This research used a questionnaire and psychophysiological responses to an investment opportunity proposal to provide insights into the opportunity recognition process. A group of 262 entrepreneurs and financiers responded to the main questionnaire study and six respondents (with an additional three respondents in a control group) were involved in the psychophysiological response pilot study. Based on previous research, it was proposed that opportunity recognition could be divided into two phases. The results provide tentative support for the notion that there are similarities between experienced entrepreneurs and financiers in terms of the first phase of the opportunity recognition process.

Why is it that some people recognize business opportunities where many others see only problems? Opportunities are everywhere, yet many people do not see them. Successful entrepreneurs, however, have the capacity to see what others do not (Timmons, 1999).

Opportunities have the qualities of being attractive, durable, and timely and are anchored in products or services that create or add value for their buyers or end users (Timmons, 1999). The most successful entrepreneurs, venture capitalists, and private investors (business angels) are opportunity focused. They start with what customers and the market want and do not lose sight of this (Timmons, 1999). However, although formal market research may provide useful information in this regard, intuition or “gut feel” based on experience is extremely important in judging market potential (Hills & Shrader, 1998).

This research builds upon previous research undertaken by Hills (1995), Hills, Lumpkin, and Singh (1997), and Hills and Shrader (1998) that focused on how entrepreneurs recognise opportunities. It extends the previous research in the following ways:

• it examines the opportunity recognition process of not just entrepreneurs but examines differences between entrepreneurs and financiers (venture capitalists, business angels, and bankers), and
• in addition to a questionnaire, it uses a psychophysiological methodology, which is not common in business related research (see, for example, Braud & Schlitz, 1991; Schlitz & Braud, 1997), to provide additional insights into the opportunity recognition process by measuring psychophysiological responses to an investment proposal stimulus (see, for example, Dollins, Cestaro, Pettit, 1998).

At the applied level, the research provides a basis for developing training programs that will assist “novice” entrepreneurs, intrapreneurs, venture capitalists, business angels, and bankers to be better able to recognise business opportunities. It also provides a basis for developing a multi-dimensional “screening instrument” that will assist financiers in recognizing potential opportunities at a generic level.

The recognition and exploitation of business opportunities in the market are core functions of entrepreneurship (see, for example, Casson, 1982; Hills & Shrader, 1998; Schumpeter, 1971; Kirzner, 1979;). Yet, many “would be” entrepreneurs fail to recognize opportunities. Timmons (1990) estimated that only 1 in 30 business ventures had founders that were good enough at opportunity identification and development to be able to grow their ventures to at least $1 million in sales turnover.

Entrepreneurs are notably overly optimistic in their assessment of business opportunities (see, for example, Cooper, Woo, & Dunkelberg, 1988). Non-entrepreneurs, however, may be less likely to characterise situations in optimistic terms and, thus, make decisions reflecting this negative perspective (Palich & Bagby, 1995).

Opportunity recognition occurs in the early stages of the business life cycle prior to venture launch but may also occur throughout the life of the enterprise and the life of the entrepreneur (Hills & Shrader, 1998). Opportunity recognition involves perceiving a possibility to create a new business venture or significantly improving the position of an existing business which, in both cases, results in new profit potential (Christensen, Madsen, & Peterson, 1989).

It seems that entrepreneurs identify opportunities by using different types of information about the environment where available (Busenitz, 1996). They make a habit of scanning their environments for information that may lead to new business opportunities (Kaish & Gilad, 1991). Focusing on markets and customers increases the probability of recognising entrepreneurial opportunities (Hills & Shrader, 1998; Bhave, 1994). Sometimes the decision to start a venture precedes recognising an opportunity and there is a concerted search for and filtration of viable business opportunities. At other times, entrepreneurs discover problems to be solved or market needs to fulfill and, only then, do they decide to start a business and become entrepreneurs (Bhave, 1994).

Entrepreneurs often act on an idea with limited information (Hebert & Link, 1988; Gartner, Bird & Starr, 1992, Busenitz, 1996). They often have to make decisions where there are no historical trends, no previous levels of performance, and little, if any, specific market information (Miller & Frierson, 1984).

Entrepreneurs, especially in the formative stages of their organizations, do not have the luxury of becoming expert decision makers in a specific area (Gilmore & Kazanjian, 1989). If entrepreneurs wait until all the “facts” are in to start convincing others that their venture is indeed legitimate, the opportunity they are seeking to exploit will most likely be gone by the time all the data becomes available (Stevenson & Gumpert, 1985). For this reason, Busenitz and Barney (1997) suggest that those who make greater use of biases and heuristics (rules of thumb based on experience) in their decision making are more likely to find themselves in an entrepreneurial context.

It is not only entrepreneurs who operate in an entrepreneurial context. Financiers do as well; yet, less is known about how they recognize opportunities. Part of this has to do with the different types of financiers that are involved at the various stages of the entrepreneurial process. Bankers, for example, generally will only finance business ventures to the extent that there are hard assets against which to secure the debt. As such, entrepreneurs often need to turn to business angels (private or informal investors who tend to invest their own money and often their time) or venture capitalists (professional investors of institutional money) for alternative sources of funding.

From one perspective, the different types of financiers have similar objectives in that they want to structure their financing instruments so as to find the right balance of sharing cash and risk (Petty & Upton, 1996). They also seem to use a similar criteria or cue set when it comes to identifying potential business opportunities. Items such as the market, the team, and to a lesser extent, technology seem to provide dimensions along which financiers recognize opportunities. For example, financial corporate backers of corporate entrepreneurs (intrapreneurs) seem to support corporate projects that are in strategic alignment with the corporation, that are in an attractive market, and where the corporate entrepreneurial team have a good understanding of the marketplace (Koen, 1998). Venture capitalist studies report that funding a potential opportunity is dependent primarily on the quality of the entrepreneurial team (Goslin & Barge, 1986; Macmillan et al., 1985; Robinson, 1987) or the attractiveness of the market (Rah, Jung, & Lee, 1994). Because business angels are not accountable to others for their investment decisions, they invest on “gut feel” rather than based on comprehensive research. Interviews of business angels suggest that they may be more influenced by the entrepreneurial team during the screening process (van Osnabrugge, 1999) though they prefer to invest in markets and/or technologies that are familiar to them or in which they have had some direct experience (Kelly & Hay, 1996).

Yet, although similar criteria or cues seem to be used by financiers in recognizing opportunities, the various populations of financiers differ substantially. Differences occur in their risk preferences, backgrounds, experiences, prejudices, and objectives (Roberts, 1991). These types of items will vary the financing decision and help to explain why some financiers may think that particular projects are opportunities while others disagree.

The process of formulating an opportunity is discussed in terms of opportunity search, opportunity recognition, and opportunity evaluation (see, for example, Hills, Lumpkin, & Singh, 1997). Hills, Lumpkin, & Singh (1997) explored the opportunity recognition characteristics of successful (“hall of fame”) entrepreneurs against “other” randomly selected successful entrepreneurs and found only modest differences. Building upon their findings and those of Hills and Shrader (1998), we suggest that during opportunity recognition, potential opportunities are first identified and then they are evaluated against situational criteria; thus, we suggest that the opportunity recognition process is comprised of two phases: a generic opportunity recognition phase and a situational opportunity recognition phase. These two phases are followed by the opportunity evaluation process. The opportunity evaluation process also is comprised of two phases. Exhibit 1 provides an overview of the entire opportunity formulation process. Table 1 provides an explanation of individual phases within the overall process.

From the literature, it would seem that there are a range of cues that entrepreneurs and financiers place importance upon when recognising business opportunities. These appear to include (and are not limited to) the entrepreneurial team, the market, and/or the technology. In sorting through the range of cues in the opportunity recognition process, creative thinking involving cross associations of chunks of experience is used to synthesize the various cues and recognise patterns in the business complexity (see, for example, Simon, 1985). Simon (1985) argues that it takes 10 years or more for people to develop appropriate levels of experience to allow them to recognize patterns in new situations based on previous experience.

Put simply, the more times that an entrepreneur or financier is exposed to the opportunity recognition process, the more chunks of experience that will be developed for them to draw upon and add to their “opportunity recognition template.” Greater experience leads to greater confidence and greater alertness to business opportunities. This will influence the number of ideas entrepreneurs and financiers generate as well as where and how they search for opportunities. Experience with previously successful opportunities will influence the processes and strategies used and where future potential opportunities will be sourced. Individual networks would suggest that while similar search strategies will be used across groups, individual sources will differ.

Hypothesis 1: There will be no difference between experienced entrepreneurs and financiers in terms of their levels of creativity. (creativity and idea generation)

Hypothesis 2: There will be no difference between experienced entrepreneurs and financiers in terms of their beliefs that they are capable of recognizing business opportunities. (alertness to opportunities)

Hypothesis 3: There will be differences between experienced entrepreneurs and financiers in terms of where they search for business opportunities in the opportunity recognition process. (opportunity sources)

Hypothesis 4: There will be no difference between experienced entrepreneurs and financiers in terms of the processes and strategies used to source opportunities. (recognition processes)

Among experienced entrepreneurs and financiers, on the one hand, there is an expectation that there will be no difference in the opportunity recognition process. Opportunities are opportunities from any experienced person’s perspective and are characterized by certain characteristics or cues (see, for example, Timmons, 1999, pp. 86–95). As such, experienced entrepreneurs and financiers will have developed similar comprehensive internal opportunity recognition templates comprised of a relatively common set of “normative” cues and a “normative” weighting set for individual cues to help them identify opportunities. This template also will reflect the underlying causes of opportunities previously identified. Hills and Shrader (1998), for example, found that underlying causes of opportunities are often found where there are problems and business solutions are available to solve those problems, where there are changes in the market, and where customers are readily identifiable.

Hypothesis 5: There will be no difference between entrepreneurs and financiers in terms of their understanding of the underlying causes of opportunities. (causes of opportunities)

Hypothesis 6: There will be no difference between entrepreneurs and financiers in terms of the underlying cues used and cue weightings used to identify opportunities. (evaluation and “gut feel”)

On the other hand, however, there are other factors that may influence the opportunity recognition outcome. These factors focus on “fit” between the opportunity and the entrepreneur or financier. Fit will be determined by items such as risk propensity (which may include venture lifecycle stage), prejudices against or preferences for particular opportunities (industries, technologies, etc.), individual backgrounds, and objectives associated with a potential opportunity (for example, lifestyle considerations may feature strongly in whether to proceed with the opportunity). These items will moderate the opportunity recognition process. Thus, at one level, there may be universal agreement among experienced entrepreneurs and financiers on whether a particular scenario is an opportunity in general terms. At the individual level, fit of that opportunity, however, as measured against personal and business related circumstances, may cause diverging decisions as to whether the scenario is a potential opportunity. In other words, given that experienced entrepreneurs and financiers agree that a particular scenario is a potential opportunity (in general terms—at least for “someone”), that opportunity may not be an opportunity for individuals due to an inappropriate fit. What may be an opportunity for one person, may not be an opportunity for another.

Hypothesis 7: There will be differences between entrepreneurs and financiers in terms of whether the opportunity fits situational (personalized and business related) criteria. (situational criteria)

Participants

There were two studies undertaken. One study involved using a questionnaire; the other study involved capturing psychophysiological responses from participants. In both instances, participants had at least nine years’ current experience in an entrepreneurial context (they either operated their own high growth businesses or they provided finance to entrepreneurs). All had successful businesses or operated successful business units.

Questionnaire Main Study: The questionnaire sample comprised 262 respondents. There were 113 respondents (43%) that had between 10 and 21 years’ of experience. This data set was collected from entrepreneurs (n=157) and financiers (n=105). The financiers were made up of venture capitalists (n=53), business angels (n=13), and members of the banking industry (n=39).

Psychophysiological Response Pilot Study: The psychophysiological response pilot study used randomly selected respondents (n=6) from members of the entrepreneur group with between 10 and 18 years’ of experience. A control group (n=3) was also tested. The control group was comprised of individuals who had no entrepreneurial or business experience but who had between 8 and 12 years’ experience in the health and engineering fields.

Instruments

The questionnaire used in the main study was modified from a questionnaire originally used by Hills (1995) that was adapted from Teach, Schwartz, and Tarpley (1989) and Christensen and Peterson (1990). The pilot study used a two-channel Bioview datagraph machine to collect psychophysiological data from respondents as they responded to an investment proposal stimulus.

Questionnaire Main Study: The Hills’ Questionnaire is a 76-item measure. There were 51 questions taken from this questionnaire. The 25 questions rejected related to “owning your own business.” The assumption was made that many of the financiers would not own their own businesses and therefore would not be able to answer the rejected questions correctly. Each item, except for those identifying major new business ideas (these were scored on a 3 point scale) was scored on a 5 point Likert scale. In addition, a demographic information page was included that asked respondents details on age, gender, academic qualifications, experience, industry, size of organization, and number of employees.

Psychophysiological Response Pilot Study: In the pilot study, participants were wired to a Bioview datagraph machine so that certain physiological responses could be measured as they responded to an investment opportunity proposal stimulus. Heart Rate (HR) was measured on a beat per minute basis from an electrode placed on the respondent’s earlobe. In addition, a single electrode was attached to each subject’s right index figure to measure Electrodermal Activity (EDA). The data was collected in hardcopy form on charts and was downloaded to a PC for future statistical analysis. A tape recorder was used to record respondents’ concurrent verbalizations as they discussed whether they thought the investment proposal stimulus was an opportunity generally speaking and, if so, whether they thought it was an opportunity for them.

The investment proposal stimulus presented to the psychophysiological response pilot study respondents was a one page executive summary based on the winning business plan from the 2000 University of Texas International Business Plan Competition known as Moot Corp^®. This opportunity was voted by a panel of seven venture capitalists as the overall winner out of a final group of four business opportunities and a preliminary group of 27 opportunities presented by students from university business schools from 12 countries. The business that was the focus of the business plan now exports its products to a range of countries.

Analysis

The analyses differed for the main and pilot studies. The main study used a quantitative analysis; the pilot study used a qualitative analysis.

Questionnaire Main Study: The questionnaire results were analysed using the Statistical Package for the Social Sciences (SPSS). Results to the questionnaire examined the differences in responses between the two groups: entrepreneurs and financiers. Independent group t-tests were used to establish differences between the two groups on the categories of alertness, causes, creativity process, sources, and evaluation.

Psychophysiological Response Pilot Study: As the sample size was small in the pilot study, participants’ responses were examined qualitatively. Two independent coders were used to analyze the responses (concurrent verbalizations and biofeedback graphs as they related to the questions asked of respondents) after having being briefed on the research and the propositions and hypotheses developed.

Procedures

The procedures differed for the main and pilot studies due to their nature and the research questions asked.

Questionnaire Main Study: A research team was formed to collect the data from entrepreneurs and financiers. A “target list” was collated from organizations and individuals known to the group, financiers listed in a venture capital directory, and high growth businesses listed in Government collated databases. Participants were first contacted by phone to seek their willingness to be involved in the research and a preferred data collection method (for example, mail, fax, email, or personal visit) was negotiated. The direct approach by the research team to the targets facilitated a high response rate with few reports of unwillingness to complete the questionnaire.

Psychophysiological Response Pilot Study: This study examined Heart Rate (HR) and Electrodermal Activity (EDA) responses to opportunity recognition cues in six entrepreneurs who were selected from the questionnaire respondents. A control group of three subjects not associated in any way with business activity was also tested. Participants were thoroughly briefed on the procedure before being connected to the psychophysiological measurement machine. After an introduction to the experiment setting and procedures and purpose of the study, each respondent was connected to the apparatus. Responses (HR and EDA) were obtained during (1) baseline, (2) while reading the one-page executive summary from the business plan, and (3) while answering a number of questions posed after reading the executive summary. Finally, participants were thanked for their help and the whole process was discussed. Care was taken to ensure that no participants were distressed by the procedure. The participants were encouraged to contact the researchers if they had any unresolved questions about the experiment. No telephone calls were received.

Results and Discussion

Questionnaire Main Study: There were few significant differences between the entrepreneurs and financiers except in the area of sources of ideas. Overall, this lends support to the notion that experienced entrepreneurs and financiers develop a general level of understanding that allows them to recognize opportunities at a generic level. This suggests that similar generic cues and/or cue weightings may be used by each group against which potential opportunities are measured.

Differences between the two groups occurred for Hypothesis 1 (creativity and ideas), Hypothesis 2 (alertness to opportunities), Hypothesis 3 (opportunity sources), Hypothesis 4 (recognition processes), and Hypothesis 6 (causes of opportunities). These differences, however, related to a specific question within various categories of questions on the questionnaire rather than for the majority of the questions in a particular category or the category of questions as a whole. In addition, differences were noted for Hypothesis 7 (situational criteria) in the psychophysiological study.

Hypothesis 1—Creativity and Idea Generation: Overall, there were no differences on the measures of creativity and idea generation. Entrepreneurs, however, differed on the importance of business ideas in the creative process (t = 2.241; p < .05). Compared to financiers, entrepreneurs thought that ideas were more important. Financiers deal in potential opportunities that are presented to them by entrepreneurs. Whereas entrepreneurs need to sift through and generate many ideas before identifying an opportunity that they can present for funding consideration. As such, it all is a matter of degree. What starts off as an idea for an entrepreneur becomes a business proposition for a financier. Though financiers need to use both right and left brain skills in evaluating business proposals, their quantitative leanings may explain their preference for evaluation rather than idea generation.

Hypothesis 2—Alertness to Opportunities: Overall, there were no differences on the measures of alertness; however, entrepreneurs were significantly different in one area believing that they had a special sensitivity or alertness toward opportunities (t = 1.963; p<.05). Entrepreneurs tend to be very positive people and tend to have strong belief in their capabilities. This result demonstrates the strength of their beliefs in their “gut feel” in identifying opportunities. The reality, however, often is different as financiers well know. Many businesses do not succeed. As a result, financiers will be more cautious in their beliefs that they are alert to recognizing opportunities perhaps because of funding decisions that have gone “bad.”

Hypothesis 3—Opportunity Sources: Financiers were more likely to rely on trade publications as sources for ideas whereas entrepreneurs tend to get information from professional acquaintances (t = 1.817; p <.001). At first, we were perplexed by this finding as we expected that financiers would rely heavily on their network of contacts to refer deals to them. However, on reflection, this result provides insight into how financiers monitor trends for future business opportunities. They get their ideas from publications to gauge consumer and industry trends and then most probably source deals in those areas. On the other hand, entrepreneurs typically are excellent networkers. They know that they need other people to help them achieve their goals. Professional advisers are exposed to a range of clients with differing businesses and products/services. Entrepreneurs apparently recognize this and use professionals as a trusted ideas source.

Hypothesis 4—Recognition Processes: Overall, there were no differences on the measures of recognition processes. Entrepreneurs, however, believed more strongly than financiers that one idea leads to another (t = 4.054; p<.001). This is not surprising. Financiers receive discrete business propositions from various sources for funding consideration. Presumably, one proposition would have no relation to the next. Entrepreneurs, on the other hand, are at a lower level in trying to identify opportunities and may use ideas generated or insights gleaned from one situation as a “springboard” to the next. In addition, it supports the notion that entrepreneurs are more open to ideas than financiers.

Hypothesis 5—Causes of Opportunities: There were no differences between entrepreneurs and financiers on the measures of the underlying causes of opportunities. Both groups appear to be attuned to the fact that there are opportunities associated with problems and market related changes.

Hypothesis 6—Evaluation and “Gut Feel”: Overall, there were no differences on the measures of evaluation and “gut feel.” Financiers, however, felt significantly more strongly than entrepreneurs (t = 4.856; p <.05) that formal market research is important when evaluating ideas. This reflects perhaps a greater tendency toward thoroughness of financiers and the fact that they are used to doing “due diligence” on the claims of entrepreneurs. Entrepreneurs, however, have to make decisions and work with only partial market and other information to develop an opportunity.

Psychophysiological Response Pilot Study: A marked difference was found between the entrepreneur respondents and the “non-business” group on Heart Rate but not Electrodermal Activity. The HR of the six entrepreneurs increased significantly while reading the executive summary, when asked questions about whether they thought the business proposition was a business opportunity, and whether they thought the business proposition was an opportunity for them. The verbalizations of all six respondents supported the fact that they believed that this was an opportunity with great potential. Reasons given tended to focus on the market, the technology, timing, and strategic alliances (which were market oriented). Two of the six respondents, however, believed that it was not an opportunity for them as they had no experience in the industry and would not want to undertake the travel necessary to develop the opportunity.

In contrast, the “non-business” group’s HR and EDA did not alter at all during these activities. Their verbalizations indicated that they did not know what they were looking for. One of the three respondents in the control group, however, said that she believed that she could recognize an opportunity. Both her physiological responses and her verbalizations indicated that she did not believe that this proposition was an opportunity though.

These results suggest that experienced entrepreneurs know what to look for in assessing opportunities whereas non-entrepreneurs do not. The results also provide tentative support for Hypothesis 7 that there needs to be a good fit between situational criteria and the opportunity (regardless of how exceptional the opportunity is perceived) if the opportunity is to proceed to the opportunity evaluation stage.

Research Limitations

This research has a number of limitations. First, the samples for the two groups were not randomly selected which affects generalizability of the results. Second, the sizes of the financier subgroups differed. Third, the experience levels of participants were nine years’ or more. Simon (1985) contends that people become more “expert-like” after 10 or more years. Fourth, there is no evidence at this point of construct, criterion related, and discriminant validities of the questionnaire. In addition, internal consistency ranges and test/retest reliabilities have not been established. Finally, the collection of psychophysiological responses in the area of entrepreneur research is new and, as with any “new” technique, its role is still to be established. The use of psychophysiological responses to provide insights into the opportunity recognition process, however, opens up a new area that offers additions to the current methods of data collection and evaluation.

Research Application

This study is part of an ongoing research program that is attempting to identify the cues used and the relative weightings applied to cues by decision makers for particular industries in the first phase of the opportunity recognition process (the GOR Phase). The results of the research are being used to develop and validate a venture-screening tool that assists in quantifying “gut-feel.” “Ideal” weighting structures are being developed for particular industries whereby there is agreement among decision-makers as to relevant cue weightings. The instrument uses 10 dimensions or cues as an underlying basis for recognizing opportunities at the highest level during the GOR Phase (for example, technology, market, product, people etc.). There are sub-dimensions or sub-cues associated with each dimension/cue.

The pilot instrument already has achieved limited success at a number of beta sites. A number of venture capitalists and investors are using the pilot instrument and, though it is not perfect, they endorse its relevance and usefulness in the opportunity screening process. The instrument is being used to help “cull” potential opportunities from non-opportunities that are presented for funding. This is being done through users of the instrument providing actual weightings along the cue set provided based on their experience. The variances between the “ideal” and the “actual” cue weightings are then analysed. A detailed report and web graphs are produced as a result. The output documentation is then used to justify preliminary rejection or acceptance of particular deals to interested stakeholders.

Exhibit 2 provides an example of one of the graphs produced by the pilot GOR Screening instrument. The graph shows the “ideal situation” for this dimension as the outer most web graph (A) and the pattern of the actual situation as determined by the financier (B). In this particular instance, the actual situation falls short of the ideal situation (C). It shows the specific dimensional areas that require improvement for this deal to be more acceptable if it is to be a candidate for the Opportunity Evaluation Due Diligence Phase.

This research set out to build on previous investigations into opportunity recognition in the entrepreneurial process. The early indications support the proposition that, in the very early stage, opportunities are seen in a similar light by anyone who has entrepreneurial experience whether they are entrepreneurs or financiers. This was supported by the early stage investigation into psychophysiological responses. Application of the propositions through the concurrent development of the opportunity recognition matrix has meant that “gut-feeling” can be quantified when recognizing opportunities at least at the Generic Opportunity Recognition Phase.

CONTACT: Justin Craig, School of Business, Bond University, Gold Coast QLD 4226, AUSTRALIA; (T) +61-7-5595 1161; (F) +61-7-5595 1160; Justin_Craig@bond.edu.au

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