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Dreaming a Difficult Dream

This book was born out of passion, history, and, yes, failure (or so I thought at the time). After the one-two punch of the spring 2000 tech-stock slide and the September 11, 2001, attacks, my brother and I finally agreed to suspend operations of the technology-based product design firm we had launched five years prior. This venture had been dying a slow death in perennial start-up mode due to lack of working capital (among a host of other factors).

I thought I had entered that project with my eyes wide open. After all, I had worked on Capitol Hill dealing with business development and federal procurement issues. I had worked for a federal commission on entrepreneurship. I had been surrounded by and strongly influenced by entrepreneurs throughout my life—had even researched them as a genealogist in my own family tree. And I had built a small-scale, modestly profitable business when I was in college, selling T-shirts, hats, and such to my fellow collegians and eventually customers in various locales in Chicago and other markets along the Eastern Seaboard.

Like most entrepreneurs, I had ignored the statistics and assumed that I would be the one to defy the odds. What I didn’t realize then is that the deck was stacked against me despite the various traits and resources I brought to the table. In fact, they just were not enough. I didn’t understand what the odds were, or how to play them. I read innumerable how-to books about business plans, but none of them taught me how to prepare for the rough-and-tumble entrepreneurial world.

Running the Numbers

Based on statistics drawn from the most recent Kauffman Firm Survey, which followed nearly 5,000 U.S. start-up ventures from 2004 to 2008,¹ the odds of starting a business that lasts at least four years, generates revenues greater than $25,000, and goes on to hire at least one employee by its fourth year are about one in eight. To put these numbers in context, the average acceptance rate at an Ivy League college in 2009 was just under 16 percent.²

Generally speaking, as a nation, we encourage young folks (and not-so-young folks) to start their own businesses, but we rarely tell them how to prepare to become successful business owners—often implying or even declaring outright that you don’t need a college education to thrive as an entrepreneur: “Look at Bill Gates; he was a college dropout!” But of those who hold up Bill Gates as an example, how many fill in the blanks? After all, Bill Gates dropped out of Harvard College, not MetroTech Community College. (He was also born rich.)

While Harvard was less selective in the 1970s than it is in the present era, it still was no cakewalk to get into—but it was much easier to get into and graduate from Harvard than to build the company that would become Microsoft. In fact, it’s fair to say that it’s probably vastly easier to get into Harvard than to build a business that will employ 20,000 people, 2,000 people, 200 people—or even 20 people, which happens to be the number of employees that the average “employer-firm” has on its payroll. In 2009, Harvard accepted only 7 percent of applicants into the Class of 2012. But fewer than 3 percent of all firms employ twenty or more people. (If any of these statistics surprise you, you now know why I wrote this book!)

Employer-firms, as the SBA calls them, are the one-fifth of all businesses that have a payroll—those that employ salaried or hourly workers. Of that one-fifth of firms with employees, almost 11 percent employ twenty or more people.³

In many respects, building a business is like entering a triathlon. Both pursuits seem very ambitious from the perspective of less adventurous souls—but they’re not nearly as impressive as growing that business or actually finishing that race. It’s fairly easy to sign up for a triathlon; the challenge, of course, is doing it—let alone being competitive in it!

Now, the likelihood of ascending to Bill Gates’s stature in business and the likelihood of being accepted by and graduating from Harvard are two very different things. It’s like comparing apples to oranges, or, as is the case with Gates, windows to doors. But whatever metaphor is most appropriate here, you get the point: starting a business that lasts and grows—let alone one that earns a consistent profit—is ridiculously hard.

If you’ve ever been asked to speak to a class of high schoolers, you probably know that you don’t encourage students to apply to Harvard without knowing their scholastic aptitude. To do so would be reckless at best, and cruel at worst. Yet every day people tell folks to start a business based on little more than hearing someone’s “great idea.” Would you tell a senior in high school who has mediocre grades, no extracurriculars, and skipped taking the SAT to apply to Harvard just because she really, really wanted to go there?

When we encourage young people to go to college, it is because we know that doing so opens up more professional and other career opportunities and the likelihood of securing better-paying jobs. That’s been the traditional thinking, anyway—certainly before the Great Recession. We also know that there are thousands of schools to choose from that can help students receive a good education, stimulate their intellectual development, expand their skills and life experiences, and improve their chances of joining the workforce after graduation. Few people claim that setting your sights on an elite, highly selective college is the only way to obtain an excellent education and good prospects of economic uplift. Yet when we tell people that they should go into business for themselves, particularly starting a company that will eventually require employees, we are essentially saying “Go to Harvard” to people whose scholastic track record may not be that competitive.

Figure 3
Elite Subgroups of Total U.S. Firm Population

Why do we do it? Because we don’t know any better. But I suspect when you’re done reading this book, you’ll resist the urge to tell someone who likes eating cake to open up his own bakery.

The good news is that in the United States, starting a business is pretty darn easy. All you have to do is figure out what you want to do, come up with a catchy name, print out a bunch of business cards on your printer, and get a business license at city hall, and you’re technically in business. And if you report even the pittance you may have made in the previous tax year, the IRS will label your activity—whether it’s babysitting or getting paid to speak at an event—as a business enterprise that must file a Schedule C, the tax form that documents the nonemployee income and expenses of sole proprietorships, entities totaling over 21 million in 2007.⁴ Of course, this means that of the millions of firms that the IRS—and as a consequence, the U.S. Census Bureau—recognizes as businesses, only a fraction actually consider themselves “in business,” which explains in part why their enterprises’ annual earnings represent on average less than 10 percent of the revenues of their counterparts with payrolls.⁵

But what if you want to start the next Netflix or Cold Stone Creamery? What if you want to start a business that will grow to hundreds (or thousands) of employees in a nice office building—the kind of business that will net you enough take-home pay to retire to a life of leisure?

People planning to start new businesses often imagine that their businesses will grow big enough to employ hundreds of workers simply because most of us work at those kinds of large companies. Firms with over 2,500 employees account for 64 percent of the American workforce, even though they make up less than 1 percent of all U.S. firms.⁶

Let’s sum up. Three out of four businesses have no employees. Nine out of ten employer-firms have fewer than twenty employees. So just getting to the point where you have done well enough to hire a few people is a nontrivial feat—only about 2 in 100 companies make it to that point. Hiring employees is not usually a business owner’s first concern, however. Their first concern is usually staying in business one way or another.

No one wants to run a business that just barely makes ends meet, whether or not it has employees. Entrepreneurs start businesses to make a profit—even tree-hugging, Birkenstock-wearing entrepreneurs. And just as a highly relevant point of reference, the average business without employees brings in just over $45,000 a year.⁷ (Given how many hours that business owner’s probably working to make this amount, his hourly wage would make a low-paying, semiskilled job look pretty appealing!) Of course, staying in business is a reasonable concern and a necessary goal. But there’s a big difference between surviving in business and thriving in business. It’s the difference between wanting not to die and choosing to live well.

For some entrepreneurs, though, the dream is not to just “make it,” but to “make it big,” which for many entrepreneurial aspirants means building a highly scalable business. This higher threshold therefore requires that the dreamer’s business not only generate recurring profits, but generate enough operating cash flow for the business owner to retain the funds (personally) to buy that vacation villa in the Caribbean, that Italian sports car, and an exclusive country club membership.

Remember: according to the Kauffman Firm Survey, only about 13 out of every 100 newly minted business owners surveyed survived four years, made over $25,000 in annual revenues, and hired employees. Surely, these milestones are nothing to sneeze at, but they are far from what is necessary to buy that Ferrari or oceanfront property in Antigua.

According to the Kauffman Foundation’s Anatomy of an Entrepreneur study, the average entrepreneur is a White, middle-aged, well-educated man with a wife and kids and considerable experience in the industry in which he established his new venture.⁸ Does this sound like you? Odds are it doesn’t.

So what does this average entrepreneur have to do with you? Nothing—unless you want to know how close to average you are in terms of the probability you will establish a viable business. After all, if the example presented in the previous paragraph represents conventional business success (on a fairly modest scale), it’s a fair question to pose whether you are more or less likely to achieve this success than “the average guy.”

How do we arrive at averages, anyway? Simply put, in order to find an average (or what in statistics is called the mean), we add the sum of the total numbers and divide by the amount of those numbers we’ve added up. So let’s assign the value zero to represent an average person’s chances of being among the 12 out of every 100 new business owners who go on to modest success. Of course, some people are going to be in a better-than-average position to achieve success; we can represent their chances by assigning them values above zero. Others may be ill equipped to survive, and we can represent their chances with values below zero.

Figure 4
What Are the Diminishing Odds of Building a Business That Lasts?

For example, we could rate two entrepreneurs at −2 and two at +2. The average—or the mean—for these four enterprising souls would equal zero. So, too, would four individuals rated −50 and +50, −75 and +75. But, as shown in Figure 4, just as likely would be four people rated −79, +92, +8, and −21. In this scenario, which number best represents you? If you’re modest, you might surmise you’re at +8, if par is zero. But how would you know for sure? Could you really be −21? Or even worse, that dismal −79?

But the statistics tell a more sobering story, which means that some large percentage of new entrepreneurs are not just overly optimistic, they’re absolutely clueless, and thus inordinately ill-prepared for their journey. They literally don’t have a clue because few people in the average entrepreneur’s sphere are in a position to alert them to the unseen forces that shape entrepreneurial opportunity—in particular, those things that will significantly boost their chances of achieving even modest success in business.

Not breaking out the champagne, are you? For good reason. Running a viable business that lasts is not for the faint of heart or the easily dissuaded. Running one that generates serious wealth for its owner is highly unlikely when you give the aforementioned statistics some serious thought. Granted, you have a better chance of succeeding in business than of winning the Powerball jackpot, but playing the lottery is much less work (and a lot less taxing on your bank account, your credit card balances, your personal relationships, and your stomach lining).

Unknowns Worth Knowing

In a country so obsessed with starting up one’s own business, inventing, pioneering, and becoming one’s own boss, you might imagine that we know quite a bit about the landscape of modern American enterprise.

We don’t.

In fact, generally speaking, Americans are entrepreneurial illiterates. We know very little about the inputs, outputs, and outcomes related to our vibrant entrepreneurial sector. We don’t know much about its composition, productivity, or impact, let alone its history. This sad reality is not a consequence of low intelligence, however, just sparse knowledge. We think we are well informed because we watch a lot of television. We also know a lot of people who have started businesses (or at least are always talking about starting one). And, of course, we patronize innumerable businesses in our neighborhoods, near where we work, wherever we travel, and wherever we surf online.

Wordsmith extraordinaire Donald Rumsfeld, President George W. Bush’s first secretary of defense, offered as clear a statement as I’ve found on the state of entrepreneurship (he was, of course, talking about the state of the war in Iraq):

Figure 5
How Close to Average Is Your Chance of Success in Business?

Reports that say that something hasn’t happened are always interesting to me, because as we know, there are known knowns; there are things we know we know. We also know there are known unknowns; that is to say, we know there are some things we do not know. But there are also unknown unknowns—the ones we don’t know we don’t know. And if one looks throughout the history of our country and other free countries, it is the latter category that tends to be the difficult ones.⁹

We think we know, generally, what entrepreneurship is. We may realize we don’t know everything about starting our own enterprise. But there is a whole host of significant facts about entrepreneurship that we don’t even know that we don’t know.

How are most new businesses started? Almost half of all new enterprises were seeded with their founders’ personal funds. Fewer than 4 percent of start-ups run by family members raise money from friends. Related co-founders of new ventures are 15 times less likely to raise funds from friends than are their nonfamily counterparts. Yet about 80 percent of all U.S. businesses are family owned. Roughly half of all new businesses are started out of their founders’ homes.

On a related note, firms started by business owners who have run two or three previous businesses have higher survival rates than those started by first-timers.¹⁰ Most family-owned businesses rarely survive past the second generation of owners. Venture capital–backed firms accounted for 11 percent—or about 12 million—of the 115 million private sector jobs in 2008.¹¹

Perhaps the single most useful fact for politicians during economic downturns and campaign seasons is that firms operating for over twenty-five years, irrespective of size, create more net jobs than new firms. In fact, according to the U.S. Department of Labor, no category of younger firms creates net jobs.¹² This single, woefully underreported fact suggests that the real engine of sustained economic growth is U.S. firms that have mature, time-tested management and long track records—firms that may also be entrepreneurial even though they are not necessarily young or small-scale ventures. Too often, politicians and uncritical entrepreneurship boosters purposely or unintentionally equate “small businesses” with entrepreneurial ventures, innovation with advanced technology, new with better, and family owned with small.

The truth of the matter is that entrepreneurship is a process—a way of thinking—more than a firm’s size, age, industry, or organizational setup. Apple Inc. is the world’s highest-valued publicly traded technology company, recently outpacing Microsoft—and, arguably, a highly entrepreneurial entity, despite having over 17,000 employees. Ford Motor Company is family owned in that the Ford family still owns about a 40 percent stake in the business and until recently the company was run by a descendant of the founder. So too are Motorola, Rupert Murdoch’s News Corp., Johnson & Johnson, Wal-mart, and Tyson Foods—none of which can be mistaken for small on any level.¹³ General Electric prides itself on innovation, yet it is no spring chicken, having been founded by the iconic American inventor Thomas Alva Edison in 1890.

What we learn from these facts—besides understanding just how difficult it is to build a business—is that it’s a good idea to ask what kinds of businesses are most viable and how they got started.

Business in America: An Overview

As of 2007, there were nearly 30 million documented businesses in the United States.¹⁴ Firms with paid employees accounted for 5.5 million of all U.S.-based businesses. Sectors that were overrepresented among these businesses included construction; professional, scientific, and technical services; health care and social assistance; and other uncategorized services. Together, the firms within these four sectors represented nearly half of all the businesses the U.S. Census lists as part of the nation’s economy. Interestingly, businesses with 500 or more employees within these four sectors combined account for less than 2 percent of all such firms.

Over half of U.S. firms are home based: 58 percent of nonemployer businesses are home based versus 22 percent of businesses with paid employees. There is a noticeable correlation between business revenues and being home based. Nearly 65 percent of businesses making less than $5,000 are home based compared to less than 6 percent of firms with revenues of $1 million or more. Not surprisingly, the data show that as business workforce size increases, the likelihood of having a home base drastically decreases: the largest percentage of employer-firms that are home based, at 29 percent, are businesses with 1–4 employees.

Those who hang out a shingle to leverage their own skills, expertise, and experience often represent what are commonly referred to as the self-employed. These individuals may prefer “being their own boss,” despise bureaucracy, or seek greater flexibility to honor that nebulous equilibrium known as “work–life balance.” Some subset of the self-employed are professionals such as lawyers, accountants, and consultants, people who often do not plan to grow their businesses in terms of hiring employees or becoming a highly scalable enterprise.

The self-employed who operate in the service economy by leveraging their skills, credentials, experiences, and networks—their invisible capital—are also known as independent knowledge workers or “entreprofessionals.” Even though they are not necessarily innovating in their business, they may be taking career risks by choosing to end their search for employment, as noted in a recent New York Times oped piece by former Clinton-era secretary of labor Robert Reich. Reich alluded to the fact that in the span of just three years, from 2001 to 2003, the number of individuals who pursued self-employment by forming subchapter S corporations (“S-corps”) and limited liability companies (LLCs) increased by over 12 percent. Appropriately, his column was entitled “Entrepreneur or Unemployed?”¹⁵

The self-employed also include business owners who are franchisees or multilevel marketing associates. Franchisees are individuals (or groups of individuals) who essentially buy a business model in a box. Based on a 2002 U.S. Census Bureau survey of business owners, they represent fewer than 4 percent of all firms with employees.¹⁶ Running a franchise is neither cheap nor easy to do well. In fact, despite the seemingly obvious advantages of buying into an already market-tested business, some research shows that the odds of success in franchising may be lower than for business owners who create their enterprises from scratch.¹⁷

Even so, franchise survival rates are surely higher than those for multilevel marketing (MLM) businesses—enterprises also known as network marketing organizations or direct sales organizations, including well-known companies such as Mary Kay, Avon, and Amway. MLMs have earned a poor reputation for having an unethical business model, some being little more than pyramid or Ponzi schemes. That said, according to the Direct Selling Association website, over 15 million people are involved in direct selling, reaching 74 percent of all Americans and accounting for over $114 billion in sales worldwide.¹⁸

Figure 6
U.S. Employer-Firm Population by Size

Indeed, there exist at least a few socially conscious multilevel marketing companies,¹⁹ just as there exist highly unscrupulous nonprofit organizations. Ultimately, though, an enterprise’s business model will shed the most light on its organizational values. The MLMs that profit by design from their members’ failure to sell mediocre (or worse) products or services after they have bought an expensive initiation fee are sadly the norm, with only a few notable exceptions. An MLM’s products and services are rarely what generates the most profits for it; that would instead be the initial fees that systematically provide the continuous infusion of cash extracted from each successive wave of often underemployed, unemployed, retired, or otherwise cash-strapped new sales associates (also known in the industry as “independent business owners”).²⁰

It’s a Family Affair

To most folks, the term “small business” is synonymous with the mom-and-pop businesses we have all patronized, worked in, talked about nostalgically with family members, or seen depicted on TV, in the movies, or in books. Eighty percent of U.S. firms are family owned and operated. Most are run as sole proprietorships that have no formal legal or business structure, while the largest are structured as private or publicly traded corporations.

We envision the corner store, the neighborhood diner, the barber shop, the dentist’s office, or the auto repair shop. These are small businesses, not the ones closing in on 500 employees, right?

Even if the employment threshold for small businesses were drastically lowered to fewer than 100 employees, there would still only be about 2 percent of U.S. firms not categorized as “small.” So we need not use the term “small businesses,” since they are the rule and not the exception. We should really just say “businesses” and “big businesses.” After all, we don’t say, “I’m an under-seven-feet-tall person.” We simply say, “I’m a person.” Why? Because over 99 percent of people walking the planet are significantly shorter than seven feet tall! We call these exceptionally tall people “seven-footers.” The point is, we compare these human skyscrapers to the majority of the population, not the other way around.

As a result, how we reframe size itself shifts not only what we consider to be “big,” but what is realistically achievable for the average American. “Big” when it comes to business is indeed the exception, and we should lower the bar significantly, if only to better correlate our worldview with the actual business landscape and the likelihood of entrepreneurs growing ventures of scale.

Still Want to Start a Business?

We’re told that starting a business is the secret to financial success (if you watch infomercials and venture into your email account’s bulging spam folder, anyway). We’ve also been told that variable-rate mortgages never go up and that credit card interest rates will stay low. Sure. Some people can make the numbers work, and their businesses grow. Most businesses, however, die on the vine.

The data reveal that most U.S. firms do not even sprout. Many folks may have great business ideas, but they don’t plant the right seeds in the right season or in the proper soil. They don’t acquire a federal tax identification number. They don’t apply for a business license, or vendor permits. They don’t build the right teams, let alone retain a lawyer, an accountant, or a bookkeeper. They don’t dedicate enough time to the business (which explains the high correlation between the extremely low average gross revenues for U.S. firms and the number of firms that are essentially run as glorified hobbies). They don’t start generating income, and as a practical result they do not and cannot hire employees. As the IRS likes to put it, the business owner “has not materially worked on the business.”

Most businesses are sideline enterprises run by otherwise employed, unemployed, chronically underemployed, or retired individuals. The lion’s share of these informal ventures will linger indefinitely or outright die. Only a small percentage of new ventures will experience steady or significant growth in terms of revenue.

The deck is stacked against most nascent entrepreneurs. Yet some folks beat the odds and prevail. Our task is to understand how and why entrepreneurship appears to be so much more viable a path for some, but not others.

In the meantime, though, let’s have a moratorium on using the term “small business” until polls show that most Americans have learned the difference between what we generally perceive as small and how economists and our government actually define it.