Chapter 5

Growing the Enterprise

o Estimates vary, but most studies confirm that around half of start-ups survive no more
than four years, and less than 4% of the remaining new ventures grow.
o In this chapter we identify the factors which contribute to the success and growth of new
ventures, and we try to differentiate the factors which entrepreneurs can influence from
those which are more contextual.

Factors Influencing Success

 A study of 11 259 new technology ventures in the USA over a period of five years found
that 36% survived after four years and 22% after five years.
 To try to explain the success and failure of these ventures, the researchers reviewed 31
other key studies of technology ventures, and found only eight factors that were
consistently found to influence success:

• Value chain management; Cooperation with suppliers, distribution, agents and customers.
• Market scope; Variety of customers and market segments, and geographic reach.
• Firm age; Number of years in existence.
• Size of founding team; Likely to bring additional and more diverse expertise to the
ventures and better decision making.
• Financial resources; Venture assets and access to funding.
• Founders’ marketing experience; But not technical experience, or prior experience of
start- ups (see below).
• Founders’ industry experience; in related markets or sectors.
• Existence of patent rights; in product or process technology, but R&D investment was not
found to be significant.
 The first three factors were by far the most significant predictors of success.
 However, clearly there is also some interaction between these effects,
o for example the founders ’marketing and industry experience is likely to
influence the attention to market scope and the value chain, and patent rights make
raising finance easier, and vice versa.
 In addition, they found that some commonly cited factors had no effect, including
founders’ experience of R&D or prior start-ups.
 The importance of other factors depended on the precise context of the venture,
o For example for independent start-ups R&D alliances and product innovation
both had a negative effect on performance,
 But for ventures of mixed origins R&D alliances and product innovation
both had a positive effect on performance.
 Despite these relatively high rates of survival, very few firms grow significantly or
consistently, the so-called gazelles, typically less than 4%.
 Although these high growth ventures area typical, they account for a disproportionate
proportion of new employment, between 12 and 33% in Europe.
 The founding conditions appear to have a very significant and persistent effect on the
subsequent success and growth of a new venture,
o But it is difficult to separate the effects of business planning, strategy and context.
 This can be a slow, painful process, but an essential one to attract the necessary talent,
resources and initial customers.
 Studies consistently find that the age, educational level, number of founders and starting
capital all have a positive effect on venture success.
o The effects of age on the success and growth of a new venture are probably the
best understood, and shown to be significant in almost every research study.
 The consensus is that the most common age of successful founders is
between 35and 50 years old, the median age being 39.
o The explanation for this clustering is that younger founders tend to lack the
experience, resources and credibility, whereas older founders may lack the drive
and have too much to lose.
 Of course there are many examples of successful entrepreneurs outside of this age range,
but the association between age of founders and success is very significant.
 To understand the influence of education, one study tracked 118070 new start-up firms
over ten years and found that human capital at foundation, measured by university degree,
had a strong and persistent positive effect on subsequent success.
 In addition, four structural factors at the time of foundation were predictors of success:
o firm size at foundation (positive),
o rate of firm entry into the same sector (negative),
o concentration of the sector (positive) and
o GDP growth (positive).
 Other research examined 622 young or new small firms over five years, and found
human and financial capital available at start-up was a strong predictor of survival and
growth, specifically the founder’s education (degree or above) and access to bank finance.
 As with age, there are many examples of successful entrepreneurs who chose not to go to
college or dropped out early, but the research does consistently demonstrate a strong
association between level of education and venture success and growth, especially in
more knowledge- or technology-intensive businesses.
 Access to sufficient capital is another widely cited founding condition for success and
growth.
 However, the evidence is more mixed than for the effects of age and education.
 Some studies suggest that access to external capital is associated with higher growth,
especially in the case of more high-technology ventures,
o But others find no such effect or even the exact opposite relationship: that higher
growth is associated with maintaining internal funding and ownership.
 The conflicting evidence and advice may be due to methodological differences, such as
definition of high growth, time period studied and soon,
o But may also reflect the influence of more fundamental moderating factors, for
example the type of venture and market or the roles and control needs of founders.
 These founder effects are even stronger for new technology-based firms (NTBFs).This is
partly because of the human capital necessary, especially the high education of founders:
• 85% have degree, almost half a PhD
• 12 or more years of experience in large private-sector firm
• Founders’ ages cluster mid-30s; two-thirds aged 30–50.
 However, NTBFs are diverse, and the type of technology will also have an influence of
the trajectory of growth.
 Finally, companies competing on price, rather than by differentiation, are much less likely
to survive.
 Contrary to the popular folklore of the poorly educated, disadvantaged entrepreneur, this
study confirms that the more typical profile of a successful new venture is a rare
combination of human capital in the form of the university education of founders,
availability of sufficient finance and a strategy of growth by product or service
differentiation.
 Similarly, the caricature of the lone, risk-taking entrepreneur is unfounded.
 The growth of a new venture in terms of sales and employment depends upon planning
skills and experience, and profitability flows from developing and exploiting networks.
 Innovative firms are more likely to grow, in terms of sales and employment, but are not
necessarily more profitable than non-innovators.
o Funding by venture capital has no effect
 On the innovativeness of a start-up, but does have a positive influence on profitability,
perhaps reflecting the priorities of such investors.
 Financial constraints only have an effect on the likelihood of survival of a new venture in
the first few years, but continue to constrain profit- ability and growth for a decade after
foundation.
 One of the challenges of developing a new venture is developing or gaining access to
complementary capabilities, assets and resources.
o For example, a start-up may have the technical know-how or intellectual property
but not be able to reach or support potential customers, or conversely an
entrepreneur may identify a market opportunity but not be able to provide the
product or service to satisfy this.
 This is one reason why firms created by pairs or small groups of founders are
significantly more likely to be successful than those formed by individual entrepreneurs.
 The contrasting capabilities and perspectives of multiple founders provide a stronger
basis to identify, develop and deliver innovative offerings.

Funding

o The initial funding to establish a new venture is rarely a major problem, as most are self-
funded.
o However, Peter Drucker suggests a new venture requires financial restructuring very three
years.
o Different stages of development each have different financial requirements:

• Initial financing for launch.

• Second-round financing for initial development and growth.
• Third-round financing for consolidation and growth.
• Maturity or exit
 In general, professional financial bodies are not interested in initial funding, because of
the high risk and low sums of money involved.
 It is simply not worth their time and effort to evaluate and monitor such ventures.
 However, as the sums involved are relatively small typically of the order of tens of
thousands of pounds – personal savings, re-mortgages and loans from friends and
relatives are often sufficient.
 The initial funding required to form a new venture may include the purchase of
accommodation, equipment and other start-up costs, plus the day- to-day running costs
such as salaries, utilities and soon.
 Research in the USA and the UK suggests that most begin life as part time venture sand
are funded by personal savings, loans from friends and relatives and then bank loans, in
that order.
 Around half also receive some funding from government sources, but in contrast receive
next to nothing from venture capitalists.
 Venture capital is typically only made available at later stages to fund growth on the basis
of a proven development and sales record.
 Given their strong desire for independence, most entrepreneurs seek to avoid external
funding for their ventures.
 However, in practice this is not always possible, particularly in the later growth stages.
 Venture capitalists are keen to provide funding for a venture with a proven track record
and strong business plan, but in return will often require some equity or management
involvement.
 Moreover, most venture capitalists are looking for a means to make capital gains after
about five years.
 However, almost by definition entrepreneurs seek independence and control, and there is
evidence that some will sacrifice growth to maintain control of their ventures.
 For the same reason, few entrepreneurs are prepared to go public to fund further growth.
Thus, many entrepreneurs will choose to sell the business and found another.
o For example, the typical technology entrepreneur establishes an average of three
ventures in their life time.
 Therefore, the biggest funding challenge is likely to be for the second round financing to
fund development and growth.
 This can be a time-consuming and frustrating process to convince venture capitalists to
provide finance.
 The formal proposal is critical at this stage.
 Professional investors will assess the attractiveness of the venture in terms of the
strengths and personalities of the founders, the formal business plan and the commercial
and technical merits of the product, typically in that order.
 As we discussed in the previous chapter, general venture capital firms typically only
accept 5% of the technology ventures they are offered, and the specialist technology
venture funds are even more selective, accepting around 3%.
 The main reasons for rejecting technology proposals compared to more general funding
proposals are the lack of intellectual property, the skills of the management team and the
size of the potential market.
 Venture capitalists can play two distinct roles.
o The first is to identify or select those NTBFs that have the best potential for
success that is ‘picking winners’ or ‘scouting.
o The second role is to help develop the chosen ventures, by providing management
expertise and access to resources other than financial that is a ‘coaching’ role.
 Distinguishing between the effects of these two roles is critical for both the management
of and policy for NTBFs.
 For managers, it will influence the choice of venture capital firm, and, for policy, it will
influence the balance between funding and other forms of support.
 A study of almost 700 bio technology firms over ten years provides some insights in to
these different roles.
 It found that when selecting start-ups to invest in the most significant criteria used by
venture capitalists were a broad, experienced top management team, a large number of
recent patents and downstream industry alliances (but not upstream research alliances,
which had a negative effect on selection).
 The strongest effect on the decision to fund was the first criterion and the human capital
in general.
 However, subsequent analysis of venture
 Performance indicates that this factor has limited effect on performance, and that the few
significant effects are split equally between improving and impeding the performance of a
venture.
 The effects of technology and alliances on subsequent performance are much more
significant and positive.
 In short, in the selection stage, venture capitalists place too much emphasis on human
capital, specifically the top management team.
 In the development or coaching stages, venture capitalists do contribute to the success of
the chosen ventures, and tend to introduce external professional management much earlier
than in.
 NTBFs not funded by venture capital.
 Taken together, this suggests that the coaching role of venture capitalists is probably as
important, if not more so, than the funding role, although policy interventions to promote
NTBFs often focus on the latter.

Growth and Performance of New Ventures

 There has been a great deal of economic and management research on small firms,
o but much of this has been concerned with the contribution all types of small firms
make to economic, employment or regional development.
 Relatively little is known about innovative new ventures.
 In most developed economies, around 10% of the economically active population engage
in new venture creation each year, a slightly higher proportion (15% or so) in the USA
and Asia and a little lower in Europe (excluding the UK) – 6%.
o However, the rate of churn (i.e. new ventures closed less those created) is high.
 Closure does not necessarily indicate failure, as a founder may choose to change business
or seek alternative employment.
 Survival rates are quite high, in the UK after two years 80% survive, and 54% after four
years (Barclays Capital, 2008).
 In the USA there are more short-term failures, probably owing to the ease of establishing
a business there, but similar rates of longer-term survival: 66% survive two years, 50%
four years and 40% more than six years.
 A study of 409 SMEs examined the differences between the highest-growing, the
gazelles, and the lowest-growing companies over a four-year period, to identify how
innovation contributed to the growth.
 It found that, in addition to high growth, the highest-growing companies also showed
higher profitability, increased number of employees and significantly higher market
shares locally, nationally and internationally than the lowest-growing companies.
 Several traits were found to contribute to this:
  The high growers had significantly (p < 0.001) younger CEOs than the low
growers,
o But the average of 47 years for the high growers clearly indicates that
several of their CEOs were over 50 years of age.
 The high growers had a significantly higher portion of new products as part of
the turnover.
 The high growers perceived themselves as better than their competitors at
understanding customer needs, offering better products, being agile but also at
keeping costs low.
 The high growers prioritized growth rather than profitability (p<0.001),
market share rather than profitability (p<0.001) and reinvesting rather than
showing profit (p < 0.001).
 Much of the research on innovative small firms has been confined to a small number of
high technology sectors, principally microelectronics and biotechnology.
 A notable exception is the survey of 2000 SMEs conducted by the Small Business
Research Centre in the UK.
 The survey found that 60% of the sample claimed to have introduced a major new
product or service innovation in the previous five years.
 While this finding demonstrates that the management of innovation is relevant to the
majority of small firms, it does not tell us much about the significance of such
innovations, in terms of research and investment, or subsequent market or financial
performance.
 Research over the past decade or so suggests that the innovative activities of SMEs
exhibit broadly similar characteristics across sectors.
 they:
o are more likely to involve product innovation than process innovation
o are focused on products for niche markets, rather than mass markets
o will be more common amongst producers of final products, rather than producers of
components
o will frequently involve some form of external linkage
o tend to be associated with growth in output and employment, but not necessarily
profit.
 The limitations of a focus on product innovation for niche or intermediate markets were
discussed earlier, in particular problems associated with product planning and marketing,
and relationships with lead customers and linkages with external sources of innovation.
 Where an SME has a close relationship with a small number of customers, it may have
little incentive or scope for further innovation, and therefore will pay relatively little
attention to formal product development or marketing.
o Therefore, SMEs in such dependent relationships are likely to have limited
potential for future growth and may remain permanent infants or subsequently be
acquired by competitors or customers.
 Moreover, an analysis of the growth in the number of NTBFs suggests that the trend has
as much to do with negative factors, such as the downsizing of larger firms, as it does
with more positive factors, such as start-ups.
 Innovative SMEs are likely to have diverse and extensive linkages with a variety of
external sources of innovation, and in general there is a positive association between the
level of external scientific, technical and professional inputs and the performance of an
SME.
 The sources of innovation and precise types of relationship vary by sector, but links with
contract research organizations, suppliers, customers and universities are consistently
rated as being highly significant, and constitute the ‘social capital’ of the firm.
o However, such relationships are not without cost, and the management and
exploitation of these linkages can be difficult for SMEs and over whelm their
limited technical and managerial resources.
 As a result, in some cases the cost of collaboration may outweigh the benefits, and in the
specific case of collaboration between SMEs and universities there is an inherent
mismatch between the short terms, near-market focus of most SMEs and the long-term,
basic research interests of universities.
 In terms of innovation, the performance of SMEs is easily exaggerated.
 Early studies based on innovation counts consistently indicated that when adjusted for
size smaller firms created more new products than their larger counterparts did.
o However, methodological short comings appear to undermine this clear message.
 When the divisions and subsidiaries of larger organizations are removed from such
samples, and the innovations weighted according to their technological merit and
commercial value, the relationship between firm size and innovation is reversed:
 o Larger firms create proportionally more significant innovations than SMEs do.
 The amount of expenditure by SMEs on design and engineering has a positive effect on
the share of exports in sales,
o but formal R&D by SMEs appears to be only weakly
 Associated with profitability, and is not correlated with growth.
 Similarly, the high growth rates associated with NTBFs are not explained by R&D effort,
and investment in technology does not appear to discriminate between the success and
failure of NTBFs.
 Instead, other factors have been found to have a more significant effect on profitability
and growth, in particular the contributions of technically qualified owner managers and
their scientific and engineering staff, and attention to product planning and marketing.
 A large study of start-ups in Germany found that the founder’s level of management
experience was a significant predictor of the growth of a venture.
 However, innovation, broadly defined, was found to be statistically three times more
important to growth than founder attributes or any other of the factors measured.
 Another study, of Korean technology start-ups, also found that innovativeness, defined as
a propensity to engage in new idea generation, experimentation and R&D, was associated
with performance.
 So was pro activeness, defined as the firm’s approach to market opportunities through
active market research and the introduction of new products and services.
 The same study also found that what it referred to as ‘sponsorship-based linkages’ had a
positive effect on performance.
 This included links with venture capital firms, which reinforces the developmental role
these can play, as discussed earlier.
 The size and location of a venture also has an effect on performance.
 Geographic close- ness increases the likelihood of informal linkages and encourages the
mobility of skilled labor across firms.
 However, the probability of a start-up benefiting from such local knowledge exchanges
appears to decrease as the venture grows.
 This growing inability to exploit informal linkages is a function of organizational size, not
the age of the venture, and suggests that as ventures grow and become more complex they
begin to suffer from many of the barriers to innovation, and therefore the explicit
processes and tools to help overcome these become more relevant.
 Larger SMEs are associated with a greater spatial reach of innovation- related linkages
and with the introduction of more novel product or process innovations for international
markets.
 In contrast, smaller SMEs are more embedded in local networks, and are more likely to
be engaged in incremental innovations for the domestic market.
 It is always difficult to untangle cause and affect relationships from such associations, but
it is plausible that as the more innovative start-ups begin to outgrow the resources of their
local networks they actively replace and extend their networks, which creates both the
opportunity and demand for higher levels of innovation.
 Conversely, the less-innovative start-ups fail to move beyond their local networks, and
therefore are less likely to have either the opportunity or the need for more radical
innovation.
 However, different contingencies will demand different innovation strategies.
o For example, a study of 116 software start-ups identified five factors that affected
success: level of R&D expenditure, how radical new products were, the intensity
of product upgrades, use of external technology and management of intellectual
property.
o In contrast, a study of 94 bio- technology start-ups found that three factors were
associated with success: location within a significant concentration of similar
firms, quality of scientific staff (measured by citations) and the commercial
experience of the founder.
o The number of alliances had no significant effect on success, and the number of
scientific staff in the top management team had a negative association, suggesting
that scientists are best kept in the laboratory. Other studies of bio technology
startups confirm this pattern, and suggest that maintaining close links with
universities reduces the level of R&D expenditure needed increases the number of
patents produced and moderately increases the number of new products under
development.
o However, as with more general alliances, the number of university links has no
effect on the success or performance of biotechnology start-ups, but the quality of
such relationships does.
 Such sector-specific studies confirm that the environment in which small firms operate
significantly influences both the opportunity for innovation, in a technological and market
sense, and the most appropriate strategy and processes for innovation.
o For example, a venture may have a choice of whether to use its intellectual assets
by translating its technology in to product and services for the market or
alternatively it may exploit these assets through a larger, more established firm,
through licensing, sale of IPR or by collaboration.
 More specifically, the venture needs to consider two environmental factors:

• Excludability; to what extent can the venture prevent or limit competition

from incumbents who develop similar technology?

• Complementary assets; to what extent do the complementary assets -

production, distribution, reputation, support, etc. – contribute to the value
proposition of the technology?
 Combining these two dimensions creates four strategy options:
• Attacker’s advantage. Where the incumbent’s complementary assets
contribute little or no value, and the start-up cannot preclude development by
the incumbent (e.g. where formal intellectual property is irrelevant or
enforcement poor), the venture will have an opportunity to disrupt established
positions, but technology leadership is likely to be temporary as other new
ventures and incumbents respond, resulting in fragmented niche markets in the
longer term. This pattern is common in computer components businesses.

• Ideas factory. In contrast, where incumbents control the necessary

complementary assets, but the venture can preclude effective development of
the technology by incumbents, cooperation is essential. The new venture is
likely to focus on technological leadership and research, with strong
partnerships downstream for commercialization. This pattern tends to reinforce
the dominance of incumbents, with the ventures failing to develop or control
the necessary complementary assets. This pattern is common in biotechnology.

• Reputation-based. Where incumbents control the complementary assets, but

the venture cannot prevent competing technology development by the
incumbents, ventures face a serious problem of disclosure and other
contracting hazards from incumbents. In such cases, a venture will need to
 seek established partners with caution, and attempt to identify partners with a
reputation for fairness in such transactions. Cisco and Intel have both
developed such a reputation, and are frequently approached by ventures
seeking to exploit their technology. This pattern is common in capital intensive
sectors such as aerospace and automobiles. However, these sectors have a
lower ‘equilibrium’, as established firms have a reputation for expropriation,
therefore discouraging start-ups.

• Greenfield. Where incumbents’ assets are unimportant, and the venture can
preclude effective imitation, there is the potential for the venture to dominate
an emerging business. Competition and cooperation with incumbents are both
viable strategies, depending upon how controllable the technology is, e.g.
through establishing standards or platforms, and where value is created in the
value chain.
 A high proportion of new ventures fail to grow and prosper.
 Estimates vary by type of business and national context, but typically 40% of new
businesses fail in their first year and 60% within the first two.
 In other words, around 40% survive the first two years.
 Common reasons for failure include:
• Poor financial control
• Lack of managerial ability or experience
• No strategy for transition, growth or exit.
There are many ways a new venture can grow and create additional value:
• Organic growth through additional sales and diversification
• Acquisition of or merger with another company
• Sale of the business to another company, or private equity firm
• An initial public offering (IPO) on a stock market.

o For example, UK Sunday Times Profit Track estimates that of the 500 fastest-growing
private firms in the UK, over five years around 100 have merged with or been acquired
by other companies or private equity firms, but only ten or so have been floated (Table
14.3).
o Some of the best-performing ones have been in ICT; others, in service innovation.
o A separate survey of technology-based start-ups reveals a dominance of Web-based
businesses, which demonstrates how much, has changed since the Internet bubble burst.
o A lack of managerial experience and credibility in their founders can also be a major
barrier to funding and growing new ventures.
o In the early stage, developing relationships with potential customers and suppliers is the
most critical, but as the venture grows the relationship and role of partners in the network
of a new venture will change.
o Later, external sources of funding need to be cultivated, which can result in changes of
ownership and the dissolution of some of the initial relationships, and substitution for
more mature partners in more stable networks.
o Overtime, the roles of different actors in the venture network become more specialized
and professional.
o Individual skills are essential in building and developing such relationships and networks.
These skills include:
o Social and interpersonal communication. To build credibility and promote
knowledge sharing.

Source: Derived from Tove Brink (2014) The impact on growth of outside-in and inside-
out innovation, International Journal of Innovation Management, 18(4), do i1450023.

• Negotiating and balancing skills. To balance cooperation and competition, and to

develop awareness, trust and commitment

• Influencing and visioning skills. To establish roles, and shares of responsibilities

and rewards.

Therefore, the challenge is not only to simultaneously manage the more mature firm and its
relations but also to maintain the early focus on innovation. To conclude, new venture
growth is a consequence of the interaction of internal factors, such as the entrepreneurs’
personalities and capabilities, and external factors such as social and physical network
connections.