New entrepreneurial ventures

Daniel Landsman

New Entrepreneurial Ventures “The difference that makes a difference”

Introduction

There are many factors that effect if an entrepreneur will be successful. Obviously, the ability

to raise capital is an important factor. Being unable to procure capital may possibly prevent some

qualified entrants from actually becoming entrepreneurs. Evans and Jovanavich1 found that if liquidity

constraints were removed, entrants would have no problems procuring capital, and within the time line

they studied entrepreneurship entry would have increased from 3.81% to 5.11%. Financing the venture

will be the first topic that I discuss which makes a difference in how successful an entrepreneur's firm

is.

The second characteristic that influences the success of an entrepreneur's new venture is human

capital . Human capital can include, but is not limited to: how much education the individual has, the

jobs the entrepreneur had previously held with rank attained, what the individuals parents did, the costs

of switching careers to go work for someone else, and also their personal feelings about their success.

There are many more human capital factor that have a substantial effect on the outcome of the

entrepreneurial venture. These effects will be discussed later for further review.

This paper is laid out I n the following format. I will first review the previously conducted

research about financing and human capital for new business ventures. Then I will present my

hypotheses, that may be tested in the future , but will be extrapolated at this point in time to attempt

1 An Estimated Model of Entrepreneurial Choice under Liquidity Constraints Author(s): David S. Evans and Boyan Jovanovic

Source: The Journal of Political Economy, Vol. 97, No. 4 (Aug., 1989), pp. 808-827

to defend my views about financing and human capital for new business ventures. Then I will look at

the data that different people have extensively collected through out their respective areas. After which

I will give my interpretation of the data along with what was originally found. Finally, I will give my

conclusions and state other areas of research that could be pursued.

Previous Research

To prevent convolution I must make clear that I am only looking at what makes a new venture

successful from the start. Klofsten2 business platform theory has some very valid points but it doesn't

focus on the area I'm trying to study. Therefore, I will acknowledge the business platform theory

Klofsten2, but choose to leave it out because it focuses on the volatility of young firms and certain

business steps that can be undertaken to avoid failure.

Penrose3 said being a successful venture has mostly to do with the profitability of the firm. If

the company is unprofitable it will go out of business because other firms force it out of the market.

This statement seemed very obvious to me because if a firm doesn't make money why would it stay in

business. Because profitability plays such a large role in determining the future outcome for a firm I

will use profitability as a measure of success.

It is important to find what drives those profits that Penrose was talking about. Financial capital

plays a roll in a firms profitability. Most studies show that when profits are measured as a gauge of

success the larger the firm with respect to assets the higher the profits. This is to be expected because

2 Klofsten, M. (1998). The Business Platform:

Entrepreneurship and Management

in the Early Stages of a Firm’s

Development. Luxembourg: European

Commission, TII.

3 Penrose, Edith Tilton

1952 Biological Analogies in the Theory of a Firm

American Economic Review 42 804-819

the firm wouldn't grow larger if it was not a profitable venture. Candida G. Brush, Linda F. Edelman,

and Tatiana S. Manolova4 studied how the initial location and aspirations of the specific entrepreneur

had an effect on the procurement of financial capital. In their model they showed that the higher the

initial aspirations the more likely the entrepreneur was to obtain larger amounts of capital. This was

because most of the time the higher aspirations would lead the entrepreneur to start the business away

from their home allowing for greater visibility to their potential clients. Also, with a separate work

location, more organized business practices would become implemented which created more credibility

with possible venders and business' partners, which eventually lead to better opportunities in order to

obtain financial capital. Levenson and Willard’s5 found that at most 2% of entrepreneurs fail to obtain

financing from banks. The biggest reason for not obtaining credit was that their business plan or project

was socially inefficient. Bates6 found that the government stepped in and helped finance many

entrepreneurs, especially the minority groups to cultivate more entry into different businesses. There

are sometimes loan guarantee schemes that are created by the government in order to help

entrepreneurs who cant get financing from banks. However, the government loan guarantee schemes,

only account for 1% of the loans made to entrepreneurs.

Other factors contribute to the profitability of firms. Human Capital Theory Becker7 “uses

economic logic to study individual decisions dealing with productivity-enhancing skills and

knowledge(school, training,other firm specific investments), career choices(decision to work,switching

4 Candida G. Brush, Linda F. Edelman, and Tatiana S. Manolova

The Effects of Initial Location, Aspirations, and Resources on Likelihood of First Sale in

Nascent Firms

Journal of Small Business Management 2008 46(2), pp. 159–182

5 [11] A. R. Levenson and K. L. Willard, “Do firms get the financing they want?

Measuring credit rationing experienced by small businesses in the US,” Small

Business Economics, vol. 14, pp. 83–94, 2000.

6 Timothy Bates Entrepreneur Human Capital Endowments and Minority Business Viability

The Journal of Human Resources, Vol. 20, No. 4 (Autumn, 1985), pp. 540-554

7 G. Becker Human Capital

New York Columbia Press 1975

employment, labor mobility) and other work characteristics(wages, reservation wages, hours of work).

It is believed that individuals choose an occupation or employment that maximizes the present value of

economic and psychic benefits over their lifetimes.” Cooper, Folta, Gimeno, and Woo8 conducted a

study that showed each firm had a specific “threshold” which is an aggregation of the deciding factors

to close the firm. Thresholds are one of many factors that the entrepreneurs posses that stem from their

own human capital. Cooper, Folta, Gimeno, and Woo8

also showed that just because a firm stays open

doesn't mean its entirely successful. Certain entrepreneurs may have other jobs or just enjoy working

for themselves as opposed to working for someone else. Therefore, Cooper, Folta, Gimeno, and Woo8

thresholds alone aren't a good measure for profitably. Due to the fact a person might stay in businesses

just because they have a greater utility doing so; not because they are profitable.

Evans and Jovanovich9 studied how the liquidity constraints on entrepreneurs effected the amount of

money they could procure for their business venture. Evans and Jovanovich10

showed how the capital

the entrepreneur was able to get in the beginning of their venture linked to their profitability. Evans

and Jovanovich11

said the high ability low asset people are affected by the wealth liquidity constraint

the most. Wealthier people would have a much easier time starting a business because they already

have the capital available. What this means is even if you have a high level of human capital it won't

do you any good unless you can come up with the necessary financial capital to match it.

Hypotheses & Model

8 Javier Gimeno; Timothy B Folta; Arnold C Cooper; Carolyn Y Woo

Survival of the fittest? Entrepreneurial human capital and the persistence o...

Administrative Science Quarterly; Dec 1997; 42, 4

9 David S. Evans and Boyan Jovanovic

An Estimated Model of Entrepreneurial Choice under Liquidity Constraints








H1: Financial Capital makes no difference in a firms profitability.(Which is my measure of success.)

H2: Human Capital makes no difference in a firms profitability.

The model that I would like to have had isn't possible because without the financial backing to

make my research legitimate I am forced to use other people's research. I will try to extrapolate the

specific factors that make entrepreneurs successful. I will expand the exit equation used by Cooper,

Folta, Gimeno, and Woo12

but only for theoretical purposes. Originally their model was designed to

show the factors that would make a firm exit their specific business. The way I'm going to use their

model in an expanded form to illustrate what are the factors that make a person successful from the

start. Their original equation shows "The entrepreneur's economic performance (EPe) is a function of

his or her general human capital represented by the vector X1, and of the human capital specific to the

current business, represented by the vector X2. Meanwhile, since specific skills cannot be transferred to

alternative employment, the economic returns available in employment (EPa) are a function of stock of

general human capital X1 and of a specific human capital to an alternative occupation X3 but not of the

human capital specific to the current business X2.

The individuals psychic income associated with either the entrepreneurial venture(PIe) or alternative

employment(PIa) is influenced by a number of factors ( respectively, X4 and X5), including the

individuals preference for the occupation, or personal satisfaction." Ue is Utility received from

undertaking the venture. Ua is the utility from taking another occupation.

Ue=EPe(X1,X2)+PIe(X4) .....1a

Ua=EPa(X1,X3)+PIa(X5) .....1b

substitute 1a and 1b into one equation EPe on one side

Start Venture if




EPe(X1,X2)>EPa(X1,X3)+PIa(X5)-PIe(X4) .....2

Cooper, Folta, Gimeno, and Woo9 put in another variable called SC which represented the cost

of switching occupations, since I'm focusing on starting the venture, I chose to omit that particular

variable . I switched around the inequality to represent when the startup of a firm should happen instead

of an exit. Cooper, Folta, Gimeno, and Woo9 equation 2 only refers to human capital which is only one

part of becoming a successful entrepreneur. I need to change their equation further to show the

financial aspect. I'm going to say that procuring capital is also an important step towards success as an

entrepreneur. Therefore, I'm going to say that the money entrepreneur's can make from the venture and

the ability to procure capital for the current venture will be represented as FCe(X6) and Fca(X7) for

the salary that the person would have received from working in an alternate occupation and their ability

to keep their job. Also I eliminated psychic capital because it can't be linked to profitability which I am

using as my measure of success.

From this we can expand equations 1a and 1b to include Fce(X6) and FCa(X7)

Ue=EPe(X1,X2)+FCe(X6).....1c

Ua=EPa(X1,X3)+FCa(X7).....1d

Start Venture if Ue>Ua

Epe(X1,X2)+FCe(X6)>EPa(X1,X3)+FCa(X7).....2b

Data

I will be referring to a few different data sets. Evans and Jovanavich13

used The National

Longitudinal Survey of Young Men . The survey is based on a national probability sample of men who



were between the ages of 14 and 24 in 1966 and who were surveyed yearly between 1966 and 1971 and

in 1973, 1975, 1976, 1978, 1980, and 1981. They used a subset of 1,949 white males wage workers in

1976, which were either wage workers or were self-employed in 1978, and who were not unemployed,

out of the labor force, in the military, or in school full-time in either 1976 or 1978. Of this subset only

89 people or 4.5 % were entrepreneurs. With that being the case the statistical inferences made may not

be representative of the entire population. To analyze the data Evans and Jovanavich13

used probit

regression.

T. Mengistae14

used data from a sample survey of manufacturing establishments that was

carried out in the mid 1990s in Ethiopia. The survey was confined to registered businesses located in

the city of Addis Ababa and was conducted in two waves. The first wave took place during September

to October 1993 and covered a random selection of 220 manufacturing establishments. Out of the first

wave 190 were owner-managed (or entrepreneurial) businesses employing less than 200 people, the

rest being medium to large scale state owned enterprises. The same 220 establishments were then

revisited in October 1995. Mengistae14

also used a different measure to see which business' were

successful. Instead of looking at profitability like Penrose15

did he chose to look at the number of

employees that worked at the firm. Mengistae15

did that because of the volatile currency in Ethiopia

and felt that number of employees was a significant indicator of how well a business is doing. To

analyze his data collected Mengistae14

used OLS regression.

Bates16

used the Dun and Bradstreet( D&B)Financial Profiles database which includes detailed

the balance sheet data as well as information on employment, industry, sales, and profits for minority-

14 TAYE MENGISTAE

Competition and Entrepreneurs’ HumanCapital in Small Business Longevity and Growth

Journal of Development Studies, Vol. 42, No. 5, 812–836, July 2006

15 Penrose, Edith Tilton





owned firms. Because firms in the sample tend to be large established enterprises relative to the

universe, they represent a more "successful" subset of the minority business community. This may have

caused anomalous skewed fallacious results. Bates used OLS regression.

In 1985 Cooper, Folta, Gimeno, and Woo17

sent out 13,000 questionnaires to the members of

the National Federation of Independent Business who reported they had been in business for 18 months

or less. They focused on entrepreneurs who had recently started their own firms. They received back

responses from 4,814 entrepreneurs who they then sent follow up questionnaires to in 1986 and 1987.

In all after smoothing the data sample for the companies that fit they model criteria they were left with

1,547 firms. To analyze the data Cooper, Folta, Gimeno, and Woo15

used censored regression with

stochastic thresholds and grouped data regression.

Through my research I found that most of the information compiled was from start up

companies that were given paper surveys. The surveys had a 40-50% response rate depending on the

given survey . The surveys have a built in response bias that isn't easily counteracted. So the data that I

looked at may possibly be skewed to only represent positive outcomes from the entrepreneurs polled.

The economists who tested their theoretical model with real data tried to account for this bias, but

where human capital is data is concerned I am still weary. For liquidity models I don't think the

skewness is as bad.

Results

For some of the human capital examination I'm going to focus on column 1 of table 3 on page 21 of

Cooper, Folta, Gimeno, and Woo18

(appendix). This deals with the economic performance equation that





I used from Cooper, Folta, Gimeno, and Woo16

earlier which I then modified. It doesn't contain any of

the information about how financing affects the success of an entrepreneur except for initial capital that

the entrepreneur has.

Survival of the fittest? Entrepreneurial human capital and the


Having a formal education seems to help the likelihood for success a great deal. Management

and supervisory experience have a moderate positive effect on success with supervisory experience

more so than management experience. Working in a similar business prior to opening a new firm seems

to have a very large positive effect. It would seem logical that if an individual already knows the field

that they're opening a business in, they would already have the abilities to cope with the different

business obstacles in that specific field. This would help the entrepreneur overcome the difficult times

in their business and eventually become more successful. Having previous entrepreneurship

experience also has a positive effect on success. Initial capital has a noticeable positive effect as well.

If, the entrepreneur doesn't have enough money to start the business but decides to move forward

anyway, the business may become stagnant. Without the necessary capital it is almost impossible for

the business to grow which is one of the factors that drive profitability. On top of that, the greater the

number of employees in a firm pointed toward a more successful venture.

One very large negative effect on firm performance is having another job. All comments made

above are statistically significant. There are however some noteworthy points that aren't statistically

significant which are correct number of jobs before stating an entrepreneurial venture, intrinsic

motivation, if their parents were owners of a business, and the hours worked. There appears to be

sweet spot in the number of jobs that a person should hold before they start a new venture. Two to four

jobs increase the likelihood of success. However five or more jobs may indicate that they may not be a

quality worker and are being pushed into entrepreneurship. These all have very high standard

deviations so the inferences may just be noise picked up by the data set. The intrinsic motivation may

be negative, because they could be complacent just working for themselves as opposed to working for

someone else. Parent owned business may have the effect that is similar to intrinsic motivation. That is

as long as the entrepreneur is self employed it may be ok to not be be as successful, all that matters is

they are self employed. Hours worked was very close to zero, but I suspect that some unexplained

phenomenon is going on. Most entrepreneurs work more hours for less pay. In this data set hours

worked seemed to have little effect on performance.

Mengistae19

found a correlation with growth and survivability of the firm. Ultimately if a firm grows

then it must be profitable, otherwise it would have be driven out of businesses(Mengistate table4

above). Also shown in that table is how business experience influences survivability of the firm. It

shows that the larger amount of business experience the entrepreneur has the higher likelihood of

survivability. Age doesn't seem to be a factor on survivability. Mengistate17

said that it may be due to

model imperfections. Evan and Leightion20

found that this is a true fact and age really doesn't affect

survivability.

19 TAYE MENGISTAE



20 David S. Evans and Linda S. Leighton

Some Empirical Aspects of Entrepreneurship

Source: The American Economic Review, Vol. 79, No. 3 (Jun., 1989), pp. 519-535 Published by: American Economic

Association

Bates21

found two different things when analyzing the data. (Bates tables3 & 4 above)

In table 3 it is clear that the entrepreneurs with a higher education were more profitable. Also in table

4a entrepreneurs who put down more capital originally were more likely to be profitable. This again



shows that being educated will help the new business venture be profitable.

Evans and Jovanovich22

studied how the liquidity constraint affect entrepreneurial start ups. Ham23

said“New businesses are liquidity constrained and that the amount of capital available to them is

limited by their personal assets.” My assumed model is consistent with Evans and Jovanovich with

respect to the only way that an entrepreneur will go into business for himself or herself would be if his

perceived salary from starting his or her own business would be greater than wage work. ( Table 3

From Jovanavich above) Shows that initial capital, education, and experience all have a positive effect

on the success of a new firm start up. Some other implications from Evans and Jovanavich20

liquidity



23 Ham, John C., and Melnik, Arie. "Loan Demand: An Empirical Analysis

Using Micro Data." Rev. Econ. and Statis. 69 (November 1987): 704-9.

constraint. “It reduces the amount of capital flowing to entrepreneurship in two ways. First, it will

prevent some people from trying entrepreneurship. Second, individuals who do try entrepreneurship

use less capital because of the constraint.” Evan and Jovanavich20

found that entrepreneurs that needed

capital were only given roughly 50% of the capital they requested. Therefore, the entrepreneurs had to

use a large portion of their own assets when starting firms. However as firms grew, most likely in

profitably, it was easier to get financing.

Conclusion

For a new business venture to be successful the entrepreneur must have the right amount of both

financial and human capital. The age of the entrepreneur makes no difference, however it may be

useful to work in the field of their business so that they can gain experience. Education is a also a very

influential factor in starting new ventures. It is very clear that the entrepreneur who achieve a minimum

of a college degree does much better than his or her uneducated counterparts in business. Educated

people business' grow more, which leads to a more profitable venture. Finally procuring capital is

important. Entrepreneurs are limited by their financial resources. This means is that in order to thrive

and be profitable an entrepreneur needs to have the money to back them for the business endeavor. It

helps if the individual who is going to start a business already has large amounts of capital, but if not

it's best to obtain an amount of capital that is enough to fully finance the business venture. This may

prove to be difficult because most venture are under financed. With the proper human capital skill set

and the right amount financial backing and entrepreneur will most likely be successful.

Other Areas for Further Research

It may be beneficial to look at sociology and psychology Human Capital Theory data for future

research. Also, I would like to see another survey conducted like the National Longitudinal Survey for

Young Men. On top of that, it would be interesting to look at individuals risk tolerances for entrance

into being self employed. The data from that may provide some valuable insights into why people

choose to be workers even if they have good ideas and could created quality business'. I would also like

to see the combination of Jovanovich's20

Liquidity model and Javier Gimeno; Timothy B Folta; Arnold

C Cooper; Carolyn Y Woo's24

exit model.




References

Bates, Timothy

Entrepreneur Human Capital Endowments and Minority Business Viability


G. Becker

Human Capital

New York Columbia Press 1975

Candida G. Brush, Linda F. Edelman, and Tatiana S. Manolova

The Effects of Initial Location, Aspirations, and

Resources on Likelihood of First Sale inNascent Firms

Journal of Small Business Management 2008 46(2), pp. 159–182

David S. Evans and Boyan Jovanovic


The Journal of Political Economy, Vol. 97, No. 4 (Aug., 1989), pp. 808-827

David S. Evans and Linda S. Leighton

Some Empirical Aspects of Entrepreneurship

The American Economic Review, Vol. 79, No. 3 (Jun., 1989), pp. 519-535

Javier Gimeno; Timothy B Folta; Arnold C Cooper; Carolyn Y Woo



Ham, John C., and Melnik, Arie.

"Loan Demand: An Empirical Analysis Using Micro Data."

Rev. Econ. and Statis. 69 (November 1987): 704-9.

Klofsten, M. (1998). The Business Platform:

Entrepreneurship and Managementin the Early Stages of a Firm’s

Development. Luxembourg: European

Commission, TII.

Levenson ,A. R. and K. L. Willard, “Do firms get the financing they want?

Measuring credit rationing experienced by small businesses in the US,” Small

Business Economics, vol. 14, pp. 83–94, 2000.

Penrose, Edith Tilton



Taye Mengistae



New entrepreneurial ventures

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