The security of entrepreneurship (guest post by Kyle Foot)

Quite simply put, there has never been a more validating time to be an entrepreneur. I could start by ranting about the impact of social media, citing the three-minute long great depression that resulted from one false tweet on behalf of the Associated Press, but that took place over a month ago. Anyone who remains doubtful that the business world has entered a new age is no longer relevant, and not worth my time in convincing.

Ten years ago, an entrepreneur’s first step in building a business from the ground up would be to attain the capital required to get things going, and (hopefully) break even by the third or fourth fiscal year after operation had commenced. Seeking a bank loan, seducing the vicious realm of venture capitalists, or being lucky enough to stumble upon an angel investor were all common practice. The entrepreneur would pitch their business plan and ultimately the bank, venture capitalist, or angel investor would decide whether the idea was worth the funding required.

Currently there has been a shift away from these methods, as revolutionary as democracy may have been to those living under the rule of an absolute monarchy in centuries prior. Crowdfunding, the process of entrepreneurs acquiring monetary capital to launch their business by appealing directly to consumers via websites such as IndieGoGo, KickStarter, and GoFundMe, provides immense threat to the aforementioned. The reason being is simple: crowdfunding derives from pitching your idea to the would-be consumers and leaving it up to them to either provide you with the necessary funding or not. No interest, no royalties, just good faith in the fact that you will deliver on your value proposition. The free hand at its finest.

The concept of crowdfunding is not entirely new, nor is its practice. Rather famously, in 1884 Joseph Pulitzer used his newspaper, The New York World, as a platform to encourage the public to donate toward construction of the pedestal that the Statue of Liberty sits on today, as the American Committee’s resource pool had run dry. In six months, Pulitzer raised the $100,000 or so required from over 125,000 people. The difference between this example and today’s version of crowdfunding is that it is no longer a pre-requisite to be a media mogul or major player in order to attain monetary capital from the general public, and the resource pool is global with immediate access to view your proposition. Additional benefits include the fact that crowdfunding works as a form of free advertising, as well as an immediate method of business plan validation from your potential customers.

Crowdfunding is becoming an essential building block in the development of startup businesses, yet for many entrepreneurs, the internet has provided an environment in which large investment is not required, as operating costs are minimal to non-existent. The purchase of a domain name (or web address) is roughly in the ballpark of a couple hundred dollars. Popular website generators such as blogspot and wordpress offer the average individual the ability to generate an online presence for free, and without devoting years of schooling toward learning computer code.

To emphasize the impact that the internet can have on cost efficiency, independent bloggers are a perfect example. The popular travel blog A Couple Travelers brought in $4906 for the month of April 2013 in advertising revenues. For the same month, their total operating expense was $400, which was actually spread over the operations of two separate websites. If the operating expense was applied solely to the one website, the operating ratio for this business would be approximately 8%. To look at it from a different angle, their gross profit margin is 92%. This blog is approximately one year old, with monthly revenues showing an increase of 60% between January and April of 2013. Although the total revenue of blogs such as this one are by no means in the realm of Coca Cola, to think that a startup business can operate at such high profitability is game changing.

This is not to say that every Tom, Dyck, and Harry should quit their day job and solely pursue the path of an entrepreneur. However, the thought that funding one’s savings or security plans via online entrepreneurship is intriguing, and perhaps necessary. Although the baby boomers managed to thrive from committing to careers with large corporations, generations who are entering or have yet to enter the workforce will not be so lucky. Although the internet has provided cost savings for small scale travel magazines as previously noted, it has also provided the opportunity for publically traded corporations to reduce their operating expenses and fuel profit margins that would have their shareholders salivating. Of course, these reductions are in the form of eliminating salaries. Why hire customer service agents when you can publish an FAQ section on your website? The security of holding a job with a multi-million dollar corporation is anything but stable.

It seems that over the past couple of decades, more people have watched technology replace their jobs than using it to their advantage. As a result, these people have deemed corporations to be greedy. That is incorrect. Corporations are savvy, and need to be in order to compete and stay alive. However, that doesn’t mean that the average employee’s personal finances must be privy to the cost-saving tactics of the corporate world. In fact, with tools such as crowdfunding and free website generators, it is now far more financially responsible to rely less on these companies and more on your own ingenuity for the purpose of accruing personal wealth. Common corporate benefits such as stock option incentives and long term investment plans remain valuable, and at no point should online entrepreneurship serve as their replacement, but rather exist in conjunction with them to provide enhanced security.

Collecting income on the side, just like crowdfunding, is not a modern concept. Investing in real estate for the purpose of alternative funding is one of the most common methods, but also one of the most risky. A decrease or crash in the housing market, unforeseen expenditures such as the replacement of appliances, and the poor habits of tenants if rental income is pursued are all valid concerns. As previously mentioned, one of the values that e-business provides is low investment and maintenance cost. Thus, it is not a question of whether people will choose to pursue alternative income online, but rather at what pace.

As this practice becomes increasingly widespread, the nature of our global economic system will be altered. Technological advancement and its integration within the world of business is gaining momentum as opposed to reaching a plateau. Relatively new online developments such as the bitcoin currency and its negative and positive effects are debated daily, while teenage app developers in the UK such as Nick D’Aloisio have become overnight millionaires. We will continue to see entirely new sets of tools further enabling businesses both large and small to operate at higher profitability, efficiency, and global reach. As a result, it is likely that there has never been a better time to be an entrepreneur, and it will only get better.

Kyle Foot is one half of coupleofyuppies.com, which provides travel and food advice for all twenty-something couples with a thirst for adventure. He graduated with a Bachelor of Commerce from McGill University. 

The social market

When AP was hacked, unwittingly sending out a Tweet that the White House has been attacked and President Obama injured, markets fell. The combination of social media and high frequency trading proved to be particularly potent, wiping approximately $136bn from US markets within 3 minutes. 

In spite of the influence social media carries, the regulation of the various platforms (Twitter, Facebook, Google, etc.) with respect to stock markets is not well established. The American Securities and Exchange Commission (SEC) now allows company information to be transmitted to investors through social media “so long as investors have been alerted about which social media will be used to disseminate such information.”

The SEC has not given guidance on the timing of disclosures or the outlets allowed. Indeed, the ruling does not even stipulate that information should be available on corporate websites in addition to other mediums. The ruling similarly avoids discussion on the timing of the disclosure or the dissemination of information across a number of channels. It is even less well established in the UK, where social media usage is more pervasive.

The lack of clear regulatory direction places an additional onus on investors, analysts and the media. Information must be sought across more channels. To meet this need, specialized research platforms exist offering investors the chance to gain a competitive advantage. Evidence from these platforms, as well as independent academic research suggests there is an advantage to this trading strategy.

Social media disclosure and trading use should be more stringently regulated in order to limit these market inequalities.  In the short term, the inclusion of social media will result in the value of a company better reflected in the market place. Information will be revealed more quickly, and spread faster. In principle, this will lead to increased volatility, with limited liquidity causing additional concern.

As more companies adopt social media channels as a way to engage investors and consumers, the ability for social media to influence the market becomes greater. As research platforms incorporating social media information continue to develop, the likelihood of social information having an impact becomes larger. This suggests regulation is necessary.

However, there is reason to be concerned that regulating social media usage is a type of censorship. The recent SEC ruling developed from a court case brought against the CEO of Netflix for posting material information on his personal Twitter account. If regulators are able to regulate who is able to say what across different platforms, it approaches the infringement of civil liberties.

That being said, it would be better for regulators provide clearer guidance to material disclosures on social media, before further market problems arise. If not, the chance that misinformation to spread through social media, causing a fall in the market and economic turmoil increases. As it currently stands, investors are unaware where and when to look for company information. This adds to market fragility, and is a cause for concern.

Choice overload

Financial instruments should be more carefully scrutinized before entering the market. Similarly, risk should be portrayed comprehensibly (and comprehensively) to investors.

If individuals behaved rationally, they would seek to enhance their welfare. They would invest and hold a portfolio of assets that met their allowable risk-return trade offs  and was consistent with investment horizon and needs. Unfortunately, this is rarely the case. Indeed, “behavioural economists and empirical researches have shown that in reality members are not particularly good at handling their retirement savings, either because they lack the necessary cognitive ability to solve the optimization problem, because they have insufficient will power to execute it, or even sometimes because they are overconfident.”

Extrapolating from the above article, one can assume that people are making sub optimal choices in their investments. Additionally, evidence suggests that the number of choices available amplifies these facts and “induce a preference for simpler, rather than less risky, options”.

The most likely candidate to address issues around choice overload, poor comprehension and the resulting obtainment of risky assets is the pubic sector. While private sector companies, such as S&P and Fitch have attempted to create evaluative mechanisms, they have failed. Since the crisis, rating institutions have been critiqued for lack of impartiality. Seemingly, a “cosy” relationship existed between rating agencies and banks during the crisis; “many financial experts believe that overly optimistic assessments by ratings firms were a key factor in creating an overblown market for derivatives and mortgage-backed securities.”

If, however, a public sector entity were able to evaluate instruments, and relay this information to the public, a more robust financial system would result. Less risky assets would be on the market, and comprehension would be improved.

Not only would investors be making better decisions, from better choices, but they would also be happier about it. While particularly cloying, it seems that that the mere “presence of categories, irrespective of their content, positively influences the satisfaction of choosers who are unfamiliar with the choice domain.”

When framed like this, it suggests that presenting choices in a better way – where options are relevant to investment goals, and are not too numerous or complex – will result in a type of self-fulfilling prophecy whereby motivation, learning and well-being are enhanced.

So I ask you, what are we waiting for?

Is financial transparency muddying the regulatory waters?

Often spoken of as a (if not the) necessary element in restoring/repairing financial markets, transparency seems to be fundamental to new regulatory frameworks and discussions between key figures. But, what does it really mean? And more importantly, what real impact will it have?

In the UK, the freedom of information act means anyone can request and receive information from government. It creates the "right of access" to information held by public authorities. This includes all e-mails. The result? Key decisions are now no longer made via technology. Discussions are held in person and accountability is limited. Certainly, this is a case where improved transparency has had negative repercussions. Consider this in the context of recent financial cases: with regards to LIBOR, e-mails, text messages and other communications are have been fundamental to our knowledge of the manipulation. Should these not have been available, our understanding would be much more limited.

Transparency, definitionally speaking, means something is clear and easy to perceive or detect; in financial markets (and according to the SEC) transparency means "timely, meaningful and reliable disclosures about a company's financial performance." True transparency, is "not just more data with the unintended consequence of investor overload and an unnecessary reporting burden on companies", but is companies disclosing the right information to investors who are financially literate enough to understand. 

On a person-to-company level, financial statements, while widely available, are frequently misunderstood. On a company-to-national level, new regulations regarding transparency are increasingly difficult for institutions to meet. Last week, the European Commission pushed for tougher disclosure rules in Basel III - forcing banks to publish profits and taxes in every national jurisdiction in an effort to minimize tax avoidance. Credit rating agencies (CRAs) are equally opaque - meant to help people understand financial instruments there is a lack of understanding regarding company ratings and risk. The US government is suing S&P for inflating ratings superficially, suggesting a need for 'transparency' exists in that space as well.  Board governance, short terminism and remuneration are all areas that must, and are, being questioned and altered.

Don't misunderstand me, I am all for the concept of improved transparency and believe it is necessary for the correct functioning of financial markets and economic growth. I am somewhat skeptical, however, of what transparency means, what externalities exist from it and whether we can regulate ethics into the system. 

What we do know is that previous systems do not work (in the context of public security, not necessarily with regards to economic growth). What makes us think these new ones will? 

We must demand from our governments evidentiary support of regulatory criterion. We must also work to improve our understanding of these matters, analyse financial statements, and question public companies.  Primarily, transparency itself must becomes clear.

The city is bleeding bankers

Increasing regulation (perceived to reduce innovation) combined with job insecurity and stricter remuneration structures are causing a brain drain in financial services. Meaning, the best and the brightest are now choosing start-ups, technology and other sectors –the chance to innovate and build business– over banking.

What does this realistically mean for the industry? In the short term, it is unlikely to be meaningful. Banks are consistently in the news cutting jobs, and reducing costs. Simply said, an exodus is apparent. In ten or fifteen years down the road, however, a lack of people will exist to step into executive and strategic positions.

On the other side, many argue there has been too much innovation in financial services. A brain drain, whereby the “creative” use their talents in other industries, and leave more conservative individuals in finance, is welcome.

Yet, we must remember that financial services currently:

• Account for 14.5% of UK economic output
• Offer a combined total of 63bn GBP in tax
• Have a 47.2bn GBP trade surplus; larger than all other net exporting UK export industries

If the industry continues to contract a lack of talent in the future will mean an even greater decline in the economy. We are currently on the cusp of our third recession in four years. If top talent continues to leave finance (or choose to not enter in the first place),  how can we drive growth?

We must consider that the movement of talent to other industries is unlikely to lead to an equivalent gain for the UK economy. Digital Shoreditch, for instance, cannot compare to Silicon Valley. Graduates are frequently choosing to move to other countries, where VC funding and government grants are easier to obtain. Additionally, if talented individuals leave the financial sector, what guarantee is there that those who will remain will act in a more conservative manner? Perhaps we will be left with a group of individuals who are unable to manage risk entirely.

Talent should remain in financial services – an industry where infrastructure is already developed and the UK is a recognized global leader. Policy makers and bank officials must begin to address issues of worker outflow now before it is too late.