Wednesday, August 15, 2012

Recent question

So much is made of the founder having previous success, but  how much more successful are those companies?  Is there a hard number that quantifies the advantage - are they 5%, 15%, or 50% more successful? Really looking for the delta between the success rate of tech start-ups overall and the rate of success rate tech start-ups founded by serial tech entrepreneurs.
Chuck Eesley10 years in and around startups, on t... Edit Bio
It depends in part on what you mean by "successful" and what on the relationship between the prior experience and the current startup. 

Gompers and coauthors have a great paper addressing this and they find the following:

"In this paper, we address two basic questions: Is there performance persistence in entrepreneurship? And, if so, why? Our answer to the first question is yes: all else equal, a venture-capital-backed entrepreneur who succeeds in a venture (by our definition, starts a company that goes public) has a 30% chance of succeeding in his next venture. By contrast, first-time entrepreneurs have only a 21% chance of succeeding and entrepreneurs who previously failed have a 22% chance of succeeding."

Their paper is worth a read as they have some very clever measures of market-timing skill and managerial skill to answer their second question. However, their definition of success is based only on IPOs and prior experience is only VC-backed firms, creating some success bias in their estimates. Note that a 1 in 5 chance of having an IPO is still quite remarkable.

Paul Gompers, Anna Kovner, Josh Lerner, David Scharfstein, Performance persistence in entrepreneurship, Journal of Financial Economics, Volume 96, Issue 1, April 2010, Pages 18-32. (http://www.sciencedirect

In a recent paper I look at a similar question, using a broader dataset of all founding attempts by MIT alumni. Instead of IPOs which are a goal of only a subset of entrepreneurs, I look at revenues as the success or performance measure. What my coauthor and I find is that the advantage of prior experience depends on how similar the current venture is to the previous one. The more dissimilar, in terms of industry or technology, the less experience helps and the more important innate talent is for performance. The empirical challenge here is that more talented entrepreneurs may be more likely to go on and found more companies, so we needed some sophisticated statistics to disentangle the impact of experience vs. innate entrepreneurial talent.

Overall, revenues are 52% higher for the experienced entrepreneur and 113% higher for the experienced entrepreneur starting a firm in the same industry. Mean revenues in this sample are $328,000. So for the experienced founder, mean revenues would be $498,000. However, if the experienced founder starts a company in an unfamiliar setting then experience becomes a liability. With a very innovative technology revenues are actually 6.8% lower. If your prior experience was before the dotcom internet disruption then for the next firm your revenues are likely to be 43.8% lower. So whether experience helps or hurts very much depends on the context and how similar the current venture and industry environment is to the previous experience.

I include the citation, abstract and a bit of the text of the paper below to give more of an example of the theoretical arguments and reasons why this may be the case.

Eesley and Roberts. Strategic Entrepreneurship Journal, 6: 207–219 (2012)

Abstract: We explore whether entrepreneurial performance is due to innate talent or the accumulation of entrepreneurial experience. Using a novel data set with multiple observations of founding attempts per individual, we generate a unique measure of entrepreneurial talent. In contrast to prior findings, the relative importance of experience versus talent changes with the context.
When the current market or technology is familiar, experience dominates. However, when the venture context is unfamiliar, talent is more important. Individuals with experience and talent handle both familiar and unfamiliar aspects and may extract more from a given level of experience. The findings advance our understanding of how the drivers of venture performance shift with the broader technological and industry environment and places limits on when experience aids performance.

Overall, this ‘learning by doing’ enables experienced entrepreneurs to imprint their ventures more effectively at the outset by choosing better opportunities (Huber, 1991; Ingram and Baum, 1997; Baum and Ingram, 1998). As time goes on, they are better able to develop viable business models, raise funding, install superior strategic processes, and complete the tasks involved in setting up a new firm. Prior experience in this case allows the entrepreneur to reuse strategies, network connections, and industry-specific knowledge. With more prior founding experience, the entrepreneur has seen a wider spectrum of issues and problems during the start-up process. The greater the number of prior start-up experiences he/she has to draw from, the less likely that the decisions that need to be made in the next venture will be unexpected or unknown to the entrepreneur. While an inexperienced entrepreneur may spend valuable time and money discussing and trying out different solutions to problems that arise, the experienced entrepreneur has likely already encountered these problems and has solutions. Specifically, we propose:

Hypothesis 1a: An entrepreneur with more venture founding experience is more likely to found a high-performing venture.

We also expect that venture experience will be particularly advantageous for focal venture performance when the entrepreneur is familiar with critical aspects of that venture. That is, when the context surrounding the new venture is more familiar to the entrepreneur and, thus, more similar to the past, learning from prior entrepreneurial experience will be of particular relevance (Argote and Ingram, 2000; Argote, Beckman, and Epple, 1990). Lessons from the past will more directly transfer to the current situation. We define familiarity as having a close acquaintance or being well known. For example, when entrepreneurs engage with familiar technologies, they are likely to face fewer surprises and less likelihood to encounter problems. There have been opportunities to work out bugs, increase predictability, and better understand customer needs related to the technology (Levinthal and March, 1993; Meyer and Roberts, 1986). Similarly, when an entrepreneur starts a firm in a familiar industry, he/she is likely to understand the competitive dynamics of the industry. He/she will already be familiar with customers, suppliers, and ways of doing business in the industry. He/she may be able to use analogies from prior experience that fit particularly well with the current venture (Gavetti, Levinthal, and Rivkin, 2005), and he/she can reuse existing relationships. When problems arise, in a more familiar context, there is a greater likelihood that they have an overlap with problems that the entrepreneur has already faced in a previous venture.
Even when choosing which entrepreneurial opportunity to pursue, if entrepreneurs stick to an industry or technology they are familiar with, they are more likely to identify a valuable opportunity. When the entrepreneur knows the market, customer preferences, and potential distribution or channel partners, he/she is more likely to choose a promising opportunity. In contrast, if the experienced entrepreneur strays into potential opportunities in an unknown area, it is more likely that unexpected challenges will arise or that the product will not be exactly what consumers want or a critical sales strategy or aspect of the business model will not work in the end. The experienced entrepreneur in a familiar domain has experience with a greater number of the constraints that must be satisfied for an idea to be a good business opportunity.
Finally, and in contrast with the benefits gained from experiences, experienced entrepreneurs may gain hubris and overconfidence along with experience (Hiller and Hambrick, 2005), making them particularly ineffective in unfamiliar contexts. For example, they may underestimate the uncertainty associated with a less familiar technology. Entrepreneurs will be less likely to benefit from their prior venture experience if their focal industry has undergone a major disruption. When the industry is disrupted, experienced entrepreneurs no longer have an understanding of industry dynamics and their experience is not likely to give them an advantage. It is then less likely that problems they encounter will be ones with which they are familiar and have a known solution from experience. Overall, we argue that entrepreneurial experience will be particularly likely to aid venture performance when the focal venture is in a context that is familiar to the entrepreneur. Both in opportunity selection and in execution, the more an experienced entrepreneur remains in a familiar context, the fewer surprises that will be encountered and the higher the likely performance of the venture.

Hypothesis 1b: The positive effect predicted in H1a will be stronger for ventures started under more familiar conditions.

Talent is a second, yet less explored, explanation for the positive link between serial entrepreneurs and performance. Here we argue that a significant source of success in starting ventures is time-invariant entrepreneurial talent differences across individuals. Schumpeter (1934) was the first in the literature to suggest that entrepreneurs have skill or talent, rather than simply being bearers of risk. Since then, relatively little scholarly work has examined entrepreneurial talent. Lucas (1978) refers to managerial talent in firm formation and defines it as an ability to get more output per worker. Others similarly have defined talent as the ability to get greater entrepreneurial earnings out of a given amount of capital invested (Evans and Jovanovic, 1989). Amit, Glosten, and Muller (1990: p. 1233) define entrepreneurial talent as ‘the ability to combine tangible and intangible assets and to deploy them to meet customer needs in a manner that cannot easily be imitated.’ Others have defined talent as having a market timing and managerial component (Gompers et al., 2010). We attempt to synthesize and simplify these definitions. By entrepreneurial talent, we mean superior ability to consistently see viable entrepreneurial opportunities and effectively act upon them to generate greater venture performance.

Given their superior ability, talented entrepreneurs are more likely to succeed in their initial ventures, and these successes are then likely to motivate them to found successive firms (Gompers et al., 2010). As a result, serial entrepreneurs may form a more talented pool of individuals than the pool of all entrepreneurs. Less talented first-time entrepreneurs may fail in their initial ventures and decide not to found a subsequent firm. Alternatively, they may face difficulty in recruiting new cofounders or raising capital. This may lead to the well-known relationship between serial entrepreneurs and venture performance.
Innate entrepreneurial talent involves more abstract reasoning, divergent thinking, synthesizing disparate ideas, and frame-breaking behaviors. These talents allow them to identify higher quality entrepreneurial opportunities since this task requires more than simply applying prior, historical experience. Every potentially valuable entrepreneurial opportunity has some aspects that are unique or unexpected. Where merely experienced entrepreneurs might mistakenly apply prior lessons, talented entrepreneurs can more naturally think through the more novel, less familiar aspects of the venture. A new opportunity may require a business model that has not been tried before or a distribution channel that needs to be created from scratch. If the opportunity requires that new markets are created or new sales and marketing strategies be generated, then the talented entrepreneur has an advantage in being able to think more flexibly rather than reflexively applying an old strategy from a prior venture.Appropriate strategic actions may be ambiguous and unpredictable or experience may not apply when an entrepreneurial opportunity is very new, highly risky, and unfamiliar. Precisely in these conditions, experience may not apply and talented entrepreneurs will excel. Overall, these arguments lead us to propose:

Hypothesis 2a: An entrepreneur with more innate talent is more likely to found a high-performing venture.

Entrepreneurial talent will be less advantageous when entrepreneurs encounter more familiar conditions. Talent is less of an advantage when the entrepreneur has already experienced this set of conditions and is already familiar with the appropriate strategic decisions and responses. In familiar conditions, the talented entrepreneur does not need to sort out new frameworks or work out the best commercialization choices to make. Talent is less relevant, when familiar contexts allow the selection and reuse of prior experience. In a familiar context, if decisions or problems arise that the entrepreneur has seen and solved previously, then talent is less useful because the problem is not one of generating new solutions but simply applying prior experience. The talented but inexperienced entrepreneur might waste valuable time thinking up possible commercialization choices and reinventing the wheel, while an experienced entrepreneur already knows the solution and can more quickly make decisions and move forward.

Correspondingly, we also expect that entrepreneurial talent will be particularly advantageous when entrepreneurs face less familiar conditions (e.g., different industry, disrupted industry, and novel technology). In these contexts, entrepreneurs must sort out appropriate strategic actions when many factors—such as market opportunities, business models, customers, and marketing channels—are ambiguous and unpredictable. Entrepreneurs with innate talent may find it easier to apply their talent toward thinking through these novel situations in which experience may simply not apply. Similar to an individual with mathematical talent who can derive an appropriate formula from first principles, talented entrepreneurs can rely less on memorized routines learned from past experience. Instead, they are more able to figure out correct strategic actions from reasoning through the appropriate choices in a new situation. They are capable of more abstract reasoning and synthesizing information. In addition, talented entrepreneurs may be more confident of their abilities when faced with unpredictability. Finally, they are more likely to engage in frame-breaking activities—such as experimentation, questioning, and observation—that are associated with divergent thinking (Dyer, Gregersen, and Christensen, 2008). Such thinking enables entrepreneurs to spot viable opportunities sooner and provide novel insights for executing them in less familiar contexts. The ability to handle the unfamiliar and unexpected results in more consistently high performance since the unfamiliar and unexpected are aspects that introduce inconsistency into performance.