Chapter 5
Growing the Enterprise
Estimates vary, but most studies confirm that around half of start-ups survive no more than
four years, and less than 4% of the remaining new ventures grow. In this chapter we
identify the factors which contribute to the success and growth of new ventures, and we try
to differentiate the factors which entrepreneurs can influence from those which are more
contextual.
Factors Influencing Success
A study of 11259 new technology ventures in the USA over a period of five years found that
36% survived after four years and 22% after five years. To try to explain the success and
failure of these ventures, the researchers reviewed 31 other key studies of technology
ventures, and found only eight factors that were consistently found to influence success:
Value chain management: Cooperation with suppliers, distribution, agents and
customers.
Market scope: Variety of customers and market segments, and geographic reach.
Firm age: Number of years in existence.
Size of founding team: Likely to bring additional and more diverse expertise to
the ventures and better decision making.
Financial resources: Venture assets and access to funding.
Founders’ marketing experience: But not technical experience, or prior
experience of start-ups.
Founders’ industry experience: In related markets or sectors.
Existence of patent rights: In product or process technology, but R&D investment
was not found to be significant.
The first three factors were by far the most significant predictors of success. However,
clearly there is also some interaction between these effects, for example the founders’
marketing and industry experience is likely to influence the attention to market scope and
the value chain, and patent rights make raising finance easier, and vice versa. In addition,
they found that some commonly cited factors had no effect, including founders’ experience of
R&D or prior start-ups. The importance of other factors depended on the precise context of
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the venture, for example for independent start-ups R&D alliances and product
innovation both had a negative effect on performance, but for ventures of mixed origins R&D
alliances and product innovation both had a positive effect on performance.
The effects of age on the success and growth of a new venture are probably the best
understood, and shown to be significant in almost every research study. The consensus
is that the most common age of successful founders is between 35 and 50 years old, the
median age being 39.6. The explanation for this clustering is that younger founders tend to
lack the experience, resources and credibility, whereas older founders may lack the drive
and have too much to lose. Of course there are many examples of successful
entrepreneurs outside of this age range, but the association between age of founders and
success is very significant.
To understand the influence of education, one study tracked 118,070 new start-up firms over
ten years and found that human capital at foundation, measured by university degree, had a
strong and persistent positive effect on subsequent success. In addition, four structural
factors at the time of foundation were predictors of success: firm size at foundation
(positive), rate of firm entry into the same sector, concentration of the sector, and GDP
growth.
Other research examined 622 young or new small firms over five years, and found human
and financial capital available at start-up was a strong predictor of survival and growth,
specifically the founder’s education (degree or above) and access to bank finance. As with
age, there are many examples of successful entrepreneurs who chose not to go to college or
dropped out early, but the research does consistently demonstrate a strong association
between level of education and venture success and growth, especially in more
knowledge- or technology-intensive businesses.
Access to sufficient capital is another widely cited founding condition for success and
growth. However, the evidence is more mixed than for the effects of age and education. Some
studies suggest that access to external capital is associated with higher growth, especially in
the case of more high-technology ventures, but others find no such effect or even the
exact opposite relationship: that higher growth is associated with maintaining internal
funding and ownership. The conflicting evidence and advice may be due to
methodological differences, such as definition of high growth, time period studied and so
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on, but may also reflect the influence of more fundamental moderating factors, for example
the type of venture and market or the roles and control needs of founders.
Finally, companies competing on price, rather than by differentiation, are much less
likely to survive. Contrary to the popular folklore of the poorly educated, disadvantaged
entrepreneur, this study confirms that the more typical profile of a successful new venture is a
rare combination of human capital in the form of the university education of founders,
availability of sufficient finance and a strategy of growth by product or service
differentiation.
The growth of a new venture in terms of sales and employment depends upon planning
skills and experience, and profitability flows from developing and exploiting networks.
Innovative firms are more likely to grow, in terms of sales and employment, but are
not necessarily more profitable than non-innovators. Funding by venture capital has no
effect on the innovativeness of a start-up, but does have a positive influence on
profitability, perhaps reflecting the priorities of such investors.
Financial constraints only have an effect on the likelihood of survival of a new
venture in the first few years, but continue to constrain profitability and growth for a
decade after foundation. One of the challenges of developing a new venture is
developing or gaining access to complementary capabilities, assets and resources. For
example, a start-up may have the technical know-how or intellectual property but not
be able to reach or support potential customers, or conversely an entrepreneur may
identify a market opportunity but not be able to provide the product or service to satisfy this.
This is one reason why firms created by pairs or small groups of founders are
significantly more likely to be successful than those formed by individual
[Link] contrasting capabilities and perspectives of multiple founders provide a
stronger basis to identify, develop and deliver innovative offerings.
Funding
The initial funding to establish a new venture is rarely a major problem, as most are self-
funded. However, Peter Drucker suggests a new venture requires financial restructuring every
three years. Different stages of development each have different financial requirements:
Initial financing for launch.
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Second-round financing for initial development and growth.
Third-round financing for consolidation and growth.
Maturity or exit.
Growth and Performance of New Ventures
There has been a great deal of economic and management research on small firms, but much
of this has been concerned with the contribution all types of small firms make to
economic, employment or regional development. Relatively little is known about innovative
new ventures.
In most developed economies, around 10% of the economically active population engage in
new venture creation each year, a slightly higher proportion (15% or so) in the USA and Asia
and a little lower in Europe (excluding the UK) – 6%. However, the rate of churn (i.e. new
ventures closed less those created) is high. Closure does not necessarily indicate failure, as a
founder may choose to change business or seek alternative employment. Survival rates are
quite high, in the UK after two years 80% survive, and 54% after four years (Barclays
Capital, 2008). In the USA there are more short-term failures, probably owing to the ease
of establishing a business there, but similar rates of longer-term survival: 66% survive two
years, 50% four years and 40% more than six years.
A study of 409 SMEs examined the differences between the highest-growing, the gazelles,
and the lowest-growing companies over a four-year period, to identify how innovation
contributed to the growth. It found that, in addition to high growth, the highest-growing
companies also showed higher profitability, increased number of employees and
significantly higher market shares locally, nationally and internationally than the
lowest-growing companies.
Research over the past decade or so suggests that the innovative activities of SMEs
exhibit broadly similar characteristics across sectors. They:
are more likely to involve product innovation than process innovation
are focused on products for niche markets, rather than mass markets
will be more common amongst producers of final products, rather than
producers of components
will frequently involve some form of external linkage
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tend to be associated with growth in output and employment, but not necessarily
profit
Where an SME has a close relationship with a small number of customers, it may have little
incentive or scope for further innovation, and therefore will pay relatively little attention to
formal product development or marketing. Therefore, SMEs in such dependent relationships
are likely to have limited potential for future growth and may remain permanent infants
or subsequently be acquired by competitors or customers. Innovative SMEs are likely to
have diverse and extensive linkages with a variety of external sources of innovation,
and in general there is a positive association between the level of external scientific, technical
and professional inputs and the performance of an SME.
The sources of innovation and precise types of relationship vary by sector, but links
with contract research organizations, suppliers, customers and universities are
consistently rated as being highly significant, and constitute the ‘social capital’ of the fi
rm. However, such relationships are not without cost, and the management and exploitation
of these linkages can be difficult for SMEs and overwhelm their limited technical and
managerial resources. As a result, in some cases the cost of collaboration may outweigh
the benefits, and in the specific case of collaboration between SMEs and universities
there is an inherent mismatch between the short-term, near-market focus of most SMEs
and the long-term, basic research interests of universities.
In terms of innovation, the performance of SMEs is easily exaggerated. Early studies based
on innovation counts consistently indicated that when adjusted for size smaller firms created
more new products than their larger counterparts did. However, methodological shortcomings
appear to undermine this clear message. When the divisions and subsidiaries of larger
organizations are removed from such samples and the innovations weighted according
to their technological merit and commercial value, the relationship between firm size and
innovation is reversed: larger firms create proportionally more significant innovations
than SMEs do.
The amount of expenditure by SMEs on design and engineering has a positive effect on the
share of exports in sales, but formal R&D by SMEs appears to be only weakly
associated with profitability, and is not correlated with growth.
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A large study of start-ups in Germany found that the founder’s level of management
experience was a significant predictor of the growth of a venture. However, innovation,
broadly defined, was found to be statistically three times more important to growth than
founder attributes or any other of the factors measured. Another study, of Korean technology
start-ups, also found that innovativeness, defined as a propensity to engage in new idea
generation, experimentation and R&D, was associated with performance. So was pro-
activeness, defined as the firm’s approach to market opportunities through active market
research and the introduction of new products and services.
The same study also found that what it referred to as ‘sponsorship-based linkages’ had a
positive effect on performance. This included links with venture capital firms, which
reinforces the developmental role these can play.
The size and location of a venture also has an effect on performance. Geographic
closeness increases the likelihood of informal linkages and encourages the mobility of skilled
labour across firms. However, the probability of a start-up benefiting from such local
knowledge exchanges appears to decrease as the venture grows. This growing inability to
exploit informal linkages is a function of organizational size, not the age of the venture, and
suggests that as ventures grow and become more complex they begin to suffer from
many of the barriers to innovation, and therefore the explicit processes and tools to help
overcome these become more relevant.
Common reasons for failure include:
poor financial control
lack of managerial ability or experience
no strategy for transition, growth or exit
There are many ways a new venture can grow and create additional value:
organic growth through additional sales and diversification
acquisition of or merger with another company
sale of the business to another company, or private equity firm
an initial public offering (IPO) on a stock market
In the early stage, developing relationships with potential customers and suppliers is the most
critical, but as the venture grows the relationship and role of partners in the network of a new
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venture will change. Later, external sources of funding need to be cultivated, which can result
in changes of ownership and the dissolution of some of the initial relationships, and
substitution for more mature partners in more stable networks. Over time, the roles of
different actors in the venture network become more specialized and professional.
Individual skills are essential in building and developing such relationships and networks.
These skills include:
Social and interpersonal communication: to build credibility and promote knowledge
sharing
Negotiating and balancing skills: to balance cooperation and competition, and to
develop awareness, trust and commitment
Influencing and visioning skills: to establish roles, and shares of responsibilities
and rewards.
Therefore, the challenge is not only to simultaneously manage the more mature
firm and its relations but also to maintain the early focus on innovation. To conclude,
new venture growth is a consequence of the interaction of internal factors, such as the
entrepreneurs’ personalities and capabilities, and external factors such as social and
physical network connections. However, an entrepreneurial disposition is necessary
but is not by any means a sufficient condition for innovation or success.
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