I thought this paper was excellent. Our language influences what we see and think and having the term “Veblen Entrepreneur” available is very useful. (For example, in cultures without words for certain colors, they can’t easily see that color. We have trouble thinking about concepts without appropriate terminology; this is where jargon is useful to experts.)
I think most people with business/economics backgrounds are familiar with Veblen goods. The term comes from Thorstein Veblen who wrote The Theory of the Leisure Class (1899). Veblen goods are valued for their conspicuous cost rather than for their utility (usefulness). Many luxury cars, watches, handbags, etc. are in this category. They are interesting in that the demand curve, which normally is downward sloping (the cheaper it is the more demand there is), may be upward sloping (the more expensive it is the more demand there is). Veblen coined the term “conspicuous consumption” – it isn’t a new phenomenon!
The authors of the paper are focused on businesses seeking venture capital, but, further down the food chain, I think there are lots of folks who do this on a smaller scale. In my (misspent) youth, I was very active in networking activities through the Chamber of Commerce, BBB, was president of a BNI group, etc. As far as I can tell, these groups are primarily useful to their participants by feeling like work without actually being work. They are frequently people with few (or no) prospective customers talking to each other in the vain hope that one of them will perhaps stumble upon one eventually. Thus, most (not all) of the folks participating were low-end Veblen Entrepreneurs. I think virtually every MLM participant, most real estate agents, and many purchasers of inexpensive franchises are Veblen entrepreneurs, and I love having a good term for it.
I also think that there are many Veblen investors (and I am apparently the first to coin that term!) where the fun, excitement, or social cachet are far more important than the expected returns. Here are some examples of what I believe are Veblen investments:
- Penny stocks
- VC/PE/Hedge Fund investments (for individuals, not institutions)
- Crypto currencies
- SRI/ESG/impact investments
You may have seen articles about Veblen investors joining Robinhood recently… frequently for the LOLs rather than the risk-adjusted returns. (But sometimes, it’s tragic.)
Anyway, back to Veblen Entrepreneurs. I typically give two pieces of advice to people (such as clients) who are thinking of starting a business:
- Read The E-Myth Revisited: Why Most Small Businesses Don’t Work and What to Do About It
- Set a hard stop on how much you will sink into the venture
I want to elaborate on that second item. Many clients have too much money to start a business. I’m sure that sounds odd. What I mean is, to start a business you must be optimistic – you have to believe that even though most new businesses fail you will be the exception. So suppose a client has $1,000,000 portfolio and is unhappy in their job (or loses it). Rather than get another, similar, job, they decide to start a small business – let’s say a restaurant. The problem is that, because of their optimism, they can delude themselves that success is “right around the corner” until they have spent the whole $1,000,000. They need to in advance set a hard stop of some sort. If they only had $200,000 then running out of those funds would force them to close the restaurant and get a job again. With $1,000,000 there is less pressure to get profitable or to abandon the attempt until the whole $1,000,000 is gone. The appropriate metric will depend on the client and business, but it should be 1) specified in advance, 2) in writing, 3) specific, and 4) inviolable.
Recent research has come out that supports my concerns. Here’s the abstract:
We examine how wealth windfalls affect self-employment decisions using data on cash payments from claims on Texas shale drilling to people throughout the United States. Individuals who receive large wealth shocks (greater than $50,000) have 51% higher self-employment rates. The increase in self-employment rates is driven by individuals who lengthen existing self- employment spells, and not by individuals who leave regular employment for self-employment. Moreover, the effect of wealth reverts for individuals whose payments run out. Rather than alleviating a financial constraint, our evidence suggests that unrestricted cash windfalls affect self-employment decisions primarily through self-employment’s non-pecuniary benefits.
Elsewhere in the paper:
[W]e find that, once individuals stop receiving shale royalty payments, they tend to exit self-employment for regular employment, consistent with the idea that shale royalty payments were subsidizing their income in a way that allowed them to be self-employed. This evidence also supports the view that the wealth shocks were not being used to fund self-sustaining or otherwise productive projects…
It is an accepted economics principle that returns will flow to the scarce factor of production. In other words, if you have the coffee shop franchise in Grand Central Station the landlord will extract the excess rents, not the coffee shop. Similarly, capital is abundant but the ability to generate excess returns scarce. Thus, you would expect those capable of producing excess returns to charge fees bringing the net excess returns to zero. These two recent papers (on hedge funds and private equity) support that view – indeed, adjusted for risk and illiquidity, the excess returns (net) are probably negative!
Investing should be done with a clear and unflinching objective of adequate risk-adjusted returns to meet your financial goals – an investment is no place to be stylish!