If integrity is viewed as merely a virtue, the temptation to sacrifice it for short-term gain can be great:

For many people, virtue is valued only to the degree that it engenders the admiration of others, and as such it is easily sacrificed especially when it would not be noticed or can be rationalized. Sacrificing integrity as a virtue seems no different than sacrificing courteousness, or new sinks in the men’s room.

Properly understood, integrity is more than a virtue.  It’s a necessary (though not sufficient – companies also need competitive, organizational, technological and human strategies) condition for value maximization:

In effect, integrity is a factor of production just like knowledge, technology, labor and capital, but it is undistinguished – and its affect (by its presence or absence) is huge. Integrity matters. Not because it is virtuous, but because it creates workability.  And workability increases the opportunity for performance, and maximum workability is necessary for realizing maximum value.

Erhard and Jensen build their case and explain their terms:  personal integrity is (broadly speaking) ”honoring one’s word,” while an entity or system has integrity when it is “whole, complete and stable.”  (I.e., its design is capable of producing the intended result, its implementation is faithful to the design, and its use is consistent with the design’s purpose.)  To illustrate what they mean by workability – “the bridge connecting integrity to value creation” – they describe a wheel with missing spokes: “It is not whole, complete and stable. It will become out-of-round, work less well and eventually stop working entirely.”

All this applies to an organization as well as human beings. An organization or system is in integrity when it is whole and complete. This means it honors its word, both to its employees and to its customers, suppliers and other stakeholders. This means nothing is hidden, no deception, no untruths, no violation of contracts or property rights, etc. And if the organization refuses to play by any of the rules of the game it is in, integrity requires it to make this clear to all others and to willingly bear the costs of not playing by one or more of the rules of the game.

This line of thinking resonates with something we argued two years ago in When Business Promotes Honesty.  Quoting sometime guest blogger Will Harrell (founding partner of Capco Asset Management in Tampa), we wrote:

The upside from being perceived as a reliable, consistent, trustworthy, &etc. vendor of certain kinds of goods and services is simply huge. Costco’s CEO has a line I love: “No easy hits on the customer.” Honesty is just a sub-category of this thesis, which in many cases has more to do with product quality or user experience than honesty per se: McDonald’s consistency, the taste of a Hershey bar, etc. It’s also not limited to customers – similar considerations apply to suppliers, capital sources, and employees.

The paper is thought-provoking, as one would expect from these authors.  Our own less scholarly endorsement of the business case for honesty (the moral case is another discussion) rests on the near-universal desire for repeat business.  While a short-term advantage in a single transaction might be gained by jettisoning the “virtue” of integrity, honesty and consistency are critical to success over the long term.  We also put a premium on transparency, as it’s easier to remember the importance of being honest when everyone involved in a business relationship can observe how decisions are being made.

We’ll close with one final thought, one which we made in that same piece two years ago:  there’s a good argument to be made that businessmen are more honest (or less dishonest) in their dealings than preachers, politicians, and professors.  Dwight R. Lee makes the case over at The Independent Review:

Businessmen interested in long-run survival are more honest in their professional dealings than are many other groups in society—not because they are more virtuous, but because they face more effective constraints. Their customers can usually detect and avoid deception more easily than can a politician’s constituents, a professor’s students, and a preacher’s congregants. …It turns out that, because most businesses are profitable only by earning the patronage of returning customers, they have stronger incentives to be truthful than do preachers (“no one can ‘test drive’ a preacher’s most important promise,” Lee observes), politicians (for whom elections are sporadic and often predetermined by gerrymandering and other devices), or professors (whose customers, the students, “often do not care much about the honesty of the professors’ claims”).

The Top 10 looks familiar to us, as it constitutes most of the geography in which we have focused our investment efforts for over twenty years now, and adds to the growing list of evidence that some states understand job creation better than others.  The 2012 edition of their annual survey of CEOs includes a feature on What Keeps Texas on Top:

The state is growing its own companies but also is displaying remarkable success in luring investments from other states, particularly California, which once again ranks last in our survey. A raft of small, technology companies have either relocated to Texas or moved key operations there.  Bigger California companies, such as Facebook, eBay and PetCo also have recently opened operations in Texas, and major manufacturers from different states, such as General Electric’s transportation unit and Caterpillar have located big new plants in Fort Worth and Victoria, respectively.  “Employers from around the nation and all over the world continue to look to Texas as the premier location for business expansion, relocation and job growth thanks to our low taxes, reasonable and predictable regulations, fair legal system and skilled workforce,” Gov. Rick Perry told Chief Executive.

Texas has powerful momentum and it’s difficult to see what could halt it…  The sheer diversification in its economy—all the way from wheat farming to semiconductors—suggests that the state could absorb many punches and keep on rolling.

• Entrepreneurial innovation has picked up over the last five years.
• Exits are back in both quantity and quality, and should be aided by the JOBS Act.  
• New software methods have shrunk the cost of starting a software company. 

The article seems written from a little bit of a East- or West- coast perspective, and perhaps with a slight early-stage tech bias.  Our business model is not dependent on the IPO market and is diversified both geographically and across several sectors, so we still enjoyed an increase in deal flow throughout the “down” decade Hixon contemplates.  But it’s still good to hear our industry has rebounded.  Here’s Hixon:

Venture capital returns took a huge hit in 2001-2003, when the tech bubble collapsed — investors lost 40% in two years. Since then the industry has been recovering, and the severe 2008-2009 financial crisis produced only a small dip. Absent the financial crisis, returns have been in the 12%-16% range.

Half the supply of venture capital has disappeared since 2006. The cost of starting businesses is way down. Exits have rebounded, and the “IPO On-Ramp” provisions of the JOBS Act promise further upside. Fundamentally, the prospects for Venture Capital investment look very bright.

Many small private companies have no or underdeveloped boards.  We encourage all our portfolio companies to build great boards and then use them constantly.  Entre- preneurs are almost always surprised how much value a good board can bring to their companies, and the best boards are a function of both the quality of the people involved and, just as importantly, how they operate.

Here we share two recent items on the subject of board recruitment – one that deals with the topic in broad terms and one that looks specifically at recruiting “digital” directors.

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In Recruiting the Digital Director, Julie Hembrock Daum, Greg Sedlock and Dana Wade of Spencer Stuart discuss the implications social media’s growth has for the recruiting process.  Demand for digital expertise at the board level is rising faster than the supply of qualified candidates, who can come from nontraditional backgrounds.  Boards may have to recalibrate their perceptions about what an ideal director looks like, define what digital means for the company, and understand the talent trade-offs:

Recruiting board directors from the digital, consumer Internet or technology fields may mean compromising on conventional benchmarks, such as prior board experience or international expertise, in favor of more contemporary skill-sets, for example, experience with social media platforms or digital advertising. Additionally, boards should understand that directors with digital expertise may not have achieved the same stature as candidates from more traditional fields; many of these candidates have not reached the C-level, for example. These young, ambitious and, oftentimes, time-starved executives can be more transient than more established executives, and they may be less familiar with the customs of a corporate boardroom.

Several questions during the recruiting process must be explored.  Is public or private experience critical?  How relevant is governance expertise?  What core competencies does the board require? Are they seeking broad experience or something specific to a hot technology of the day?  And then, once recruited, the new director must be positioned for success:

(C)arefully define the role that the new director is expected to play on the board. Is the new director expected to contribute in the same manner as other directors, or is there a digital-specific function he or she is expected to fill? Is the new director expected to chair a committee? Answering these questions is important when recruiting any new director, but especially [for digital directors].

***

Firas Raouf of OpenView Partners makes parallel recommendations, with a broader view, in How to Recruit a Board of Directors:

Recruiting a board starts by you realizing that you should recruit a board the way you would recruit employees. Start by defining your needs.  One approach is to examine your skill sets as a founder/CEO… Then think about the skill sets you lack and where a mentor could help in the role of a board member… Then think about your plans for growing the company and the role of a board member in opening strategic partnership doors, whether for funding or business development.

Rauof also describes a few symptoms associated with a bad board:

• The CEO frequently laments that board meetings take up too much of time for the value added
• The CEO feels the urge to hide things from them, and/or doesn’t think they’d understand the business
• Members spend too much time between projects. When you run out of things for them to do, it’s time to recruit their replacements.

Most founders/CEOs think that a board is something that creates a lot of unnecessary work for them, adds little value, and is manned by individuals who will get in the way of running the company.  That can be true if you recruit bad board members. But if you recruit great board members, you will get great value.

The Founder’s Dilemmas, by Harvard Business School professor Noam Wasserman, compiles 10 years’ worth of studies of 3,600 start-ups (and nearly 10,000 founders) to examine the pitfalls of entrepreneurship:

People are motivated by high-profile stories of hugely successful entrepreneurs, but the truth is that it’s very hard to become one.  The “ultimate” entrepreneur combines someone who’s passionate and has a strong vision that they pursue single-mindedly with someone who is analytical and looks down the road and wants to understand the pitfalls along the way before they make early decisions that will get them in trouble.  [It's a hard combination to strike.]  My mission is to inform entrepreneurs about key lessons based on data, rather than merely what’s anecdotally “known,” so they don’t have to learn the hard way and they don’t get burned by anecdotes that capture the wrong lessons.

In one review, Professor Wasserman is asked, in light of this analysis – the rare combination of skills required to succeed – whether or not co-founders make sense:

You have to judge founder by founder, and idea by idea. Some ideas lend themselves to one person being able to tackle it. Others that are more complex require disparate skills, and to maximize success you need things that you don’t have. Some founders who’ve accumulated work experience in the industry and are able to manage multiple functions, and whose goals and personalities fit with being solo, might be better off alone than a founder with big holes [in his experience] who will open himself up to much bigger risks if he doesn’t fill them.

Irrespective of how many founders are involved in the idea’s germination, growing the acorn into a mighty oak is a long-term project that will eventually include adding partners who share the vision and can bring additional resources – financial, expert, and network – to bear.  Choosing partners who best fit requires as much rigor and thoughtfulness as any decision an entrepreneur makes.

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The Wide Lens, by Tuck School of Business professor Ron Adner, explores the “business ecosystem” – distributors, retailers, and salespeople – critical to the launch of any successful innovation.  Adner recounts successes (Apple’s path to market dominance), monumental failures (Michelin’s run-flat tires or Pfizer’s inhalable insulin), and works-in-progress (electric cars or electronic health records).

Companies understood how their success depends on meeting the needs of their end customers, delivering great innovation, and beating the competition; but [they fell] victim to the innovator’s blind spot: failing to see how their success also depended on partners who themselves would need to innovate and agree to adapt in order for their efforts to succeed…  To be sure, great customer insight and execution remain vital, [but] two distinct risks now take center stage:

• Co-Innovation Risk: The extent to which the success of your innovation depends on the successful commercialization of other innovations.
• Adoption Chain Risk: The extent to which partners will need to adopt your innovation before end consumers have a chance to assess the full value proposition.

…When you try to break out of the mold of incremental innovation, ecosystem challenges are likely to arise… a strategy that does not properly account for the external dependencies on which its success hinges does not make those dependencies disappear.  It just means that you will not see them until it is too late. … Dependence is not becoming more visible, but it is becoming more pervasive. What you don’t see can kill you.

Adner provides an easy-to-grasp example in an excerpt printed in The Atlantic:  the first portable digital audio player (1998), cleverly (?) named “MPMan”:

It sold 50,000 players globally in its first year. But [it was very different than the Walkman] 20 years earlier.  You couldn’t purchase them in traditional retail settings.  Downloading an album – legally or not – could be a multi-hour affair. It didn’t matter that MPMan was first – it wouldn’t have mattered if they were 6th, 23rd, or 42nd. Without the widespread availability of mp3s and broadband, the value proposition could not come together.

As we reported in The 10 rules of entrepreneurship, the best products don’t always win.  Compelling innovations can and do fail after launch – as did this precursor to Facebook.  It’s a long and difficult journey from idea to successful business, involving many inter-related factors.

Scott Anthony, writing at the Harvard Business Review Blog Network  gets at the nature of the thing – and coins a great phrase - when he advises not to confuse passion with competence:

When I’m evaluating entrepreneurs and their ideas, I look for “innovation bipolarity,” a version of F. Scott Fitzgerald’s first-rate intelligence: “the ability to hold two opposed ideas in the mind at the same time and still retain the ability to function.” Entrepreneurs should be able to argue passionately that their idea will change the world, and then, without skipping a beat, honestly assess the risks standing in the way of its success and describe what they are doing to mitigate them.

Of course, there are examples of dogmatism and fanaticism triumphing in the face of healthy skepticism. But that’s not a scalable approach to innovation.

Mr. Anthony’s ”psychoanalytical” recommendation ties in nicely with the “genetic” markers identified by Dyer/Gregersen/Christensen in their double helix analogy from The Innovator’s DNA: 

Innovative entrepreneurs have something called creative intelligence, which enables discovery yet differs from other types of intelligence (as suggested by Howard Gardner’s theory of multiple intelligences).  It is more than the cognitive skill of being right-brained. Innovators engage both sides of the brain as they leverage the five discovery skills to create new ideas.  In thinking about how these skills work together, we’ve found it useful to apply the metaphor of DNA. Associating is like the backbone structure of DNA’s double helix; four patterns of action (questioning, observing, experimenting, and networking) wind around this backbone, helping to cultivate new insights.  And just as each person’s physical DNA is unique, each individual we studied had a unique innovator’s DNA for generating breakthrough business ideas.

In our experience, the entrepreneurs who make it from garage to funding to successful high-growth company display another type of bipolarity: the ability to reason causally and effectually.    Saras Sarasvathy, professor at the Darden School of Business, likens great entrepreneurs to Iron Chefs,  “at their best when presented with an assortment of motley ingredients and challenged to whip up whatever dish expediency and imagination suggest” (effectual reasoning), while successful corporate executives “set a goal and diligently seek the best ways to achieve it” (causal).

Different authors, different analogies, but on the same quest:  to capture the eternal sunshine of an entrepreneur’s mind.

BumperCrop

This year Tampa has its own bus in the competition, and one of the teams on the bus includes former BPV intern Doug Smith.  You can read about Tampa’s entry at examiner.com, and you can check out Inc‘s write-up from last year’s event.  Doug will be tweeting his team’s progress at @_BumperCrop, their entry that “helps local small-scale farmers and home-growers connect to local consumers to easily share and exchange their excess crops.”  You can also check out their project site BumperCrop.com, or follow @StartupBusFL for our state’s other competitors.  StartupBus.com provides real-time comprehensive coverage of the entire competition.

• Partner with VCs who have built winners in your space and reference well with entrepreneurs and CEOs. They’ll make a difference. (#4)
• Create a market impression that is greater than reality.  This has to be done carefully – history is littered with companies that failed to live up to the hype. (#5)
• Be honest and transparent with your team and with your board. (#7)

While on the opposite side of the country from Mr. Richards, investing in different ventures, we’ve dispensed similar advice here at NVSE:

On the entrepreneur-VC partnership in The Fate of Control:

Entrepreneurs who are raising growth capital (i.e. bringing on a long term partner) as opposed to selling their businesses (i.e. get the best valuation) should invest a lot of time conducting due diligence on their prospective financial partner.  A credible partner will let you (indeed, encourage you) to talk to as many of their previous entrepreneur partners as you want to get a feel for what they are like to work with.  Entrepreneurs should ask for references from successful investments, unsuccessful investments and current investments.  Ask for the venture firm’s entire list of previous and current investments and randomly call a number of them.  Find some independent sources on your own who weren’t provided as references but know the venture firm.  Picking a financial partner is as important a decision as any an entrepreneur will make in building his or her company.  Most venture firms will have a good “rap”, but it’s absolutely essential to verify that through due diligence.

On striking the right balance between impressions and reality, in Trust Me:

One particular conclusion resonated strongly with us and is applicable for the duration of any successful Long Term Relationship, whether referencing the product, business, or the little things:  To be effective, each of these actions must be underpinned by authenticity.  In other words, only promise what you can deliver.

On honesty and transparency (1 of 2), in Communicating Good News and Bad:

In our experience, the relationship between entrepreneur and venture partner in private companies is more cooperative, longer-term, and (mercifully) not subject to the quarterly reporting pressures of public companies.  Moreover, venture investors have real “skin in the game” and have the same incentive as the entrepreneur to understand the nuances of the business and focus on long term value creation.  As a result, the communication of good news and bad tends to be more forthright and in real-time, enabling partners (assuming they are good partners!) to understand intuitively the right kind of counsel and support to offer during both the good times and during the inevitable challenges of building a business.

…honest and transparency (2 of 2), in When Business Promotes Honesty:

In our experience, the business case for honesty (the moral case is another discussion) can often be based on the fact that many businesses rely on repeat business.  So although dishonesty may improve the profit or advantage in a single transaction it would result in less success over the long term… BPV often backs the same entrepreneurs in more than one business, and we view honesty and consistency as critical to sustaining long term relationships for long term growth as opposed to trying to squeeze maximum value from a single transaction.  We also put a premium on transparency, as it’s easier to remember the importance of being honest when everyone involved in a business relationship can observe how decisions are being made.

That was the motivational message given to NASCAR driver Kurt Busch by his team owner for Saturday Night’s Shootout at the Daytona International Speedway.  For those of you who are Formula 1 followers and have observed the highly complex and computerized detachable steering wheels in those machines, please understand that if you bring only the very traditional NASCAR version of that part back to the garage after a race, the rest of the car is scrap.

That was a not too subtle way of saying that the owner expected Busch to push himself and his car to the limits and take whatever risks necessary to earn the checkered flag.  (He didn’t, by the way.)  In this week leading up the to the annual Daytona 500, I thought a racing theme would be a good way to focus on motivational issues for your startup employees and even your cofounders.

Job one is to make sure the founding team is all on the same page with respect to enthusiasm and work ethic…  And, it goes without saying that you need to lead by example.  Far more important at the early stage is leadership, as opposed to management.  If you show that you are willing to give the company your utmost and literally drive the wheels off to beat the competition, your employees will follow you.  All those textbook methods of performance reviews, pay incentives, etc. will come in handy when you get to the 50th or 100th employee, but right now you’ve got to be the one out front – with inexhaustible energy, enthusiasm, creativity, and a clearly articulated vision.

Excellent point, excellent analogy - similar to one we ourselves once used when writing on a different topic:  failure.  In Danica Patrick vs. Ricky Bobby on the subject of failure, we feature a video from Honda’s “Dream the Impossible” documentary series in which engineers (and Danica Patrick) discuss the role multiple failures played in the successful development of their racing engine.  The video has its own “bring me the steering wheel” moment (engine pieces, actually), and does a very nice job of tying Mr. Dyer’s and our points together.  Failure is a byproduct of pushing the envelope, so it’s critical to learn from mistakes and to fail the right way.

Consider the conclusions from some recent research: Small businesses may not be a strong source of prosperity. Not only are they less productive than their larger counterparts, they have, according to a World Bank study, a lower rate of productivity growth because they invest only a small proportion of total R&D money. They therefore charge higher prices and pay lower average wages.

An analysis of census data by economists Erik Hurst and Benjamin Pugsley found that companies employing fewer than 20 people made up 90 percent of the six million businesses with one or more employees in the US in 2007. Most were small entrepreneurs creating what might be considered “lifestyle” jobs for themselves, intending to stay small and avoid employing many others. Eighty percent that were studied in detail didn’t create a single job between the years of 2000 and 2003. Another study, The Illusions of Entrepreneurship: The Costly Myths That Entrepreneurs, Investors, and Policy Makers Live By, by Scott Shane, found that while small businesses create more jobs than their larger counterparts, they also destroy more jobs. While they created jobs in the year of their founding, they netted out destroying jobs in years two through five as most of them failed, suggesting less job security than in larger organizations.

At the international level, economists Rafael La Porta and Andrei Schleifer conclude that a nation’s wealth is inversely proportional to the share of jobs provided by small businesses. Again, this is due in part to the lower productivity of such jobs.

We believe this argument is based on a category error:  the misconception that lumps together “lifestyle” companies and high-growth start-ups.  Job growth comes mostly from new businesses which grow rapidly, not the more common short-hand of “small businesses.”  The jobs created by high-growth companies, busy inventing products and services (and sometimes industries), dwarf those lost in the ongoing employment churn experienced by small businesses.  The net result is remarkably stable cumulative job creation from start-ups despite their high failure rate.  The aforementioned study by Scott Shane may be correct that small businesses “destroy” jobs in years two through five as they fail – but by that fifth year the surviving firms still employ 78% of the jobs created, and the additional start-ups created in those intervening years more than make up for the lost 22%.

Remember this about those large companies:  they all have birthdays, either as start-ups themselves or as spin-offs from other companies who once were start-ups.  Over half the companies on the F500 were started during a recession or bear market.  The patents for the Television, Jukebox, and Nylon were granted during the greatest period of job destruction in our history:  The Great Depression.  (Although we can’t confirm any patent information on the chocolate chip cookie, it too was invented at the same time.)  This is precisely the creative destruction that makes our economy an engine of innovation and wealth creation.

At the international level, the 2008 study by La Porta and Schleifer contemplates the “informal” firms operating in gray or black markets, who intentionally avoid scale in order to avoid detection, and therefore lag in productivity gains, have trouble financing growth, and seldom mature into larger firms.  For those countries, larger – i.e., formal – is better, but obviously these reasons don’t apply to the U.S. economy.  We also suspect that in many of those countries, national wealth is skewed by the large (often government-run) operations who extract natural resources.   Any nation that favors its large corporations will indeed see less wealth created by its small businesses.  Over the long term it will see less wealth created, period.

Anyone who’s worked for a large corporation – especially in an R&D department – would not rely primarily on that model for innovation.

Anyone who’s worked for a large corporation – especially in a dying industry – would not rely primarily on that model for job growth.

Yes, start-ups lack the economies of scale and R&D budgets of larger firms; but that’s the support venture capital provides.  Those start-ups that do gain traction are able to raise capital, and, with hard work and a little luck, become large companies.  With early-stage activity at its lowest level since 1977, it’d be a good time to help restore a favorable and predictable environment for new business formation – for entrepreneurs and their sources of capital.

Derek Thompson, senior editor at The Atlantic, makes the case in “The Entrepreneur State: Safety Nets for Startups, Capitalism for Corporations.“  He starts from a different question: “What if the law were biased, not toward the oil and gas industry or the cotton farmers, but to the creative, the self-employed, and the entrepreneurs?” 

The broadest debate in Washington, and on the primary trail, is about whether government needs to step up to create jobs or step back to allow the market to work by itself. But what if we need both: A stronger safety net to lessen risk for wannabe-startups and purer free market approach for established corporations?  …

This isn’t industrial planning. It’s not about picking winners. It’s making rules that increase the odds that entrepreneurs play the game in the hope that many of them will win.

As a general rule, entrepreneurs don’t win. They mostly fail. Trying to start a company is like playing a high-risk casino game with your career. It’s roulette, except thousands of dollars, thousands of hours, and unquantifiable sacrifices are on the table. If we want more people to play startup roulette, we shouldn’t focus on how much to tax them if they win $200,000. We should focus on minimizing the downside of losing so that startup roulette feels less risky. After all, startups shouldn’t just be for rich kids who can afford to take a chance on a big idea.

You can build a stronger safety net stitch by little stitch, by creating new tax deductions for startups or making long-term venture capital gains totally tax free. Or you can focus on the whole net…  We could fortify welfare for startups as we disassembled the welfare state for corporations. The corporate tax code is more holes than Swiss cheese, which distorts business decisions and forces us to keep one of the highest marginal tax rates in the world. Reducing both the rate and the exemptions would raise taxes on some companies and cut taxes for others, but it might also level the playing field, attract more investment, and even raise more money for the government. Combined with our bloated, if well-intentioned, regulatory system, corporate welfare saps the market of competitiveness and makes voters angry by what they perceive as favoritism among elites.

It would be naive to think we can cleanse the law of all biases. But what if the law were biased, not toward the oil and gas industry or the cotton farmers, but toward the creative, the self-employed, and the entrepreneurs? What if we combined a liberal approach toward mitigating risk for startups with a conservative approach toward taxing and regulating established corporations? The result might be more people playing the entrepreneur’s game, more entrepreneurs winning the game and ramping up their companies, and more companies to hire more workers.