Are entrepreneurs born risk-takers? Is there something about their personalities that predisposes them to take risks that others can’t stomach? Can entrepreneurship be taught?

According to entrepreneurship researcher Saras Sarasvathy, entrepreneurs aren’t different from anyone else; they simply adopt a different approach to problem solving.

Dr. Sarasvathy suggests that entrepreneurs actually create their own odds of success by taking incremental steps that move them closer to their goals. After being an entrepreneur for over 25 years and studying the behavior of many others, I think she’s right. She calls this incremental approach “effectuation” because it takes advantage of the compounding effects that the entrepreneur causes by their own actions.

Here are 6 key points to understand about Dr. Sarasvathy’s theory of effectuation:

1. Entrepreneurs start with what they have and who they are. What do you know a lot about? What early or deeply personal experiences have affected you? What connections do you have? Leverage these assets to do something and then see what comes of it. This first step leads to additional opportunity, and sometimes these opportunities are very big and unpredictable. Action attracts others, and those others enhance opportunity and the odds of success.
2. Entrepreneurs limit risk by understanding what they can afford to lose at each step. True entrepreneurs never take very much risk at once. Typically the calculation goes something like this, “I think it would be worth investing $50,000 in exploring this opportunity. If I lose it, I can survive. What’s the worst that can happen?” There are two likely outcomes of that reasoning: either the experiment is successful, in which case the investment is rewarded and leads to other follow-on opportunities, or the experiment is not successful, which most likely also will lead to other follow-on opportunities. Either way, new opportunities typically emerge because action attracts others.
3. Entrepreneurs create their own market opportunity. When Burt Rutan set out to build Spaceship One, it was not because he perceived that there was a  big market for expensive one-off spacecraft that was going unmet. He started with what he knew how to do and an affordable risk. When Pierre Omidyar started Ebay, he didn’t anticipate it would become a multibillion dollar company. Google’s founders Sergey Brin and Larry Page tried to sell Google for $1M, but were instead forced to see it through and become multibillionaires. The market for a company is often not clear at the moment of founding. Entrepreneurs find their way to the market by the creative, iterative leverage of what and who they know.
4. Entrepreneurs trust people. The best entrepreneurs internalize the African proverb, “If you want to go fast, go alone; if you want to go far, go together.” To uncover large opportunities, it’s often necessary to coordinate the interests of many. The best entrepreneurs involve more people in the effectuation process, because more people means more assets, which often has a non-linear impact on the eventual outcome. In fact, Sarasvathy argues that a degree of calculated “over-trust” and “intelligent altruism” is a rational strategy for uncovering large multiplayer opportunities that would otherwise be hidden or impossible to achieve.
5. Effectual thinking can be taught. Because entrepreneurship is just an application of effectual logic and not the result of innate personality traits, it can be taught. We do not accept the notion that “scientists are born, not made,” and even while we might believe that some people are more disposed to scientific work than others, we do not accept the notion that people cannot be taught to think scientifically. It is similarly possible to teach people effectual thinking. Tellingly, in communities where effectual thinking is common (Silicon Valley, for one), people who had not previously displayed effectual tendencies are often motivated to adopt the pattern once they see it can be effective at problem solving or in generating wealth. Effectual thinking may not only be teachable; it may be contagious in the right circumstances.
6. Failure increases the odds of individual success. While the success rate of a typical individual venture might be quite low, an entrepreneur that sustains a failure is more likely to succeed in later rounds. Failure teaches the entrepreneur about affordable risk, suggests boundaries for over-trust behaviors, and offers hints about how to maximize opportunity. We should never stigmatize failure, but instead understand that it is part of the effectual process.

Pop Business Books

It is fashionable to tell people stories about Purple Cows, Tipping Points, Outliers, Whuffie, Crushing It, and practicing a Four Hour Workweek. However, these books all have their roots in effectual thinking. Do something. Utilize what you really know to stand out and be different. Work with others to uncover the opportunity you want to find. If books like this can motivate people to act, they’re probably a good thing. But I find they can be crazy-making because they don’t offer the intellectual underpinnings to explain why (or how) these approaches might actually work. They’re most often shaming you into action, and in the end they’re giving you a fish, instead of teaching you how.

Effectuation and Social Networks

The internet (in general) and social networks (like Twitter and Facebook, in particular) are platforms for effectuation. They allow entrepreneurs to find the people who will, at each successive stage, help to contribute to the success of their enterprise. These could be customers, partners, or investors. Any platform that allows like-minded individuals to find each other is an accelerant to the effectuation process. In fact, the like-mindedness of these stakeholders is more important than the roles that they play. What is the difference between a company and a customer when both are stakeholders in the product? Who is paying whom for what and when is a detail that needs tended to, but without finding the people who will participate in the conversation that maximizes the utility of the product, maximizing revenue will never be a consideration.

The Myth of the Visionary Entrepreneur

We give a lot of credit to successful entrepreneurs. Warren Buffett, Bill Gates, Steve Jobs, and Richard Branson are some of the most admired people in the world. In some ways that credit is deserved (though one could argue that civil servants and humanitarians are worthy of even more praise). However, we assign them too much credit, or at the very least we assign them credit for the wrong insights.

These people did not anticipate the circumstances of their success, and did not set out to attain the particular achievements for which they are most well known. Rather, these people are all master effectuators. They took action early. They involved others. They took many successive steps that moved them closer to their passions. They suffered failures. And perhaps most importantly, they are alive to tell about it.

There are many unsung heroes and master effectuators who have had great success but whose stories have ended less well. And we don’t hear as much about them. The final outcome should not diminish their achievement.

You do not need to be the next Bill Gates or Steve Jobs, or even have an idea right now, to be an effectual entrepreneur. Start now and take the journey. You will be glad you did.

References

• Saras Sarasvathy on entrepreneurship at BigThink.com
• Effectuation [book] by Saras Sarasvathy at Google Books
• Effectuation and Over-Trust [article] by Sarasvathy & Dew at Entrepreneur.com

“Disneyland will never be completed. It will continue to grow as long as there is imagination left in the world.” – Walt Disney

Thinking about Eric Ries‘ lean startup methodologies, it occurred to me that Walt Disney pioneered the form in 1955 with the creation of Disneyland. Let’s take a look.

Private Beta: July 17, 1955

Disneyland was officially launched in a private beta in July 1955 to 6,000 guests by invitation only. Unfortunately, those folks shared their invitation links and 22,000 extra guests showed up with forged tickets! Special guests Ronald Reagan and Art Linkletter helped Walt Disney put on a good show that was live-streamed on television.

But the park was anything but a success that first day. Ladies’ heels sunk into the asphalt slurry sidewalks in the hot July sun. A plumbers’ strike meant that only a few water fountains were operational. A gas leak closed several sections of the park.

These setbacks led Disney’s team to refer to this fateful day as Black Sunday. The opening day generated such negative publicity that Disney and his team took special care to invite the press back the next day and in the coming days to see “the real Disneyland” and see things as they had been intended.

But even if things had gone as planned, only 18 attractions were operational those first few days. Tomorrowland had just four attractions and was admittedly incomplete. Several other attractions would open later in 1955 and 1956.

When Disneyland opened in July 1955, it was literally the minimum viable product. With just $5 Million in financing, there was a lot that Walt wanted to put into the park, but there was only so much money and time.

They launched with what they had ready and took the hit for the stuff that was broken. Why? So they could learn from their customers.

Customer Development

Disney listened to his customers. This change log on the site Yesterland.com shows how much stuff opened in 1955 was eliminated or modified over the years.

New rides were added, old ones modified; others became simply obsolete or required updates. The awkward and failure-prone Flying Saucers ride was replaced in 1967 with the Tomorrowland Stage, which was in turn replaced in 1986 with the Magic Eye Theater. The “Rocket to the Moon” became the “Rocket to Mars.” The iconic Matterhorn Bobsleds ride didn’t open until June 1959, nearly four years after the park’s debut!

Disney’s guest relations department has had the benefit of hearing a huge volume of customer feedback – about which attractions people enjoy, which ones they hate, and which ones literally make them sick. With such a powerful mechanism for continually collecting feedback from millions of customers (who take pride in interacting with one of the world’s most prestigious brands), the Disney organization has benefited from a feedback cycle of continuous improvement.

If Disney and his team had gone into “stealth mode” for 55 years, could they ever have produced the park that we see today?

Build On One Success

After Disneyland was successful, and could benefit from a methodology of continuous improvement, they were able to obtain the financing necessary to build Disney World, Epcot, Euro Disneyland, Animal Kingdom, Disney’s California Adventure, and several other projects. You might think of each of these as several products in a portfolio, but they all flowed from the fundamental success of the original and the conviction that it was okay to launch with a halfway-there product in July 1955. They knew that customers would help them find the way forward.

Disneyland has always been the result of the interaction of management and customers to produce an experience that is valuable for its customers and profitable to operate.

Your software business should take the same approach. You don’t know what your customers are going to want. Launch with something workable, even if flawed. Then iterate with continuous improvements after that. Then, you and your customers will be building something valuable together.

Your product should never be completed, as long as there is imagination left in the world!

Entrepreneurs sometimes think that they are the ones “doing the work,” and that investors are but a necessary evil: parasites looking for a free ride on the back of the hardworking startup.

This false dichotomy blinds entrepreneurs to the reality that they, too, are investors and must always think like one. It deeply affects your decision-making process.

The Business Case

Why is your entrepreneurial endeavor a good idea? In a capitalist system, all entrepreneurial activity has just one purpose: to make money. Presumably, your business idea will require the investment of some of both your time and your money. Your time has opportunity cost associated with it (what you could be earning doing something else); and your money could be in the markets earning 5-7%. Over time, your business idea should return a value greater than 7-10% compounded in order to make it worth doing at all. Many businesses can yield several hundred percent returns, either in the form of free cash flow or an exit (selling that cash flow) later on.

You might argue 1) there are other reasons besides making money to start a business, 2) capitalism has flaws, 3) we don’t actually live in a capitalist system. These are fascinating, valid arguments, but let’s put them aside for now.

If you accept the idea that making money is the only reason to start a business, then why would you spend your time and invest your money in a business concept that you would not ask someone else to invest in as well?

Bad answer: Because you don’t think an investor will “get it” and you don’t want to waste your time figuring out how to convince people you don’t know that your idea and team are worthy of their cash.

Good answer: Because you don’t need additional cash and don’t want to give up equity right now. You might consider taking investment after your prototype is complete to make a couple of key hires.

This “bad answer” is a kind of exceptionalism: you think that you are special, that you have all the answers you need, that this time it will be different, and that you won’t ever need investors. But like most exceptionalist attitudes, this mindset is a self-deception.

Always Be Transactable

In economics, transactability is the degree to which something can be traded, usually for money. If you don’t think like an investor yourself, you are adopting a mindset of non-transactability early on. You’re essentially saying, “I don’t even want to think about trading equity for money because I am exceptional and I don’t care about what anyone else thinks of my business.”

The problem with adopting a non-transactable mindset is that it tends to persist and self perpetuate. When do you go from being non-transactable to transactable? When do you decide it’s okay to give up equity to key hires or partners? When do you decide it’s okay to accept a small amount of investment? What will I do when it’s time to sell the business?

Many early-stage entrepreneurs dismiss these questions, assuming that they will “figure them out when they get to them,” or they say that they’ll “never sell their business.” These are both flawed arguments: if you don’t think about how you would trade equity for cash (and vice-versa) from the start, you are likely to handle any situation that requires it poorly.

Your Business Has a Valuation From Day One

This morning, Apple has a market cap valuation of $184.64 Billion (more than Google, less than Walmart). Your business is probably worth less, but it still has a value!

The “valuation” of your business is, quite simply, what someone else would be willing to pay to own it. That is usually a combination of the depreciated value of your assets, less your liabilities, plus a multiple of whatever free cash the business might be available after operating expenses. Some businesses get really high exit multiples (product companies, 8-10X net) and others get lower exit multiples (service companies, 3-4X net). There are no “rules” for business valuation; it’s a lot like home prices. You can look at comparables and take some guesses, but it boils down to what a buyer is willing to pay. It’s nice to have a lot of buyers, too.

You should always be thinking about maximizing the value of your business. What would somebody else pay to be in your shoes? In the early stages, the answer is almost “not much” or even negative. That’s to be expected, but over time, if you succeed the answer will start to be $100K, or $1M, or $10M. You need to be thinking about that trade all the time, and at least have some sense of what your business valuation is and how you might maximize it.

Everybody Is an Investor

You may not think so at first, but you are always asking for investment. If you are hiring someone, they are evaluating your business plan, your chances of success and whether your company represents something they want to invest their time in.

Your trading partners are also evaluating you and determining if they want to enter a relationship with you. Your customers also evaluate whether they should bet on doing business with you.

By keeping transactability always in mind and caring what others think of your business, you will be more likely to appear viable to these constituencies. And being transactable helps you make better deals with partners and customers: you learn what can be traded and what can’t.

I’ll Never Sell!

Some people have no intention of ever selling their business, and instead just want to be their own boss and make some money. This is fine, and most people call this approach running a “lifestyle business.” It’s well suited for sole-proprietors and can offer great personal freedom.

But this can be a treadmill: most often, you’re trading money for your time. Even at a high hourly rate, your income is tied to how many hours you can bill. Take a month off and you lose a month’s pay.

Or, you may have built up a clientele that pays recurring subscription fees or other residual income. While this can free up your time somewhat, if those recurring revenues are not high enough to sell to an acquirer, you can still be stuck.

At some point, you will want to get off this treadmill. What then? Do you just shut down the business and throw it away? That’s a very bad idea. Ask again, what would someone else pay to be in your shoes? The answer might be $50K, or $200K, or $1M depending on your business. You can and should capture this and shop it around in the market.

Or, you might have a service company that you want to pass on to your family. What then? What’s that worth? How do you manage your estate planning effectively?

Any business where “you” are the face of the business can be tough to sell in the market. But even these kinds of businesses can be sold. I’ve seen this happen, and it’s usually for meagre amounts of money. (Think computer sales + repair, HR services, accounting.)

Precisely because of their low market valuations, I’m not big on lifestyle companies. But my point is that they too have valuations that someday need to be reckoned, and to start any company – even a lifestyle company – without thinking about business valuation, investors, and transactability is foolish.

Always Have a Pitch

The simple way to keep your head on straight is to always have a pitch. You should always think about how you would explain your business to an investor. It may well be that the only investor you are concerned about pitching early on is yourself, your partner, your friends and family, or even your spouse. But you should also be thinking about what other kinds of investors (angels and yes, even VCs, where and if applicable) might think too. Because you just might need them later.

You are your own lead investor. If you cannot articulate why you’re doing what you’re doing and why it might generate good returns in the long run, then why do it?

The First Church of American Business teaches that virtue accrues from execution, and that the ability to manage big, complex to-do lists either personally or via delegation is the key to getting ahead in business.

From there it also holds that competition is all about having and managing longer and more complex to-do lists, and beating out the other guy who’s presumably doing the same thing. Books with titles like “Execution,” “Getting Things Done,” and the “7 Habits of Highly Effective People” depict the business world as a crazy-making self-perpetuating scheme of testosterone-fueled competition, which ultimately aims to canonize its Saints the way the sports world does its highest trophy winners.

Business book writers have it particularly easy; they go back and look for the “winners” of this apparent competition (Jack Welch, Bill Gates, Eric Schmidt) and assign them all manner of superhuman qualities. Occasionally they come across somebody who somehow managed to get on top without shaming (and presumably out-executing) all of his or her peers, and they shrug in disbelief and assume that they must have “the vision thing” and canonize the schmuck anyway; the last thing the high priests of productivity would want to admit was that they didn’t see someone coming.

My deepest wish is to go back to 1960 or 1985 (maybe both) and gouge out the eyes of these practitioners with their own tassel loafers. We’ve seen how this all worked out; this approach to business has led us to the only place it could: a testosterone-fueled sham of an economy.

Certainly execution is important. But in the rush to assign virtue to execution itself, we’ve lost sight of what it is we’re executing – that “vision thing.”

Design is the most important force for good in the world today. Overstated? I don’t think so. Design indicates intent. I believe humanity has good intentions for the world; therefore I believe that design is the way in which we will manifest those good intentions.

Many people are confused about what design is. They confuse it with industrial design (iPod, Beetle, Aeron Chairs) or graphic design (packaging, advertising, marketing, websites), or simply assume it’s one of those “art things” that they don’t have to worry about because they didn’t study it in business school.

But in fact, people design things every day. We are all designers of our lives. In the simplest choices, we are signaling our intentions about how we want to interact with the world and sending subtle cues about the kinds of interactions we desire.

Getting good at design is a little bit like becoming a Jedi master – it comes from a place inside where less is more and where silence is more powerful than sound.  It’s about looking for the reasons why something will work rather than the ways it might fail. It’s about finding the line, the melody, the art, the poetry in mundane transactional details and teasing it out to make it serve you. It’s tough to explain, but over the next few days, I’ll be reviewing some recent, unconventional examples of design in my own experience.

Design is all about executing a small number of the right tasks.