City research: Friendship found to be a key factor in start-up success (and failure)

Hundreds of thousands of new businesses are registered in the UK every year yet 20 per cent fail within the first 12 months and 60 per cent are terminated within their first three years.

Decisions to terminate a venture typically occur as financial losses increase. Entrepreneurs are faced with the decision to increase their financial commitment to a failing venture multiple times before finally terminating it.

Academicss Tori Yu-wen Huang and Professor Vangelis Souitaris of Cass Business School and Sigal G. Barsade of The Wharton School, University of Pennsylvania sought to understand how entrepreneurial teams react when their venture’s finances begin to suffer.

The study found the stronger the friendship bond among the team members, the more likely the team was to increase its financial commitment to the venture. Emotions were found to be important in entrepreneurial decision-making, with those emotions being strongly felt when ventures face termination.

“Our results indicate how important it is for entrepreneurs to understand and manage their team’s emotions, which leads to better decision-making,” the academics agree.

“It also helps explain the continued engagement of entrepreneurial teams who, even when fearful, have hope.”

“We focus on the influence of group fear and group hope because compared to other emotions, fear and hope are associated with uncertainty. This is inherent to the decision to escalate commitment to a venture.”

Hope trumps fear

Using a simulation-based on data from 66 entrepreneurial teams across 569 rounds of decision-making, the researchers found “hope trumps fear”. That is, the relationship between group hope and increasing financial commitment to a failing venture is stronger than the relationship between group fear and terminating that venture.

Since entrepreneurs invest not only money but also time and effort in their ventures, the academics examined the team’s engagement as a mediator between fear and hope and continued financial commitment versus termination. They found this explained the results.

“We employed an immersive laboratory methodology to realistically simulate and observe teams of three business students serving as co-founders of a computer start-up,” write the academics.

“To examine the dynamic nature of these decisions, we tracked each team’s joint level of fear, hope and behavioural engagement through multiple rounds of simulation.”

The researchers conclude that although continued and increasing commitment to what is forecasted to be a failing venture can be costly, persistence is a quality widely valued in business and entrepreneurial contexts.

“Distinguishing ‘problematic’ escalation from ‘fruitful’ persistence is a kind of art and a skill that entrepreneurs have to develop,” adds Professor Souitaris.