Knowledge that Transforms

Venture capitalists responded to a questionnaire that asked them to identify their degree of involvement in a number of activities for a funded venture as well as other characteristics of the venture, including its performance. The three-page questionnaire was distributed to a sample of 350 venture capitalists during December 1986 and February 1987. In all, 62 questionnaires (18%) were completed and returned. The results indicated that venture capitalists were involved most—compared to the entrepreneur—in the financial aspects of the venture. The activity that had the highest degree of involvement was serving as a sounding board to the entrepreneur. The lowest degree of involvement occurred in those activities concerning the ongoing operations. Factor analysis on involvement patterns in the venture activities identified four distinct areas of involvement: development and operations, management selection, personnel management, and financial participation. The venture capitalists indicated that if they could change their degree of involvement, overall they would have done so only slightly. It was evident, however, that they would have increased their involvement in those activities requiring a minimal time commitment, such as formulating business strategy or marketing plans, or serving as a sounding board to the entrepreneur. It was evident that they would have decreased their involvement in activities that required substantial time commitment, such as developing production or service techniques, selecting vendors and equipment, or soliciting customers or distributors. Perhaps the most important result was the identification of three distinct levels of involvement adopted by venture capitalists: 1) Laissez Faire involvement, in which the venture capitalists exhibited limited involvement; 2) Moderate involvement, in which venture capitalists exhibited moderate involvement; and 3) Close Tracker involvement, in which venture capitalists exhibited more involvement than the entrepreneur in a majority of the identified activities. Because tests regarding the venture firms, the products or services in relation to the market, and management team characteristics did not significantly explain why the three distinct types of venture capitalist involvement emerged, it appears that venture capitalists exhibited different involvement levels solely because they elected to do so. Tests also indicated that the difference in the performance level of the ventures among the three groups was statistically insignificant. Regression analyses indicated that for each of the three types of involvement, involvement in various activities had different correlations with performance. Among Laissez Faire involvement ventures, developing the professional support group had a positive correlation with venture performance. Among Moderate involvement ventures, monitoring operations had a positive correlation with venture performance while involvement at the strategic level and in searching for management candidates exhibited negative correlations. Finally, among Close Tracker involvement ventures, negotiating employment terms with management had a positive correlation with performance, while searching for management candidates exhibited a negative correlation. It is interesting that searching for management candidates in both the Moderate and Close Tracker ventures had a negative correlation with venture performance. These results are important because they show that depending on the involvement types selected by venture capitalists, different involvement strategies in the various activities should be more suitable. If venture capitalists recognize this they can adopt more appropriate strategies, which may lead to more successful ventures.

A common characteristic of entrepreneurial farms is fast growth. A common problem for their managers is obtaining enough resources to accommodate that growth. A typical entrepreneur (either individual or corporate) often desires to pursue a detected opportunity but lacks the necessary resources to make it happen. Again, gaining access to those resources becomes the “first” entrepreneurial problem. One of the most efficient weapons used by entrepreneurial firms to gain market share from larger, more powerful corporations is their flexibility. But the progressive accumulation of resources that growth often entails brings almost necessarily a loss of that very flexibility that made the firm successful in the first place. This can be termed the “second” entrepreneurial dilemma. “Networking” practices are a way to overcome these problems. Essentially, networking is a system by which entrepreneurs can tap resources that are “external” to them, i.e., that they don't control. In its simplest form, networking consists of the use of all personal relationships to obtain advice, financing, “insider” sales, etc. (Birley 1986). In its most sophisticated form, entrepreneurs set up an elaborate web of relationships between companies, most of them of similar entrepreneurial characteristics, that are extremely efficient and flexible at delivering a product or service. In all cases, we find that the ability to exploit resources that are outside the entrepreneur's control is a constant of entrepreneurial, high-growth management. This is why entrepreneurs have been defined as being primarily motivated by the pursuit of opportunities, as opposed to those managers exclusively concerned with the proper management of the resources already controlled by their firm (Stevenson 1983; Stevenson and Gumpert 1985). This paper proposes a view whereby the essence of entrepreneurship is seen precisely in the ability and willingness to use external resources. A statistical validation of the main hypothesis, i.e., that entrepreneurial, fast- growing firms do use more external resources than their competitors, is then attempted. The results strongly support the hypothesis. It is found that the fastest-growing firms in a very large sample of public companies are much less integrated (make more use of external resources) than their competitors; in addition, those firms that are at the forefront of using external resources grow, on average, much faster (more than 10% every year) than their competitors over a long period of time (ten years). This study's implication for managers seems clear. It constitutes yet another piece of evidence in favor of the efficiency of networking arrangements. Being flexible enough to use external resources allows the entrepreneurial firm to break through the limits to sustainable growth and, at the same time, lowers its risk, for it taps into someone else's experience and know-how. Entrepreneurs and entrepreneurial managers must not be deterred by the lack of resources in the pursuit of opportunities.

The organized venture capital industry is now more than 40 years old. In the last decade, the pool of venture capital has increased almost tenfold to a current total of about $30 billion. Despite its comparative maturity, there has been no systematic tracking of the financial performance of the industry. An extensive search of the scholarly literature found that published information on rates of return was skimpy and not very reliable. In response to the need for valid and reliable industrywide rates of return. Venture Economics launched a data base in 1985 that records the rates of return of venture capital funds quarterly. For the period 1970–1984, there are 131 different funds in the data base. For the period 1970–1978, the data base covers 15% of all new capital committed to private funds; for the period 1981–1982, it covers 50%. Venture Economics adds funds to the data base on an ongoing basis. Preliminary analysis of the compound annual rates of return for the period 1978–1985 shows that funds started in 1978–1979 performed magnificently, with returns well in excess of the oft-quoted industry expectation of 25–30%. Funds started in the later part of the period did not perform nearly as well. However, it is much too early to make any predictions about the final rates of return of the funds because the oldest fund for which the rates are presented in this paper was 7 years old and the youngest was 15 months. Because they will have a life of at least 10 years, these funds have a long way to go before their portfolios are fully harvested and their final rates of return are known. The implications of the work reported in this paper will be derived from the following fact: The rates of return of venture capital are being recorded in a systematic way for the first time in the history of the organized industry. It is now possible to study the performance of venture capital with valid and reliable data. We expect that those studies will cover a range of applications from pragmatic analyses such as the performance of investment portfolios to theoretical questions such as the efficiency of the market in allocating venture capital.

Women have been leaving large corporations in increasing numbers in recent years to start their own businesses. However, they have not been succeeding at the same rate as their male counterparts. One potential barrier to a successful new venture is access to startup capital. Anecdotal evidence suggests that women starting their own businesses may have more difficulty obtaining financial support than men. In a loan decision simulation, this study systematically tested the allegations of female entrepreneurs that bank loan officers are more likely to grant loans, to make a counteroffer, and to make larger counteroffers to male entrepreneurs compared to female entrepreneurs under identical circumstances. Loan officers usually make funding decisions on the basis of information gathered from an interview and a business plan, while venture capitalists often screen proposals on the basis of a business plan alone. A second purpose of this study was to determine whether the mode of presentation—business plan versus business plan with interview—increased the male or female entrepreneur's probability of successfully obtaining a loan. A third purpose of this study was to examine the effects of the decision maker's previous experience on funding decisions. The recommendations of (experienced) loan officers versus (inexperienced) undergraduate students were compared in order to determine how experience and accountability influence loan decisions. The study consisted of a 2 × 2 × 2 research design with three independent variables. Loan officers and undergraduate students either read a business plan, or read a business plan and watched a videotape of an interview between a loan officer and a male or female entrepreneur who was seeking a loan to start a business. Participants then indicated the likelihood that they would recommend approval of the loan, make a counteroffer of a smaller amount and the magnitude of the counteroffer. There was no evidence that sex stereotypes influenced business funding decisions. With respect to the amount of counteroffer, a significant three-way interaction was obtained between entrepreneurial gender, presentation format, and participant status. Loan officers made larger counteroffers to the female compared to the male when they read the business plan and watched the interview. Students made larger counteroffers to the male compared to the female when they read the business plan and observed the interview. Loan officers were significantly more cautious and conservative than students in their funding decisions. Failure to support allegations of bias against women entrepreneurs is discussed in terms of possible unrealistic expectations regarding the ease of obtaining startup capital. Further research is needed to examine this explanation. One implication of these findings is that female entrepreneurs should seek opportunities to meet with loan officers to present their business proposals. In the interview, the female has the opportunity to address questions of motivation and competence. On the other hand, bankers may make more impartial decisions when relying on information in the business plan alone, where financial considerations would have greater weight. Finally, the results suggest that studies using students as proxies for bank loan officers have very limited generalizability.

Small firms confront significant dilemmas as they struggle to capitalize on growth opportunities. Surges in demand frequently result in the hiring of additional operating and administrative personnel. Rapid growth in employment, however, creates managerial problems whose resolution requires firms to design collateral systems that both mobilize staff attention toward a shared vision and support the firm's strategic outlook (Hambrick and Crozier 1985; Kotter and Sathe 1978). This article reports on a cross-sectional study of 95 small U.S. firms that experienced a five-year surge in growth. Findings indicate that the internal systems designed by these firms to support their rapid growth varied systematically by strategic orientation and degree of product diversity. Contrary to expectations, the relationship between strategy and structure failed to demonstrate a significant effect on these firms' levels of performance. Indeed, the data suggest that in fashioning these systems, firms' managements may, in fact, be responding to contradictory pulls. 1. Bureaucratization versus Decentralization. Increased hiring stimulates bureaucracy: firms formalize procedures as staffing doubles and triples. Employee participation and autonomy decline and internal labor markets develop. Tied to growth, however, is also an increased diversity in product offerings that favors less formalized decision processes, greater decentralization, and the recognition that the firm's existing human resources lack the necessary skills to manage the broadening portfolio. 2. Environment versus Strategy. High environmental turbulence and competitive conditions favor company cultures that support risk taking, autonomy, and employee participation in decision making. Firms confront competitors, however, through strategies whose implementation depends on the design of formal systems that inhibit risk taking and autonomy. 3. Strategic Emphases on Quality versus Cost versus Innovation. Rapidly growing firms strive to simultaneously control costs, enhance product quality, and improve product offerings. Minimizing costs and undercutting competitors' product prices, however, are best achieved by traditional hierarchical systems of decision making and evaluation that contrast with the kinds of autonomous processes most likely to encourage the pursuit of product quality and innovation. The findings suggest that managing surges in growth involves multiple challenges: resolving the stresses and strains induced by attempts to control costs while simultaneously enhancing quality and creating new products to maintain competitive parity, and centralizing to retain control while simultaneously decentralizing to encourage the contributions of autonomous, self-managed professionals to the embryonic corporate culture. Rapidly growing firms are challenged to strike a balance between these multiple pulls when designing their managerial systems.

The importance of innovation is underscored by the fact that some authors blame U.S. industry's competitive decline on the excessively short-term focus of managers as opposed to longer-term innovative product or process development. At the same time the contribution of small firms to research and innovation continues to rise. Thus from 1945 to 1980 they introduced an average 48% share of innovations, a figure that rose to 56% for the 1980–1985 period. This article studies innovation in small manufacturing firms in Texas. The study sample was drawn from the 1985 Directory of Texas Manufacturers and covered SIC codes 34–39. These include Metal Fabrication, Nonelectrical Machinery, Electrical and Electronic Machinery, Transportation Equipment, Instrumentation, and Miscellaneous Manufacturing. A total of 50 usable responses were received of which the CEO was the responding executive in 38. Prior literature on innovation provided the relevant variables. In broad groupings, these covered strategy, structure, function, environment, the firm, and the responding executive plus his role in innovation. Product differentiation and risk taking were also included. Each broad group often consisted of several variables. For example, the environment grouping comprised dynamism, heterogeneity, and hostility. In all there were 31 independent variables. Their data values were based on either the responses to individual questions or the means of responses to groups of questions. The dependent variable, product-service innovation, averaged the responses to questions on technological leadership and quantity and quality of innovations. A stepwise regression procedure yields an eight-variable model with an R2 of 0.66. A runs test on the residuals confirms the randomness of errors. The computed discriminant function classifies the sample firms correctly in 43 of 50 cases. While the modeling process is successful, the models have not been retested on fresh data because of the small sample and so the caveat of sample specificity remains. The recurring variables in the two models are integrated decision making, environmental heterogeneity, percentage of research expenditure to cost of goods sold, and the responding executive's role in technical development of innovations. For the latter, the answer seems to be that less is more or “hands-off” is best. The coefficients for the others are all positive. For investors or lenders the consequence of being able to evaluate the innovative potential of small firms is likely to attenuate the risk. Secondarily, it is also likely to enhance the efficient allocation of resources. The data obtained lacked sufficient variation in structural variables like centralization—the sample firms tended to be centralized. Thus future research exploring centralization and its effect on innovation in small firms would be most interesting, particularly as prior results are somewhat ambiguous.

This research explored the extent to which entry order (the decision to enter a market early as a “pioneer,” or to wait and follow) determines not only market share, but other competitive factors such as position and promotion that late entrants might hope to employ to overcome a pioneer's advantages. The study analyzed data on 119 nonservice new corporate ventures (consumer and industrial) from the Profit Impact of Marketing Strategy (PIMS) research data base, STR4. Based on a review of the strategic management and marketing literatures, three hypotheses on the effects of entry order were generated and subsequently tested. The first hypothesis states that pioneers achieve higher market shares than followers. Since, a priori, the market share for the pioneer has to be larger than the market share split among later entrants, the issue is the rate at which the early entrant's market share will decrease as additional businesses enter, what we term the “degree of lateness effect.” Later entrants have the choice of being an early follower, that is entering the industry soon after the pioneers, or waiting until the industry matures (late entrants). A high degree of lateness effect would indicate that early followers would gain higher market shares than late entrants. An analysis of the data indicated that pioneers have significantly higher market shares than followers and that little degree of lateness effect existed between early and late entrants. The second hypothesis states that pioneers will achieve differentiation advantages (in such areas as product and service quality, promotion, and technological positioning) greater than followers. There is considerable theoretical and empirical evidence that pioneers are able to generate competitive advantages through name recognition, image leadership, the establishment of technical standards which make switching to other products difficult, and superior consumer information advantages due to market lead times. An analysis of the data indicated that pioneers have significant competitive advantages in product/service quality and technology over followers. The one area where pioneers did not have a competitive advantage over followers was in advertising and promotion. The third hypothesis states that followers will achieve cost advantages greater than pioneers. While learning curve theory suggests that pioneers will enjoy cost/price advantages, contrasting arguments can be made that followers can enjoy lower costs by “coattailing” on the pioneer's efforts to educate consumers, develop a dominant design, and create an infrastructure to span the gap from raw material suppliers to finished good deliveries. We suggest that because pioneers are likely to have attained differentiation advantages, followers will have only one alternative left: compete on the basis of price and become the lowest-cost producer. An analysis of the data indicates that while followers do appear to have lower prices than pioneers, followers do not have significantly lower cost structures. This result implies a lower level of profitability for a follower strategy. Overall, the results of this study advance the notion that new corporate ventures should enter as pioneers, rather than as followers. Pioneers had higher market shares and stronger competitive positions (higher quality, more differentiated products, and better service) than followers. Followers appear to have few successful competitive options available outside of promotion for gaining market share.

This study compares management performance before and after leveraged buyouts of 25 sample companies. Average performance for the two years before a leveraged buyout is compared to average performance for the two years after a buyout. The year of the buyout is omitted from comparisons because it usually includes recognition of a number of atypical events which distort comparisons. Managers must acquire some equity ownership as part of the buyout, and a major restructuring must not occur in either the pre- or post-buyout periods. Seven accounting variables, adjusted in the pre-buyout periods to reflect values reflected in the post-buyout periods, are used to measure performance. Comparison of pre- and post-buy out performance are made directly for the same entity. Comparisons are also made of pre- and post-buyout performance in terms of the ratios of company performance to industry performance. Multivariate analyses of variance, using all seven variables, reflect change in both comparisons which is significant at the .001 level. Post-hoc tests are performed to attempt to identify the extent of change in the separate variables and to examine the significance of income tax savings. Financial performance after the buyouts is superior to performance before the buyouts. The evidence is convincing that management focus changes, apparently from minimizing variability in reported profits to maximizing cash flow. The improvement is greater than from income tax savings alone. Three groups of LBO participants are interviewed to gain insight into the forces behind the changes which are reflected in the financial data. Executives of institutional investors, LBO house principals and chief executive officers of LBO companies, all anticipate a higher return on investment in the post-buyout period and more efficient use of corporate assets. They tend to consider cashflow to be the primary measure of performance of LBO companies. The reason for the improvement in performance cannot be identified with certainty, but no explanation is more persuasive than the introduction of entrepreneurial management by the small group of new owner-managers. Interviewees provide anecdotal evidence that the utility functions of on-site managers and other investors converge on the task of debt reduction, indicating a reduction of agency costs. Absence of free cash flow in the post-buyout period also provides support for lesser agency costs. However, the introduction of entrepreneurial management is interpreted to include the exploitation of a wider set of opportunities to achieve wealth and position for owner-managers than from the reduction of agency costs alone. The findings are important for investors, future LBO players, and for makers of public policy. Efficiency improvements can reasonably be expected from similar future leveraged buyouts, improvement not dependent on income tax savings.