The founder effect: the impact a founder's experience has on start-up
© 2014 EPFL
A founder's business experience can have a major impact on their start-up's chances of survival and success. What kind of impact, though, depends on the type of experience the founder has, as John Dencker and Marc Gruber discovered.
Successful start-ups are often associated with their entrepreneurs, but what impact does a founder actually have on the prospects of a new venture? Management academics John C. Dencker and Marc Gruber have peeled back the veneer of early stage companies to examine the value a founder contributes – depending on the type of opportunity that is exploited.The idea that a founding entrepreneur's knowledge and experience might shape the performance of their new enterprise seems obvious. Yet, despite research on the subject, determining the effect a founder's knowledge on a start-up's success has proved difficult. Dencker and Gruber, however, approach the topic from a different perspective.
They designed a study to investigate whether the impact of the entrepreneur's knowledge might vary, depending on what type of opportunity was being exploited. As the concept of opportunity is not easy to define in way that makes it measurable, the authors focused on one particularly important feature of opportunity – its risk. The degree of risk involved affects the nature of the challenges facing the founder entrepreneur. Chasing an opportunity in high risk sector, usually means operating in more volatile and disruptive market conditions, with tougher competition, trying to meet rapidly changing consumer demands. Together, these factors make failure more likely. On the other hand, riskier opportunities, if successfully exploited, should lead to better rewards than low-risk ventures and greater firm success.
As an indicator of risk, the authors used industry-specific credit risk ratings and individual firm ratings in year two and three of the firm's life. In terms of a founder's knowledge, the authors focused on two dimensions: Managerial experience relates to the knowledge required to operate a business, and is obtained by investing time observing, studying, and making business decisions, and also understanding organizational routines, and the way organizations work. Industry experience is accumulated over time working in a particular industry. The study data was based on the experiences of 451 entrepreneurs based in Munich, Germany and their attempts to launch and grow start-up businesses in a variety of non-high tech, non-high-growth industries, over a five year period. The firms were started as part of a back to work scheme for the unemployed. The entrepreneur data was obtained from a survey of the firm's founders, while industry credit risk ratings came from the Centre for European Economic Research (ZEW). Firm performance was assessed using revenues generated over the first three years. Context matters First Dencker and Gruber examined the start-up risk-performance relationship in isolation from the impact of the founder. Then they looked at the joint effect of opportunity and founder know-how on a firm's outcome. This allowed the authors to separate out any impact that founder knowledge had on start-up success. The results revealed, as the authors had speculated, that the value of founder knowledge was contextual, i.e. it depends on the type of opportunity that the founder exploits.
Founders with more managerial experience did better with start-ups in risky sectors than managers with low levels of managerial experience. Interestingly, while greater industry experience was an advantage in low-risk sectors, it was actually a disadvantage in high-risk sectors. Managerial experience confers an advantage in risky settings for several reasons, the authors suggest. These include the ability to: decipher the tough competitive environment often prevalent in high-risk sectors and obtain sustainable competitive advantage; cope effectively with the high levels of change and uncertainty encountered in high-risk sectors; convince people that the founder is sufficiently competent at running a start-up, despite the high-risk situation, to warrant investment.
Founders with more managerial experience not only seem to know more about how to behave in high-risk situations, but it is likely that they engage in these activities more efficiently and effectively than founders with industry experience. Dencker and Gruber's findings shed some light on the relative value of the founder’s human capital in relation to the task that the founder seeks to accomplish. For investors, their findings mean that they should take into account the extent of the founder's managerial and industry experience, but do so in the context of the level of risk involved with the business opportunity being exploited by the founder. In addition, the authors' work allows policymakers to offer more informed advice to individuals interested or involved in starting a business, under a government backed enterprise creation scheme, for example. And for would-be entrepreneurs there is an important message too: the more managerial experience you have, the better your chances of steering that risky business opportunity to success. " The Effects of Opportunities and Founder Experience on New Firm Performance" by John C. Dencker, North Eastern University, Boston, and Marc Gruber Ecole Polytechnique Fédérale de Lausanne, College of Management of Technology, Lausanne, Switzerland.