The Second Time Around? Repeat Entrepreneurs from MIT
The Second Time Around? Repeat Entrepreneurs from MIT
By:
Charles E. Eesley and Edward B. Roberts?
October 25, 2006
Abstract
In this paper we explore the factors that condition the likelihood that an entrepreneur starts a second firm. We use data from survey responses of 1,789 entrepreneurs to examine firm founding behavior. Results indicate that multiple entrepreneurs differ from single-firm entrepreneurs in certain demographic and educational characteristics prior to starting a first firm. The phenomenon of graduates embarking on careers of multiple entrepreneurship appears to be growing over time. The results also show that the first firms of eventual multiple entrepreneurs differ from the first firms of single-firm only entrepreneurs. The paper indicates that those entrepreneurs with the highest probability of starting a second firm have greater time and access to financial resources to undertake a new venture. Starting a first firm sooner after graduation, being divorced, the first firm being acquired, and raising initial capital for the first firm from angel investors all increase the probability that the entrepreneur will start a second firm.
I. Introduction
A growing literature in strategy and economics has noted that an important source of new entrants is incumbent firms in the same industry (Klepper 2001; Gompers, Lerner, and Scharfstein, 2005). However, these studies have developed and emphasized theories regarding employees leaving incumbent firms to start new ventures. Various lenses, such as agency theory, organizational capability theories, employee learning theories, and evolutionary theories have been used to evaluate why employees decide to leave their firms to spin-off new firms. Most of these theories emphasize some sort of conflict between the spin-off and the incumbent's top management. On the other hand, in the finance literature, a growing group of scholars have examined the determinants of CEO turnover. However, these authors typically focus on forced CEO turnover in relation to firm and industry performance. CEOs who voluntarily leave and what they do after leaving are seldom studied (for important exceptions see Wasserman 2003; Bertrand and Schoar 2003). At the intersection is a relatively important gap in our understanding-- the founder or CEO who is pushed out or voluntarily leaves a firm and decides to start a new firm. The existing theories of spin-off activity (with the possible exception of evolutionary-based theories) do not explain or fit this phenomenon well, and the existing work on CEO turnover with an emphasis on corporate governance of large firms does not shed much light on the phenomenon either. As a result, it has proven difficult to determine how prior founding experience should be interpreted (i.e. as a measure of risk aversion, learning, or reduced asymmetric information on quality for investors).
The importance of the entrepreneur who starts multiple firms over the course of a lifetime has been recognized in the academic literature as a potentially widespread aspect of new firm creation for at least 35 years (Cooper, 1970). However, in relation to its likely significance for economic growth and for the field of entrepreneurship the phenomenon has been understudied (see Table 1). With some recent exceptions (Sarasvathy & Monon, 2005), almost no theoretical work has been done (Westhead, 1998). As a result, the few empirical studies use different definitions, populations, and control variables leaving little consensus on foundational questions about how important or how widespread is this phenomenon in the U.S. or internationally. This deficiency is especially true in regard to companies formed to exploit new technology. The purpose of this paper is to advance our understanding of what factors condition the likelihood that a founder will leave a firm and start a new firm. Is it differences in underlying individual demographic characteristics or differences in characteristics of the first firm experience or performance that motivate novice founders to initiate a new firm founding. To answer these questions, we use a founder-firm matched panel data set, where we track over time founders across different firms that they start or choose to remain with. Our cross-industry data also allow us to examine how industry characteristics may affect how likely a founder will be to try founding a second new firm.
II. Background Literature / Theory
Especially compared to the early years when entrepreneurs were seen as a homogeneous group, a number of different groupings of entrepreneurs has emerged in recent years. As Hsu (2006b) notes, an important recent theme in the literature is heterogeneity among entrants prior to the development of the venture, especially in terms of the experience of the founder or founding team. Compared to the literature on differences between entrepreneurs and non-entrepreneurs, scholarly attention to the heterogeneity among entrepreneurs has been very limited until recently.
Prior literature has examined the determinants of self-employment. Carroll and Mosakowski (1987) show that the transition to self-employment depends on factors including family background and prior experiences with self-employment. Our research differs in its focus on high technology entrepreneurs and their firms. As pointed out earlier (Shane & Khurana, 2003), self-employment does not necessarily involve the founding of a new firm, such as when an individual does independent consulting or contract work. Further, firms started to commercialize new technologies tend to be larger and have a strong impact on economic productivity. Therefore repeat entrepreneurs who focus on technology represent a particularly important and relatively unexplored area of study.
Wasserman (2003) examines Founder-CEO succession in 202 venture-backed Internet start-ups. His study does not look explicitly at what Founder-CEOs do once replaced or after leaving the firm. He finds that many Founder-CEOs remain in the firm, even when they are replaced as CEO. Of importance for the current study, he finds that the likelihood of a Founder-CEO being replaced increases with the achievement of critical milestones in building the company.
Unlike the previous studies looking at the effects of prior career experiences or prior firm founding on the likelihood of subsequent firm founding, the present study examines individual and firm-level factors related to the transition from an active founding role in one firm to starting a second firm. In addition, our research takes advantage of data on the timing of the entire founding history and on the entrepreneur's personal success.
III. THEORY AND HYPOTHESES
In this paper we develop and test a theory of entrepreneurial exit and then re-entry into entrepreneurship. Through entrepreneurial experience the founder builds up social and financial capital in addition to personal experience and human capital. As these three forms of capital are raised by the entrepreneur, he or she may choose to invest them in continuing and advancing the entrepreneurial career. If the entrepreneur chooses to "reinvest" these forms of capital produced by the first firm, one possibility is that the capital is invested in such a way as to maximize the number of high quality business opportunities available to the entrepreneur to pursue at minimal cost to the entrepreneur in terms of time, effort and/or money. This process of reinvesting the fruits of entrepreneurship can be conceptualized as a continuum from the initial startup to repeat entrepreneurship. The entrepreneur may be able to become involved in new firms because the older "new" firm has progressed to a more stable state where he/she does not need to worry about it as much and others, perhaps more experienced managers have taken over the day to day operations. While we portray the progress as a continuum, obviously steps could be skipped, perhaps indicating a more rapid personal development as a successful multiple entrepreneur.
A nascent entrepreneur begins with relatively little human, social, and financial capital and access to many ideas, but probably only a few high quality entrepreneurial opportunities. If the entrepreneur succeeds in the first start-up and decides to start a second firm, the various forms of capital raised through the first startup will presumably tend to make this second effort somewhat easier.
The buildup of human, social and financial capital with the entrepreneur is likely to occur with a substantial lag after the founding of the initial firm. The first firm of a nascent entrepreneur requires an incredible amount of effort, time and energy. As the firm gains its operational experience, the entrepreneur has increasing opportunity to reflect and begins to accumulate skills related to the entrepreneurial process along with important social contacts and, slowly, financial capital as well. As a result of the startup and operation of the first firm, the entrepreneur may see various business opportunities or shadow options (McGrath, 1999) that he or she may not have been able or willing to pursue at the time, but which can now serve as the basis for a subsequent firm. An emerging literature has been developing to apply real options theory to strategy as a way of increasing flexibility (Bowman & Hurry, 1993; McGrath, 1996). As McGrath (1996, p. 103) points out, among several factors that may relate to the likelihood of recognizing viable new opportunities is previous entrepreneurial experience.
While McGrath and MacMillan (2000) suggest that entrepreneurs with previous founding experience have developed a "mindset" or the ability and competence to pursue only the best opportunities, this may not be the entire story. It may be that while novice entrepreneurs only pursue what they see as the very best opportunities, repeat entrepreneurs may take a longer view. Repeat entrepreneurs may pursue a wider range of opportunities in round 1, allowing them to see many shadow options and choose only the best opportunities to invest in as real options for greater performance in round 2.
Having reached the level of repeat entrepreneur, the individual will have built up higher levels of all types of capital and, also through the operation of the previous businesses, customer contacts or social contacts will have perceived a number of other business opportunities. At any point in this progression, as the entrepreneur builds sufficient financial capital, he or she may invest a portion of assets in early-stage ventures. In the investment community jargon, investments made by wealthy individuals have become known as angel investing and such individuals have been coined as angel investors or informal investors to distinguish them from venture capital institutions (Freear, Sohl, & Wetzel, 1994; Wetzel, 1983). These deals may be undertaken serially or in parallel and offer the entrepreneur multiple opportunities for entering into the venture as an active entrepreneur as well. In each stage of the continuum (from the bottom left of Figure 2 to the top right), a greater number of business opportunities will arise (or perhaps be sought out by the entrepreneur) and will be available for pursuit or active involvement as a founder. Further, these opportunities become available to the entrepreneur at smaller and smaller cost in terms of relative time and effort necessary to encounter them and commercialize them. Indeed, other scholars have asserted that prior startup experience reduces the costs of entrepreneurial activity and increases the probability of acting on opportunities (Carroll & Mosakowski, 1987).
Depending on personal preferences and style, an entrepreneur may not choose to reinvest her or his capital in further entrepreneurship. Especially if the first firm is still in operation and he is happy with his role there, the founder may choose to stay with the first firm and not continue down the path of multiple entrepreneurship. Our point is simply that this option becomes open to him or her and is easier to achieve after a first founding. One may also think of the progression described above as shifting into a role of opportunity recognition and generation, of "rainmaker" so to speak in the entrepreneurial process. The entrepreneur may then be in less of a day to day operational role in any one firm, but is engaged more fully in a business idea generation and evaluation role. These rare individuals may be playing a very valuable role in the entrepreneurial processes within one or more industries.
Why Start a Second Firm?
When asking who starts multiple firms and what conditions this choice, we are essentially asking about what motivates or enables an entrepreneur to start a second firm. At the individual level and at the first firm level, a number of factors may lead to the choice to start another firm. If starting a second firm is motivated by expectations of the returns to reinvesting financial, human and social capital back into further entrepreneurial activities, then factors that increase the expected return should result in a higher likelihood for starting a new firm. Similarly, factors which decrease the expected return should decrease the probability the entrepreneur will decide to undertake a second firm. The "expected returns" to investing in entrepreneurial activities may be financial or non-financial. Nonetheless, the first firm experience is likely to condition the level of non-financial rewards anticipated as well as the relative importance of these compared to financial returns. During the first firm experience, the entrepreneur may discover, in fact, whether the non-pecuniary benefits to entrepreneurship make it more attractive than returning to regular employment (Barton 2002). First, simply having the time and energy to start another firm may be an important factor. If the entrepreneur is quite old, then he or she may expect that the fruits of a second firm creation will not accrue with enough lifetime left to enjoy them.
By:
Charles E. Eesley and Edward B. Roberts?
October 25, 2006
Abstract
In this paper we explore the factors that condition the likelihood that an entrepreneur starts a second firm. We use data from survey responses of 1,789 entrepreneurs to examine firm founding behavior. Results indicate that multiple entrepreneurs differ from single-firm entrepreneurs in certain demographic and educational characteristics prior to starting a first firm. The phenomenon of graduates embarking on careers of multiple entrepreneurship appears to be growing over time. The results also show that the first firms of eventual multiple entrepreneurs differ from the first firms of single-firm only entrepreneurs. The paper indicates that those entrepreneurs with the highest probability of starting a second firm have greater time and access to financial resources to undertake a new venture. Starting a first firm sooner after graduation, being divorced, the first firm being acquired, and raising initial capital for the first firm from angel investors all increase the probability that the entrepreneur will start a second firm.
I. Introduction
A growing literature in strategy and economics has noted that an important source of new entrants is incumbent firms in the same industry (Klepper 2001; Gompers, Lerner, and Scharfstein, 2005). However, these studies have developed and emphasized theories regarding employees leaving incumbent firms to start new ventures. Various lenses, such as agency theory, organizational capability theories, employee learning theories, and evolutionary theories have been used to evaluate why employees decide to leave their firms to spin-off new firms. Most of these theories emphasize some sort of conflict between the spin-off and the incumbent's top management. On the other hand, in the finance literature, a growing group of scholars have examined the determinants of CEO turnover. However, these authors typically focus on forced CEO turnover in relation to firm and industry performance. CEOs who voluntarily leave and what they do after leaving are seldom studied (for important exceptions see Wasserman 2003; Bertrand and Schoar 2003). At the intersection is a relatively important gap in our understanding-- the founder or CEO who is pushed out or voluntarily leaves a firm and decides to start a new firm. The existing theories of spin-off activity (with the possible exception of evolutionary-based theories) do not explain or fit this phenomenon well, and the existing work on CEO turnover with an emphasis on corporate governance of large firms does not shed much light on the phenomenon either. As a result, it has proven difficult to determine how prior founding experience should be interpreted (i.e. as a measure of risk aversion, learning, or reduced asymmetric information on quality for investors).
The importance of the entrepreneur who starts multiple firms over the course of a lifetime has been recognized in the academic literature as a potentially widespread aspect of new firm creation for at least 35 years (Cooper, 1970). However, in relation to its likely significance for economic growth and for the field of entrepreneurship the phenomenon has been understudied (see Table 1). With some recent exceptions (Sarasvathy & Monon, 2005), almost no theoretical work has been done (Westhead, 1998). As a result, the few empirical studies use different definitions, populations, and control variables leaving little consensus on foundational questions about how important or how widespread is this phenomenon in the U.S. or internationally. This deficiency is especially true in regard to companies formed to exploit new technology. The purpose of this paper is to advance our understanding of what factors condition the likelihood that a founder will leave a firm and start a new firm. Is it differences in underlying individual demographic characteristics or differences in characteristics of the first firm experience or performance that motivate novice founders to initiate a new firm founding. To answer these questions, we use a founder-firm matched panel data set, where we track over time founders across different firms that they start or choose to remain with. Our cross-industry data also allow us to examine how industry characteristics may affect how likely a founder will be to try founding a second new firm.
II. Background Literature / Theory
Especially compared to the early years when entrepreneurs were seen as a homogeneous group, a number of different groupings of entrepreneurs has emerged in recent years. As Hsu (2006b) notes, an important recent theme in the literature is heterogeneity among entrants prior to the development of the venture, especially in terms of the experience of the founder or founding team. Compared to the literature on differences between entrepreneurs and non-entrepreneurs, scholarly attention to the heterogeneity among entrepreneurs has been very limited until recently.
Prior literature has examined the determinants of self-employment. Carroll and Mosakowski (1987) show that the transition to self-employment depends on factors including family background and prior experiences with self-employment. Our research differs in its focus on high technology entrepreneurs and their firms. As pointed out earlier (Shane & Khurana, 2003), self-employment does not necessarily involve the founding of a new firm, such as when an individual does independent consulting or contract work. Further, firms started to commercialize new technologies tend to be larger and have a strong impact on economic productivity. Therefore repeat entrepreneurs who focus on technology represent a particularly important and relatively unexplored area of study.
Wasserman (2003) examines Founder-CEO succession in 202 venture-backed Internet start-ups. His study does not look explicitly at what Founder-CEOs do once replaced or after leaving the firm. He finds that many Founder-CEOs remain in the firm, even when they are replaced as CEO. Of importance for the current study, he finds that the likelihood of a Founder-CEO being replaced increases with the achievement of critical milestones in building the company.
Unlike the previous studies looking at the effects of prior career experiences or prior firm founding on the likelihood of subsequent firm founding, the present study examines individual and firm-level factors related to the transition from an active founding role in one firm to starting a second firm. In addition, our research takes advantage of data on the timing of the entire founding history and on the entrepreneur's personal success.
III. THEORY AND HYPOTHESES
In this paper we develop and test a theory of entrepreneurial exit and then re-entry into entrepreneurship. Through entrepreneurial experience the founder builds up social and financial capital in addition to personal experience and human capital. As these three forms of capital are raised by the entrepreneur, he or she may choose to invest them in continuing and advancing the entrepreneurial career. If the entrepreneur chooses to "reinvest" these forms of capital produced by the first firm, one possibility is that the capital is invested in such a way as to maximize the number of high quality business opportunities available to the entrepreneur to pursue at minimal cost to the entrepreneur in terms of time, effort and/or money. This process of reinvesting the fruits of entrepreneurship can be conceptualized as a continuum from the initial startup to repeat entrepreneurship. The entrepreneur may be able to become involved in new firms because the older "new" firm has progressed to a more stable state where he/she does not need to worry about it as much and others, perhaps more experienced managers have taken over the day to day operations. While we portray the progress as a continuum, obviously steps could be skipped, perhaps indicating a more rapid personal development as a successful multiple entrepreneur.
A nascent entrepreneur begins with relatively little human, social, and financial capital and access to many ideas, but probably only a few high quality entrepreneurial opportunities. If the entrepreneur succeeds in the first start-up and decides to start a second firm, the various forms of capital raised through the first startup will presumably tend to make this second effort somewhat easier.
The buildup of human, social and financial capital with the entrepreneur is likely to occur with a substantial lag after the founding of the initial firm. The first firm of a nascent entrepreneur requires an incredible amount of effort, time and energy. As the firm gains its operational experience, the entrepreneur has increasing opportunity to reflect and begins to accumulate skills related to the entrepreneurial process along with important social contacts and, slowly, financial capital as well. As a result of the startup and operation of the first firm, the entrepreneur may see various business opportunities or shadow options (McGrath, 1999) that he or she may not have been able or willing to pursue at the time, but which can now serve as the basis for a subsequent firm. An emerging literature has been developing to apply real options theory to strategy as a way of increasing flexibility (Bowman & Hurry, 1993; McGrath, 1996). As McGrath (1996, p. 103) points out, among several factors that may relate to the likelihood of recognizing viable new opportunities is previous entrepreneurial experience.
While McGrath and MacMillan (2000) suggest that entrepreneurs with previous founding experience have developed a "mindset" or the ability and competence to pursue only the best opportunities, this may not be the entire story. It may be that while novice entrepreneurs only pursue what they see as the very best opportunities, repeat entrepreneurs may take a longer view. Repeat entrepreneurs may pursue a wider range of opportunities in round 1, allowing them to see many shadow options and choose only the best opportunities to invest in as real options for greater performance in round 2.
Having reached the level of repeat entrepreneur, the individual will have built up higher levels of all types of capital and, also through the operation of the previous businesses, customer contacts or social contacts will have perceived a number of other business opportunities. At any point in this progression, as the entrepreneur builds sufficient financial capital, he or she may invest a portion of assets in early-stage ventures. In the investment community jargon, investments made by wealthy individuals have become known as angel investing and such individuals have been coined as angel investors or informal investors to distinguish them from venture capital institutions (Freear, Sohl, & Wetzel, 1994; Wetzel, 1983). These deals may be undertaken serially or in parallel and offer the entrepreneur multiple opportunities for entering into the venture as an active entrepreneur as well. In each stage of the continuum (from the bottom left of Figure 2 to the top right), a greater number of business opportunities will arise (or perhaps be sought out by the entrepreneur) and will be available for pursuit or active involvement as a founder. Further, these opportunities become available to the entrepreneur at smaller and smaller cost in terms of relative time and effort necessary to encounter them and commercialize them. Indeed, other scholars have asserted that prior startup experience reduces the costs of entrepreneurial activity and increases the probability of acting on opportunities (Carroll & Mosakowski, 1987).
Depending on personal preferences and style, an entrepreneur may not choose to reinvest her or his capital in further entrepreneurship. Especially if the first firm is still in operation and he is happy with his role there, the founder may choose to stay with the first firm and not continue down the path of multiple entrepreneurship. Our point is simply that this option becomes open to him or her and is easier to achieve after a first founding. One may also think of the progression described above as shifting into a role of opportunity recognition and generation, of "rainmaker" so to speak in the entrepreneurial process. The entrepreneur may then be in less of a day to day operational role in any one firm, but is engaged more fully in a business idea generation and evaluation role. These rare individuals may be playing a very valuable role in the entrepreneurial processes within one or more industries.
Why Start a Second Firm?
When asking who starts multiple firms and what conditions this choice, we are essentially asking about what motivates or enables an entrepreneur to start a second firm. At the individual level and at the first firm level, a number of factors may lead to the choice to start another firm. If starting a second firm is motivated by expectations of the returns to reinvesting financial, human and social capital back into further entrepreneurial activities, then factors that increase the expected return should result in a higher likelihood for starting a new firm. Similarly, factors which decrease the expected return should decrease the probability the entrepreneur will decide to undertake a second firm. The "expected returns" to investing in entrepreneurial activities may be financial or non-financial. Nonetheless, the first firm experience is likely to condition the level of non-financial rewards anticipated as well as the relative importance of these compared to financial returns. During the first firm experience, the entrepreneur may discover, in fact, whether the non-pecuniary benefits to entrepreneurship make it more attractive than returning to regular employment (Barton 2002). First, simply having the time and energy to start another firm may be an important factor. If the entrepreneur is quite old, then he or she may expect that the fruits of a second firm creation will not accrue with enough lifetime left to enjoy them.
