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Rich vs King: The Entrepreneur's DIlemma
Posted in Growth
By Noam Wasserman,
Introduction
Despite the importance of new ventures to economic development, such organizations suffer from a significant liability of newness that results in a high rate of failure (Stinchcombe 1965; Aldrich and Fiol 1994). The factor that underlies this heightened failure rate is a lack of resources (Stinchcombe 1965). Although an entrepreneur might already control some of the resources necessary to pursue an opportunity, critical resources must almost always be acquired from outside resource providers (Stevenson and Jarillo 1990). By acquiring these resources, entrepreneurs can build more valuable companies than if they only used those resources they already control.
The values of an organization’s most powerful actors have a strong impact on the organization’s strategic choices, particularly regarding the attraction and allocation of resources (Tagiuri 1965; Hambrick and Mason 1984:193). Consistent with upper echelons theory (Hambrick and Mason 1984), this study suggests that entrepreneurs’ choices about resource acquisition will have fundamental implications for their organizations and for the financial value they can build. It focuses on the main two motivations, the profit motive and the control motive, that lead entrepreneurs to start new ventures (Sapienza, Korsgaard and Forbes 2003), how those motivations shape early choices about attracting human and financial resources, and how choices that increase the ability to achieve the profit motive should conflict with the ability to achieve the control motive (and vice versa). It uses a unique dataset comprised of data from 457 private technology start-ups, to test hypotheses about tradeoffs between financial gains and control.
Theory and Hypotheses
In new ventures, the entrepreneur is the critical actor shaping the firm (Hannan and Freeman 1989; Eisenhardt and Schoonhoven 1990), and entrepreneurs’ early choices have a powerful “imprinting” effect on the evolution of the organization (Boeker 1989; Bettis and Prahalad 1995). New ventures are thus an excellent arena in which to study the impact of actors’ strategic choices on them and their organizations. Entrepreneurs are attracted to take on the challenge of building new organizations by the profit motive (e.g., Schumpeter 1942; Kirzner 1973) and by the drive to control decision making within the company they started (e.g., Sapienza, Korsgaard et al. 2003). However, “Entrepreneurship is a process by which individuals pursue opportunities without regard to the resources they currently control.” (Stevenson and Jarillo 1990:23) Because they are pursuing new opportunities, entrepreneurs usually lack key resources needed to build their organizations (Starr and MacMillan 1990). Assembling the necessary resources enables entrepreneurs both to increase their organizations’ rates of growth and to reduce its risk of failure, potentially increasing dramatically the value of their companies. For the entrepreneur, this introduces a fundamental tension, because the need to attract outside resources can conflict with the major factors, both tangible and intangible, that motivate people to become entrepreneurs. As detailed below, the entrepreneur will have to choose between attracting the resources that will help build a valuable company, in the process giving up a lot of equity and decision-making control, or else retain equity and control while not being able to build as valuable a company. These tradeoffs should exist both at the entrepreneur level and at the company level. (It is also suggested that one way that entrepreneurs can affect the tradeoff is by accumulating appropriate human capital prior to founding the venture.) For instance, the founder of Steria, an information-technology systems and services company, faced such a tradeoff (Abetti 2005). In the end, the entrepreneur’s desire “to remain independent and master of his own destiny” led him to refuse to accept capital from outside investors (relying instead on founder capital and bank loans), to maintain control of the company’s equity, to not grant stock to Steria’s employees, and to remain chief executive officer.
As a result, the company’s growth was slowed markedly (Abetti 2005). An alternate path for the entrepreneur would have been to take capital from outside investors and to allocate equity to others working for the company, thus potentially building a more valuable company. However, doing so would have conflicted with what motivated him to start Steria.
For the full paper please click through to Noam Wasserman's website