While stories abound in the business press about multibillion dollar leveraged buyouts (LBOs), scant attention has been paid to this type of buyout financing in smaller companies. Some observers argue that LBOs are little more than financial manipulation, while others suggest that they are an alternative form of entrepreneurial endeavor and that smaller company LBOs may serve to rejuvenate formerly stodgy organizations. In this study, data from 56 firms that experienced an LBO between 1981 and 1987 were analyzed to ascertain the current state of smaller company LBOs and what changes, if any, occur after the LBO takes place. Most of the smaller company LBOs occur in industries far different from the high-growth, high-technology environments of the glamorous start-up. The cash flow requirements of the high debt component seem to favor industries in which growth is very slow or even negative and in which the technology is stable. Likewise, smaller LBOs are relatively immune from foreign competition. The typical smaller company LBO individual has generally been associated with the company as an officer or director prior to the buyout, and possesses at least a college education. While it was presumed that the typical LBO individual would be between 40 and 55 years of age, a substantial number of both older and younger individuals were discovered in the study. In terms of internal operating changes after the buyout, it was expected that the locus of decision making would shift toward the lead investor and that managerial compensation would become increasingly incentive based. Unexpectedly, little change in the locus of decision making occurred, but there was a pronounced shift away from salaried compensation. Sample firms indicated that asset stripping or personnel layoffs occurred relatively infrequently, and the most common operating changes focused on such revenue-generation efforts as increased sales and marketing and on imposing more stringent capital budgeting requirements. The study suggests that the once-stable environments in which these firms operated may become far more exciting in the future. On the positive side, these smaller companies are being operated by owner-managers experienced in both the company and the industry. The financial requirements of the high debt levels and the resulting emphasis on cash flow rather than profitability may make these firms extremely fierce competitors. On the negative side is the instability that may be caused by the high debt levels. Because most of these companies have not yet faced an economic recession, their long-term viability remains to be tested.

It is clear that entrepreneurs and their firms can vary widely. Nevertheless, most of the research to date on entrepreneurship has examined central tendencies, with relatively little attention devoted to entrepreneurial diversity. This study examines one of the most distinguishing characteristics of young firms—initial size. The focus is whether smaller start-ups differ from larger ones in the backgrounds of the entrepreneurs, their processes of starting, or the subsequent patterns of development. In this longitudinal study, an initial sample of 1903 young firms was examined to determine differences in characteristics of the entrepreneurs and in their processes of starting. One year later, data were obtained from 742 of these firms, permitting analysis of how initial firm size was related to subsequent difficulties encountered and changes made, as well as to performance. As expected, along almost every dimension, these starting larger firms had the backgrounds that would seem to be necessary for the assembly of substantial resources. They tended to have more education, more management experience, and goals that were more managerial in nature. They also were more likely to have partners. Women were associated more often with smaller ventures, but, for this sample, there were no differences in the representation of minorities between the smaller and larger start-ups. Those starting larger ventures tended to rely more upon external investors and to start ventures more closely linked to their previous jobs. Both groups of entrepreneurs sought information from a number of sources, but those founding larger ventures utilized professional advisors more, whereas those starting smaller ventures utilized informal sources. In the year after the first questionnaire, differences between the two groups were less marked than expected. Both groups of surviving firms reported low levels of serious problems, with the smaller ventures (somewhat surprisingly) reporting serious problems less often. There were not many differences in changes made except that smaller ventures were more likely to lose partners and larger ventures were more likely to add branches or locations. Both groups reported high rates of mean growth in sales. The smaller ventures (with their small initial bases) showed larger percentage increases. Smaller ventures also showed higher percentage increases in employment and, surprisingly, a greater increase in the absolute number of employees. Somewhat more of the smaller ventures had discontinued. Both groups included many firms that grew substantially and others that scaled back, demonstrating the fluidity and experimentation characteristic of young firms. For entrepreneurs and their advisors, for public-policy makers, and for researchers, any progress in understanding entrepreneurial processes should, in the long run, enhance venture performance. The patterns observed here indicate that firms of different initial size tend to be associated with particular entrepreneurial characteristics, processes of formation, and subsequent patterns of development. This diversity should be recognized in the development of assistance programs and university courses, as well as in the interpretation of previous research. For public-policy makers, the growth of these firms, both small and large, indicates the potential of economic contributions from entrepreneur ship. Further, the growth of the smaller start-ups suggests that even those ventures that appear to have few resources and modest potential can, in the aggregate, contribute substantially to the economy.

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.