Business Brilliant

by Lewis Schiff

  About 750,000 new small businesses open up in the United States every year, and another 750,000 small businesses shut down. About 90 percent of the closed businesses report no losses to creditors because the companies were in debt only to their founders. Like most small businesses, they were run by sole proprietors who relied only on their credit cards and other personal resources for cash reserves and capital.

  The irony is that many of these small businesses fail because the sole proprietors run out of funds just as they reach the brink of success. This may sound counterintuitive, but when a business begins to grow, expenditures almost always climb more quickly than revenues. Fast growth, which should be a good thing, often causes undercapitalized companies to overextend themselves, make clumsy mistakes, and fail. This is why so many small business owners become slaves to their creations. They are overworked, underpaid, in debt, and teetering at the edge of insolvency—and this is especially true of those whose businesses are succeeding and growing.

  Paul Green is someone who once fit that description exactly. Today Green is possibly the richest guitar teacher in the world, having founded the national School of Rock franchise chain. But he might be just another struggling small businessman if he didn’t know the right dentist, someone willing to be his first investor.

  Back in 1998, Green was twenty-five years old and scratching out a living in Philadelphia by teaching one-on-one electric guitar lessons to small children and teenagers in a music store attic. Most music instructors are very poorly paid, but money wasn’t Paul Green’s main source of frustration. It was how slowly his students were learning. Most of them didn’t practice enough and Green, who loved rock and roll with a passion, found it hard to hear them play so badly, week after week.

  One day he hit on the idea of getting some of his students to start playing together in a rock band’s rehearsal space. He found they sounded better because they’d been rehearsing more often, thanks to peer pressure. They hated playing badly in front of each other. Their progress persuaded him to open his own for-profit school of rock music so that all his students could rehearse with each other and then put on live performances for parents and friends. He rented a rundown three-story building and invited a few of his guitar-teacher friends to join as faculty. By 2003, he had 80 kids enrolled at the Paul Green School of Rock. Tuition barely covered salaries and expenses, though, and Green had to take a restaurant job on the side to make ends meet.

  On October 3 of that year, a new movie called School of Rock opened in cinemas nationwide. It starred Jack Black as a manic, impulsive electric guitar teacher who behaved a lot like Paul Green. Green was enraged and felt he’d been ripped off. Two years earlier, a camera crew from the cable channel VH-1 had shot footage for a documentary about Green’s school, but nothing had ever come of the project. The new Jack Black movie was released by Paramount, a sister company to VH-1, but the filmmakers denied they had conceived their movie with any help from VH-1. Green briefly considered suing, then dropped the idea. As it turned out, Jack Black’s School of Rock would be the best thing ever to happen to Paul Green’s School of Rock.

  Enrollment at Green’s school doubled within a few months of School of Rock’s opening. There wasn’t enough space in the old building to accommodate everyone, and Green opened a second site in the suburbs. Expansion and new tuition dollars were positive signs of success, but they also marked the beginning of Green’s troubles. He started to run himself ragged trying to manage two separate schools located miles apart.

  Green was complaining one day during a visit to Joseph Roberts, his dentist. Roberts had a son in Green’s school, so he already knew quite a bit about the enterprise. As a successful private practitioner on Philadelphia’s high-rent Rittenhouse Square, Roberts also knew a lot more than Green about running a business. His expert diagnosis was that Green needed to register his School of Rock as a corporation and take on investors. It wouldn’t be possible for Green to expand to a third site or a fourth without them. Roberts went on to become Green’s first investor and the first chairman of the Paul Green School of Rock, LLC.

  Investor money raised by Roberts and Green allowed the school to expand to five sites around Philadelphia while Green started scouting locations in other cities. Then a private-equity firm bought a minority stake in the business and installed a management team to roll out an ambitious nationwide franchise expansion plan. By 2010, there were 50 School of Rock branches across the country, with nine in the greater New York City area alone. Annual revenue hit $10 million. That year, Green was able to cash out his interest in the company and leave to pursue a few things even closer to his heart. He is music coordinator for the Woodstock Film Festival and is working with Adam Lang, co-creator of the 1969 Woodstock Festival, on starting a music college in the Woodstock, New York, area.

  Until Paul Green started taking on investors, he had been playing a game of “heads I win, tails I lose” with his business. The result was lots of glowing press and some degree of success, but always in the shadow of catastrophe, always one bad quarter away from collapse. Failure at any point along the way would have left Green much worse off than when he started. He would have been jobless and stuck with a pile of debt. That’s the way hundreds of thousands of businesses die each year, with a whimper and with some sole proprietor holding the bag.

  Know-who got Green into Warren Buffett’s game: “Heads I win, tails I don’t lose.” In The Origin and Evolution of New Businesses, author Amar Bhide uses this expression at least five times in four chapters to describe how the most successful entrepreneurs identify and pursue their opportunities. Smart entrepreneurs are always trying to set up deals in which success will be well rewarded while failure will exact only a minimal cost. In Bhide’s view, the “heads I win, tails I don’t lose” approach dispels the popular image of the entrepreneur as “an irrational, overconfident risk-seeker.” Bhide’s studies showed that most founders of Inc. 500 companies had put less than $10,000 into their businesses at the start-up stage, an amount small enough so they could bounce back easily even if everything went wrong. Buffett has some sage words of advice of his own on this score: “In order to succeed,” he says, “you must first survive.”

  Nonetheless, most new business owners never obtain outside investors to help finance growth and protect themselves from risk. The main reason is that most never ask for it. One study says that fewer than 4 in 10 businesses look for external funding during their first two and a half years in existence. One reason for this is that many new businesses are either too small or not growth-oriented enough to be attractive to outside investors. But another reason might be that owners don’t know how to seek out a common but little-known source of business investment, the informal investor.

  Paul Green’s dentist was an informal investor. Damien Hirst’s first patron was an informal investor. They were not friends, not family, nor were they in the investment business, like angel investors or venture capitalists. They were just people who had a bit more money than Green and Hirst, who liked what they saw in them, and were willing and able to make what might be considered a modest gamble. The most famous informal investor of this kind was a Scottish car salesman named Ian McGlinn. In 1977, McGlinn gave a friend of his girlfriend’s about $7,000 to expand her little retail store in Brighton, England. In exchange, McGlinn got a half-share in the business, which was called The Body Shop. In 2009, McGlinn sold all his stock in The Body Shop for more than $200 million.

  By some estimates, informal investors like Roberts and McGlinn contribute eight times more money than venture capitalists to new small businesses in the United States each year. Scott A. Shane, an Ohio professor who studies business start-ups, says that informal investors have a low profile because they’re not very interesting to the media. “The typical [informal] investor looks too much like you and me,” he writes in The Illusions of Entrepreneurship, “and his investments are mundane at best.” More than half of all informal investments are for about $15,000 or less, an
d many informal investors have incomes below $50,000. But together they are a deceptively large force. Shane cites estimates that about 1 percent of all households in the United States have some ownership stake in a private business managed by someone outside the household. That’s 1 million informal investors.

  Shane says that most informal investors are different from angel investors and venture capitalists in another important way: They’re not looking for huge returns on their investments. “In fact,” Shane writes, “one study found that more than one-third (35 percent) of informal investors expected no return (that’s zero, nada, zilch) on their investments in start-ups. Clearly the typical informal investor is investing in start-ups for non-financial reasons, such as to help out a friend.”

  The message to take from that statistic should be pretty simple. Go out and make more friends.

  The Success Contagion

  Few people who have met Bill Gates would consider him “a people person.” One of his Harvard professors deemed him someone with “a bad personality and a great intellect.” Gates always seemed bored with small talk and generally incurious about people. His social awkwardness, as well as his poor personal hygiene habits, became the stuff of legend. “Even after spending a lot of time with him,” Walter Isaacson once wrote in a Time magazine profile of Gates, “you get the feeling that he knows much about your thinking but nothing about such things as where you live or if you have a family. Or that he cares.”

  But if Gates seemed uninterested in people personally, during Microsoft’s formative years he never stopped obsessing over what they were thinking and doing within the computer industry. As one computer executive said about Gates in the early 1990s, “If you talk to Bill about any software company or any hardware company, there’s a very high probability that he will be able to tell you who the CEO is, what their software is, what their problems were.” Gates wasn’t a glad-hander or a schmoozer, but he was unquestionably a networker.

  Entrepreneurs succeed when they function as bridges between different kinds of networks. Gates, for instance, ended up acting as the bridge between IBM and the personal computing community. Gary Kildall might have been that bridge if it weren’t for his indifferent attitude toward his networks of customers and strategic partners. When IBM decided that Kildall was too difficult to deal with, the company asked Gates to produce its new PC operating system. Gates knew he couldn’t possibly build such a product from scratch on IBM’s tight deadline, but he accepted the challenge anyway. Then he relied on his network of Seattle computer contacts to find an obscure operating system, Q-DOS, which he purchased and repackaged for IBM as MS-DOS.

  The word entrepreneur comes from the French terms for “between” and “to take.” Entrepreneurs take profits by brokering the relationship between players and filling so-called structural holes that ordinarily prevent disparate groups from working together. In this sense, Guy Laliberté brokered a relationship between his network of circus performers on one hand, and his network of Quebec business and government leaders on the other. Neither group had the independent means to create Cirque du Soleil. Only Laliberté knew enough people in both worlds to bring them together. Paul Green and his dentist filled the structural hole between the thousands of parents willing to pay for their children’s music lessons and the investors who bankrolled the School of Rock.

  If networks are so critical to business success, it should stand to reason that the most successful people would have the greatest number of close personal contacts. But the Business Brilliant survey and other social research show that this isn’t the case. Middle-class survey respondents, for instance, said that on average they have 9 people with whom they “extensively/closely network in order to source more new business.” Among self-made millionaires, however, the average number is just 5.7. This number actually gets smaller as wealth levels increase. It’s 5.1 among self-made millionaires with net worths between $10 million and $30 million. Those above $30 million net worth average just 4.8 members in their close networks.

  How can this be? Why wouldn’t the wealthiest people report the largest number of immediate contacts? To answer this question, we have to look at what social science tells us about the nature of friendship itself. Although even a teenager can compile 5,000 friends on Facebook these days, it seems to be an immutable fact of human nature that no one can maintain more than a handful of true “best friend” relationships. Surveys continue to show that the average American, for instance, has about four close social contacts with whom that individual can comfortably discuss very important matters. The majority of Americans have between two and six close social contacts of this kind, making up what has been called a “core discussion network.”

  The smaller numbers in the core business networks of the Business Brilliant survey’s wealthy and very wealthy respondents suggest that effective networking requires a very tight, very close group of this kind. When the middle-class survey respondents say they network “closely and extensively” with nine people on average, the way they define the phrase “closely and extensively” comes under suspicion. If survey research tells us that hardly anyone can maintain “close” ties to nine different people, then maybe what most middle-class respondents regard as “close and extensive” networking isn’t very close and extensive at all.

  The Business Brilliant survey has some evidence that supports this possibility. It shows that self-made millionaires are on more intimate terms with members of their core networks, particularly regarding crucial matters of motivation and money. For instance, 7 out of 10 self-made millionaires said, “It is essential I understand the motivations of my business associates.” Fewer than 2 out of 10 members of the middle class said the same. When asked how they evaluate prospective business associates, a majority of self-made millionaires said that, among other details, they want to know how much these prospects earn and the size of their net worth. Fewer than 1 out of 6 respondents in the middle-class sample said they wanted to know these things. It seems that self-made millionaires succeed by networking with small core groups of people they know and understand very well. Middle-class business networks are more likely to consist of larger groups of casual acquaintances.

  Researchers who have studied social networks say that network size alone does not predict your capabilities as a connector. It is the structural makeup of your core discussion group that can best predict how successful you will be as a bridge or a connector, someone who can broker relationships and profit by filling those “structural holes” between networks. What matters most is how many people you know in your networks who don’t know each other.

  In their book Connected, Nicholas A. Christakis and James H. Fowler say that within the average American’s social network, there is a 52 percent chance that two of his or her contacts will know each other. This factor in networking is called transitivity. A transitivity rate above 52 percent suggests that, more than most people, you are deeply embedded in one type of network where many people know each other. You are so deeply embedded that it is not likely that you will serve as an effective bridge to other networks. On the other hand, if you have a low-transitivity network, one in which lots of the people you know don’t know each other, then you are much more likely to occupy a central position in your network, one in which people commonly ask you to recommend contacts that they can’t reach easily on their own.

  “If you are happier or richer or healthier than others, it may have a lot to do with where you happen to be in the network,” Christakis and Fowler write. Connectors and bridges are said to have a lot of “friends of friends” relationships, called “weak ties,” in diverse areas of activity, which is advantageous for the connector. “People who have many weak ties will be frequently sought out for advice or offered opportunities in exchange for information or access. In other words, people who act as bridges between groups can become central to the overall network and so are more likely to be rewarded financially and otherwise.” This is true inside large organizations,
too. We’ve all known one or two connectors at work who seem to know lots of people in different parts of the organization. These people tend to have a lot of influence in the workplace precisely because they know so many people who don’t know each other that they can be the bridge to getting things done in some cases.

  One thing I notice about Gates, Laliberté, Hirst, and Green is that all of them started out deeply embedded in their respective networks—computer programmers, circus artists, art school graduates, and music teachers. What set them apart was how they reached out and made networking inroads into somewhat alien worlds of superior wealth and resources—IBM, the government of Quebec, patrons of the arts, and private equity investors. Christakis and Fowler point out that the care and tending of your social network requires this sort of deliberate action because “social networks tend to magnify whatever they are seeded with.” By seeking stronger ties to people with greater wealth and resources than your own, you are seeding your network for future triumphs, even if your networking efforts don’t meet with any immediate measurable success.

  Chapter 4 described how Gates progressively sowed the seeds of his tremendous success by always seeking partnerships with the strongest computer industry players who would partner with him. Laliberté seized the opportunity to make contact with Quebec government officials during Cirque’s first summer as a part of the province’s 450th anniversary celebration. Hirst’s solicitation of a $10,000 grant from a real estate company for the Freeze exhibit opened the way for his vast wealth in conceptual art. Green owes everything he has to that initial partnership with his well-to-do, financially savvy dentist.