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The economics ofentrepreneurship 3:
What makes a typical entrepreneur?(I) Characteristics
Robert CressyProfessor of SME and Entrepreneurial Finance
Cass Business School
Copyright © 2001, Robert Cressy
Learning objectives
n To understand the nature of the typical startupbusiness
n To understand the nature of the entrepreneur(s)running it
n To understand the drivers of small businessperformance
n To be able to use this information to judge theirown and others’ startup performance
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Copyright © 2001, Robert Cressy
Plan of the lecture
n What makes a typical entrepreneur?n The empirical evidence
n UK’s Startup Tracking Exercisen The Datasetn The Entrepreneursn The Businessesn Financen Growthn Survivaln Conclusions
n Class exercise:n Putting the results to work
The Startup TrackingExercise
Evidence from the UK on thetypical entrepreneur
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Copyright © 2001, Robert Cressy
Background
n Commissioned by NatWest bank of GreatBritain in 1990
n They had done the first of what was to be 2large-scale representative surveys of startups inthe UK
n Research carried out by Robert Cressyn Reported inn Cressy and Storey, 1994n Cressy, 1996
Copyright © 2001, Robert Cressy
1/ The dataset
n Samplesn Random samples of
n 2000 start-ups in 1988n Boom period in UK economy
n 750 startups in 1991n Recession period
n Trackingn Each entrepreneur interviewed by his/her Branch Manager
prior to start-upn Questionnairen Fixedn Multiple choice qualitative/numerical questions
n Each business followed quarterly/half yearly until 1994
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Copyright © 2001, Robert Cressy
Dataset cont’d
n Data recorded:n At startup
n Background info onn Businessesn Entrepreneursn Banking requirements
n After startupn Bank account data
n Borrowingn Depositsn Securityn Marginsn Defaults
Copyright © 2001, Robert Cressy
Dataset cont’d
n Survival informationn Did the business account continue?n If not, was the closure
n Solvent?n Insolvent?
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Copyright © 2001, Robert Cressy
Exercise 1:Identikit of the typical entrepreneur &
his/her businessn What do you think are the main characteristics
of a typical entrepreneur and his/her business?n Note: Recall the definition of an entrepreneur from
the first lecturen Consider the following factorsn Agen Assetsn Qualificationsn Experience
Copyright © 2001, Robert Cressy
Exercise 1 cont’d
n Industryn Employmentn Motivationn Legal typen Sizen Use of technology
n Word processingn Computer-controlled processesn Customer accounts
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Copyright © 2001, Robert Cressy
2/ Findings: The entrepreneurs(Part answer to Ex. 1)
n Most entrepreneurs are youngn They start in their early 30’s (see chart overleaf)
n But a small number start at an advanced age (70s or80s!)
n The average age of startup entrepreneurs is lower thanthat of established business people (see chart overleaftaken from Cressy, 2000)
n The average age of an entrepreneur increases during arecessionn Indicated by the rightwards-shift in the distribution
Copyright © 2001, Robert Cressy
Chart 1a:Age of entrepreneurs
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15 20 25 30 35 40 45 50 55 60 65 70 75 80
Age of proprietor (years)
Per
cent Start-ups in 1988
Start-ups in 1991
Estd bus, 1998
Source: Cressy, 1993; 2000
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Copyright © 2001, Robert Cressy
Entrepreneurs cont’d
n Most (70%) entrepreneurs have some degree offormal qualifications
n But 30% have no formal qualifications at alln At least 70% of owners were previously in
employment (Chart 1b)
Copyright © 2001, Robert Cressy
Chart 1b:Prior labour market status of entrepreneurs
Previous labour market status of entrepreneurs
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50
60
70
80
90
Unemployed Other status (study/housewife etc) Job
Per
cen
tag
e o
f en
trep
ren
eurs
1988
1991
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Copyright © 2001, Robert Cressy
Entrepreneurs cont’d
n A significant proportion of the entrepreneurs haveexperience of some kind:n One third (38%) of the startup entrepreneurs have prior
business experience (see chart ..)n These are called serial entrepreneurs
n Relevant work experiencen Two-thirds of entrepreneurs have prior work experience in the area
of the startup
n Managerial backgroundsn Over a quarter (28%) of entrepreneurs run other businesses
simultaneously (see chart…n These are called portfolio entrepreneurs
Copyright © 2001, Robert Cressy
Entrepreneurs cont’d
n In Recessionary environments the majority ofentrepreneurs come from employment in managerialpositions
n In Boom periods the majority come from the ranks ofmanagerial or skilled manual workers (Chart 1c)
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Copyright © 2001, Robert Cressy
Chart 1c:Prior job status of entrepreneurs
Status in previous job (if employed)
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10
15
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30
35
40
Supervisory/Foreman Semi/Unskilled Manual Clerical/White Collar Skilled Manual Director/Partner Manager/Professional
Per
cen
tag
e o
f en
trep
ren
eurs
1988
1991
Copyright © 2001, Robert Cressy
Chart 2Serial entrepreneurs
Serial EntrepreneursStartup Tracking Exercise, 1988
Serial entrepreneurs38%
One-shot entrepreneurs62%
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Copyright © 2001, Robert Cressy
Chart 3Portfolio entrepreneurs
Portfolio entrepreneursStartup Tracking Exercise, 1991 sample
Portfolio entrepreneurs28%
Single business entrepreneurs72%
Copyright © 2001, Robert Cressy
n The typical entrepreneur is an asset-ownern Two-thirds own their own house
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Copyright © 2001, Robert Cressy
Entrepreneurs cont’d
n Most common reason for starting up:n To be their own bossn To be independentn More fulfilment/satisfaction
n ‘Making money’ hasn lower priority in Boom periodsn Higher priority in Recessions
Copyright © 2001, Robert Cressy
Entrepreneurs: Overall
n Entrepreneurs typicallyn Have experience and assetsn Are motivated to be independent/more fulfilled
rather than getting richn Do not wish, nor are equipped, to grow fast
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Copyright © 2001, Robert Cressy
3/ The businesses(Part answer to Ex. 1)
n Most common sectors (Chart 2a):n Other services (26-27%)n Property/financial/professional services(12-18%)n Retail (15-17%)n Catering/leisure(11%)n Construction (7-12%)
Copyright © 2001, Robert Cressy
Chart 2a:What sectors do entrepreneurs choose?
Industrial Breakdown of Samples
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5
10
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Agricu
lture
Transp
ort/Distr
ibution
Motor Tr
ades
Wholesa
le
Construc
tion
Produc
tion/Manu
facturi
ng
Catering
/Leisu
reReta
iling
Proper
ty/Fina
ncial/P
rofessio
nal S
ervice
s
Other
Per
cen
tag
e o
f b
usi
nes
ses
1988 sample
1991 sample
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Copyright © 2001, Robert Cressy
Businesses cont’d
n Legal type (Chart 2b)n Sole trader (53-65%)n Partnership (21-24%)n Limited company (10-26%)
Copyright © 2001, Robert Cressy
Chart 2b:What legal types do entrepreneurs choose?
Choice of legal type
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30
40
50
60
70
Partnership Limited Company Sole Trader
Per
cen
tag
e o
f bu
sin
esse
s
1988
1991
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Copyright © 2001, Robert Cressy
Businesses cont’d
n Sizen Full time employees (at start): 1-2n Part time employees (ditto): 1
Copyright © 2001, Robert Cressy
The Businesses cont’d
n Startup moden Franchise (4%)n Non-franchise (96%)
n Use of computers/ITn Word processing(31%)n Control of equipment (34%)n Customer accounts (21%)
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Copyright © 2001, Robert Cressy
The businesses: Overall
n In services rather than manufacturingn Very small (Micro)n Low techn Not designed for fast growth (legal type)
Copyright © 2001, Robert Cressy
Exercise 2:Overdraft finance
n What is an Overdraft? (Ask your bank managerif need be!)
n How does it differ from a Term loan? (Ditto)n What are the main advantages and disadvantages
of an overdraft versus a term loan to a smallbusiness?
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Copyright © 2001, Robert Cressy
Exercise 2 cont’dSources of finance used
n What do you think are the main sources of finance usedby the entrepreneur to start his/her business?n Owner savings: % using this source…..n Loan from main bank : % using…
n Of which:n Overdraft % using..n Term loan: % using..
n Hire Purchase: % using….n Friends and relatives: % using…n Loan from another bank: % usingn Government schemes: % usingn Outside equity (venture capital and angel finance): % using..
Copyright © 2001, Robert Cressy
4/ Finance(Answer to Exercise 2)
n Definition: Overdraftn A borrowing facility that enables, but does not
oblige, the borrower to borrow up to a predefinedmaximum amount (the overdraft Limit) at a fixedmargin above the bank’s cost of funds.n Borrowing in excess of this Limit is deemed unauthorised
and is subject to a penal rate of interestn Overdrafts are in principle repayable on demand i.e. at 24
hours noticen In practice this is unlikely to happen unless the borrower is in
financial difficulty and is more likely therefore to occur in arecessionary environment
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Copyright © 2001, Robert Cressy
Finance cont’d
n Overdrafts are usually used to finance working capitalrequirements of the businessn These arise because of the mismatch in the timing of cash flows
from customers and suppliers
n Hence an overdraft is normally expected to be drawndown and paid off during the typical period of trade credit,I.e. n the UK 3 months or 90 days
n Persistent ovedrafts are called hardcore and often convertedby agreement into Term loans, typically at a lower rate ofinterest
Copyright © 2001, Robert Cressy
Finance cont’d
n Definition: Term loann A Term loan is an agreement by which the borrower is given
a sum of money in the present and repays this in instalmentsto the lender over a fixed period of time agreed in advance.The borrower also pays interest on the loan in proportion tothe amount borrowed, again in amounts agreed in advanceand at fixed intervals.
n The interest rate paid on the loan is either fixed or floating .n Fixed rate loans incur a rate of interest that is independent of the bank’s
cost of funds.n Floating rate loans incur a fixed margin but a rate of interest (Base
rate + margin) that varies with the bank’s cost of funds.
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Copyright © 2001, Robert Cressy
Chart 3:Sources of finance used by startups
Frequency of finance usage by source, United Kingdom 1991
0.0
10.0
20.0
30.0
40.0
50.0
60.0
70.0
80.0
VENTURECAPITAL
FINANCE HOUSE OTHER BANKFINANCE
OTHER FINANCE GOVERNMENT MONEY FROMFRIENDS ANDRELATIVES
MAIN BANK OWNER EQUITY
% u
sing
sou
rce
Source: Cressy, STE data
Copyright © 2001, Robert Cressy
Finance cont’d
n Overdraft facilitiesn in 1988/91 more likely than term loansn less so now (year 2000)n in greater demand during recessions
n Sources of finance:n bank finance is used by
n 1/3 in a boomn 2/5 in a recession
n Personal finance, i.e. own equity, is used byn 1/3 of business in a boomn rising to 2/3 in a recession (see overleaf)
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Copyright © 2001, Robert Cressy
Chart 4:Importance of finance sources
Importance of finance sources for startups when used United Kingdom 1991
0.0
20.0
40.0
60.0
80.0
100.0
120.0
OTHER BANKFINANCE
GOVERNMENT FINANCEHOUSE
MONEY FROMFRIENDS AND
RELATIVES
OTHER FINANCE MAIN BANK VENTURECAPITAL
OWNER EQUITY
% o
f to
tal
fina
nce
Source: Cressy, STE data
Copyright © 2001, Robert Cressy
Finance cont’dn Importance of sources
n Bank financen although only used by less than half of startupsn contributes 2/3 of the total startup capital of users
n Personal financen used by 68% of businesses
n Typically constitutes 100% of the startup capital of users
n Venture capital is virtually unknown amongst start-ups (<1%)n When used it is in very large sums
n £1.5m average in 1991
n Money from friends and relativesn Of some importance (11% use it)
n When used constitutes 1/3 capital
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Copyright © 2001, Robert Cressy
5/ Summary: Finance sources
n Owner equityn The most common source of finance (chosen by a
clear majority of entrepreneurs) and usually the onlysource of funds for those businesses!
n Bank financen A very important secondary source of funds for a
large minority of usersn Very unequal amounts utilised:
n a large number of businesses get small amountsn a small number get very large amounts
Copyright © 2001, Robert Cressy
Finance sources: Summary chartChart: Frequency and importance of finance sources
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20
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60
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100
120
0 10 2 0 30 40 50 60
Median % using source
Med
ian
% o
f fun
ds w
hen
used OWN BANK
OWNER EQUITY
FRIENDS/RELATIVESFINANCEHOUSE
VENTURE
CAPITAL
OTHER
GOVERNMENT
OTHER BANK
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Copyright © 2001, Robert Cressy
Summary cont’d
n Money from friends and relatives (‘Love money’)n Important source of funds for a small minority of businesses
n Other Bank, Government and Finance housefinancen Important source of funds for very small minority of
businessesn Other Finance (mainly grants from charities)
n Very important for a very small minority of businessesn Venture capital
n Extremely important source of funds for a tiny minority ofbusinesses
Copyright © 2001, Robert Cressy
Finance cont’d
n Government funds rarely used to start upn Only 8% of firms (1 in 12) use themn When used, quite significant
n 40% of total finance
n Most popular finance combination used:n Personal money plus bank funds
n 11% firms chose this combinationn reflects the need to motivate entrepreneurs
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Copyright © 2001, Robert Cressy
Exercise 3:Amounts of finance used
n What amounts (£000s) of various sources of finance doyou think and entrepreneur might need to start herbusiness?n Owner equity £ ..kn Venture capitaln Main bankn Other bankn Finance housen Governmentn Other finance
Copyright © 2001, Robert Cressy
Chart 5:Amounts of finance used
Amounts of finance used by startups United Kingdom 1991
0.0
1000.0
2000.0
3000.0
4000.0
5000.0
6000.0
7000.0
8000.0
GOVERNMENT OTHER FINANCE MONEY FROMFRIENDS ANDRELATIVES
MAIN BANK OWNER EQUITY OTHER BANKFINANCE
FINANCE HOUSE
£s
Source: Cressy, STE data
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Copyright © 2001, Robert Cressy
Exercise 4:Committing the entrepreneur
n Why do you think the amount of owner equityin the business and the amount of own bankfinancing are equal in the above chart?
Copyright © 2001, Robert Cressy
Committing the entrepreneur(Answer to Ex. 4)
n Entrepreneurs with limited liability can go bustat the expense of the bankn They are limited in their losses to their shareholdings
in the companyn The firm’s creditors may then find they cannot
retrieve money they lentn The bank will typically use methods that commit
the entrepreneur to the success of her businessn This means she has something to lose if the business
fails
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Copyright © 2001, Robert Cressy
Committing cont’d
n Two common methods are to requiren Loan Collateral e.g. owner’s house or firm’s premisesn Financial investment of the entrepreneur i.e. owner
equity in the businessn This might be done on a £ for £ basisn This is the most likely reason for the equality of owner equity and
own bank finance in the previous chart.
Copyright © 2001, Robert Cressy
Committing cont’d
n Example from the STEn The bank will also take into account the provision of
collateral in the decision to grant an O/D and the amount ofthe O/D if granted
n Using the STE dataset for 1991 we find that the medianoverdraft facilities for entrepreneurs who invest their ownmoney are highern £5000 if you put your own money inn £3000 if you don’t
n Strictly matched funding (£ for £) would imply £0 O/D forthe latter groupn Thus the bank uses investment by the entrepreneur to gain
commitment to the business but will still lend provided there iscollateral to support the loan
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Copyright © 2001, Robert Cressy
6/ Summary and conclusions
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