Author Scott Shane seeks to dispel popular illusions about startups—starting with the myth that founders earn more than they would as employees
Entrepreneurship creates jobs and drives the U.S. economy, making smart founders and savvy investors rich in the process, right? Not so, says Scott Shane, professor of entrepreneurial studies at Case Western University and author of The Illusions of Entrepreneurship, to be published by Yale University Press this month.
Shane argues that increasing the rate at which new companies are formed does little for the economy or job growth; instead, expanding existing businesses would be a more efficient way to spend time and money. Shane, who is also a researcher on new businesses for the Ewing Marion Kauffman Foundation and an angel investor with the Cleveland-area North Coast Angel Fund, wants to give every aspiring business owner a reality check.
Shane's book reveals a bleak picture of entrepreneurship in the U.S. It shows the average new venture will fail within five years, and even successful founders usually earn 35% less over 10 years than they would working for others.
Shane spoke recently with BusinessWeek.com's John Tozzi about the myths of entrepreneurship. Edited excerpts of their conversation appear here. We also offer a playbook (BusinessWeek.com, 1/23/08) and a link to a quiz Shane put together to test knowledge of entrepreneurship.
You collect a lot of data in your book and come to some counterintuitive conclusions about entrepreneurship. What would you say is the biggest illusion?
I think the biggest myth entrepreneurs have is that the growth and performance of their startups depends more on their entrepreneurial talent than on the businesses they choose. I hate to deflate egos, but on the other hand I want people to have a realistic understanding of things. The industry a person picks to start a business has a huge effect on the odds that it will grow. If you go back 20 years or so, about 4% of all the startups in the computer and office equipment industry made the Inc. 500, 0.005% of startups in the hotel and motel industries made that list, and 0.007% of startups in eating and drinking establishments. So that means the odds that you make the Inc. 500 are 840 times higher if you start a computer company than if you start a hotel or motel.
The subtitle of your book is "The costly myths that entrepreneurs, investors, and policy makers live by." What's the cost of these misconceptions?
At the individual level, the core fact here is the typical, median, right-smack-in-the-middle entrepreneur is a failure. The cost is everything associated with that. So if you start a business and the business dies, you could have been working for somebody else. You could have been making a salary. You could have had the stability—you wouldn't have had that kind of stress that comes from the up and down of running that business.
So there's the personal costs. From an individual level, the myth is that somehow if you manage to hit the average or hit the median, you're going to be fine. The reality is that the distribution is so skewed you have to hit the top for it to matter, and in fact, you have to hit the top 10% to have income as an entrepreneur better than what you would have gotten working for other people.
Describe the typical startup that you found.
The median startup is a business that's capitalized with about $25,000. The financing of that business comes from the entrepreneur's savings. The business is a retail or personal service business, a hair salon or a clothing store, that kind of thing. The founder doesn't have expectations of a very high growth business, in fact [the entrepreneur is] probably thinking a goal of $100,000 a year of revenue is a good goal.
And it's most likely to be organized as a sole proprietorship and to have no employees besides the owner—is that correct?
That's right. And in fact we're getting close to half, very close to the median would even be home-based.
Why do you think the myth of entrepreneurship, the image that you're debunking, is so popular?
Part of it is we have a belief that entrepreneurship is good because it's associated with things that we like to believe about Americans: being independent, doing your own thing, going your own way. The other part of it is that paradoxically, there is one really, really good thing about entrepreneurship that people don't talk about, which is dominant and we have lots of evidence to support: People who run their own businesses have greater job satisfaction than people who don't. I think part of it is that we're trying to make sense of this paradox—that we really like it, but financially it isn't so great. So we create a myth that says because we like it and it makes us happy, it must also make financial sense, because otherwise there's a kind of conflict we can't resolve.
You do point to this data that people are so much happier working for themselves that they'd need to earn 2.5 times as much working for someone else to be as happy. If that's the case, then despite the personal financial risks they take on, is there anything wrong with that?
It makes a lot of sense if people say, "You know what? I'm going to earn less money running my own business, but I really don't like to work for other people, and that's why I'm doing it. It's making me happier and I really don't care." I think that's great. The part of it that becomes a problem is when people just won't admit the reality that it may make them happy and they're doing it because they want to be independent, [but] then they delude themselves into believing that also it's financially better.
One of the things you describe is the typical entrepreneur makes decisions that lower his chances for success. Why do you think that happens?
Part of it is that they're in a hurry and don't have time. So to give you a good example—a business plan. We have lots of evidence that all kinds of performance measures of startups are enhanced if you write a business plan (BusinessWeek.com, 1/7/08). But a lot of people, actually the majority of people don't write them. If business plans help and they don't do it, why don't they do it? I think one reason is if you're not going to raise money from another party, the sole purpose of the business plan is to help you run your business. But if you think, "But it'll take me a lot of time to write it and I could just be starting," if you're in a hurry, you just start, and it handicaps your business. So I think one part is the rush.
The second part is, unfortunately, ignorance about what does work. We don't have a lot of information out there about what it takes to make a business successful.
You write that "encouraging startups is lousy public policy," based on the data you've examined. What would you propose as policy alternatives?
The part that's lousy public policy is the idea that entrepreneurs, regardless of what kind, are good, and if we just have more of them, it's better. But what's a good public policy is if we picked certain kinds of startups, and we emphasized the increase in those. But the way the policies are set up, they don't encourage the specific high-potential startups. Most of the policies are: More entrepreneurs—just let's get volume. It's a very volume-oriented strategy. That's bad public policy.