Part 9: Entrepreneurship = Luck + Talent + Wisdom

Based on what I know today today, I estimate that entrepreneurship is one third talent, one third luck and one third wisdom. Talent is not teachable and, at present, is very hard to identify in first time entrepreneurs. Luck cannot be taught nor bought but plays an important role in success, and, unfortunately, is often misinterpreted as talent or wisdom. Finally, wisdom is teachable but we must be incredibly careful about following only guidelines that are borne out by data and not just a series of anecdotes.clover

Entrepreneurship is one third luck

We all love to believe in superstars, and superstars there are, but there is strong evidence to suggest that luck plays a big role in startup success. The best evidence I see is that entrepreneurs who are successful with their first venture have only a 30% chance of success on their subsequent venture. If luck played a weak role, then there’s no reason why previously successful entrepreneurs should continue to be successful from there-on*.

Entrepreneurship is one third talent

Data show that talent has a big influence on success. I believe this because the success rate of previously successful entrepreneurs is much higher than average. If talent wasn’t a thing then it wouldn’t matter whether your founding team had persistently been successful in the past – this simply isn’t borne out in the data. You might argue that having past-entrepreneurs on your team helps simply because they have experience. However, I don’t think this is the case, because then entrepreneurs who failed in the past would also be useful to have on your team, which isn’t true when you look at the data [in fact, their performance is very close to average].

Entrepreneurship is one third wisdom

There is also one important aspect of entrepreneurship that can be thought, which might be thought of as wisdom, rules of thumb, or, more formally, heuristics.

One way to develop rules of thumb is by carefully thinking through the fundamentals of a successful startup. Peter Thiel’s rules provide one such example. Sustainable profits are achieved by finding a way to achieve a durable competitive advantage, which, in its strongest form, is, by definition, a monopoly. A monopoly can come about as a result of enforceable patents, trade secrets, economies of scale or network effects; by optimizing for such characteristics, it seems one could improve the startups chances of success.

A second way to develop rules of thumb is to look at broad datasets but, unfortunately, there are few. Furthermore, amongst the few studies that exist, few, if any, characteristics of a startup that can be measured early in its life have been proven to lead to greater success in its later stages. Setting team composition aside, the only real correlator with success seems to be revenue, but there aren’t even enough data to prove this for startups at an early stage, and, what’s more, we know that many early stage startups simply don’t have any revenue – meaning we could really do with other new metrics.

Putting it all together

Taking the insights I have gleaned from the research and thinking of others, I have compiled a model to estimate the future success of early stage startups. For sure this model is at best weak and at worst wrong. However, I include it because I think the approach to building the model is a useful tool for others.

The model I propose has three pieces: team, traction and fundamentals – each piece worth one point, giving a maximum score of three. Importantly, the model is quantitative and relies only on information that is measurable:

1st Piece: Team (Maximum points = 1 pt.)

Raw talent – If at least founder has previously founded a startup that was acquired or went public, assign 1/2 point. Failing the above test, if at least one founder has founded a startup with current annual revenue of above $10 million, assign 1/4 a point.

Founding team size – Assign 1/6 of a point for each of the following roles on the starting team – up to a maximum of 1/2 point in total: a CEO type role; a lead technical role; a sales and marketing type role; some other distinct role.

2nd Piece: Traction (Maximum points = 1 pt.)

Sum up the total revenue earned by the startup to date. Include only revenue that has been received. Assign 1/6 pt for $0-100, 1/3 pt for $100-1,000, 1/2 pt for $1,000-10,000, 2/3 pt for $10,000-100,000, 5/6 pt for $100,000-$100,0000, and, 1 pt for above $1,000,000.

3rd Piece: Fundamentals (Maximum points = 1 pt.)

Intellectual property – Companies with chemistry or pharma based patents or trade secrets – ones that are either very hard to copy or else are really obvious if someone copies the patent so you can sue them; 1/3 pt. Companies with patents that are easy to copy but somewhat possible to track if other people copy; 1/6 pt. Other companies fitting neither previous description; 0 pts.

Economy of scale – Software; 1/3 pt. Hardware or infrastructure; 1/6 pt. Companies fitting neither of the two previous descriptions; 0 pts.

Network effects. 1/3 pt for any marketplace or communications company and 0 pts for all other companies.

Parting words – Can entrepreneurship be taught?

Before concluding, I want to point out that I’ve taken for granted the assumption that every entrepreneur wishes to optimize for success. Indeed, as an entrepreneur, you really only get to make one bet; you’re betting on the success of your own company, not a portfolio of companies. In this regard it makes sense to optimise for success. However, I really think that, while we should largely optimize for success, there must be limits. If we were all to follow the framework I have outlined above everyone would end up building a communications or marketplace based software startup. Indeed, half joking, that’s more or less what has happened. Importantly, though, not all problems we face in this world are addressed via marketplace based software startups and that, I think, is where the assumption that we should solely optimize for success might just fall down. Mission plays an important role.

Now, to conclude on whether entrepreneurship can be taught. Luck and talent each play a huge role in startup success and, by definition almost, neither is easy to teach. However, we can teach aspiring entrepreneurs to be smarter about how they build their founding team. By following the right rules of thumb – for example, focusing on building a startup with strong intellectual property, economies of scale and network effects – entrepreneurs can likely improve their chances of success. Unfortunately, as things stand today, there are relatively few good rules for entrepreneurs to follow that have been rigorously established. In my view, this stems from a lack of publicly available datasets on startups, insufficient focus on relating measurable characteristics of early stage companies (such as revenue or number of patent applications) to success, and an over-emphasis on hard to measure characteristics (like market size). With a focus on relating measurable startup characteristics to their future success, I believe there are many more rules of thumb that can be established to the benefit of future entrepreneurial generations.

*This isn’t strictly true. For example, it is possible that entrepreneurs who are successful first time round aren’t necessarily successful the second time because they fail to follow certain rules of thumb – e.g. they didn’t opt for a startup that had economies of scale and strong intellectual property – indeed there are many alternate ways of thinking about this. However, to me, it seems that a big reason is simply that luck plays a strong role, so if you’re successful first time around, there’s no guarantee of being successful the next time.

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2 thoughts on “Part 9: Entrepreneurship = Luck + Talent + Wisdom

  1. Hey Ronan,

    I’m enjoying your regular articles.

    At the moment I’m reading “The Choice” by Dr. Eli Goldratt, Founder of Theory of
    Constraints

    In the book he talks about “Luck”

    He defines luck as the word we use – when opportunity meets preparation.

    At first run through I agreed with him, but the two questions that kept coming
    up were…
    1. “How do you prepare?” – for a project, new business venture, job, or new
    dance team
    2. How can you recognize and take advantage of opportunities at the right time?

    The response from Dr. Goldratt was “Accurate thinking”
    The closer we see reality as “it is” – the greater chance of success.

    The next question was.. How do you do that, think accurately?
    Answer I got: “By understanding the underlying cause and effect relationship of
    the problem, venture, or goal you are trying to improve”

    Ok… So In order to be best prepared, I need to document and understand the
    cause and effect relationships of a situation.

    Next question: Why is understanding the cause and effect relationship so
    important?

    Because of one belief/assumption: “Inherent Simplicity”

    This idea, discovered by Newton acknowledges – if you go far enough down the
    cause and effect tree you will notice the diagram converges on 1 or 2 root
    causes. These would encompass the 20% of activities needed to see 80% of results
    in your venture.

    Newton’s quote – “Nature is exceedingly simple and harmonious with itself”

    understanding cause and effect is a method for focusing on the right thing, at
    the right time, using the appropriate resources for the job.

    While reflecting on this I recalled a conversation Bill Gates had with Warren
    Buffet when he was growing up (I think around 14 years old). Gates looked up to
    Warren Buffet, and as a surprise his mom decided to pull some strings and get
    Buffet to join them for dinner. While at the dinner table they did not waste any
    time and started talking.

    To jump start the conversation, Gate’s mom asked – “What is the single most
    important thing you can credit for your success” – Both Gates and Warren
    answered – “Focus!”

    With this preparation we can be sure to focus on the right activities, or at
    least the activities with a greater chance for success.

    The next question remaining is: How do you recognize and take advantage of
    opportunities?

    Well, The more you understand the cause and effect relationships of a given
    industry, business, team, system…
    The more likely you are to identify areas for improvement. Something the rest of
    the world has neglected due to a lack of familiarity with the underlying
    causes/effects.

    Now it is important to recognize the following:
    “Every improvement is a change, but every change is not an improvement”

    The story used was – computers.
    If a consumer’s computer breaks or has a problem they may get frustrated and
    upset. This would be the extent of their progress.

    If an IT professional, or technician who builds computers and understands how
    everything is put together and why it works comes across a problem with the
    computer, they would go through the “categories of legitimate reservation” and
    then run through a few assumptions for what the problem could be.. Assuming it
    was a serious problem… They could go so far as taking the computer apart to
    its component parts and putting it back together from scratch… a complete
    reset/reboot/rebuild of the system.

    Now.. We have an idea of how to prepare for a situation… even a situation we
    may not have identified yet… and we have the understanding (assumption), we
    will best be able to take advantage of any opportunities because of our
    preparation; understanding cause and effect – (i.e. We’ll see what levers to
    manipulate).

    After this analysis, I was sold.

    Luck = Preparation + Opportunity
    Bad Luck = Lack of preparation + Opportunity

    I’ve been practicing accurate thinking and it takes a lot of time, but I can see
    how it also changes the way we communicate with others and their ability to
    understand what we’re saying. It also requires a significant amount of effort.

    While having a conversation with his daughter Efrat, Dr. Eli Goldratt was asked:
    What choice impacted your life the most?

    His answer –
    ” I wanted to live a full life. The most important decision that led directly to
    it was my decision to constantly devote time to understanding, really
    understanding, each one of my areas of interest: family, work, friends”

    When he says understanding we know – He is talking about understanding
    cause/effect

    The key to this conversation however is he applied and went through the rigor of
    understanding cause/effect only in his areas of interest.

    Thus developing new insights, and being able to take billion dollar company’s
    and 10X them.

    They call it viable vision – where you turn a company’s net profit into its
    current gross revenue over a few years.

    See you tonight,
    Ulrich

    1. Many thanks Ulrich for your detailed feedback. The question of what we mean by luck is an interesting one to me. In my mind I define luck as factors that are uncontrollable. Indeed, examining the fundamentals with great care, as you suggest, seems to me to be a way to increase our control and, perhaps, reduce “luck”. That being said, I do feel that there are certain environments that are highly uncontrollable and in my opinion entrepreneurship is one.

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