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Accidental Entrepreneurs: the evolution of a small business

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smallBizEvolution_GrowthStages
Accidental Entrepreneurs ?

“(08-11) 17:45 PDT — A month after he was laid off in October, 38-year-old Marcus Ronaldi realized he was facing the toughest job market he had ever experienced. “I had been out of work before, but this time I wasn’t getting any calls,” said Ronaldi, a high-tech job recruiter.

In November, as he despaired of landing a full-time job, Ronaldi started taking subcontracts from other recruiters with hard-to-fill vacancies in technical or executive fields.

“At first I did it just to keep busy and to help pay the bills, while I continued looking for a job,” said Ronaldi of Daly City.

But as he got more contracts, Ronaldi began to consider himself self-employed, a conviction that jelled a couple of weeks ago when he got a tip about a full-time job.

“I turned the tip over to a friend because I was happy doing the contingent stuff,” he said

Ronaldi is an example of what Bay Area business analyst Carolyn Ockels calls “necessity-preneurs” – people who become self-employed because regular jobs are so tough to find.

“I think a lot of people are trying to fill the income gap with any skill or service they can find,” said Ockels, managing partner of Emergent Research in Lafayette.”

A July report from the Small Business Administration documents the self-employment surge nationwide. The SBA said the number of self-employed people grows about 2 to 3 percent a year when the economy is good. In 2008, the most recent year on record, the number of people working for themselves jumped 8.1 percent.”

Accidental Entrepreneurs / Necessary Entrepreneurs ?

Wow.  People starting their own business.  “Accidental” and “Necessary” in the context of Entrepreneurs does not give the impression that the decision to go into business was an intentional, planned, deliberated, and considered process.  It sounds more like a reaction to unexpected (or at least, undesirable) series of past events. 

Is “taking the plunge” into small business a good idea if you are an “Accidental” Entrepreneur?

Angels

Angles seem to show up in a lot of different places.  There are places where they “fear to tread” and Angel Investors.  In the dot com era there was a company called Divine InterVentures.  You know where there is divinity, angels, and portents of angels something must be up.  Is it a divine “Interventu/re/ion”?

I noticed that the wife of Michael Geber (author of “The E-Myth” collection of books) wrote a comment to one of my articles.  The E-Myth books are another sort of “Portent” of the future, warning you of perhaps a potentially unexpected future.  A future that, if you do not prepare yourself – pay your dues, may result in creating undesirable outcomes.

The Record of History and the E-Myth

History repeats itself.  But in business failure, history should not repeat itself.  What history does show is that people do not learn much from history.  Going back at least 20 years, research has been available on the characteristics and attributes of small business success and failure.

Yet, based on ongoing empirical research done by the SBA, business schools, and independent researchers – research easily accessible through common distribution channels (especially the Internet) – avoidable business failures continue to be made by people who take the plunge and go into business for themselves without adequate preparation.

Michael Gerbers ‘E-Myth” books really do a good job at warning “Technicians” who want to start businesses about the pitfalls.  If you read my previous postings on Gerbers’ books you know that a unique feature of his books is the amount of time he spends on analyzing the psychology and mind-sets  of those folks who start small businesses.  Specifically, the three personas of an individual – “The Technician”, “The Manger”, and “The Entrepreneur” and how an imbalance of these three personas can affect business success or failure.

Michael Gerber talks about the step before the business.  “Who are you?”  And, “who you are”, (and you may not know really who you are), may affect and limit your business success.  Read Gerbers “E-Myth” books to find out “who you are”.

From Gerbers’ E-Myth to Harvard Business Review

Way back in 1983 (26 years ago at the time of this writing) there was an article in the Harvard Business Review that provided a framework for understanding the evolution of small business.  This article provided a framework to understand the transitions that a start up business had to make to become a successful, mature, and profitable.   This article from 26 years ago is still cited today.

It’s light years distance between Gerbers’ books and Harvard Business Review.  But there is a connection.  The connection is the “Who you are”, your psychology, your adaptability, your judgment, and your personal preferences, and how these will affect a small business start-up on its evolutionary journey.

The 1986 article in Harvard Business Review provides two insights

  1. A framework for understanding the progressive evolution of small business from start-up.
  2. The make it / break it role of the individual business owner and how personal psychology, mind-set, adaptability, and a whole host of other personal attributes will limit (or encourage) business success or failure.

So, I blew the dust off this 26 year old article.  Below is a summary of the framework  and, at the very end, a rather long quote from the article on the role of the individual business owner across the evolutionary journey.

The Five Stages of Small Business Growth

Categorizing the problems and growth patterns of small businesses in a systematic way that is useful to entrepreneurs seems at first glance a hopeless task.  Small businesses vary widely in size and capacity for growth. They are characterized by independence of action, differing organizational structures, and varied management styles.

Yet on closer scrutiny, it becomes apparent that they experience common problems arising at similar stages in their development.

These points of similarity can be organized into a framework that increases our understanding of the nature, characteristics, and problems of businesses ranging from a  dry cleaning establishment with two or three minimum- wage employees to a $20-million-a-year computer software company experiencing a 40% annual rate of growth.

smallBizEvolution_Characteristics

The diagram above may look complex – it isn’t.

In the framework, there are 5 stages of business evolution and 5 characteristics that define each stage.

Of course, this is an evolutionary tale.  And like Darwin, businesses with DNA that are suited to the environment and are competitive are “rewarded” by the sheer pleasure of reaching the next stage of  evolution.  Those small businesses, in their evolutionary journey, that are not suited and not adaptable to the environment, and are not competitive in an industry segment –  are “discarded”.  Only the strong survive.

In the model there are five stages (plus 1) of business evolution

  1. Existence
  2. Survival
  3. Success (leading to a choice of disengagement or growth based on owner “psychology”)
  4. Take-off (rapid growth)
  5. Resource Maturity
  6. Ossification (Decline)

Each stage is characterized along dimensions of

  1. Management Style
  2. Organization
  3. Extent of Formal Systems
  4. Major Strategy
  5. The relation of the Business and the business owner

At each of the 5 stages of small business evolution there are challenges which must be overcome.  Successful progression along the evolutionary path requires adaption and specific changes to the 5 characteristics cited above.  Failure to adapt and make those changes results in the death of the business.

The interesting question is that happens to the “owner DNA” when a business fails.  Is that the end of the line?  Or does the “DNA” learn from the past and “try again”? 

Here is a summary of the framework.

Evolutionary Stage 1 – Existence

What are the challenges?

  1. Becoming a viable business end-to-end.  Getting customers, delivering products, and providing services well enough to become a viable business.
  2. Expansion of customer base.  Expanding from a few key customers or pilot to a much broader sales base.
  3. Cash.  Having enough money to cover cash demands  in the start-up phase.

Characteristics

  1. Management style – The owner performs all the important tasks and provides the energy to run the business.
  2. Organization – Simple, only a few employees – perhaps family members – to do administrative tasks.
  3. Extent of formal systems – Minimal or none.  Ad hoc decision making.
  4. Major Strategy – Simply, to stay alive.
  5. Relation of business to owner – the owner is essentially the business.

Failure modes

Never  gaining sufficient customer acceptance or product capability to become viable.

Exit

  1. Chose the business when the start-up capital runs out / Bankruptcy
  2. Sell the business for its asset value.  Generally, sell at a loss

Comments

Just about everyone overestimates sales and the timing of sales.  The term I have head in place of “sales projection” is “sales hallucination”.  That’s about right.  Once the expenses out-run sales and the cash runs out – that’s it.

Evolutionary Stage 2 – Survival

At this point the business and demonstrated that it is a viable business entity.

What are the challenges

  1. Maintain capital assets.  The business must be able to generate enough cash to break even and to cover the repair or replacement of capital assets as they wear out.
  2. Cash flow.  The business must be able to  generate enough cash flow to stay in business and finance growth to a size that is sufficiently large given the industry and market niche, to earn an economic return on assets and labor.

Characteristics

  1. Management style – Same as Existence stage, the owner performs all the important tasks and energy to run the business.
  2. Organization – Minimal number of employees.  They are under direct supervisioin of the owner.
  3. Extent of formal systems – Minimal.  Ad hoc decison making.
  4. Major Strategy – Survival
  5. Relation of business to owner – the owner is essentially the business

Failure Modes

  1. The business earns only marginal returns on invested time and capital.
  2. Marginal returns cause the business owner to give up or retire.

Exit

  1. Remain in Survival stage earning marginal returns on invested time and capital and eventually go out of business when the owner gives up or retires.
  2. Sell the marginal business at a slight loss.

Evolutionary Stage 3 – Success

At this point the business is viable and the owner is faced with a decision to to exploit the company’s accomplishments and expand the business or keep the company stable and profitable providing a base for the owners other activities.

Sub-stage – Decision – Success-Disengagement (stay small, earn reasonable profits, and hold on)

The company has obtained true economic health
The company has sufficient size and product-market penetration to ensure average or above-average profits.

A company can stay at this point indefinitely unless competitive changes destroy its market niche or ineffective management destroys the company’s competitive abilities.

Characteristics

  1. Management style – The company is large enough to have functional managers.
  2. Organization – Hierarchy with professional functional managers and staff.
  3. Extent of formal systems – Basic financial, marketing, and production systems are in place. Planning in the form of operational budgets support functional delegation.
  4. Major Strategy – Maintain the profit status quo
  5. Relation of business to owner – The owner and company managers monitor strategy to, essentially, maintain the status quo.

Substage – Decision – Success Growth

At this stage the owner consolidates the company and marshals resources for growth through the borrowing power of the company.  Managers must be hired with a focus on the company’s future rather than maintaining its current condition and status quo.

Failure modes

  1. Success growth may revert to Success-Disengagement.
  2. If not the above, then the company falls back to Survival Stage.

Exit

  1. Retrench to previous stage
  2. Out of business – bankruptcy

Evolutionary Stage 4 – Take-off

Challenges

Growth. How to grow rapidly and finance this rapid growth.

Characteristics

  1. Management style – Delegation.  The owner must delegate responsibility to others.  The key managers must be competent to handle a growing and complex business environment.
  2. Organization – Decentralization.  The company now is “divisionalized”
  3. Extent of formal systems – Maturing.  Strategic and Operational Planning.  This is now performed with key managers.
  4. Major Strategy – Grow the business.
  5. Relation of business to owner – The owner and the business have become reasonably separate yet the company is still dominated by by both the owners presence and stock control.

During this stage  there must be enough cash to satisfy the demands of growth.

The copmay now has these options

  1. Continue to grow the business
  2. Sell the business at a profit.

Failure Modes

  1. Growing too fast with the result of running out of cash.
  2. Owner unable to delegate effectively to make the company work.

Exit

Retrench to a previous stage

Evolutionary Stage 5 – Resource Maturity

Challenges

  1. Consolidate and control the financial gains brought about by rapid growth.
  2. Retain the advantages of small size (flexibility of response and entrepreneurial spirit)
  3. Expansion of the management force

Characteristics

  1. Management style – Line and staff.
  2. Organization – Hierarchy with professional management and staff in place.
  3. Extent of formal systems – Extensive
  4. Major Strategy – Optimize return on investment
  5. Relation of business to owner – The owner and the business have become reasonably separate.

Exit

  1. Retrench to previous stage
  2. Sell the business or merge

Evolutionary Stage 6 – Ossification

This is basically, business “old age”.  Lack of innovative decision making and avoidance of risk.

The diagram below depicts the framework evolution stages and failure & exit modes.

smallBizEvolution_Exits

Managerial Challenges

Bottom line, the early success of a small business start-up is clearly on the shoulders of the owner.  The sad thing is that many “accidental entrepreneurs” go into a business venture with “eyes tightly shut”.

According to one researcher, people starting businesses seldom (less than 4% have one) have a written business plan. It’s not about having a written business plan to say that you have a written business plan.  It’s about having a written business plan to demonstrates that you have thought though the critical aspects of the business – market opportunity and size;  competitive analysis;  marketing plan, customer segmentation; pricing strategy; cash flow;  break-even analysis;  exit strategy; and all the rest that goes into a plan that, unthought in advance, will diminish the chances of success.

In fact, in writing the plan for a particular business, you might find that the idea to go into business with the product or service portfolio you have in mind may not be justifiable.  That is, the market opportunity might not be there, the competition is too strong, the capital demands or barriers to entry are too high, or any other thing that you might find out in the process of researching and writing the plan.

Better to know this up front than lose your savings, deplete you 401(K), blow the kids college fund, and/or exercise any other personal financial disaster that might extend to your family and (X) friends as investors.

Finally, are you the kind of person that can navigate the small business evolutionary transitions?

Here is what the Harvard Business Review article has to say on the talents and abilities of the small business owner as the business progresses through the various evolutionary stages.  To make it to Maturity, the owner has to be adaptable and flexible through all the evolutionary stages, or risk failure.

In the early stages, the owner’s ability to do the job gives life to the business: Small businesses are built on the owner’s talents: the ability to sell, produce, invent, or whatever. This factor is thus of the highest importance. The owner’s ability to delegate, however, is on the bottom of the scale, since there are few if any employees to delegate to.

As the company grows, other people enter sales, production, or engineering and they first support, and then even supplant, the owner’s skills—thus reducing the importance of this factor. At the same time, the owner must spend less time doing and more time managing. He or she must increase the amount of work done through other people, which means delegating.

The inability of many founders to let go of doing and to begin managing and delegating explains the demise of many businesses in substage IIl-G and Stage IV.

The owner contemplating a growth strategy must understand the change in personal activities such a decision entails and examine the managerial needs depicted in Exhibit 5. Similarly, an entrepreneur contemplating starting a business should recognize the need to do all the selling, manufacturing, or engineering from the beginning, along with managing cash and planning the business’s course—requirements that take much energy and commitment.

The importance of cash changes as the business changes. It is an extremely important resource at the start, becomes easily manageable at the Success Stage, and is a main concern again if the organization begins to grow. As growth slows at the end of Stage IV or in Stage V, cash becomes a manageable factor again. The companies in Stage VI need to recognize the financial needs and risk entailed in a move to Stage IV.

The issues of people, planning, and systems gradually increase in importance as the company progresses from slow initial growth (substage III-G) to rapid growth (Stage IV). These resources must be acquired somewhat in advance of the growth stage so that they are in place when needed. Matching business and personal goals is crucial in the Existence Stage because the owner must recognize and be reconciled to the heavy financial and time-energy demands of the new business. Some find these demands more than they can handle. In the Survival Stage, however, the owner has achieved the necessary reconciliation and survival is paramount; matching of goals is thus irrelevant in Stage II.

A second serious period for goal matching occurs in the Success Stage. Does the owner wish to commit his or her time and risk the accumulated equity of the business in order to grow or instead prefer to savor some of the benefits of success? All too often the owner wants both. but to expand the business rapidly while planning a new house on Maui for long vacations involves considerable risk. To make a realistic decision on which direction to take, the owner needs to consider the personal and business demands of different strategies and to evaluate his or her managerial ability to meet these challenges.

Finally, business resources are the stuff of which success is made; they involve building market share, customer relations, solid vendor sources, and a technological base, and are very important in the early stages. In later stages the loss of a major customer, supplier, or technical source is more easily compensated for. Thus, the relative importance of this factor is shown to be declining.

The changing role of the factors clearly illustrates the need for owner flexibility.  An overwhelming preoccupation with cash is quite important at some stages and less important at others. Delaying tax payments at almost all costs is paramount in Stages I and II but may seriously distort accounting data and use up management time during periods of success and growth.

“Doing” versus “delegating” also requires a flexible management. Holding onto old strategies and old ways ill serves a company that is entering the growth stages and can even be fatal.

Conclusion

Accidental Entrepreneurs?

“Godspeed, John Glenn”

Resources

Angels – http://www.ecoastangels.com/  Criteria – http://www.ecoastangels.com/pages/criteria.html

The Accidental Entrepreneur
http://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2009/08/11/BUF81974CT.DTL

From Tuck School of Business at Dartmouth
Learning From Corporate Mistakes: The Rise and Fall of Iridium

An article from Fortune magazine
Mel Karmazin fights to rescue Sirius
(cached PDF version)

A couple (among thousands) of articles recounting  the story of Webvan and why it failed

Success and Failure of Pure-Play Organizations: Webvan versus Peapod, a Comparative Analysis


A Tangled Webvan

Key Reasons Why Small Businesses Fail by Titus – IIB Business Support Americas
Planning Against Business Failure – U of Tennessee
Small Business Success – A review of the Literature – Athens State College

From FORTUNE Magazine 1993 –
THE DAY THE MONEY RAN OUT Consumed with his business, Michael Gerber awoke one morning to a financial crisis — and five years of nightmarish struggle. By CHARLES BURCK September 6, 1993 (FORTUNE Magazine) – Read it

Small Business Administration – Office of Advocacy Reports
http://www.sba.gov/advo/research/chron.html

Startup Business Characteristics and Dynamics

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Written by frrl

September 19, 2009 at 3:18 pm

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