For Startups,
Ideas Matter
Bottom
Line: Predicting
a startup’s success before the venture is even launched may seem impossible.
But entrepreneurs and investors should never overlook the value of assessing
the basic concept behind the business.
You
only have to watch an episode of Shark Tank to realize that
turning the glimmer of an idea into a viable business entity is no easy feat.
Many researchers attribute a startup’s fortunes to its founder’s
ability to attract funding, lure essential employees, and deploy initially
limited resources to pursue a strong but sustainable rate of growth. Venture
capitalists essentially use the same metrics when they peer through the fog of
uncertainty and weigh whether a fledgling project deserves their investment —
and if so, for how long.
But
perhaps, the authors of a new paper suggest, the success or collapse of a new venture
can be predicted by evaluating the fundamental idea behind the business,
long before an entrepreneur secures first-round financing or
signs the lease on that first office space. Maybe the commercial viability of a
new business hinges less on the founder’s personality, experience, and
relationships with angel investors, the authors posit, and more on the simpler
metric of whether the idea is good.
Few empirical studies have been done on
whether the commercial feasibility of an idea is linked to a startup’s early-stage
results or the long-range funding it may receive. It’s difficult to obtain
projections from a firm’s embryonic phase that aren’t tainted by hindsight or
tied to the amount of investment and resources plowed into the concept around
the time of its inception. After all, when an early-phase investor does like an
idea, he or she tends to put money into it, meaning evaluations usually can’t
be untangled from the financing and resources a young company receives.
Entrepreneurs may also be more or less likely to further fund or expand their
ventures on the basis of investor feedback, effectively turning their initial
interactions with financial backers into self-fulfilling prophecies.
To get around this problem and focus on the
importance of the basic business idea, the authors exploited a unique database:
the Massachusetts Institute of Technology’s Venture Mentoring Service (VMS),
which seeks to help entrepreneurs develop their early-stage business concepts.
The authors gathered data on the characteristics, evaluations, and eventual
outcomes of 652 ventures that made use of the VMS between 2005 and 2012. Most
of the projects — which ultimately raked in more than US$700 million in venture
financing — targeted competitive sectors typified by high levels of entrepreneurship,
such as manufacturing, software, and medical devices.
When an entrepreneur joins the VMS, a select
group of more than 100 analysts, executives, and investors with extensive
experience in consulting early-stage businesses receive a summary, prepared by
VMS staff, that outlines the proposed venture. The summary lays out the
projected business model, technology requirements, key customer base, and
obstacles to implementation. However, the startups’ summaries, which are
uniform in tone and form, provide minimal information about the founding team
and its credentials
Armed only with this summary, and without
meeting the entrepreneurs, VMS advisors have to decide whether to work with a
venture — the vast majority of which are unfunded and unincorporated at this
point. It’s hard to get an advisor’s approval: On average, mentors express
interest in fewer than 5 percent of the proposals they review. If a high number
of mentors want to advise a given project, therefore, it provides a strong
signal of the perceived quality of the business idea during its earliest
incarnation.
The VMS concentrates on serious endeavors,
not pie-in-the-sky fantasies. In the sample taken by the authors for their
study, 46.5 percent of ventures got off the ground. Of those, 18.6 percent
received backing from professional investors, and 22.4 percent eventually
reached the dreamed-of commercialization phase, generating revenue from the
ongoing sale of their products or services.
Concepts that generated a higher level of
mentor enthusiasm were far more likely to get to that phase. Even a small
uptick in the proportion of mentors attracted to a venture resulted in an
average 17 percent hike in the likelihood that the startup would ultimately be
commercialized, the authors calculated.
But the effect fluctuated greatly across
industries. Mentor interest was much more strongly linked to eventual
commercialization in sectors heavily dependent on R&D efforts — such as the
energy, hardware, and science industries — and to startups whose business ideas
were based on documented academic research or the possession of intellectual
property. Ventures in R&D-intensive industries that received higher levels
of initial advisor backing also raised significantly more funding.
Researchers have noted that business concepts can morph in
dramatic ways during a startup’s initial phase. As a result, many investors
hesitate to judge a proposal too early, and prefer to have some tangible
evidence in hand before opening their checkbook. Indeed, the mentors in the
study conducted their evaluations far earlier and with much less data than the
typical professional investor, who seeks to generate as much information as
possible before pledging support. And yet, based solely on a business
proposition, these experts were far more likely to attach themselves to
projects that eventually came to market than to those that ran aground.
These
findings are especially relevant in a time when young companies increasingly turn to seed funds, accelerators, and even online
fundraising platforms to get their start. These financial intermediaries
operate below the level of venture capitalists and allow entrepreneurs to
modify their ideas at an earlier stage, albeit with less financing. Tapping
into expert advice from diverse sources at the earliest opportunity could be
the best way for entrepreneurs to solidify their business plan — and to
encourage investors to place their bets.
Source: “Are ‘Better’
Ideas More Likely to Succeed? An Empirical Analysis of Startup Evaluation,” by Erin L. Scott (National University of Singapore),
Pian Shu (Harvard University), and Roman M. Lubynsky (Massachusetts Institute
of Technology), Oct. 2015, Harvard Business School Technology &
Operations Management Unit Working Paper No. 16-013
http://www.strategy-business.com/blog/For-Startups-Ideas-Matter?gko=ad7ef
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