How Entrepreneurship Works
Entrepreneurship is one of the resources economists categorize as integral to production, the other three being land/natural resources, labor, and capital. An entrepreneur combines the first three of these to manufacture goods or provide services. They typically create a business plan, hire labor, acquire resources and financing, and provide leadership and management for the business.
Entrepreneurs commonly face many obstacles when building their companies. The three that many of them cite as the most challenging are as follows:
- Overcoming bureaucracy
- Hiring talent
- Obtaining financing
Economists have never had a consistent definition of “entrepreneur” or “entrepreneurship” (the word “entrepreneur” comes from the French verb entreprendre, meaning “to undertake”). Though the concept of an entrepreneur existed and was known for centuries, the classical and neoclassical economists left entrepreneurs out of their formal models: They assumed that perfect information would be known to fully rational actors, leaving no room for risk-taking or discovery. It wasn’t until the middle of the 20th century that economists seriously attempted to incorporate entrepreneurship into their models.
Three thinkers were central to the inclusion of entrepreneurs: Joseph Schumpeter, Frank Knight, and Israel Kirzner. Schumpeter suggested that entrepreneurs—not just companies—were responsible for the creation of new things in the search for profit. Knight focused on entrepreneurs as the bearers of uncertainty and believed they were responsible for risk premiums in financial markets. Kirzner thought of entrepreneurship as a process that led to the discovery.
How to Become an Entrepreneur
After retiring her professional dancing shoes, Judi Sheppard Missett became an entrepreneur by teaching a dance class to civilians in order to earn some extra cash. But she soon learned that women who came to her studio were less interested in learning precise steps than they were in losing weight and toning up. Sheppard Missett then trained instructors to teach her routines to the masses, and Jazzercise was born. A franchise deal followed. Today, the company has more than 8,300 locations worldwide.1
Following an ice cream making correspondence course, two entrepreneurs, Jerry Greenfield and Ben Cohen paired $8,000 in savings with a $4,000 loan, leased a Burlington, Vt., gas station, and purchased equipment to create uniquely flavored ice cream for the local market.2 Today, Ben & Jerry’s hauls in millions in annual revenue.
Although the “self-made man” (or woman) has always been a popular figure in American society, entrepreneurship has gotten greatly romanticized in the last few decades. In the 21st century, the example of Internet companies like Alphabet, fka Google (GOOG), and Facebook (FB), both of which have made their founders wildly wealthy, have made people enamored with the idea of becoming entrepreneurs.
Unlike traditional professions, where there is often a defined path to follow, the road to entrepreneurship is mystifying to most. What works for one entrepreneur might not work for the next and vice versa. That said, there are seven general steps that most, if not all, successful entrepreneurs have followed:
Ensure Financial Stability
This first step is not a strict requirement but is definitely recommended. While entrepreneurs have built successful businesses while being less than financially flush (think of Facebook founder Mark Zuckerberg as a college student), starting out with an adequate cash supply and ensuring ongoing funding can only help an aspiring entrepreneur, increasing their personal runway and giving them more time to work on building a successful business, rather than worrying about making quick money.
Build a Diverse Skill Set
Once a person has strong finances, it is important to build a diverse set of skills and then apply those skills in the real world. The beauty of step two is it can be done concurrently with step one.
Building a skill set can be achieved through learning and trying new tasks in real-world settings. For example, if an aspiring entrepreneur has a background in finance, they can move into a sales role at their existing company to learn the soft skills necessary to be successful. Once a diverse skill set is built, it gives an entrepreneur a toolkit that they can rely on when they are faced with the inevitability of tough situations.
Much has been discussed on if going to college is necessary to become a successful entrepreneur. Many famous entrepreneurs are famous for having dropped out of college: Steve Jobs, Mark Zuckerberg, and Larry Ellison, to name but a few.3
Though going to college isn’t necessary to build a successful business, it can teach young individuals a lot about the world in many other ways. And these famous college dropouts are the exception rather than the norm.3 College may not be for everyone and the choice is personal, but it is something to think about, especially with the high price tag of a college education in the U.S.
It is not true that majoring in entrepreneurship is necessary to start a business. People that have built healthy businesses have majored in many different subjects and doing so can open your eyes to a different way of thinking that can help you in establishing your business.
Consume Content Across Multiple Channels
As important as building a diverse skill set is, the need to consume a diverse array of content is equally so. This content can be in the form of podcasts, books, articles, or lectures. The important thing is that the content, no matter the channel, should be varied in what it covers. An aspiring entrepreneur should always familiarize themself with the world around them so they can look at industries with a fresh perspective, giving them the ability to build a business around a specific sector.
Identify a Problem to Solve
Through the consumption of content across multiple channels, an aspiring entrepreneur is able to identify various problems to solve. One business adage dictates that a company’s product or service needs to solve a specific pain point; either for another business or for a consumer group. Through the identification of a problem, an aspiring entrepreneur is able to build a business around solving that problem.
It is important to combine steps three and four so it is possible to identify a problem to solve by looking at various industries as an outsider. This often provides an aspiring entrepreneur with the ability to see a problem others might not.
Solve That Problem
Successful startups solve a specific pain point for other companies or for the public. This is known as “adding value within the problem.” Only through adding value to a specific problem or pain point does an entrepreneur become successful.
Say, for example, you identify the process for making a dentist appointment is complicated for patients, and dentists are losing customers as a result. The value could be to build an online appointment system that makes it easier to book appointments.
Network Like Crazy
Most entrepreneurs can’t do it alone. The business world is a cutthroat one and getting any help you can will always help and reduce the time it takes to achieve a successful business. Networking is critical for any new entrepreneur. Meeting the right people that can introduce you to contacts in your industry, such as the right suppliers, financiers, and even mentors can be the difference between success and failure.
Attending conferences, emailing and calling people in the industry, speaking to your cousin’s friend’s brother who is in a similar business, will help you get out into the world and discover people that can guide you. Once you have your foot in the door with the right people, conducting a business becomes a lot easier.
Lead by Example
Every entrepreneur needs to be a leader within their company. Simply doing the day-to-day requirements will not lead to success. A leader needs to work hard, motivate, and inspire their employees to reach their best potential, which will lead to the success of the company.
Look at some of the greatest and most successful companies; all of them have had great leaders. Apple and Steve Jobs, Bill Gates and Microsoft, Bob Iger and Disney, and so on. Study these people and read their books to see how to be a great leader and become the leader that your employees can follow by the example you set.
Given the riskiness of a new venture, the acquisition of capital funding is particularly challenging, and many entrepreneurs deal with it via bootstrapping: financing a business using methods such as using their own money, providing sweat equity to reduce labor costs, minimizing inventory, and factoring receivables.
While some entrepreneurs are lone players struggling to get small businesses off the ground on a shoestring, others take on partners armed with greater access to capital and other resources. In these situations, new firms may acquire financing from venture capitalists, angel investors, hedge funds, crowdfunding, or through more traditional sources such as bank loans.
Resources for Entrepreneurs
There are a variety of financing resources for entrepreneurs starting their own businesses. Obtaining a small business loan through the Small Business Administration (SBA) can help entrepreneurs get the business off the ground with affordable loans. SBA helps connect businesses to loan providers.
If entrepreneurs are willing to give up a piece of equity in their business, then they may find financing in the form of angel investors and venture capitalists. These types of investors also provide guidance, mentorship, and connections in addition to just capital.
Crowdfunding has also become a popular way for entrepreneurs to raise capital, particularly through Kickstarter. An entrepreneur creates a page for their product and a monetary goal to reach while promising certain givebacks to those who donate, such as products or experiences.
Bootstrapping for Entrepreneurs
Bootstrapping refers to building a company solely from your savings as an entrepreneur as well as from the initial sales made from your business. This is a difficult process as all the financial risk is placed on the entrepreneur and there is little room for error. If the business fails, the entrepreneur also may lose all of their life savings.
The advantage of bootstrapping is that an entrepreneur can run the business with their own vision and no outside interference or investors demanding quick profits. That being said, sometimes having an outsider’s assistance can help a business rather than hurt it. Many companies have succeeded with the bootstrapping strategy, but it is a difficult path.
Small Business vs. Entrepreneurship
A small business and entrepreneurship have a lot in common but they are different. A small business is a company, usually, a sole-proprietorship or partnership, that is not a medium-sized or large-sized business, operates locally, and does not have access to a vast amount of resources or capital.
Entrepreneurship refers to an individual that has an idea and intends to execute on that idea, usually to disrupt the current market with a new product or service. Entrepreneurship usually starts as a small business but the long-term vision is much greater, to seek high profits and capture market share with an innovative new idea.
How Entrepreneurs Make Money
Entrepreneurs make money like any business: they seek to generate revenues that are greater than costs. Increasing revenues is the goal and that can be achieved through marketing, word-of-mouth, and networking. Keeping costs low is also critical as it results in higher profit margins. This can be achieved through efficient operations and eventually economies of scale.
Taxes for Entrepreneurs
The taxes you will pay as an entrepreneur will depend on how you set up your business in terms of structure.
Sole Proprietorship: A business set up this way is an extension of the individual. Business income and expenses are filed on Schedule C on your personal tax return and you are taxed at your individual tax rate.
Partnership: For tax purposes, a partnership functions the same way as a sole proprietorship, with the only difference being that income and expenses are split amongst the partners.
There are many benefits entrepreneurs can achieve through taxes, such as deducting their home office and utilities, mileage for business travel, advertising, and travel expenses.
C-Corporation: A C-corporation is a separate legal entity and has separate taxes filed with the IRS from the entrepreneur. The business income will be taxed at the corporate tax rate rather than the personal income tax rate.
Limited Liability Company (LLC) or S-Corporation: These two options are taxed in the same manner as a C-corporation but usually at lower amounts.
7 Characteristics of Entrepreneurs
What else do entrepreneurial success stories have in common? They invariably involve industrious people diving into things they’re naturally passionate about.
Giving credence to the adage, “find a way to get paid for the job you’d do for free,” passion is arguably the most important component startup business owners must have, and every edge helps.
While the prospect of becoming your own boss and raking in a fortune is alluring to entrepreneurial dreamers, the possible downside to hanging one’s own shingle is vast. Income isn’t guaranteed, employer-sponsored benefits go by the wayside, and when your business loses money, your personal assets can take a hit; not just a corporation’s bottom line. But adhering to a few tried and true principles can go a long way in diffusing risk. The following are a few characteristics required to be a successful entrepreneur.
When starting out, it’s essential to personally handle sales and other customer interactions whenever possible. Direct client contact is the clearest path to obtaining honest feedback about what the target market likes and what you could be doing better. If it’s not always practical to be the sole customer interface, entrepreneurs should train employees to invite customer comments as a matter of course. Not only does this make customers feel empowered, but happier clients are more likely to recommend businesses to others.
Personally answering phones is one of the most significant competitive edges home-based entrepreneurs hold over their larger competitors. In a time of high-tech backlash, where customers are frustrated with automated responses and touch-tone menus, hearing a human voice is one surefire way to entice new customers and make existing ones feel appreciated; an important fact, given that some 80% of all business is generated from repeat customers.
Paradoxically, while customers value high-touch telephone access, they also expect a highly polished website. Even if your business isn’t in a high-tech industry, entrepreneurs still must exploit internet technology to get their message across. A startup garage-based business can have a superior website than an established $100 million company. Just make sure a live human being is on the other end of the phone number listed.
Few successful business owners find perfect formulas straight out of the gate. On the contrary: ideas must morph over time. Whether tweaking product design or altering food items on a menu, finding the perfect sweet spot takes trial and error.
Former Starbucks Chair and CEO Howard Schultz initially thought playing Italian opera music over store speakers would accentuate the Italian coffeehouse experience he was attempting to replicate. But customers saw things differently and didn’t seem to like arias with their espressos. As a result, Schultz jettisoned the opera and introduced comfortable chairs instead.
3. Money Savvy
Through the heart of any successful new business, a venture beats the lifeblood of steady cash flow, which is essential for purchasing inventory, paying rent, maintaining equipment, and promoting the business. The key to staying in the black is rigorous bookkeeping of income versus expenses. And since most new businesses don’t make a profit within the first year, by setting money aside for this contingency, entrepreneurs can help mitigate the risk of falling short of funds. Related to this, it’s essential to keep personal and business costs separate, and never dip into business funds to cover the costs of daily living.
Of course, it’s important to pay yourself a realistic salary that allows you to cover essentials, but not much more; especially where investors are involved. Of course, such sacrifices can strain relationships with loved ones who may need to adjust to lower standards of living and endure worry over risking family assets. For this reason, entrepreneurs should communicate these issues well ahead of time, and make sure significant loved ones are spiritually on board.
Running your own business is extremely difficult, especially getting one started from scratch. It requires a lot of time, dedication, and failure. A successful entrepreneur must show resilience to all the difficulties on the road ahead. Whenever they meet with failure or rejection they must keep pushing forward.
Starting your business is a learning process and any learning process comes with a learning curve, which can be frustrating, especially when money is on the line. It’s important never to give up through the difficult times if you want to succeed.
Similar to resilience, a successful entrepreneur must stay focused and eliminate the noise and doubts that come with running a business. Becoming sidetracked, not believing in your instincts and ideas, and losing sight of the end goal is a recipe for failure. A successful entrepreneur must always remember why they started the business and remain on course to see it through.
6. Business Smart
Knowing how to manage money and understanding financial statements are critical for anyone running their own business. Knowing your revenues, your costs, and how to increase or decrease them, respectively, is important. Making sure you don’t burn through cash will allow you to keep the business alive.
Implementing a sound business strategy, knowing your target market, your competitors, your strengths and weaknesses, will allow you to maneuver the difficult landscape of running your business.
Successful communication is important in almost every facet of life, regardless of what you do. It is also of the utmost importance in running a business. From conveying your ideas and strategies to potential investors to sharing your business plan with your employees to negotiating contracts with suppliers all require successful communication.
Types of Entrepreneurs
Not every entrepreneur is the same and not all have the same goals. Here are a few types of entrepreneurs:
Builders seek to create scalable businesses within a short time frame. Builders typically pass $5 million in revenue in the first two to four years and continue to build up until $100 million or beyond. These individuals seek to build out a strong infrastructure by hiring the best talent and seeking the best investors. They have temperamental personalities that are suited to the fast growth they desire but can make personal and business relationships difficult.4
Opportunistic entrepreneurs are optimistic individuals with the ability to pick out financial opportunities, getting in at the right time, staying on board during the time of growth, and exiting when a business hits its peak.
These types of entrepreneurs are concerned with profits and the wealth they will build, so they are attracted to ideas where they can create residual or renewal income. Because they are looking to find well-timed opportunities, opportunistic entrepreneurs can be impulsive.4
Innovators are those rare individuals that come up with a great idea or product that no one has thought of before. Think of Thomas Edison, Steve Jobs, and Mark Zuckerberg. These individuals worked on what they loved and found business opportunities through that.
Rather than focusing on money, innovators care more about the impact that their products and services have on society. These individuals are not the best at running a business as they are idea-generating individuals, so often they leave the day-to-day operations to those more capable in that respect.4
These individuals are analytical and risk-averse. They have a strong skill set in a specific area obtained through education or apprenticeship. A specialist entrepreneur will build out their business through networking and referrals, resulting in slower growth than a builder entrepreneur.4
4 Types of Entrepreneurship
As there are different types of entrepreneurs, there are also different types of businesses they create. Below are the main different types of entrepreneurship.
Small Business Entrepreneurship
Small business entrepreneurship is the idea of opening a business without turning it into a large conglomerate or opening many chains. A single-location restaurant, one grocery shop, or a retail shop to sell your handmade goods would all be an example of small business entrepreneurship.
These individuals usually invest their own money and succeed if their business turns a profit, which they live off of. They don’t have outside investors and will only take a loan if it helps continue the business.
These are companies that start with a unique idea; think Silicon Valley. The hopes are to innovate with a unique product or service and continue growing the company, continuously scaling up as time moves on. These types of companies often require investors and large amounts of capital to grow their idea and reach multiple markets.
Large company entrepreneurship is a new business division created within an existing company. The existing company may be well placed to branch out into other sectors or it may be well placed to become involved in new technology.
CEOs of these companies either foresee a new market for the company or individuals within the company generate ideas that they bring to senior management to start the process.
The goal of social entrepreneurship is to create a benefit to society and humankind. They focus on helping communities or the environment through their products and services. They are not driven by profits but rather by helping the world around them.
Entrepreneurs and the Economy
In economist-speak, an entrepreneur acts as a coordinating agent in a capitalist economy. This coordination takes the form of resources being diverted toward new potential profit opportunities. The entrepreneur moves various resources, both tangible and intangible, promoting capital formation.
In 2020, there were 31.7 million small businesses in the United States.5
In a market full of uncertainty, it is the entrepreneur who can actually help clear up uncertainty, as they make judgments or assume the risk. To the extent that capitalism is a dynamic profit-and-loss system, entrepreneurs drive efficient discovery and consistently reveal knowledge.
Established firms face increased competition and challenges from entrepreneurs, which often spurs them toward research and development efforts as well. In technical economic terms, the entrepreneur disrupts the course toward steady-state equilibrium.
How Entrepreneurship Helps Economies
Nurturing entrepreneurship can have a positive impact on an economy and a society in several ways. For starters, entrepreneurs create new businesses. They invent goods and services, resulting in employment, and often create a ripple effect, resulting in more and more development. For example, after a few information technology companies began in India in the 1990s, businesses in associated industries, like call center operations and hardware providers, began to develop too, offering support services and products.
Entrepreneurs add to the gross national income. Existing businesses may remain confined to their markets and eventually hit an income ceiling. But new products or technologies create new markets and new wealth. And increased employment and higher earnings contribute to a nation’s tax base, enabling greater government spending on public projects.