Growthology

Learning from business failure

There is a substantial body of research on the failure of new businesses. Among other topics, researchers have explored the causes of firm failure, the jobs destroyed by these business closings, and the impact of this churning on our economy more generally. In this post, we consider research that highlights a silver lining to the failure of a new business:  the benefits of this experience for a serial entrepreneur’s next endeavor. Yongwook Paik, a 2008 Kauffman Dissertation Fellow, examines the effects of prior firm-founding experience on subsequent firm performance in a paper based on research for his PhD dissertation in Economics (see executive summary here). 

Paik hypothesizes that prior firm founding experience increases both the human capital and social capital of serial entrepreneurs, allowing them to build the skills they need for greater success in their next endeavor. Using data from U.S. venture-capital-financed semiconductor firms that entered the market during 1995-1999, Paik analyzes the effect of founders’ prior firm-founding experiences on the survival rate and the annualized rate of return on investment in subsequent ventures.  He also takes into account selection effect of serial entrepreneurs and the role venture capitalists play by selecting the most promising new businesses and mentoring new companies. Comparing “serial entrepreneurs” (those who have founded a company previously) to “novice entrepreneurs (first-time founders), he finds that the survival rate of firms founded by serial entrepreneurs is substantially higher than that of firms founded by novice entrepreneurs, but that serial entrepreneurs do not see a greater annualized return on their investments.  Firm-founding experience, it seems, allows entrepreneurs to build the skills needed for early-stage firm survival, but not necessarily those that lead to greater financial success. In addition, he finds that the mentoring of venture capitalists helps a young firm survive in its early phases and results in a higher rate of return on investment.

This study offers significant insight into the way that entrepreneurs build the skills they need for later success and serves as an important reminder to venture capitalists and other funders of new businesses that serial entrepreneurs’ previous failures are not indicators of future failure.  In fact, these experiences may lead to greater future success.

Cities and Myths of Entrepreneurship

Good discussion/interview at Atlantic between two Kauffman friends, Brad Feld and RIch Florida, on cities and entrepreneurship. An excerpt:

What are the leading myths about building more effective startup communities?

There are there common ones: 'We need to be more like Silicon Valley,' 'We don't have enough capital,' and 'Angel investors must be organized.'

For decades, cities have been proclaiming themselves the next Silicon Valley. That’s nonsense — cities — and the entrepreneurial leaders — should focus on creating the best startup community for their city, based on the unique attributes of their city. Learn from the amazing things in Silicon Valley, but instead of trying to be like Silicon Valley, be the best Boulder, or best Chicago, or best New York, or best Portland. You already have an identity as a city — you don’t need to be Silicon Alley or Silicon Slopes.

Next, there never is a balance between supply and demand of capital. Entrepreneurs shouldn't worry about this — instead they should focus on creating amazing companies. Capital will always find amazing companies. While there are many things that can be done over time to attract more capital to a region, the biggest thing is for entrepreneurs to actually go create some significant companies.

Finally, related to this is the notion that angel investors should be organized into formal angel investor groups. While this can be helpful, it’s often extremely harmful and stifling, as many angel investor groups try to look like small venture capital firms rather than acting like helpful angel investors.

More here. 

[Updated] The Patent Troll Tragedy

I hope we are approaching the end point in the patent troll game. Recall, patent trolls -- non-practising entities that obtain patents and sue operating companies (especially in software) -- have been playing an increasing role in innovation economies. They often threaten young companies with lawsuits as soon as they obtain funding; or hamstring older companies, forcing them to divert cash into costly licenses for absurd patents rather than pay for costly defenses in uncertain, patent-friendly jurisdictions. 

New data from Colleen Chien of Santa Clara University shows the situation. According to her research, 61% of patent lawsuits in the U.S. in 2012 have been brought by patent trolls. 61%. This is  a record, both in relative and absolute terms, as the following graph (from a recent presentation of Ms Chien's) shows. 

There must be changes in patent laws to prevent this sort of abuse. One approach, the SHIELD Act, would force patent trolls to pay for unsuccessful litigation in a "loser pays" system. While it's far from perfect, and fundamental reforms are needed to U.S. patent law, it is noteworthy that there, at least, some attempts being made to deal with a patent system that is increasingly consuming itself, while the rest of us pay for the litigation and misplaced resources.

[Update] A law colleague of mine points out tonight that some of the 2011 and 2012 increase in lawsuit activity is a function of the America Invents Act changes in September 2011 that prohibited having multiple defendants in one suit. As a result of this unbundling, there are more NPE suits, making them a much larger percentage of overall patent lawsuit activity. At the same there has been a reduction in the number of operating companies being sued, as the following figure shows.

What does this mean? It means that some of what we're seeing in the first graph is partly a result of rule changes, which is worth noting. At the same, there is a reduction in the number of companies being sued, which, given more suits, means more patent litigation, in general, at any given firm. 

[Update 2] Colleen Shien at Santa Clara University points out to me in separate correspondence that even these numbers are subject to confusing factors. For example, in a recent case Cisco received more than 300 NPE letters before that turned into an eventual patent-related action. Even if that number is considerably lower, say 25-50:1, it is exceedingly burdensome, especially for smaller companies subject to NPE nonsense.

Add to this the costs involved, which according Prof Shien's work is roughly as follows: 

• Fighting troll in court costs startups $857K (N=7)
• Settle $340K (n=12)
• Fight out of court $168K (N=18)

It is,  indeed, a species of tax on innovation, one whose proceeds goes to economic vandals.

Influences of Founder or Joiner Mindsets

Today we’re going to look at a working paper by Michael Roach and Henry Sauermann (disclosure: the Kauffman Foundation partially funded this research). The paper, “Founder or Joiner? - The Role of Preferences and Context in Shaping Entrepreneurial Orientations” can be accessed here. Personally speaking I am interested in emerging lines of research like this that shed more light on the employees of startups.

I think you should take away three primary things from this—(1) more PhD students report having a joiner orientation than a founder orientation, (2) social influences don’t appear to matter to forming a founder orientation, but they do for forming a joiner orientation (would have happened anyways), and (3) without individual preferences that relate to entrepreneurial job characteristics, social influence alone may not be enough to form founder and joiner orientations.

Survey work and descriptive statistics

The authors conducted a survey of 4,282 Science & Engineering PhD students at U.S. universities and asked them a number of questions about their interest in entrepreneurship. They coupled the survey with 50 qualitative interviews.

They categorize students into either having a “founder orientation” or “joiner orientation:”

• Founder orientation: Those who responded ‘definitely will’ or ‘likely will’ to “How likely are you to start your own company?”

• Joiner orientation: Those who responded ‘extremely attractive or ‘attractive’ to “Putting job availability aside, how attractive do you personally find a career in a startup with an emphasis on research or development?”

Based on responses to these questions, 11 percent of the students are categorized as having an orientation to being a founder, and 45 percent as having an orientation to joining a startup.

The authors then asked respondents to look back to when they first began their PhD program and rate their pre-existing orientation to entrepreneurship. As they note, this can be a little problematic. Anyone who likes entrepreneurship at the time of the survey could say “oh yeah, I liked it back then too” even if they did not. Nevertheless, they do find 73 percent of those with a founder orientation reported having pre-existing inclinations to entrepreneurship while only 50 percent of those with a joiner orientation did. This is interesting because it means that a founder orientation may be more likely to form earlier in life than a joiner orientation.

Additionally, these students with a pre-existing inclination are actually more likely to report their current orientation as joiner (65 percent) rather than founder (24 percent). The authors offer this potential reason “[this suggests] a longstanding interest in joining a startup may be more pervasive than a longstanding interest in founding one’s own company.” They find suggestive (i.e. not as clear as other findings in the paper) that those with pre-existing inclination are more likely to sort into schools or projects that are more entrepreneurial, but have little evidence that they match with faculty that have prior entrepreneurial experience.

Factors that influence founder and joiner orientation

Roach and Sauermann compared these founders and joiners to students who signaled orientation to working for an established firm, comparing individual preferences and social influences.

I’ve created these summary tables (all errors are my own). A plus sign (+) signals a significant difference and a minus sign (-) no difference. Two plus signs (++) means that there is significance and that the preference is stronger between either the founder or joiner.¹

Individual Preferences	Founders	Joiners
Autonomy	++	+
career advancement	+	+
risk tolerance	++	+
Money	-	-
desire for basic research	+	++
desire managerial activities	+	-

 

Social-Contextual Influences	Founders	Joiners
Department supportive of entrepreneurship	-	+
Advisor with entrepreneurial experience (mentors)	+	-
Their research perceived to have commercial value	++	+

The above tables include those individuals who reported having a pre-existing inclination to entrepreneurship. How do these orientations form for those who did not report a pre-existing desire to be entrepreneurs?

For these individuals, Roach and Sauermann find individual preferences as listed in the table above matter to forming both founder and joiner orientations, but the same cannot be said for social-contextual influences. A founder orientation is likely to emerge even in the absence of social influences (having an advisor with prior entrepreneurial experience and conducting research with perceived commercial value), whereas some social factors (supportive department and perceived commercial value of research) do appear to affect the emergence of a joiner orientation.

All in all, I think this is an inteesting line of research and am particularly curious to see the authors follow these students and find out how orientation translates to actual startup activity.

 

¹ E.g. Both founders and joiners have significant preferences for autonomy relative to those who have established firm orientations, but the difference is even stronger for founders.

Family-Owned Businesses in Japan

Tyler Cowen highlights a forthcoming paper (previous working paper version here) about family-owned businesses, marriage, and adoption in Japan. The Economist has a summary here, though notes that the research is a decade old (circa 2000) so it's unknown whether the trend still holds. In Japan, it is common practice for men in their 20s and 30s to be adopted and for marriages to be arranged with a business purpose in mind--the relationships are formed so that these men come in to the family to carry on the family-owned business. This paper documents that this practice improves the competitiveness of family-owned businesses, and helps explain why so many large, established companies in Japan are family-owned (whereas in most other developed economies they are not). It's unclear to me how much of this is substitute behavior for selling or otherwise turning over business ownership outside of the family. Perhaps there is a greater desire to maintain "family" control over businesses in Japan relative to other established economies.