Are MBAs good entrepreneurs?

This one is gonna be short. And it probably deserves to be short.

Are MBAs good entrepreneurs?

The way this question is posed seems to predestine the answers to be negative. As an MBA candidate myself in the HEC Paris programme that puts quite some emphasis on entrepreneurship, I do have to elaborate a bit more on this topic, mostly qualitatively. But your gut instinct is right — at this moment I don't think MBAs make for better entrepreneurs than non-MBAs.

The main problem is most of the tools that an MBA student acquires in the program are designed for corporate environment, not startups. Take the notorious NPV (Net Present Value) for example. The idea of calculating an NPV number for a certain project, be it a new one or replacement one, just goes fundamentally against entrepreneurship.

Why? 

The NPV requires predicting the future: revenues, COGS, SG&As and above all, discount rates. While there are many ways to construct the prediction, they almost always involve incorporating substantially the historical operational numbers.

Let's take the other end of the private equity spectrum, buyout investments, for example. Unlike startup investments, buyout investments aim at minimizing the amount of uncertainties. The buyout funds typically go after companies in a mature industry, with a history of operation, facing similar macro risks as the entire industry, having a low leverage currently and with healthy operational cash flow. The reason they aim for such companies is because they're gonna use substantial leverage to buy 100% of its equity. The debt to asset ratio could amount to 60% or 70% even in the much moderated buyout environments today. They will then use the Free Cash Flow to the Firm (FCFF) generated from the operation with the help of the operational consultant or even CEO they bring in to service the debt. The last thing they want is non-systematic risks since it'll put the company in constant default threat that can not be blamed on the macro when they have to explain to the angry LPs why a certain investment tanked.

In other words, buyout funds principally look for "good to great" deals in terms of operation and seldom venture outside. The whole concept of amplifying the fund IRR with debt simply does not allow them to pick up a company with crappy operations and pray for it to become a homerun.

The training of MBAs fits nicely into the buyout scenario, even though the buyout firms rarely hire MBAs out of business schools.

A finance-oriented MBA is supposed to be able to take a existing company's financial reports and other information if it's a listed company, rebuild an interlinked version in Excel, identify the non-recurring items as well as remove the divested businesses, establish a base-line operational scenario and build a financial model for the next 5 years based on a certain assumption of deal structure ("How the buyout fund is going to finance the buyout"), operational performances and exit valuation. Macro trends should also be included in the analysis as well as other identifiable risks, if the MBA is well versed in financial analyses. This is what we called a LBO Model and is the most fundamental part of a junior job in any buyout fund.

Now in the case of startups, obviously this does not make sense at all.

It's not even the question of whether to use debt to amplify return or not — there's rarely any REAL debt financing in VC investments — but rather it's simply that there's no historical operations that you could build your model on. The heck with it: some startups in Series A fund-raising don't even have revenues!! Even at Series B or Series C where you have operational results it's pointless trying to predict the future based on those numbers since the whole idea of startup is aiming for exponential growth in a very uncertain product category.

But we’re not talking about MBA financiers but MBA entrepreneurs, right?

Yes, you're right. But that's exactly my point — an MBA is trained to weigh over many options and try to pick the best one in terms of NPV. This is already hard enough when the target is an established public company with all financial data publicly available — anyone knows how much value iWatch is going to add to Apple when it's announced in October? When the uncertainties are overwhelming as in most startup scenarios, most tools that MBAs acquired in school simply don't work and everything is back to square one.

Transient

The fact is more often than that MBAs will feel that the startup endeavour is a negative NPV and possibly call it a quit sooner than necessary. They simply calculate too much. (The question of whether any random MBA really knows how to calculate is a different topic.)

Worse for both the startup and its investors, MBAs usually have more alternative career choices than a college dropout that fancies to create the next popular sex-chat app. Most MBAs would be able to join a big corporate if given the right angle. It's entirely possible that a B2B startup would lose its MBA co-founder simply because France Telecom likes him or her so much during their pitch of the startup product to the giant corporate that is supposed to revolutionize the whole e-Payment industry.

In fact, I have had a fellow MBA classmate who left a high-profile finance job after getting sick of the ugly nature of the industry and claimed he wanted to be an entrepreneur and contribute to the society. Without me even asking, he quickly threw in the additional comment that if it doesn't pan out in 1 or 2 years, he could still join a Private Equity firm by leveraging his past experiences and networks in the financial industry.

This guy basically committed all the sins an entrepreneurs could possibly commit before he EVEN starts his own venture. Worse, he told a venture capitalist about this. I was to be honest quite bewildered by the whole conversation at that moment.

This guy — a basically nice guy that would be appreciated in most human relationships — is probably a singularity. Still, you get the idea that MBAs in general simply calculate too much. With the huge amount of uncertainties in front out them in an entrepreneur's career and having invested so much monetarily in the MBA programs, there's simply a higher possibility that they would jump ship too soon when other opportunities presents themselves.

And that, my friends, is an absolute NO-NO for an venture capitalist when he's evaluating an entrepreneur.

That said, it doesn't mean MBAs cannot be involved in a startup endeavor constructively. My view is that MBAs are best for startups that already have established the product offering and are looking for the most well managed way to grow, both in fund-raising and operation. An MBA with financial or accounting training will be a good CFO candidate for any startup. He or she might also be extremely useful in helping the startup figure out where the pasture is greener given the startup's technology or offering.

But a startup founded by an MBA, who had spent numerous Thursdays getting drunk in the school parties and has probably too many fellow MBA cohorts who work for Siemens or Nestlé?

Well, let's just say I might prefer to spend my 1 hour of interview with a college dropout whose hairstyle is horrible even by the Californian standard.


Update July 22nd, 2014 — a piece on Bloomberg Businessweek echoes my sentiment of MBAs being best involved with startups in a CFO-type of roles: « How an MBA Could Have Saved Snapchat's Founder From Himself »

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