Causes and consequences of initial network positions

Research by Benjamin Hallen

Entrepreneurs begin their ventures lacking a lot of things—employees, funding, customers, technology, among others. A large part of success is the ability to get these things, and that depends in large part on the entrepreneur’s ability to network with people and organizations that can provide them with everything from further connections to equipment to good advice. Network ties—alliances, board interlocks, equity investments between organizations, and the like—can play an important role in the success of a new venture, influencing the venture’s ability to acquire capital and industry information, share resources and capabilities, or benefit from their peers’ relationships with buyers and suppliers.

Benjamin Hallen, assistant professor of strategy, explored the mechanisms by which entrepreneurs create this crucial initial set of network ties in a recent paper. Hallen examined 92 U.S. Internet security ventures from the VentureXpert database founded between 2000-2002, and their investment ties with professional investors who provided capital and advice in exchange for equity in the new firm. Drawing data from new ventures in the same industry allowed the authors to more accurately compare founder human capital and accomplishments in each firm. Hallen used each venture’s original Web pages to find background on founder’s educational background, previous accomplishments, previous work relationships, and their skill sets.

As you might expect, new ventures are more likely to form a relationship with a potential partner if they are already connected through the founder’s network of relationships. But Hallen found that the entrepreneurs only benefit from founder ties for a short period after founding. So who you know does matter, but only within the first year of the new venture’s life. Entrepreneurs need to leverage their founder ties soon after they begin their venture, finds Hallen.

That leads to a tricky trade-off. Initial network position has a long-term effect on a venture’s abilities to pursue other investors, because investors of similar status tend to invest in the same projects. A high-status investor—one who provides better benefits, introductions and advice—is unlikely to be attracted to a project that already has a circle of lower-status investors. This places entrepreneurs, who are often desperate for an initial inflow of cash, in a difficult position, because while lower status investors can provide needed funding, they also limit the circles from which future investors might come.

“Some entrepreneurs actually end up bringing in more money, but they may be endangering their venture’s chances of getting a high status investor,” says Hallen.

Entrepreneurs should think carefully, then, about the ties they form. The strong consequences of initial ties suggest that a venture’s initial round of investments is a unique opportunity. Even though low-status investors may be willing to invest at a higher rate, those relationships will make it more difficult to attract higher-status investors later on.

Hallen also found that well-connected entrepreneurs with high human capital—great resumes and skills—will benefit from pursuing high status investors immediately. But entrepreneurs without great connections and less human capital will be better served by waiting to pursue high-status investors until they have some significant accomplishments under their belts. At that point, they will become more attractive to the high-status investors they seek, and can hope to jump into a higher status circle of investors.

However, Hallen cautions, once an entrepreneur has gotten out a product and has some distinguished accomplishments, he or she should be careful about the investors with whom they choose to work, because an entrepreneur’s current network has significant influence over what future investors the entrepreneur can pursue.

That’s because pursuing investors outside of your network may raise questions about why people in the entrepreneur’s network aren’t funding the venture. “The implication is that if you can’t get funding from people you already know, your venture probably isn’t worth funding,” says Hallen.

“The Causes and Consequences of Initial Network Positions of New Organizations: From Whom Do Entrepreneurs Receive Investments” is forthcoming fromAdministration Science Quarterly.