Last week for Practically Friday, Jared examined conflict resolution looking at evidence from married couples. This week for Valentine's Day, we look at something essential to any successful relationship, whether business or personal: trust.
Just as there are many reasons a person chooses a spouse, numerous factors determine whether or not venture capitalists or angel investors will fund a company. The traditional and most frequently studied reasons include market size, past performance, and the company's future projections. But that's not everything. "This approach, widespread though it is, fails to consider that an investment in an early-stage company is a decision to commit to a business idea and, just as importantly, to an entrepreneur who will lead the business idea," says Kauffman Dissertation Fellow Lakshmi Balachandra, an assistant professor at Babson College. In her Ph.D. dissertation (abstract and executive summary here) she examined two research questions regarding the role an entrepreneur's perceived trustworthiness has in an investor’s decision to provide capital:
- How does the assessment of an entrepreneur's trustworthiness impact an early-stage investor’s interest in investing? For example, will entrepreneurs with economically viable/sound business models be considered for investment even if they seem untrustworthy? and
- To what extent do behaviors and cues presented by the entrepreneur influence the investor to trust them and decide to invest in them, as opposed to economic aspects of the business?
To determine how trustworthiness played a role in funding, Balachandra looked at 101 videos of entrepreneurs pitching to angel investors and analyzed them based on the ultimate investment decision, post-pitch survey results, and the demographic information of the involved parties, as well as third-party ratings regarding the behavior of the entrepreneurs during their pitch. Her results were as anticipated:
Investors’ assessment of the entrepreneur’s trustworthiness following the pitch directly impacts and moderates any interest in investing that they had from evaluating the economic factors of the business. I found that, as hypothesized, the economic factors of the venture are the primary consideration for angel investors. However, the investors' evaluation of the trustworthiness of the entrepreneur directly influences the way the investors then assessed the economic factors of the business. That is, when investors found the entrepreneur to be trustworthy, they rated the economic factors as more attractive as well.
The difference? A full 10 percent: "when entrepreneurs 'pitch' more trustworthiness, they are 10% more likely to have investors interest[ed] in investing in their business." So what qualities made an entrepreneur appear more trustworthy? Coachability or character (who a person is) mattered three times more to investors than competency (aptitude at a point in time and prior experience).
So what did these entrepreneurs actually do to appear trustworthy? (Since this is Practically Friday and all.) Most importantly, they:
In considering if they can trust the entrepreneur from his/her pitch, investors must believe they can make up for any lack of competency of the entrepreneur. For example, if an entrepreneur doesn’t know financial accounting, a professional accountant can be hired to fill this knowledge gap. This is in stark contrast with character: there is no way for an investor to compensate for differences in character which I measured as coachability in my study. This quality is critical to the investor since if the investor invests, the investor will be working with the entrepreneur for the foreseeable future.
- Had a higher level of speaking skills and presentation ability (character and competency).
- Had a greater number of social network connections, indicated by name-dropping (character and competency).
- Were open and accepting of suggestions, feedback, and critiques (character).
- Had a similar background/experience to the investor (character).
- Tended to be younger (character).
- Laughed more often (character).