Founder satisfaction levels with external partners in new ventures : top management, strategic decision making and innovation in service contexts

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Founder satisfaction levels with external partners in new ventures

Top Management, Strategic Decision Making and Innovation in Service Contexts

Name: Stan Joris Landman

Student number: 11152982

Study: Business Administration

Track: Strategy

Level: Master

Institution: University of Amsterdam Thesis supervisor: Alex Alexiev

Date: 26-01-2017

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Preface

Before you lies the thesis: “Founder satisfaction levels with external partners in new ventures”. This thesis was written by a Master student of The University of Amsterdam. The main motivation for the author to write this thesis was to graduate for the Master study Business Administration, with the specialization Strategy. Writing this thesis was a very informative and interesting journey, in which I was able to gain more knowledge about European start-ups, venture founders and external partners. I started with this research in January 2016 and this thesis was completed in January 2017.

This research was completed for the University of Amsterdam and was focused on gaining knowledge in the field of entrepreneurship and founder-external partner relationships. My thesis can be accessed through the database of the University of Amsterdam.

I would like to thank my thesis supervisor Alex Alexiev, which is an Assistant Professor in Strategic Management and Innovation, for his contributions and support to complete my thesis. I would also like to thank Eloise Fredirici, for the thesis workshops Survey Design & Quantitative Data Analysis, and Bernardo Correia Lima for his help through the course Thesis Proposal. Finally, I would also like to thank all respondents participating in the survey, without their cooperation I would not have been able to complete this research.

I hope you enjoy reading this thesis. Stan Landman

Amsterdam, January 26, 2017.

This document is written by Student Stan Landman who declares to take full responsibility for

the contents of this document. I declare that the text and the work presented in this document is original and that no sources other than those mentioned in the text and its references have been used in creating it. The Faculty of Economics and Business is responsible solely for the supervision of completion of the work, not for the contents.

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Abstract

Objective: This research is focused on the satisfaction levels of entrepreneurs with regard to the collaboration with the main/lead external partners of the venture. This research is focused on both the pre investment and post investment phase between venture founders and external partners. The first hypothesis are related with the gender and risk attitude of the venture founder. The author also researched the relationship between the time available to find and reach a contract with the external partner in the pre-investment phase and the satisfaction level of venture founder(s) in the post-investment phase. In this research the influence of the team composition of the venture during the negotiation phase with the external partner on venture satisfaction was explored as well. Lastly, the author also investigated the effects of external partner syndication on venture founder satisfaction levels.

Method: A survey, conducted in October/November 2016, which consists of a randomly selected group of founding members of European ventures which have attracted external partners during the period 2012-2016.

Conclusions: The results show that a number of hypothesis were confirmed. Founders which didn’t include an anti-dilution clause in their agreement with the external partner are significantly more satisfied than founders who accepted an anti-dilution clause. Also investments which take place through a group of external partners increase founder’s satisfaction levels significantly.

Limitation: The sample (N=45) was limited, therefore future research is necessary. Keywords: Venture Founder(s), External Partners, Satisfaction Level, Search Process, Buy-Back Clause, Anti-Dilution Clause, Gender, Team Composition, Risk Attitude & Alliance Syndication.

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1. Introduction

Relationships between founders and external partners in new venture teams have already attracted interest and research in the past (Barney et al., 1996, Ehrlich et al. 1994, Kozmetsky et al., 1985). New Venture Teams (NVT) comprise of two different subgroups, these subgroups are the founder(s) and external (financing) partner(s) of the venture.

Founders are sources of sustained competitive advantage. Founders are an extremely important determinant for venture survival (Botazzi et al, 2002). Founders are visionary individuals that have a primary role in the venture. They are the foundation of the venture and also have a big impact in creating and sustaining the company culture (Barney, 1986). Guenther found that especially during the early years of the venture exit of entrepreneurs will be critical for the survival of the venture (Guenther et al. 2015). Leaving founders can hurt the venture and its shareholders. Also other parties may contribute to the success of the venture. External partners contribute both financial and non-financial resources to new ventures. External partners can give the founder and the firm access to new markets & industries, improved access to existing markets and industries, supply the venture with financial power/resources, give access to new knowledge/expertise/networks and improve the reputation of the venture (Buckman, 2007, Large & Muegge, 2008). Especially the supply of financial resources is often crucial, since this will enable firms to overcome credit constraints, and be born in the first place (Botazzi et al., 2002). Capital constraints and the role of external equity investors is an important part of the entrepreneurial process (Fried & Hisrich, 1995, Shepart et al., 2000).

This thesis is focused on the satisfaction levels of venture founders and is an extension to the studies of Barney et al. (1996), Besunitz et al. (2004), Carnevale & Lawler (1986), Carree & Verheul (2012), Constantinidis et al. (2006), Dohmen et al. (2012), Peneder (2010), Rothaermel

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6 (2013), Thompson et al (1996) and Zheng (2011). Some of these scholars (i.e. Thompson et al.) conducted research, which targeted different populations (i.e. students). Therefore these studies need to be extended to venture founders to check whether these findings are also true for a population of venture founder(s). Other scholars conducted studies which were especially focused on entrepreneurs, but these studies were exploratory or incomplete. Carree & Verheul for example conducted an interesting research which targeted the satisfaction levels of venture founders, but the authors totally neglected the relationship between entrepreneurs and external (financing) partners. This while the contributions of external partner(s) are crucial for venture survival (Botazzi et al., 2002). In this section the author will briefly explain what the earlier mentioned scholars have found in the past.

Busenitz conducted in 2004 together with Barney, Fiet & Moesel a study, which focused on new venture teams’ assessment of learning assistance from venture capital firms (2004). These scholars found that there are three different determinants for NVT success (Busenitz et al., 2004). These three processes include relationship conflict, task conflict and information exchange (Boone & Hendirks, 2009, De Dreu & Weingart, 2003, Jehn, 1995). The relationship between these two groups, founders and external partners, can have positive or detrimental effects on the venture. Carree & Verheul did a research on the determinants of satisfaction among entrepreneurs (2012). Carree & Verheul measured the income satisfaction level, level of psychological well-being and leisure time of 1107 venture founders of Dutch firms, which are less than a year old. They complement this with other factors influencing satisfaction levels such as the distinction between general and specific human capital, venture specific controls and start-up motivation to found the venture (Carree & Verheul, 2012). One of the shortcomings of their study is that Carree & Verheul did not look at the relationship between venture founder and external partners. External partners play a vital role in the growth lifecycle processes of firms. Dyer, Kale & Singh (2001)

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7 acknowledged that founders can generate competitive advantage through alliances. This alliance can be with other firms through interfirm alliances, but also with external parties (for example: a VC firm) joining the firm through alliances inside the firm. This is also found in the research of Peneder. Peneder found that capital backed Austrian firms grew significantly faster than other Austrian firms which were not backed financially (Peneder, 2010). On the contrary, if the relationship between the founders and external partners reaches suboptimal levels, this can result in competitive disadvantage and hurt the relationship between the firm/founder and external partner (Rothaermel, 2013).

Also before reaching an agreement between founder and external partners there is an important period, known as the pre-investment phase, which may influence founder satisfaction levels in the post-investment phase. Thompson, Peterson and Brodt did a research on the effectiveness of solo and team negotiators in negotiations. Negotiations are a mixed motive task, because people’s interests can be compatible and competitive (Bazerman et al., 1985). Negotiations consist of two parts, the first part focuses on the integrative part. The integrative part of the negotiations focuses on creating value. The second part of negotiations is the distributive component, where the parties divide the scarce resources (such as land, money, knowledge and labor). Negotiations are one of the most important tasks of both venture founder(s) and external partners. Thompson found that: “teams, more than solos, developed mutually beneficial trade-offs among issues and discovered compatible interests” (Thompson et al., 1996). Teams are better in discovering compatible interests, because teams lead to increased information exchange between parties and this in turn leads to a higher accuracy in judgements of the other party’s interests compared to solo negotiators (Thompson, et al., 1996). This resulted in higher joint and individual payoffs for teams compared to individuals. This finding can also be relevant for founder(s), who have to negotiate with external partners to acquire financial and non-financial resources against

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8 favourable deal terms. Thompson, Peterson and Brodt however did not focus their research on relationships between entrepreneur and external financing partners specifically, since their study focussed on undergraduate students, who participated in a psychology course. Therefore it cannot be assume that these findings also apply for venture founders.

Venture founders also have the choice whether to collaborate with an single external partner or with an alliance of external partners. Joining forces with an alliance of external partners has benefits and disadvantages. Various scholars, such as Dyer et al., Brander et al. and Grant & Baden Fuller, found various benefits for venture founders when ventures work with alliances of external partners. Other scholars, such as Hughes & Weiss, Ueda, Turcan, De Clercq & Dimov, showed that alliances may also result in disadvantages for the venture. Hughes and Weiss pointed out that venture founders have to spend lots of time and financial resources to manage the relationship with external partners (2007). An unanswered question is whether venture founders are more satisfied when they work with an alliance of external partners or when they only work together with a single external partner. Previous research did not focus on

answering this question.

Constantinidis, Cornet and Asandei (2006) found that there are still gender effects for venture financing. Male-owned ventures are more successful in attracting financing than woman-owned ventures. How does these gender affects influence founder satisfaction levels with their external partners has also not been researched before.

Another aspect which is very important and may have a crucial effect on negotiations between founders and external partners in the pre-investment phase is the role of time pressure. Carnevale & Lawler looked at the role of time pressure on the process and outcome of bilateral negotiations (1986). The authors found that high time pressure mainly has effects when the negotiators take a self-rational approach instead of a cooperating approach in the negotiations.

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Self-9 rational negotiators in high time pressure negotiations achieve poor negotiation outcomes and frequently even non agreements according to Carnevale & Lawler (1986). Self-rational negotiators in combination with time pressure lead to greater competitiveness, firm negotiator aspirations and reduced information exchange, while negotiators with a cooperative orientation reached under time pressure higher levels of cooperativeness and lowered their aspirations (Carnevale & Lawler, 1986). This study was a laboratory experiment and the sample consisted of 96 participants from the University of Iowa, so this study was also not focused specifically on negotiations between founders and external partners. None of the studies investigated the relationship between time pressure and venture founder satisfaction.

There was also no research on the effects of other terms in the agreement between the venture founder(s) and external partner(s), which may influence venture founder satisfaction levels. In this research the author also looked at the relationship between the relationship between the negotiated terms, such as buy back clauses and anti-dilution clauses, and venture founder satisfaction.

Zheng conducted a research on how entrepreneurs evaluate Venture Capital Firms (2011), where previous studies always used to investigate founder – external partner relationships from the external partners perspective. Zheng however used the opinions of entrepreneurs from TheFunded.com for his research. This forum is also easily accessible by VC firms, because they frequently meet the “high selective criteria” of the Funding.com. This is because many of the people involved in VC firms were start-up founders in the past themselves. A start-up founder who is negative about a VC firm in public can harm the relationship with their external partner in the future. Therefore many founders will be likely to only give positive feedback about the external partner, in order to protect the relationship and prevent the external partner of losing face in public. Therefore there is a likely chance that the results of this study were biased positively.

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10 All these findings of the previous studies already provides information of relationships between venture founders and external partner, but in these previous studies did the authors not focus on the satisfaction levels of venture founder(s) with the external partner(s). This author aims to fill this gap to improved understanding of venture founders experiences and judgements with regard to their external partner(s). Therefore all this knowledge will be combined to answer the following research question:

The central research question: The determinants influencing founder satisfaction levels with

regard to the collaboration with external lead/main financing partner in the most recent funding round.

1.1 Theoretical relevance

This present study fills a gap in the literature by looking at the pre- and post-investment stage in founder-external partner relationships. Most research regarding entrepreneur – external partner relationships has the external partner as center point instead of the venture founder. There is relatively little known about the preferences & judgements of venture founders. This research is focused on filling the literature gap by researching the satisfaction levels of venture founder(s) in venture founder – external partner relationships.

Other scholars (i.e. Zheng) only focused on subgroups of external partners (i.e. venture capitalists). This research also looks at the complete set of external partners (from business angels to universities), and tries to contribute to theories focused on venture founder satisfaction. Also the studies of others scholars were duplicated to check whether their theories also benefit different populations to check whether the theory is also valid for them.

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1.2 Practical relevance

Investigating the relationship of various determinants, conditions and decisions in the pre-investment phase on founder(s) satisfaction levels in the post-pre-investment phase may lead to an improved understanding in the relationship between venture founders and external (financing) partners. This improved understanding will especially be relevant for venture founders, who are in the process of attracting (new) external partners in their venture. External partners, who (plan to) invest in ventures can also use the results of this research during the negotiations in the pre-investment phase to improve the relationship with the founders of the ventures in which they invest.

2. Literature review

The literature review section is divided into various subsections, in order to organize the information in a more structured way

2.1 Definitions

In this section the definitions for the firm, start-ups, entrepreneurs and external partners will be given.

2.1.1 Firm definition

The firm is defined as a collection of productive physical resources (machines, factories and other tangibles), financial resources (equity capital, debt capital, retained earnings), human resources (innovative ideas, experience, intelligence, training and wisdom) and organizational resources (teamwork, trust, friendship and reputation of groups of individuals) under administrative coordination and authoritative communication that produces goods and services for sale in the market for a profit (Alchian & Demsetz, 1972, Barney, 1991 & Penrose, 1959).

The various resources are combined to cover the costs of production and generate additional value. Firms are also seen as goal-oriented social systems which is reached by collective action of

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12 the participating members (Aldrich & Ruef, 2006). In other words: the firm can be seen as a nexus of contracts (Jensen & Meckling, 1976).

2.1.2 Start-up definition

Start-ups are at first small businesses. The difference between a “regular small business” and a start-up is a difference in business model. Start-ups have the intension to grow their business extremely fast to become a large business. Steve Blank, academician and entrepreneur, uses the following definition to define a start-up: “A start-up is an organization formed to search for a repeatable and scalable business model” 1.The business model used also changes frequently to continue growing the business.

2.1.3 Entrepreneur definition

According to Bøllingtoft & Ulhøi are entrepreneurs “individuals who recognize and exploit opportunities made possible by recombinations of existing production factors and/or recognized changes in the market and/or new technology” (Bøllingtoft & Ulhøi, 2005). Entrepreneurship is one of the key factors driving economic growth and innovation of a country and helps deliver new job opportunities for all its citizens (Geibel & Manickham, 2015, Bygrave & Timmons, 1991). To support this statement the examples of Apple, Microsoft, Federal Express, and Intel can be used as a reference (Sahlman, 1990). These firms were also start-ups in the past and managed to become very large and successful corporations today. Thus today’s start-ups can also become successful companies in the future.

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13 2.1.4 External partner definition

External partners are also often called passive shareholders. External partners have a relationship with the firm, but they are always only limitedly liable. This means that they can only lose the resources they have invested in the venture. The external partner also has the right to claim a part of the residual of the firm, because they own a share in the venture. External partners do not have formal authority and don’t make operational management decisions in the venture. They can however use their control rights to ensure that the venture founders are influenced by the external partner. Individuals, companies and/or other institutions can take the role as external partner of the venture.

There are two types of external partners, these are main/lead external partners and non-lead external partners. The main external partner is the external party which is the largest external partner in the venture. Sometimes the external partner does not enter the venture as a single party. The external partner can also be joined by non-lead external partners who also participate in the investment round, this is called alliance syndication. This research is focused on the relationship between the venture founders and the main external partner of the most recent completed funding round of the venture. The main external partner of the most recent funding round can benefit a lot when the venture becomes a success, because they are an important external shareholder of the venture. The author chose to focus on the largest external partner of the most recent completed funding round, because it’s easier for the founder to memorize her/his experiences with this external partner.

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2.2 Importance of founders

Founders can according to Barney be seen as VRIN-resources, which is in line with the Resource Based Theory of the Firm. VRIN stands for Valuable, Rare, Unique and Non-Substitutable (Barney, 1991). Valuable is a resource when it creates value for the firm, this can be done through exploitation of opportunities and/or the neutralisation of competitive threats. If a resource does not generate value than it gives the firm even a disadvantage. Rare is a resource when the resource can only be acquired by only one or a few firms. When a resource is both rare and valuable it results in at least competitive parity or even competitive advantage. Inimitability refers to how difficult and costly it is for other companies to imitate the valuable resource of the other firm. Non-substitutable is a resource when it cannot be replaced by functional substitutes. If a resource meets the four criteria then it can be a source of (sustained) competitive advantage. Founding members of new ventures can be VRIN resources of the firm and generate sustained competitive advantage for the venture and contribute to the value-added of the venture.

When founder satisfaction levels with regard to the collaboration with their external partner(s) are low, can result in harmed performance, lower valuations and/or even bankruptcy of the venture due to a reduction in effort and commitment of the founder. Also when satisfaction level is low of the founder, exit intensions of the founder of the venture is likely to increase and can result in the departure of the VRIN resource.

Previous research mainly focused on the perception of external partners on the relationship between entrepreneurs and external partners in principal-agent/steward relationships. One of the few exceptions on this is the study of Zheng (2011). Zheng focused on his study on the perception and evaluation of VC firms by entrepreneurs to increase the understanding of relationships between entrepreneurs and external partner. However this study had one important limitation. The study was based on data from online VC evaluation website TheFunded.com. Zheng looked at the

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15 comments entrepreneurs gave VC firms to evaluate VC firms through the eyes of entrepreneurs (Zheng, 2011). Information provided on the website TheFunded.com can also be relatively easily accessed by external partners. The underlying reason for this is that external partners also often have start-up experience and are able pass “the selective criteria” to become a member of TheFunded.com. This might result in other entrepreneurs being dishonest on the website to prevent damaging business relationships with existing and/or potential external business partners. This can thus have influenced the results of the study of Zheng.

Founders leaving the venture can have detrimental effects for the venture due to following factors: loss of strategic vision, loss of innovative ideas, loss of knowledge, loss of skills, loss of experience, loss of commitment, impacting company culture, and/or even termination of the venture (Kaish & Gilad, 1991, Schein, 1983, Lim et al., 2013). Barney found that also organizational cultures can also be a source of sustained competitive advantage (Barney,1986). Since a firm’s culture can be valuable, rare, perfectly inimitable and non-substitutable. The organizational culture is mainly created through norm formation round critical incidents and identification with the leading players, a.k.a. the founder(s), of the firm (Schein, 1989). Also during the preservation of the firm’s culture, the founder(s) have an important role to sustain it when new members join the organization. An organizational culture which meets Barney’s criteria also results in sustained superior financial performance (Hirshleifer, 1980).

In addition, founders also invest a lot of sweat and money in the venture. It should also be noted that founders compared with managers can be different in their goals, priorities, and level of engagement, leading to a divergence between their strategic choices (Kor, 2003, 2006), thus leaving founders may hurt the venture and all its shareholders.

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2.3 Importance of external partners

External partners contribute both financial and non-financial resources to new ventures (Cosh, et al., 2009). External partners can give the founder and the firm access to new markets & industries, improved access to existing markets and industries, supply the venture with financial power/resources, give access to new knowledge/expertise/networks and improve the reputation of the venture (Buckman, 2007, Large & Muegge, 2008). Especially the supply of financial resources is often crucial, since this will enable firms to overcome credit constraints, and be born in the first place (Bottazzi et al., 2002). Capital constraints and the role of external equity investors is an important part of the entrepreneurial process (Fried & Hisrich, 1995, Shepart et al., 2000). External capital can come from various options according to Cosh, Cummings and Hughes (2009). The authors mention that external equity can be obtained through “banks, venture capitalists, private individuals, leasing, factoring, suppliers/customers, partners/working shareholders” (Cosh, et al., 2009). The standard pecking order theory assumes that firms prefer to finance new projects with internal cash flows first and then, if necessary, thereafter seek external debt capital and lastly seek external equity capital. The underlying reason is that cash and/or external debt will not dilute the ownership of the founder(s) (Maljuf & Myers, 1984 and Myers, 2000). The assumptions of this theory are outdated since external suppliers of capital also add value to the ventures in their portfolio (Cosh, et al., 2009) .

2.4 Lifecycle growth stages of a venture

For a firm to become a mature and successful corporation they have to go through various stages in the enterprise lifecycle process (Scott & Bruce, 1987, Gupta et al., 2013). Founding a new venture is not without risk. Timmons found that 40% of new firms won’t survive the first year

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17 (1990). The percentage of firm failure within 5 years after establishment can reach 60% (Cooper et al. 1988, Philips & Kirchhoff 1989). Timmons complements this by stating that even 90% of the firms won’t reach the age of ten years (1990). In this part the general growth theory of a firm will be explained. There are five different stages a firm goes through in its lifecycle (Scott & Bruce, 1987).

The first stage is the inception stage. In the first stage of a firm will the effort and skills of an entrepreneur the central component. The focus is on developing a commercially viable product/service in the market. The difficulty of this also depends on the industry lifecycle. Also the administrative processes have to be formalized in the early seed stage. This stage is also known as the early seed stage.

The second stage is the focused on survival of the firm. The key focus in this stage is ensuring finance for working capital. This financing can come from the founder self, financial institutions (for example banks), customers, suppliers and/or external financing parties. The level of competition is still low in this stage, but when the firm’s business is improving other entrants will enter the market. The main problems incurred during this stage will be overtrading and increased complexity of expanded distribution channels. Also the basis of competition changes and there will be a growing pressure for information. This is stage is also called the seed stage.

The third stage is focused on growth (early growth). When a firm reaches this stage it should be profitable, but it does not generate cash for the owner. All profits earned will flow back in the firm to enable to finance the growth of the company. Co-ordination becomes more important and often formal R&D departments are established. Firm owners sometimes already sell their company in this stage of development. Extreme growth often overstretches resources of the firm. Generating enough cash can be a challenge. The main problems in this stage are entry of larger competitors. The fourth stage is focused on expansion (late growth). In this stage systemization of the

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18 administrative functions is crucial for survival. In this stage equity partners join the company. Dividends become more important to attract these investors to secure long-term funds. The track record of the company will allow the company to attract these long term funds. The main problems of this stage is to manage the distance between top management to the operating staff and there will be an increasing need for external focus to maintain competitive advantage.

The last stage is focused on reaching maturity of the firm. In this stage the firm is still growing. The firm will develop into a large corporation. The main focus in this stage will be controlling the cost, improving productivity and revealing new growth opportunities. In this stage managers/founder can be pressurized by the shareholders to ensure the future of the firm.

2.5 General investment process in new ventures

When looking at the relationship between start-up founders and external investors, there are three main process phases in the investment cycle (De Clercq et al., 2006). Eckhardt, Shane & Delmar refer the financing process as a multistage selection model (2006). This research focuses mainly on the pre-investment phase and post investment phase in founder-external partner relationships.

2.5.1 Pre-investment phase

Before the founder and external investor start collaborating there will be a pre-investment stage. The pre-investment stage is the period before the external partner enters the venture (De Clercq et al.,2006). This part of the investment cycle starts with the decision of the founders to seek financing of external capital (Eckhardt et al., 2006). After this decision the search process starts to find an adequate external partner, obtain the right amount of money, and structuration of a fair deal for the venture founder(s). Another option is that the founders are approached by an external partners themselves.

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19 In the pre-investment stage the integrity of the partners involved is very important for the founders of the venture. Not only are entrepreneurs afraid to lose their business ideas and proprietary technology (Ueda, 2004), but also being sacrificed for other portfolio companies during the post-investment phase (Turcan, 2008). During the pre-investment stage the search process of the founders for external (financing) partners is most important.

The pre-investment stage can also be seen as an auction where potential external partners bid against each other with financial and non-financial resources to secure a portion of the venture (Bankman & Gilson, 1999).

2.5.2 Post-investment phase

The post investment stage starts when the external partner enters the start-up and becomes an official shareholder in the firm. The investment can be done by contributing through various things. Most common contributions by external partners are financial resources, mentorship/training, access to new markets, better access to existing markets, access to new knowledge, professionalization of the internal organization, defining the firm’s strategy, financial planning, recruitment of key employees, and accommodate housing (Cassamatta, 2003). In this phase growing the business and managing the relationship with the external investor are important for the venture.

2.5.3 Exit phase

The exit phase is the phase when the external partner exists the start-up and ends being a shareholder in the company. It other words, it’s the sale of an investment (Wall & Smith, 1997). The relationship is then terminated, the start-up and external partner will go their own separate way. Another option is that the relationship is terminated by bankruptcy of the start-up or that the founder(s) leave the venture voluntarily or by force.

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2.6 Summary theoretical framework & structure of the hypothesis

A short summary of the theoretical framework is included for the readers to clarify all information. The author started with showing the importance of both venture founders and external partners for venture survival. Subsequently he also clarified the firms lifecycle stages and the general investment processes of ventures. The benefits and disadvantages of venture founder(s) collaborating with external partner(s) were also explained the author. The

pre-investment phase is an crucial part to start a successful relationship between venture founders and external partners. Venture founders do not always have all resources required to make the venture a success, therefore they need to collaborate with external partners.

The most important findings of earlier studies which are related with this study are summarized below:

 The standard order pecking theory is not valid anymore. Venture founder(s) recognize that external partners also add value to the ventures they invest in.

 The external partner(s) that supply the venture with financial resources are often seen as the center point in previous studies from other scholars.

 Time pressure & profitability influences decision making.  Gender effects still affect female entrepreneurs negatively.  Risk attitudes plays an important role in decision making.

 Negotiations performed by teams reach better (joined) negotiation outcomes than negotiations done by solo’s. Teams reach better outcomes due to an increased level of information exchange.

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21  The conditions discussed during the pre-investment phase have an crucial impact on the

relationship between venture founder(s) – external partner(s) in the post-investment stage.

The information summarized in the theoretical framework will be used in the next sections of this study.

2.6.1 Structure of the hypothesis

In the following part of this paper the hypothesis will be introduced. The author chose to separate the various hypothesis into three different groups. The first group of hypotheses (H1 & H2) are related with the characteristics and attitude of the venture founder.

The second group of hypotheses (H3-H5) are all related with the pre-investment phase between venture founder and external partner. Hypothesis 3 is focused on the circumstances for the venture in the negotiation. Hypothesis 4 & 5 are related to protection clauses that are often discussed by both external partners and venture founders during the pre-negotiation phase. The last set of hypothesis (H6-H7) are related with the number and type of people/parties involved during the negotiation from the venture’s and external partner(s) side.

2.7 Risk attitudes & gender founder

The first group of hypotheses (H1 & H2) are related with the characteristics and attitude of the venture founder. The first part of this section will discuss the influence of the types of risk attitudes of venture founders. The second part is focused on the effect of founder gender on founder satisfaction levels.

2.7.1 Risk attitude

Dohmen, Falk, Huffman and Sunde state that “the usual practice in economics is to treat individual attitude as a black box” (Dohmen et al., 2012). However, almost every important

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22 economic decision involves uncertainty and therefore risk (Dohmen, et al., 2012). This is also the case for venture founders. The risk attitude of the founding member(s) of the venture may be a very important influencing factor when the venture searchers for external (financing) partners. There are three different attitudes towards risk: risk averse, risk neutral and risk seeker (Arrow, 1971, Wilson, 1968).

A risk averse actor prefer to minimize the level of risk exposure and are willing to pay a premium to exclude risk and assure security. Risk averse players are also frequently called pragmatists or conservators (Ingram & Thompson, 2012).

Risk neutral players prefer accepts moderate levels of risk, but will avoid extreme levels of risk. Risk neutral players are also called managers (Ingram & Thompson, 2012). A risk seeking actor will not diversify away from risk. Risk seekers try to maximize their expected value, and are willing to be exposed to high levels of risk in the process of value maximization. Risk seekers are therefore frequently called maximizers (Ingram & Thompson, 2012).

The attitude towards risk have considerable consequences in the decision making process. Scholars previously always assumed that principals, thus external partners, are less risk averse compared to agents, thus founders, since they can spread their risk through portfolio management. This assumption was later reduced because entrepreneurs also have the ability to spread risk through portfolio management. This can be done through two different ways. The first option for the entrepreneur is to start with empire building of the existing firm through mergers & acquisitions or organically growing the business. The second option for an entrepreneur to diversify risk is to set up a completely new firm next to the other venture.

Risk seeking persons are likely to have higher aspiration levels to maximise value than risk neutral and risk averse actors. Risk seeking founders will therefore will be less likely to accept a proposal of the external partner and this may result in a higher satisfaction level of the founder in

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23 the end. The higher aspiration level forces the external partner to improve their non-financial and financial contributions to the venture to become a shareholder (Cosh, et al., 2009). However there can also be disadvantages for founder(s) with a risk seeking attitude. Turning down financial offers from external partners will no expand the financial resource pool of the venture. This will expose the founders and the venture towards more risk and a higher chance of closing/bankruptcy than firms with founders who chose to diversify the risk toward the external partners to secure the firm’s survival on the short term. The benefits and disadvantages of risk attitude of the founders will therefore be covered in the following hypothesis:

Hypothesis 1: Founders with a risk seeking attitude will have higher satisfaction levels than founders with a risk neutral or risk averse attitude.

2.7.2 Gender founder

Previous research has showed that women-owned ventures represent an increasing proportion of new businesses in western countries (Constantinidis, et al., 2007). Cliff found in her research that not only do women start businesses less frequently than their male counterparts, she also found that the women who set up businesses achieve less growth than male venture founders (Cliff, 1998). Constantinidis and collegians also showed that there is a gender effect with regard to venture financing. Male founders are more successful in acquiring venture financing than woman venture founders (Constantinidis, et al., 2007). Greene, Bush, Hart and Saparito found that the flow of venture capital investment to women-led businesses remains relatively small (Greene, et al., 2001) even though the proportion of women-owned ventures is increasing.

One of the reasons may be that male negotiators care more about their own payoff and use a competitive negotiation style, while women are more focused on finding consensus and are more focused on the relational negotiating style (Miller & Miller, 2002). Women have a tendency to

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24 think too much about the other party’s welfare and therefore accept the other party’s requests too quickly. The consequence is that women perform less in the distributive part of negotiations than men do (Kimmel, et al., 1980). Men also set higher aspiration levels and are more firm during negotiators than their female counterparts (Singer, 1989). Gender differences between founders may also have different consequences on founder satisfaction levels. A relational negotiation style may be good for the relationship between founder and external partner on the long term, while a competitive negotiation style, which is beneficial on the short term, may backfire on the long term. Therefore to understand the relationship between gender founder and founder satisfaction the following hypothesis is introduced:

Hypothesis 2: Founders, who are male, will have higher satisfaction levels than founders who are female.

2.8 Differences between parties & opportunities for integrative agreements

In this section the differences between venture founder and external partners will be discussed which enable them to reach more integrative agreements, this will result in higher joint payoffs and therefore should result in higher satisfaction levels of the parties involved. The first opportunity is that players have different priorities/goals. When both entrepreneurs and their external (potential) partners reveal each other’s primary and secondary priorities, goals and concerns. Through revealing each other priorities, goals and concerns all players are better able to identify the other party’s true interests and reach better agreements by giving in on the secondary priorities to reach the primary priorities. Many researchers found that mutually cooperative approach result in the best results for all parties involved (Lax & Sebenius, 1986, Lewicki et al., 2003, Pinkley & Northcraft, 1994). When the parties don’t do this, they will miss the opportunity to discover mutually beneficial or integrative solutions (Bazerman & Neale, 1992).

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25 The second reason to reach better integrative agreements is to reveal each party’s time preference. Different time preferences of the players involved generate opportunities for all the players. A venture founder often has a short time preference to secure important financial resources for the firm or him/herself, while the external parties are more focused on generating return on investment through a the long term time preference (Templar et al, 2012). Loewenstein and Prelec also say that actors have time-inconsistent preferences (1992).

Third is that players have different expectations of scarce resources for the future.

When one party expect the value to go up in the future, while the other party expects the value of a resource in the future to go down, will result in opportunities for both parties to reach a better contract and higher satisfaction levels as a result of better outcomes. This is called contingent contracts (Thompson, 2008) and is often based on the fact that the players have different information available to them.

Fourth, People have different risk attitudes (Eisenhardt, 1989), which generates opportunities for better integrative agreements. This is already discussed in the section of human behavioural motivation and risk attitude.

Another question which is very important and might influence the satisfaction levels of entrepreneurs with regard to the collaboration with external investors is whether the start-up is profitable at the time of investment or not. Entrepreneurs from profitable ventures are less pressurized to reach contracts with external parties, where an entrepreneur of a non-profitable venture may be forced to close a contract without full satisfaction to secure the survival of the firm. Founders of profitable firms are able to increase their demands, negotiate more firmly and improve the deal conditions with external partners. Profit gives the entrepreneur a high degree of freedom and allows them to strive for higher standards, which is in line with aspiration theory. Therefore the following hypothesis is introduced:

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26 Hypothesis 3: The more time available for the founder to search and reach a contract with the external partner, the higher the founder(s) satisfaction level will be with the external partner. This hypothesis may be mediated by the profitability of the venture at the time of external investment.

2.9 Protection clauses for the parties involved

Another important determinant for founder satisfaction regarding the collaboration with external partners may also be determined during the contracting phase. During the negotiations venture founders have the option to include buyback clauses for a fixed time in the future for a price agreed upon during the pre-investment stage. When these re-purchase clauses are included in the contract between entrepreneurs and external founders, may result in higher motivation, effort and satisfaction levels of venture founders since they have the possibility to buy back the shares for a fixed price in the future. Wall and Smith found that “many buyouts of external partners are through buyback, but they also acknowledge that many deals don’t include this during the outset of the deal” (Wall & Smith, 1997) . Another option is that the existing shareholders have the first right to purchase the shares at market price when the external partner wants sell the shares. In some ventures however are the shares of the external partner might be non-transferable, to ensure that the external partner is not participating in the venture for the short term. All this will lead to the following hypothesis:

Hypothesis 4: When there is a buyback clause to regain the shares sold to the external partner ,which can be exercised by the founder, increases the satisfaction level of the founder with the external partner.

The previous hypothesis is mainly focused on benefiting the founder(s). However it is also possible that the external partners want a clause in the contract which can negatively affect the founder(s) and ownership share (Mo, 2004). External partners can choose to protect their

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27 ownership share “against the dilutive effect of a down round by obtaining weighted average or full ratchet adjustment to their stock conversion price” (Mo, 2004). This means that the external partner receives additional shares in a future down round, because the stock acquired in the previous round will be repriced. These additional shares for the external partner harms the ownership share of the founding member(s). An agreement between founder(s) and external partner, with an anti-dilution clause of the external partner’s share may therefore influence the satisfaction level of the founding members. Since the founding members will mainly bear the negative consequences, while the external partners do not feel the consequences of a future downround valuation. This may be perceived/experienced by the founders as unfair. Therefore the following hypothesis is introduced: Hypothesis 5: When the external partner has a clause to protect their share against dilution the founder(s) will be less satisfied with the external partner.

2.10 The negotiation process, team composition and information exchange

Information exchange, relationship conflict and task conflict are three important determinants for New Venture Team success (Busenitz et al., 2004). In this section I focus on the first determinant information exchange and combine this knowledge with the results found in a study performed by Thompson.

Thompson found that to reach optimal contracts between selling partners, thus venture founder(s), and buying parties, thus external partners, it is important to look at how the parties involved entered the negotiation. There are two different options, founder(s) can chose to enter the negotiation as a team or as an individual with the external partner in the pre-investment stage (Thompson et al., 1996). Thompson and scholars found that teams are more effective than solo negotiators. The underlying reason is that teams conduct more inquiry related activities then solo negotiators (Thompson et al., 1996). This results in higher judgement accuracy of the other party’s

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28 true interests and enabling higher joint payoffs for the party’s involved. Realizing the other party’s true interests can reveal compatible interests and this will result in logrolling opportunities (Thompson et al., 1996). In their study they found that participants in team vs team negotiations did not miss any of compatible interests, while team vs solo negotiators missed 6% of the time all compatible interests and solo vs solo negotiators missed 31% of the compatible interests between the parties in the same bargaining game. This may thus also benefit both entrepreneurs and external partners. In turn leading to higher satisfaction levels of founders as well when they negotiate as a team instead of individually, because of higher individual and joint payoffs. This leads to the following hypothesis:

Hypothesis 6a: The venture founders which negotiated as a team of multiple founders in the pre-investment phase with the external partner will have a higher satisfaction level compared with founders who negotiated as a single founder with external partners in the pre-investment phase. Hypothesis 6b: The venture(s), which negotiated through a team of persons will have founder(s) with a higher satisfaction level compared the ventures which only negotiated through a single individual with external partners in the pre-investment phase.

2.11 The number of external partners involved & effect on satisfaction level founders

Frequently do external partners not enter the firm as a single external partner. They often enter a firm through an alliance of various external partners. The reason to conduct syndication behaviour has a couple of underlying motives, which will be explained in this section of the paper. The most important reason for external partners to collaborate as a syndication, when investing in new ventures is that the partners collectively have more financial and non-financial resources then they have alone.

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29 The combined financial resources of external partners will enable the venture to raise more money, while the external partners themselves will be less exposed to risk of losing all their financial resources, because collectively they can invest in a higher number of new ventures. When looking at the non-financial resources, the following things have been found during previous studies. Grant & Baden-Fuller found that when a venture collaborates with more external partners, the venture will have a broader scope of knowledge, consequently the have more chances to use this knowledge to become profitable (Grant & Baden-Fuller, 1995, 2004). Brander found that when there is a syndication of external partners, the value added potential of the venture increases because other parties contribute to the venture with other operational and strategic knowledge (Brander et al., 2002). This can vary between contributing by sharing industry expertise, life stage expertise, detection of new customers, help with filling top management team vacancies, creation of synergies, creation of economies of scale and enabling contacts with additional investors (Barney & Hesterly, 1996, Cosh, et al., 2009).

However there are also downsides for start-up entrepreneurs when they have to deal with alliances. The main downside of alliances of external partners are that there are costs created by shirking external partners, especially when the alliance of external partners is very large, anonymous and when it’s difficult to observe their contributions to the venture (De Clercq & Dimov, 2008) This refers to opportunistic behaviour and is for the other party costly to find out in the post investment phase. But shirking can be reduced, because it can damage the reputation of the external partner. A damaged reputation might result in losing out on the opportunities to invest through investment alliances in other promising ventures in the future.

Another disadvantage of alliances is that the venture founders will have more time deficiencies, because they have multiple partners which they have to inform. Thus an alliance of external partners has both benefits and disadvantages for venture founders.

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30 To research the effects of these benefits and disadvantages on satisfaction levels the following hypothesis is introduced.

Hypothesis 7: When the investment takes place through an investment alliance of multiple external parties will result in higher founder satisfaction levels compared to an investment of a single external partner.

2.12 How do entrepreneurs evaluate (potential) external partners

There has only been a limited number of studies, which focused on the evaluation of external partners by entrepreneurs (Barney, et al., 1996, Zheng, 2011). Barney, Busenitz, Fuet & Moesel looked at the assessment of learning from venture capital firms from the perspective of new venture teams (1996). The authors measured three different constructs for this paper. These constructs are Business Management Advice, Operational Assistance and Technological Innovation.

How entrepreneurs evaluate their external partners effects the interactions in entrepreneur – external partner relationships is according to Zheng determined by six different categories (Zheng, 2011). These six categories are competence of external partner (competent versus incompetent), attitude of external partner (friendly vs arrogant), correspondence between entrepreneurs and external partners (fast vs slow), ethical behaviour of external partners (ethical vs unethical), handling term sheet or compensation (fair vs restrictive) and operational assistance (much vs little). Also past success/track record of external partners influence evaluations of entrepreneurs.

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2. Review of hypotheses & conceptual model

In this section an overview will be given for all the hypothesis. Subsequently the conceptual model will be provided. Hypotheses 1 and 2 are focused on the relation between founder attitudes/characteristics on the satisfaction levels of founders with regard to the external partner. The third hypothesis is focused on the search and negotiation process between the entrepreneur and main/lead external partner(s) during the pre-investment phase. Hypothesis 4 and 5 focuses on the effects of different clauses which can be negotiated during the pre-investment phase and might have influence on the post investment phase in the founder-external partner relationship. Hypothesis 6 and 7 investigates the effects of the negotiation process/conditions on founder(s) satisfaction level.

Hypothesis 1: Founders with a risk seeking attitude will have higher satisfaction levels than founders with a risk neutral or risk averse attitude.

Hypothesis 2: Founders, who are male, will have higher satisfaction levels than female founders Hypothesis 3: The more time available for the founder to search and reach a contract with the external partner, the higher the founder(s) satisfaction level will be with the external partner. This hypothesis may be mediated by the profitability of the venture at the time of external investment. Hypothesis 4: When there is a buyback clause to regain the shares sold to the external partner which can be exercised by the founder increases satisfaction level of the founder with the external partner.

Hypothesis 5: When the external partner has a clause to protect their share against dilution the founder(s) will be less satisfied with the external partner

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32 Hypothesis 6a: The venture founders which negotiated as a team of multiple founders in the pre-investment phase with the external partner will have a higher satisfaction level compared with founders who negotiated as a single founder with external partners in the pre-investment phase. Hypothesis 6b: The venture(s), which negotiated through a team of persons will have founder(s) with a higher satisfaction level compared the ventures which only negotiated through a single individual with external partners in the pre-investment phase.

Hypothesis 7: When the investment takes place through an investment alliance of multiple external parties will result in higher founder satisfaction levels compared to an investment of a single external partner.

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33 + +/- +/- + +/- +/- +/-

Profitability venture at time of external investment

Time available to search and contract external partner

Venture founder satisfaction level with regard to the collaboration external partner

Existence Buyback Clause shares owned by external

partner?

Existence of anti-dilution clause of the shares from the

external partner

Is the external partner investing alone or in an alliance with other external

partners? Risk Attitude Founder (risk

avoider, risk neutral or risk seeker)

Gender of the founder (male/female)

Did the founder(s) negotiate alone or as a team of multiple

founders with the external partner during the

pre-investment phase?

Did the venture negotiate through a single individual or as a team of

multiple individuals with the external partner during the

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3. Methods

In this section will first the sample selection be discussed. The second part will focus on the data collection method used for this research. Third and lastly the variables measured in this study will be explained.

3.1 Population

The population for this research was focused on ventures which were founded in Europe. A global population would have been better, but due to time and financial constrains this was not possible. It was also important to ensure that the role of external investors exists, therefore only the European ventures which have attracted external financing were included in the population. For this research the Start-up database of Start-up Europe, which is an initiative of the European Commission, was used. According to the database 5.909 companies have successfully collected external funding, which will be the population for this research (date: 2016-08-01). This is only a small subgroup (2,1%) of the complete database with 280.187 European firms.

The majority of the chosen population is an early growth stage company (2299 firms). Also the group of seed companies (2031 firms) and late growth (782 firms) are well represented in the population. 95 firms have reached the maturity stage. 702 firms have no provided an indication of their lifecycle growth stage.

The majority of the firms (3185) have a workforce between 2 and 50 employees. There are only 102 firms with one employee only. 712 firms have a population between 51 and 500 employees. 51 Ventures have more than 500 employees. 1859 ventures had no indication on the number of employees of the venture.

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35 The ventures included in the population operate in large number of different industries. The industry with the most operating start-ups is the fintech sector with 494 firms. The second most represented industry in the European Start-up Database is the analytics industry with 442 firms. Also the marketing/sales industry (310), travel industry (298) and medical/healthcare industry (316) are well represented. Other industries, which also exceed more than 100 firms are food, biotech, content, internet of things, developer tools and the fashion industry.

3.2 Data collection method

To conduct this research the author chose to use a survey. This study is cross-sectional, because there was not sufficient time to conduct a longitudinal study. The best option would be, to conduct a longitudinal research, which measures the satisfaction of founders directly after the start of the post investment phase between founder and external (financing) partner, a couple of years after the start of the post investment phase and when the exit phase has been completed. The reason for this is because satisfaction levels can develop and change over time. Since this is not an option, the author choose to focus on ventures, which are in the post-investment stage and have acquired external funding in the period 2012-2016.

In the European Union there are 23 official recognized languages. According to the Special Eurobarometer 386 report is English the most spoken language in Europe. Offering the survey in multiple languages, i.e. English, Dutch, French, Italian and Spanish, will give translation problems and generate additional costs for this research, because the author is not a native speaker of those languages. Therefore the decision was made to conduct the survey in English only.

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3.3 Sample method

A random sampling technique was used for this research to select the participants from the chosen population. Each venture of the population has an equal and known chance of being selected. The optimal number of respondents is 361 on a population of 5909 firms with a confidence interval of 95% and a margin of error of 5.00%. Previous research has showed that response rates of surveys targeting business owners are relatively low, response rates of approximately 30% are usual (Dennis, 2003). Therefore to get the 361 respondents to have statistically meaningful results invitations should be send to approximately 1204 ventures to complete the survey.

In the invitation to complete the survey, all venture founders were asked to fill in the questionnaire. Many ventures have been founded by a team of individuals, this will increase the chance to reach and maybe even exceed the 361 respondents desired. In addition, the participants are guaranteed anonymity and the participants will be informed that the acquired data will only be used for this research. So that the venture founders feel free to answer honestly without thinking about repercussions of for example external partners. The founders who complete the survey also have the possibility to receive this thesis. Incentivizing business owners to participate in surveys by offering a monetary reward is considered by some business owners to be insulting (White & Luo, 2005), therefore the author chose not to offer an incentive to participate in this survey. Instead the founders are asked to fill in the survey to help create insight on how relationships between venture founders and external partners can be improved in the future. With this knowledge they can contribute to a more successful European Start-up ecosystem.

1291 firms were randomly selected of the total population of 5909 firms. From these 1291 selected ventures the author has found 1100 email addresses relating to the venture. Some ventures did not have an email address on their website or on Crunchbase. Crunchbase is “the leading platform to discover innovative companies and the people behind them” according to founder Mike

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37 Arrington. 83 ventures did not have an email address on the ventures website or on Crunchbase, but these ventures however had contacts forms on their website. 20 ventures (1,7%) of the sample did not have contact information or a web form on their website, so these firms were not asked to fill in the survey. Another 144 ventures (11,2%) of the selected sample were not operating anymore. This was the result of acquisitions (55) and bankruptcies or closings (89). This is very low compared to the previous finding of Timmons, who found that 40% of new firms won’t survive the first year and 90% of the ventures will not reach 10 years (1990). The explanation for this low number is that the ventures in the population have secured finance from external partner(s). With this finance the venture can overcome credit constraints, and be born in the first place (Botazzi et al., 2002). 6 of the 1291 ventures already went public through an Initial Public Offering.

Another concern was that of those 1291 ventures some have acquired external funding a long time ago, this will result in memorizing problems, therefore the author decided to only send the survey to the ventures which have acquired external funding in the period 2012-2016.

All these factors reduced the number of invitations to 894. The sample was asked by email to fill in the survey. The invitation email which was send to the venture founders is enclosed in the appendix. To increase the number of responses the author chose to send the potential participants two times a reminder to fill in the survey. The first reminder was send one week after the first invitation. The second reminder was send two weeks after the first invitation to complete the survey. The first two emails were send in the beginning of the week, because response rates of surveys send on Monday and Tuesday were significantly higher than Wednesdays, Thursdays, Saturdays and Sundays. The third email was send on Friday in the afternoon, because this was also a favourable time period to send invites according to research published on CheckMarket.2

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3.4 Variables description

In this part of the research the author will explain how the independent, mediating and dependent variables are measured. First the independent variables will be explained, followed by the mediating variable and dependent variable.

3.4.1 Independent variables

There are seven different independent variables used in this research.

The first variable focuses on the personal risk attitude of founders. Risk attitude of the founder will be measured through the measurement scale introduced by Ding, Hartog & Sun (2011). The founders are asked to answer the following question: “How do you see yourself: Are you in general a person who takes risk or do you try to evade risks? Please self-grade your choice (Ranging on a scale from 1 to 9)”. The values 1, 2 and 3 will represent risk averse actors, the values 5, 6 and 7 will refer to risk neutral individuals and the scoring values 7, 8 and 9 will be chosen by risk seeking individuals. The second independent variable looks at the gender of the founder.

The third independent variable looks at the time available to find and reach sign a contract with the external partner. This variable is related to the pre-investment period in entrepreneur – external relationship. This variable is measured through the number of months to find and reach a contract with the main/lead external partner of the most recent investment round.

The fourth and fifth independent variable are related to the post-investment period in the founder - external partner relationship. The fourth independent variable is whether there is a buyback clause for the entrepreneur in place. There are two different types of buyback clauses. The first type is whether the venture founder(s) have the possibility to buy back the shares issued to the external partner during a fixed period for a pre-determined price. This is made up of two different

Founder satisfaction levels with external partners in new ventures : top management, strategic decision making and innovation in service contexts