How To Foster the Starting of New Businesses

The only government program that I have seen that really ever seemed to do any good as far as creating new businesses and new jobs was the plan that allowed people to take their unemployment compensation and use it to start a new business. I am sure that most of those businesses failed because most new businesses fail, but some surely succeeded and employed people. Everything else I see coming out of the government really is not much help to the really small business person.

First, the government needs to stop doing things that get in the way. In particular, the government needs to stop getting in the way of new businesses trying to raise capital. For example, the changing of a “qualified investor” was made five times as stringent during the last year of the Bush administration. Maybe it was time to do this if you believe that the old law made sense because inflation has surely changed the notion of what is a comfortable nest egg, but the old law limits the right of ordinary Americans to be capitalists as much as any law on the books.

Making this law more stringent is a huge case of Nanny-state. You can’t foster new businesses, i.e. encourage people to take risks, by saying that they are unqualified to take them. The government does far more to prevent people from investing in legitimate new businesses that should have a beneficial effect for the whole society than it does to put people like Bernie Madoff out of business. Whether or not you believe that protecting people from themselves is a legitimate role of government, you have to conclude that the current rules and processes do not do everything they can to promote new business. Let’s take a look at what else they could do.

Create a Special Tax Break for Providers of Start-Up Capital

Should the guy who makes a hundred grand betting on Joe’s Widgets pay the same tax as the guy who made a hundred grand on Bank of America? Not if you want people to be eager to participate in new ventures. Is this fair to Bank of America, Microsoft, and IBM, to name a few? Not really, but they don’t need start-up capital. The cost to them is small and likely is a less than appropriate tax on their hugeness. Do you want create more small businesses or cater to the status quo? If you want a vibrant economy, you better not be catering to the status quo.

I’d like to see the first hundred percent return on such investments be tax free. That is, if you put up a million dollars to get Joe’s widgets started, you would not pay any tax on the first two million you took back out after Joe hits it big. That is, you don’t get taxed on getting your money back, and you don’t get taxed on the first matching win. I’d go even further and tax only fifty percent of the next hundred percent, and only seventy-five percent of the next hundred percent.

I don’t think that this is overly generous since most new businesses fail without ever making a profit for the investors, but it is a heck of a lot better than the deal angel investors get today. (They call them angels because they require so much faith.) The only way to get more money into these operations is to change the risk/reward profile. Most investors are not math-impaired.

Should investors pay a higher tax rate if they made their money from an organization that got bailed out by the government? They should, and actually they already are because the government is taking a big cut.

Problem/Opportunity Funding

Our country faces many problems and many opportunities. There is even occasionally some degree of consensus on what is a problem and what is an opportunity. I think the government and/or private agencies need to be able to support new businesses that can demonstrate that they are solving a problem for the community or opening an opportunity that will increase the prosperity of the community. The problem with such programs are that they disrupt the status quo, but a healthy capitalist economy is one that fosters change. Change is always going to come, and it will run you over if you are not ready for it on every level.

Foster Competition

It was a sad day when Packard went out of business, but it wasn’t devastating. Packard was just one of many auto companies, and they failed all the time. I’m not sure how much GM and Chrysler ended up with, but we could have started hundreds of new car companies at one hundred million dollars a shot. Wouldn’t that be a better use of our money than giving it to people who have proven they can’t manage a company? Wouldn’t that provide more jobs for auto workers? Wouldn’t that ensure that we would offer the world a broader choice in automobiles? Wouldn’t that mean that all cars would get better. The answer to all of these questions has to be yes if you believe in capitalism.

The auto bailout is exactly the wrong thing to do if you want to solve the problem. If it works, we end up with companies that should have failed and which are almost certain to face the same kind of problem in the future. If it doesn’t work, we are out billions and still have the same economic problems we were trying to prevent. A future with fifty car companies is a future far less prone to economic stresses than a future with three.

Redefine Small Business

A Company with $250 M in revenues is not a small business that needs help from the government. By the time a company is generating $10M a year in revenue, it should be able to stand on its own and raise capital on its own. A company needs the most help when it is just a business plan, or a business that is attracting attention and needs a little help to get to the next level. These are the companies that will increase employment, but they are also the companies that have the hardest time getting money from the banking industry. We need a government-guaranteed loan program that focuses on really small businesses that need to get to the point where they can inspire faith.

The most explosive growth of business in the micro-capitalism sphere, and there is a huge gap between that level and the level where the government will even recognize you. We either need to come up with a private solution to this, or the government ought to jump in.


I believe that we can make American business young again with just a few simple changes in our tax law. If we let everyone use their own judgment about these bets, it will help even more.

The government shouldn’t need to participate beyond that, but if it does stick its nose in, the focus needs to be on solving the problem, not in protecting the status quo – the path of least resistance that government always follow.


Let’s Speculate

I hear that some people want to outlaw speculation.   I guess they don’t understand that speculation is what drives capitalism, or that the precious little difference between speculation and investment lives almost entirely in the eye of the beholder.

If you were going to make speculation illegal, how could you define it so that you would not prohibit investment?  Are you speculating any time you put your money into something without the intention of making use of it yourself?  What makes stocks and bonds any different?  Aren’t the buyers and sellers of those speculators?

We need speculators.  Speculators help entrepreneurs found new businesses.  Heck, entrepreneurs are speculators who speculate they can make something big out of something very small.

Speculators are the lifeblood of our society.  A speculator believes in ope, and puts his money where his mouth is.  Does that mean that there is no problem?  Is there some point or degree when speculation turns from good to bad?

Actuallly, it turns out that there is.  Speculation is great for the system when the supply of speculators is limited.  When everybody wants to be a speculator, things get out of hand.  You get too much money chasing too few goods, and the cost of those goods inflates, sometimes wildly.  This is not good for the consumers of those goods, and it is not good for those holding the bag when the speculators move on to another fashion.

Can we stop this?  If so, do we want to?  I don’t think we can stop speculation, and I don’t see any possible good coming from an effort to try.  I am not even sure that more information helps since information feeds and caters to the speculators until it turns.

And if you hadn’t noticed, we already do the most effective thing you can do to control speculation — we tax it! Capital gains taxes are taxes on speculation.  We even give people a break if they take a longer than six months view when they speculate by differentiating between short-term and long-term capital gains.

We can control some things that happen around speculation.  For example, a thirteen-year old kid was reported to have bought nine houses during the housing boom.  He was speculating, but that wasn’t the crime.  The crime was that he was using fraudulent promises so that he coulde speculate with somebody else’s money — somebody else that did not check very deep.

If you look closely, you can see that the real problem is that the boom made people sloppy with their money.  A boom is when you want to be most careful.  “When life looks like Easy Street, there is danger at your door.”

So let’s not shoot the speculators, but let’s start getting real careful when it looks like everyone is speculating about the same thing.

The Odds are Not Immutable

Some people grow up with the idea that the odds are the odds even though it turns out that this is rarely true.  In almost every situation there are ways to adjust the odds.

Let’s look at a situation dominated by the odds, a single-table poker tournament.  A coomon form has nine players.  The winner gets fifty percent of the purse, the second-place finisher gets thrity percent, and the third place finisher gets twenty percent.  The house usually collects a fee of around five to ten percent for running the game.

If the odds dominate, every nine games on average you will have one first, one second, and one third.  If you are playing for one hundred dollars, you are out ninety bucks at this point if the house is taking a ten percent cut.

Obviously some people lose far faster than this and some people make money.  Both the big losers and the big winners have changed the odds.  The difference is that the winners know how they are changing the odds; the losers don’t.

Aggression and lack of aggression is part of the problem in a no-limit or pot limit tourney.  In the early part of the tournament, you want to be aggressive when you have the best hand, and you want to fold when you don’t.  The most important way to change the odds in this kind of event is to make sure that you are almost always one of the final six.  If luck dominates from that point on, you will get one first, one second, and one third out of every six games.  Now you should be making a few hundred dollars every nine games.

Note that this doesn’t always work.  Sometimes you can’t be in the final six because you run into bad luck.  Bad things can always happen, but if you play only the very vest hands when everyone is still in the game, you are going to fold most of the time.  In most of these events, there are usually some people with no patience.  Show a little yourself, and you should be in the final six ninety percent of the time.

Once you are in the final six, your next goal should be to change the odds of finishing in the final three.  If you have acquired a lot of chips, you can get to the final three by continuing to play only the best hands, but that is not always the best strategy.  Sometimes you want to raise with mediocre or even relatively poor hands.  This actually increases your odds.

Take a game like Omaha High Low, for example,  Some hands have significant advantages and some have serious deficiencies, but most hands are almost even bets against almost almost all other Omaha hands.  If you have a hand that is only forty percent against one other hand and only twenty percent against two other hands, you don’t have a calling hand.  However, depending on your opponents, you may have a raising hand.

When you raise, you win one hundred percent of the hands where your opponents do not call.  If you get them to fold half of the time, and win forty percent of the time when they call, you are going to win seventy percent of the time.  If they reraise, that’s another proposition.  If you call, you are usually up against a better hand.

The odds are also changed by who your opponents are and how they play.  Sometimes you are up against oppoents that always fold if you raise.  Raise these people often.  When they finally call, it doesn’t matter because they don’t have any chips left.

Sometimes you are up against people who always call.  When you call a raise, you need to win the hand with your cards.  That means that callers will only win as many hands as their cards allow.  That demonstrabbly is the path for a slow steady losing pattern because of the house fees, but it changes your odds too because it limits the effects of those raises.

You have to be a lot more selective about the hand syou raise with when you face a calling station.  Raising against them has the same odds as calling, but your odds on winning the tournament are increased dramatically when you know hwo is a calling station and who isn’t.  When you know you have the best hand, bet.  Don’t try to slow-play these players.  They won’t bet into you.  You make the most when you make them call.

As you can plainly see from these examples, two simple risk management procedures can transform a mediocre losing player into a mediocre winning player.  The game offers hundreds more.  Discover and apply them.

Real life and those gambles we call investments are much more complex than a game of poker.  That complexity means that there are far more opportunities for you to institure simple risk management procedures that tilt the table in your direction.  You want the chips to fall towards you, don’t you?

Common Sense Risk Management

Taleb is right when he talks about risk management failing so dramatically in part because of its reliance on statistics, but the problem is neither statistics nor statisticians.  That’s a lot like blaming car manufacturers because people have auto accidents.  They might be the cause sometimes, but most of the time they are the fault of someone who bought the car and misused it.  Statisticians know the difference between ninety-nine and one hudred percent; non-statisticians muddy the line between four to one and a sure thing.

Most of the real problem was really that common sense was not applied.  Basic risk management is almost all common sense.  It begins with asking what can go wrong.  Next, list each risk clearly and completely.  Third, develop a plan to prevent or at least mitigate each risk.

I can’t believe that this is new information to anyone, but it is apparent that this process was either skipped or sabotaged in case after case.  This failure was most spectacular in banking and insurance, i.e., risk management professions.  Since it is hard to believe that they skipped the process entirely, we need to understand where they sabotaged it.

I think statistics was used to sabotage the process.  Many people looked at statistics that said that a bet would win ninety or even ninety-nine percent of the time, and said “That will never happen.”  I heard it myself dozens of times, and what may be most surprising, that same people who were burned by that leap of faith continue to be the same people who are still uttering those words.

If you are a risk manager of any kind and ever say that something will never happen, you are not the guy for the job.  If you can imagine it happening, it almost certainly can happen.  That doesn’t mean that the the fantasized disaster can or will happen, or that you can do anything to prevent the disaster or mitigate the effects.  However, it is certain that you cannot come up with a plan ot deal with the disaster unless you treat it as a real threat and make a plan.

Note that you can recognize a catostrophic risk and still do nothing about it.  At some level that is okay.  For example, if you sell property insurance in Florida, you should recognize that it is a possibility that one hurricane could wipe out Florida — take it right off the map.  Obviously, that would oxer-extend the resources of all of the insurance companies in Florida, and they would almost certainly fail without stunning balance sheets and geographical diversification.

You can’t stop such a hurricane, at least with our present technology.  If the hurricane cuts a wide enough swath through your customer base, geograhic diversification will help a little.  The insurance industry has withstood some major blows, but so far the hurricanes have remained small enough so that only a few companies actually failed.  If the U.S. got hit with a 250 knot storm that hit the country for ten days, insurance companies wouldn’t be the only organizations to fail.

Has it ever happened?  To the best of our knowledge, it has not happened on this planet.  However, similar events do occur constantly on both Venus and Jupiter so that we know that physics isn’t standing in the way.  There is a non-zero chance of it happening here, but when the chances are small enough and the possible remedies are so ineffectual that you simply have to accept that risk.  A financial disaster at that point would probably be insignificant given the scope of the natural disaster.

Many people recognize risk know how to mitigate that risk, and do nothing about it.  People who drive without insurance and people who do not back up the work they’ve done on a computer are two examples that spring immediately to mind.  The issue here is cost.  They don’t want to spend either the money or the time.

Again, deciding not to spend the money or the time to mitigate any risk may still be a valid decision, but if you are a risk manager, you need to document the risk as well as the reason why the mitigation plan was too expensive.  You should review each risk categorized this way regularly because conditions change.

An obvious example of this is buying stocks on margin.  If you buy stocks on margin at ten bucks a share, it is very expensive to buy ten dollar puts to cover them.  Prohibitively expensive, in fact.  However, if the stock moves fifty dollars a share, puts with strikes of twenty dollars or less will be extremely cheap.  If I was forced into a position where I had no practical option but to buy stocks on margin (usually a good position, I would review the cost of puts on a monthly and maybe even weekly basis.  But I digress …

Risk management is almost never about statistics.  Statististics are used to justify risk management decisions,  but no risk management plan should need statistics as a defense.  Ask the question:  What can go wrong?  Answer the question.  Deal with the answers.  That’s all it takes.

Budget or Bankroll?

Are you on a budget or a bankroll?  Knowing this is the difference betweeen sanity and insanity if you are investing or gambling.  Do you know how to tell the difference?

For most people, the test is easy.  If you are taking money out of your income stream to fund your gambling or investment, you are (or at least should be) on a budget.  The purpose of such a budget is to ensure that you are not spending money on these activities that you need to pay the rent or eat.  If you like to play poker, but lose consistently, you need to be on a budget.

It’s perfectly fine to play poker and lose if you enjoy spending your time that way and can afford it.  When you are figuring out whether or not you can afford it, make sure you assess the value of the time spent.  For example, if you are a mediocre poker player (as most people are by definition), you can limit you financial budget by playing for lower stakes.  Let’s say, five dollars is all you think you could afford to lose every week.  If you found tournaments that cost a dime to enter, five dollars would last a whole week even if you never finished in the money.

In fact, there are enough tournaments that are free to get into so that you could easily spend two hundred hours of your time playing in them every week without spending a nickel.  The real cost of your activity is the cost of your own time.  If you could make as little as fifty cents an hour, you would have effectively spent a hundred dollars on your gambling habit.  If you live in the U.S. and get minimum wage, the alternative use cost to you is about fifteen hundred dolalrs for each two hundred hours you spend at the table.  If you’ve got a skill that earns you fifty dollars an hour, each one hundred hours you spend on the tables is five grand that you could have had in your pocket.  True that time has more value than the money you get for it, but you have to budget your time to make things work in this worl.d.

Very few people, comparatively, are working on a bankroll.  A bankroll consists of other people’s money that you have made in this activity.  Your investment fund only becomes a bankroll when you take out all of the money you originally put in.  Budgeting is still important after you have reached this point, but how much of my bankroll can I afford to bet is a different question than whether this game and these stakes fit within your budget.

If you have a bankroll, you should be guided by past history and Kelly’s Law.  Kelly’s Law says that you need some kind of evidence of an edge before you take any bet or make any investment.  If it’s a stock, you need a reason to believe that it is going in the idrction you are betting on.  If it’s a poker game, that means that you need a past history of making money playing poker.

If your past history says that you lose in poker, playing poker is an amusement decision, not a gambling decision.  If it is a gambling decision, the other implications of Kelly’s Law need to be followed as well.  One of these is that you should never bet more than half of your money on less than a sure thing.  Think of it as a scale where you can bet half of your money on a bet you are 99.99% certain to win, but only one percent of your cash in bets where you have a five percent edge.

It is important to keep in mind as so many people recently have not, that every time you bet all of your money on less than a sure thing, you risk losing all of your money.  It doesn’t matter how smart you are or what you think you know.  The unknown can strike at anytime.

This of course also implies that you should never use leverage except in the case of a sure thing.  Leverage is betting all the money you have and all of the money you can talk your broker into lending to you.  This clearly violates the principle of never betting more than half ofd your bankroll on less than a sure thing.

Sure things are incredibly rare, but ninety-nine percent things are available most of the time.

Insurance executives will confirm that these once a hundred year storms come far more often than that.  Poker players can tell you how often they get beat by a draw that could only lose to a single card in the deck.  If it can go wrong, it will far more often than it looks like it can.  Stay within your budget if you are on a budget and inside of Kelly’s guidelines if you have a bankroll, and these events will not wipe you out when they inevitably happen.

How Common is Financial Fraud?

Obviously, the Democrats seem to be a lot better at detecting it than the Republicans, but they do have favorable timing on their side.  Bernie Madoff made a lot of people take a real close look at all of their investments, and not all liked what they saw.

Frauds like Ponzi schemes aren’t common, but they aren’t rare either.  CNBC is in no danger that they will run out of material for their American Greed series, and a similar International Greed series would not lack for mateial either.

I would bet that there are several hundred frauds going on right this minute.  Several hundred isn’t a big number in a world this size, but several hundred fraudsters still can hurt tens of thousands of victims.

The odds are pretty good that you both know someone who lost money to Bernie Madoff or Allan Stanford, and that you also know someone who is being defrauded right this minute.  I read not too long ago that more than one hundred Ponzi schemes have turned up since Madoff was outed.

There are a lot of crooks out there, and the system is not set up well to catch them.  This is partly because catching crooks is not the priority of the regulations.  The priority of all regulations is to protect the industry being regulated. That is not the original intent or the nominal rationale of any regulation, but industry lobbyists set the agenda for politicians because industry pays for their politcal campaigns.

Where are these crooks?  They are where the money is.  It is as simple today as it was to John Dillinger who robbed banks because “that’s where they keep the money.”  But smart crooks have noticed that you can’t make a billion dollars robbing banks with a gun.  You need nice looking paperwork, but everybody has a computer these days.  Anybody with a little skill and patience with a computer can generate enough paperwork to look like a real business.

So how do you tell a real business from fraudulent business?  To some extent you can’t, but businesses that don’t make anything tangible should be given the highest level of scrutiny.  Businesses that claim to make money by moving some kind of paper should be looked at very carefully.  Lots of businesses do make their money this way, but make sure you understand exactly what is going on before you give them your money.  It you think what the people are doing is over your head, it’s out of your budget.

Of course, fraud isn’t limited to outright scams.  Tyco and Enron were real businesses that had fraud inside them.  Probably every large business has had to deal with some level of fraudThere are lots of real businesses with some level of fraud.  We already know that lots of embezzlers are caught and prosecuted while many more are caught and quietly asked to leave.  Legitimate businesses can turn into frauds when they are looted from within.

And even if you duck all manner of fraud, you can always lose when you hand your money to other people.  Lots of legitimate businesss efforts fail, and almost all fail eventually.  Invest in honest businesses that you have checked out thoroughly, and don’t lose more than ten percent of your stake in any one venture.

Capitalism IS Gambling, and fraud is only one of the risks.  A good gambler takes steps to protect himself against cheaters.  Be a player, not a mark.

When Are You Going to Stop Gambling?

When you are dead.    Every living creature in this universe is gambling on a million things every second of its existence.  Don’t think that you get off easy because you don’t actively gamble.  You don’t!

One of the fascinations I have with our American culture is that we pretend that gambling is a sin  The real sin is pretending that you are not.  You may not playing cards, betting on horses, rolling dice, betting on football games, or playing the market, but you are gambling.  I think gambling was heresy in a world that believed in predestination, but that world doesn’t exist any more, does it?

You are gambling with your money, your health, and your life.  That is a simple statement of fact. but we are really interested in your money.  How are you gambling with your money?

Once you realize that every single thing you do with your money is gambling, you can start thinking about what you are doing to gamble successfully.  If you think you are not gambling, you never even get to this point.  You can’t have a continuous improvement plan for an activity you are not even aware of.

What does getting better at gambling really mean, anyway?  It means winning more and losing less.  It means winning more when you win and losing less when you lose.  Gambling is not only a process, it is a process with well-defined commonly understood and agreed upon metrics.  The person with the most money is usually the best gambler.

That is, that person is usually the best gambler when it comes to money.  Having pile of money is nice, but we all know of people that had miserable lives with plenty of cash, as well as people who have great lives despite never having won a monetary bet in their lives.  Money is just one way of keeping score, and it is only the best way of keeping score when the goal is strictly the accumulation of money.  That’s a broad limitation, but important nonetheless.

The number one currency in most of our wagers is time.  You can always get more money and try again as long as you don’t run out of time, but you can never get that time back.  Money can help you make the most of time, but it can never get you time back.  And time is really all we have.

So how do you get better at gambling?  It’s all about identifying and eliminating risks.  A risk is anything that might cause you to lose a bet.  For example, every day you are making a bet that your house won’t burn down.  There are many things you can do to increase your chances of winning this bet.  This is just like any other bet.

What if the bet we are talking about is that you will have enough money to retire?  A lot of people get this bet wrong.  Some of these people always knew they were going to lose that bet, but the loss has come as a surprise to lots of people lately.  Many of these people thought they had already won this bet, and many of them had if they had taken all of their profits two years ago.  Some couldn’t and some wouldn’t, but almost all who didn’t got clobbered.

A lot who got clobbered ignored the first rule of risk managment.  “Don’t put all of your eggs in one basket.”  Victim after victim in the Bernie Madoff case said that they gave Bernie all of their money.    The same is true of of many of Allan Stanford’s victims, but getting Ponzied isn’t the only risk.  You might have had all of your money in Enron, Washington Mutual, or General Motors.

Of course, there were many who were forced to keep all of their eggs together.  Employee stock options made many employees multi-millionaires on paper, but many of these people had to keep their company stock.  Some could have cashed their options and sold the stock, but if they didn’t sell the stock or never cashed their options, all of that money disappeared.  Sometimes it disappeared by itself, and sometimes it took some or all of their other money with it.

Other common sense rules of risk management that got ignored included: “If you bet all of your money all of the time, you will lose it all eventually no matter how smart you are.”  Use of leverage or margin is betting MORE than all of your money all of the time.  The use or misuse of leverage is behind nearly every market disasters except outright frauds.

There are lots of other risk management rules that everyone knows.  Apply them!  Remember that you are gambling. and take the appropriate steps to protect your butt.  You already know what to do.  Pay attention and use some discipline!