A Model for Predicting the Success of New Ventures

One question that intrigues all of us is, what qualities in an entrepreneur will guarantee that his venture is successful? It’s an important question that entrepreneurs try to determine for themselves, while investors and stakeholders also try to answer in hopes that they can pick the surefire winners out of hundreds of startups.

Some academic work has focused on the character of entrepreneur alone, trying to measure the correlation of certain personal traits with success, using large sample sizes. Some of this work has focused on specific traits like age, education, and number of years of experience, yet later research has refuted the idea that these three elements significantly predict to the success. For example,

  • While education was proven to be important in high technology ventures (Roberts 1968; Cooper 1971), this relationship has not proven to be true for other settings (Hoad and Rosko 1964; Douglass 1976).
  • Managerial experience has been found also to be of little value unless directly related to the sector of the new venture (Hoad and Rosko 1964).
  • When it comes to age, publications show mixed results; it’s difficult to conclude that age is a strong predictor of a venture’s success.

Venture capitalists (VCs) have since made advances in their analysis by adopting more complex models of new venture success, such as the model that Sandberg and Hofer set forth, stating that new venture peformance is a factor of the founding entrepreneur, in addition to strategy and industry structure (Sandberg and Hofer 1987). In other words, no amount of education and experience that entreprenuer has can eliminate the weight of these last two factors.

To take a closer look, the elements that venture capital investors now look at can be divided to three categories: the industry the new venture is entering, the specific strategy the entrepreneur will follow, and some psychological and behavioral traits of the entrepreneur. Here I'll sketch these in detail:

Industry:

  • The size, structure, average returns, and growth of the industry and market to be entered (the general market attractiveness)
  • The prospects and potential of the specific market segments of interest to the new venture (more specific market analysis)
  • The entry barriers that the new entrepreneur will face, number and size of competitors (the competitive landscape)

Strategy:

  • The unique product features of the new venture compared to existing competition (product or service differentiation)
  • The specific entry plan the entrepreneur wants to follow (venture start-up plan)
  • The required investment and the portion the entrepreneur is willing to commit personally, also known as “pain equity.” Regardless of the amount of investment an entrepreneur is asking for, VCs care much about the entrepreneur taking a considerable financial risk along-side them, following the saying “put your money where your mouth is.” (financial commitment)
  • Project returns with some kind of sensitivity analysis showing the potential gains and losses under different optimistic and pessimistic scenarios (potential returns)
  • The new venture management structure and controls for governance (managerial capabilities)

Entrepreneur:

  • The entrepreneur’s need for achievement, and risk preferences are considered important factors that could affect the success of new ventures (psychological characteristics).
  • VCs may also use their own human judgment to assess the track record and prior life of the entrepreneur, looking at qualities like iron will, determination, enthusiasm, willingness to face facts, sense of urgency and resourcefulness (Dominguez 1974) (behavioral traits).
  • In general, several tests, both empirical and intuitive, are generally used by VCs to assess both the psychological characteristics as well as behavioral traits of new entrepreneurs.

I would say that generally, when it comes to assessing an entrepreneur’s role in the success of a potential venture, investors would do well to focus less on aspects like age and education, and more on a founder’s deeper psychological and behavioral traits that will shape a new venture. And most importantly when assessing an entrepreneur, we need to look at the value that the new venture adds to the general industry, as well as the market attractiveness of the opportunity that the entrepreneur spotted (this could be termed the “what”), and the strategy the entrepreneur plans to follow to add his/her own independent value to the market (the “how”).

In other words, anyone looking to assess what an entrepreneur brings to the table should not point to a superficial set of characteristics or limit themselves to investing in entrepreneurs of a given background; rather, they should combine the who, the what, and the how to form a holistic prediction of success.

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