Enabling the Natural Act of Entrepreneurship

Harvard Business Review

I met Slovenian entrepreneur, Sandi Cesko, in 2007 when his Ljubljana-based multi-channel retail operation, Studio Moderna, had about $70 million in sales. Not bad. I met him again two months ago: six years later he had scaled up by a factor of ten — all the result of organic growth — and employs over 6000 people. Even better.

Scale-up means growth, and growth means jobs, wealth, and tax revenues. In a recent post on HBR.org, I called attention to the fact that we entrepreneurship promoters are too focused on start-up, and need to re-balance the dialog to support scale-up as well. That dialog includes all stakeholders, from the entrepreneurs themselves to investors to government policymakers. For you entrepreneurs, the challenges of scale-up are first and foremost the responsibility of managements and boards. Don't go looking to public officials for help in growing your venture ten times bigger. But you policymakers can still play a key role in fostering an entrepreneurship ecosystem that supports scale-up entrepreneurs. So here are some suggestions, most of which by the way, happen to be essentially cost-free:

Removing barriers to growth should be your number one priority. Entrepreneurship is a natural act, a normal aspect of the human condition that spans geography, culture, and history. Three thousand years ago the Phoenicians in Tyre were as globally entrepreneurial as the startupists are today in nearby Tel-Aviv. This natural drive to grow something big and new needs to be unleashed, not pushed or incentivized. The Brazilian government recently decided to make life easier for very small businesses so they passed special laws and tax breaks for micro-enterprises, called "simples." A great idea, and the Simples Nacional taxation system has indeed turbocharged formalization of Brazil's informal economy.

But without solving the fundamental problem of an incredibly opaque and complex bureaucracy, the Brazilian government has, despite the best intentions, kicked the can down the road and it is precisely the scale-up entrepreneurs who suffer: there is now paradoxically an incentive for entrepreneurs to stay small because when they grow, they are suddenly hit with a harsh administrative reality. As one Rio-based entrepreneur told me, "I got to nine people, took one look at the huge regulatory stair that I would have to climb to get to ten, and went back to opening up additional small companies instead of growing one big one. It is hell to manage."

The commonality of perverse behavioral outcomes from good policy intentions leads to a second prescription:

Do not discriminate in favor of entrepreneurs. "Not" is not a typo. If you remove the barriers, then you don't need to incentivize entrepreneurs to commit their natural act. Because it is extremely difficult to define a priori what an entrepreneur is and is not, pro-entrepreneur incentives will inevitably create a direct or indirect cost for those entrepreneurs who don't happen to fall into government's typically limiting definition. How many programs divert scarce public funds to discriminate in favor of certain entrepreneurial ventures, often under the rubric of "small business"? For example, in France it is twice as likely to find a 49-person company as a 50-person company. Huh? Here, policy has created a distorted system, in which it is rational to want to stay small and suppress the drive for growth. Piecemeal policies, like angel tax credits, loan guarantees, reduced payroll taxes, direct investments, government venture funds, etc., have spread like wildfire. Their effectiveness is almost impossible to measure, yet compared to removing the obstacles to the "natural act," they are quick fixes, and also use up scarce public resources.

Real entrepreneurs don't mind paying taxes, so develop a clear, right-sized and strictly enforced tax system. Taxes per se do not hinder entrepreneurship. I have talked to many entrepreneurs and policymakers in Denmark, one of the highest tax regimes in the world. Of course, no one likes to pay taxes, but the Danes don't complain as much as you might expect in part because they receive a high quantity and quality of public services for their taxes. And no less important, company tax administration is relatively fast, simple, predictable, and logical.

Anyone from Mexico or Ukraine knows that many tax regimes are hostile to business in general, but some of them seem to diabolically target the entrepreneurs who otherwise would be creating the next wave of jobs. Taxes on revenues (not to be confused with VAT), taxes on assets, taxes that are paid in advance of profits or receipts, tax refunds that take months to be repaid — these are a huge burden to a rapidly scaling company in which cash flow management is a matter of survival. If we want the jobs these companies create, then we have to design (and strictly enforce) a better tax system, rather than manipulate taxes as incentives. We don't need to incentivize people to act naturally.

Want to solve the capital problem? Start by paying suppliers on time. Here is a paradox: In Puerto Rico every government supplier knows that it will take them at least a year to be paid, despite the fact that the law stipulates payment within 40 days. So Puerto Rican entrepreneurs hire consultants to badger government procurement to pay up, and in parallel they jack up their prices to finance the long receivables cycle. There is a law making it a crime for the government to pay late, but it is widely believed that if you try to enforce the law, it will be a long time before you see your next contract.

I once guestimated that about a billion dollars of cash are used by suppliers to finance the Puerto Rican government's late payments, not to mention the extra cost to the public of the price increases that suppliers charge. Oh, and by the way: Puerto Rican growth ventures are starved for capital, and government agencies have invested public funds to try, unsuccessfully, to kick start a venture capital sector.

Unjam the exit if you really want to improve entrance and scale-up. Not having a reliable exit channel for businesses creates a traffic jam at the start-up on-ramp. For example, it is nearly impossible for scaling ventures in many countries, including Brazil and Denmark, to count on an IPO for a successful exit. This blockage slows down the entire flow of ventures and venture capital, with lack of risk capital and lack of highly scalable ventures each keeping the other below their potential.

The blockage of capital flows also has follow on effects: Why would any rational person leave a secure, soft, high-status job at state-owned Petrobras or Vale without a really compelling prospect of making it rich? Having startup policies without taking care of access to IPO markets is like having a fast new ramp onto a pot-holed dirt road.

Stay off of ventures' balance sheets — and get onto their income statements. Policymakers seem more and more to be looking to play venture capitalist or banker. We see the results of this confusion in the (again, well-intentioned) US Department of Energy loans and loan guarantees for cleantech companies. Being a company shareholder or debt holder can and should misalign your interests in broader public goods with those narrower interests of rapidly building a growing and competitive venture. Governments and shareholders should have different motivations. The only occasionally valid excuse for being on a venture's balance sheet (and then for only a very short period) is to create a "demonstration effect" that shows unaware investors that there are profitable opportunities to invest in.

That does not mean government offices are irrelevant to entrepreneurs' profit and loss statements. At an entrepreneurship ecosystems workshop I ran in St. Petersburg, Russia, last November, a confident entrepreneur publicly challenged a famous priest: "With such a large purchasing budget, what is the church doing to buy from entrepreneurs?" The same can be asked of governments: you can stimulate a lot of entrepreneurship by clearly defining and allocating resources to social problems that need solving. The "space race," "cold war," "war on poverty," and many other initiatives created powerful and natural new markets for entrepreneurs (and big companies as well) to compete in. Obamacare is creating more opportunities for entrepreneurs by boosting a new market to address a brand new social priority.

Convene, celebrate, catalyze. Mayor Thomas Menino launched the Boston Innovation District in 2010 with his fifth inaugural address. He and his staff had created a simple compelling vision around work-play-live, a set of operating principles and a digital community, and then worked to bring different actors together: real estate developers, startup competition organizers, entrepreneurs, advertising agencies, investors, established high-tech companies, private incubators, a college (Babson), community organizations and artist associations. 4000 new jobs later, the mayor's office has spent virtually no money, fielded only a virtual team, and, with one exception, offered no monetary incentives to locate there. The private sector has footed the entire bill of accommodating over two hundred new scale-driven companies, primarily because they saw it as a good investment.

Of course, as we all know, the devil in policy effectiveness is almost always in the details, and I have simplified the argument. But this does not weaken the larger truth that when it comes to encouraging scale-up entrepreneurship, the first and best thing policymakers can do is to get the artificial barriers to this natural act out of the way.

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