Fostering Innovation and Entrepreneurship

Fostering Innovation and Entrepreneurship

Christian Schwarzkopf Fostering Innovation and Entrepreneurship Entrepreneurial Ecosystem and Entrepreneurial Fundamentals in the USA and Germany

Christian Schwarzkopf Karlsruhe, Germany Karlsruhe Institute of Technology, Germany, 2015 OnlinePlus material to this book can be available on http://www.springer-gabler.de/978-3-658-13511-9 ISBN 978-3-658-13511-9 DOI 10.1007/978-3-658-13512-6 ISBN 978-3-658-13512-6 (ebook) Library of Congress Control Number: 2016936553 Springer Gabler Springer Fachmedien Wiesbaden 2016 This work is subject to copyright. All rights are reserved by the Publisher, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed. The use of general descriptive names, registered names, trademarks, service marks, etc. in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use. The publisher, the authors and the editors are safe to assume that the advice and information in this book are believed to be true and accurate at the date of publication. Neither the publisher nor the authors or the editors give a warranty, express or implied, with respect to the material contained herein or for any errors or omissions that may have been made. Printed on acid-free paper This Springer Gabler imprint is published by Springer Nature The registered company is Springer Fachmedien Wiesbaden GmbH

Acknowledgements I would like to thank my thesis advisor Professor Rothengatter for having given me the opportunity to write about this exciting topic, for his continuous and great support, as well as for his valuable feedback throughout the years of this dissertation. I would also like to thank my Professors, Orestis Terzidis and Andreas Oberweis, for their valuable feedback and motivation. Many thanks go to my family and their support, especially my father Professor Schwarzkopf for his intense feedback and valuable discussions. Finally, I would like to thank all the persons who have helped me to master this thesis, by giving advice and feedback, participating in the surveys, and by providing me with insights from an investor s perspective, from academia as well as from an entrepreneur s perspective. Last but not least, thanks to my business partner Tim, who supported my aspiration to pursue this doctoral thesis throughout this long period. Christian Schwarzkopf

Abstract Entrepreneurship and innovation have been identified in politics and in industry as crucial elements for economic success. In this context, the importance of a successful entrepreneurial environment is mentioned, and sometimes the term ecosystem is also being used. Yet the fairly new term Entrepreneurial Ecosystem has not been sufficiently defined, analyzed and developed, in order to understand what it actually stands for. The major goal of this thesis is to develop a holistic concept of an Entrepreneurial Ecosystem taking economic, social and personal aspects into account and identify areas, in which Germany nowadays can improve and learn from the USA. In the beginning, the areas of innovation and entrepreneurship have been analyzed, showing that innovation is all about implementation of new things in a market, and entrepreneurship is about persons that are part of the innovation process, by starting business with an invention or a new business aspect that they bring into the economy, according to their own believes and goals. Not everyone can become a successful entrepreneur, because the necessary inherent abilities cannot be learned or taught. However, these qualities alone are not enough to guarantee success. Success factors of startups and its entrepreneurs have been part of an analysis and have been supplemented by two surveys the author conducted among investors and entrepreneurs. The surveys especially revealed that self motivation, and the combination of individual ability and skills of the entrepreneurs were considered by both groups as the most important success criteria. A comparison between the United States and Germany showed that today the US indeed is a more entrepreneurial country and has had, on average over the last years, about 40 times more available venture capital than Germany. Its open culture, its recent 200+ years of immigration history, as well as its investor friendly tax policy and its entrepreneur friendly bankruptcy laws all together favor the foundation and growth of new ventures in the US. As a role model for global entrepreneurship, the US success factors, as well as the literature research and the surveys have helped to identify the four important areas of an Entrepreneurial Ecosystem. These areas occur in a circular form creating 4 independent circles, starting from the personal characteristics in the center to the impersonal business qualities and activities on the outside parameter. Every circle has its own distinct qualities and characteristics. Among them are abilities and skills in the Personal Circle, family and friends in the Private Circle, higher education and training in the Educational Circle and business world and culture in the Public and Business Circle. For the purpose of this study of entrepreneurial phenomena and their

VIII Abstract success relation, the focus is on Germany and its needs for improvement, which are necessary to overcome the under financing of startups and to induce a more proentrepreneurial climate. Encouraging the legal person company or corporation to invest parts of their yearly profits into venture capital is one of the potential solutions. Furthermore, looking into how the German state can encourage and motivate more successful entrepreneurs, inventors as well as investors to participate in startup businesses and companies. Eventually, a more unified and business open minded Europe creates one huge common domestic market, in which startups could grow as large and as fast as startups can in the USA.

Table of Contents Abstract... VII List of Tables... XV List of Figures... XVII Abbreviations... XIX 1 Introduction... 1 1.1 A Rationale for Innovation & Entrepreneurship... 1 1.2 Innovation and Entrepreneurial Background... 3 1.3 German & US Market... 3 1.4 An Entrepreneurial Ecosystem... 4 1.5 Motivation... 4 2 Methodology... 7 2.1 Approach... 7 2.2 Hypotheses... 8 3 Knowledge Base... 9 3.1 History of Innovation... 9 3.2 Three Potential Waves of Innovation Development... 10 3.2.1 First Wave of Innovation... 11 3.2.2 Second Wave of Innovation... 11 3.2.3 Third Wave of Innovation... 12 3.3 Further Defining Innovation... 13 3.3.1 Type of Innovation... 13 3.3.2 Innovation as a Must for Survival... 15 3.3.3 Origin of Innovation From Ideas to Inventions... 16 3.3.4 Numbers and Monetization of Patents and Innovation... 16 3.4 Defining Entrepreneurship & Entrepreneur... 17 3.4.1 Differentiation of Unternehmer, Entrepreneurs and Intrapreneurs... 18 3.4.2 Entrepreneurs vs. Financial Risk... 19 3.4.3 Further Definitions of Entrepreneurs... 20 3.4.4 Social Entrepreneurship... 21 3.5 First Definitions of the Entrepreneurial Ecosystem... 21 3.5.1 Boulder Entrepreneurial Ecosystem... 23 3.5.2 Developments of Further Entrepreneurial Ecosystems... 23 3.5.3 Entrepreneurial Ecosystem by Isenberg... 24 3.5.4 Two Entrepreneurial Ecosystems by the World Economic Forum, Stanford University, Ernest Young and Booz & Company... 26 3.6 Startup & Spin Off... 29 3.6.1 Founding Process... 30

X Table of Contents 3.6.2 Company Stages of Startups... 31 3.7 Three Areas of Innovation... 34 3.8 Open Innovation... 36 3.9 Innovation Management... 37 3.10 Financing of Startup Companies... 40 3.10.1 Personal Financing... 42 3.10.2 Trade Off Theory... 42 3.10.3 Pecking Order Theory... 43 3.10.4 Debt Security Real and Personal Property... 45 3.10.5 Equity... 46 3.11 Financing with Risk Capital... 46 3.11.1 Business Angels (BA)... 47 3.11.1.1 Facts & Figures about BAs... 47 3.11.1.2 Motivation of Business Angels... 49 3.11.2 Private Investors... 49 3.11.3 Crowd Funding... 50 3.11.4 Venture Capital (VC)... 50 3.11.4.1 Organizational Entity... 51 3.11.4.2 Structure and Investment Focus... 52 3.11.4.3 Facts & Figures about VC... 53 3.11.4.4 Differences between BAs & VCs... 54 3.11.5 Series A, B, C... 55 3.11.6 Comparison of Different Risk Capital Types... 56 3.11.7 The Right Fund Size... 58 3.11.7.1 Fund Size Calculation... 58 3.11.7.2 Importance of the Fund Size with the Example of WhatsApp... 59 3.11.8 Brief Outlook on the Development of the Venture Capital Market... 60 3.12 Investment Decisions of Venture Capitalist & Business Angels... 60 3.12.1 Adverse Selection at the Beginning of the Encounter... 60 3.12.2 Investor s Decision Process... 61 3.12.3 Venture Capitalist & Business Angel Cycle... 63 3.12.3.1 The Deal Origination... 63 3.12.3.2 The Screening... 63 3.12.3.3 The Evaluation... 64 3.12.3.4 The Deal Structuring... 65 3.12.3.5 Post Investment Activities... 66 3.12.3.6 Monitoring... 66 3.12.3.7 Value Adding... 67 3.12.3.8 Exit... 68 3.13 Business Planning... 70 3.13.1 The Basic Structure of a Business Plan... 71

Table of Contents XI 3.13.2 Effectiveness of Business Plans... 72 3.13.3 Business Plans in a New Context... 73 3.14 Business Case... 74 3.14.1 Business Cases in an Entrepreneurial Environment... 74 3.14.2 Scenario Planning... 75 3.15 Government Support... 76 3.16 Competitions... 76 4 Success Factors... 79 4.1 Success... 79 4.2 Characteristics of Entrepreneurs... 80 4.3 Entrepreneurs as Social Creatures... 82 4.4 Important Factors for Success of Startups... 84 4.4.1 Entrepreneurial Team... 85 4.4.2 Product and Service... 86 4.4.3 Market Characteristics... 86 4.5 Expert Panel Survey... 88 4.6 The Investor s Perspective... 89 4.6.1 General Aspects on the Investors Most Successful Companies... 89 4.6.2 Product and Service Characteristics... 90 4.6.3 Market Characteristics... 92 4.6.4 Venture Team Characteristics... 92 4.6.5 General Factors... 95 4.7 Success Factors from the Entrepreneurs Perspective... 98 4.7.1 Market Characteristics and Strategy... 98 4.7.2 Product and Service Characteristics... 99 4.7.3 General Internal and External Factors... 99 4.7.4 Venture Team Characteristics... 101 4.7.5 Motivation and Characteristics of the Founders... 103 4.7.6 Deriving Influence on the Startup s Growth... 106 4.7.7 Most Important Success Areas... 107 5 Market Comparison... 109 5.1 Venture and Startup Relevant Figures... 110 5.2 Market Situation... 113 5.2.1 Concept of Buyer s and Seller s Markets... 114 5.2.2 Situation in Germany and the US... 115 5.2.3 Results of the Different Distribution of Power... 115 5.3 Possible Reasons and Analysis of VC Developments... 117 5.4 History, Geography & Culture... 117 5.4.1 Anglo Saxon Tradition... 118

XII Table of Contents 5.4.2 Geographical Position of the US... 119 5.4.3 Geographical, Political and Cultural Situation of Germany and Europe... 120 5.4.4 Current European Innovation Initiative... 121 5.4.5 The German Kleinstaaterei... 121 5.4.6 Honor and Pride... 122 5.4.7 Educational Systems... 123 5.4.8 Beginning of Entrepreneurship and VC in Germany... 123 5.4.9 The Beginning of Venture Capital in the US... 124 5.5 Consequences of Historical Differences... 124 5.6 Risk Aversion... 125 5.7 Boldness The Global Market Size Estimation... 127 5.8 Performance and Maturity of Venture Funds... 128 5.9 Taxation... 129 5.9.1 Income Tax... 130 5.9.1.1 Concept and Comparison... 131 5.9.1.2 Differences and Potential Entrepreneurial Impact... 131 5.9.2 Corporate Tax... 133 5.9.2.1 Federal Concept and Comparison... 133 5.9.2.2 State Concept and Comparison... 134 5.9.3 Capital Gains Tax... 135 5.9.3.1 German Capital Gains Tax... 135 5.9.3.2 United States Capital Gains Tax... 136 5.9.3.3 Differences and Potential Entrepreneurial Impact... 137 5.9.4 Double Taxation Problem... 138 5.9.5 Summary on Taxation... 138 5.10 Bankruptcy Laws... 139 5.11 Gender Aspect... 140 5.12 Top 100 Established National Companies... 141 5.13 Internet Success Cases & Copycats... 142 5.14 Top 100 Global Startups... 147 5.15 Summary of the US German Market Comparison... 148 6 The Entrepreneurial Ecosystem... 149 6.1 The Basic Elements... 149 6.2 The Ecosystem Circles... 149 6.3 The Laws and Linkage of the Circles... 152 6.4 The Personal Circle Abilities, Skills, Experience and Character... 153 6.4.1 Ability & Skills... 154 6.4.2 Character Traits... 155 6.4.3 Experience... 157 6.4.4 Comparison of the Personal Key Elements... 157

Table of Contents XIII 6.5 The Private Circle Family, Friends, Neighbors, Coaches and Clubs... 160 6.5.1 Neighbors... 160 6.5.2 Family... 161 6.5.3 Friends... 161 6.5.4 Clubs... 162 6.5.5 Coaches... 162 6.6 The Educational Circle From Kindergarten to Higher Education... 162 6.6.1 Kindergarten... 164 6.6.2 School Years... 164 6.6.3 Higher Education... 165 6.6.3.1 Basic Entrepreneurial and Business Skills... 165 6.6.3.2 Coding... 165 6.6.3.3 Networking and Experience by Professionals... 166 6.6.3.4 Bachelor and Masters Degrees... 166 6.6.4 Internships... 167 6.6.5 Further Education... 167 6.7 Public & Business Circle From Culture, to Economy and Geography... 168 6.7.1 Finance World... 169 6.7.2 Culture... 171 6.7.3 History and its Connection to Geography and Culture... 171 6.7.4 Geography... 173 6.7.5 The Influence of the Media... 174 6.7.5.1 Media Coverage... 174 6.7.5.2 Transporting a Negative Message about Entrepreneurship... 175 6.7.5.3 TV and Movies... 176 6.7.5.4 Different Reactions in Germany and the US... 176 6.7.6 Economy & Business World... 177 6.7.6.1 Business Plans & Business Cases... 179 6.7.6.2 Tools & Business Methods... 180 6.7.6.3 Markets & Economic Situations... 182 6.7.7 Language... 184 6.7.8 Government... 184 6.7.8.1 Government Programs for Founders in Germany... 186 6.7.8.2 Government Programs for Investors in Germany... 189 6.7.8.3 Government Programs for Research Institutions & Universities in Germany... 190 6.7.9 Mixed Sub Element: The Founding Process... 190 6.7.10 Social Networks... 191 6.7.11 Co Founders... 191 6.8 Business Model... 192 6.9 Interaction within the Entrepreneurial Ecosystem... 194 6.9.1 Hand of Fortune... 195

XIV Table of Contents 6.9.2 Interacting through Open Innovation... 198 6.10 Important Phases and the Role of the Circles... 198 6.11 Deriving Key Elements for Improvement... 199 7 Improving the Entrepreneurial Ecosystem... 201 7.1 Fostering Entrepreneurship on a Higher Educational Level... 201 7.1.1 Integrating Experienced Entrepreneurs... 201 7.1.2 Flexibility in the Student s Curriculum and Part Time Employment... 202 7.1.3 A New Form of Business Planning... 203 7.1.3.1 Golf Layout Business Plan... 203 7.1.3.2 Application by Different Teams... 205 7.1.4 Scenario Planning in Business Cases... 206 7.1.4.1 Worst, Medium and Best Case Scenario... 206 7.1.4.2 Scenario Comparison... 208 7.2 Comprehensive Founding Material and Information Base... 209 7.3 Government Enforced Programs... 210 7.3.1 Corporate Venture Law Increasing the VC Volume out of Annual Profits... 210 7.3.2 Special Tax Treatment... 212 7.3.2.1 Tax Free Period... 213 7.3.2.2 Tax Deductions for Employment Growth... 213 7.3.3 Opening the Labor Market for More Talents... 214 7.3.4 New Bankruptcy Law for Startups... 215 7.3.5 Laws Protecting Startups against Written Warnings... 216 7.3.6 Gender Support... 217 7.4 One European Startup and Venture Market... 218 7.4.1 The Venture Capital Perspective... 218 7.4.2 The Startup Perspective... 219 7.5 Open Markets for International Investors outside the EU... 220 7.5.1 The German Market as a Safe Haven for Capital... 220 7.5.2 Good Competition for German Investors... 221 7.6 Open Culture for Entrepreneurship... 222 7.7 Pro Entrepreneurship Media Involvement... 222 7.8 Overview on Potential Changes... 223 8 Summary & Outlook... 227 Appendix... 231 References... 233

List of Tables Table 1: Three Waves of Innovation after the Ancient World... 13 Table 2: Sources of Ideas for Inventions (Ripsas, Sven 1997, p.138)... 16 Table 3: Various Founder Types Source: Szyperski & Nathusius (1999, p.27).... 19 Table 4: Components of the Entrepreneurial Eco System Pillars (World Economic Forum 2013)... 28 Table 5: Startup Stages... 33 Table 6: 3 Areas of Innovation... 35 Table 7: Comparison of the BA Market (Saublens & Secretariat 2008, p.18), (Centre for Strategy & Evaluation Service 2012, p.15), (European Investment Fund 2011)... 48 Table 8: Comparison of the US and German VC Markets (Dow Jones VentureSource 2010) (Jacobi 2013) (Majunke Consulting 2013) (H. Brandis & Whitmire 2011, p.4) (CB Insights 2012) (Bundesverband Deutscher Kapitalbeteiligungsgesellschaften (BVK) 2013) (Bundesverband Deutscher Kapitalbeteiligungsgesellschaften (BVK) 2011a). 53 Table 9: International Series A & B Deals 2013 & 2014 (Source: Author & Crunchbase 2014)... 56 Table 10: Comparison of Investors (Source: Author & (Crunchbase 2014))... 58 Table 11: VC/BA Cycle (Boocock & Woods 1997, p.41)... 63 Table 12: Product/ Service Characteristics (Scale from 0 100pt, n=28 (investors))... 91 Table 13: Market Characteristics (Scale from 0 100pt, n=28 (investors))... 92 Table 14: Venture Team Characteristics (Scale from 0 100%, n=28 (investors))... 93 Table 15: Functional Expertise of the Team (n=28 (investors))... 93 Table 16: Reasons to Fail Mentioned in Free Text Fields (114 answers from 28 participants clustered)... 94 Table 17: Reasons to Succeed Mentioned in Free Text Fields (118 individual answers from 28 participants clustered in the above categories)... 95 Table 18: Ranking of the General Factors (Scale from1(not at all important) to 6 (extremely important))... 96 Table 19: Startup Strategies (n=62 (entrepreneurs))... 99 Table 20: Average Product/ Service Characteristic... 99 Table 21: Importance of General Factors (n=47 (entrepreneurs))... 100 Table 22: Venture Capital and Economic Key Figures... 112 Table 23: Reasons for Strong Positions in Markets (Wirtschaftspedia 2012)... 114

XVI List of Tables Table 24: Number and Maturity of VC Funds (Hendrik Brandis & Whitmire 2011, p.17) Original: Cross selection of Dow Jones Venture Source... 129 Table 25: Tax as a Factor on VC Climate (Deloitte et al. 2010, pp.18 20)... 129 Table 26: Income Tax Rates in Germany (Kreft 2011b, pp.185 186)... 131 Table 27: Income Tax Rates in the US (Department of Treasury 2011)... 131 Table 28: Corporate Tax Rates in the US (Tax Foundation 2011a) (Department of the Treasury 2006, p.17)... 134 Table 29: Selected Rates of Assessment in Germany (Author, (Destatis 2005))... 134 Table 30: Capital Gains Tax in the US 2011 (Tax Foundation 2013)... 136 Table 31: Capital Gains Tax in the US 2013 (IRS 2013)... 137 Table 32: Entrepreneurial (Dis )Advantages of Taxation Systems... 138 Table 33: German Copycats and their US Origin... 143 Table 34: Personal Traits in Circle I... 158 Table 35: Influencing Aspects from the Economy & Business World Element... 179 Table 36: Government and State Programs for Founders... 188 Table 37: Hand of Fortune Characteristics... 197 Table 38: Entrepreneurial Ecosystem Improvements... 226

List of Figures Figure 1: An Entrepreneurial System of New Venture Creation (Neck et al, 2004)... 23 Figure 2: 6 Domains of Entrepreneurship (Isenberg, 2011)... 25 Figure 3: Entrepreneurial Ecosystem by World Economic Forum and Booz & Company in 2011... 27 Figure 4: Entrepreneurial Ecosystem (The World Economic Forum 2013)... 27 Figure 5: 3 Areas of Innovation Stakes, Benefits & Complexity... 36 Figure 6: Typical Second Generation Stage Gate Process (Cooper & Kleinschmidt 1990, p. 46). 38 Figure 7: Typical Third Generation Stage Gate Process (Cooper 1996, p. 479)... 39 Figure 8: Structure of a VC Fund (BVCA 2012, p.4)... 51 Figure 9: Timmons Model of Entrepreneurial Process (Timmons et al. 2004, p.16)... 74 Figure 10: Industry Areas of Successful Companies(Investors could choose several categories) 89 Figure 11: Money Invested on the Venture by the Founding Team's Member... 90 Figure 12: Markets Served by the Startups (n=62 (entrepreneurs))... 98 Figure 13: Distribution of Co Founders (n=53 (entrepreneurs))... 101 Figure 14: Entrepreneurial Experience (n=53 (entrepreneurs))... 101 Figure 15: Growth of the Foundation Teams (n=53 (entrepreneurs))... 102 Figure 16: Team Expertise (n=53 (entrepreneurs))... 102 Figure 17: Characteristic of Team Members (n=53 (entrepreneurs))... 103 Figure 18: Importance of Aspects at the Foundation of the Company (n=48 (entrepreneurs)). 104 Figure 19: Ranking of Needed Skills and Abilities (n=48 (entrepreneurs))... 105 Figure 20: Different Attitudes of Entrepreneurs (n=48 (entrepreneurs))... 105 Figure 21: Average Growth of a Successful Startup... 106 Figure 22: GDP vs. VC 2008 2012 Average (compare Table 7 & (Countryeconomy 2014)... 110 Figure 23: Airbnb Pitch Presentation (Airbnb 2008)... 128 Figure 24: Entrepreneurial Ecosystem... 151 Figure 25: Business Model Canvas (Osterwalder et al, 2010)... 193 Figure 26: Hand of Fortune... 197 Figure 27: Field or Golf Layout Business Plan... 204 Figure 28: Scenario Comparison... 208

Abbreviations Bn BA BRIC BVK CRM ERP EUR EXIT GDP IAS IP IPO K M OCEAN PE PMI ROI SME SWOT T TEA US/USA USD VC Billion Business Angel Brazil, Russia, India and China (Bundesverband Deutscher Kapitalbeteiligungsgesellschaften) Customer Relationship Management Enterprise Resource Planning Euro (Currency) Sell of the complete or parts of the company, especially to return the money to the investors Gross Domestic Product International Accounting Standard Intellectual Property Initial Public Offering Thousand Million Openness, Conscientiousness, Extraversion, Agreeableness, Neuroticism Private Equity Project Management Institute Return on Invest(ment) Small Medium Enterprise Strengths Weaknesses Opportunities Threats Trillion Total Early Stage Entrepreneurship Activity, age 18 64 in the first 3.5 years United States of America US Dollar (Currency) Venture Capital