the economics of entrepreneurship 3 - city university...

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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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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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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


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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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


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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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


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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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


Chart 1a:Age of entrepreneurs

0

2

4

6

8

10

12

14

16

18

20

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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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)


Chart 1b:Prior labour market status of entrepreneurs

Previous labour market status of entrepreneurs

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20

30

40

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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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



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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Chart 1c:Prior job status of entrepreneurs

Status in previous job (if employed)

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5

10

15

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25

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


Chart 2Serial entrepreneurs

Serial EntrepreneursStartup Tracking Exercise, 1988

Serial entrepreneurs38%

One-shot entrepreneurs62%

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Chart 3Portfolio entrepreneurs

Portfolio entrepreneursStartup Tracking Exercise, 1991 sample

Portfolio entrepreneurs28%

Single business entrepreneurs72%


n The typical entrepreneur is an asset-ownern Two-thirds own their own house

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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


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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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%)


Chart 2a:What sectors do entrepreneurs choose?

Industrial Breakdown of Samples

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5

10

15

20

25

30

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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Businesses cont’d

n Legal type (Chart 2b)n Sole trader (53-65%)n Partnership (21-24%)n Limited company (10-26%)


Chart 2b:What legal types do entrepreneurs choose?

Choice of legal type

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10

20

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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Businesses cont’d

n Sizen Full time employees (at start): 1-2n Part time employees (ditto): 1


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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The businesses: Overall

n In services rather than manufacturingn Very small (Micro)n Low techn Not designed for fast growth (legal type)


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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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..


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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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


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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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


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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Chart 4:Importance of finance sources

Importance of finance sources for startups when used United Kingdom 1991

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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



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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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


Finance sources: Summary chartChart: Frequency and importance of finance sources

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20

40

60

80

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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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


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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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


Chart 5:Amounts of finance used

Amounts of finance used by startups United Kingdom 1991

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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


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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?


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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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.


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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6/ Summary and conclusions

the economics of entrepreneurship 3 - city university...

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