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                    Fast capital can speed startup's crash, author warns
                     Experimentation under cash-strapped conditions has traditionally
                     created resilient, successful firms, Amar Bhidé argues.

                     GORDON PITTS

                     Wednesday, February 23, 2000

                     Amar Bhidé shudders when he hears the latest tale of an obscenely fat capital injection in a money-losing
                     Internet startup.

                     That's not the way it's supposed to be, the Harvard University business professor says, and it troubles him.

                     Fledgling companies shouldn't achieve instant gratification from open-handed venture capital funds and
                     spectacular initial public offerings. In his view, it defies the historical pattern of successful startups the world

                     "It always has been that after you've proven something, you get the capital," Prof. Bhidé says. "The successful
                     startups have had to experiment on a scale dictated by available funds."

                     That experimentation under capital-scarce conditions has created resilient and flexible companies, such as
                     Hewlett-Packard Co., Intel Corp. and Microsoft Corp. But that's not the model deployed by eBay Inc.,
            Inc., Healtheon/WebMD Corp. and countless other on-line hopefuls. These companies seem to
                     be launched with one big idea and a lineup of financial backers looking for huge rewards by being the first
                     mover in a new product area.

                     All this happens before there is even the whiff of profit. In fact, the current model snubs its nose at history --
                     the bigger the losses, the better the stock performance.

                     Prof. Bhidé, who is teaching this year at the University of Chicago, worries about this disconnect between
                     positive cash flow and fast capital. The risk is that when the crash comes, it is going to be that much more
                     dangerous for the capitalist system.

                     Prof. Bhidé has just completed a 10-year study of hundreds of fast-growth U.S. companies, compiled in a rich,
                     dense book called The Origin and Evolution of New Businesses. This update of The Origin of Species
                     postulates a Darwinian theory for entrepreneurs.

                     He has interviewed and researched founders from Inc. magazine's annual lists of the fastest-growing U.S.
                     private companies and hundreds of case studies prepared by his students at Harvard.

                     What he's discovered is that most successful startups have developed in an unspectacular manner that
                     contrasts sharply with the image of overnight success:

                     Most successful founders didn't have new ideas. They started off by copying or slightly modifying someone
                     else's concepts. In fact, what they sold was already available in some form or another -- they simply provided it
                     more efficiently, more cheaply or with desirable modifications.

                     Most high-growth entrepreneurs didn't have deep managerial or industry experience.

                     Because of these shortcomings, company founders operated under severe financial constraints, with more than
                     80 per cent bootstrapping their business from savings, credit cards or second mortgages. Only 5 per cent have
                     historically attracted funding from venture capitalists.

                     Because they started with meagre funding, they had little time for strategy and planning. They adapted to
                     unexpected problems and opportunities, lending them an opportunistic style.

                     Prof. Bhidé in his book argues that starting a business in such uncertain conditions requires a high tolerance for
                     ambiguity. "Entrepreneurs have to confront fluid, rapidly changing situations where they cannot anticipate the
                     nature of the outcomes, let alone assess their profitability distributions."

                     So the image emerges of capital-constrained nobodies with low-level experience, pushing themselves out into
                     an indifferent world with copycat products that have been moderately refined -- and then scrambling to take
                     advantage of a changing environment.

                     Prof. Bhidé says unforeseen changes in technology or regulation work to the successful entrepreneur's
                     advantage. "Most entrepreneurs take advantage of exogenous change instead of driving their own change," he
                     said in a telephone interview.

                     This scrambling image is not the picture of all-knowing superstar, embodied in Amazon's Jeff Bezos or
                     Netscape's Jim Clark. Prof. Bhidé says more typical role models are William Hewlett and David Packard,
                     founders of Hewlett-Packard who haphazardly tinkered their way to computer success from a California

                     Because business founders traditionally have so little funding, they have to work hard to persuade outsiders,
                     including suppliers and customers, to take a chance on them. A crucial factor in any startup's success is its
                     ability to offload some of the risk to customers, who are usually businesses themselves.

                     Prof. Bhidé says this offloading is not conscious on the part of entrepreneur or customer. The customer takes
                     the chance that in six to eight months, the time and money invested in the supply relationship will continue to
                     pay off.

                     Can past successes guide today's would-be entrepreneurs? Prof. Bhidé thinks so. He sees some common rules,
                     although these must be violated at times: Be prepared to take advantage of exogenous change in your industry;
                     and beware of trying to sell to a lot of individual consumers. If your business operates through brokers instead
                     of directly to customers, you have less chance of success. And you will likely be happier in a venture that sells
                     high-ticket items.

                     Prof. Bhidé is not entirely scornful of the on-line whiz kids who seem to be skipping the bumpy learning curve.
                     The enormous distribution of capital will surely help generate new technology. He would just prefer that the
                     funds be spread out over more time and companies.

                     In the end, it is the absence of profit in these dot-com companies that bothers him most. There is something
                     disturbingly uncapitalistic about their business models.

                     He sees parallels to Japan in the eighties, when money-losing national champions were granted free tickets to
                     vast capital injections. "The lack of profit discipline created a lot of waste and fat," he says.

                     In an interview with Inc., he sums up his concern: "A healthy capitalist economy keeps its entrepreneurs on a
                     tight leash -- they live or die by the profits they make."

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