A Model of Entrepeneurship

This article presents a simple model of entrepreneurship and checks it against convenience data.

We start from a rational actor framework adjusted for perceived value rather than actual value, although perceived and actual value should correlate in the short run and converge in the long run. The founding assumption is that potential entrepreneurs will choose to become actual entrepreneurs when they perceive the venture as efficient or profit-maximizing.

Perceived efficiency occurs when the actor decides entrepreneurship is preferable to every other activity. To be a bit more precise we should make the model probabilistic. If the entrepreneur is indifferent between two activities we would forecast a 50% chance for each one, assuming they are mutually exclusive and collectively exhaustive. In this sense we do not guarantee the actor will behave in even a perceived profit-maximizing way, but we assign such possibility the highest likelihood.

Our model accounts for the actor's skill level, information, and risk profile. We anticipate that an actor will engage in entrepreneurial activity when the information they possess leads them to believe such activity is profit-maximizing. They are anticipated to estimate the following:

1. The actor's own capability, time preference, and risk preference.
2. Estimated benefits from entrepreneurship on a probabilistic basis with a time schedule, even if the estimate is incorrect. This includes business-side estimates of revenue and also personal estimates of utility or other gains.
3. Estimated benefits from alternative activity on a probabilistic basis with a time schedule. Primarily, traditional employment benefits.

While validation of this model would need to be conducted empirically, we can do a thought experiment for weak validation.

Assuming:

1. Actors decrease in risk preference with age.
2. Actors have a subjective discount rate which follows a U-shape with respect to age. Although the causal mechanism seems to be survival probability, age is a proxy variable which is both more available and intuitive. This is used as the metric for time preference.
3. Actors have a competency rate which exhibits diminishing marginal return with respect to time.
   1. The \"sweet spot\" seems to be 3-10 years of professional experience because this is the number of years of experience to be considered mid to upper level in many professions without entering into the mid to late senior phase where marginal gains are small.
   2. Competency with respect to time is also related to education and many other things, but this is a rough estimate.
   3. Moreover, we assume that actors can estimate (roughly, or even incorrectly, but still with sufficient confidence to drive them toward action) comparative inter-firm competency, not just own-productivity.
4. By the time the competency sweet spot rolls around most actors can roughly forecast comparative employment and entrepreneurial benefits and costs.
5. The average age of getting out of college, which initiates the professional experience time period, is about 23.

These assumptions are rough and need empirical validation but they might do the trick for a quick mental validation. From these assumptions we predict that entrepreneurship is like a rational gamble or a cousin of an investment choice which is best taken by young professionals in their late 20s.

Specifically, I predict the highest propensity for entrepreneurial activity occurs at ages 26-33.

In this sweet spot they have gained significant education and experience but they are still willing to take a moderate amount of risk and they are willing to spend some money in the current period in order to potentially reap significant future benefit in a way similar to financial investment.

So, does real data match our prediction of entrepreneurial propensity?

• This paper says data is conflicting and scarce, but some scholars have \"argued that the average age of 35 is most prevalent in determining an individuals’ entrepreneurial intent in starting up.\"
• This Asian study had highest entrepreneurial activity over the age range 25 - 44, but the 35-44 range slightly beat out the 25-34 range.

I guess most of the data says entrepreneurs are a touch older than I expected. Why is this? Not sure at the moment but some possible explanations:

1. Capital accumulation plays a key role and people a bit older are better off this way.
2. 10+ professional years of experience may:
   1. Result in larger marginal gains than expected.
   2. Play an important signaling role.
   3. Result in small competency gains, but a competitive market may have a sensitive threshold such that small changes in competency result in large changes in potential revenue on the market from entrepreneurship.
3. There is some indication that social networks play a key role and I haven't investigated this fully. Older people might have better networks.
4. Entrepreneurs might get started around 26-33 but quickly cease entrepreneurial ventures on failure, while those that succeed stay in as they increase in age. We might be seeing an accumulation effect in the 35-44 range where there are a small number of 'new entrepreneurs' and a small number of continuing entrepreneurs which adds to a total larger share.
5. My underlying model is fundamentally wrong. I think this is not true since I wasn't very far off, but it could be true.
6. Some combination of the above.