Are you building the right kind of capital for your startup?

September 8, 2018 ENT600 - Entrepreneurial Planning, Graduate Program Coursework Comments (2) 39

In its original use the word, “capital,” referred to the number of cattle a person might own. The headcount of cattle and total assets of the owner were often synonymous in ancient Greece and Rome, so capital took on the broader meaning of “wealth” until sometime in the thirteenth century when it evolved to mean money advanced to an entrepreneur to start a business (Hodgson, 2014). Wealth created through goods and stock—assets that could be turned into cash for investment—became the primary definition of the word capital for more than 500 years.

In the eighteenth century, industrialization changed the economic structure. Labor, as well as money, became a critical factor in the ability to create wealth. Economist Adam Smith recognized the importance of labor in the creation of new products and introduced the idea that “capital” applies to people as well as things (Smith, 1776). Karl Marx expanded on the Smith’s idea, arguing that “capital is not just things or people, but a social relationship between people, established by the instrumentality of things” (Hodgson).  And the concept of capital grew again—financial, human, and social.

In modern economics, capital is typically defined as an asset that you can use to produce something that is economically useful to a business or an individual.  The word, then, has different meaning depending upon its context (Goodwin, 2003). The most common types of capital are:

  • Financial – referring to an investment that produces something of value;
  • Natural – involving the supply of natural resources in any form that plays a productive process in economic gain;
  • Human – referring to individual education, skills, abilities, and labor used in some combination to produce assets for economic benefit;
  • Produced (Physical) – relating to those physical assets (products or objects) created for sale by applying Human Capital to Natural Capital for economic gain;
  • Social – referring to the goodwill, trust, shared values and social knowledge that, in combination, facilitates a financial benefit.

Even with these different meanings, you still might think capital is synonymous with money. And it would make sense since if you’re a founder, you are spending a lot of time raising and worrying about financial capital.

Indeed, financial capital is essential to get your business off the ground and keep it going. However, human capital is required to strengthen your weaknesses and often to produce a physical product, and your social capital is necessary to attract employees, customers, advisors, and investors (Wasserman, 2012). For those of you that manufacture a product, access to natural capital supports your ability to create produced capital which is the output that generates the revenue necessary for you and your company to thrive.

If you consider the different context in which the word capital can be used, you might begin to reconsider which type of capital should become your priority. Should you still concentrate on building financial capital first? Maybe.

Of all the capital types, it might be more critical for you to first invest in building your social capital. Some argue that social capital—the trust and goodwill you have created with others—might make it easier to raise financial capital, develop supply networks, entice customers, and find employees willing to help you accomplish your goals (Wasserman, 2012). Most successful entrepreneurs will tell you a robust network of support is critical to building sustainable ventures. Your social capital and your personal network is an essential part of your success.

Maybe the ancient Greeks and Romans were on to something when they considered capital to be synonymous with wealth. Perhaps they understood that wealth was rooted as much in the social connection as it was in financial assets. Wealth is measured in many ways, but social capital may well be a good predictor of financial wealth.

What do you think? Is social capital the key to building wealth and financial success?

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References

Goodwin, N. R. (2003, September). Five Kinds of Capital: Useful Concepts for Sustainable Development (Working Paper No. 03-07). Retrieved September 9, 2018, from Global Development and Environment Institute: http://www.ase.tufts.edu/gdae/publications/working_papers/03-07sustainabledevelopment.PDF

Hodgson, G. M. (2014, 4 April). What is capital? Economists and socialists have changed its meaning: Should it be changed back? Cambridge Journal of Economics, 1063-1086. doi:10.1093/cje/beu013

Smith, A. (1776). Wealth of Nations (Annotated edition, 2003 ed.). Bantam Classics.

Wasserman, N. (2012). The Founders Dilemma. Princeton: Princeton University Press.

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Photo by Arthur Poulin on Unsplash

David Harkins is a serial entrepreneur with significant experience in branding, strategy, licensing and marketing.

In his spare time, he consults, coaches, speaks, writes, hikes, explores, and creates art. Although, not necessarily in that order.

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The Entrepreneur and the Sunk Cost Fallacy

May 25, 2018 Change, Entrepreneurship Comments (0) 300

If you’re an entrepreneur and you’re not familiar with the term “sunk costs” you may have a problem.

A “sunk cost” is any past cost for something that you’ll not be able to recover. Typically, sunk costs are not included when making forward-looking decisions because those costs will remain the same regardless of what you may choose to do. In manufacturing, for example, a sunk cost might be the cost of equipment because it is a cost that has been incurred which will remain constant regardless of whether that equipment produces any product.

Think of it this way: It’s money you needed to spend that you’ll never get back.

The problem for most of us is that our forward-looking decisions become too tied to those sunk costs. We often become emotionally invested and the more investment we make, the harder it becomes to divest ourselves from those costs. In these situations, it is difficult to consider the pros and cons objectively. Instead, we try to recoup sunk costs, which makes us do irrational things.

Researchers Hal Arkes and Catherine Blumer argue that when we continue a behavior or work because of our previous investments of time, money, or effort, we fall victim to what has become known as the sunk cost fallacy (Arkes & Blumer, 1985). We place such a high value—either monetarily or emotionally—on those investments that we irrationally behave when faced with a decision that devalues those prior investments. Moreover, we look for ways to justify our choice rather than accepting the sunk costs as what they are—money we can never recoup.

Let’s look at it a more personal way.

Say you bought a quart of your favorite yogurt at the grocery store. It’s been in the fridge for a few weeks unopened, and putting away the dinner leftovers you spot it and realize that yesterday’s date is the “use by” date on the package. Concerned that it will spoil, you open and eat as much of the yogurt as you can—maybe even all of it—even though you’ve already had dinner because you’d rather do that than “waste your money” on food that will spoil.

The money for the yogurt was gone several weeks ago. You’re not going to get it back. But you’re emotionally invested with your favorite yogurt and your money. So, you chose to load up on the yogurt, which you didn’t enjoy as much this time. You only felt bloated and uncomfortable in the end. You made a decision that left you uncomfortable because of your emotional tie to money and your yogurt.

Make sense?

Consider another example. If you’re an artist, you invest a lot of time and energy in creating art. You might even have an MFA, so you have those education costs and maybe student loans to pay back. The time and energy to earn the degree, and the cost of your education are sunk costs. You will never get that time, energy, or money back. And still, you may be inclined to factor all those costs into the sales price of the art you create because you’re emotionally invested in those costs. But in doing so, your art rarely sells, or sells very slowly, because trying to recover the sunk costs will likely price your work out of range for your market. What you should really be doing is setting the price for the art based on the current market value of the art and perhaps the incremental costs to create it—paint, brushes, canvas—rather than all of the costs—sunk and incremental—you have invested in the artwork.

It.’s important to remember that sunk costs can occur in any situation where what is invested cannot be recovered in any way. Sunk costs can be the 30 years we spent in an industry that has since evolved beyond our experience, skills, and perhaps relevancy, for example.  Or trying to prove you are right about something when being right doesn’t matter. Maybe even ending a partnership that has long outlived its usefulness to all parties, but you keep hoping things will improve. Or maybe, doing everything you can to save a failing business because you’ve invested so much in it, hoping that things will turn the corner if you don’t quit. Those decisions are all based on the sunk cost fallacy and will become one of the causes of failure.

Making decisions about the future by basing them on backward-looking decisions of investments time, money, or effort, do not move the business forward. And many of us are guilty of spending too much time in the past for fear of wasting our investments. Psychologist Robert Leahy suggests that human beings fundamentally hate the idea of wasting anything. We have a desire to prove we’re right, we fear regret, we don’t want to feel bad, and we are unable to anticipate the positive side of giving up on the past or how others may view us if we chose to give up (Leahy, 2014).  I would argue that for entrepreneurs, this is all about overcoming the social stigma of failure, a risk that every entrepreneur faces when he or she steps into the ring.

No one likes to fail. But it takes many entrepreneurs a long time to admit that they are failing, or have failed, especially if that failure is not public. Even in the midst of a failing business, many entrepreneurs don’t seek the help they may need, often for fear of judgment. Failure suggests you didn’t do your homework—you misjudged the market, the opportunity, the customers. Perhaps it suggests you didn’t manage your budget well, or couldn’t keep your employees motivated. Those things could be true, but it is just as likely that you have been—conciously or not—making forward-looking decisions that factor in your sunk costs. And putting sunk costs in proper perspective can make all the difference between swimming with the sharks, or being eaten alive.

References

Arkes, H. R., & Blumer, C. (1985). The psychology of sunk costs. Organizational Behavior and Human Decision Processes, 35, 124-140. Retrieved May 24, 2018, from https://pdfs.semanticscholar.org/e456/4b88ca2349962a707b76be4c75076ad6bd43.pdf

Leahy, R. (2014, September 09). Letting Go of Sunk Costs. Retrieved May 24, 2018, from psychologytoday.com: https://www.psychologytoday.com/us/blog/anxiety-files/201409/letting-go-sunk-costs

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David Harkins is a serial entrepreneur with significant experience in branding, strategy, licensing and marketing.

In his spare time, he consults, coaches, speaks, writes, hikes, explores, and creates art. Although, not necessarily in that order.

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Interview: Jim Mitchem on Entrepreneurship

May 8, 2018 Interviews Comments (0) 878

Jim Mitchem, an author and partner with branding firm Out of the Ether, and I explore starting a service business, the willingness to take risks, branding, continuous self-improvement, and many other things in this interview for my Everyday Entrepreneurs podcast.

 

You can listen below on Soundcloud or subscribe to the podcast on iTunesGoogle PlayStitcher, or wherever you get your podcasts.

David Harkins is a serial entrepreneur with significant experience in branding, strategy, licensing and marketing.

In his spare time, he consults, coaches, speaks, writes, hikes, explores, and creates art. Although, not necessarily in that order.

Connect with him on social media below:

Continue Reading