Why Economists Make Lousy Businesspeople

I have a lot of respect for the study of economics in general. But some economists seem so utterly disconnected from reality that I am sometimes amazed that they don't need full-time caregivers. Case in point: Arnold Kling wrote this in Econlog today: Funding Start-Ups

"I have a prejudice against outside funding for start-ups. In Under the Radar, I wrote that "Fundraising is not for businesses. Fundraising is for charities." I was so proud of that line that I used it twice.

"To me, an entrepreneur who looks for investors is like somebody who can't swim who finds himself in the middle of a lake. It's dangerous to go near the drowning man unless you know what you are doing. If you are not a trained lifeguard, chances are he will drown you as well as himself."

Let me see if I understand this correctly. In Arnold Kling's ideal world, all startups would be funded entirely by the founders until they become operating cash flow positive.

Kling is obviously an intelligent individual, so I'm going to give him the benefit of the doubt and assume that he's never been involved in a startup, and hasn't really thought through the implications of this notion. Otherwise, I assume, he would quickly change his mind.

The first mistaken assumption is that an entrepreneur, given a choice, would rather focus on raising money than selling stuff. This is absurd. Speaking as someone who knows a lot of entrepreneurs, and who is one myself, raising money is somewhere below pumping out the septic tank on our list of stuff we enjoy doing. Most entrepreneurs absolutely despise raising money, and would much rather be making stuff to sell (which is why we're entrepreneurs, after all), but it is a necessary part of being a startup.

In fact, to be a founder-funded, at least one of these conditions must be met: (a) It has to be a time-and-materials business, such as a consultancy or a contractor with no significant pre-revenue R&D or infrastructure; or (b) the founders have to be independently wealthy. If condition (a) is met, as it often is for businesses like building contractors or technology consultants, then in practice very few startups raise outside money.

The problem is that condition (b) is almost never met. The vast majority of entrepreneurs are of ordinary means, and cannot afford the high probability that a failed startup would destroy them financially. Yet there are a lot of great ideas out there which require initial development and/or infrastructure before they can start bringing in outside revenue.

Like, for example, Google (which couldn't start selling advertising until it had the infrastructure to support lots of searches). Or Apple, or Cisco, or just about any other successful technology company since the 1950's.

Venture capital (and related capital like angel investors), for all its imperfections, serves an extremely important purpose: it connects individuals who want to take risks with their ideas to organizations which want to take risks with their money. It is extremely unusual to find both in the same person.