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«Carlos H. CHIU Chief Economist Carlos-Marc Empire Capital Group, Hong Kong e-mail: carlosmarc168 August 2015 An earlier draft of this ...»

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Diffusion and Duration of Entrepreneurial Finance for Serial Venturing: Behavioral

Dynamics and Bayesian Estimation

Carlos H. CHIU

Chief Economist

Carlos-Marc Empire Capital Group, Hong Kong

e-mail: carlosmarc168@gmail.com

August 2015


An earlier draft of this paper was entitled “Entrepreneur Dynamics and Venture Longevity:

Opportunity Discovery in Social and Technological Domains”, CECG ERC Working Paper No.

2014E807 (revised in January 2015). This research was supported financially by a research grant of CECG Economic Research Center (CECG Grant # ERC14-2081). Its early versions have been presented in CECG Economic Workshop (Autumn) 2014, Hong Kong; Seminar in Entrepreneurial Finance, Beijing Private Equity Association, China, January 2015; European Academy of Management, Warsaw, Poland, June, 2015. Thank constructive suggestions from all participants. All errors remain our responsibility.

1  Abstract Without typical financing sources from venture capitalists and banks, entrepreneurs could be short of capital needed. When barriers for entry and exit are low, venturing activities become intensified and fund-raising efforts become difficult.

This paper intends to clarify entrepreneurial finance alternatives based on social ties or community attention without collaterals, such as the agent fund, micro-finance and crowd-funding. If succeeding in the first venture, then the entrepreneur’s follow-on ventures may signal reputation effect to capital providers. We attempt to examine the diffusion of the social tie-based financing vehicles for startups on the one hand, and the duration of serial venturing conditioned on the reputation effect of entrepreneurship, on the other.

Our Bayesian bootstrap estimation shows the relative roles of basic information transmission versus other forms of peer influence, and distinguishes financing information passing by serial entrepreneurs and first-time startup founders. In addition, serial ventures by small retail proprietors outperform large retail-chain owners if the former only controls the ownership of each venture sequentially. The probability of exiting from business falls with past experience at starting new ventures, which supports the reputation effect of serial venturing.

Key Words: Entrepreneurial Finance, Serial Venturing, Bayesian Estimation 2  Introduction Raising capital for capturing business opportunities and then supporting new venture developments are central to entrepreneurial finance. Unlike startups in R&Dintensive industries, venturing activities in retailing and other “brick and mortar” industries frequently encounter barriers of raising either equity capital from venture capitalists or debt capital from banks. What is worse, typical retail entrepreneurs do not have valuable assets as collaterals offered to the capital providers. What startup founders in retailing could count on for capital raising is constrained by their social ties or community attention.

To survive the “death-valley” stage of venturing activities (Cumming & Johan, 2014), startup founders need to leverage their social ties and to draw on community attention. First, founders could benefit from such financing alternatives based on social ties -- i.e., micro-finance, angel funds. Extant literature has examined spillover effects of such social tie-based financing vehicles. Second, as a more recent development for entrepreneurial finance, crowd-funding has gain instant popularity in entrepreneur community. Wide spread of such peer-to-peer fund-raising practices has witnessed the economics of community attention, and has become a vital option for founders running retail stores around the corners. Nevertheless, the processes and patterns of diffusion of such financial innovation for “brick and mortar” entrepreneurs are still under-researched.

Moreover, due to insufficient funding vehicles available for new ventures in such “brick and mortar” industries, survival rates for retail startups are arguably low. Thus, an acceptable yardstick for measuring venturing success is the duration of ownership controlled by the founder. Lacking of professional reputation could disable entrepreneurs to secure favorable terms in fund-raising. That is, high costs of equity capital confer venturing disadvantage for retail entrepreneurs. However, if the entrepreneur succeeded in the first venture, then follow-on ventures taken up by the same person – i.e., serial ventures – could signal his professional quality to the providers of entrepreneurial finance. Thus, it is worthwhile investigating the duration of serial venturing conditioned on the reputation effect of entrepreneurship.

Two research questions emerge from the above social innovation of entrepreneurial finance. First, to what extent, social tie-based financing alternatives spill over among the entrepreneur community in retail? Second, what is the duration of serial ventures conditioned on the reputation effect of entrepreneurship? To address these two questions, this study proposes a Bayesian model that draws on a bootstrap algorithm. We attempt to find out the diffusion patterns of social tie-based entrepreneurial finance alternatives. In addition, we intend to clarify the routes followed by entrepreneurs to achieve the success of serial venturing.

An entrepreneur of serial ventures (i.e., serial entrepreneur, in short) starts more than one venture due partly to inherent superior opportunity discovery capability (Amaral, Baptista, & Lima, 2011). Serial entrepreneurs could proactively pursue new skill combinations that disrupt the existing economic equilibrium and capture business opportunities (Keyhani, Levesque & Madhok, 2015).

3  The business success of entrepreneurship has been measured by the duration of new ventures (Gompers, et al., 2010), wealth creation and managerial control (Wasserman, 2012), and entrepreneurial rents in general (Keyhani et al., 2015). Once an entrepreneur has a second startup in such low entry-barrier industries as retail, the probability of starting a follow-on venture tends to increase. This may be due to the (over)confidence of founders in their own skills relative to others’ (Cain, Moore, & Haran, 2015), which has two-side effect on venturing success.

The likelihood of serial entrepreneurship also depends on the founder’s capacity of cognitive learning — i.e., being more likely to adapt self-behavior after success than after failure. Drawing on literature on the role of values in judgment and decision-making, Matusik et al. (2008) found that the founder’s process value (i.e., values governing the types of means to an end that an individual values) influenced the perceived worth of the founder’s human capital. Such “value homophily” arising from venturing activities could affect how evaluators view objective criteria for venture performance and fund-raising (Chandler, 1996; Hsu, 2007). Startup experiences based on cognitive learning in specific, on learning-by-doing in general, are central to the venturing activities in the “brick-and-mortar” industry contexts such as retailing.

Entrepreneurs with a track record of success were more likely to succeed in follow-on ventures than first-time entrepreneurs (Gompers, et al., 2010). An inquiry into the duration of serial venturing in retail is appealing. The retail and small-scale services businesses have high churning rates, i.e., a proxy for serial venturing activities pursued by entrepreneurs. Once one becomes an entrepreneur for a second time, the probability of starting a follow-on venture keeps rising, which could be driven further by the cognitive learning-based reputation effect.

The structure of this paper is organized as follows. Our research context of US retailing is discussed in Section Two. From the big data of venturing activities in retailing, this paper attempts to address the duration of serial venturing. In next two sections, we present a model for diffusion of entrepreneurial finance and our research method, respectively. Section Five demonstrates our findings from econometric analysis on the big data of US retail startups. We conclude this paper in Section Six.

The Big Data Context of Retail Ventures Cognitive learning is important for the success of an entrepreneur’s serial ventures (Lazear, 2005). Conditioned on the capacity of cognitive learning, serial venturing actions involved varied degrees of social interactions with multiple stakeholders. For entrepreneurs in “brick and mortar” industries, mainstream financing sources are hard to come by. Instead, financing alternatives based on social ties and community attention are more viable options for startup founders in such an industries. Thus, entrepreneur communities and founder’s social contacts emerge as crucial stakeholders for the success of serial entrepreneurship.

4  Due to cognitive biases, the entrepreneur's interests may misalign with stakeholders’ (Wassermanm, 2012). For instance, lacking of cognitive awareness to new service know-how, a startup founder might fail to build customer bases efficiently. Without reaching a critical mass of service operations timely, capital providers are likely to withdraw from a startup’s next-round fund raising. This is a typical “death valley” phenomenon in the entrepreneurial finance literature (Cumming & Johan, 2014).

An entrepreneur is a generalist who need not possess just one skill, but could be competent in many domains (Lazear, 2005). In the venturing process, an entrepreneur strives to leverage and deploy fungible resources, in order to get the value that corresponds to the minimum of return on assets underlying the generalist’s skills.

Generalists could be simply endowed with the multi-functional skill set that makes them better entrepreneurs. Prior experiences acquired from a generalist’s role results in the skills that make an entrepreneur perform better.

On the other hand, an entrepreneur' prior startup success could lead to overconfidence in follow-on ventures. Overconfidence may further misguide overly risky product innovation (Simon & Houghton, 2003), ill-fated market entries (Koellinger, Minniti & Schade, 2007), competitive blind spots (Ng, Westgren, & Sonka, 2009), and overvaluation of businesses (Hayward & Hambrick, 1997). Thus, hubris may complicate the assessment of an entrepreneur’s professional quality.

From the standpoint of capital providers, how do they perceive and evaluate the value of a founder’s entrepreneurship? Drawing on literature on the role of values in judgment and decision-making, Matusik et al. (2008) found that the founder’s process value influenced the perceived worth of the founder’s human capital. Such “value homophily” – i.e., the similarity-attraction effect in judgment and decision-making contexts -- may affect how evaluators view objective criteria for venture performance and fund raising (Chandler, 1996; Hsu, 2007). Specifically, Startup experience based on cognitive learning in specific, on learning by doing in general, positively affects capital providers’ evaluations of a founder’s venturing quality; on the other hand, value homophily positively moderates the relationship between the founder’s startup experience and evaluation of his/her self-direction value (Matusik et al., 2008).

Let’s turn to the dataset of US retailing. Table one shows that the number of incumbent retail businesses (or establishments, in general) between 1900 and 2011 in the State of New York in USA. The population of retail ventures grew by more than 50% over the time period of sampling. In terms of the level of entry and exit each year, 2,452,311 businesses were opened, while 2,214,460 of them were closed.

Relatively monotonic growth in the total number of retail businesses in Column 1 shows a high churning rate: About 20% of retail businesses exiting each year indicate relatively short life of survival; 95% of retail ventures have fewer than 20 stores opened.

------------------------------Insert Table 1 about here 5 

------------------------------Due to data limitation, we are not able to analyze the differences between each financing alternatives for entrepreneurs. Instead, we attempt to find out the factors that affect the duration of serial ventures, whose reputation effect could signal to capital providers. In turn, the more reputable founders are, the more likely they could access social tie- and community attention-based financing alternatives, such as angel funds, micro-finance, and crowd-funding. Huang et al.(2015) employed kickstart.com’s archival data to study the reputation effect of entrepreneurs on fundraising. They found that the cognitive learning-based reputation effect played an important role in attracting the supporters of crowd-funding in successive rounds at early stages of venturing activities.

Entrepreneurship reflects an individual’s conjecture that a first-person opportunity exists and is attractive. If realized, such an opportunity promises a favorable net profit margin (Eckhardt & Ciuchta, 2008). Thus, it is important to consider how potential entrepreneurs evaluate third-person opportunities and overcome uncertainty. McMullen and Shepherd (2006) posited that the opportunity recognition process consists of “attention” and “evaluation” stages. In the attention stage, individuals observe third-person opportunities by virtue of having been sensitized to a given set of problems and exposed to information describing potential solutions. Once an individual recognizes a third-person opportunity, a first-person evaluation ensues, during which the individual identifies a defined course of action and determines whether the identified course of action is feasible and desirable.

Within the context of small business owners with no more than 20 ventures, only 25.6% of those owners who had opened another venture since 1990. Moreover, only 9% of such entrepreneurs had opened two or more businesses by the time they opened new ones. Our sample of retail ventures covers the majority of small business owners' serial venturing activities. In fact, most of these entrepreneurs operate their ventures sequentially.

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