ABSTRACT
INTRODUCTION
OWNERSHIP CONTROL, RESOURCES AND PERFORMANCE
HYPOTHESES
RESEARCH METHODOLOGY
RESULTS
LIMITATIONS
DISCUSSION AND IMPLICATIONS
ACKNOWLEDGMENTS
CONTACT
REFERENCES
TABLE 1
TABLE 2
TABLE 3
TABLE 4
TABLE 5

This research examines how the sources of seed capital and the structures of equity ownership control affect the performance of knowledge-intensive new ventures in high technology industries. Anchored in several theoretical perspectives this research compares the effects of institutional and non-institutional sources of seed of ownership control on firm performance. Performance is conceptualized in terms of innovation speed and operationalized as speed to product and speed to market. The findings indicate that for speeding ideas into products the structure of ownership control has a significant effect on performance while the source of ownership control does not. For speeding products to market, the resource position of the firm has a significant effect on performance while neither the source nor the structure of equity ownership control does. The study’s main conclusions show that money may be necessary but is likely not sufficient for high technology start-up firms to turn ideas into products and take products to market.

If they are to survive, high technology start-ups must speed ideas into products and turn products into markets. En route, start-up firms face a number of strategic choices. Key among them are choices about the sources and structures of ownership control. High technology start-ups operate in turbulent, high-risk environments, that make raising funds from traditional capital market sources difficult. As such, equity seed capital for high technology entrepreneurial start-up firms originates from multiple sources whose mix may prove critical. Besides the entrepreneur, investors in the high technology start-ups often include friends, family, private investors or angels, professional venture capital firms, a variety of strategic partners, and corporate parents. Through their ownership positions, each group of investors, whether institutional or non-institutional, may exercise control over the firm, potentially add value, and influence firm performance. (Bygrave & Timmons, 1992; Sapienza, Manigart, & Vermeir, 1996—among many others). In addition to selecting the appropriate mix of investors, start-up firms must also make decisions about the structure of equity ownership and control. While of enormous theoretical and managerial consequence, the links between these choices in governance and the outcomes in performance have received limited attention in the literature. To this end, this research seeks to answer several questions: How do the sources of capital and the structures of ownership control influence the performance of high technology start-up firms? Do institutional sources when in control of equity increase the likelihood that the firm will complete either new product development or and begin international sales and do so faster?

The research context for the study is the emerging high-technology sector in Israel. Over the past ten years, public policy and private initiative stimulated impressive growth rates in high-technology entrepreneurship in Israel. The explosive growth of Israel’s high technology sector has attracted widespread attention. For example, in their survey of “Venture Capitals” Wired Magazine (July 2000) placed Israel in the top four of the world’s high technology hot spots: one behind Silicon Valley, on par with Boston and Stockholm, and ahead of London, Helsinki and Bangalore. Israel’s estimated 2,500 entrepreneurial start-ups incubate and commercialize research and development in a variety of knowledge intensive high-technology industries. Such high-technology start-ups fall at all stages of development, cross a number of industrial categories, receive public and private seed capital, and face mixed governance structures with diverse groups of stakeholders. Though manifesting substantial competitive potential, Israeli start-ups in high-technology until now have received only marginal attention from researchers in strategy and entrepreneurship. This research represents the first systematic attempt to understand how the sources of seed capital drive the innovative performance of Israel high technology firms. Findings have implications that transcend the Israeli context and more generally inform our understanding finance, governance, and performance of high technology start-up firms.

Ownership Control

Researchers have long recognized that organizational control may play an important part in explaining firm performance. Both resource dependence (Pfeffer & Salancik, 1978) and agency theories (Fama & Jensen, 1983) suggest that it is important to consider who controls the ownership of the firm, how such ownership is structured, and why it becomes concentrated (Shleifer & Vishny, 1995). Resource dependence theory argues that for dependence between two organizations to occur control must be concentrated. On the other hand, agency theory suggests that concentration of ownership serves as countervailing response to managerial control of the firm. For example, the literature also presents several competing hypotheses to explain the effects of institutional sources of ownership on innovation and firm performance (Kochhar & David, 1996). In the context of firm emergence, ownership control is potentially of great relevance because the sources of a firm’s seed capital can originate with diverse environmental actors (Aldrich, 1999; Katz & Gartner, 1988). Indeed, high technology start-up firms often have stakeholders that are both institutional and non-institutional in their origin and whose individual goals may not be congruent with one another or the firm. The extent to which they exercise formal control over the firm through their equity position may influence the direction of the firm and its subsequent performance. This research tests whether differences in the source and structure of equity ownership control explain early firm performance.

Firm Resources

In this research, resources are taken as building block of the firm. Resource based view of the firm and resource dependence theory both treat firm resources as critical to growth, and together they help establish a link between the needs of the firm and power of the environment. The resource based view of the firm argues that the identification, generation, accumulation, combination, and deployment of firm specific resources is critical to firm growth (Penrose, 1959; Chandler & Hanks, 1994; Green & Brown, 1997). External organizational actors may significantly impact the ability of the firm to create resources through their use of power, authority, and legitimization. (Pfeffer & Salancik, 1978). This research tests how institutional and non-institutional investors when in control of equity ownership effect the emerging firm’s ability to create resources.

Firm Performance

Firm performance is the final dependent variable in this research and is measured with multiple time-based measures. Stinchcombe (1965) and others have argued that new firms have to overcome the liability of newness arising from age, small size, lack of organizational structure, and product track-record. For high technology start-ups, whose product life cycles are short and time is of the essence, the speed with which a firm moves from idea to product may impact its ability to overcome the liabilities of newness. Finishing product development and shipping the first product for revenue are considerable milestones in the life of a high technology start-up (Schoonhoven, Eisenhardt, and Lyman, 1990). That is, high technology start-up firms that increase the speed with which they move from idea to product and product to market will gain independence quickly from their sources of seed capital, will gain first mover advantage and put more distance between themselves and the competition, will have lower development costs, and will reap greater economic value from getting the product to market faster. Performance is captured in the notion of innovation speed which is operationalized in terms of how quickly a firm completes new product development (speed to product) and the speed with which a firm completes first international sale (speed to market). Each measure captures the period of time that has elapsed between firm founding and the event occurring

The following hypotheses are grounded in the theoretical perspectives discussed above, the extant empirical literature, and grounded empirical fieldwork. The hypotheses suggest that through their origin and control over equity capital sources of seed capital can influence the overall resource position and performance of the firm. An extended conceptual model and more elaborate explanations can be found in Khavul (2001).

Effects on Speed to Product

A high technology start-up firm’s sources of ownership control and resource positions can impact the speed with which the firm can turn ideas into products. Resource based theory argues that the primary goal of the firm in the early stages is to turn assets, such as idea, money and people, into resources that are scarce, unique, and difficult to imitate (Amit & Schoemaker, 1993). High technology start up firms need to turn their technical ideas and investment capital into products; moreover, they need to do so with dispatch (Schoonhoven, Eisenhardt & Lyman, 1990). Firms that are able to turn assets into resources and do so more effectively will be more likely to have completed new product development.

Resource Effect:

Hypothesis 1: Start-up firms with higher resource positions are more likely to have completed new product development than firms with lower resource positions.

The literature presents a number of competing arguments to explain the differences between institutional and non-institutional investors as they relate to innovation in the firm. (Kochhar & David, 1996.) One line of reasoning suggest that institutional investors because they are more active and have potentially greater resources to contribute to the start-up firm will be more intent on driving the speed of new product development. In addition, institutional investors have more information and a better perspective on the unique opportunities a particular start-up presents. Institutional investors also have larger networks and can be at the center of substantial knowledge flows that may benefit the start-up. This research tests such arguments by hypothesizing that start-up firms under institutional control will be more likely to have completed new product development than firms under non-institutional control.

Source of Ownership Control Effect:

Hypothesis 2: Start-up firms where private institutional sources of seed capital hold a controlling interest in equity are more likely to have completed new product development than those start-up firms where private non-institutional sources of seed capital hold a controlling interest in equity.

Structure of Ownership Control Effect:

Hypothesis 3: Start-up firms where mixed sources of seed capital hold a controlling interest in equity are more likely to have completed new product development than either start-up firms with institutional or non-institutional sources of seed capital hold a controlling interest in equity.

Effects on Speed to Market

Finishing product development is clearly only one measure of performance and an intermediate one at that. To survive high technology start-ups have to take products to market. Given the size of Israel’s domestic market, this research uses international sales rather than domestic sales as a measure of performance. The hypotheses suggest that the resource position of the firm and the source of its ownership control affect the speed with which start-up firms turn products into markets. In the case of this research, speed to market is operationalized in terms of the time from start of firm to the first international sale. It is hypothesized that in order to complete the first international sale, firms must have not only turned their ideas and money into a new product but also have built organizations capable of doing so. For example, this means that they have hired leading management and marketing expertise, secured access to marketing channels through strategic partners or intermediaries, and raised additional financing. In short, to become international new ventures, firm have to build up resource positions that support future growth (Oviatt & McDougall, 1994). That is, start-up firms with higher resource positions are more likely to have completed first international sale than firms with lower resources positions.

Resource Effect:

Hypothesis 4: Start-up firms with higher resource positions are more likely to have completed first international sale than firms with lower resource positions.

It was hypothesized that firms under institutional control will be more likely to complete new product development. Similarly, in the case for speed to market, it is hypothesized that firms under institutional control will be more likely to complete first international sale than those under non-institutional control. Here the arguments around the strength of institutions can be made more explicit. It can be argued that institutions have broader social and marketing networks which they bring to bare in the product commercialization process. Certain institutions such as strategic partners may be better at delivering marketing contracts that lead to first sale.

Source of Ownership Control Effect:

Hypothesis 5: Start-up firms where private institutional sources of seed capital hold a controlling interest in equity are more likely to have completed first international sale than those where private non-institutional sources of seed capital have a controlling interest in equity.

Structure of Ownership Control Effect:

Hypothesis 6: Start-up firms where mixed sources of seed capital hold a controlling interest in equity are more likely to have completed first international sale than start-up firms where either institutional or non-institutional sources of seed capital hold a controlling interest in equity.

This research adopts a multi-method approach which incorporates grounded case interviews, population level data collection, and a hypotheses testing survey. The primary unit of analysis is the high technology start-up firm. The ultimate dependent variable is firm performance which is captured by two time-based measures. The key research question asks how sources of seed capital and the structures of their equity ownership control affect firm performance. To establish a theoretical link between a firm’s sources of seed capital and its performance requires an interplay of ideas at multiple levels. As such, the research operates at the meso level of analysis that incorporates traditional micro, firm-level variables, and macro environmental variables. The meso-level approach incorporates both types of variables in the same theoretical formulation and research design.

The research incorporated data from face to face case interviews (n = 81), population level databases (n = 1,679), and a random sample hypotheses testing survey (n = 120). Interview Data: The research is grounded in face to face interviews (n = 81) with CEOs and Founders of high technology start up firms, venture capitalists, private investors, and public-policy makers. Grounded theorizing and hypotheses building were the primary aims of the qualitative case interviews. Interview notes were transcribed and subject to theme convergence. Population Data: This research relies on population level data collected from multiple secondary sources and systematically verified. Establishing the population was critical for credible random sampling and future validity checks. Survey Data: The results reported in this paper are based a mail survey that captured both cross-sectional and longitudinal data. Hypotheses testing was the primary purpose of the survey. The survey was mailed to a random sample 575 Israeli high technology start-up firms; of these, n = 120 usable surveys were returned. In 1999, the targeted firms represented 34% of the identifiable population of 1,679 Israeli high technology start-up firms. The effective response rate for the survey is 26 percent. This response rate is well within the acceptable norms for empirical research in the entrepreneurship literature.

Based on shareholder information, the firms in this research were classified into three groups: (i.) those where institutional sources of seed capital control equity ownership (ii.) those were non-institutional sources of seed capital control equity, and (iii.) those were the control of equity is mixed or shared between institutional and non-institutional sources of seed capital. Institutional sources included professional venture capital, strategic partners, and corporate parents while non-institutional sources included personal-friends-family finance and private investors or angels. The level of ownership control was set at a supra majority of fifty-one percent. Survey data was analyzed using factor analysis, and analysis of variance, and the Cox Proportional Hazard Model.

Survey Instrument

To test the hypotheses, a survey instrument that collected both cross sectional and longitudinal data was developed specifically for this study. The survey combines five point Likert scales to measure theoretical constructs, direct questions designed to gather demographic information, and several open ended questions. Nine random, naïve subjects from the target population took the survey as pre-test and provided comments on the structure and clarity of the instrument that were incorporated into the final version of the survey. In addition to the English language version, the instrument was translated into both Hebrew and Russian and was retranslated back to English. There were no significant differences between surveys returned in different languages. The measures were shown to be reliable within acceptable standards. Performance is captured by speed to product and speed to market that are each captured by multiple indicators and load on two orthogonal factors. The individual factor loadings range from .78 to .94. and the cumulative variance explained is 74 percent. Resource position is measured with four subscales using a multiple items in each and five point Likert scoring. Cronbach’s alpha for the resource position measure is a = .75.

Sample Characteristics

The survey targeted Founders and CEOs of the entrepreneurial high technology start-up firms. Of those who answered the survey, 70 percent were CEOs (the remainder VPs, CTOs, and CFOs); 66 percent were members of the original founding team; 68 percent held equity in the firm; 40 percent reported having some prior start-up experience. The education level was high with 28 percent holding a doctoral degree and 65 percent trained in science and engineering. Women represented 11 percent of the sample and immigrants 37 percent (of which 7 percent were immigrant from the former Soviet Union.) The high percentage of CEOs and other top management team members among the respondents suggests that this research appropriately tapped into the critical institutional memory and information within the firm.

The research targeted privately held entrepreneurial high technology start-ups across several industrial categories. The firms included in the analysis were founded between 1990 and 1998. The sample represents firms in four major industrial categories: 32 percent of the firms were involved in medical and biosciences; 14 percent in communication; 30 percent in software and internet; 24 percent in semiconductors and hardware. At the time of the study, the average firm was 4.5 years old with 17 full-time employees. Based on age, industry, location, and size, the firms in this sample are representative of the larger population of Israeli high technology start-ups.

Validity

Validity tests were conducted on three random samples from three groups of interest: (i.) firms that responded to the survey (n = 45); (ii.) firms that did not respond to the survey (n = 45), (iii.) firms not surveyed (n = 45). Random selection of firm enhanced external validity; however, to establish external validity tests showed that the data collection was not subject to response and selection bias. The three groups were compared across four key characteristics for which data was available: location using telephone city codes; year the firm was founded; number of employees in 1998; major industry categories. Chi-squared and ANOVA tests revealed no significant differences between the group to which a firm belonged and either of the four firm characteristics above. Further tests for convergent, content, and construct validity were also conducted. With the usual caveats in mind, it is possible to argue that the sample in the study is free of bias and its results are generalizable to the larger population of Israeli high technology start-up firms.

The findings of this research generally support its analytical arguments and conceptual model. While a number of the hypotheses were not supported as stated, the findings shed light on future research directions. The major findings of this research are presented below and summarized in Table 1. Detailed analysis of effects on speed to product are presented in Table 2 and Table 3. Detailed analysis of effects on speed to market are presented in Table 4 and Table 5.

The results reveal partial support for these hypotheses. There are three major results.

1. Firms with higher overall resource positions are significantly more likely to have taken products to market and completed first international sale. Specifically, a one-unit improvement on the resource position scale increases, at any given point in time, the likelihood of completing first international sale by approximately two hundred and forty percent.
2. Firms where institutions hold controlling interest in equity are not more likely to have completed new product development or to have taken products to market faster than firms where non-institutional sources hold controlling interest in equity.
3. Firms where controlling interest in equity is mixed are significantly more likely to have completed new product development and have done so faster than either firms solely controlled by institutional or non-institutional sources. Specifically, at any given point in their lives, the likelihood of completing new product development for firms under mixed control is approximately eighty-one percent higher than for firm under institutional control and approximately sixty-eight percent higher than for firms under non-institutional control.

In summary, in the case of speed to product, there are significant effects for structure of ownership control and, in the case of speed to market, there is a significant resource effect.

A limitation of this study is that it is focused on firms in only one country, at a particular stretch in its history and in the history of technological innovation. In due course, a longitudinal study of the firms in the sample should be undertaken and extended to other countries. Given the tentative and private nature of the information the firms are asked to report, the opportunities for confirming this data from external sources is extremely limited. This problem plagues much work on emerging organizations. Where available, a full archival search was conducted on all the firms in the sample to corroborate the data.

This study sought to shed light on how the sources and structures of the firm’s ownership control and its resource position affect its performance. The study’s main conclusion shows that money may be necessary but is likely not sufficient for high technology start-up firms to overcome the liability of newness. In order for start-up firms to survive they must deliver; that is, they must be able to turn ideas into products and products into markets. Start-ups must be able to convert the ideas and money that spur innovation into the resources and knowledge that create competitive advantage. The findings of this research hold several major implications for how entrepreneurs and investors can improve the likelihood that start-up firms will innovate quickly and compete more effectively.

The fit between the sources of seed capital and the entrepreneurial firm matters. Entrepreneurs face strategic decisions about potential sources of seed capital. Investors face strategic decisions about where to invest and with whom to co-invest. The multiple sources of seed capital, whether friends, family, venture capitalists, private angel investors, strategic partners, or corporations, become ownership partners through their investments in the firm. The results of this study suggest that the mix of stakeholders in the firm matters to meeting early performance milestones. Entrepreneurs and investors should select each other carefully.

The structure of ownership control matters for speeding from ideas to products. Entrepreneurs and investors who share ownership control are significantly more likely to complete product development and do so faster. Entrepreneurs and investors often compete for control, indeed, to some, “control is everything.” The results of this study show that the manner in which ownership control is shared significantly impacts the likelihood that the high technology start-up firm will complete new product development. Firms where ownership control is mixed or shared are more likely to complete new product development. Moreover, they will also do so faster than firms where control is not shared. Thus, compared to firms where control of equity ownership is shared, the likelihood of completing new product development, at any given point in time, for firms under institutional and non-institutional control is dramatically lower. Specifically the likelihood goes down eighty-one percent for firms under institutional control and sixty-eight percent for firms under non-institutional control. Entrepreneurs and investors should consider how ownership control should be shared.

Building resources significantly improves the likelihood and speed with which a firm moves from products to markets. High technology start-up firms rarely fail because the technology they are developing does not work. More often they fail because they lack the resources for bringing products to market. For example, speeding products to market requires resources such as highly productive employees, leading management personnel, leading outside board members, smooth operating procedures, access to marketing channels, and access to alliance partners. This research shows that firm which have built these resource positions are significantly more likely to complete their first international sale. Moreover, they will do so faster. Specifically, for every twenty percent improvement in their resource positions firms increase the likelihood of completing first international sale by approximately two hundred and fifty percent. Start-up firms should build critical resources if they want to compete in international markets.

The author wishes to thank James E. Post, Candida G. Brush, Shlomo Kalish, and Miri Lerner for their help and the Open Society Institute for its support.

CONTACT: Dr. Susanna Khavul, Assistant Professor of Entrepreneurship, London Business School, Regent’s Park, London NW1 4SA United Kingdom; (T) 44-20-7262-5050, ext 3663; skhavul@london.edu

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