aware of the ripple effect of any changes, then
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he/she can be prepared to make all of the required changes at one time and not extend
the production interruption. The unfortunate thing about these changes is that they usually
occur at a peak production period when time demands are greatest on the manager. If the
manager could predict the take-off in sales, the modifications could be made before the
peak arrives or during a slack period after the peak has passed, saving a shut-down
during a period of high production requirements.
The primary means of reducing the impact of people, production equipment, or systems
problems is to be prepared. Being prepared means doing an in-depth analysis of any
changes and planning for the total impact of those changes. To plan ahead is to reduce
the cash flow impact of increased sales and production.
TABLE 1
TYPICAL ORGANIZATIONS OBSERVED
BUSINESSES
An oak office furniture manufacturer Silk screen specialty product manufacturer Sheet
metal light office fixture manufacturer A made-to-measure drape manufacturer A sport cap
direct mail wholesaler A tire store A jewelry store
SOCIAL SERVICE AGENCIES
An alcohol rehabilitation center A chamber of commerce A hospital A university A

university foundation
DEPARTMENTS
A university maintenance department
TABLE 2
INTERNAL SYSTEMS OR PROCEDURES AFFECTED BY RAPID GROWTH
MARKETING
Sales Distribution Service Credit Customer Complaints Shipping
INTERNAL PROCESSING
Order Processing Inventory Handling Inventory Control Production Scheduling Production

Flow/Process Production Control Purchasing Quality
ORGANIZATIONAL
Hiring/Training/Indoctrination Communication Organizational Control Problem Solving

Decision Making Planning Asset Accounting Cost Accounting Capital Goods Acquisition
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James Buckenmyer, DBA, is professor of management at Southeast Missouri State

University. He earned his Ph.B. in commerce from Notre Dame, an MBA from the
University of Toledo, a communications MA from Governors State University and a
Management and Organization Behavior DBA from Washington University.
Publication Information: Article Title: Prepare Your Company Now for the Perils of Rapid
Growth. Contributors: James A. Buckenmyer - author. Magazine Title: Industrial
Management. Volume: 34. Issue: 3. Publication Date: May/June 1992. Page Number: 2+.
© 1992 Institute of Industrial Engineers, Inc. Provided by ProQuest LLC. All Rights
Reserved.
Article 2
A Qualitative Study of the Management Practices of Rapid-growth Entrepreneurial

Firms
by Bruce R. Barringer , Foard F. Jones , Pamela S. Lewis
INTRODUCTION
In 1995, the number of new business start-ups in the United States reached record levels.
Although the statistics are not yet available for 1996 and 1997, there are strong
indications that this trend is continuing (SBA Office of Advocacy, 1997). Many of these
new businesses are entrepreneurial firms. This is positive sign for the United States
economy, because entrepreneurship entails innovation, which is the growth engine of our
nation's economy (Birley, 1986).
Although these developments are encouraging at the national level, an important concern
for individual firms is how to sustain growth. This is a particularly salient issue for
entrepreneurial firms. As a result of access to proprietary technology or the introduction of
an innovative product or service, many entrepreneurial firms get off to a fast start and post
impressive initial growth rates. However, these impressive growth rates often wane.
Presently, only about 20% of United States firms grow faster than the gross domestic
product (GDP), which averaged just 2.5 % over the past 4 years.
Although practitioner magazines like Fortune, Forbes, Inc., and Entrepreneur often write
about rapid growth firms, very little academic research has focused on the characteristics
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of the companies that are able to maintain a relatively high growth rate. This is an
unfortunate shortcoming in the literature, because the managers of rapid-growth firms
face obvious challenges in sustaining their growth rates. Choosing appropriate
management practices is becoming an increasingly complex task as the number of
management techniques and practices continues to grow. As a result, an understanding of
the management practices that typify rapid- growth firms may be helpful in drawing
attention to the techniques that contribute to sustainable rapid growth. Rapid-growth firms
are important to our nation's economy, because a growth in revenues is typically
accompanied by a growth in employment and financial returns to shareholders.
Against this backdrop, the objective of this study is to develop theoretical models of the
management practices that facilitate firm growth for a sample of rapid-growth and a
sample of slower-growth entrepreneurial firms. The models will be developed using
qualitative research techniques. The purpose of developing two separate models is to
draw a contrast between the management practices that typify rapid-growth versus
slower-growth entrepreneurial companies. An improved understanding of the
management practices that typify rapid-growth firms may be useful not only to
practitioners, but also serve as a point of departure for researchers who are interested in
conducting studies in this important area.
THEORETICAL PERSPECTIVE ON RAPID-GROWTH FIRMS
Although they are somewhat of an aberration, we know that rapid-growth firms exist and
are not confined to new ventures, firms that are in the initial stages of their organizational
life cycle, or firms in specific industries. For instance, each year Inc. magazine publishes a
list of the fastest growing private firms in America. In 1996, the 500 firms that made the list
had an average of 61 employees, revenues of $9.5 million, and a 5-year growth rate of
more than 500% (Inc., 1996). The Inc. 500 has been used as a source of survey data in
several academic studies, including Ginn & Sexton (1990) and Terpstra & Olson (1993). In
a broader-based study of entrepreneurial firms, Sexton & Seale (1997) examined the
attributes of 906 regional and national winners of the Ernst & Young LLP Entrepreneur of
the Year award. The firms in this sample, which represented a broad cross section of
companies in terms of age, size, and industry, increased their average sales by 28% from
1994 to 1995. To put this number in perspective, the average growth rate for Fortune 500
firms from 1995 to 1996 was 8.3% (Fortune, 1996).
What is different about rapid-growth versus slower-growth firms? We do know that firm
growth is limited by capital and managerial constraints (Caves & Murphy, 1976; Hunt,
1973; Oxenfeldt & Kelly, 1969). How do rapid-growth firms overcome these constraints?
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Do rapid growth firms emphasize managerial practices that are not emphasized to the
same extent by slower-growth companies.
While the management literature on rapid-growth firms is rather sparse, some insightful
studies do exist. Researchers have found that rapid-growth firms are more likely to
engage in strategic planning than their slower-growth counterparts (Covin, Slevin, &
Covin, 1990; Shuman, Sussman, & Shaw, 1985). In a study that compared the similarities
of two separate databases of rapid-growth firms, Siegel, Siegel, & MacMillian (1993)
found that rapid-growth firms are typically led by experienced managers and are similar in
their propensity to develop close customer contacts and utilize advanced technology.
Other management variables that have been associated with either rapid-growth firms or
firms that are attempting to grow rapidly include: premium pricing (Covin, Slevin, & Covin,
1990), product quality (Hills & Narayana, 1989; MacMillian & Day, 1987), a strong
corporate culture (Winn, 1995) and an emphasis on internal research and development
(McCann, 1991). Researchers have also found a relationship between firm growth and
entrepreneurial intensity. For example, Covin et al. (1990) found that growth-seeking firms
in high technology industries tend to have a more entrepreneurial strategic posture than
their slower-growth counterparts.
Although each of the studies cited above provides partial insight into the management
practices of rapid-growth entrepreneurial firms, to the best of our knowledge, no previous
study has attempted to contrast the management practices of rapid-growth versus slower-
growth entrepreneurial firms. The purpose of this study is to provide a starting point for
research in this important area.
METHODOLOGY
Case Selection
The data used to develop the theoretical models described above came from a set of
case studies provided by the Ewing Marion Kauffman Foundation. The cases were based
on a subset of data derived from a survey of leading practices of the regional and national
winners of the Errfst & Young Entrepreneur of the Year program sponsored by the
National Center for Entrepreneurship Research at the Kauffman Foundation. The
Entrepreneur of the Year program recognizes fast-growth business firms from a wide
variety of industries throughout the United States. Each of the cases is approximately
1500 words. The cases contain narrative information provided by the respondents to the
survey. Each case follows a similar pattern and contains information pertaining to the
following categories: company founder, company profile, innovative business approaches,
future plans, and other considerations. Prior to being delivered to us, the cases were
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sanitized to protect the identity of the subject firms. We were provided the annual growth
rate (averaged over a 3 - 4 year period) and the annual sales (also averaged over a 3 - 4
year period) that correspond to each of the individual cases.
A total of eight cases representing rapid-growth firms (> 12.5% annual growth rate) and
eight cases representing slower-growth firms ( < 12.5% annual growth rate) were selected
for inclusion in the study. The manner of selection was purposeful sampling (LeCompte,
1993; Patton, 1990), which is a criterion based selection method that permits a sample to
be constructed that fits a predefined profile. We wanted an equal number of rapid-growth
firms and slower-growth firm in the sample in order to build separate models based on
similar amounts of data.
summary of the major characteristics of the rapid-growth and slower-growth firms included
in the sample is provided in Table 1. The average growth rate for the rapid-growth firms
was 125.8% compared to the average growth rate for the slower-growth firms of 6.25%.
This sharp difference in the average growth rate between the two categories of firms in
our sample provided us a unique opportunity to draw a contrast between the management
practices that lead to firm growth for rapid-growth versus slower-growth companies. As
shown in Table 1, the rapid-growth firms are larger and more skewed towards the
computer industry than the slower-growth firms. These are indigenous characteristics of
the sample that should be considered when interpreting the results of the study.
It should be noted that the cases are based on the respondents comments on the
management practices that exist in their respective firms. It is possible that a firm may
utilize a management practice and fail to mention it in their narrative. The structure of the
Ernst & Young LLP Entrepreneur of the Year Program, however, led the respondents to
comment on the issues that have been the most salient to them in their business
experiences.
It should also be noted that the domain of interest in this study is "management" issues.
Firm growth is affected by a variety of factors, including management practices, capital
constraints, industry growth rate, environmental characteristics, and the general health of
our nation's economy. We did not attempt to build a set of comprehensive models that
include issues dealing with access to capital, industry growth rates, or general economic
conditions.
Data Coding
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The cases were analyzed by means of a content analysis technique (Miles & Huberman,
1994). The intended purpose of this exercise was to identify common themes across the
cases relative to the management practices that typify rapid-growth and slower-growth
entrepreneurial firms. As we started coding the cases and became more familiar with our
data we added the categories "business premise" and "other variables" to our study. The
definitions of these terms will be provided in the results section of this paper. Other
management practices, which may be of interest but were not specifically identified by the
subject firms, were not included in our analysis.
The cases were initially coded at the sentence level by one of the authors using typical
content analysis techniques (Strauss, 1987; Taylor & Bogdan, 1984). From the coded
data, thematic categories were developed representing the business premises, business
practices, and other variables that were emphasized by more than one of the firms in the
sample. The initial coding and thematic category development was audited by a second
author. The minor discrepancies that existed between the coders were resolved by
examining the data together. This approach is similar to an approach utilized by Browning,
Beyer, & Shelter (1995). Table 2 provides examples of the data coding for the rapid-
growth firms in our sample.
The thematic categories that emerged from this approach are shown in Table 3. The table
separates the rapid-growth and the slower-growth entrepreneurial firms for purposes of
comparison. For each of the categories, the table depicts the number of firms that
"emphasized" each of these categories in their narrative cases.
Normally, the data obtained from the case studies would be triangulated with other data
pertaining to the subject companies (such as annual reports, company documents,
newspaper and magazine articles, etc.) to validate the information in the cases. Because
we do not know the identity of the firms in our sample, this was not possible. The tradeoff
that we made in accepting this limitation was access to the data versus validation by
means of triangulation. Although this limitation should be recognized in interpreting the
results of the study, from a practical standpoint we see no reason to believe that a firm
would be untruthful in providing information on the Ernst & Young survey.
RESULTS AND ANALYSIS
The results of the thematic category development shown in Table 3 provide a comparison
of the business premises, business practices, and other variables that are emphasized by
rapid-growth and slower-growth entrepreneurial firms. The next section of this paper
provides an analysis of each of the major categories of variables shown in Table 3. Also,
the conceptual models are introduced and discussed.
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Business Premise
The term business premise refers to a business' fundamental reason for organizing as a
company. A sharp contrast was observed between the rapid-growth firms and the slower-
growth firms in this category. The rapid-growth firms tended to have as their fundamental
business premise the desire to fill an unfulfilled need. An example of this is a firm in our
sample that pioneered the technology that provides users of specially equipped
computers the ability to "cut and paste" video like a word processor cuts and pastes text.
Another example is a firm in our sample that produces memory upgrades for computers.
The first consumer PCs that appeared on the market offered minimal memory to stay
price competitive. Recognizing that many computer users would need additional memory
capacity, this company was the first to sell memory upgrade kits.
Rather than attempting to fill an unfilled need, the slower-growth firms in our sample
tended to organize for the purpose of filling a niche in an existing market, which is a
common recommendation for new ventures and small firms. For example, one of the firms
in this category sells environmentally safe chemical products. Another slower-growth firm
in our sample provides laundry services for nuclear power facilities and other specialized
industries. These firms are operating in specialized niches in their respective industries.
Business Practices
Both similarities and differences were observed between the rapid-growth firms and the
slower-growth firms in our sample in regard to the management practices that they use.
Both groups of firms place a heavy emphasis on recruitment and staffing of personnel,
customer relations, and channels development. Other similarities, although not
emphasized by as many firms in each category, were observed in the areas of incentive
compensation, employee empowerment, and the use of noncash forms of employee
recognition (such as special awards). Striking differences were observed in several areas.
The rapid-growth firms place a stronger emphasis on strategic alliances, channels
development, and planning than the slower-growth firms in the sample. In regard to
strategic alliance formation, a manager of one of the rapid- growth firms wrote (the
nonsense words like "xx" and "Fcomp" represent data sanitation):
Essential to navigating the digital superhighway into the xx is the development of strategic
alliances, with partners in complementary industries. During the past year, Fcomp has
entered into key relationships with companies such as ccomp (a leading broadcast
camera manufacturer) to collaborate on the development of technologies which will have
a profound effect on the communications of the future.
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A number of other reasons were provided by the rapid-growth firms for strategic alliance
formation ranging from technological collaboration to access to distribution channels. In
regard to channels development, this was an area that was emphasized by five of the
eight rapid-growth firms in the sample. Apparently, at least for the rapid-growth firms in
our sample, finding multiple channels to bring their products/services to market is an
essential management practice.
The slower-growth firms placed a relatively stronger emphasis on a quality focus and goal
setting than the rapid-growth firms. Four of the eight firms in the slower-growth category
have a quality based business strategy. This strategy was less apparent in the rapid-
growth firms. In regard to goal setting, a representative of one of the slower-growth firms
wrote:
The founder, president, and CEO that led Fcomp from relative obscurity to an xx company
in xx years has a goal to make Fcomp a half-billion dollar service company within xx
years. I believe this goal, albeit it is very ambitious, is achievable based on the wide
acceptance of Fcomp's management philosophy and demonstrated financial
responsibility.
Other Variables
Two additional variables that do not fit neatly into the above categories but were
uncovered in the content analysis were respect of industry peers and environmental
munificence. Five of the slower-growth firms mentioned the importance of obtaining
awards or some other form of recognition from an industry group or some other
stakeholder. For example, one slower-growth firm wrote:
Fcomp's improvements in quality were recently highlighted as the company was named
"xx" by xx Magazine in their "xx" survey of shippers.
The implication is that recognition by industry peers and other stakeholders helps a firm
continue to build upon past successes. On another topic, the rapid-growth firms in our
sample operate in more munificent environments than the slower-growth rate companies
(see Table 3). This factor positively affects the ability of rapid-growth firms to find
opportunities to fill unfilled needs, locate willing strategic partners, and may contribute
directly to firm growth and profitability. We do know, however, from an examination of
other lists of rapid-growth firms (e.g. Inc. 500, Ernst & Young LLP Entrepreneur of the Year
Program, Fortune 500) that rapid-growth firms are by no means restricted to companies in
specific industries.
Conceptual Models
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To summarize the information provided in Table 3, we developed conceptual models of the

business premises, business practices, and other factors that facilitate growth for rapid-
growth and slower-growth entrepreneurial firms. The models are shown in Figures 1 and
2. We used a simple heuristic to determine the variables to be included in the models. If a
variable was emphasized by four or more of the eight firms in each category (as shown in
Table 3), the variable was advanced to the category's conceptual model. This heuristic is
arbitrary, but does represent a uniform and common-sense approach to advancing
variables to the conceptual models.
The models reiterate the information provided above and visually depict the principle
differences between rapid-growth and the slower-growth entrepreneurial firms in our
sample. The models may also provide a point of departure for future research in this area.
DISCUSSION AND CONCLUSION
This study has provided us the opportunity to examine the differences in the business
premises, business practices, and other variables that typify rapid-growth versus slower-
growth entrepreneurial firms. Initially, we found that rapid-growth firms tend to organize for
the purpose of filling an unfulfilled need, while slower-growth firms tend to organize for the
purpose of filling a niche in an existing market. The obvious advantage of organizing for
the purpose of filling an unfilled need, if the idea is good and sells, is that a firm can enter
markets as a temporary monopolist (Schumpeter, 1936). This scenario generates what
economists call "excessive rents" (i.e., excessive profits) (Eliasson, 1992). These
excessive rents, however, are only available to a firm on a sustained basis if it continues
to innovate and find additional unfilled needs to satisfy or if barriers to entry are erected
that prevent other firms from introducing competing products. An interesting extension of
our study would be to determine if firms that are able to sustain rapid-growth do so by
continuing to achieve a high level of innovation. If so, this finding would validate the
importance of high levels of entrepreneurial behavior (i.e., innovation, risk-taking, and
proactivity) for firm growth and profitability. It would also be interesting to examine the
performance difference between rapidgrowth and slower-growth firms. Rapid-growth may
place a heavy financial toll on a firm during its start-up stage, with payoffs coming in the
expansion and maturity stages of the organizational life cycle. Whether rapid-growth firms
follow a traditional organizational life cycle is another question for future research.
The differences in the business practices emphasized by the rapid-growth versus slower-
growth firms provide insight for practitioners and researchers. One explanation for why
rapidgrowth firms emphasize the use of strategic alliances is that alliance formation acts
as a substitution for management. This assertion is consistent with the generally accepted
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paradigm that a firm can only grow as fast as its managerial talent (Caves & Murphy,
1976). By entering into alliances with other firms, however, a company can circumvent this
heuristic and in effect "outsource" a portion of its managerial requirements to its alliance
partners. This practice may enable a firm to grow at an accelerated rate. This is a
complicated issue that was recently addressed by Deeds & Hill (1996). In a study of 132
biotechnology firms, the authors found a U-shape relationship between alliance formation
and new product development. Specifically, the authors found that although strategic
alliance formation may initially have a positive effect on the rate of new product
development, at some point adding additional alliance partners has diminishing and,
ultimately, negative returns. The extent to which these results generalize to rapid-growth
firms is an interesting topic for future research. It would also be interesting to examine the
financial performance differences between rapid-growth firms that do and do not
participate in strategic alliances.
In terms of the other variables in the model, the emphasis that rapid-growth firms place on
channels development denotes their focus on bringing their products/services to market.
Incentive compensation and planning appear in the model for rapid-growth firms, although
there was a less dramatic difference between the two categories of firms examined in this
study relative to these variables. The slower-growth firms in our study tended to pursue a
quality based strategy, emphasizing goal setting and noncash forms of recognition.
It is interesting to note that the slower-growth firms emphasized the importance of the
respect of industry peers and other stakeholder groups. Various forms of recognition may
be particularly important to the slower-growth firms that are pursuing a quality strategy.
Recognition, such as a quality award or a "best-supplier" award from a prestigious
company may help a firm differentiate its products/services from a competitor and provide
the firm an advantage in recruitment and staffing, customer relations, and channels
development.
This study has obvious limitations. To control for environmental effects, it would have
been preferable to have had a sample of rapid-growth and slower-growth firms with
similar demographic characteristics. The number of companies in each category was
restricted to eight. This is consistent with the nature of qualitative research, which
emphasizes richness of detail over the generalizability of the results (Eisenhardt, 1991).
Still, it should be recognized that the results of this study are based on the examination of
a fairly small number of firms. Future studies that examine a broader sample may produce
more fine-grained results. Also, the rapid-growth firms in our sample are clearly in more
munificent industries than the slower-growth firms. While it is reasonable to assume that
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industry munificence alone could not explain the average growth rate of 125.8% for the
rapid-growth firms, the impact that industry munificence has on the other variables in the
study (such as the opportunity for alliance formation or channels development) is
unknown. Conversely, the strength of the study is that through the cases we hear the
voices of the firms themselves telling us what is important to them. This is the "theory
building" nature of our qualitative research methodology. Other methodologies, such as
deductive based surveys, presuppose what is important to the subject and test a priori
developed propositions or hypotheses in a given setting.
In conclusion, this study provides a contribution to the entrepreneurship literature by

articulating the business premise, management practices, and other variables that typify
rapid-growth entrepreneurial firms. The study also provides an important point of
departure for researchers who are interested in examining the differences in the business
premises and business practices that differentiate rapid-growth and slower-growth
entrepreneurial firms.
-1-
Publication Information: Article Title: A Qualitative Study of the Management Practices of

Rapid-growth Entrepreneurial Firms. Contributors: Bruce R. Barringer - author, Foard F.
Jones - author, Pamela S. Lewis - author. Journal Title: Journal of Business and
Entrepreneurship. Volume: 9. Issue: 2. Publication Year: 1997. Page Number: 21+. ©
1997 Association for Small Business and Entrepreneurship. Provided by ProQuest LLC.
All Rights Reserved.
Article 3
What Do They Think and Feel about Growth? an Expectancy-Value Approach to

Small Business Managers' Attitudes toward Growth (1).
by Johan Wiklund , Per Davidsson , Frederic Delmar
This study focuses on small business managers' motivation to expand their firms. More
specifically, we examine the relationships between expected consequences of growth on
the one hand, and overall attitude toward growth on the other. Data were collected in
three separate studies over a ten-year period using the same measuring instrument. The
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results suggest that noneconomic concerns may be more important than expected
financial outcomes in determining overall attitude toward growth. In particular, the concern
for employee well-being comes out strongly. We interpret this as reflecting a concern that
the positive atmosphere of the small organization may be lost in growth. We conclude that
this concern may be a cause for recurrent conflict for small business managers when
deciding about the future route for their firms.
In this article we investigate how small business managers' beliefs concerning the
consequences of growth influence their overall growth attitude. We find this to be an
important question. Although previous research has shown that small firm growth is the
most important source of new jobs (Davidsson, Lindmark, & Olofsson, 1994, 1996;
Kirchhoff, 1994; Reynolds & White, 1997), there are also clear indications that many small
business managers deliberately refrain from exploiting opportunities to expand their firms.
We test the influence of the eight most important perceived consequences of growth on
the overall growth attitude in three separate, large-scale surveys of small business
managers.
Previous research suggests that there is reason to more carefully assess the role of
growth motivation when examining firm growth. Many small business managers are not
willing to pursue growth (Davidsson, 1989a, 1989b; Delmar, 1996; Gundry & Welsch,
2001; Storey, 1994). An important implication of this is that many small firms do not
realize their full growth potential (Scott & Rosa, 1996), which may constitute a source of
great under-utilization of resources. Our knowledge of why small business managers vary
so greatly in their growth motivation is still limited. It constitutes an area worthy of further
investigation, as research that examines the effect of growth motivation on subsequent
business growth finds support for a positive relationship (Bellu & Sherman, 1995;
Kolvereid & Bullvag, 1996; Miner, Smith, & Bracker, 1994; Mok & van den Tillaart, 1990)
(2).
In this article we explicitly assess reasons for differences in levels of growth motivation.
More specifically, we focus on the beliefs and attitudes toward expanding a business.
Building on the expectancy-value theory of attitudes (Ajzen, 1988, 1991; Ajzen & Fishbein,
1977, 1980; Fishbein, 1967; Fishbein & Ajzen, 1975), we are interested in how the overall
attitude toward growth is influenced by specific cognitive beliefs about the consequences
of growth. By doing so we are able to tease out the relative importance of different
motives underlying small business managers' attitudes to growth. This research is
important for two principal reasons. First, in mainstream economic literature the
supremacy of the economic motive is taken for granted--people act in ways to maximize
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their profits. In the small business context, a more diverse view may be relevant. We know
that people start and operate their own firms for a variety of reasons other than
maximizing economic returns (Davidsson, 1989a; Delmar, 1996; Gundr y & Welsch, 2001;
Kolvereid, 1992; Storey, 1994). This does not mean that their motives are totally irrational.
However, it is important to assess the relative importance of economic and noneconomic
motives in order to understand why small business managers exhibit the growth-related
attitudes and behaviors that they do.
Second, we believe that this research can have practical implications. People's beliefs are
influenced by the persuasive argumentation of others (Ajzen, 1991; Chaiken & Stangor,
1987). Hence, it should be possible to affect small business managers' beliefs about
growth through providing them with the relevant information and knowledge. That is, if
certain beliefs have a stronger influence on overall attitude, society may be able to take
specific actions related to these areas that, in turn, will affect the small business
managers' attitudes toward expanding their firms.
The article proceeds as follows. The next section introduces the expectancy-value theory
of attitudes and shows how previous empirical research regarding the motivation of small
business managers can be placed in this conceptual framework in order to explain
individual differences in growth motivation. Eight hypotheses concerning how specific
expected consequences of growth affect growth motivation conclude the section. Next,
the replication design is presented along with the analyses carried out to test the
hypotheses, the samples, and the variables. The hypotheses are then tested by means of
regression analysis in the following section. A discussion of the results and their
implications for future research as well as small business managers concludes the article.
Theory and Hypotheses
Attitudes and Beliefs
Motivation theories are aimed at explaining why individuals choose to act in a certain
direction. One of the major concepts in motivation theories is attitude. An attitude is a
valuation of an object or a concept, i.e., to which extent an object or concept is judged as
good or bad. While personality variables such as Need for Achievement or Locus of
Control have been extensively researched in psychological studies of entrepreneurial
behavior (cf. Stimpson, Robinson, Waranusuntikule, & Zheng, 1990), attitudes have
received relatively little attention (Robinson, Stimpson, Huefer, & Hunt, 1991).
In psychological language, personality variables are distal, i.e., weak determinants of

specific behaviors. Personality theories are intended to measure general individual
Page 266
tendencies that are stable across a spectrum of different situations (Epstein, 1984).
Therefore, general personality variables are likely to have limited predictive power when
applied to any specific context (Ajzen, 1991), such as firm growth. Attitudes on the other
hand are proximal, i.e., more specific and because of their specificity, they are considered
to be important determinants of behavior. On the other hand, attitudes are less stable over
time and across situations, changing through interactions with the environment (Eagly &
Chaiken, 1993).
There has been much controversy over the importance of attitudes in predicting behavior.
However, research has shown that attitudes can predict behavior if certain conditions are
met (Bagozzi & Warshaw, 1992; Kim & Hunter, 1993). Attitudes have been found to be
moderately strong predictors of goal-directed behavior (r = .79 between attitude and
behavior when methodological artifacts were removed, cf. Kim & Hunter, 1993). Thus, it
would appear that the concept of attitudes is relevant in the present context.
Since long, there has been an unresolved discussion about whether attitude is a
unidimensional construct consisting of the "amount of affect for or against a psychological
object" (Fishbein, 1967, p. 478 citing Thurstone, 1931), or a three-dimensional construct
containing an affective, a cognitive, and a behavioral/intentional component (see Chaiken
& Stangor, 1987, for a discussion of these different views).
According to the tripartite view, attitudes can be broken down into three different classes
of evaluative responses (Eagly & Chaiken, 1993): (1) cognitive responses, also known as
beliefs, are thoughts that people have about the attitude object (e.g., I believe expanding
the business will enhance the possibilities of the business to survive a crisis); (2) affective
responses consist of feelings, moods, or emotions that people have in relation to the
attitude object. (e.g., I feel happy/anxious about expanding my business); (3) behavioral
responses are the overt actions or intentions exhibited by people in relation to the attitude
object (e.g., I turned down the order, because it would have meant expanding the
business).
In this article, we instead adhere to the view heralded by Ajzen and Fishbein (Ajzen, 1988,
1991; Ajzen & Fishbein, 1977, 1980; Fishbein, 1967; Fishbein & Ajzen, 1975) suggesting
that the cognitive, affective, and behavioral dimensions represent three separate but
causally linked constructs termed belief, attitude, and intention. The reason that we chose
this approach is that it has been successfully applied to a range of different situations.
These concepts are central elements of the Theory of Reasoned Action and the Theory of
Planned Behavior, which are validated theories (Locke, 1991) that constitute "the
dominant theoretical framework in the attitude-behavior literature" (Olson &
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Zana, 1993, p. 131) and "continue to generate the most research" (Petty, Wegener, &
Fabrigar, 1997, p. 640).
Embodied in these theories lies the expectancy-value model of attitude (Ajzen, 1991).
This model explicitly deals with the relationship between beliefs and attitudes. It has been
fruitfully applied in several different areas, such as decisions concerning choice of
restaurant, blood donation, detergents, and automobiles and can be considered a
paradigm in itself (Bagozzi, 1984). According to this theory, an attitude reflects the degree
to which a person likes or dislikes an object, where the term object can refer to any aspect
of the individual's world. Importantly, the theory is developed to predict specific attitudes in
specific contexts (Ajzen & Fishbein, 1980). In our case we are interested in the specific
behavior of expanding a firm. We therefore focus solely on the attitude toward this specific
behavior. The individual's attitude toward a behavior can be predicted by the salient
beliefs that he or she holds about performing the behavior. It should be noted that the
beliefs must correspond to the specifi c behavior concerning action, target, context, and
time in order to permit understanding and prediction of the attitude (Ajzen & Fishbein,
1980). That is, in order to predict the attitudes of expanding the business a certain
magnitude (e.g., doubling the size) we should explicitly assess the beliefs of the
consequences of performing that particular behavior (i.e., the expected consequences of
doubling the size).
Beliefs associate an object with certain attributes. In the case of behavioral beliefs, the
object is the behavior of interest and the associated attributes are the expected
consequences of that behavior. Consequences can be good or bad and of varying
magnitude. For instance, an individual may believe that expanding the business 100
percent may lead to a minor increase of profitability but a major decrease in job
satisfaction. The strength of an individual's belief is captured by his or her subjective
probability that performing a behavior will lead to a certain outcome. Returning to the
example above, the individual may be very certain that growth will lead to improved
performance (although to a small extent) but less certain that job satisfaction will
decrease (although if it does, the decrease will be substantial). According to the original
formulation of the expectancy-value model, a person's attitude toward a particular
behavior can be predicted by multiplying his or her evaluation of each behavior's exp
ected consequences by the strength of the belief that performing the behavior will lead to
that consequence and then summing the product across all beliefs (Ajzen & Fishbein,
1980).
Page 268
However, empirical tests of this model has revealed that the interaction of evaluation of
expected consequences on the one hand and the strength of the belief on the other fails
to give significant results (Bagozzi, 1984), leading to a questioning of the multiplicative
combination of beliefs and evaluations (Valiquette, Valios, Desharnais, & Godin, 1988).
More specifically, the strength of the belief dimension has failed to contribute to the
prediction of attitude (Pieters, 1988). Tentative analyses of our data supported these
findings (Davidsson, 1987). Therefore, we focus solely on expected consequences in our
analyses.
Moreover, in the original formulation of the expectancy-value model, salient beliefs are not
weighted for their relative importance in determining the attitude (e.g., Ajzen & Fishbein,
1980). This approach looses the idiosyncratic dimensionality and uniqueness of the micro
beliefs that comprise the attitude (Bagozzi, 1984). Bagozzi (1985) argues that there are in
fact several alternative ways of modeling the relationship between beliefs and attitude,
some of which estimate the relative importance of individual beliefs. Two of these do not
assume a multiplicative combination of beliefs and evaluations. If multicollinearity is
severe, latent variable modeling with higher- and lower-order latent variables is necessary.
If not, as an alternative the attitude can be regressed over the individual's evaluation of
expected consequences as assessed along a positive-negative dimension. We have
chosen the latter alternative, because an empirical test shows that multicollinearity is not a
problem (cf. footnote 4).
Identifying Relevant Beliefs and Hypotheses
As suggested by the expectancy-value theory of attitudes, we regard expected

consequences of growth as evaluations of the behavior's consequences, or beliefs. Based
on this logic, we argue that a plausible reason that some small business managers refrain
from growing their firms is that they expect some consequences of growth to be negative.
If a small business manager believes, for instance, that increased size may jeopardize the
firm's ability to maintain the quality of its products or services, such anticipated negative
consequences of growth should lead to a negative attitude toward expanding the
business. On the other hand, if the small business manager sees expansion as a means
to attain personal goals, e.g., the possibility of earning more money, such expectations of
positive consequences of growth should positively influence his or her growth attitude. In
other words, positive expectations of growth are likely to enhance the motivation of a
small business manager to expand his or her firm whereas, neg ative expectations of
growth are likely to reduce the growth motivation.
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In order to establish more precisely small business managers' salient beliefs about
growth, a literature review of comprehensive classical works on small business
management and motivation was conducted (Bolton, 1971; Boswell, 1972; Deeks, 1976;
Smith, 1967; Stanworth & Curran, 1973). This literature review identified eight key areas
that are important for small business managers and at the same time likely to be affected
(positively or negatively) by growth. These key areas and their sources in the literature are
exhibited in Table 1. We now detail the arguments concerning each of these areas and
formulate the associated hypotheses.
With regard to workload, the reasoning is that some managers who are--and intend to
stay--involved in all aspects of their business expect growth to increase their workload.
Other managers foresee hiring and delegating, and hence reducing their personal load.
Thus,
Hypothesis 1: The expectation that increased size would lead to a reduction (increase) of
the owner-manager's workload is associated with a more positive (negative) attitude
toward growth.
Likewise, regarding work tasks some owner-managers define themselves primarily as

craftsmen and resist the transition to full-time management that expansion may (be
perceived to) necessitate. Other managers may be looking forward to letting go of some
hands-on work they cannot yet afford to delegate. Thus,
Hypothesis 2: The expectation that increased size would allow the owner-manager to
spend more (less) time on favored work tasks is associated with a more positive
(negative) attitude toward growth.
Concerning employee well-being it has been observed that some managers fear that
growth would force formalization and destroy the family-like atmosphere of the small
organization, where every member is indispensable. At the same time it has been noted
that nongrowing small organizations offer very limited career opportunities for their
employees. Again, then, growth may be associated with positive as well as negative
expectations. Thus,
Hypothesis 3: The expectation that increased size would make employees enjoy work
more (less) is associated with a more positive (negative) attitude toward growth.
It may seem self-evident at first glance that growth should improve the owner-managers
personal income. However, the literature suggests that this is not universally believed to
be the case. For example, the manager may hold that the environment leaves little room
for profitable growth. Thus,
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Hypothesis 4: The expectation that increased size would increase (decrease) the owner-
manager's income and other disposable economic benefits is associated with a more
positive (negative) attitude toward growth.
Owner-managers' need for autonomy is heavily stressed in the literature. The relationship
between autonomy and growth appears to be complex and possibly involves more than
one dimension, which is why we include independence and control as separate
dimensions. On the one hand, a small firm is weak in relation to its environment, not
leaving much real independence for the owner-manager. On the other hand, taking
additional loans, sharing equity or accepting the dictates of a large, dominating customer
may be precisely what is required in order to achieve growth-at the expense of some
independence. Similarly, some managers may perceive that increased size would force
them away from contact with the day-to-day realities of the firm, reducing their ability to be
on top of everything that happens or could happen to it. Other managers may think that
the more managerial role in an enlarged firm would reduce myopia and give more time for
strategic issues, and thereby increase their control of the firm's long term dest iny. Thus,
Hypothesis 5: The expectation that increased size would enhance (reduce) the owner-
manager's ability to survey and control operations is associated with a more positive
Hypothesis 6: The expectation that increased size would increase (decrease) the firm's
independence in relation to customers, suppliers, and lenders is associated with a more
positive (negative) attitude toward growth.
Also for the last two dimensions, positive as well as negative beliefs can be found in the
literature. Some managers may associate increased size with a reduction in flexibility,
which would reduce the firm's crisis survival ability. Others may associate size with the
financial muscles that could cushion a situation of that kind. Thus,
Hypothesis 7: The expectation that increased size would make it easier (more difficult) for
the firm to survive a severe crisis is associated with a more positive (negative) attitude
toward growth.
With regard to quality some may fear that their own detachment from direct control is a
risk, whereas others would see the possibility to introduce formal and systematic quality
control of a kind that the very small firm cannot afford. Thus,
Hypothesis 8: The expectation that increased size would make it easier (more difficult) for
the firm to maintain the quality of products and services is associated with a more positive
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Although we have presented an extensive list of expected consequences of growth, the

question arises about whether this list is exhaustive or if small business managers in fact
expect additional consequences that affect their growth attitude. Previous expectancy-
value research suggests that the domain of salient beliefs could be generated through an
open-ended elicitation procedure (Ajzen & Fishbein, 1980; Bagozzi, 1984). In order to
identify the beliefs that are salient in a population, a representative sample should be
selected for the procedure (Ajzen & Fishbein, 1980; Bagozzi, 1984). Therefore, previous
to the first survey, unstructured interviews were conducted with eleven small business
managers by one of the authors. The sample was selected to represent as broad a
spectrum as possible concerning types of small firms and small firm owner-managers.
The interviews first covered general aspects of the business and then issues pertaining to
growth. Direct questions about expected consequences of growth were only asked at the
very end of the interview and only if they had not previously been spontaneously
mentioned by the respondent. These interviews confirmed that the eight dimensions
identified in the literature in fact reflected important expected negative and/or positive
consequences of growth. Further, the managers did not report any other important
consequences of growth neither spontaneously nor when prompted.
It should be noted that these expected consequences of growth may or may not be well
founded. For example, a belief that growth reduces crisis survival ability can be
questioned on the basis that research tends to show positive relationships between
growth or size on the one hand, and survival on the other (Kirchhoff, 1994). In other
words, it is possible that small business managers expect consequences that in fact will
not materialize, should their business expand. However, in order to further validate that
we have identified relevant expected consequences of growth, we turned to the literature
that explicitly deals with the actual consequences of growth. Flamholtz (1986) recognizes
ten growing pains, i.e., possible negative consequences of growth. While his growing
pains are conceptualized in a way that is not directly transferable to our context, it is clear
that he identifies similar consequences. Flamholtz identifies possible changes to
workload, work tasks, employee well-being, control, and quality. In their study, Hambrick
Crozier (1985) found similar potential negative consequences of growth, but also noted
that the very survival of the firm may be threatened. All in all, these studies support that
six of the eight consequences we have identified may in fact materialize as a company
expands. A reason that these authors do not address changes to personal income and
independence in relation to lenders, customers, and suppliers may be that they mainly
focus on the negative consequences of growth, whereas they may find positive effects of
growth on personal income and independence.
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Finally, Ajzen & Fishbein (1980) hold that individuals can only attend to a limited number
of beliefs about behavioral outcomes at any given moment and suggest that five to nine
would be an appropriate number. Taken together, the above makes us confident that we
have identified the relevant range of generally important beliefs about the consequences
of growth. This gives us the research model depicted in Figure 1.
Method
Basic Research Design
This study uses a replication design. As noted by others, small business growth studies
are largely incompatible because similar phenomena are studied in isolated research
projects using different concepts, models, measures, and methods (Davidsson & Wiklund,
2000; Delmar, 1997; Storey, 1994). As a consequence, our knowledge about small-firm
growth is still quite incomplete and incoherent. This lack of replication is shared with the
broader domain of business studies (Hubbard, Vetter, & Little, 1998). We agree with these
authors that "The goal of science is empirical generalizations or knowledge development.
Systematically conducted replications with extensions facilitate this goal." (Hubbard,
Vetter, & Little, 1998, Abstract; see also Lindsay & Ehrenberg, 1993). The present study
attempts to contribute to cumulative knowledge by means of replication with extension.
Three separate studies addressing the same issues with the same measurement
instrument in similar samples were carried out during a ten-year perio d. These three
studies are jointly analyzed in this article.
According to Hubbard, Vetter, & Little (1998), replication is a substantial duplication of

previous empirical research in order to increase the internal validity of the research
design. The aim of replication is typically to determine if the findings from the original
study are reproducible. A replication with extension goes somewhat further and aims at
increasing the generalizability of research findings by modifying the initial study in some
way. If the results reproduce in the modified studies, this would indicate a higher
generality of the findings, i.e., they extend beyond the specific context of any single study.
In the present case, data were collected from three different samples during a ten-year
period utilizing the same measurement instrument. The data collections coincided with
different phases of the business cycle, and each study used somewhat different sample
frames. In this sense, the present research could be regarded as replication with
extension. This serves the much-sought-for purpose of g eneralizing findings beyond what
is possible from a solitary study.
However, the fact that the data from all three studies are analyzed simultaneously allows
us to perform additional analyses. Thanks to the large number of cases provided by the
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three samples combined, it is possible to split the sample into different subsamples and
conduct separate analyses within each of these. It is also possible to analyze all cases in
one analysis. Such additional analyses facilitate additional validation of the findings
(Campbell & Fiske, 1959).
Taken together, the multiple analyses on different samples and subsamples conducted
here reduce the risk of Type I errors (erroneous rejections of the null hypothesis). This risk
may be substantial in conventional singular analyses, solely relying on the p < .05
criterion (Cohen, 1994; Hubbard, Vetter, & Little, 1998). The separate analyses of multiple
samples also reduce the risk of Type II errors, i.e., failure to reject the null hypothesis
when it is false (Cohen & Cohen, 1983).
Sample Characteristics
Over a ten-year period, three independent telephone interview studies were conducted.
The two initial studies in 1986 and 1994 were stratified over the Swedish equivalent of
ISIC codes. Independent firms from specific manufacturing, service, and retail industries
were selected. The samples were also stratified over the standard Swedish size brackets
1-4, 5-9, 10-19, and 20-49 employees. In addition to this, the 1996 sample was stratified
over the firms' previous growth rate so that high-growth firms were overrepresented in the
sample for all size brackets and industries. The samples had 440, 400, and 630
respondents respectively, totaling 1,470 respondents, with corresponding response rates
of 83 percent, 55 percent, and 75 percent. The data were collected from the managing
director, who in most cases is also the majority owner. The managing director was
explicitly asked for at the beginning of the interview.
At the time of the interviews, 40 firms had outgrown the largest size bracket and were
omitted. The smallest size bracket was left Out of the analyses since only one of the
studies included firms of this size. This reduced the number of cases to a total of 1,248.
The actual number of cases used in the analyses is somewhat lower due to internal
nonresponses. There are some statistically significant differences among the three
samples (see Table 2). The 1986 study reports somewhat younger respondents, smaller
firms, and a smaller share of manufacturing firms compared to the two latter studies. The
firms of the 1994 sample are on average the youngest. However, for the purpose of this
article, the differences are unproblematic. Analyses are mainly performed on different
subsamples where these differences are controlled; or else these variables are added as
control variables.
Variables and Measures
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The Dependent Variable. To measure attitude toward growth, respondents were asked
whether a 100 percent increase in the number of employees in five years time would be
mainly negative or mainly positive. Respondents who gave an answer in either direction
were then asked to specify whether they perceived such an outcome as "somewhat,"
"rather strongly," or "very strongly" positive/negative. A seven-point scale ranging from
very negative to very positive was thus used to measure this variable. This type of single
item bipolar 7-point good/bad scale has been the most often advocated and used variable
to measure attitude toward behavior (Ajzen & Fishbein, 1980; Fishbein & Ajzen, 1975). It
is suggested to be the most stringent and valid variable, at least in situations where the
distinction pleasant/unpleasant is inappropriate, as in our case (Bagozzi, 1984). The
explication of a specific amount of growth over a specific time span in the question is
important, as the individual's attitude toward growth may vary de pending on both amount
and time. Individuals may exhibit more positive or negative attitudes toward larger or
smaller amounts of growth as well as toward faster or slower growth rates.
Three other possible measures of the dependent variable were also available: (1) whether
a 25 percent increase in the number of employees in five years time would be mainly
negative or mainly positive; (2) the intended ideal size five years ahead regarding sales;
as well as (3) regarding number of employees. While it would have been possible to utilize
either of these alternative measures of the dependent variable or to compute a global
growth motivation index, we prefer to rely on the question concerned with a 100 percent
increase in the number of employees. The reason is that this makes the dependent
variable and the independent variables symmetric. That is, they are all anchored in the
doubling of the number of employees. This sort of symmetry in independent and
dependent variables is deemed important by the expectancy-value theory (e.g., Ajzen &
Fishbein, 1980). (3)
The Independent Variables. The eight belief variables derived from the literature review
are displayed in Table 3. In order to establish validity and reliability, the format of the
questions was modeled after the examples given by Ajzen & Fishbein (1980, p. 66). More
specifically, respondents were asked how a doubling of the number of employees,
regardless of whether this is deemed desirable or possible, would be likely to affect each
of the eight areas. A five-point scale, ranging from "much more negative" to "much more
positive," was used for measurement (the specific words describing the positive/negative
dimension varied across questions, cf. Table 3).
The explicit statement "doubling of the number of employees" was chosen in order to
ensure that the beliefs referred to the same behavior as the attitude across variables and
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respondents. In other words, the context of the belief variables reflected the context of the
attitude variable as closely as possible, as recommended in the literature (cf. above and
Ajzen & Fishbein, 1980, p. 64).
Control Variables. Five variables were used as contingency variables to subdivide the
three samples into subsamples and as independent variables in multiple regression
analysis. Firm size, firm age, and industry have been shown to affect growth in previous
research (Aldrich & Auster, 1990; Audretsch, 1995; Barkham, 1994; Carroll & Hannan,
2000; Davis & Henreksson, 1999; Dunne & Hughes, 1996; Kirchhoff, 1994). The sex and
age of the small-business manager have also been associated with differences in growth
(Brush, 1992; Davidsson, 1989a; Deaux & Lafrance, 1998; Delmar, 2000). These
variables may influence growth directly as assumed in most research, but it is also
possible that they have an indirect influence via the attitude toward growth of the
entrepreneur. Thus, it is valuable to investigate their influence on attitude toward growth.
Firm size was measured as the number of full-time equivalents. To determine the industry,
respondents were asked if the firm's main line of business was manufacturing, service, or
retail. Analyses suggest that the Swedish equivalents of ISIC codes are not always
updated or relevant. Therefore, we instead relied on the respondents' self-report of main
activity as a better indictor of their main industry. Respondents were asked if they knew
what year the firm was founded, which was used to calculate the age of the firm. Finally,
the respondents' birth year was used for calculating their age, whereas sex in most
instances was evident from the interview.
All control variables were recoded into dummy variables. Firms were classified into the
standard size brackets 5-9, 10-19, and 20-49 employees. Ten years was the cut-off for
being a "young" or "old" firm, whereas the mean of 47 years of age was used to
discriminate between young and old entrepreneurs.
To make comparison across the three studies more valid, the wording and relative
positioning of the questions were the same in all three studies.
Analyses
Multiple linear regression was carried out to test the hypotheses. Two different analysis
designs were applied for the control variables. In the first step, the control variables were
entered as independent variables to the regression equation, alongside with the
expectancy variables.
In the second step, they were used to divide the sample, since it is possible that the
pattern of relationships differs among industries, size brackets, sex, and age groups.
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In line with the replication approach, the hypotheses are tested by examining the extent to
which results are replicated across the different analyses, rather than relying solely on
conventional tests of significance (p < .05). If substantial and statistically significant effects
recur across the analyses, this is taken as evidence that the data support the hypothesis.
Conversely, repeatedly small and nonsignificant effects led to the rejection of the hypothesis.
When results are mixed, judgment is used to determine if the hypotheses are supported or
not. In other words, judgment rather than objective criteria is used to support or reject
hypotheses. This is consistent with the research design and not problematic: "First, do not
look for a magic alternative to NHST [null hypothesis significance testing], some other
objective mechanical ritual to replace it. It doesn't exist.... we must finally rely, as have the
older sciences, on replication" (Cohen, 1994, pp. 1001-1002).
The skewness and kurtosis statistics of the dependent variable fall well within the
boundaries for normality (Robinson & Hofer, 1997; Shapiro & Wilk, 1965). Thus,
parametric tests of significance are applicable. Since positive expectations are
hypothesized to increase growth motivation and vice versa, directional, single-tailed tests
of significance are applied. Forced entry of independent variables and list-wise deletion of
missing data are used.
Results
Table 4 shows the correlation matrix and summary statistics for the variables used in our
analyses (with the exclusion of the nominal variables sex and industry). All expectancy
variables have moderately positive correlations, ranging from .14 to .41. The model we
have chosen, i.e., regressing attitude across expected consequences, could be
associated with multicollinearity (Bagozzi, 1985). The moderate correlations suggest that
this is not the case. However, to ensure that multicollinearity was not an issue,
multicollinearity diagnoses were applied to all regression analyses (4). The strongest
correlation with attitude toward growth can be noted for employee well-being (r = .41). The
correlation between firm age and expected workload is moderately negative (r = -.17). The
other correlations are weaker.
The hypotheses were tested by first analyzing the three samples combined, which is
displayed in Table 5. The second column of the table shows the results excluding the
control variables. The adjusted explained variance of .24 indicates that expected
consequences have an influence on attitude toward growth and that the proposed model
is relevant. Statistically significant effects in the hypothesized direction are obtained for all
expected consequences but work tasks. According to the conventional criterion (p < .05),
this supports H1 and H3 to H8. However, the magnitude of the coefficients for variables
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other than employee well-being are small in magnitude. The large number of cases makes
small effects statistically significant. When the control variables are added to the equation,
shown in column three, they alter the equation only to a small extent. Albeit statistically
significant on three instances, their standardized regression coefficients are generally low
and the explained variance is not increased. Co mparing the two analyses, it appears that
explanatory variables are not dramatically different in different industries, size brackets,
age groups, or between men and women. Hence, the results appear to have a high
degree of generality.
As mentioned earlier, data were collected from three different samples during a ten-year
period. There are reasons to analyze the samples separately and compare the results.
First, although statistically significant, effect sizes were generally small in the full sample.
A comparison of results across samples makes it possible to check the stability of the
results. If the results are the same for all three samples, conclusions will be more valid.
Second, data were collected during different stages of the business cycle, which may
affect the beliefs and attitudes of the respondents and their effects. Different explanatory
variables may be important during different phases of the business cycle. A pure trend
effect over time is also conceivable.
The results of the analyses of the three different samples are displayed in Table 6.
Employee well-being is by far the most important explanatory variable in all samples,
whereas the magnitude and rank order of all other explanatory variables vary. The joint
probability measures illustrate that obtaining positive coefficients this large for any variable
in all three samples is highly unlikely if there were no effects in the population. In all, the
relationships are relatively stable overall, but not in detail. No clear cyclical or trend
pattern emerges over this time period.
To further validate the findings, we assessed the extent to which results were stable
across different contexts. Therefore, the samples from the three studies were combined
and the control variables were used to subdivide the sample. This gives us a total of
twelve regression analyses in this stage. The results from these regressions are displayed
in Table 7. The adjusted explained variance ranges from .16 to .28, indicating that
expected consequences have an influence on attitude toward growth in all regressions.
The results reveal that noneconomic concerns are very important determinants of attitude
toward growth. Personal income is not the most important variable in any regression,
suggesting that money is not the most important motivator. A remarkably consistent result
across the regressions is that employee well-being is the most important explanatory
variable. This holds for 11 out of the 12 regressions, reinforcing the findings from the
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previous analyses. The exception is found among female entrepreneu rs where

independence comes Out the strongest. The regression for the female subsample,
however, is somewhat problematic, since it only contains 61 cases and should be
interpreted more restrictively. Due to the small sample size, very large effects are needed
in order to achieve statistically significant results even at the .05 level. As a comparison,
while a regression coefficient of .06 is statistically significant among males, a .19
regression coefficient is not, among females.
Workload is relatively unimportant in all subsamples as is work-tasks, with the exception

of young entrepreneurs and the smallest size bracket. The pattern concerning
independence is the opposite; it has a statistically significant effect in all regressions
except in the smallest size bracket.
Statistically significant standardized regression coefficients for the remaining explanatory

variables have the same signs across all 12 analyses, indicating that the regressions are
stable. However, their rank order and magnitude vary, depending on how the sample is
divided. Interpretation of these coefficients should be restrictive. Considering the
moderate explained variance and the magnitude of the employee well-being coefficient in
all regressions, relatively little is explained by other variables in the regressions.
No less than 17 regression analyses have been performed to test the hypotheses. A
summary of the outcomes of these tests is presented in Table 8. This table illustrates that
the variables employee well-being, independence, personal income, control and survival
of crises generally receive the largest, and always positive standardized regression
coefficients. These variables are also statistically significant on most instances. Thus, it is
relatively safe to conclude that the hypotheses concerning the influence of employee well-
being (H3), independence (H6), personal income (H4), control (H5), and survival of crises
(H7) on attitude toward growth are supported by the data. Regarding the three remaining
hypotheses, results are more mixed and they do not get equally consistent support by the
data. Therefore, even if the bulk of the evidence is in favor of the hypotheses, it must be
concluded that for most of the respondents, expected consequences of growth
concerning workload (Hl), work tasks (H2), and quality (H 8) do not have an important
influence on attitude toward growth.
Discussion
Explaining Growth Attitude
In this article, we set out to examine how small-business managers' overall attitude toward
growth was influenced by the consequences they expected from growth. In doing
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that, we used data from three separate survey studies employing the same measuring
instruments. This allowed us to come up with many useful comparisons. Some results
recur very consistently across subanalyses and can therefore be accepted even if the
associated probability of the coefficient is not very low in every analysis. Other results,
while "statistically significant" in one analysis, may be disregarded because the result
appears in isolation. The general approach-to repeat the same measurement in several
separate surveys-is something we would highly recommend to other researchers. Results
from multiple samples are a much better basis for determining one's degree of
confidence, than is significance testing alone.
On average, our regression models could explain close to 25 percent of the variation in
attitude toward growth in our different subgroups. This shows that there are substantial,
general relationships between expected consequences of growth and attitude toward
growth. In other words, small-business managers' feelings about whether the growth of
their business is good or bad can, to a reasonable extent, be explained on the basis of the
consequences that they expect from growth.
Nonetheless, over three quarters of the variance is left unexplained by our models, and
the reasons for this deserve some discussion. A first possibility is, of course, that
important explanatory variables were omitted. Perhaps other expected consequences of
growth are important and therefore should have been included. Our selection of
explanatory variables was based on a thorough literature review as well as elicited in an
open-ended procedure. Consequently, we regard it highly unlikely that any additional
more important variables of this kind are to be found. The control variables we have used
are also the most important ones in previous research on small-firm growth. Therefore,
the "add variables" route is unlikely to raise explained variance by more than a few
percentage points. Further, our results are similar to what have been reported in previous
studies (explained variance of 10 percent to 36 percent would be typical according to
Ajzen, 1991).
The most important reason for the modest explanatory power is instead, arguably, the fact
that regression coefficients represent average effects. According to expectancy-value
theory, there is reason to believe that the true effect for each individual differs from this
average (Ajzen & Fishbein, 1980; Bagozzi, 1985). For some managers quality is a great
concern, whereas for others their own workload is the top-of-the-mind issue. This fact,
i.e., that the coefficients represent average effects, is a general problem in this type of
research and probably the major reason that explanatory power rarely reaches much
higher values than ours even when seemingly all relevant variables have been included.
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The second major reason is that measurement error is substantial, because the questions
do not have exactly the same meaning to each respondent and because people differ in
their response styles. Thus, very strong relationships between the independent and
dependent variables should perhaps not be expected. We regard o ur modest explanatory
power as a result of these general problems, rather than the omission of important
explanatory variables.
Relative Importance of Different Beliefs
Turning to a more detalled assessment of our results, a central finding is that expectation
of financial galn is not the outstanding determinant of attitude toward growth. This is
clearly contrary to economic theory, but also to normative management theories where the
motivation to grow is taken for granted, based on financial outcome being the primary
concern of the manager. Our findings suggest that other expected outcomes of growth
that are largely noneconomic in nature also influence attitude toward growth. This
includes, for example, beliefs concerning the effect of growth on the managers' ability to
keep full control over the operations of the firm, the firm's degree of independence in
relation to external stakeholders, and its ability to survive crises. The effects are generally
not very strong. However, while not always statistically significant according to
conventional criteria, they appear very consistently with the same sign across samples,
industries, size classes, and age groups. What this means is probably that the effects are
real, but they are small because each type of expected outcome has a substantial effect
on attitude toward growth only for some managers, whereas it is relatively uninfluential for
others. Hence the modest average effect represented by the regression coefficients. This
illustrates the strength of our combining data from three studies using the same
instruments. In a single and perhaps smaller study, each and every one of these effects
may have been disregarded as "not statistically significant, therefore non-nonexistent"- a
very common practice among social scientists. The same would probably have happened
had three different studies used different instruments to assess the same theoretical
relationships. With our "same instrument, multiple samples" approach, we can conclude
with confidence that these expectations do have effects on attitude toward growth.
Our most important finding is that expectations concerning the effect of growth on
employee well-being is the single most important determinant of overall attitude toward
growth. This result stands out with impressive consistency across samples, industries,
size classes, and age groups. The important question is, of course, exactly what this
means. The very translation of the Swedish original is tricky. While no fully satisfactory
translation to English presents itself, the reader might find it informative that the Swedish
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wording is likely to evoke associations to camaraderie, comfort, atmosphere, and job

satisfaction.
Several interpretations are possible. A critical mind would perhaps like to dismiss the
result as not really showing that small-business managers' great concern for their
employees affects their attitude toward growth. Rather, one might argue, is this variable
picked as their scapegoat for less socially desirable reasons to refraln from growing their
firms larger. However, additional analyses performed suggest that the variable works both
ways. That is, some managers believe that growth will improve employee well-being, and
this enhances their attitude toward growth. Another reason for not dismissing the result in
this way is that there are other expected outcomes, most notably product/service quality,
that would be an equally logical candidate for a social desirability effect.
However, we would agree that it is not unlikely that the managers also have their own
well-being in mind when answering the question. A sound interpretation is probably that
the result reflects a real concern for the "soft" qualities associated with small scale, and
that this concern is justifiable. There is research to suggest that regarding is sues like
comradeship, involvement, and job satisfaction, employees and people in general think
highly of small firms (Curran et al., 1993; Davidsson, 1993). Even more impressive
evidence for the "soft" advantages of a small scale is presented in the classical study by
Barker and Gump (1964; cf. also their extensive references to other studies). Therefore,
the small-business manager may have a very real reason to be concerned about the
atmosphere of the small firm when faced with expansion opportunities. The generality of
our finding in the subanalyses suggests that this concern is a source of a recurrent
goal/conflict for many small-business managers.
Limitations and Future Research
The issue of work atmosphere and employee well-being is worthy of further research
efforts. One aspect of this would be to assess whether the concern for employee
wellbeing and its effect on attitude toward growth is a cultural peculiarity of Sweden (or
perhaps the Scandinavian countries), or if it is more universal. While both outcomes of
such an assessment are conceivable, the review of classical works as well as more recent
research suggests that a very high concern for employees is not unheard of in other
cultures (cf. Kazumi et al., 1996). Future research should also try to capture in more detail
what the "concern for employee well-being" really encompasses; whether it affects real
growth and not only attitude toward growth; if managers who have successfully led their
companies through a growth phase also felt such concerns before the expansion;
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whether their expectations were accurate; and what they might have done to counteract
the possible negative effects of growth on employee well-being.
Our study has been about attitude toward growth, not actual growth. Whether attitude
toward growth--as measured here--has an influence on actual growth or not is an
empirical question that remains to be answered. In accordance with previous studies (cf.
above), we would hypothesize that such is the case. In order to find out, longitudinal
research is needed where attitude toward growth is measured at one point of time and
actual growth outcomes are measured later.
A potential limitation to the results presented here has to do with common method
variance. While common method variance problems in survey research seem to have
been overstated (Crampton & Wagner, 1994), they cannot be neglected (Lindell &
Whitney, 2001). The favoring of telephone interviews over mail questionnaires probably
reduces common variance, but does not eliminate the risk that reported relationships may
be somewhat inflated.
Conclusions and Implications
Beliefs play an important role in understanding why people act the way they do. According
to expectancy-value theory, behavior is a function of beliefs relevant to the behavior.
Salient beliefs are considered to be the determinants of a person's intentions and actions
(Ajzen, 1991). In our research, small-business managers' beliefs about the consequences
of growth have provided insights into the reasons that they think that expanding their
business is a good or a bad thing. One interesting finding is that noneconomic concerns
are more important than the possibility of personal economic gain or loss. Of particular
importance is the well-being of the employees, which probably encompasses concerns for
the work atmosphere of the small firm in general. Managers who believe that the work
atmosphere will improve due to growth tend to have a positive attitude toward growth.
Conversely, those who expect that growth will deteriorate the work atmosphere tend to
have a negative attitude toward growth.
To some extent, these expectations are probably well founded. The work atmosphere will
probably be affected by growth. On the other hand, it is possible for the small business
manager to influence the work atmosphere in order to avoid possible negative
consequences. Active measures for introducing newcomers and building a sound
company culture can be taken to this effect (cf. Hambrick & Crozier, 1985). If managed
correctly, growth can be associated with new challenges and development opportunities
for staff rather than loss of direction or alienation.
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Like other beliefs, beliefs about consequences of growth can be influenced by the
persuasive argumentation of others (Chaiken & Stangor, 1987). If relevant information
about the positive consequences of growth-and methods to circumvent negative effects-
were made available to small-business managers, this could lead to a more positive
attitude toward growth. Information about the positive effects on work atmosphere and
ways of mitigating potential negative consequences may affect growth motivation more
than would prospects of increased personal income.
Table 1
Sources for Selection of Expected Consequences of Growth That May
Influence Growth Motivation
(1.) This research was made possible through generous grants by Knut and Alice
Wallenberg's Foundation, Jan Wallander's Foundation, Ruben Rausing's Foundation, and
The Swedish Foundation for International Cooperation in Research and Higher Education.
An earlier version of the article received the Best Paper Award at the 1997 Babson
College/Kauffman Foundation Entrepreneurship Research Conference and appears in
Frontiers in Entrepreneurship Research, 1997. (2.) A meta-analysis of the studies finds a
weighted average correlation of .39 between motivation and growth.
(3.) For the purpose of testing the properties of our measure, an index was created. The
"intended ideal size five years ahead" responses and present-size figures were used to
calculate intended growth rates of both sales and employees and converted to two seven-
point scales. The two items from the 25 percent and the 100 percent scales were summed
with these two items to form a global growth intention index. The Cronbach's Alpha value
of the index was .72 and corrected item-total correlations ranged from .47 to
.55 indicating that the index has acceptable reliability (Nunnally, 1967) and that all items
share sufficient variance with the index (Nunnally & Bernstein, 1994). This index was also
successfully used in predicting actual growth outcomes in another study (Wiklund &
Shepherd, 2004). This suggests that our measure is (1) sufficiently reliable and (2)
predictively valid (Nunnally & Bernstein, 1994). We therefore feel confident in relying on
this single item measure for our dependent variable.
(4.) Due to space limitations, individual figures are not reported. An examination of the
variance inflation factor (VIF) suggests that there was no incidence of multicollinearity.
Individual figures range from 1.08 to 1.45, which is welt below critical values (cf. Hair,
Anderson, Tatham, & Black, 1998).
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Johan Wiklund is an associate professor at the Center for Entrepreneurship and Business
Creation at the Stockholm School of Economics and at Jonkoping International Business
School.
Per Davidsson is a professor at Jonkoping International Business School.
FredericDelmar is an associate professor at the Center for Entrepreneurship and

Business Creation at the Stockholm School of Economics.
Publication Information: Article Title: What Do They Think and Feel about Growth? an
Expectancy-Value Approach to Small Business Managers' Attitudes toward Growth.
Contributors: Johan Wiklund - author, Per Davidsson - author, Frederic Delmar - author.
Journal Title: Entrepreneurship: Theory and Practice. Volume: 27. Issue: 3. Publication
Year: 2003. Page Number: 247+. COPYRIGHT 2003 Baylor University; COPYRIGHT
2004 Gale Group

Study how higher potential ventures "grow up big" and the special problems,
organisation and leadership requirements of rapid growth;
Identify how entrepreneurial leaders foster favourable cultures;
Identify the specific signals and clues that can alert entrepreneurial managers to
impending crisis and approaches to solve these.
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12.3.1: INTRODUCTION
In chapter 1 we have pitched David against Goliath;
Because of their innovative and competitive breakthroughs entrepreneurial ventures have

demonstrated the capacity to invent new paradigms of organisation and management;
Entrepreneurial ventures are quick, flexible and creative;
Brontosaurus capitalists are multi-layered military-like, slow moving, uncreative and

"dead";
Many new training institutes adapt to train MBA students to become entrepreneurial.
12.3.2: GROWING UP BIG

Higher potential ventures do not stay small very long;
Managing and growing a venture is different from assessing the opportunity, forming
the venture and marshalling the resources to do it;
The various stages of development of a venture require different skills and resources
to harvest potential;
The stages are:
Doing
Managing
Managing managers
12.3.2.1: The problem in rate of growth
The faster the rate of growth the greater the potential for difficulty. This is because of the
various pressures, chaos, confusion and loss of control.
Growth rate affects all aspects of a business. As sales increase, more people are hired
and as inventory increases, sales outpace manufacturing capacity. Facilities are then
increased, people moved, accounting systems and control cannot keep up and so on.
Distinctive issues caused by rapid growth are:
Opportunity overload: An abundance of sales or new market opportunities.
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Abundance of capital: Financing is not the problem, rather how to evaluate investors
as "partners" and the terms of the deals.
Misalignment of cash burn rate and collection rates: Unless effective integrated
accounting, inventory, purchasing, shipping and invoicing systems and control are
in place this misalignment can cause chaos and collapse.
Decision-making focuses on day-to-day issues rather than strategic issues:

Rather than strategizing, decisions are made on a day-to-day and week-to-week
basis.
Surprises are the order of the day: Expansion of space or facilities is a problem and
one of the most disrupting events during the early explosive growth of a company.
Managers were not prepared for the surprises, delays, interruptions spawned by
such expansion.
12.3.2.2: Industry turbulence
The foregoing difficulties are compounded by industry turbulence such as price

fluctuation.
12.3.3: THE IMPORTANCE OF CULTURE AND ORGANISATIONAL

CLIMATE
Organisational climate - the perceptions of people about the kind of place it is to work in.
The climate of an organisation can have significant impact on performance. It is created
both by the expectations people bring to the organisation and the practices and attitudes
of the key managers. The setting of priorities is critical. Superior teams operate differently
in setting priorities, resolving leadership issues and which roles should be performed by
members of leadership teams.
12.3.3.1: Organisational climate can be described along six basic

dimensions:
Clarity. Clarity in terms of being well organised, concise and efficient in the way that
tasks, procedures and assignments are made and accomplished.
Standards. The degree to which management expects and puts pressure on

employees for high standards and excellent performance.
Commitment. The extent to which employees feel committed to the goals and
objectives of the organisation.
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Responsibility. The extent to which members of the organisation feel individual

responsibility for accomplishing their goals without being constantly monitored.
Recognition. The extent to which employees feel they are recognised and rewarded
for a job well done, instead of only being punished for mistakes or errors.
Esprit de corps. The extent to which employees feel a sense of cohesion and team
spirit, of working well together.
12.3.3.2: Approaches to management
a) Leadership
No single leadership pattern seems to characterise successful ventures. Leadership

may be shared or informal or a natural leader may guide a task.
Leadership is based on experience and not authority. There is no competition for

leadership.
The leader understands the relationship among tasks. The leader does not force his
or her own solution on the team or exclude the involvement of potential resources.
b) Consensus building
Leaders of most successful ventures define authority and responsibility in a way that
builds motivation and commitment to cross-departmental and corporate goals.
Consensus management requires working with peers and subordinates outside formal
communication channels.
Participation and listening are emphasised.
c) Communication
The most effective managers share information and are willing to alter individual
views.
d) Encouragement
Innovations and calculated risk-taking is encouraged in contrast to punishment and

criticism.
e) Trust
Effective managers are perceived as trustworthy and straightforward.
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f) Development
Effective managers have a reputation and capacity to develop human potential, i.e.
they groom and grow other effective managers by their example and their
mentoring.
12.3.4: ENTREPRENEURIAL MANAGEMENT BREAKTHROUGH
12.3.4.1: Marion Kauffman and Marion Labs
Marion Labs
0 Over 300 millionaires and 13 foundations were created from the builders of
the company.
RJR Nabisco (10 times larger than Marion Labs)
0 Generated only 20 millionaires.
The difference?:
Marion Labs based its management on 3 core values:
Treat everyone as you would want to be treated.
Share the wealth with those who have created it.
Pursue the highest standards of performance and ethics.
12.3.4.2: Jack Stack and Springfield Remanufacturing Corporation
Stack and a dozen colleagues acquired a tractor engine remanufacturing plant from the
failing International Harvester Corporation for 10 cents a share in 1883.
In 1993, the shares were valued nearly $20 and the company had completely turned
around with sales approaching $100 million.
What happened?:
At the heart of his leadership was creating a vision. Think and act like owners, be the
best we can be, and be perpetual learners. Build teamwork as the key, by learning
from each other, open the books to everyone, and educate everyone so they can
become responsible and accountable for the numbers, both long and short term.
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12.3.5: THE CHAIN OF GREATNESS
Exhibit 10
The Chain of Greatness

12.1) Describe the 6 basic dimensions of* an organisational climate.
12.2) Discuss the qualities of an effective manager.
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THE ENTREPRENEUR AND THE TROUBLED

COMPANY

Examine the principal causes and danger signals of impending trouble;
Discuss both quantitative and qualitative symptoms of trouble;
Examine the principal diagnostic methods used to devise intervention and turnaround
plans;
Identify remedial actions used for dealing with lenders, creditors and employees.
13.2.1: WHEN THE BLOOM IS OFF THE ROSE

Sooner or later, competitive dynamics catch up with many smaller (and larger)
businesses.
In 1999, one third of the Fortune 500 companies in 1970 no longer existed.
There are similarities as well as differences in the experience of difficulties between large
and small businesses.
New and small businesses must solve difficulties quicker since they have a far less
margin for error than larger businesses.
Most often, a crisis is the result of management error. Sometimes, however, there are
uncontrollable factors.
13.2.2: CAUSES OF TROUBLE

It was found that most often, external circumstances define the environment to which a
troubled company needs to adjust. THEY RARELY ACCOUNT BY THEMSELVES FOR
AN INDIVIDUAL COMPANY FAILURE. Most causes of failure can be found within
company management.
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There are three broad areas namely:
Strategic issues:
Misunderstood market niche. Failure to understand the company's market

niche and to focus on growth without considering profitability.
Mismanaged relationships with suppliers and customers. Failure to understand

the economics of relationships with suppliers and customers. For example
allowing practices to dictate payment terms when they may be in a position
to dictate their own terms.
Diversification into an unrelated business area. Using the cash flow generated
in one business to start another without good reason.
Mousetrap myopia. Starting a firm around an idea rather than an opportunity.

Firms that have "great products" looking for other markets where they can
be sold.
The big project. The company gears up for a "big project" without looking at
the cash flow implications. For example, spending cash by adding capacity
and hiring personnel but sales do not materialise.
Lack of contingency planning. Firms need to be geared to think about what

happens if things go sour.
Management issues:
Lack of management skills, experience and know-how. Management mode

must change from doing to managing to managing managers.
Weak finance function. A new emerging company may start off with a
bookkeeper but will have to hire a financial professional when the need
arises.
Turnover in key management personnel. This can be critical in businesses that

deal in specialised or proprietary knowledge. For example, one firm lost a
bookkeeper who was the only one who really understood what was
happening in the business.
0 Big-company influence in accounting. The mistake of focusing on accruals

rather than cash.
Poor planning, financial/accounting systems, practices and controls:
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Poor pricing, over-extension of credit and excessive leverage. Excessive

leverage can result when growth outstrips the company's internal financing
capability and a cash flow problem develops.
Lack of cash budgets/projections.
Poor management reporting. Management reports — inventory analysis,

receivables aging, sales analysis — are usually late or not produced at all.
Lack of standard costing. Many businesses have no standard costs that they
can compare the actual costs of manufacturing products. The company will
know only after the fact how profitable a product is.
Poorly understood cost behaviour. The relationship between fixed and variable
costs is not understood. For example, a factory may close on Saturday's to
save overtime but the manufacturing backlog of a high margin product
more than justify the overtime.
13.2.3: THE GESTATION PERIOD
Crisis rarely develops overnight. The time between the initial cause of trouble and the
point of intervention is seldom less than a year.
How management reacts to a crisis and what happens to morale determine what will
happen in the intervention.
Management members should think of turnaround instead of survival.
13.2.3.1: The paradox of optimism
The process of trouble
Normally the first signs of trouble are written off as teething trouble.
Mostly, outsiders such as bankers, board members and customers see trouble
brewing.
They wonder why nothing is being done and credibility begins to erode.
Management will then admit that trouble exists. However, requisite actions to meet the
situation are anathema (detested).
The downfall will continue until the situation becomes stressful.
During this period, the entrepreneur makes poor decisions which eventually lead to
final demise.
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13.2.3.2: DECLINE IN ORGANISATIONAL MORALE
Employees lose confidence which will be projected outwards. Employees lapse into
survival mode. Very often they enter the "blame game" which is counter-productive to the
finding of resolutions.
13.2.4: PREDICTING TROUBLE

There are two main categories namely financial results (or quantitative signs) and non-
quantitative signs.
Non-quantitative signals
Change in management or advisors.
Inability to produce financial statements on time.
Accountant's opinion that is qualified and not certified.
Changes in behaviour of the lead entrepreneur, e.g. avoiding phone calls.
New competition.
Launching of a "big project".
Lower research and development expenditures.
Writing off assets.
Lowering of credit line.
13.2.5: THE THREAT OF BANKRUPTCY

Quite often, the stigma of bankruptcy overrides the benefits thereof in the mind of the
entrepreneur.
Since none of the creditors of a business would like to see it fail, bankruptcy is a
tremendous bargaining tool in the hands of the management of the troubled company.
13.2.6: INTERVENTION
This refers to the turnaround process.
The critical task is to diagnose the situation, develop an understanding of the bargaining
position with creditors and produce a business plan for the turnaround.
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13.2.6.1: Diagnosis
This process consists of the following elements, namely:
Strategic analysis: The purpose of this analysis in a turnaround is to identify the

markets in which the company is capable of competing and deciding on a
competitive strategy.
Analysis of management: This consists of interviewing members of the

management team and coming to a subjective judgement of who belongs and who
does not.
Analysis of financial figures: A detailed cash flow analysis which will reveal areas
for remedial action.
Determine available cash in the near term.
Determine where money is going.
Calculate per cent-of-sales ratios for different areas of a business and then
analyse trends in costs.
Reconstruct the business. Compare the business as it should be to business

as it is.
Determine differences. The ideal cash flow plan and financial statements are
compared to the business's current financial statements.
13.2.6.2: The turnaround plan
This plan defines remedial actions as well as projections that can be used as a
management tool.
It helps to address organisational issues. The plan replaces uncertainty with a clearly
defined set of actions and responsibilities.
It is an important source of bargaining power. By identifying problems and providing for

remedial actions, the plan enables the firm's advisors to approach creditors and tell them
in detail how and when they will be paid. If the plan proves that the creditors are better off
working with the company rather than liquidating it, they will be willing to negotiate.
13.2.6.3: Other important issues
Generating quick cash
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The plan has established enough creditor confidence to buy the turnaround
consultant time to raise additional capital and turn underutilized assets into
cash.
It is important to raise cash quickly and for this purpose the working capital
accounts hold the most promise.
The best route to cash is discounting accounts receivable.
Inventory is not as liquid as receivables but still can be liquidated to generate

quick cash.
Prices and cash discounts need to be increased and credit terms eased.
0 Putting all accounts payable on hold eases the cash flow burden in the
near term.
Dealing with lenders
0 Lenders need to be satisfied that there is a workable long-term solution.
1 There are two sources of bargaining power — bankruptcy is an

unattractive result to a lender and credibility. The company that can prove
to the lender that it is capable of paying is in a better bargaining position.
Dealing with trade creditors
0 The first step is understanding the strength of the company's bargaining

position.
Trade creditors have the lowest priority claims and are therefore often the most
willing to deal.
As long as the company can offer a trade creditor a better result as a going
concern than it can in bankruptcy proceedings, the trade creditors should
be willing to negotiate.
Trade creditors will work with a troubled company if they see it as a way to
preserve a market.
The second step is to prioritize trade creditors according to their importance to

the turnaround. The most important creditors need to be taken care of first.
The third step is to switch suppliers if necessary. Priority suppliers will be able
to give credit references.
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0 The fourth step is to communicate effectively. If a company is honest, there

is not much a creditor can do, and at least it can plan.
Work force reductions
0 Layoffs are inevitable in a turnaround situation.
Layoffs should be announced as a one-time reduction and be done all at one

time.
Further layoffs should be accomplished as soon as possible because

employees will never regain their productivity as long as they feel insecure.
0 Cut deeper than seems necessary. If other remedial actions turn out to be
difficult to implement, the difference may have to made up in further
reductions in the workforce.
Longer term remedial actions
If the turnaround plan has created enough credibility and has bought the firm time, longer-
term remedial actions can be implemented. These actions will usually fall into three
categories:
Systems and procedures that contributed to the problem in the first place
can be improved or implemented.
Asset plays. Assets that could not be liquidated in a shorter time frame can
be liquidated, for example, real estate could be sold.
Creative solutions. For example, one firm had a large amount of inventory that
was useless in its current business. It found that if the inventory could be
assembled into parts, there would be a market for it. The company shipped the
inventory to Jamaica, where labour rates were low, for assembly, and it was
able to sell the entire inventory very profitably.

13.1) Name and give 2 examples of each of the 3 main areas which can lead to failure of
the venture.
13.2) State 5 signals that predict trouble.
13.3) What steps can be taken to turn an ailing venture around?
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THE HARVEST AND BEYOND

Examine the importance of first building a great company and thereby creating
harvest options;
Examine why harvesting is an essential element of the entrepreneurial process and
does not necessarily mean abandoning the company;
Identify the principal harvest options, including going public
14.2.1: LEARNING CONTENT

Most entrepreneurs will admit it is the satisfaction of the process of building a great
company that provides "the kicks".
First build the company, then harvest it.
14.2.2: BUILDING A GREAT BUSINESS

Wealth and liquidity are results — not causes- of building a great company.
The great paradox in the entrepreneurial process is: Build a great company but do not
forget to harvest.
Example: A 100 year old family business was approached by a buyer who was willing to
pay $100 million for the business. The family insisted it would never sell the business
under any circumstances. Two years later, market conditions changed and the credit
crunch transformed slow-paying customers into non-paying customers. The business was
forced into bankruptcy, which wiped out 100 years of family equity.
Having a harvest goal and crafting a strategy to achieve it are what separates successful
entrepreneurs from the rest of the pack.
Entrepreneurs should not only seek to provide employment for themselves but to create a
living for many others.
Setting a harvest goal helps an entrepreneur get after-tax cash out of an enterprise,
thereby enhancing his or her net worth.
Within the process of harvest, the seeds of renewal and reinvestment are sown.
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Thus, a harvest goal is not just a goal of selling and leaving the company. Rather, it is a
long-term goal to create real value added in a business which in turn adds to the worth of
the business in the market place.
14.2.2.1: Crafting a harvest strategy: timing is vital
When the company is first launched, then struggles for survival, and finally begins its
ascent, the farthest thing from the founder's mind is selling out.
The possibility of selling usually comes unexpectedly. New technology, a large competitor
or a major account is lost may force the entrepreneur to sell.
Suddenly the business is for sale at the wrong time, for the wrong reasons and for the
wrong price.
At some point, with a higher potential venture, it becomes possible to realize the harvest.
It is wiser to be selling when the strategic window is opening than when it is closing.
Bernard Baruch said that he made all his money by selling too early.
In shaping a harvest strategy, some guidelines and cautions can help:
Patience. A harvest strategy is more sensible if it allows for a time frame of at

least 3 to 5 years and as long as 7 to 10 years.
Vision. Don't panic as a result of precipitate events. Do not sell under duress.
Realistic valuation. Greed is the executioner of an attractive harvest. Don't

hold out too long.
Outside advice. It is difficult but worthwhile to find an advisor who can help
craft a harvest strategy while the business is growing and at the same
time, maintain objectivity about its value and have the patience and skill to
maximise it.
14.2.3: HARVEST OPTIONS

The seven principal avenues by which a company can realise a harvest from the value
are:
14.2.3.1: Capital Cow
The high-margin profitable venture (the cow) produces more cash for personal use
(the milk) than most entrepreneurs have the time or inclination to spend.
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The result is a capital-rich and cash-rich company with enormous capacity for debt
and reinvestment.
14.2.3.2: Employee stock (share) ownership plan
Employee stock ownership plans have become very popular among closely held
companies as a valuation mechanism for stock for which there is no formal
market.
Founders can also sell their stock to the plan and other employees, and thereby gain
liquidity.
It is viewed as a positive motivational device as it creates widespread ownership of

stock among employees.
14.2.3.3: Management buy-out
A founder can gain from a business by selling it to existing partners or to other key
managers in the business.
If the business has assets and a healthy cash flow, banks and insurance companies
will finance the buyout.
Usually a certain amount of cash is taken up front and the rest paid over a period of
time.
If the purchase price is linked to the future profitability of the business, then the seller
is totally dependent on the integrity and ability of the buyer.
Also the buyer can reduce the price by growing the business as fast as possible,
spending on new products and people and showing very little profit. The seller
then ends up on the short end of the deal.
14.2.3.4: Mergers, acquisition on strategic alliance
Merging is another way for founders to realise gain. For example a company with a
good product but no marketing or general management skills can merge with
another company that can fill these gaps.
14.2.3.5: Outright sale
Outright sale is the ideal route to go because up-front cash is preferred over most
stock. In a stock-for-stock exchange there is always the risk that the price of the
stock may fall.
Page 305
14.2.3.6: Public offering
The vision of having one's company listed on the stock exchange arouses passions of
greed, glory and greatness.
However, sometimes it is more trouble than it is worth. (Stock exchange crashes.)
There are advantages to going public — such as finding funds for rapid growth, such
as expanding the existing market or moving into a related market.
There are also disadvantages, such as disclosure requirements, cost of audits and tax
filings.
14.2.3.7: Wealth building vehicles
Investing in retirement plans is deductible to the company and grows tax free.

14.1) Why is harvesting an essential element of the entrepreneurial process?
14.2) Name and briefly describe the 7 avenues by which a company can realise a harvest.
Page 306

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1: THE ENTREPRENEURIAL REVOLUTION.................................................................... 7

1.1: LEARNING OUTCOMES........................................................................................ 7

1.2: LEARNING CONTENT............................................................................................ 7

1.2.1: THE ENTREPRENEURIAL REVOLUTION....................................................... 7

1.2.2: ENTREPRENEURSHIP: AMERICA'S SECRET ECONOMIC WEAPON..........8

1.2.3: THE ENTREPRENEURIAL REVOLUTION ACCELERATES AND

1.3: SELF-ASSESSMENT QUESTIONS...................................................................... 10

2: THE ENTREPRENEURIAL PROCESS........................................................................ 11

2.1: LEARNING OUTCOMES....................................................................................... 11

2.2: LEARNING CONTENT.......................................................................................... 11

2.2.1: ENTREPRENEURSHIP: DEFINITION............................................................ 11

2.2.2: ENTREPRENEURSHIP IN ITS DIFFERENT FORMS.................................... 11

2.2.3: THE ENTREPRENEURIAL PROCESS........................................................... 13

2.3: SELF-ASSESSMENT QUESTIONS...................................................................... 19

Study Unit 2: THE ENTREPRENEUR.............................................................................. 20

3.2: LEARNING OUTCOMES....................................................................................... 54

3.2.2: ACQUIRABLE ATTITUDES AND BEHAVIOURS OF ENTREPRENEURS......55

3.2.3: UN-ACQUIRABLE ATTITUDES AND BEHAVIOURS...................................... 58

3.2.4: ENTREPRENEURIAL APPRENTICESHIP..................................................... 59

3.3: SELF-ASSESSMENT QUESTIONS...................................................................... 59

STUDY UNIT 3: THE OPPORTUNITY............................................................................. 60

4: CREATING, SHAPING, RECOGNISING, AND SEIZING an opportunity......................60

4.2: LEARNING OUTCOMES....................................................................................... 76

4.3: LEARNING CONTENT.......................................................................................... 77

4.3.1: THE ROLE OF IDEAS.................................................................................... 77

4.3.2: PATTERN RECOGNITION.............................................................................. 78

4.3.3: IDEAS AND OPPORTUNITIES....................................................................... 79

4.3.4: SCREENING OPPORTUNITIES..................................................................... 81

4.3.5: GATHERING INFORMATION......................................................................... 86

4.4: SELF-ASSESSMENT QUESTIONS...................................................................... 88

5: SCREENING VENTURE OPPORTUNITIES................................................................ 89

5.1: LEARNING OUTCOMES....................................................................................... 89

5.2: LEARNING CONTENT.......................................................................................... 89

5.2.1: THE FOUR CORNERSTONES OF VENTURE OPPORTUNITIES.................89

5.2.2: QUICK SCREEN............................................................................................. 89

5.2.3: VENTURE OPPORTUNITY SCREENING GUIDE (VOSG)............................91

5.3: SELF-ASSESSMENT QUESTIONS...................................................................... 99

STUDY UNIT 4: RESOURCES FOR THE new VENTURE............................................ 100

6: RESOURCE REQUIREMENTS................................................................................. 100

6.1: Reading............................................................................................................... 100

6.2: LEARNING OUTCOMES..................................................................................... 144

6.3: LEARNING CONTENT........................................................................................ 144

6.3.1: IDENTIFYING RESOURCES........................................................................ 144

6.3.2: OUTSIDE PEOPLE RESOURCES............................................................... 158

7: ENTREPRENEURIAL FINANCE................................................................................ 163

7.1: LEARNING OUTCOMES..................................................................................... 163

7.2: LEARNING CONTENT........................................................................................ 163

7.2.1: VENTURE FINANCING: THE ENTREPRENEUR'S ACHILLES HEEL..........163

7.2.2: THE FINANCIAL STRATEGY FRAMEWORK............................................... 167

7.2.3: FUND RAISING STRATEGIES..................................................................... 168

7.3: SELF-ASSESSMENT QUESTIONS.................................................................... 168

STUDY UNIT 5: DIVERSE ISSUES IN ENTREPRENEURSHIP: THE

8: THE ENTREPRENEURIAL MANAGER..................................................................... 169

8.1: LEARNING OUTCOMES..................................................................................... 169

8.2: LEARNING CONTENT........................................................................................ 169

8.2.1: INTRODUCTION........................................................................................... 169

8.2.2: PRINCIPLE FORCES AND VENTURE MODES........................................... 170

8.2.3: STAGES OF GROWTH................................................................................. 171

8.2.4: MANAGING FOR RAPID GROWTH............................................................. 172

8.2.5: KNOWLEDGE AND SKILLS REQUIRED OF ENTREPRENEURIAL

8.3: SELF-ASSESSMENT QUESTIONS.................................................................... 178

9: THE NEW VENTURE TEAM...................................................................................... 179