Building Social and Financial Capital (ENT 600 Week 3)

How do I take those first steps to get my business off the ground?

In The Founder’s Dilemmas, Noam Wasserman identifies two primary roads that will lead a business from the drawing board to start up and to profitability:  social capital, “the durable network of social and professional relationships through which founders can identify and access resources;” (47) and financial capital…well, cash money (48).  Founders with years of experience can often tap into a network of professional and personal contacts which can lead to the other type of capital–human–as well as access to financial capital.  Some founders survive the period preceding profitability with financial capital in the form of savings, loans, even severance packages from former employers. (48)

Wasserman points out that over half of all enterprises fail to leave the drawing board due to a lack of financial capital, because let’s face it: we’re all adults here and we have kids to raise and bills to pay and your mortgage lender doesn’t care how great an idea you have if you can’t make your house payment and start ups can take a while to reach that happy place where they pay the bills.

Erica Drake, founder, CEO and Chairman of Maverick Entrepreneurs, breaks down the three types of financial capital entrepreneurs generally resort to, with the caveat that “(t)o tell an entrepreneur that a prospective investor may not be ideal is like telling a starving man that the food doesn’t taste very good.”  Ninety-five percent of companies start out bootstrapping, “a combination of your own money, savings and credit, mixed with money from friends and family.”  Some founders choose debt–borrowing money to start your business and survive until profitability–and equity, selling off parts of your company to investors who believe in your vision and your team.

All of these have positives, negatives and roadblocks.  Bootstrapping takes a lot of time, but when/if the company reaches profitability, all decision making and profit goes to the founder(s).  Borrowing is fast, but forces a founder to put up collateral like houses, cars, property, etc.  Sure, nothing says you’re all in like a lien on the family home, but then failure has some pretty dire consequences even worse than just failing at business.  Additionally, not all entrepreneurs possess assets or sufficient credit rating to even qualify for financing.  Equity at start up feels like free money, but one of two outcomes are assured when accepting investment capital: 1) Your business succeeds, but now the company has other stakeholders with a say; or 2) Your business fails and hopefully your investor(s) were not also good friends and/or in-laws.  (The lesson here: it’s better to borrow from strangers).

There’s a pretty simple reason 95% of businesses start out bootstrapping: the founder(s) don’t have the financial or social capital to do it one of the other ways because frankly, no entrepreneur is going to say no to any type of funding on start up.  Wasserman points out that having copious amounts of one type of capital can lead to what he calls “a virtuous cycle” where social capital begets human capital like more founders and a quality management team which in turn begets the kind of seed money that speeds up the road from drawing board to start up to profitability. (48)  Drake might add that many companies bootstrap their start ups because “most investors won’t fund a new start-up, so they have to bootstrap it until they can get the company to the next stage (i.e., early-development or development) before funding becomes possible.”

“The reality is,” according to Drake, “most funding inevitably is a combination of debt and equity, which is often contributed by the entrepreneur, at least initially.”  Drake also adds some innovative solutions to surviving the bootstrapping phase that we here at Abundance endorse 100%:

  1. Crowd funding, getting a lot of people to contribute small amounts for a small payoff down the road like a finished product when the business is up and running;
  2. Strategic alliance, where businesses work together to barter services, refer customers, and offer reduced rates to each other; and
  3. Joint Venture, a little closer than a strategic alliance where companies requiring each other’s competencies can form a more formal partnership, share departments, services, and assets.

All of these methods, of course, fit under the rubric of social capital.  Because unless you have a nice trust fund or win the lottery, you are gonna need a little help from your friends.

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Resources:

Wasserman, Noam.  The Founder’s Dilemmas: Anticipating and Avoiding the Pitfalls That Can Sink a Startup.  Princeton University Press, 2012.

Drake, Erica. “3 Types of Capital – An Overview for Entrepreneurs,” LinkdIn, 12/20/2016.

 

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This is not only my Professional Blog where I post my assignments for my Master of Entrepreneurship program at Western Carolina University, it’s also my Professional Blog on my actual business web site for my actual functioning business!  Since they overlap so neatly in my personal Venn Diagram, I think clients, potential clients, or just idle passersby will find some value in my analysis as much as my classmates and instructors.  Enjoy!

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6 Comments

  1. sabrarch32

    Hi Arjay,
    Regardless if someone has a nice trust fund or win the lottery, I still think that it is good for the person starting the business to save their money and use someone else’s that way if something does fall though they have a cushion to fall back on. It is always a good idea to work on social capital, and maybe if you are not the best people person you have someone on your team that has the personality to draw the people you need to get your business started.

  2. Arjay,

    I really like the innovative solutions endorsed by Abundance. You are correct about many founders lacking financial capital. Without these solutions and social capital, many ideas would never get launched.

    The innovative solutions are great advice for nonprofits as well as for profits. In fact, many times nonprofits are encouraged to develop strategic alliances with other organizations that have similar a mission, who might otherwise be competitors fighting for the same financial resource (community grants, donors etc.). By working together both organizations expand their mission and reach and have a much more attractive proposal/program. Crowd funding is another way to get the mission, product, idea out in front of a much larger audience; especially in the early stages of developing the business. Thanks for the inspiration! Jill

  3. Hi Arjay,

    I really like how you describe the meaning of financial capital and the strong (perhaps even absolute) connection to social capital for any type of new venture. I especially like how your blog reflects your “Executive Summary” (@ “It’s All About The Weird”.) The messages you share are transparent, passionate, authentic and real. It’s very clear you understand the impacts of financial and social capital…and you have no idea what the word “quit” means…that’s awesome!

    Sure, we all need financial capital to start and run our businesses, and you provide several excellent sources; but it’s our social capital that makes it all come together. Through social capital we learn what we don’t know…about business, people, ourselves and life. Though I knew my trade very well, I was equally poor at building social capital and I struggled with my business but was reluctant to accept the facts. This time around, I’m going find a partner who will bring balance to the business. It’s critical that entrepreneurs know themselves, their true strengths and weaknesses, the latter of which may sting to learn. Ask anyone who had to start over to give you the real (the truly real) reason for the second/third/etc. entrepreneurial, non-serial lap and he/she will probably be able to boil it down to lack of social capital.

    To end on a positive note: You can build social capital – even someone like me with a highly analytical brain. I finally understand that I can’t do it all, so my social capital contribution will be small and very focused on select people eager to build and maintain a strong social capital base.

  4. Your comment about the value of a joint venture is excellent. Many people in this program have a fairly circumscribed vision of what kind of company they want to create. It’s clear that they’re not going to need millions of dollars to accomplish their goals. But we can all see that some money is required. The most cases I expect there is somebody with similar goals and who wants to reach a similar audience but it’s not a competitor. Your idea to seek out a joint venture seems like the perfect solution.

    • To say this program is dropping an atomic bomb on my plans so that I may build upon the ashes is an understatement. Especially when I finished my Personnel Plan and my year 3 payroll was around $3 million. Clearly I’m going to create joint ventures and close business relationships with lots of professionals while building toward that $3 million in payroll. Unless I have hit the funding vein I think I have…..

  5. Great post Arjay! I really like the strategic alliance idea. A barter of services is a great idea that can continue to build social capital. I know businesses do this, but when I read your post all these ideas of how that could be beneficial for my business and others began to come to mind. The partnerships could potentially lead to ways of identifying new markets and A-players. I like the bootstrap approach to a certain degree, if I was an investor, because it shows that the founders not only believe in their idea, but are also invested in it.

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