THE EFFECTUAL ENTREPRENEURSHIP AND FINANCIAL BOOTSTRAPPING APPROACH TO NEW VENTURE PERFORMANCE

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SMALL BUSINESS AND ENTREPRENEURSHIP (M SC. BA)

MASTER THESIS RESEARCH

THE EFFECTUAL

ENTREPRENEURSHIP AND

FINANCIAL BOOTSTRAPPING

APPROACH TO NEW VENTURE

PERFORMANCE

UNIVERSITY OF GRONINGEN

Submitted by: Manohar Sitapati

Student number: S2401576

Email: m.sitapati@student.rug.nl

Date: 18.04.2014

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1) INTRODUCTION

In the last decades, especially with the coming of the internet, the entrepreneur has become an increasingly popular figure in the current culture. Moreover the recent global financial crises and the outsourcing trend of large companies have made the prospect of self-employment a more viable option for many people in the western world. The enduring claim of entrepreneurial activity to promote economic growth and development has generated the interest of government policies to foster entrepreneurial activity (Minniti, 2008).

However, for any aspiring entrepreneur and for the promoters of entrepreneurship there always seems to be a lack of financial capital and/or new venture creation experience as first obstacles. Along with the ambition of creating a new venture that grows over the first few years of activity. There are some issues that concern entrepreneurs. These issues represent the topics of interest of this work.

The first issue is that of how a person can start a business with a very short supply of funds. In fact, when having few collaterals and investors are not available, dealing with resource and financing needs becomes a very relevant topic of interest.

The second issue concerns the lack of experience in starting a venture and the challenge of starting a business. There ought to be an entrepreneurial model from entrepreneurship theory that aspiring and novice entrepreneurs can take insights from when starting a new venture. Additionally, if expert entrepreneurs do things differently than novice entrepreneurs in the venture creation process, it’s interesting to see what these differences are and how these might affect the new venture creation process performance.

The third issue regards the successful launch of a new venture. Whether the adoption of insights that entrepreneurs can take from entrepreneurial theory affects or not the performance in a new venture is an important factor in determining the usefulness of such theories. It’s also interesting to determine if entrepreneurs possess different characteristics based on their preference for one entrepreneurial venture creation process over another. This helps determining whether a model is better received by particular kinds of people.

Even when an entrepreneur decides to confront the risk associated with launching a venture there are challenges that persist for small businesses. These challenges are liability of smallness and liability of newness, or in other words small businesses themselves lack the resources that are available to established companies. The major lack of resources concerns the lack of financial resources. Many entrepreneurs lack the access to financing because of their lack of business experience (important for reputation) and lack of security (collateral) for loans (Jones and Jayawarna, 2010).

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1.1) OBJECTIVE AND DESCRIPTION OF THE STUDY

1.1.1) Objective of study

From an academic point of view the objective of this study is to investigate how inexperienced entrepreneurs can succeed, either with a first successful venture or eventually as serial entrepreneurs, despite a lack of financial resources. As an article by Beck and Demirguc-Kunt (2006) illustrates, access to finance is an important difficulty for SMEs. They argue that small firms face a more difficult access to finance, therefore hindering growth. It’s interesting to observe that small firms have poorer access to finance than large companies in both the developing and developed world (Beck and Demirguc-Kunt, 2006). However successful entrepreneurs managed to either overcome or circumvent this difficulty and eventually grow their companies to today’s successful large companies. The explanation for these successes is still not satisfactory. In fact, as an extensive study by Moroz and Hindle (2011) on the subject of a model of entrepreneurship affirms, entrepreneurship research lacks a clearly dominating model which explains entrepreneurial success.

From a practical point of view the objective of this study is to address the issues that an ambitious, inexperienced and not wealthy aspiring entrepreneur would face once he/she has decided to start a new venture and in the first years of activity. The central object of focus in this thesis however concerns both the entrepreneur and the new venture itself. This implies that a measure of performance and success is to be measured from the venture’s point of view, but it’s the behavior and actions of the entrepreneurs that are studied for their effects. In essence the issues that concern this thesis are:

 Availability of financial resources  Experience in creating new ventures

 Performance in new venture and entrepreneur’s performance

The end objective of this study is to provide a theoretical insights for inexperienced aspiring entrepreneurs with a lack of financial resources, as well as providing the first steps towards an academic consolidation of the best fitting financial resources acquisition and entrepreneurial process theories.

1.1.2) Description of the study

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Ashley (2008) suggested that entrepreneurial leadership itself is pragmatic, with a focus on problem solving and value creation in the market. They also affirm that pragmatism in entrepreneurship is concerned with innovation and accomplishment. In short Surie and Ashley (2008) define pragmatism as: “a philosophical approach that emphasizes experimentation and action characteristic of entrepreneurial leadership”.

In the second level of analysis these theories act as components for the links between the main issues and the most useful type of analytical measures concerning these links are selected. The links review is mainly based on previous studies that demonstrate, or disprove, the link and relationship between theoretical concepts in the first level of analysis. More in particular the first link is concerned about the relationship between the lack of entrepreneurial experience and the achievement of positive venture performance. It’s likely that the relationship will be based on studies that prove or disprove the effects of a selected entrepreneurial process theory towards firm performance. Then the second link concerns the relationship between the lack of financial resources and the achievement of a positive venture performance. The sort of relationship that can be expected to be based on studies that prove or disprove the effects of a financial resource acquisition theory towards firm performance. Lastly, the third link concerns the relationship between the lack of financial resources and the lack of entrepreneurial experience. The sort of relationship that can be expected is the commonalities that theories in the first level of analysis have towards each other.

Finally in the last level of analysis the core of the thesis is developed. The core of this work concerns the concurrent consideration for the three issues that were analyzed, for their measures and for their propositions. In this part the final testing model and the methodology are developed. The testing model has the objective of organizing a testable set of propositions. These propositions help in testing the assumptions behind the thesis concept. Then the test are made and the results presented. The limited amount of time and data available could impede highly significant results, notwithstanding the core part of this work furnishes a valid framework on the basis of which it’s possible to further test and develop this new perspective on effectual entrepreneurship and financial bootstrapping. The results of the pilot testing results in the distillation of a few core recommendations on financial resource acquisition and entrepreneurial practice that favor entrepreneurial performance at the firm and personal level. FIGURE 1 below represents the analysis structure of this thesis in a Venn diagram.

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2) RESEARCH QUESTION

The main research question that this master thesis aims to answer is:

Pertaining to the successful creation of new ventures, what are the financial resource acquisition and the entrepreneurial practice principles that best apply in situations of lack of financial resources and entrepreneurial experience?

2.1) SUB-QUESTIONS

1. How can novice aspiring entrepreneurs compensate for their lack of experience? What and how can aspiring entrepreneurs learn from expert entrepreneurs from an academically accepted theory or set of concepts?

2. How do early stage entrepreneurs overcome their lack of financial resources? Is there a study area that suggests viable financial resource acquisition tools to the aspiring and novice entrepreneurs? 3. What are the relevant behavioral principles and practices that an entrepreneur can enact to

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3) THE FIRST LEVEL OF ANALYSIS

3.1) FINANCIAL RESOURCES ACQUISITION

3.1.1) The challenge: the lack of financial resources

There is a recurring theme that concerns entrepreneurs and small businesses. This is the lack of financial capital. The gap that is created by the lack of finances is caused by problems that entrepreneurs face as they want to attract long-term finance from the financial market. The typical sources of finance referred to entrepreneurs are banks and venture capital companies (Winbork and Landström, 2000).

There are several reasons for the existence of the financial gap. In their study Winbork and Landström (2000) have listed three reasons that they researched the literature. These are: information asymmetry, high transaction costs and bonding costs (Winbork and Landström, 2000).

 The information asymmetry concerns the relationship between small business managers and potential external financiers. This occurs because small business managers have a far superior quantity of information about the potential of their own business than the potential financiers, but financiers may possess superior knowledge about the potential of the industry as a whole. This information asymmetry causes a greater uncertainty for the financiers to face, thus making it harder for business owners to be approved for financing (Storey, 1994).

 The high transaction costs that concern external financiers are initial and current assessment costs for the investment case. These costs are created because there is the need to organize carry out and monitor the exchange. These needs themselves arise from the fact that the transaction costs for financing small businesses are increased by information asymmetry. Therefore financing costs are higher for small businesses than for large businesses. This too contributes to the financial gap (Williamson, 1981).

 The bonding costs of enterprises represent the costs incurred when wanting to reduce agency costs. This is the case when small businesses search for potential external financiers. The underlying need for small businesses to provide some sort of insurance to financiers about non-opportunism creates bonding costs. Therefore bonding costs increase the cost of getting external funding for small business and increase the financial gap (Jensen and Meckling, 1976).

A possible solution for dealing with the financial gap is to avoid external financiers. In fact many entrepreneurs don’t want to raise external capital in order to retain the value of their capital equity stake, and more importantly, many are simply unable to raise the necessary capital externally. This is due to the fact that many aspiring entrepreneurs either lack the necessary managerial experience, the innovative and original idea that is necessary, or both for them to convince investors. In these cases the entrepreneur doesn’t have the necessary assets that an objective investor requires to make an investment (Bhidé, 2000).

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possible to achieve the acquisition of resources with little interaction with external investors. Alternatively by solving the need for financial resources by responding to the need that the finance was supposed to address in a non-financial way. This brings us to the consideration of the concept of financial bootstrapping (also referred to as “bootstrapping” only) as theory of choice to represent a pragmatic solution to the financial gap issue. In the next section the motives behind the consideration of financial bootstrapping as a useful entrepreneurship research area are explained.

3.1.2) Choice of financial resource acquisition theory type to study

According to Storey and Greene (2010) the financing possibilities for aspiring entrepreneurs that want to start a new venture can be generally classified as either internal or external to the entrepreneur’s personal wealth. The internal sources of financing of an entrepreneur concern mainly the personal wealth of the business owner and that of his/her close family and friends.

When talking about the decision to study financial choices that lead to a particular set of desired financial sources, the pecking order hypothesis (POH) is very relevant for entrepreneurs as it demonstrates how small business owners generally prefer internally generated sources of finance as opposed to externally raised sources (Watson and Wilson, 2002). In essence POH shows how managers prefer one source of finance over another even when they are priced in a non-competitive way. This is because managers of companies with good prospects prefer using internal sources of finance, moreover they would avoid selling shares to prevent proprietorship dilution. Consequently, owners that expect their businesses to grow will become highly creative in finding alternative ways of funding that do not involve external funding and equity selling. New small business owners have a limited range of availability of choice between the sources of finance. In general they use personal savings and loans from friends and family in the case of internal sources and mostly bank loans in the case of external financing. Established small businesses have more range in the availability of sources of finance. This is because they normally have easier access after the business begins to perform in the market. Moreover, established businesses have a higher use of credit cards compared to new ventures. The major sources of finance for the established small businesses are credit cards, overdrafts and trade credit (Storey and Greene, 2010).

In origin POH assumes that a more internal distribution of finance sources is preferable. The preference for sources of finance categories are ordered as follow (Storey and Greene, 2010):

1. Internal sources of finance

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Essentially bootstrapping ways include delaying payments, forgoing owner’s salary, buying second-hand equipment and even using credit cards (Storey and Greene, 2010). The bootstrapping concept is presented in more detail the following parts of this work.

3.1.3) Bootstrapping definitions

The term of bootstrapping in the entrepreneurship literature has referred to various meanings including: community economic self-development, business development process, use of internally generated funds such as cash-flow, or the role of the corporate entrepreneur in getting the resources he/she needs for his/her venture within the corporation (Harrison, Mason and Girling, 2004).

Freear et al. (1995) defines financial bootstrapping as “a range of highly creative ways of acquiring the use of resources without borrowing money or raising equity financing from traditional sources”.

Additionally Winborg and Landström (2000) define bootstrapping methods as “methods used to meet the need for resources without relying on long-term external finance”. By “long-term external finance the researcher mainly means long-term loans from banks and venture capital companies

According to Harrison et al. (2004) financial bootstrapping is a collection of strategies aimed at the gathering and gaining control of resources not currently owned by the entrepreneur. These strategies are divided into two groups:

1. Use of creative ways to acquire finance without the recourse to banks or without raising equity. 2. Strategies to minimize or eliminate the need for finance by securing resources at little or no cost.

By combining the recurring elements of these definitions a generalized definition of bootstrapping is proposed: “Bootstrapping is a collection of methods that business owners can use to acquire resources. These methods include highly creative ways to acquire the necessary finance or circumvent the need for this finance. However these methods make it a point to avoid external funding through loans and equity financing.”

3.1.4) Bootstrapping methods and bootstrapper orientations

In their empirical research Winborg and Landström (2000) describe the use of bootstrapping methods by small business managers and contributed to the understanding of the financial bootstrapping behaviors of these managers. In this study the researchers identify bootstrapper types each with specific characteristics, orientations, and an accentuated use of certain bootstrapping strategies.

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F1) Owner financing

This group concerns the direct or indirect provision of resources from the owner (manager) and relatives includes activities such as the owner working with assignments in other businesses, relatives working at non-market salary, use of owner’s private credit cards for business expenses and withholding owner’s salary.

F2) Minimizing of accounts receivable

This group includes methods that deal with methods such as speeding up invoicing or using interest on overdue payments. Therefore this group concern the management of accounts receivable, more specifically the goal is the minimization of these accounts.

F3) Joint utilization

This group concerns the sharing and borrowing resources from other businesses. In this group the relationship that the owner has with his/her external partners is itself the mean of obtaining the resources. Co-ownership, barter, borrowing and cooperative buying are part of this method-group. F4) Delayed payments from the business

This group includes methods such as delaying the payment of suppliers, delaying the payment of the value-added tax and leasing of equipment.

F5) Minimizing stocks

This group concerns the minimization of own resources invested in stock. For example the use of formal routines to manage stocks can minimize the stock. Another method is seeking better conditions with suppliers, then the supplier themselves co-finance the resources invested in the stock.

F6) Subsidy finance

This group concerns obtaining subsidies or any public or private institution that supports either entrepreneurship or a specific business industry, such as renewable energy for example.

Bootstrapper orientations

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O2) Socially oriented mode

The socially oriented mode of resource acquisition characterized by the use of the personal and business networks for the acquisition of resources at low or no financial cost. The bootstrapping methods used when socially oriented concern the joint utilization of resources. The only bootstrapper type that has a predominantly socially oriented mode of resource acquisition is the relationship-oriented bootstrapper.

O3) Quasi-market mode

The quasi-market orientation mode for resource acquisition is characterized by the acquisition of resources from governmental institutions. These institutions are defined as a quasi-market source for funds by Winborg and Landström (2000). The only bootstrapper type that predominantly focuses on the quasi-market mode of resource acquisition is the subsidy-oriented bootstrapper.

3.1.5) The non-bootstrapping

In this study there is also the need to evaluate and confront the use of market-oriented mode of resource acquisition. This mode implies the use of external sources of finance that are available in the capital market such as banks, private and institutional investors. In this work these concepts are referred to as “OM” for market-oriented resource acquisition mode and “FM” for capital market finance sources. The interest in defining these additional concepts resides in the facilitation in evaluating the attitude towards bootstrapping in as a non-exclusive continuum of resource acquisition modes for entrepreneurs.

3.2) EXPERIENCE IN CREATING NEW VENTURES

3.2.1) The challenge: the lack of experience in new venture creation

One of the main objectives of any entrepreneur is to see his/her business successfully founded and performing to the expectation he/she set for it. In order to do that a novice aspiring entrepreneur must find a way to compensate for the lack of experience that he/she might have. In fact of the many factors that are important for predicting the outcome of the business start-up process, the most important is entrepreneurial experience (Rotefoss and Kolverheid, 2005). The belief in the importance of the entrepreneur’s experience is a very old notion. In the case of venture capitalists involvement, half of the most important criteria to make an investment decision revolve around the entrepreneur’s experience and skills (Zacharakis and Meyer, 2000). In fact irrespective of the product, the market or the financial criteria, it is the entrepreneur who fundamentally determines whether the venture capitalist will place an investment at all (MacMillan, Siegel and Narasimha, 1985).

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previous start-up experience were about 50% less likely to start another attempt compared with individuals with no start-up experience. In fact when the entrepreneurial experience is mainly unsuccessful, the result can be a major discouragement to start-up a business and a fall back into an employee position (Kim, Aldrich and Keister, 2006).

Another option, that is unlikely yet viable, is for the entrepreneur to learn the best practices from an appropriate entrepreneurial model theory. In order to be of any practical value in compensating for a lack of entrepreneurial experience an entrepreneurial theory must be pragmatic and it must contain entrepreneurship specific heuristic principles. This theory must be recognized as a sound theory in the academic domain of entrepreneurship, otherwise the risk of finding non-tested and overall non-true set of principles is too great. In the next section the search for such a theory is conducted.

3.2.2) Choice of entrepreneurial model

Traditionally entrepreneurship has been studied with a focus on the set of personality traits of the entrepreneur or on his/her environment’s set of circumstances. These focus areas have been studied in the effects they have on entrepreneurial performance.

In their study on the entrepreneurial process Moroz and Hindle (2011) tried to analyze and harmonize the extant theories of entrepreneurship. They studied 32 extant theories of entrepreneurship and they tried to find an entrepreneurial process that is both generic and distinct. Of these 32 models only 4 demonstrated potential of having processes that are both generic and distinct. These are the works of: Gartner (1985), Bruyat and Julien (2000), Sarasvathy (2006), and Shane (2003).

The four models were all found to be not completely satisfying to Moroz and Hindle (2011). Their intent was, in other words, to find a entrepreneurial model that had both a generic set of core factors and relationship, supported by evidence, and additionally be distinct to entrepreneurship, not management in general. Each one of the four models had peculiar advantages and disadvantages, however the concept of effectuation by Sarasvathy was dynamic and it was the only one to be pragmatic in its approach and it was the only model with direct implications for practice. Dynamic frameworks show how and why variations in the environment and in the entrepreneurial process shape outcomes. A more dynamic process view fits the objectives of this thesis. From a practical applications point of view, in the words of the authors: “The concept of effectuation contained several ontological difficulties but was the only one of the models that presented a direct practical focus.” (Moroz and Hindle, 2011).

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address, learning useful expertise through the heuristic principles of effectuation. This allows to overcome such lack without going through the discouraging failures that expert entrepreneurs had to go through. Another theoretical perspective has emerged that is often closely related compared to effectuation. In face both of these theories explain entrepreneurship while challenging the more established structures of processes, relevance of artifacts and roles of actors. This theory is Baker and Nelson’s (2005) Entrepreneurial Bricolage theory. However this theory was discarded from being considered in the selection of Moroz and Hindle (2011). They were searching for an entrepreneurial process that is both generic and distinct. They held that this would resolve many issues concerning the nature of entrepreneurship as a field of theory and practice.

In conclusion, this section considers a process of selection from an analysis study on entrepreneurship as a process resulting in four dominant processes. After this one out of the four competing processes has been chosen as the most apt to help fulfill the objective of this thesis: to investigate how inexperienced entrepreneurs can succeed , either with a first successful venture or as serial entrepreneurs, despite a lack of financial resources. Clearly the theory of effectuation emerges as a better choice of entrepreneurial model for the framework of this thesis. A good reason for this choice is the case that effectuation is the most pragmatic and thus provides more useful theoretical insights for inexperienced aspiring entrepreneurs than the other theories. But much more importantly there is the fact that effectuation aims at delivering learnable, testable and teachable elements of entrepreneurial experience. Whether these elements are related to high performance in the process of new venture creation is still to be determined. The effectuation theory and its elements are presented in more detail in the following literature section of this work.

3.2.4) Effectuation principles

In her conceptualization of effectuation Sarasvathy (2001) contrasts the concept of causation to that of effectuation. In practice effectuation and causation are fundamentally cognitive processes that Sarasvathy (1998) developed after a think-aloud test to expert and non-expert entrepreneurs. The underlying cognitive processing logic of expert entrepreneurs was then analyzed and a distinguished from those of non-expert entrepreneurs, resulting in the concept of effectuation (Perry, Chandler and Markova, 2011).

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Related to effectuation Related to causation BP1 Beginning with predetermined means Beginning with predetermined goals

BP2 Focus on affordable loss Focus on expected returns

BP3 Emphasis on strategic alliances and

pre-commitments Emphasis on competitive analysis

BP4 Leveraging environmental contingencies Exploiting pre-existing knowledge BP5 Seeking to control an unpredictable future Seeking to predict an a risky future

Table 1) Effectual and causal behavioral principles (after Sarasvathy, 2001)

These behavioral principles were then named and given further elaboration. A description of the five principles of effectuation is the following:

BP1) Bird-in-hand: start with your means

When entrepreneurs start to build a new venture they start with their means, who I am, what I know and whom I know. Then, the entrepreneurs imagine possibilities that originate from their means.

Causal processes work conversely by assembling means after the goal is set. BP2) Affordable Loss: focus on the downside risk

Entrepreneurs limit risk by understanding what they can afford to lose at each step, instead of seeking large all-or nothing opportunities. They choose goals and actions where there is upside even if the downside ends up happening.

Causation models focus on maximizing the potential returns, then works to minimize associated risk. BP3) Patchwork Quilt: form partnerships

Entrepreneurs build partnerships with self-selecting stakeholders. By obtaining pre-commitments from these key partners early on in the venture, expert entrepreneurs reduce uncertainty and co-create the new market with the interested participants.

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BP5) Pilot-in-the plane: control instead of prediction

By focusing on activities within their control entrepreneurs know their actions will result in the desired outcomes. An effectual worldview is rooted in the belief that the future is neither found nor predicted, but rather made through exploration.

Causation processes focus on the predictable aspects of an uncertain future. This reasoning accepts that existing market forces will cause the future to unfold.

The fundamental logical distinction between effectuation and causation concerns the choice of which is constant or changeable between means and effects. In fact, as stated by Sarasvathy (2001), what causal processes do is to “take a particular effect as given and focus on selecting between means to create that effect” (Sarasvathy, 2001), while what effectual processes do it to “take a set of means as given and focus on selecting between possible effects that can be created with that set of means” (Sarasvathy, 2001). In the following section an overview of the entrepreneurial process according to effectuation theory is presented.

3.2.4) Effectuation process overview

A comprehensive review of the concept of effectual entrepreneurship (also referred to as “effectuation” only) would take too much volume in this work. However an overview is presented in order to give an idea of what effectuation is. Following this section there is a presentation on the highly relevant position of effectuation concerning entrepreneurship and financing.

According to Sarasvathy (2001): “Effectuation processes take a set of means as given and focus on selecting between possible effects that can be created with that set of means”. In other words, entrepreneurs working through the framework of effectuation do not plan their businesses. Sarasvathy (2001 and 2005) gave the basis for the research on the effectuation process. She states in her articles (2001 and 2005) that her new approach is innovative in a few ways in contrast to the causation approach. Sarasvathy (2005) states: “In a causal worldview, the end product is determined by the initial “opportunity” identified by the entrepreneur through exploration, and the adaptive changes over time to exploit the pre-selected “market” and/or “vision” that is initially “envisaged” as existing in the theoretical space of all possible markets”. FIGURE 2 below shows the process of effectuation.

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In this figure it’s important to note that the effectuator does not start the new venture creation journey with an opportunity in mind. He/she might have a general goal or idea of what is the centre of interest but the discovery and evaluation of opportunities are not taken into consideration at first (Sarasvathy and Dew, 2005).

At first the effectuator starts with analyzing personal actual means: “who I am”, “what I know” and “whom I know”. These are in fact the really controllable starting aspects that, if well developed, may allow for some degree of control over an uncertain future (Sarasvathy and Dew, 2005).

Once determined what the actual means of the entrepreneurs are, the actual courses of action possible are to be taken into consideration. The crucial question in this step is “What can I do?”. This step is a first limitation on the opportunities of exploitation. It is easily understandable that many opportunities require either prohibitive initial investments or require extremely specialized knowledge, both of which can limit anyone’s courses of action under certain conditions (Sarasvathy and Dew, 2005).

Subsequently the effectuator interacts with his/her personal social network and especially with people that can contribute to the entrepreneur’s possible courses of action. These people may be friends or acquaintances that are employed or active in sectors that are of interest to the effectuator (Sarasvathy and Dew, 2005).

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concept and as such it will emerge only gradually. The elements of the theory, its concepts and principles have to be further studied, measured and tested (Perry, Chandler and Markova, 2011).

3.3) PERFORMANCE

3.3.1) The challenge: new venture survival and growth

The research on small business and entrepreneurship has shown the importance of the role of performance in new ventures. In fact the claim of entrepreneurial activity in promoting economic growth and development has generated the interest of government policies to foster this entrepreneurial activity in their economies (Minniti, 2008) and academic research follows closely. More chiefly, an important focus area of small business economics research has been on the potential of small businesses to generate employment in the economy. In fact in their study Acs and Mueller (2009) affirmed that “the literature and issues focusing on gross employment dynamics are important”. This study reminds of the importance of employment effects that businesses have on a particular region. In particular they studied which kind of businesses, between new and small businesses and established and large businesses. They found that only firms which grew to have between 20 and 500 employees were the ones that had lasting employment effects within diverse metropolitan areas.

The consequence of this sort of focus is a strong attention of the academic research on entrepreneurship to strongly value the growth of new firms as a measure for performance and success. As said by Acs and Mueller (2009) “new firms have to grow rapidly in order to increase their likelihood of survival”. However as Sarasvathy (2004) argues, a more genuine concern about the phenomenon of entrepreneurship should be focused on how it can be possible to promote entrepreneurship in both individuals and economies, without over-focusing on firm performance but on the survivability of entrepreneurs in particular environments. This raises the question: is a focus on growth the best way to ensure survival? A study from Shepherd, Douglas and Shanley (2000) argues that it’s not necessarily the case. In their study the researchers described the impact of novelty , of external shocks and of risk reduction strategies on new venture survival. They determined how the liability of newness of a new venture is majorly dependent on the degree of ignorance that the venture has in the areas of market, production and management. More importantly they also provided a number of risk reduction strategies. One of the most unusual facts is that one of the strategies is “committing to a more moderate growth plan” (Shephard, Douglas and Shanley, 2000). According to the authors, the risk reduction strategies proposed in the study can mitigate the effect of external shocks and can mitigate the mortality risk of new ventures.

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3.3.2) Conventional elements of performance

Conventionally the performance of a new venture is measured as the performance of a firm. The most commonly used measures for performance are the firm’s growth and the firm’s business volume difference from year to year. A study of Chandler and Hanks (1993) on measuring the performance of emerging businesses states that “the growth and business volume measures operationalized in this research have good availability and internal consistency and are superior to the satisfaction with performance and performance relative to competitors’ scales in terms of content validity”. In this study the external validity of these measures is proved by a regression analysis of the independent variables identified. The measures that were recommended to quantify growth were: perceived growth in market share, change in cash flow and sales growth. The measures that were recommended to measure business volume were: earnings including the salary of the founder, sales volume and net worth (Chandler and Hanks, 1993).

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4) THE SECOND LEVEL OF ANALYSIS

4.1) THE FIRST LINK: EFFECTUAL ENTREPRENEURSHIP AND PERFORMANCE

In this section the objective is to research and illustrate the results of previous studies concerning the effect of effectuation on performance. Following, a research and consideration of the measures that are used in researching and testing effectuation are presented. Finally the most relevant measures are selected and propositions are formed to help test the impact of effectuation on the relevant aspects of performance.

4.1.1) Existing results

In their study Read, Song and Smit (2008) performed a meta-analytic review of effectuation and venture performance. For performing this meta analysis review the researchers analyzed the articles published by the Journal of Business Venturing, totaling data from 9897 new ventures.

In this study the variables that represent the effectual principles are carefully selected to be tested in their relation to venture performance. The selection involved a division between relevant and non-relevant elements for the focal venture at hand. At the end only four out of the five effectual principles were tested: means, affordable loss, partnership, and leverage contingencies. The principle of “design” wasn’t tested. Of the four principles that have been tested all were significantly and positively related to venture performance with the exception of the affordable loss principle. The following TABLE 2 below shows a summary of the specific elements that were tested along with the division and the results available from the study. The more extended results table with the complete list of measuring elements used in the study is available in APPENDIX 2.

Effectual behavioral principle Result of study

Means: Who I am (BP1a) Significant and positively related Means: What I know (BP1b) Significant and positively related Means: Whom I know (BP1c) Significant and positively related Affordable loss (BP2) Not significantly related

Partnership (BP3) Significant and positively related Leverage contingency (BP4) Significant and positively related

Table 2) Summary of Read, Song Smit (2008) study's findings Implications for this work

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Nonetheless in this study the issue lays in the link between the principle of affordable loss (BP2) and performance. Interestingly this work strongly focuses on analyzing the potential relevance of such principles. The affordable loss principle was tested with a verification of the risk taking propensity (as inverse) and the risk distribution/mitigation of the subjects of the studies that were part of the meta-analysis. However it’s arguable whether these are the best measures to take into account when wanting to test for affordable loss. In fact though the ideal effectual entrepreneur limits risk by understanding what he/she can afford to lose at each step, instead of seeking large all-or nothing opportunities, focusing on the risk taking attitude alone is not sufficient.

A planned effort into assessing the personal financial situation and to determine the level of affordable loss are essential parts of applying the affordable loss principle. Other important elements that are characteristic of an entrepreneur that applies such principles are the commitment level to the set affordable loss level of investment, the proactive conduct of business in an inexpensive way, as well as using only personal

resources to develop products or services. Probably these elements are very difficult to observe and study in the context of a meta-analysis, but it ought to be possible to develop effective measures to analyze and evaluate qualitative data from interviews with entrepreneurs or chronicled activity logs from them. Once these elements are fully considered and assessed a test on the effects on performance is going to be more precise.

Even thought the results for the principles of means (BP1), partnership (BP3), and Leverage contingency (BP4) are determined to be positively and significantly related to venture performance, more behavioral and qualitative types of measurements are necessary. In fact even concerning other principles one of the aims of this work is to propose measures to test effectuation as a behavioral logic in entrepreneurs with a level of “being effectual” as a continuous variable, not a one or zero sort of classification. Different interpretations of effectuation and different ways to measure it from other studies might give better measures. For instance the principle of means (BP1) entails a conscious effort to assess one’s means, financial, social and human capitals, as these are some of the indications of effectual behaviors. Therefore it becomes necessary to consider other studies for selecting the relevant measures of effectuation that this study needs.

Proposition #1

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4.2) THE SECOND LINK: FINANCIAL BOOTSTRAPPING AND PERFORMANCE

4.2.1) Existing results

From a theoretical point of view it is well understood that financial bootstrapping is a good strategy for acquiring resources and helping new ventures to succeed. Moreover the theories of resource dependency and resource constraint are predictors of the role of bootstrapping in the performance of an enterprise. In fact resource dependency theory holds that firms prefer to rely on their own resources and resource constraint holds that firms with fewer resources actually make a more efficient use of resources overall (Jones and Jayawarna, 2010).

There are several advantages that bootstrapping can have on a venture, as opposed to ventures that don’t engage in such strategies. In their study Jones and Jayawarna (2010) uncovered several advantages that bootstrapping strategies have on firm performance based on several other studies. An overview of which advantages and form which reference they come from are summarized in the TABLE 3 below.

Bootstrapping benefits References

Ability to respond to customers more effectively Carter et al. (2003a); Brush et al. (2006) Easier dealing with unpredictable sales Bhide (1992); Baker, Pricer, and Nenide (2000)

More efficient use of resources Leibenstein (1976) Achievement of rapid growth Brush et al. (2006) Adoption of a discipline of leanness Timmons (1999)

Relief from excessive debt Timmons (1999)

Basis for further resource acquisition Carter et al. (2003a); Brush et al. (2006); Freear, Sohl, and Wetzel (1991)

Table 3) Referenced bootstrapping benefits

After the observation of all these referenced benefits Jones and Jayawarna (2010) set out to analyze and prove whether an effective use of bootstrapping techniques improves performance in new ventures. A test was conducted on the effect of bootstrapping as moderator between the entrepreneur’s network ties (independent variable) and firm performance (dependent variable). The results indicate that there is a significant and positive relation between payment-related and joint utilization bootstrapping techniques. The expected negative relation between owner-related bootstrapping methods and firm performance was found to have no statistical support. In summary a direct citation from the conclusion of the study states: “The data confirms that those entrepreneurs who make use of appropriate bootstrapping techniques improve growth in turnover and sales” (Jones and Jayawarna, 2010).

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bootstrapping methods and growth in value added (dependent variable). The useful bootstrapping methods were: use of owner funds, flexible human resources policies, minimizing accounts receivable, applying for and obtaining subsidies. However bootstrapping methods that minimize investments such as: use of personal bank loans, cooperative purchasing, delaying payments through leasing or inventory minimization were found not to be significant.

Despite neither enabling or refraining new venture growth, these minimizing bootstrapping methods allow for a capital structure with less external debt. The study of Vanacker et al. (2011) indicated that entrepreneurs that relied more on bootstrapping methods in the early stage of venture creation realized the same results as entrepreneurs who used less bootstrapping, but with less need for external finance. Indirectly this gives an advantage to bootstrapping entrepreneurs as they retain a larger part of their equity and retain more control over the venture. Furthermore there are savings in not dealing with external loans costs as well as a more efficient use of resources under constraint.

Overall bootstrapping seems to be a very beneficial set of methods that entrepreneurs can use to enhance their new venture’s performance as well as their growth and indirectly, survivability. While the two studies presented here, and the studies they took insight from, analyze the effects of particular groupings of methods used, this study focuses more on the entrepreneur himself/herself. This means that the ideal elements to measure bootstrapping, in this context, are related to the orientations and the strategies of bootstrapping entrepreneurs. In the following section the precise selection of measures is explained.

Proposition #2

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4.3) THE THIRD LINK: FINANCIAL BOOTSTRAPPING AND EFFECTUAL

ENTREPRENEURSHIP

4.3.1) Effectuation and new venture finance

The financial focus of the theory of effectuation is mainly rooted in the principle of affordable-loss. The conventional way of approaching the financing of new ventures is based on maximizing returns and minimizing risks. In fact in the words of Dew et al. (2009): “Classic risk-return analysis is often prescribed as the way to help make this decision” while referring to the decision of entry into entrepreneurship. Likewise Sarasvathy notes that also in the causation approach the entrepreneur seeks to have the highest return and tries to lower the risk by selecting optimal strategies. A causal logic to new venture financing demands the calculation up-front of the amount of money necessary to start the business, and it demands the investment in time effort and energy for raising those funds.

The effectuation entrepreneur assesses his means first and then chooses the best possible effect that can be created with the available means. In other words this asks for how much the entrepreneur is willing to lose in the worst case. However this also demands to leverage well the limited means in creative ways to generate new ends as well as new means. In this approach the entrepreneur picks a comfortable level of risk and tries to increase the return within this level of risk. In practice this means that the effectual entrepreneur uses the building process of the enterprise itself to bring partners to commit and he/she creatively leverages slack resources available in the world. Slack resources are simply potentially utilizable resources that can be used and redirected towards a practical use for the achievements of organizational goals (George, 2005). To calculate expected returns a (causal) entrepreneur has to perform estimations and predictions concerning the risk, and the cost associated with the funding capital and engage in the acquisition of such capital. Instead the effectual entrepreneur reduces his/her dependence on predictions by calculating his/her affordable loss. Even though the calculation of affordable loss does not depend on the venture, calculating affordable loss is very possible. The necessary elements in this estimation are the current financial condition of the entrepreneur and his/her estimate of psychological cost in the worst case scenario. In terms of advantages that using affordable loss has over calculating expected return is that the former is a non-predictive mode of estimation and in effect it nullifies the role of uncertainty in early-stage funding decisions (Sarasvathy, 2008).

A way of showing the practical financial calculations taking place when an aspiring entrepreneur decides to start a venture is to analyze the financial calculation processes around the “plunge decision”, or in other words the decision to engage to be the founder of a new venture. In this regard the study of Dew et al. (2009) compares the plunge decision logic behind neo-classic investment theory (expected returns), real-options logic and affordable loss. (Dew et al., 2009).

The plunge decision comparison

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stay at his job or pursue his/her vision for a start-up, in other words, to take the plunge. According to neo-classic theory investment this aspiring entrepreneur should have to calculate the net present value (NPV) of his job’s income and the level of investment that is required to start the business. The variables to take into consideration are: S representing the NPV of the salary, representing the level of investment, p representing the probability of success, q representing the probability of the worst case of failure, R representing the return on investment. Given these variables the decision to take the plunge is recommended only when: (expected value of return of the new venture superior to NVP of salary) (Sarasvathy, 2008).

Instead real-options logic implies breaking the investment into stages so that the entrepreneur has the option to abandon the venture at the end of each stage and contain losses. This happens when investments are staged in a manner so that they are interrupted under poor conditions. In calculation this translates into having become a series of smaller investments . The difference with the previous decision recommendation lies in the fact that is reduced. As a consequence the decision depends more on R and S (Sarasvathy, 2008).

Finally, as already elaborated, affordable loss essentially means setting an upper limit to the entrepreneur’s investment in the venture based on that he/she evaluates to be affordable to lose. Distinctly form the logics presented above, affordable loss takes into consideration the opportunity cost of not starting a new venture. In fact the opportunity cost of starting the venture is S or its function f(S) in all three cases. However there is also an opportunity cost of R or f(R) that effectuation takes into account. The affordable loss logic recommends for entrepreneurs to pick a level of personal risk that is acceptable and work on augmenting the returns (Sarasvathy, 2008).

In conclusion of this section, effectuation’s affordable loss principle is not to be considered the best nor the only necessary venture launch financial logic available. In fact Sarasvathy (2008) suggests that affordable loss could add to neo-classic investment theory and real-options logic by simply suggesting that the I should be limited so that losses could be contained in the case of the worst scenario. In practice the key to decision making when considering the financial aspect of “the plunge” is to make a creative use of multiple rationalities that are relevant to the particular case at hand. The toolbox of rationales can be extended to include: NPV, min-max, real-options, affordable loss, integrative negotiation, leveraging slack resources, and even intuition (Dew et al., 2009).

4.3.2) Affordable loss and financial bootstrapping

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As already presented in the previous section the main considerations that effectuation has made towards finance concern the effectual principle of affordable loss. It is already straightforward that this principle implies the use of bootstrapping techniques. In fact Sarasvathy (2008) explains many times how effectuation is about leveraging the limited means available in creative ways to generate new ends and acquire new means. She further refers to creative ways as useful to bring an idea to the market within the means that can be assembled or even close to no cost. These creative ways are never fully explained in detail except for last one of the affordable loss heuristics. The affordable loss principle is characterized by three heuristics (Sarasvathy, 2001):

1. Invest only to the extent that complete loss can be survived 2. Imagine creative ways to get things done with zero resources

3. Work up from the cheapest to the highest-cost options. That is, do not buy what you can rent, do not rent what you can borrow, do not borrow what you can get for free

In the third heuristic a hint of practical and more detailed method of reducing the cost of operations emerges, however this remains largely unsatisfactory given the variety of bootstrapping methods available for acquiring resources at low cost.

In effectuation there is a strong lack of a more complete consideration of the funding preferences of entrepreneurs as well as their evolution and the lack of presentation methods of resource acquisition and conservation. However this is where the opportunity of complementation comes for financial bootstrapping.

Proposition #3

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5) THE THIRD LEVEL OF ANALYSIS

5.1) METHODOLOGY

5.1.1) Testing model

In this part of the thesis the results of the previous levels of analysis are put together to form a testable model for qualitative-types of study. The idea of the test can be best summarized in an illustration, presented in the FIGURE 3 below.

Figure 3) Testing model (own design)

The model shows how the effectual entrepreneurship’s behavioral principles (BP) is the independent variable tested for its influence on the dependent variable of performance. Following financial bootstrapping is tested for having moderation on the relationship between effectual entrepreneurship and performance. Additionally financial bootstrapping is tested for its influence on performance. There are three assumptions when testing this model:

1. The use of bootstrapped resources is related to performance 2. The use of effectual principles is related to performance

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failed to present all the relevant variables pertaining to the entrepreneur’s behavioral logic, especially concerning the principle of affordable loss (BP2) which proved not to be significantly related to performance. For this thesis the assessment of the principle of affordable loss (BP2) to performance is crucial. Yet this doesn’t have to be a direct effect on performance. Concerning new venture performance this is evident by the fact that financial results are influenced by the consequences of decisions that the entrepreneur makes on the operations of the venture. Concerning entrepreneurial performance the influence of the behavioral principles of effectuation have a clear indirect effect as these are assumed to be moderated by the effects of experience on entrepreneurial performance. For these reasons it’s assumed that the link between effectuation and performance are moderated through the use of bootstrapping.

5.1.2) Developing keywords

Effectuation measures

The elements selected by Read, Song and Smit (2008) do not suggest a way to precisely analyze the entrepreneur’s aptitude for effectual entrepreneurship. Furthermore the lack of testing for the design (BP5) principle and the inconclusiveness of the finding on the affordable loss (BP2) principle denote that other studies must be considered.

Two other studies proved useful in proposing elements for measuring, discern the development, validate, and test the effectual entrepreneurship principles as observable behaviors. These studies are the studies of Chandler, De Tienne, Mumford (2007) and Fisher (2012). The measures from these two studies are presented in APPENDIX 3 and APPENDIX 4. For selecting the elements of measure to take into account in this work the measures of the previously mentioned studies are collected, rendered clear and concise and relevant keywords are identified.

The following is a list of selected concepts, in the form of descriptive sentences, that characterize effectual behaviors adapted from Chandler, De Tienne, Mumford (2007) and Fisher (2012). These sentences are further condensed into keywords that are relevant for the technical analysis of qualitative data based on the guiding concepts.

BP1) Focus on resources

Keywords: Resources, capability, knowledge, decision, priority. 1. Extensive use of available resources and capabilities

2. Priority to available knowledge and resources over acquisition

3. Decision-making based on available knowledge and resources concerning business options

4. Decision-making based on available knowledge and resources concerning products/services alternatives 5. Decision-making more focused on available internal abilities than on external factors

BP2) Affordable loss

Keywords: Funding, investment, risk, affordable.

1. Commitment of resources limited to personal “could afford to lose” basis.

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3. Funds to invest limited to the level that safeguarded financial security in case of loss. 4. Preference for inexpensive ways to conduct business

5. Product or service development using only personal resources BP3) Partnership

Keywords: Friends and family, agreement, customer, supplier, discount. 1. Free services from friends, family, and other network contacts 2. Low cost resources from family, friends, and other network contacts

3. Agreements with customers, suppliers and other organizations and people to mitigate the amount of uncertainty

4. Agreements with other people and organizations to mitigate changes in business environment. 5. Use of pre-commitments from customers and suppliers

6. Negotiations with other parties prior to having a fully developed product or service BP4) Flexibility

Keywords: Change, flexibility, product/service, opportunity, surprise. 1. Evolutions of business as opportunities emerged

2. Adapted activities to the available resources

3. Flexibility through promptly taking advantage of opportunities 4. Avoidance of courses of action that restrict flexibility and adaptability 5. Rapid changes of offering or revenue model

BP5) Design

Keywords: Concept, experiment, development, business model, selling. 1. Current product/service not as originally conceptualized

2. Experimentation with different products and/or business models 3. Development of multiple variations of a product or service 4. Exploration of several business models

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Bootstrapping measures

In the case of testing the bootstrapping aptitude of an entrepreneur the study of bootstrapping method-use is useful. More in particular the notion of bootstrappers resource acquisition orientation is particularly relevant because of its suggestion for a particular behavioral logic of the entrepreneur concerning his/her attitude towards resources. Therefore the chief aim of measuring bootstrapping in this work is to determine the mix of resource orientations. These orientations are: internally, socially and quasi-market oriented modes of resource acquisition. To these orientation an additional non-bootstrappers orientation of resource acquisition mode is proposed: the market oriented mode. This mode of resource acquisition includes all the interactions with funding sources that subject the entrepreneur to ask for financial resources to professional financial actors in the market such as venture capitalists and banks.

The advantage in considering the resource acquisition orientation mode over classifying the financial sources into groups resides in the fact that orientation modes correspond to the behavioral choices of entrepreneurs and thus gives clues as to what cognitive logics they use when needing resources.

To achieve this a common analysis of the bootstrapping methods that are used by the entrepreneur is appropriate. Once the type and intensity of bootstrapping methods used is assessed, the task continues with the grouping of these methods into bootstrapping orientation mode groups. The internal mode (O1) of resource acquisition includes the methods belonging to owner financing (F1), minimizing accounts receivable (F2), delaying payments (F4) and minimizing stocks (F5). The socially oriented mode (O2) of resource acquisition includes the methods belonging to joint utilization (F3). The quasi-market mode (O3) of resource acquisition includes the methods belonging to subsidy finance (F6). And finally the market mode (non-bootstrapping) of resource acquisition includes all uses external and market driven sources of finance such as finance from venture capitalists and non-personal investments from financial institutions. This concretely translates in the following set of measures adapted from Winborg and Landström (2000):

Owner financing (F1)

Keywords: Credit card, friends and family, salary, other business 1. Use of personal credit card

2. Loan from friends and family 3. Withholding owner’s salary 4. Assignments in other businesses 5. Relatives working for non-market salary Minimizing accounts receivable (F2)

Keywords: late payers, invoice, payment, contracting, overdue payment 1. Cease business with late payers

2. Routines to speed invoicing 3. Interest on overdue payments

4. Offer same conditions to all customers 5. Raise capital from factoring a company 6. Pick customers who pay quickly

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Keywords: exchange, lending, sharing, co-purchasing 1. Barter instead of buying/selling

2. Borrow equipment from others 3. Own/share equipment with others 4. Share employees with other businesses 5. Co-ordinate purchases with others Delaying payments (F4)

Keywords: leasing, delayed payment, co-renting, value-added tax 1. Lease equipment instead of buying

2. Delay payments to suppliers 3. Share business space

4. Delay payment of value-added tax Minimizing stocks (F5)

Keywords: supplier, stock, routine, cash payment 1. Best conditions with supplier

2. Routines to minimize stock 3. Discounts if paying in cash Subsidy finance (F6).

Keywords: subsidy, grant, public organization 1. Subsidy from public organizations

External market finance (FM)

Keywords: loan, bank, equity, venture capital/capitalist, angel 1. Loan from bank

2. Equity finance form venture capital firms 3. Equity finance from business angel

New venture performance measures

In final consideration the performance measures that serve the purpose of this thesis are defined as a combination of both commonly used performance measures in the literature and relevant performance measures available in the data, however focusing on survival instead of growth.

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Recent sales performance (NVP1) 1. Had sales in the last 4 months 2. Sales revenue in the last 4 months Business development assessment (NVP2)

1. Official registration of company

2. Assessment of business phase advancement New venture resilience level (NVP3)

1. Survival for 3 years or longer

2. Achievement of profitability in last 24 months Team suitability to new venture (NVP4)

1. Team completeness 2. Average salary per month

5.1.3) Data analysis

The data considered for this research comes from 2 databases of the VentureLab International in Entschede, The Netherlands. VentureLab International is a business incubator that offers business development support for technology-based start-ups and it serves as business growth accelerator for high-tech well-established companies.

The first database is the diary data of entrepreneurs. The entrepreneurs that participate in the business incubator’s program have to give a weekly report of their activities concerning the new venture creation. The report includes data about learning points, results, issues and next steps that concern the entrepreneur and his/her venture during the week. This data is rich in information concerning a variety of subjects from the entrepreneurs and there is the possibility of exploring into the entrepreneurs’ behavior. Because of the limited scope of this Master Thesis, this study is an illustrative study into the subjects of effectuation and bootstrapping. This means that out of the 200 available cases of entrepreneurs only 30 cases are selected based on the quantity of entries. In fact a great amount of entrepreneurs didn’t fill the diary data in a consistent manner. Then the top 10 cases to analyze are selected based on the density of main keywords in the answers. This allows for the discard of cases where the entrepreneur entered the answers in Dutch (which the author can’t speak) and discard cases where “None” or “N.A.” were calculated as proper answers.