Entrepreneurs Human Capital (Bailetti And Hurley 2008) Final

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The entrepreneur’s human capital and the process of creating, appropriating and expanding the value of the company

Tony Bailetti1 and Brian Hurley2

Introduction The objective of this paper is to examine the relationship between an entrepreneur’s human capital and the process in which the company creates, appropriates and expands value.3

The study of the relationship between entrepreneurial innovation4 and economic growth can benefit by: (i) considering the company and entrepreneur spaces as being distinct; (ii) a better understanding of the components of an entrepreneur’s human capital and how these components affect performance at the individual, company and community levels; (iii) understanding the process used to create, appropriate and expand the value of the company; and (iv) promoting best practices to improve the performance of an entrepreneur’s human capital.

This paper provides: (i) a model that explains how an entrepreneur’s human capital affects performance measured at the individual, company, and community levels, and (ii) observations on how to increase the entrepreneur’s human capital.

The model and observations will be of interest to novice and habitual entrepreneurs, risk capital suppliers, government policy makers, and leaders of economic development organizations.

Entrepreneur’s space as distinct from company’s space

An entrepreneur’s human capital refers to the individual’s capability to acquire, assimilate, transform, and exploit knowledge and relationships. Entrepreneurs concurrently: (i) build their own human capital, and (ii) create, appropriate and expand value for their companies and associated stakeholders.

1 Tony Bailetti holds a joint appointment in the Sprott School of Business and the Department of Systems and Computer Engineering, Carleton University, Ottawa, Ontario, Canada.

2 Brian Hurley is a repeat entrepreneur and is currently the President and CEO of Purple Forge, a small technology company with headquarters in Ottawa, Ontario, Canada.

3 For the purpose of this paper, we assume that the entrepreneur owns and operates the company. This assumption does not limit the model and observations described in the paper.

4 In this paper, we do not consider the intrapreneurial innovation that occurs in large companies.

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Human capital cannot be separated from the entrepreneur in the way that financial and physical assets can [Becker, 1993]. The entrepreneur develops human capital while creating, appropriating and expanding the value of a company. However, the entrepreneur’s human capital is not tied to a company. The entrepreneur’s human capital exists whether or not the company continues to exist. The entrepreneur can use his human capital to pursue other opportunities [Baird and Morrison, 2005] serially or in parallel.

When we recognize that the entrepreneur and company spaces are separate, we observe that the success of an entrepreneur is not necessarily tied to the success of the first company the entrepreneur owns and operates. At the early stages of venture formation, the value the entrepreneur creates and appropriates for the company and the value of the entrepreneur’s human capital are tightly joined. As the company grows, these two values follow different paths.

The success of the entrepreneur and that of the company are not the same. The value of the human capital an entrepreneur accumulates over a lifetime is what matters to him/her. Repeat entrepreneurs are characterized by their capacity to absorb and learn from their entrepreneurial experiences thereby augmenting their initial endowment of entrepreneurial skills [Stam, 2005]. Repeat entrepreneurs tend to raise more venture capital at an early round of financing and tend to complete the early round much more quickly [Zhang, 2007].

We argue for the need to conceptualize two distinct spaces, entrepreneur and company, when examining how technology innovation and entrepreneurship produce economic growth. How entrepreneurs accumulate and use their human capital to create, appropriate and expand company value should be central to any discussion of economic growth. Entrepreneurs significantly impact economic activity at a local level through fostering localized job creation, increasing wealth and local incomes, and connecting local economies to the larger global economy [Henderson, 2002; Mueller, 2007]. Entrepreneurial activity tends to be the underlying factor that automatically and naturally attracts venture capital to a community [Kreft and Sobel, 2003]. Increases in an entrepreneur’s human capital from prior start-up experience has been shown to increase the ability of the entrepreneur to more quickly go through the entire process of starting a firm, developing it and executing the exit strategy, recognizing a new opportunity and founding a new start-up [Eesley, 2006].

Model for how human capital affects performance

Figure 1 provides a model that defines what entrepreneur’s human capital is and how it affects performance at the individual, company and community levels.

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Our conceptualization of human capital applies the concept of absorptive capacity [Cohen and Levinthal, 1990; Zahra and George, 2002; Zotto 2003] to the entrepreneurial setting. The model in Figure 1 shows that the entrepreneur’s prior knowledge, experience, cognitive skills, networks, and reputation are the antecedents that affect the entrepreneur’s capacity to acquire, assimilate, transform and exploit knowledge and relationships.5

At the early phase of company evolution, the entrepreneur’s human capital defines the company’s path of evolution and development. However, the entrepreneur’s human capital belongs to the entrepreneur, not the company.

Triggers are events that compel the entrepreneur to act (e.g., spouse demanding the entrepreneur take a job, financial crises). The roots of these events are requirement to fulfill human hierarchy of needs often referred to as Maslow’s hierarchy of needs [Maslow, 1943]. These needs include: physiological (e.g., food, water), safety (e.g., of body, of employment, of the family), love/belonging (e.g., friendship, family), esteem (e.g., self-esteem, confidence, achievement, respect of/by others), and self-actualization (e.g.,morality, creativity, problem solving).

Triggers can also be the appreciation of the need for risk management relative to future outcomes. In particular, the realities for new business starts are very harsh. Consider the following: More than 50% of the time venture capitalists replaced the Chief Executive

Officer (CEO) in a venture backed company before exiting [White, D’Souza and McIlwraith, 2007]

Entrepreneurs who succeeded in a prior venture (i.e., started a company that went public) have a 30% chance of succeeding in their next venture; and first-time entrepreneurs have only an 18% chance of succeeding, and entrepreneurs who previously failed have a 20% chance of succeeding [Gompers, Kovner, Lerner and Scharfstein, 2006]

Only 14% of venture-backed start-ups will make it to initial public offering (IPO), 33% will be acquired, and the rest - over 50% - will fail [Global Insight, 2007].

In light of these facts, self-aware entrepreneurs will have “rational self-interest” and work to ensure that they actively seek to expand their human capital in a manner that maximizes the potential for successful outcomes whether or not their companies are successful. Regime of appropriability refers to the institutional and industry dynamics that affect the company’s ability to protect the advantages of new products and processes. When appropriability is low, the entrepreneur will not invest heavily to build industry specific human capital. When appropriability is high, the

5 Bosma, van Praag, Thurik, and de Wit [2002] provide an alternative conceptualization of the relationship between human capital and performance at the company level.

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entrepreneur will invest in human capital required to protect assets (e.g., know how to file patents).

Performance refers to the effectiveness of the entrepreneur’s human capital relative at the individual, company and community levels. Effectiveness at the entrepreneur’s individual level measures whether or not the entrepreneur’s goals for its human capital were met. Effectiveness at the company level measures whether or not the company’s goals for value creation, appropriation and expansion were met (e.g., time to cash, time to breakeven, time to first round of financing, amount of funds raised, market share, profits). Effectiveness at the community level measures whether or not the community’s goals were met (e.g., number of knowledge jobs, quality of health care, quality of infrastructure).

Table 1 provides examples of ways entrepreneurs, startup companies, and communities create, appropriate and expand value.

The entrepreneur’s human capital creates opportunities for the entrepreneur, the company and its stakeholders (including investors and employees), and the communities where the company operates.

The company creates value through its product, intellectual property, customers and revenue. The employees acquire value through employment, personal development and stock option value appreciation. The company investors acquire and expand value through the increase in the intrinsic value of the company, ultimately leading to a liquidation event that delivers hard cash returns on initial capital investments.

The community (including the associated governments) is an important stakeholder of the value that entrepreneurs create. The community acquires value from the entrepreneur through their efforts to create value for their companies. The community benefits from the entrepreneur’s company through such things as: new jobs, larger tax base, better infrastructure, better schools, more economic growth opportunities through associated ecosystem growth, more cultural and sport facilities, better health-care, increased philanthropy and so on.

Process to create, appropriate and expand the value of the company The entrepreneur’s vision gives birth to the innovation from which the opportunity exists for a company to create, acquire and expand value. For many entrepreneurs that is the highest value they will ever create for the company and their intrinsic value to the company diminishes from that point forward. This is particularly true in the case where the entrepreneur does not have a controlling interest in the company itself.

Initially, an entrepreneur is the key engine of value creation. The entrepreneur identifies the opportunity, scopes the innovation, leads the sales efforts, builds key relationships, and guides the team forward down the twisty path to success. As the

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company progresses in size and maturity, traditional management and organizational processes and tools come into play to focus the business value creation process. Team members around the entrepreneur adopt the vision and carry it forward. Company evolution occurs organically and the entrepreneur, investors and the team itself foster it. The importance of the entrepreneur as the primary value creation engine for the company decreases over the life of the company.

Every entrepreneur will implicitly or explicitly have two plans: Plan A – the start-up “hitting it big” plan focused on the company’s vision, strategy, and tactics; and Plan B focused on the entrepreneurs personal goals that assume the company will fail or they will no longer be with the company. Both plans imply a set of pre-conditions required for success. The self-aware entrepreneur will spend time enumerating and reflecting on these pre-conditions and actively address them by increasing their own human capital. The resources and context of the company will provide the ability to acquire human capital in the following general areas:

Knowledge about new technologies, new markets, business processes, etc.; Opportunity to develop and hone new business opportunity recognition and

exploitation skills – learn the tools and information necessary to pin-point where the entrepreneurial opportunities are, why they are opportunities, and how to exploit successfully [Dellabarca, 2002];

Cross-function knowledge spanning areas such as finance, marketing, sales, engineering, human resources, product management, outsourcing, partnerships;

Personal growth and development of soft skills related to behaviors, interpersonal and leadership skills;

Markets and sales models for different industries, e.g. government vs public, Enterprise vs SME;

Personal industry and/or community visibility, reputation, and influence; and Personal access to resources and knowledge through expanded networks of

individuals and businesses, analysts, press, government agencies, different regional networks, capital and different company alumni.

Ideally, the company and the community would recognize the existence of Plan A and Plan B and take a proactive, and collaborative, role in working with the entrepreneur to help direct and develop the entrepreneur’s human capital in order to maximize performance outcomes for the company and community.

Practices to improve performance of an entrepreneur’s human capital

Human capital is directly linked to positive performance outcomes [Bosma, van Pragg, Thurik, and de Wit, 2002]. Unfortunately, the focus of attention is typically on the company - the human capital growth aspects of the entrepreneur are often neglected. Human capital development for entrepreneurs is very much an

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experiential process and different groups of entrepreneurs learn in different ways [Politis, 2005]. The following best practices can help an entrepreneur expand their human capital while engaged in a particular start-up company: Joining and participating in a professional group such as Young Presidents

Organization, and the Entrepreneur’s Organization. These organizations can provide a peer group and education programs that can be used to develop new skills and perspectives, in addition to expanding an entrepreneur’s social network

Obtaining formal 360 degree feedback to identify peer and employee perceptions on strengths and weaknesses

Formal executive coaching - executive coaching is a confidential one-on-one relationship between a professional coach and the entrepreneur in for the purpose of improved organizational performance and personal effectiveness

Training courses targeted at knowledge development from professional groups such as YPO, EO, at industry conferences, or from top business schools such as Kellogg

Directed self-study through books relevant to the industry, business, and personal development. For instance, an entrepreneur unfamiliar with how to benefit from board of directors might want to purchase a variety of books on governance, how to run effective board meetings, influence and persuasion, etc..

Subscribe to and read journals, magazines, electronic newsletters and blogs to stay abreast of trends and new ideas and to develop different perspectives

Participate in a not-for-profit organization associated with the company’s industry, market or region to extend the entrepreneur’s network and associated access to knowledge and resources

Formal mentoring - a mentor is an individual, usually older, always more experienced, who helps and guides another individual’s development

Formal or informal advisors who have deep experience in areas where the entrepreneur or company team has weaknesses

Networking with peers, potential executive officers, angel investors, venture capitalists, partners, service providers, analysts – which can provide quicker access to future team members and capital resources

Focused effort to collect insights and opinions on industry and opportunities from social, professional and business network

Hold formal postmortems at major points in the company development - postmortems are a very good reflective method to look back at what worked, what didn’t and why, and to learn what would could have been done differently and why

Prepare and give speeches and presentations at local and industry conferences Prepare and publish articles and papers online, newspapers, journals and

conference publications Focused effort to engage market analysts, government agencies, reporters, etc,

to expand the entrepreneur’s personal network and access to experience, perspectives and resources

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Use social networking tools such as Linked In and Plaxo to maintain contact and grow professional and business network

Observations Entrepreneurs should recognize that increasing their human capital increases their prospects for increased performance, and the potential for faster execution and positive outcomes in follow-on business ventures. Entrepreneurs should develop their human capital value using the practical methods available.

Risk capital suppliers should proactively work to develop the human capital of founders of companies they have invested in to maximize their performance.

Policy makers and leaders of economic development organizations should define the unit of analysis for economic policy as the entrepreneur and not the company as well as address the needs of the various types of entrepreneurs.6

Communities should provide entrepreneurs with the means to improve the number and quality of the opportunities they shape.

Leaders of economic development organizations should hire habitual or repeat entrepreneurs, not individuals with large company experience or first time founder-owner experience as Executives in Residence (EIR). The EIRs play an important role supporting novice entrepreneurs and employees with entrepreneurial aspirations.

References

Baird, D. G. and E. R. Morrison (2005) "Serial entrepreneurs and small business bankruptcies", University of Chicago Law & Economics, Olin Working Paper No. 236; Columbia Law and Economics Working Paper No. 265.

Becker, G. S. (1993) Human capital: A theoretical and empirical analysis with special reference to education. 3rd edition, University of Chicago Press, Chicago.

Bosma, N., M. van Praag, R. Thurik, and G. de Wit (2002) “The value of human and social capital investments for business performance of startups”, Tinbergen Institute Discussion Paper, TI 2002-027/3.

Cohen, W. M. and D. A. Levinthal (1990) “Absorptive capacity: A new perspective on learning and innovation”, Administrative Science Quarterly, Vol. 35, No. 1, March.

6 The following types of entrepreneurs have been identified in the literature: (i) novice entrepreneurs; (ii) portfolio entrepreneurs; (iii) serial acquirer entrepreneurs; (iv) serial starter entrepreneurs; (v) direct re-entrants; (vi) latent re-entrants; and (vii) employees with entrepreneurial aspirations.

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Dellabarca, R. (2002) “Understanding the opportunity recognition process in entrepreneurship, and consideration of whether serial entrepreneurs undertake opportunity recognition better than novice entrepreneurs”, MBA Dissertation, University of Cambridge.

Eesley, C. E. and E. B. Roberts (2006) “Cutting your teeth: Learning from rare experiences”, MIT Sloan Working Paper 4609-06, MIT Sloan School of Management, June.

Global Insight (2007) “Venture impact – The economic importance of venture capital backed companies to the U.S. economy”, 3rd Edition, National Venture Capital Association.

Gompers, P., A. Kovner, J. Lerner, and D. Scharfstein (2006) “Skill vs luck in entrepreneurship and venture capital: Evidence from serial entrepreneurs”, Working Paper 12592, National Bureau of Economic Research, October.

Henderson, J. (2002) “Building the rural economy with high-growth entrepreneurs”, Federal Reserve Bank of Kansas City, Economic Review.

Kreft, S. F. and R. S. Sobel (2005) “Public policy, entrepreneurship, and economic freedom”, Cato Journal, Vol. 25, No 3, Fall.

Maslow, A. H. (1943) A theory of human motivation, Psychological Review 50:370-96.

Mueller, P. (2007) “Exploiting entrepreneurial opportunities: The impact of entrepreneurship on growth”, Small Business Economics (2007) 28:355-362, DOI 10.1007/s11187-006-9035-9, Springer.

Politis, D. (2005) “The process of entrepreneurial learning: A conceptual framework”, Entrepreneurship Theory and Practice, July.

Stam, E., D. Audretsch and J. Meijaard (2005) “Entrepreneurial intentions subsequent to firm exit”, SCALES-paper N200506, EIM Business and Policy Research, August.

White, R. J., R. D’Souza and J. McIIwraith (2007) “Leadership in venture backed companies: Going the distance”, Journal of Leadership and Organizational Studies (Baker College), Vol. 13, Issue 4, Spring.

Zahra, S. and G. George (2000) “Absorptive capacity: A review and reconceptualization”, Academy of Management Proceedings, BPS:K1.

Zhang, J. (2007) “The Advantage of experienced start-up founders in venture capital acquisition: Evidence from serial entrepreneurs”, Institute for the Study of Labor, IZA DP No. 2964, July.

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Zotto, C. D. (2003) “Absorptive capacity and knowledge transfer between venture capital firms and their portfolio companies”, DRUI Summer Conference on Creating, Sharing and Transferring Knowledge, May 12.

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Figure 1 – How a Entrepreneur’s Human Capital Affects Performance

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Table 1 - Value Creation, Acquisition and Expansion

How to create value How to appropriate value How to expand value

For the entrepreneur

Satisfy self esteem and self actualization needs

Negotiate agreement that defines equity position and compensation upon departure

Develop personal plan that identifies skills, experiences, reputation, behaviors and relationships required in two scenarios: i. remain with company, and ii. depart company

Use company to acquire required skills, experiences, reputation, behaviors and relationships

Set up individual processes and tools that support individual growth

For startup company

In markets space where company operates:

Collaborate to increase number of customers

Collaborate with customers, complementors, suppliers and intermediaries

Decrease costs of providing products and services

Contribute to legitimize solutions

Increase number of customers that purchase company’s products and services

Increase customers’ willingness to pay for company’s product and services

Decrease customers cost of owning company’s products

Develop brand

Create IP

Secure funding

Make it easy for customers to purchase from company and for suppliers to share risks

Attract, lead and retain team

Set up organizational processes and tools that support organizational growth

Expand into new markets

For the community

Attract and support habitual entrepreneurs

Establish an ecosystem approach to venture creation

Establish an attractive economic policy environment (e.g. taxes, incentives, labor law)

Link habitual entrepreneurs with keystone organizations that anchor global ecosystems

Link entrepreneurs with early buyers

Link entrepreneurs with capital sources

Invest in the health of the ecosystem that supports entrepreneurial activity and company creation

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Tony Bailetti Tony Bailetti holds a tenured faculty appointment in both the Department of Systems and Computer Engineering and the Eric Sprott School of Business at Carleton University. He was the Director of the Technology Innovation Management Program from 1998 to 2005 and 2006 to 2007. He is currently the Director of Ontario's Talent First Network. He was the Director of Carleton University's School of Business from 1981 to 1988 and worked at Bell-Northern Research (today a part of Nortel) from 1988 to 1992. Professor Bailetti has published in engineering management journals such as IEEE Transactions on Engineering Management, Journal of Product Innovation Management, Research Policy, and R&D Management. Brian Hurley Brian Hurley is an entrepreneurial leader with over 24 years of experience in building strong teams, innovative products and international businesses. Brian is currently CEO of Purple Forge, which he founded in 2008. He founded Liquid Computing in 2003 and as it's CEO raised over $44M in venture financing, built a world-class team, delivered an award winning product to market and won initial sales. Brian has built and led numerous successful business teams in Nortel, Bell-Northern Research and Microtel Pacific Research. Brian is the best-selling author of "A Small Business Guide to Doing Big Business on the Internet". He is an active member of the local Ottawa tech community and is member of the OCRI Board of Directors and the Young Presidents Organization. Brian graduated from Carleton University with a Bachelor of Engineering.