Burn the Business Plan

by Carl J Schramm

  Why did I give him that advice? For one thing, engineers start far more companies than graduates in any other major and, as a rule, they start a first business only well after leaving college. When I tried to discuss this reality, Foster dismissed my advice. He had already been seduced into an empirically false belief system, led on by professors and counselors who assured him that his college could instruct him in the surefire protocol of starting a successful company.

  Foster can be forgiven for embracing this illusion. My simple advice, which I borrowed from Ewing Kauffman, is that the only way to learn how to start a company is to start a company. It sounds dangerously flimsy when compared to the detailed curriculum, exercises in how to write a business plan, and access to incubators that colleges now offer to serve the growing demand for training startup.

  Nonetheless, like the hundreds of thousands of college students who study entrepreneurship, this student was a victim of academics who have made what philosophers call a “category mistake.” They believe that teaching entrepreneurship, like teaching accounting and dentistry, involves imparting specific knowledge and skills that will dependably produce the desired outcome. They believe there is an empirically based core of knowledge that, once absorbed, will increase a student’s chances of starting a successful enterprise.

  These academics led Foster to believe that, if he took the prescribed courses and spent a year in an incubator, he would understand what entrepreneurs do. Foster had no idea that students who study entrepreneurship have no better odds of starting a successful business than anyone else. Nor did he know that the average lifetime earnings of students with a degree in entrepreneurship are the same as for most college graduates, but lower than those with degrees in engineering.2 Foster also didn’t know that businesses started by students immediately after graduating had a five-year survival rate of under five percent. If his academic advisers knew any of that, they weren’t talking.

  In short, Foster was unaware of facts that were highly relevant to his decision to change majors, primarily because most advocates for entrepreneurship studies suffer cognitive dissonance regarding these realities; it is a human tendency to shift factual interpretations to fit one’s hopeful beliefs and preconceived notions. Unless the course is called “Owning and Operating a Successful Nail Salon in Atlanta,” those who teach entrepreneurship cannot promise that they will give their students any special knowledge or any unique skills that will equip them to operate as professional entrepreneurs. They cannot provide that special knowledge because it is too circumstantial to be codified.

  The nature of what entrepreneurs must know is different from what students who become accountants, chemists, and structural engineers learn in school. The essential “body of knowledge” imparted in these fields is based on observations that have been systematically tested, sometimes over centuries. Fact-based findings, tested repeatedly, have become rules that must be understood by anyone who aspires to practice these professions and to advance knowledge in these disciplines.

  * * *

  Accounting students gain knowledge by having to accurately calculate trial balances from real accounting data. Chemistry students must demonstrate that they know why the molecular weight of one atom explains why it will bond with another. Engineers must understand the strength of steel girders to a structure’s ability to withstand an earthquake. The entrepreneur, however, cannot be taught in the same way as those studying a rule-based discipline. There is no time-tested body of knowledge that will improve the probability that a startup will be successful. There are a lot of practical common sense factors to weigh when deciding if the entrepreneurship path is for you, some of which are discussed in this book, but following rules or recipes does not work.

  In contrast to those in the evidence-based disciplines, learning by doing is the only way entrepreneurs come to know what they know, much like surgeons or sculptors. Of course, those two fields require a thorough knowledge of anatomy or stone qualities, but the successful practice of surgery or sculpting depends on implicit or practical knowledge that resides only in the hands, acquired by experience.

  Denny Foster naturally expected that anything taught at the college level would reflect empirically established causal relationships arising from years of scholarly research. But, in fact, what is taught in entrepreneurship classes largely is a system of belief in ritual practices that professors presume will lead to starting successful companies. The first thing that Foster was taught is that writing a business plan is the platform for all subsequent success—the sine qua non that will lead to a relationship with a venture capitalist, a godlike figure who will hold power over Foster’s success. Foster was then instructed that working in an incubator would help him develop an idea around which he can form a startup. Finally, he learned that he needed a mentor, a Yoda-like adviser, to help him decode the secrets of starting a business.

  In 1920, “Shoeless Joe” Jackson was tried for having taken a bribe to throw the 1919 World Series, which allowed the Cincinnati Reds to beat his team, the Chicago Black Sox. As Jackson left the courthouse, a devastated young boy, who, like millions of others, regarded Jackson as a hero, looked up at Joe, and begged, “Say it ain’t so, Joe.”3 Unfortunately, college students who forego learning useful subjects and follow a course in entrepreneurship in the hope of learning how to start a company, might say the same. Can it be that what students of entrepreneurship are taught, the advice every aspiring entrepreneur hears, isn’t all that helpful? What does the evidence show?

  Writing Winning Plans

  A few years ago, when guest lecturing in a well-known MBA program, I spoke of the futility of writing business plans. A student in the front row began chuckling. When I asked him what he found amusing, he recalled taking an undergraduate entrepreneurship course where a written business plan had determined his grade. The professor, impressed with the young man’s idea to build an online market for used dorm furniture, encouraged him to enter the school’s annual business-plan contest, where potential investors, executives, and other academics judged the commercial potential of the contestants’ ideas. The student had won first place, a cash prize of $25,000. His victory allowed him to compete against students from other schools in subsequent contests and, by the end of the semester, he had won three more, racking up $100,000 in cash, and a scholarship for the MBA he was pursuing.

  The young man went on to tell his classmates that there was no way his idea could have worked and that while he was writing the plan, none of his fellow students would validate his idea. After competing in three contests, he observed that all of the processes shared certain unreal qualities. First, the judges seemed partial to socially responsible ideas, like recycling furniture, and seemed to subliminally signal that creating a company that would make money took a back seat to noble intentions. Second, most winning plans favored product ideas that served campus needs—a necessarily limited market—and the winning ideas thus seldom had potential to scale. Finally, he reported that judges tended to choose plans with detailed financial forecasts, no matter how unlikely the market uptake for the proposed products or services might be. He added that writing a winning business plan had been his first successful startup and was likely to be his last as he planned to pursue a career consulting for large corporations after completing his MBA.

  In every business plan competition, prize money is awarded on the assumption that those who win have demonstrated top tier business ideas and will turn those ideas into startups. Experience shows, however, how unconnected most business plans are to actually building a successful business.

  Consider that Rice University’s business plan competition—the Super Bowl of such contests—awards in some years as much as $3 million of prize money, mostly in the form of offers of capital from wealthy investors. More than a thousand entrepreneurs apply to compete, but only forty-four are invited to Houston for the finals. Tellingly, only about thirty-five percent of all winners of the Rice competition have ever started a company
. What little follow-up data exists on other university competitions suggests that an even lower percentage of those contestants turn their plans into startups.

  Advising every aspiring entrepreneur to write a business plan appears to have very little predictive value as to who actually will follow through to start a business. These findings also support what we learned in Chapter 1: While case studies of individual businesses might suggest that a written business plan was useful in a particular instance or at a particular stage of development, there is no objective evidence that writing a plan has helped a large number of aspiring entrepreneurs.

  That the debate over the value of the business plan is not yet settled tells much about how some professors of entrepreneurship think, which is too close for comfort to Feynman’s cargo-cult metaphor. Few colleges keep track of their alums who study entrepreneurship, thus overlooking the single best source for evaluating the effectiveness of what is being taught. Moreover, university business plan contests, where the assumption is that the winners are those most likely to start successful companies, seldom track their winners’ experiences, let alone compare it with that of students who lost, much less students who didn’t even enter.

  This lack of curiosity is intriguing. It suggests that business programs are convinced that what they teach is true, and that it need not be confirmed by examining their students’ outcomes. In most university catalogs, writing a business plan is described as the capstone of what entrepreneurship students learn. And, whereas students in other disciplines are tested on their mastery of a body of knowledge and how that is applied in specific situations, grades in entrepreneurship courses depend on a professor’s subjective assessment of the viability of the idea proposed in a student’s plan—how well it conforms to the eleven-step convention and how convincingly the student can pitch his or her plan. Teaching entrepreneurship is a classic case of form triumphing over substance. As one student dryly observed, “If it ends with a grade, it won’t end with a business.”

  Recreating the Garage—Not!

  Professors encourage students of entrepreneurship to spend time in a business incubator, where they presumably can discover or develop ideas for new businesses. Run as an adjunct—or, in Denny Foster’s case, as an add-on—to formal training, incubators typically are nonprofit co-working spaces funded by local universities, businesses, chambers of commerce, and/or grants from government-funded economic development agencies. Often located in a commercial landlord’s hard-to-rent real estate, the average incubator hosts twenty-five entrepreneurs who stay roughly one year.

  Believing that aspiring entrepreneurs will cross-fertilize their ideas or form businesses together, incubators encourage social interaction among their tenants. Starting a business thus becomes a communal act. Every incubator has staff that host events and presentations intended to increase their tenants’ chances of success. One common event is a “pitch night,” at which entrepreneurs present their ideas to each other and to potential investors. Others include lectures by startup founders, hackathons to develop ideas for new companies, and workshops on topics ranging from how to file for a patent to sourcing goods from China. Incubators also offer access to lawyers and accountants who are ready to help cash-starved startups, in the hope that some will become future clients.

  To visit an incubator is to have a sense of attending a perpetual social event, where the networking, connecting, and chatting never stop. Incubators make interactive theater out of starting a business.

  The idea that incubators could increase the number of new startups was sparked in the 1990s, when Michael Porter argued that urban decay could be retarded in any city if it assembled a cluster of companies in a specific industry. He anticipated the larger idea of localized entrepreneurial ecosystems that emerged from AnnaLee Saxenian’s 1994 book, Regional Advantage: Culture and Competition in Silicon Valley and Route 128,4 in which she argued that the explosive growth of Palo Alto and Boston in the 1980s was due more to entrepreneurial activity than to the concentration of the computer industry.

  Saxenian’s book led hundreds of cities worldwide to replicate the institutional resources that they read as her prescription for growth. To benefit from entrepreneurial activity, a community needed a nearby university to provide a stream of innovation, as well as venture capital investors, but that was not enough. It also needed a place where aspiring entrepreneurs could work on transforming their ideas into companies, a scaled-up modernization of the garages in which companies like Amazon, Apple, Disney, Google, and Hewlett-Packard so famously got their start.

  Much like the idea of business-plan writing, the theory of incubators would seem to make sense. Recall, however, that places dedicated to fermenting new businesses were not part of the startup landscape until relatively recently: In 1980, there were fewer than a dozen incubators in the United States; by 2016, there were more than 1,600.

  Similar to other formal efforts to support entrepreneurs, it appears that, as a rule, time spent in an incubator is time wasted. As the number of incubators has exploded, the number of new companies being started has declined. The National Business Incubation Association offers no convincing data concerning its members’ effectiveness in increasing the number of new startups or the number of new jobs they create. It appears that a significant majority of members do not respond to surveys about their outcomes.5 In fact, the only published matched-sample study of the impact of incubators, compiled by Professor Alejandro Amezcua of Syracuse, relied on eighteen years of data, and concluded that “incubated companies have slightly lower survival rates than their unincubated counterparts.”6

  An aspiring entrepreneur who spends a year in an incubator is no more likely to start a company than those entrepreneurs who skip the incubator and go directly about the business of organizing a new company. Because the culture of incubators is designed to be encouraging, supportive, and mostly uncritical, an aspiring entrepreneur can spend weeks and months working on ideas that previously have been tried and failed or that have little prospect for market appeal. In that environment, it seems less, not more, likely that an aspirant will confront the reality of business startups and redirect his energy to potentially more productive work.7 As a result, incubators—perhaps the most tangible and expensive component of the entrepreneurial ecosystem—appear to have a negative rate of return on the time that their tenants spend there.

  Most aspiring entrepreneurs leave an incubator without a new business, usually because they had no consequential innovative idea when they arrived. They have spent months playing at business, much as children play house, and gone through the motions of being entrepreneurs, including pitching their business ideas to putative investors of ideas that are unlikely to grow into businesses.

  This finding is consistent with studies of the effectiveness of the “big brothers” of incubators, entrepreneurial accelerators. Although similar in appearance to community-based incubators, accelerators are privately owned for-profit firms that initially were developed by venture firms to selectively admit aspiring entrepreneurs.8 The accelerator often pays the aspiring entrepreneur’s living expenses and provides resources to further develop their startups. Upon admission, entrepreneurs cede a portion of his startups’ potential value to the accelerator’s owners, who then choose which they will fund based on which embryo startups they believe will have the best growth potential.

  But statistical evidence on accelerators, gathered by Seed-DB, suggests that they are no more productive than incubators. Using data submitted by seventy of the 160 accelerators that participated in its survey, Seed-DB concluded that only two percent of companies graduating from what it deemed the top twenty accelerators—a group that includes Y-Combinator and TechStars, the two most widely emulated models in the country—had “meaningful” exits where they were acquired or sold shares to the public. Moreover, Seed DB concluded that it often takes ten years for an accelerated company to achieve success, just like most other startups.9

  Y-Combinator, the
granddaddy of all accelerators that started in 2005, accepts fewer than five percent of all applicants. Although less than ten percent of its hundreds of handpicked, highly coached, and financially supported startups achieve significant success, several notable companies have emerged from their system, including Reddit, Airbnb, and Dropbox. Nevertheless, the average rate of return on invested capital across all accelerators reporting their data, including Y-Combinator, is negative twenty-four percent. Despite the prevailing belief that accelerators can identify promising entrepreneurs and provide them with an experience that should result in a greater success rate, it appears that the accelerator model is no better at picking winners than are venture investors.

  Beware the Toxic Mentor

  Aspiring entrepreneurs often hear that having a mentor, an experienced and reliable adviser, is critical to their success. The idea is based on the Greek myth of Odysseus, King of Ithaca, who asked Mentor, a wise and trusted friend, to watch over his son, Telemachus, while he was off fighting the Trojan war.

  Unfortunately, when it comes to starting a company, mentors can be as dangerous as they are helpful. The reason lies in the seldom told second part of Telemachus’ story.11 Mentor, despite his promises and best intentions, couldn’t protect Odysseus’ son. In fact, Mentor’s counsel was so dangerous that the all-knowing goddess Athena took on his identity to prevent Telemachus from following the real Mentor’s advice. The moral of the myth was that Telemachus must find his own way in life. More colloquially, knowledge not gained through personal experience is often of limited value. The take away for entrepreneurs is that relying on a mentor can be risky.