The Truth About Start-Ups
Every year hundreds of thousands of companies start up. Many will fizzle. Most will muddle along. And a few -- a very few -- will thrive. Which ones? And why? Here are the eight habits of highly effective companies
Start-ups don't succeed by accident. But -- to judge by statistics and facts instead of anecdotes and myths -- neither do they succeed for the reasons we're often told.
The reason some companies balloon with spectacular sales and job growth isn't that they have a lot of money when they start. (Though some do begin with more than others.) It isn't that their founders really, really wanted to be successful. (Though a willingness to trade free time for work time is probably a prerequisite.) It isn't even that the products and services they offer are fourfold better than those of their competitors. (Though that's sometimes the case.)
The real predictors of fast growth -- more than money, more than will, more than product even -- are the ways a company is put together. Everything from who gets involved in the venture to who owns it determines its chances of success. If you strip away all the folklore about what we think we know about start-up companies and pay attention only to the indisputable facts, certain patterns appear -- companies that grow begin differently from the ones that don't, in a handful of starkly identifiable ways.
The distinguishing traits of a successful start-up have to do with the kind of experience and knowledge its founders possess. (And that's most definitely founders, plural.) They have to do with a start-up's ability to seek and nurture alliances, whether for financing or product development. And they have to do with the market ambitions a company adopts right at the outset.
Are successful company builders aware of those patterns? Can you learn the truth about start-ups by asking those founders what separates their ventures from the rest of the pack? Usually not. Often successful company builders don't know they're doing things that are exceptional, or they answer in platitudes. ("We focus on the customer; we pay attention to quality.")
One thing they do know is that they're the exception to the rule. Depending on who's doing the counting and how broadly one defines business, there are more than 20 million enterprises in the United States today. (That number includes even ventures that filed tax returns with income less than $500.) Narrow it down to companies that had at least one employee (other than the owner), and there are still more than 5 million businesses. And most of them are not advancing at fantastic speeds: the majority took in less than $100,000 in 1987, and only 7% took in more than $500,000.
Fortunately, there are data that provide a straightforward look at how the truly exceptional companies are different from the regular performers. Government agencies, university researchers, independent firms, and we at Inc. have compiled databases and cranked out facts and figures about the start-up world.
Now is a good time to take a look at the results. The mid-1980s were a particularly fertile period for start-up activity. Today the successes and failures of that business-launch wave are playing out. And while about 75% of those companies are likely to have survived the five-year mark, and half probably have made it to eight years, only a small fraction blossomed quickly into Great American Growth Companies.
They are thriving because they came up with intelligent responses to a changing business environment. They are thriving because they were organized in a way that enabled them, once they were under way, to be smarter than other companies. The patterns that emerge to describe how they were put together aren't random. They are the patterns of success.* * *
The Eight Habits of Highly Effective Companies
1. They rely on team efforts. Each year this magazine compiles the Inc. 500, our list of the fastest-growing companies in the country. (Companies are ranked by absolute percentage growth of sales over five years and must have a minimum of $100,000 in sales for the base year.) Typically, we credit the success of each company to the chief executive, a founder depicted as a solo artist who struggled alone to get the business off the ground -- and many of the companies extolled in these pages do have single-founder roots. But the reality is that wildly successful start-ups are more likely to be team efforts, made up of interdependent and multitalented people. Of the youngest of the 1992 Inc. 500 companies -- the 306 founded in 1985, 1986, and 1987 -- almost two-thirds were started by partnerships.
Academic studies of growth companies show the same pattern. Paul Reynolds, a researcher at the Center for the Study of Entrepreneurship at Marquette University, in Milwaukee, found that only 6% of the "hypergrowth" companies (the top one-fiftieth by revenue growth) in his study of 1,709 businesses in Minnesota and Pennsylvania were founded by a single person; 54% had two founders, and 40% had three or more. That contrasted dramatically with the more plentiful low-growth companies in his sample: a full 42% of them were solo ventures, and just 15% had three or more founders.
In fact, teams of some sort are found throughout successful start-ups. A third of the Inc. 500 group have formal boards of directors, and another third maintain informal advisory panels. Almost half take a "partnership" stance toward employees by sharing profit-and-loss information with them.
That this characteristic has emerged as fundamental reflects the increasing business savvy of today's founders. The smartest among them recognize not only the demands made by an increasingly complex and competitive environment but the limitations of confronting those demands alone. Teams can cope with a range of challenges no individual could satisfactorily meet. Little wonder, then, that launching with a team seems to give start-ups a better chance not only to survive but to thrive.* * *
2. They're headed by people who know their line of work. Successful entrepreneurs aren't just sharing the work -- they know the work, coming to it with professional experience in their fields. Reynolds found that the majority of CEOs of hypergrowth start-ups had more than 10 years' experience in the industries in which they founded their companies. By contrast, the majority of CEOs at low- to no-growth companies had no experience or had spent just a few years learning their industries from the inside.
That coincides with a broader trend: increasing numbers of corporate careerists are entering the world of entrepreneurship. As the stability equation (which is more secure, a corporate job or self-employment?) shifts for the white-collar elite, more people with seasoned skills are capitalizing on their knowledge through ventures of their own. Almost 20% of laid-off managers started or bought their own businesses and consulting firms in 1990, according to international outplacement firm Challenger, Gray, & Christmas, based in Chicago; that's up from just 6% to 8% in the early 1980s.
The trend toward industry experience helps explain why successful companies are so often started by teams. Corporate refugees have learned not only their industries but the habit of bringing product developers, salespeople, and finance minds together; once on their own, they carry over the team habit. "My interpretation," says Reynolds, "is that these are people who've been searching for an opportunity for something like this or who simply see an opportunity, and they form a team and go after it."* * *
3. They're headed by people who have started other businesses. Successful company builders often haven't spent their entire careers at one large corporation: at some point they've practiced the business of running a business. Half the 1992 Inc. 500 CEOs had started at least one other business before their current one took off, and a sizable number (17%) had started three or more. The pattern is mirrored by the founders of highly successful companies in Reynolds's study. Sixty-three percent of them had started at least one other business, and 23% had started three or more. On the other hand, only 20% of the general business-owner population has been self-employed before, according to a survey by the Bureau of the Census. (That survey looked at partnerships, sole proprietorships, and S corporations.)
Many of the people now running the most successful start-ups in the country have at one time been losers. Multiple foundings have meant multiple failures; among the Inc. 500 CEOs, of the 343 businesses they'd started in earlier lives, only 27% are still in existence.
Having grown an earlier venture instills an awareness of the risks of running a company and a better understanding of what it takes to construct organizations from scratch. Founders of multiple companies learn how much time it takes to do the "little things" that are part of establishing a company -- from selecting a computer system to putting in place a health plan -- and how potentially derailing those details can be when they're not handled right.* * *
4. They're headed by men. Much has been written about the number of women starting businesses over the last decade. The tally of woman-owned enterprises did increase in the 1980s, at twice the rate that the overall number of enterprises did, according to the Census Bureau. By the bureau's count (excluding C corporations and companies reporting less than $500 in revenues), there were 2.6 million woman-owned businesses in 1982 and 4.1 million in 1987, a 58% increase. The number of businesses overall increased 29% in the same period. By 1987 one in three companies in the general business population was woman-owned. (Researcher Reynolds also is finding that 30% of the start-up teams he's looking at now in a new study in Wisconsin include women.)
But the running of fast-growth companies still remains a predominantly male endeavor. Of Inc. 500 companies founded from 1985 to 1987, 93% are run by men. Reynolds, too, found that 93% of hypergrowth companies have male CEOs.
Why do women, who account for 30% of general business ownership, account for only 7% of the fast-growth subset? It's not just that women are more likely to be running tiny, employeeless ventures than men are: while as many as 90% of the businesses women run are indeed sole proprietorships, so too are the vast majority of businesses run by men. It may be that because founders of the most successful companies come to their start-ups with years of corporate experience in their fields, proportionately fewer women going into business fit that description. And woman business owners -- at least the majority of those running emerging companies at this point -- seem to try less often for rapid growth.
Worth noting, however, is that women are more involved in the growth-company world than it first appears. Fully one-quarter of 1992 Inc. 500 CEOs say their spouse works at their company. Many fast-growth ventures are in fact cofounded by husband-and-wife teams, even if the female half of the partnership doesn't get the more senior position or accompanying recognition.* * *
5. They're disproportionately manufacturers, and they're high tech. If you count all enterprises in the U.S. economy, including sole proprietorships, about 16% are retail operations, and just 3% are manufacturers. Confine the field to businesses that have employees (eliminating the huge number of single-person companies), and still just 6% are manufacturers. The rest are in services, construction, finance, and so on.
The fast-growth start-ups have significantly different ratios. Manufacturers represent 27% of the Inc. 500 companies founded from 1985 to 1987, retailers just 7%. The lion's share -- 56% -- are in services, with the rest in distribution.
What's more, the fast-growth start-ups often are high tech. A sizable 47% of the Inc. 500 hot starts call themselves high-tech ventures. (And with just 27% being manufacturers of any kind, that 47% includes not just producers of high-tech products, but business services and retailers that use technology.)
The skewed percentage of high-tech manufacturers among that Inc. 500 group is not surprising: in his study in the 1980s of high-tech manufacturers, researcher David Birch of Cognetics Inc. found those companies to be twice as likely as other manufacturers to have more than 50 employees by their fifth year. They also were more stable, he found, failing in smaller percentages over time than other manufacturers did.
Bruce Kirchhoff, a professor of entrepreneurship at the New Jersey Institute of Technology, has reported similar findings. "Twice as many of what we call technology-based firms, which are largely manufacturers, achieve high growth in the first eight years of their life than low-technology firms."
Why is that so? As Inc.'s Edward O. Welles noted in his article "How to Get Rich in America" (January, [Article link]), technical changes have made competing easier for small manufacturers. The automation of machine tools has meant that large-company economies of scale no longer produce insuperable advantages over fast-on-their-feet innovators.
It would be a mistake, however, to ignore the expansion of many nonmanufacturing segments of the economy. Though manufacturers are disproportionately represented among fast-growth companies and employ more people than any other sector, more than half the fast-growth start-ups are in services. Their importance should not be underestimated, says Bruce Phillips, senior economist with the Small Business Administration in Washington, D.C. "Look at the major growth sectors of the economy today and there are some manufacturing sectors, like biotechnology, but certainly there are plenty of service industries -- health services, social services, data-processing services -- which are growing equally rapidly. And more rapidly, in many cases."* * *
6. They're better financed -- but not by much. If a company's characterization as "high tech" is open to interpretation, even more ambiguous is how much money constitutes "being well financed." Some businesses have to plow more cash into their launches than other businesses will see in 10 years. Others bootstrap along and expand through cash flow alone all the way onto the Inc. 500. While one can assume that well-financed companies have a better chance of doing well, there is no similar corollary that says less well financed companies will do poorly.
The stats: the Census Bureau's 1987 survey of businesses showed that 30% of all companies were started with less than $5,000. Just 22% of the youngest 1992 Inc. 500 group were. Whereas 33% of the general business population was seeded with more than $50,000, half of the youngest Inc. 500 companies started with at least that amount. (The numbers likely would be closer if the bureau's study had included the roughly 3 million C corporations in business that year.) So, yes, fast-growth companies enter the race with more money, but only slightly more.
That makes sense: if high-growth companies include more manufacturers, they will not just want but need more initial financing. Research and development, cast moldings, capital equipment, and marketing materials -- all necessary for a manufacturer's start-up -- cost more than marketing materials alone, which launch many a nascent service company.
Still, you can look at the numbers and end up marveling at the ability of Inc. 500 founders to parlay relatively puny amounts of capital into extraordinary growth. Think of it: fully 22% of the youngest Inc. 500 companies were seeded with less than $5,000. Only 7% -- 21 of those 306 under-seven-year-old companies -- were capitalized with $1 million or more. A million dollars may be a good chunk of cash, but we're talking about the most successful young companies in the country, and they generally achieved their station without unusual financial resources. Formal venture capital, for instance, doesn't appear in most of these corporate histories: 8% of the youngest Inc. 500 companies and none of the fast-growth companies Paul Reynolds followed had venture seed money. "That's the way the world is," says Reynolds. "The venture capitalists are on the periphery of the real action."* * *
7. They're not owned by the founders alone. In the hypergrowth world, company builders don't keep all the equity -- many don't even own a majority of their companies. Fully 50% of the CEOs of the youngest 1992 Inc. 500 companies own less than half the equity in their businesses (although many of them may be keeping it within the company, sharing ownership with cofounding partners). Still, that's a pretty dramatic number, especially considering that as recently as four years ago only 21% of Inc. 500 CEOs owned less than half of the companies they headed. The equity today's CEOs don't hang on to is spread among cofounding partners, other employees, and outside investors (mainly family, friends, and individual angels). An astounding 29% of the CEOs of the newest Inc. 500 companies say they didn't invest any of their own savings in their businesses.
Among the census-reported partnerships and Subchapter S corporations, about half the owners said they raised no equity capital. Another 35% drew from their own savings, while slightly fewer than 10% hit their families up, and 2% to 8% turned to their friends, partners, or business's former owners (if they purchased the operation).
What we're seeing here is the overlapping of the characteristics of success. Managers of companies that grow fast have track records in their industries that help them know how to compete better; those track records also make it easier for them to raise money. They practice their team orientation by sharing equity with employees (who, in turn, are likely to be the kinds of people who can raise or contribute capital of their own). In the process, the founders are demonstrating their skills in crafting alliances -- alliances among team members and alliances among equity owners.* *
8. Their markets are not just local. Successful young companies tend to be far-reaching ones; half the Inc. 500 companies get more than half of their revenues from sources outside their region. Better than a third get at least some sales from exports. Early indications from a Commerce Department study of exporters are that the hottest small companies are unexpectedly important international traders: 10% of small businesses are producing anywhere from 25% to 40% of U.S. products and services sent outside the country.
"The declining price of communications technology -- fax machines, 800 numbers -- clearly has made more firms look at larger-than-local markets," says the SBA's Phillips. "Many manufacturers, especially ones that have a product advantage over their overseas competitors, are starting out and looking at export markets, for instance, right at the beginning. That's something in the 1990s that didn't exist much before."
Not surprisingly, two-thirds of the 1992 Inc. 500 companies get at least some of their sales from large companies. (One-third report they have a full strategic partnership with a large company, too.) At some point in those relationships the young companies may have had a choice -- to grow and serve the larger companies, or to lose the accounts. Those that chose to take up the challenge and the opportunity to further their alliances ended up expanding -- in territory, in affiliation, and in revenues.* * *
Although there still may be room in the ranks of fast-growth businesses for novice company founders or companies that operate in isolation or sell only locally, the path of successful companies clearly is to create an organization that is more experienced and more broadly ambitious from the start. The business environment already is fast-paced and unpredictable; the use of teams to found companies is the first in a wave of responses to that.
If Inc. repeats this exercise in five years -- examining from that vantage point what 1993's start-up companies look like -- we're likely to see somewhat redefined "secrets to success." Here are some predictions: We'll find that larger percentages of successful start-ups will have formed alliances with major companies in their early years. More will be exporting ever greater portions of their output to customers overseas. Today's start-ups, we'll discover, will have continued to modify the ways they're set up, whom they become dependent on, and how far-reaching they try to be, all in response to the increasing globalization -- and increasing complexity -- of the marketplace. It's how they will capture the advantages open to them. More and more, shrewd organizational transformations are what every company will have to muster in order to compete. Those who make those transformations best will be the businesses that succeed the most spectacularly.