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This Is How to Create Wealth for the Middle Class

Posted on Tuesday, Dec 23rd 2014

The world is becoming a more unequal place everyday. The concentration of wealth at the tip of the economic pyramid is increasing.

The Economist recently did a piece on the subject:

A NEW paper by Emmanuel Saez of the University of California, Berkeley, and Gabriel Zucman of the London School of Economics suggests that, in America at least, inequality in wealth is approaching record levels. The authors examine the share of total wealth held by the bottom 90% of families relative to those at the very top. In the late 1920s the bottom 90% held just 16% of America’s wealth—considerably less than that held by the top 0.1%, which controlled a quarter of total wealth just before the crash of 1929. From the beginning of the Depression until well after the end of the second world war, the middle class’s share of total wealth rose steadily, thanks to collapsing wealth among richer households, broader equity ownership, middle-class income growth and rising rates of home-ownership. From the early 1980s, however, these trends have reversed. The top 0.1% (consisting of 160,000 families worth $73m on average) hold 22% of America’s wealth, just shy of the 1929 peak—and almost the same share as the bottom 90% of the population.

On the other side of the spectrum, the fortunes of the wealthy have grown, especially at the very top. The 16,000 families making up the richest 0.01%, with an average net worth of $371m, now control 11.2% of total wealth—back to the 1916 share, which is the highest on record.

There has been research on Fortune At The Bottom of the Pyramid, C. K. Prahlad’s acclaimed thesis.

A Nobel Prize has been awarded to Muhammad Yunus for his pioneering work in Micro Finance focusing on this segment.

And yet, a domain that calls for the maximum diligent thought today gets very little attention: how do you activate middle class wealth creation?

In my 2013 book The Other 99% (Entrepreneurs): Fortune In The Middle Of The Pyramid, I wrote:

So what is the solution? Can the ideals of democracy and capitalism be combined to establish a more robust, stable system?

I believe so. Here’s how.

We need to use the fundamental principle of capitalism — the creation of value that people are willing to pay for — and apply it to the middle of the pyramid on a global scale. In other words, we need large numbers of entrepreneurs who are willing and able to build products and offer services that address demand from certain specific segments of customers. We need to teach them how to build businesses that can become sustainable — profitable — and create jobs. We need to also teach them to grow by applying the same kinds of methodology and discipline that, traditionally, a venture-funded company may use.

Everybody talks about the role small businesses play in growing economies and creating jobs. However, as it stands, in America alone, 600,000 businesses die in the vine every year. This colossal infant entrepreneur mortality is a product of colossal levels of ignorance about how to build and sustain businesses.

I have studied some of the reasons behind this mortality.

One reason is that entrepreneurs have been fed a myth that entrepreneurship equals venture capital. The media, business schools, incubators — every part of the eco-system that is supposed to teach good business practices — reinforces this myth.

The reality is that over 99% of entrepreneurs who go out to seek financing get rejected.

There are two primary reasons behind this phenomenon. One, most business opportunities seeking venture capital are too small, and too slow growth to fit the venture model. The second, entrepreneurs often go to VCs too soon, without doing adequate homework.

There is actually a method to the madness of entrepreneurship. And while the ‘character traits’ that support entrepreneurship — courage, tolerance for risk, resilience, persistence —?cannot be taught, the method of building businesses can and should be taught.

In fact, it should be taught not just at elite institutions, but at every level of society, en masse.

If we can democratize the education and incubation of entrepreneurs on a global scale, I believe that it would not only check the infant entrepreneur mortality, it would create a much more stable economic system.

Why? Because this middle of the pyramid — large numbers of small and medium businesses — is outside the reach of the speculators. If they produce something of value that their customers want, they can build stable businesses. They may not grow 300% a year. They may never become billion dollar enterprises.

That’s okay.

Too much energy in the business world today is being spent on high-growth businesses that go after very large business opportunities. All of the startup incubation eco-system of the world focuses on the venture-fundable businesses only. As a result, less than 1% of the world’s entrepreneurs are able to access high caliber incubation support.

My thesis is that the other 99% entrepreneurs hold the key to Capitalism 2.0: a system of distributed, democratic capitalism. Still focused on creating value, generating wealth, creating jobs, but not so focused on speculation.

Mercantile capitalism has hit its limits. Democratic, distributed capitalism will allow the pendulum to swing back and hand power back to the value creators.

The good news is that in this era of high bandwidth connectivity, most parts of the world can access online learning, and use online channels to build businesses. Let’s say, we digitally teach and incubate millions of online businesses over the next few decades.

We teach them fundamentals like Entrepreneurship = Customers + Revenues. Financing is optional. Exit is optional.

From Africa, to Indonesia, to Colombia to Maine, generations of entrepreneurs proliferate. They all are given the opportunity to access certain methodology and knowledge.

What do you think will happen?

Infant entrepreneur mortality will drop. Larger number of entrepreneurs will learn how to grow their businesses. An entrepreneur who would have otherwise done $1 million a year, with proper support, will perhaps do $5 million a year.

And quite possibly, larger numbers of entrepreneurs would qualify for venture capital because they would not go too soon to seek capital. They would go only when they are ready, when their ideas are validated, when investors are likely to invest in them.

A more robust pipeline of fundable businesses will develop. These, then, can attract capital and grow faster.

The only way to increase middle class wealth is to teach more people how to become successful entrepreneurs.

Not necessarily billionaire entrepreneurs.

Not even $100 million entrepreneurs.

We need more people who can build $1 million, $5 million, $10 million, $20 million businesses.

There is also an obsession with exits in the entrepreneurship universe. This is counter-productive. In 2013, 70,713 ventures received angel financing (Source: Center for Venture Research, UNH). However, the number of companies that get venture financing has remained ore or less steady over the years at about 1000. Presumably, over 70k entrepreneurs and their investors aspire to substantial exits down the line. However, the market cannot sustain that many exits.

Instead of a large percentage of these 70k ventures becoming infant mortality statistics, I would like to see them focus on building value by generating customers, revenues, and profits, so that even if they don’t get follow-on venture financing, they can still survive as robust businesses.

They also need to think through other models of investor compensation like dividends, because the exit-focused investing is likely not going to pay off. However, if you build a $5 million or $10 million business that yields 20% profit, you can offer investors dividends on an ongoing basis to make it worth their while.

The problem I see with the way capitalism is evolving is that the market is full of gamblers. Entrepreneurs and investors see Facebook acquiring WhatsApp for $19 billion, and think they can also buy a lottery ticket.

Whatever happened to the value creators?

To create fortune in the middle of the pyramid, we need to get back to basics: producers create value, consumers pay to access value.

We cannot let speculators hijack the system.

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