The Evolution of Entrepreneurs' Fund-Raising Intentions: A Multiple Case Study of Financing Processes in New Ventures

Marc Grünhagen The Evolution of Entrepreneurs’ Fund-Raising Intentions

GABLER EDITION WISSENSCHAFT Entrepreneurship Herausgegeben von Professor Dr. Malte Brettel, RWTH Aachen, Professor Dr. Lambert T. Koch, Universität Wuppertal, Professor Dr. Tobias Kollmann, Universität Duisburg-Essen, Campus Essen, Professor Dr. Peter Witt, WHU – Otto Beisheim School of Management, Vallendar

„Entrepreneurship“ ist ein noch relativ junger Forschungszweig, der jedoch in Wissenschaft und Praxis stetig an Bedeutung gewinnt. Denn Unternehmensgründungen und deren Promotoren nehmen für die wirtschaftliche Entwicklung einen zentralen Stellenwert ein, so dass es nur folgerichtig ist, dem auch in Forschung und Lehre Rechnung zu tragen. Die Schriftenreihe bietet ein Forum für wissenschaftliche Beiträge zur Entrepreneurship-Thematik. Ziel ist der Transfer von aktuellen Forschungsergebnissen und deren Diskussion aus der Wissenschaft in die Unternehmenspraxis.

Marc Grünhagen

The Evolution of Entrepreneurs’ Fund-Raising Intentions A Multiple Case Study of Financing Processes in New Ventures

With a foreword by Prof. Dr. Lambert T. Koch

GABLER EDITION WISSENSCHAFT

Bibliographic information published by the Deutsche Nationalbibliothek The Deutsche Nationalbibliothek lists this publication in the Deutsche Nationalbibliografie; detailed bibliographic data are available in the Internet at http://dnb.d-nb.de.

Dissertation Universität Wuppertal, 2008

1st Edition 2008 All rights reserved © Gabler | GWV Fachverlage GmbH, Wiesbaden 2008 Editorial Office: Frauke Schindler / Nicole Schweitzer Gabler is part of the specialist publishing group Springer Science+Business Media. www.gabler.de No part of this publication may be reproduced, stored in a retrieval system or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the copyright holder. Registered and/or industrial names, trade names, trade descriptions etc. cited in this publication are part of the law for trade-mark protection and may not be used free in any form or by any means even if this is not specifically marked. Cover design: Regine Zimmer, Dipl.-Designerin, Frankfurt/Main Printed on acid-free paper Printed in Germany ISBN 978-3-8349-1071-4

Foreword

Recent entrepreneurship research discusses numerous potential obstacles on the path towards business formation. The acquisition of resources, especially external finance, constitutes a formidable challenge founders have to meet. Substantial rejection rates of potential investors create external selection pressures on new ventures in that they contribute to failures or influence the growth of surviving young companies. However, the founders themselves take an active role in the search for financial resources by addressing various potential financiers and taking decisions on the direction and continuation of their search for investors. Similarly, the results of the large US Panel Study of Entrepreneurial Dynamics point at the importance of adjustments in founders’ fund-raising intentions in the course of early stage financial development of new ventures. The work at hand focuses on this process of solving problems during the search for external funding in emerging new ventures. The author explicitly does not analyze which factors of success will allow to convince potential investors with certainty. Regarding the search for funding as an open-ended process for epistemological reasons, he rather aims at the reconstruction of search processes and the derivation of explanatory patterns for the actions of venture founders in search of external funding. The central question for the factors which may influence “entrepreneurial fundraising intentions” is answered through the analysis of the discrepancy between founders’ initial financing preferences and their evolution in the context of selection feedback of potential investors demanding for new venture legitimacy. This work can therefore take the credit for integrating current research on new venture legitimacy into the framework of evolutionary economics and at the same time for discarding rather mechanistic firm-life-cycle concepts. The author shows systematically how perceived barriers to legitimizing with potential investors and their selection feedback may function as possible antecedents of evolving fundraising intentions. Both the development of a conceptual model of fund-raising intentions and the indepth case studies of eleven new ventures are very much worth reading because they combine high analytical standards with a great practical relevance. Marc Grünhagen

VI

Foreword

very successfully draws on the results of his international entrepreneurship research as well as his expert knowledge as a former corporate finance and venture capital professional. May this book find many willing readers and contribute to the scientific discussion in the field to a significant extent.

Prof. Dr. Lambert T. Koch

Preface

This book explores the emergence and development of new ventures. In a way, the writing process itself also seemed like a kind of “venture”. And like founding a new firm, it required substantial material support and encouragement from others. First of all, I would like to thank my parents, who have wholeheartedly supported my “academic endeavours” over many years. I would also like to thank Wolfgang Kuhn, who inspired me to write a thesis and introduced me to the idea of joining the Entrepreneurship Team at the University of Wuppertal. My colleagues within this team have supported the dissertation project in many ways, and for this support I am grateful. I would also like to express my gratitude to Prof. Dr. Lambert T. Koch, my thesis supervisor, for his constructive advice throughout the project and to Prof. Dr. Michael J. Fallgatter, who agreed to second-mark this thesis on what has been very short call. In the final stage I have been thankful for the indispensable support of Johannes Leicht, who has helped me with the typeset of this work. Along with this, I also thank Heidi Hein and Andreas Dorn for advising and encouraging me on this path, which truly was the right one to choose. During the endgame of the project Dirk Schmidt’s interest in the results of my work gave me encouragement. Last but not least I would like to thank Finn, who – in the final weeks before completion – has showed me that there is life outside the study room.

Marc Grünhagen

Contents

Figures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . XIII Abbreviations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . XV 1.

Outline of problem and overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

1. 1.

Focus of the study . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2

1. 2.

Research issues and objectives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4

1. 3.

Conceptual approach . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

1. 4.

Empirical study and potential contributions . . . . . . . . . . . . . . . . . . . . . . 10

1. 5.

Outline . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14

2.

Epistemological concept: entrepreneurs as human agents . . . . . . . . 17

2. 1.

New venture failure as an epistemological issue . . . . . . . . . . . . . . . . . . 17

2. 2.

Epistemological implications of human cognition . . . . . . . . . . . . . . . . . 17

2. 2. 1.

Unit of analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18

2. 2. 2.

Individual perception and cognitive construction of reality . . . . . . . . . . 21

2. 2. 2. 1.

Objective perception and the individualistic alternative . . . . . . . . . . . . . 21

2. 2. 2. 2.

Sense-making of the environment and individual memory . . . . . . . . . . 26

2. 2. 3.

The fallibility of knowledge and the viability requirement . . . . . . . . . . 29

2. 3.

Subjectively rational action and inter-subjective interaction . . . . . . . . . 32

2. 3. 1.

Subjectively rational action and its cognitive antecedents . . . . . . . . . . . 32

2. 3. 1. 1.

Cognitive antecedents underlying entrepreneurial action . . . . . . . . . . . . 34

2. 3. 1. 2.

A concept of creative subjectively-rational action . . . . . . . . . . . . . . . . . 36

2. 3. 2.

Social inter-subjectivity and agent interaction . . . . . . . . . . . . . . . . . . . . 40

2. 3. 2. 1.

Alignment of reality constructions in interaction processes . . . . . . . . . . 41

2. 3. 2. 2.

Social construction and social acceptance of behaviour . . . . . . . . . . . . 42

3.

New ventures: definition, financing needs, and legitimacy . . . . . . . . 47

3. 1.

Definitions and characteristics of new ventures . . . . . . . . . . . . . . . . . . . 47

3. 1. 1.

The general theme of entrepreneurship . . . . . . . . . . . . . . . . . . . . . . . . . . 47

3. 1. 2.

New ventures versus established firms (definition I) . . . . . . . . . . . . . . . 49

3. 1. 2. 1.

Principal challenges in defining new entrepreneurial ventures . . . . . . . 49

X

Contents

3. 1. 2. 2.

Definitional dimensions of new ventures in this study . . . . . . . . . . . . . 50

3. 1. 3.

Characteristics of new ventures in contrast to established firms . . . . . . 54

3. 1. 4.

Infant ventures versus emerging ventures (definition II) . . . . . . . . . . . . 57

3. 2.

External financing needs of new ventures . . . . . . . . . . . . . . . . . . . . . . . 62

3. 2. 1.

Resource needs of new ventures in general . . . . . . . . . . . . . . . . . . . . . . 62

3. 2. 2.

Financing needs and their implications for the empirical study . . . . . . 64

3. 2. 2. 1.

Exogenous determinants of external financing needs . . . . . . . . . . . . . . . 65

3. 2. 2. 2.

Financing source and capital structure preferences . . . . . . . . . . . . . . . . 67

3. 2. 3.

Financial resources and the development of new ventures . . . . . . . . . . 68

3. 2. 3. 1.

Implications of financial resource availability . . . . . . . . . . . . . . . . . . . . 68

3. 2. 3. 2.

Impacts of financing constraints . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69

3. 3.

Legitimacy of new ventures and the acquisition of resources . . . . . . . . 72

3. 3. 1.

Legitimizing challenges in new ventures . . . . . . . . . . . . . . . . . . . . . . . . 75

3. 3. 1. 1.

Definition and characterization of organizational legitimacy . . . . . . . . . 75

3. 3. 1. 2.

Different types of legitimacy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 77

3. 3. 1. 3.

The need for new ventures to gain legitimacy . . . . . . . . . . . . . . . . . . . . 80

3. 3. 2.

Options for legitimzing action and potential sources of legitimacy . . . . 83

3. 3. 2. 1.

Characterizing legitimizing action . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83

3. 3. 2. 2.

Principal legitimizing options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 85

3. 3. 2. 3.

Gaining legitimacy by signalling conformance . . . . . . . . . . . . . . . . . . . 91

3. 3. 3.

Possible differentiations in the challenge to gain legitimacy . . . . . . . . . 95

3. 3. 4.

Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 100

4.

Financiers’ legitimacy demands and the evolution of entrepreneurs’ fund-raising intentions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 101

4. 1.

Understanding financial resource acquisition as a process . . . . . . . . . 102

4. 1. 1.

Inquiring into the fund-raising struggle of new ventures . . . . . . . . . . . 102

4. 1. 2.

Possible process-oriented perspectives . . . . . . . . . . . . . . . . . . . . . . . . . 104

4. 1. 2. 1.

Life-cycle concepts in new venture development and financing . . . . . 104

4. 1. 2. 2.

The universal Darwinian principle of BVSR as a meta-concept . . . . . 106

4. 1. 3.

Pattern exploration in the context of invariant restrictions . . . . . . . . . 116

4. 2.

The restrictions and financial selection environment . . . . . . . . . . . . . . 119

4. 2. 1.

Overview of the restrictions environment . . . . . . . . . . . . . . . . . . . . . . . 119

4. 2. 2.

Potential financiers and their legitimacy demands . . . . . . . . . . . . . . . . 125

Contents

XI

4. 2. 2. 1.

Sources of finance and financiers’ pre-investment evaluation . . . . . . . 126

4. 2. 2. 2.

Screening and evaluation criteria of external financiers . . . . . . . . . . . 132

4. 2. 2. 3.

Stability and inter-subjectivity of financiers’ evaluation criteria . . . . . 140

4. 2. 3.

Pre-investment screening as external selection . . . . . . . . . . . . . . . . . . . 144

4. 2. 3. 1.

External selection pressures on fund-raising processes . . . . . . . . . . . . 144

4. 2. 3. 2.

External financial selection and internal selection choices . . . . . . . . . 147

4. 3.

Entrepreneurial variation-selection in fund-raising processes . . . . . . . 153

4. 3. 1.

Creative variation and selective choice in entrepreneurial action . . . . 154

4. 3. 2.

Trial variation and selective choice of action over time . . . . . . . . . . . 157

4. 4.

Evolving fund-raising intentions: exploratory theoretical orientations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 163

4. 4. 1.

General entrepreneurial intentions models as a reference . . . . . . . . . . 164

4. 4. 2.

Overview: exploratory framework of fund-raising intentions . . . . . . . 169

4. 4. 3.

Conceptual orientations for empirical exploration . . . . . . . . . . . . . . . . 172

4. 4. 3. 1.

Perceived feasibility of acquiring funding (TO 1a and 1b) . . . . . . . . . 174

4. 4. 3. 2.

Changes in fund-raising intentions (TO 2a-c) . . . . . . . . . . . . . . . . . . . . 182

4. 4. 3. 3.

Selection feedback from potential financiers (TO 3) . . . . . . . . . . . . . . 192

5.

Multiple case studies of fund-raising processes in new ven-

5. 1.

Case study design and data collection . . . . . . . . . . . . . . . . . . . . . . . . . 197

5. 1. 1.

Multiple case design . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 197

5. 1. 1. 1.

Exploring fund-raising processes with case studies . . . . . . . . . . . . . . . 197

tures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 197

5. 1. 1. 2.

Definition of the multiple case design . . . . . . . . . . . . . . . . . . . . . . . . . 200

5. 1. 2.

Data collection . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 204

5. 1. 2. 1.

Case selection framework and procedure . . . . . . . . . . . . . . . . . . . . . . . 204

5. 1. 2. 2.

Time frame of data collection and case interviews . . . . . . . . . . . . . . . 208

5. 2.

Case study results: preliminary patterns in fund-raising processes . . . 217

5. 2. 1.

Approach to analyzing multiple case evidence . . . . . . . . . . . . . . . . . . . 217

5. 2. 2.

Case vignettes: description of ventures and their funding attempts . . . 221

5. 2. 3.

Entrepreneurs’ sense-making of their financial environment . . . . . . . . 226

5. 2. 3. 1.

Funding sources and screening challenges: financial munificence . . . 228

5. 2. 3. 2.

Venture characteristics and funding flexibility: fund-raising capabilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 243

XII 5. 2. 3. 3.

Contents

Feasibility of fund-raising: external munificence and internal capabilities (P 1a and P 1b) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 254

5. 2. 4.

Patterns in initial funding-raising attempts over time . . . . . . . . . . . . . 265

5. 2. 4. 1.

Types of changes in intentional fund-raising attempts . . . . . . . . . . . . . 266

5. 2. 4. 2.

Entrepreneurs’ reasoning behind changes in fund-raising plans . . . . . 273

5. 2. 4. 3.

Changes in fund-raising intentions and shifts in perceived feasibility/desirability (P 2a and P 2b) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 275

5. 2. 4. 4.

Financier feedback and changing fund-raising intentions (P 3) . . . . . . 294

5. 2. 5.

Selection, evolving fund-raising intentions and venture development . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 308

6.

Conclusions and implications for research and practice . . . . . . . . 315

6. 1.

Summary of findings and potential limitations . . . . . . . . . . . . . . . . . . . 315

6. 1. 1.

In conclusion: summarizing the results of the study . . . . . . . . . . . . . . 315

6. 1. 2.

Conceptual and methodical-empirical limitations . . . . . . . . . . . . . . . . . 319

6. 2.

Implications for research and entrepreneurial practice . . . . . . . . . . . . . 323

6. 2. 1.

Implications for future research . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 323

6. 2. 2.

Implications for practice . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 327

References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 331

Figures

figure 2–1:

interdependence of stimuli perception and human memory . . . . . . . . 27

figure 2–2:

cognitive antecedent layers of human behaviour . . . . . . . . . . . . . . . . 34

figure 2–3:

concept of individual action at one moment in time . . . . . . . . . . . . . 37

figure 3–1:

definition criteria of new ventures in this study . . . . . . . . . . . . . . . . . 53

figure 3–2:

characteristic liabilities of new venture organizations . . . . . . . . . . . . 55

figure 3–3:

properties of organizations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59

figure 3–4:

stages and properties of new venture creation . . . . . . . . . . . . . . . . . . 60

figure 3–5:

determinants of financial resource needs and preferences (desirability of external financing) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65

figure 3–6:

different categorizations of legitimacy types relating to organizations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 78

figure 3–7:

principal options to gain legitimacy . . . . . . . . . . . . . . . . . . . . . . . . . . . 86

figure 3–8:

institutional and strategic agency perspectives of legitimation . . . . . . 88

figure 3–9:

conflict of legitimation between institutional determinism and voluntaristic strategic agency . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90

figure 3–10: potential sources of legitimizing accounts . . . . . . . . . . . . . . . . . . . . . . 94 figure 3–11: ideal-type differences in pragmatic legitimizing . . . . . . . . . . . . . . . . . 96 figure 4–1:

financial restrictions and selection environment . . . . . . . . . . . . . . . . 120

figure 4–2:

pre-investment evaluation criteria in new venture financing . . . . . . 135

figure 4–3:

cumulative variation-selection in human action . . . . . . . . . . . . . . . . 155

figure 4–4:

entrepreneurial action as trial-variation and selective implemen-

figure 4–5:

model of entrepreneurial intentions towards venture formation . . . . 168

figure 4–6:

orienting framework: entrepreneurs’ fund-raising intentions

tation over time . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 158

over time . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 171 figure 5–1:

time boundaries of case design and collection of interview data . . . 210

figure 5–2:

systemization of external and internal categories of perceived

figure 5–3:

perceived challenges from financiers’ pre-funding screening . . . . . . 230

figure 5–4:

perceived magnitude of possibilities for external funding . . . . . . . . 239

figure 5–5:

perceived venture project characteristics . . . . . . . . . . . . . . . . . . . . . . 244

funding chances . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 227

XIV

Figures

figure 5–6:

perceived flexibility in fund-raising . . . . . . . . . . . . . . . . . . . . . . . . . . 251

figure 5–7:

perceived fund-raising chances of entrepreneurs . . . . . . . . . . . . . . . . 256

figure 5–8:

feasibility of fund-raising and underlying beliefs about financial

figure 5–9:

types of changes in fund-raising intentions of entrepreneurs . . . . . . 267

munificence and funding capabilities . . . . . . . . . . . . . . . . . . . . . . . . . 263 figure 5–10: reasoning of continuous changes in fund-raising plans . . . . . . . . . . 274 figure 5–11: entrepreneurs’ reasoning behind their abandonment of fundraising plans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 275 figure 5–12: changing fund-raising plans and feedback from potential financiers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 295 figure 6–1:

propositions P 1 – P 3 as possible building blocks for future theory development . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 316

Abbreviations

BA

business angel

BAFIN

Bundesamt fuer Finanzdienstleistungsaufsicht

BVSR

blind variation and selective retention

cf.

confer

ed(s).

editor(s)

e.g.

exempli gratia

et al.

et alii

etc.

et cetera

GEM

Global Entrepreneurship Monitor

i.e.

id est

ibid.

ibidem

KfW

Kreditanstalt fuer Wiederaufbau (KfW Mittelstandsbank)

LED

light emitting diode

P

proposition

p.

page

PR

Public Relations

Q

quarter

PSED

Panel Study of Entrepreneurial Dynamics

SME

small and medium-sized enterprises

SORC

stimulus-organism-response behaviour-consequences

RPG

role-playing-games

Tbirth

’birth’ (formation) of new venture organization

Tgest

beginning of new venture gestation phase

Ti1

time of first round of case interviews (in the empirical study)

TO

theoretical orientation

TPB

theory of planned behaviour

UK

United Kingdom

US

United States

VC

venture capitalist

vs.

versus

1. Outline of problem and overview Numerous books, journal articles, and enterprise policy initiatives have stressed the importance of entrepreneurship and the role of entrepreneurs (cf., for example, Shane, 2003). Entrepreneurs have been considered pioneers of economic change (e.g. in building the internet economy) and as an engine of social and economic development (Acs & Audretsch, 2003, 3 and Mahoney & Michael, 2005, 48; also cf. Zahra et al., 2000; Koch, 2001 and Craig et al., 2007). A crucial reason why society, policy makers, scientists and others take an interest in entrepreneurs seems to be the following: Entrepreneurs are assumed to be the ones who sense novel business opportunities that other people do not perceive (cf., for example, Sarasvathy et al., 2003, 146 for a conceptual systemization of why opportunities may arise and how they are perceived by entrepreneurial agents). In particular, it has been supposed that opportunities emerge because of asymmetrically distributed information and the uncertainty inherent in their exploitation (Shane, 2003, 161). Entrepreneurs will bear the risks and uncertainty involved in the allocation of resources to exploit these opportunities, while others may hesitate to do so (cf., for example, Gifford, 2003 for entrepreneurs’ risk bearing role and Sarasvathy et al., 2003, 147pp. for what the authors call the ‘allocative process view’ on entrepreneurial opportunities). In light of this, there may be a fundamental challenge implicit in the unique role of entrepreneurs in exploiting perceived opportunities by allocating resources. On the one hand, opportunities may arise precisely because of the above asymmetrical distribution of information and the uncertainty surrounding their exploitation. On the other hand, this complicates the entrepreneur’s task of acquiring the resources required for exploitation (Shane, 2003, 163). Asymmetric information (and agency problems) have been seen as impediments particularly to acquiring financial resources for entrepreneurs (cf. Gompers & Lerner, 2003 and Berger & Udell, 2003 for the context of equity and debt financing of new ventures and small business). However, in addition to information asymmetry, genuine uncertainty about the prospects of a new venture will also be a problem in resource acquisition (Shane, 2003). “Making sense of the uncertainty of a new venture so that others can buy into it is a particular challenge” (Brush & Manolova, 2004, 275). This challenge is particularly virulent as acquiring resources from others in society is a prerequisite for transforming a business opportunity into a new venture organization (Brush, 2001, 65; also cf. Aldrich & Martinez, 2001 and Bhave, 1994). In general, pursuing opportunities with the willingness to use resources currently not possessed has been seen as an essential element of what defines entrepreneurship (cf. Stevenson & Jarillo,

2

1. Outline of problem and overview

1990, 23 and Mahoney & Michael, 2005, 46; a working definition of entrepreneurship based on this will be elaborated in chapter 3. 1. 1. below). Among the resources required for establishing a business, financing is regarded as a particularly critical one (Klofsten et al., 1999, 83p.; cf. Wong & Ho, 2005). Having said this, note that a large number of new businesses, in particular small service start-ups, begin with little capital; most of them fund the initial stages of company establishment out of their personal savings (cf. Aldrich, 1999, 75). However, growth-oriented and technology-based ventures may frequently need substantial financing and other external resources (Welpe, 2004, 35 and Tornikoski, 2005, 13). The volume of external financing may also be significant. For example, external funds accounted for almost half of all funding (external and internal) in a representative sample of emerging US ventures, even though only a quarter of all entrepreneurs have used external financing (Stouder & Kirchhoff, 2004, 369 reporting data from the US panel study of entrepreneurial dynamics). In light of its significance, the availability of external finance to be obtained by entrepreneurs in order to establish their ventures has been a primary concern. It has been stressed in the literature on the subject that the availability of funding may be instrumental to firm formation in the first place, as well as to survival and future growth (cf., for example, Bruederl et al., 1992 or Brown & Kirchhoff, 1997). In particular, capital constraints may impede the creation of new ventures and hamper their development (Wong & Ho, 2005; also cf. Levenson & Willard, 2000 or Storey, 2003 discussing possible capital rationing for entrepreneurial ventures and small businesses). In addition, obtaining initial external financing has also been perceived as a problem by entrepreneurs themselves (Lindstroem & Olufsson, 2001, 164p.).

1. 1. Focus of the study In view of the possible struggle new businesses face in terms of attracting external funding, this study will concentrate on the process of how entrepreneurs try to raise initial external funding for their new venture projects. This focus complements existing research in the following ways. As noted above, considerable attention has been paid to the issue that financial constraints and potential difficulties in raising sufficient funding may be detrimental to engaging in start-up behaviour and venture creation in the fist place. However, what

1. 1. Focus of the study

3

happens in those cases where nascent entrepreneurs and firm founders are already engaged in trying to establish their ventures? Brush (2001, 64) pointed out that, generally, assembling an initial resource base will involve a process of several steps characterized by substantial “bumps and turns”. It has to be appreciated that attracting initial external funding may be a principal challenge, which has an effect not only on intentions to start one’s own business at all, but also during the formation and establishment process. In this respect it would be interesting to understand how entrepreneurs’ searches for initial external finance unfold over time and what makes them change their fund-raising plans or even abandon the search for external funding completely.1 There is descriptive evidence from quantitative empirical studies on seed and start-up fund-raising efforts of entrepreneurs and small business owners. Two of the largest Anglo-American studies, Cosh et al. (2005) and Stouder & Kirchhoff (2004), provide an overview of the types of external financing applied for and the sources of external funding used (also cf. Brachtendorf, 2004 and chapter 4. 2. 2. for the European and German context). These studies reveal the importance of formal bank financing and non-standard means of bootstrap financing (e.g. via working shareholders, credit cards, or trade financing) as compared to the minor share of equity financing from venture capitalists. In addition, in the above studies outright rejection rates from different potential financiers are reported as well (also cf. Bloomberg & Letterie, 2005 for survey data on applications for bank loans and rejection rates from a sample of Dutch nascent entrepreneurs). Evidence suggests that entrepreneurs may well face problems when trying to raise external financing early on in the venture formation and establishment process (Stouder & Kirchhoff, 2004; also cf. the arguments above). Having said this, in the study by Cosh et al. (2005, 5), many young firms reported that they actually obtained external capital.2 This may suggest that while it is difficult to attract initial funding, entrepreneurs may still make efforts to identify other sources of external capital during the fund-raising process. There is also a further main point to be made about such adjustments by entrepreneurs in face of external pressures from potential financiers or other resource owners. 1

2

Examining the resource-acquisition behaviour of entrepreneurs and its effects has also been generally recommended, e.g., by Morris (2001), Bosma et al. (2003), and Heirman and Claryssee (2005) calling for more longitudinal studies on the role of resources since venture establishment is not static. Note that the former study concentrates on emerging businesses while the latter focuses on existing new businesses. Note also the mixed evidence regarding the existence of capital rationing as Cosh et al. (ibid.) point out.

4

1. Outline of problem and overview

On the one hand, there may be serious selection pressures on new venture projects as half of them fail to become business entities and only few ever grow (Aldrich, 1999, 75).3 On the other hand, the above suggests that entrepreneurial agents themselves may have an active role in the process of trying to find alternative solutions to the fund-raising problem (e.g. by applying to different potential financing sources throughout the process or adjusting their business plan to make do with fewer external funds). It has been found, for example, that entrepreneurs turned their attention to various sources of bootstrap financing as they perceived difficulties in tapping traditional formal sources such as bank- or venture capital investors (cf. Winborg & Landstroem, 2000). It will be an interesting exercise to build on the above descriptive insights into the potential sources of external finance that entrepreneurs attempt to tap and the successes and rejections they may experience. In particular, there is a belief that entrepreneurship research also needs to understand how changes in entrepreneurs’ decisions to try different possible sources and constellations of financing may come about over time. Such changes may occur as entrepreneurs struggle to obtain initial funding. The next chapter will set this contention within the overall context of the research issues and objectives to be pursued.

1. 2. Research issues and objectives This thesis sets out to explore the following overarching research issues concerned when addressing processes of initial fund-raising in new ventures.4 • Given that acquiring initial funding for new ventures may be a challenge, how do entrepreneurs go about this process of convincing potential external financiers? • How do entrepreneurs make sense of their environment of possible financing sources which they may attempt to tap over time? More specifically, how are possible funding opportunities and demands of potential financiers, as well as any experienced feedback from them, perceived by entrepreneurs? • Finally, how do entrepreneurs try to raise initial funding over time in view of the contextual conditions of the financial environment? In particular, how may perceptions of this environment and feedback from potential financiers contribute to entrepreneurs’ financing plans as the fund-raising struggle unfolds over time? 3

4

Note that this might also be because many entrepreneurs will have no growth aspirations themselves (cf., for example, Davidsson, 1991). A detailed treatment of the kind of new ventures and behavioural aspects involved will be looked at later.

1. 2. Research issues and objectives

5

The first question above defines the principal issue to be explored. The second and third questions are related to the overarching research objective of striving for an elementary understanding of fund-raising processes. This is best explained by first explaining what this study is not trying to do. Scholars have attempted to address the question raised by Aldrich and Martinez as to how entrepreneurs may be able to acquire external resources and become established in the market place (cf. Aldrich & Martinez, 2003, 392). Examples come from the fields of entrepreneurial finance (e.g. Bloomberg & Letterie, 2005) and new-venture legitimizing (e.g. Delmar & Shane, 2004 or Tornikoski, 2005). Also, practical guides to writing business plans offer suggestions regarding how founders may convince external audiences, including financiers (e.g. by presenting a competent team of founders, a unique selling proposition, a patented technology, or endowments from third parties like existing distribution partners). This study does not aim to identify what kind of possible success factors entrepreneurs might best conform to in order to assemble the financial resources they need. It is believed that there is no clear path to achieving successful fund-raising with certainty. Rather, the search process itself will be open-ended as to the success or failure of its financial outcomes as well as to the set of entrepreneurs’ possible choices of fund-raising action. In short, this is due to the fact that perceptions of the environment are based on creative individual constructions to bring about structural uncertainty in human interaction (cf. principally Rizzello, 2000 and O’Driscoll & Rizzo, 1985, 2).5 In this respect, Vanberg (2004, 16) points out that, as agent behaviour and outcomes of social processes may not be predicted exactly, the analysis objective has to be more modest than predicting optimal outcomes and their causes. Here, Holland (1992, 20) recommends that “it is the process of becoming, rather than the never-reached end points, that we must study if we are to gain insight”. Following this, a notion of heuristic pattern explanation will be pursued in order to understand fund-raising processes in new ventures; this will be based on reconstructing broad patterns of entrepreneurs’ intended fund-raising action over time (this approach is discussed, for example, in Geue, 1997 or Vanberg, 2004; also cf. Hesse & Koch, 1998; see 4. 1. 3. for details). The essential point to gaining insight by this approach is that external boundaries may make the future direction of the process explainable to some

5

The principal concept behind this will be elaborated throughout this thesis both epistemologically and conceptually (cf., in particular, chapters 2. 1. to 2. 3. and chapter 4. 1. 3. below).

6

1. Outline of problem and overview

extent (Harper, 1996, 103). In particular, institutionalized boundaries may lead to some degree of inter-subjectivity in the given context of entrepreneurs’ interaction with potential financiers (cf. Budzinski, 2003, 222). This is why research questions (2) and (3) focus on perceptions of the financial environment and how these perceptions may feed into agents’ fund-raising plans over time. The focus is on understanding entrepreneurs’ intended funding plans rather than on the outcomes of actions since the latter may not only have intended but also unintended consequences which cannot be explained (cf. Geue, 1997, 71p.). In order to pursue the research objective of exploring broad patterns in the evolution of external funding plans throughout the initial financing process of new ventures, the following conceptual and empirical approach has been chosen. In the empirical study to be conducted, the particular objective will be to develop propositions for future research on the evolution of entrepreneurs’ plans and action choices to obtain initial funding. Suggestions for the operationalization of theoretical constructs relevant to these preliminary propositions will be made.

1. 3. Conceptual approach First of all, any preparatory theoretical conceptualization of entrepreneurs’ fund-raising efforts will have to appreciate the open-ended nature of the process and the imperfect foresight of agents. It will be shown that traditional firm development and financing life-cycle concepts, which − at least to some extent − imply a predetermined and smooth unfolding of financing stages, are inadequate here (for a first critique of these concepts cf. vd. Ven & Poole, 1995, 515; Aldrich, 1999, 198; or Witt, 2002; for details see 4. 1. 2. 1. below). Instead, an evolutionary concept will be employed in the form of universal Darwinian blind variation and selective retention (BVSR; cf. chapter 4. 1. 2. 2. for definitions and details). This notion provides a more suitable, modest ontological meta-concept (Hodgson, 2002, 278 and Knudsen, 2004, 76p.). Whilst the evolutionary epistemology of BVSR may be applicable to a range of socio-cultural and other processes (Cziko, 1995,

308; also cf. Campbell, 1965, 24), the use of cumulative variation-selection has also been recommended to describe development processes in individual new ventures (see Fallgatter, 2004, 25). In order to apply the BVSR notion to the core process of raising funding for new-venture development it needs to be acknowledged that entrepreneurs

1. 3. Conceptual approach

7

will make purposeful choices when trying to attract resources from the financial environment. Having said this, from an epistemological point of view, creative variations of entrepreneurs’ fund-raising plans will still be blind to their future success in attracting external finance (for this general point cf. Cziko, 1995, 305pp.; Jablonka, 2003, 29; or Kappelhoff, 2004, 17p.). Seeking funding to establish the venture will therefore be conceived to come about by a creative search and construction process in which a viable fund-raising plan may only emerge by hindsighted selective retention of what turned out to work ex post (cf. Cziko, 1995, 306 and 310). This conception may also appeal intuitively in view of the considerable risk of failure of attempts to create a firm, and the substantial share of rejected applications for funding across various types of financiers (cf. chapters 4. 2. 2. and 4. 2. 3. below). With respect to the above trial search and construction process involved in raising funding, this thesis focuses on entrepreneurs’ internal selection choices from the variations they created (cf. Hesse, 1990, 64 on the role of the agent as a choosing subject in this context). The active role of entrepreneurs in this process has also been indicated for the firm gestation and establishment process as a whole, e.g. by Bhide (2000, 69), stressing the opportunistic adjustments made by entrepreneurial agents (also cf. Bouchikhi, 1993; Vromen, 2001; Pasanen, 2005 and chapters 4. 1. 2. and 4. 3. below). Furthermore, in their exploration of start-up event sequences, Carter et al. (1996, 152) note that those who decided to give up “have tried and tested out their ideas and found that they would not work according to their expectations”. The latter also hint at the above environmental selection pressures which Aldrich (1999, 75) has assumed to be detrimental to many start-up attempts. In terms of trying to attract initial funding, these pressures may be exerted by potential external financiers refusing to provide resource support. Thus, there may be both external selection pressures on the fund-raising process as well as internal selection implicit in entrepreneurs’ choices of fund-raising plans and the changes they go through over time (cf., for example, Witt, 2001, 18 and, in particular, Henderson & Stern, 2004 for the differentiation between external and internal selection in managerial contexts). This will require a discussion of two specific concepts: 1) a notion of how external selection mechanisms function in the financial environment surrounding new ventures; and 2) a concept for understanding entrepreneurs’ selective choices from possible courses of fund-raising action. The latter will also include a conceptual orientation for exploring the possible antecedents of these choices and the perception of contextual selection

8

1. Outline of problem and overview

pressures by entrepreneurs. This specification of the universal Darwinian BVSR principle is necessary because variation and selection mechanisms will be specific to the domain to be studied (Hodgson & Knudsen, 2004, 285 and Knudsen, 2005, 396; also cf. Kappelhoff, 2004 and Buenstorf, 2005, 22).

1) Environment of financial resource selection Regarding the fund-raising process of new ventures, it has been noted that selection pressures from the financial environment may precede sales-market selection as investors act as gatekeepers for new business ideas to enter the market (cf. Brouwer, 2000 and Loansbury & Glynn, 2001, 546). Already at this point “certain types of variations permit resource acquisition and legitimation” (Brush & Manolova, 2004, 276) while others will not. The characteristics and origin of this distinct type of selection may be different than pressures from direct competition within the entrepreneur’s own industry. The framework to be used to understand selection pressures from financiers will be new venture legitimacy. Legitimacy is commonly characterized as a “generalized perception or assumption that the actions of an entity are desirable, proper or appropriate within some socially constructed system of norms, values, beliefs, and definitions” (Suchman, 1995, 574).6 External audiences will demand legitimacy before providing active resource support to emerging ventures (Newbert & Tornikoski, 2003). Meeting this need for legitimacy will be critical for new ventures, in particular when attempting to acquire resources needed for survival (Delmar & Shane, 2004). For example, financial support may be denied to a new venture as “the venture’s lack of reputation and track record creates a heightened perception of risk on the part of the potential resource provider” (Brush, 2001, 71). The legitimacy concept provides an understanding of possible demands of external financiers which founders might have to take account of for new venture establishment. Financiers’ selection criteria may be based on these legitimacy demands, e.g. for investments in new ventures to be profitable. At the same time deliberate actions of entrepreneurs to gain legitimacy may also be appreciated within the legitimacy framework (cf. Milne & Pattn, 2000; Scott, 2001; or Tornikoski, 2005 for the underlying

6

Cf. Aldrich (1999), Zimmerman and Zeitz (2002), and Tornikoski (2005) for the application of this definition to the domain of entrepreneurship.

1. 3. Conceptual approach

9

institutional and strategic agency perspectives on legitimacy). In principle, the advantage of the legitimacy framework is that it neither assumes complete environmental determinism nor complete voluntarism. This allows the decision making of potential financiers and entrepreneurs to be placed in a conceptual framework of possible institutional constraints on new ventures and their financing process. Practically, the selection by external financiers may take place in their pre-investment screening of new ventures (cf., for example, Wright & Robbie, 1998 for formal equity financing and Schulte, 2005 for the lending process of banks). This will be elaborated upon based on empirical screening criteria of different types of equity and debt financiers, criteria which are pertinent in the literature of entrepreneurial finance.

2) Internal choices of fund-raising plans over time To specify the cumulative BVSR of entrepreneurs’ action choices, a notion of focal fund-raising intentions and how they change over time will be applied. These fundraising intentions will be a central element in the concept of trial variation and notional concretization (and selection) of action to be employed in chapter four (cf. 4. 3. and Fallgatter, 2004). Essentially, internal selection choices of fund-raising efforts to be pursued during the initial struggle for financing will be understood as changes in fundraising intentions, e.g. shifts in the amount and sources of funding to be sought. The concept to be mapped out will build on general models of entrepreneurial intentions which examine how a person’s intention to start a business forms (see Krueger, 2003 or Linan & Chen, 2006 for an overview).7 Generally, founding a new venture is a distal process unfolding over time (Kyroe & Carrier, 2005). As such it may hardly be conceived as singular stimulus-response behaviour which is why intentionality is considered to be central to its formation and implementation over time (Krueger, 2003 and Mair & Noboa, 2005). The same may hold for the core process of raising funding for a new venture project. The rationale for setting agents’ evolving fund-raising choices within a framework of entrepreneurial intentions is the following.

7

Concepts of entrepreneurial intentions have their origin in applications of Shapero’s entrepreneurial event model and applications of Ajzen’s (and Fishbein’s) theory of reasoned action and planned behaviour respectively; cf. Shapero (1985) as well as Ajzen and Fishbein (1980) and Ajzen (1991 and 2002).

10

1. Outline of problem and overview

Intention frameworks focus on central cognitive antecedents of intentions to perform or not to perform a specific target behaviour such as trying to found a business or raise finance for it (cf. Krueger, 2000). The formation and change of intentions to act in a specific way (and eliminate alternative courses of action) therefore involves internal selection by the entrepreneur. Moreover, an intentions-based framework allows an exploration of the possible impact of various perceived exogenous influences on cognitive antecedents of intentions and, in turn, intent itself (Krueger, 1993, 16). In this thesis, this type of framework will be used as an orientation to explore perceived challenges to acquiring funding as well as any feedback received from financiers in the context of changing fund-raising intentions as they evolve over time. In particular, it will be interesting to study how difficulties in meeting financiers’ legitimacy demands and experienced rejections may impact upon the perceived feasibility of raising external funding.8 This seems promising in so far as entrepreneurs may well include the demands and expectations of external stakeholders such as financiers in their decision-making rationale in the course of implementing their business idea (cf. Grichnik & Immerthal, 2005, 568 and 575).

1. 4. Empirical study and potential contributions Empirical study The empirical study of entrepreneurs’ fund-raising processes will be based on a multiple case study design. Case studies are useful for examining complex change processes and their contexts over time (Curran & Blackburn, 2001, 59; Lichtenstein & Brush, 2001, 39; and Pauwels & Matthyssens, 2004, 126).9 The qualitative empirical research objective will be to look for possible cross-case similarities based on a literal replication logic (cf. ibid. and Yin, 2003); this is so as to identify broad patterns in the fund-raising processes under examination (see, for example, Ghauri, 2004, 114; also cf. Lamnek, 1995a, 23 stressing that action patterns may be explored by choosing similar case contexts).

8

9

Commonly, intentions models focus on the perceived desirability and feasibility of a target behaviour as central antecedents of intentions (cf., for example, Reitan, 1997). In contrast to the initial formation of intentions to seek external financing based on its desirability, during the fund-raising struggle, feasibility considerations may take centre stage. See chapter 5. 1. 1. for further reasoning and specification of the chosen empirical design.

1. 4. Empirical study and potential contributions

11

The empirical study features results from eleven cases of new ventures seeking initial funding from external financiers (including a contrast case). The analysis of their fundraising processes is based on longitudinal data collected in two rounds of in-depth case interviews in 2006 and 2007 (plus supplementary data sources to improve validity). In order to appreciate the study’s analytical focus, the kind of ventures and process phases the cases pertain to should be briefly noted at this point (the methodical framework and procedure for selecting cases will discussed in detail in 5. 1. 2. below).10 This study focuses solely on legally independent new ventures building their own factor combination from scratch.11 This is because the legitimizing and financing situations of ‘derived’ company formations through spin-off, succession, or acquisition are likely to be very specific. Moreover, only existing new ventures in their infancy phase will be looked at, i.e. cases that neither involve more mature adolescent firms, nor emerging ventures still in their conception or gestation phase (cf. 3. 1. 4. for a definition of these differentiations). Regarding the exclusion of emerging ventures, the following should be noted. Many emerging venture projects never lead to the creation of a new firm (Tornikoski, 2005, 11 and Aldrich, 1999, 75). In view of this, studies concentrating on existing new firms may suffer from a survivor bias (this has been claimed by, e.g., Mellewigt & Witt, 2002; Delmar & Shane, 2004; or Tornikoski, 2005).12 Having said this, this bias pertains only to studies claiming that their results are representative and universal to all ventures, irrespective of their development stage. However, the study in this thesis does not claim to generalize its results to apply to the entirety of new ventures, including emerging ones. Rather, this study, in particular its findings, focuses solely on fund-raising processes in ventures that have actually made it to the stage of company existence.13 Moreover, this study is only relevant to new ventures that require external funding to establish themselves but not to those who do not. Another prerequisite was that case ventures had to be searching for funding at the time of the first 10

11

12

13

For the rationale of theoretical or purposive sampling cf. Miles and Huberman (1994, 28), Curran and Blackburn (2001, 63), or Ghauri (2004, 112). Cf. 3. 1. 2. for detailed definitions of this and other delimitations such as venture age and size limitations. The particular statistical problem in this case refers to Heckman’s sample selection bias (Heckman, 1976), which may occur because of the non-randomness of venture survival from the population of all emerging venture projects. Note though that the retrospective part of the empirical study also entails earlier fund-raising efforts in the pre-founding phase of existing company cases. In addition, it should also be noted that the empirical case study will not strive for statistical generalization (cf. chapter 5. 1. for the study’s analytical replication logic).

12

1. Outline of problem and overview

interview. This was in order to study fund-raising processes as they took place (cf. principally Hindle, 2004 or Davidsson, 2005, 8 for the advantages of this kind of contemporary approach). Note also that the study’s time frame pertains to a limited period which makes it more likely that external restrictions on fund-raising are stable and may not be influenced by entrepreneurs. The latter is also the reason why this study looks at single new ventures but does not pertain to population level legitimizing strategies within the emergence of new industries.14 Case ventures will be taken from various industries and no differentiation will be made as to whether they are innovation- and growth-oriented or imitative, small-business-type start-ups.15 Finally, since the financial environment of new ventures may be country-specific, this study is limited to analyzing new ventures located in Germany. Bearing in mind these limitations, the potential benefit of the study and the conceptual approach behind it will be described below.

Potential benefit The study may contribute to future research in three distinct ways. First, the study may be of interest to researchers of new-venture evolution and legitimacy. It offers a specification of principal variation and selection procedures for a core process within newventure evolution, namely the assembly of an initial financial resource base within the external environment of financial-resource selection. Thinking of new-venture evolution in terms of different core processes is of benefit since, as noted earlier, external selection mechanisms and legitimacy restrictions may be domain-specific (cf. Zimmerman & Zeitz, 2002, 415 and Bucar 2004, 23 for the domain-specific nature of legitimizing with different external audiences). In this respect, a preliminary bearing is provided on how entrepreneurs actually perceive selection pressures and demands for legitimacy when trying to attract financial support from the environment.

14

15

At the population level, institutional frameworks may be influenced and, in fact, built by pioneering entrepreneurs acting in concert (cf., for example, Zimmerman & Zeitz, 2002 for this kind of institutional entrepreneurship; cf. Aldrich & Baker, 2001 and Aldrich & Martinez, 2003 for a differentiation of analysis levels of legitmization). This kind of distinction is considered arbitrary in view of the open-ended evolutionary nature of venture development (cf., for example, Bhide, 2000 and also Aldrich & Martinez, 2003 in this respect). However, commonly assumed differences in challenges to legitimize and raise funding between ventures operating in new versus established industries will still be addressed within the concept of perceived external restrictions.

1. 4. Empirical study and potential contributions

13

Second, the study may also be interesting for scholars of entrepreneurial finance. We know that founders of new ventures may attempt to tap different potential sources of initial funding and that they are sometimes rejected and even fail completely to obtain finance (cf. the discussion above). Therefore, new insights into how new-venture founders themselves perceive the financing challenge and engage in various efforts to raise funding over time may be of interest here. Also, there is a considerable body of literature on financing and capital-structure choices of new ventures and small businesses which largely focus on founder preferences for a certain pecking order or for specific types of finance (see, for example, Sapienza et al., 2003; Denis, 2004; Cassar, 2004; Cosh et al., 2005). Given that founders may find it difficult to implement their initially preferred source of external financing, this thesis enables an analysis of how possible changes of original financing choices may emerge throughout the fund-raising struggle. This will complement the above static concepts of financing choices and pecking orders. Third, models of entrepreneurial intentions have concentrated on the formation of intentions to found a new venture in the first place. Given that intentions are task-specific (Krueger, 2003), this study explores the application of an intentions-based framework to the distinct task of venture financing within the entrepreneurial process. Moreover, this study tries to understand how financing intentions are implemented and how they might change in cases where founders have engaged in efforts to establish a new venture. This may be valuable as it has been contended that entrepreneurship research knows little about how existing entrepreneurial intentions (ibid.) and business ideas may change over time in the context of external pressures on the start-up process (Davidsson et al., 2004). Concerning contributions to entrepreneurship practice it should be noted that universal success factors to raise funding with certainty cannot be offered (this will be ruled out in chapter two below on epistemological grounds; also cf. the brief notes in the above introduction of BVSR processes). A viable financial resource base may rather only be arrived at by searching the environmental space of possible financing options. In light of this it will be valuable for entrepreneurial management, consultants to new businesses as well as for enterprise policy makers to know more about how founders actually try to raise funding and change their intentions during the search for initial funding. This study offers preliminary insights into the possible antecedents of such changes and how individual entrepreneurs may perceive external constraints which limit the above search space. In particular, our understanding may be improved of how decisions to discontinue fund-raising intentions and give up on the venture project may come about in face of problems to convince potential financiers.

14

1. Outline of problem and overview

With this understanding, consultants and enterprise policy makers may be able to influence critical antecedents of abandoned fund-raising efforts. For example, actors involved in new-business support may fine tune their suggestions of alternative funding sources as founders may consider the obstacles relating to their current fund-raising approach to be insurmountable. In this respect, this study may complement existing strategies to influence peoples’ perceptions of the feasibility (and desirability) of founding one’s own business in order to encourage entrepreneurial activity in the first place (cf., for example, Reitan, 1997). Given that successful establishment and financing of ventures is uncertain, it is also necessary to understand how entrepreneurs who have decided to found a venture may change their plans and react to difficulties they come across during the further establishment process. This study takes a step in this direction by examining in-process challenges to acquiring initial finance. To explore these challenges, this thesis proceeds as follows.

1. 5. Outline The introduction above has pointed out that it will be necessary to appreciate the imperfection of entrepreneurial agents’ perception of the environment and their lack of foresight. The second chapter builds the epistemological foundation of the conceptual framework to be elaborated. In particular, it will address how human agents perceive and make sense of the external environment. Moreover, a concept of subjectively rational action will be put forth as a basis for the notion of cumulative variation-selection in entrepreneurial action to be elaborated in 4. 3. In chapter three, a working definition of entrepreneurship will first be provided which puts the resource-acquisition challenge centre stage (3. 1.). In this definitional section the new ventures to be studied will also be defined in more detail. Chapter 3. 2. then characterizes typical problems or liabilities of new ventures and, within this context, the significance of their financial resource needs. Following on from these liabilities on the one hand and the need for external resources on the other, the challenge for new ventures to gain legitimacy with external audiences will be addressed (3. 3.). This prepares the conceptual ground for understanding the resource-owner environment which exerts demands for legitimacy on new ventures. The fourth chapter takes a procedural look at the focal fund-raising issue. Chapter 4. 1. introduces the principal evolutionary concept of entrepreneurial action to follow the

1. 5. Outline

15

universal Darwinian BVSR notion. Also the idea of reconstructing broad patterns in fund-raising processes evolving alongside external restrictions will be put forth at this point. After this, the necessary specifications of the principal framework will be worked out. This comprises the financial environment and entrepreneurs’ fund-raising action over time. Consequently, 4. 2. elaborates upon possible restrictions caused by legitimacy demands of potential financiers. These demands may be based on financiers’ selection criteria used in their pre-investment screening process. Chapter 4. 3. and 4. 4. address how entrepreneurs’ fund-raising action over time may be understood based on the above meta-concept of BVSR. Chapter 4. 4. specifies entrepreneurs’ selective choices of fundraising action in particular, seeing these choices as focal changes of fund-raising intentions. Also, a conceptual orientation will be carefully prepared as to how changes of fund-raising intentions might emerge and how entrepreneurs’ might perceive their financial environment. The fifth chapter discusses the design of the empirical study (5. 1.) and reports on the findings obtained (5. 2.). In particular, the discussion of results will filter out preliminary proposals for future research on fund-raising processes in new ventures. The sixth and final chapter concludes the thesis. Based on a summary of the study’s results and possible limitations, academic and practical implications will be suggested in conclusion.

2. Epistemological concept: entrepreneurs as human agents 2. 1. New venture failure as an epistemological issue There have been noticeable cases of both new venture failure, e.g. in the e-commerce sector, as well as aborted investments in new ventures in the venture capital market (cf., for example, Hager et al., 2004 and Ravenpor, 2004). This raises the question of how resource acquisition and allocation action by both entrepreneurs and external financiers of new ventures may be conceptualized. This kind of explanation is of necessity different from perfect resource allocation by actors equipped with complete and infallible knowledge in a rational choice world where the above failure anomalies would be difficult to explain. To appreciate this issue of imperfect knowledge, Rizzello (2000, 138) recommends to “elaborate economic models of individual behaviour which are coherent with the ones produced in psychology and neurobiology” (also cf. Koch & Fallgatter, 2000, 79p.). Following this Hayekian tradition, Rizzello further suggests an analysis of the ontological and epistemological preconditions pertaining to the characteristics of human perception (as the reception of stimuli by sense-organs), decision-making, and action (also cf. Koch, 1996 and Powell, 2003). Consequently, this chapter examines ontology, i.e. how human agents fundamentally relate to the nature of existence or reality (cf. Potter, 2000 or Benton & Craib, 2001), and epistemology, i.e. the ways of gaining knowledge of this reality (also cf. Baillie, 2003). An agent’s knowledge comprises all individual sensational and processed impressions about the external environment up to the present (cf. Picot et al., 2003). An individualized characterization of knowledge is given preference over a holistic concept for reasons to be put forward below.

2. 2. Epistemological implications of human cognition First of all, 2. 2. 1. will address the identification of adequate units of empirical analysis, i.e. choosing between the individual entrepreneur or the venture organization as the unit of action. The selection of objects for analysis is usually regarded as a primarily conceptual and methodical problem for empirical analysis in entrepreneurship research (cf. Hindle, 2004 and 2. 2. 1. below). However, it will be argued that this should also be treated as a problem pertaining to the epistemological domain. This problem involves finding an adequate point in the range between strong (methodological) individualism

18

2. Epistemological concept: entrepreneurs as human agents

and purely holistic approaches (cf. Udehn, 2002). Any epistemological position in this context must appreciate the preconditions of human cognition, defined as “all processes by which sensory input is transformed, reduced, elaborated, stored, recovered, and used” (Mitchell et al., 2002a, 96). Therefore, the approach of choosing units for analysis serves as an introduction to the epistemological discussion in 2. 2. The remainder of the chapter is then organized as follows. Based on approaches from cognitive science, 2. 2. 2. describes human perception as being based on individual constructions of reality. Finally, chapter 2. 2. 3. addresses the fundamental fallibility of the knowledge gained by agents from past social interaction. Both individual reality constructions and the fallibility of knowledge drawn from experience will suggest an important epistemological implication for understanding the fund-raising struggle in new ventures. Entrepreneurs do not automatically know which potential funding source may be tapped successfully. Rather, the outcomes of the process will remain uncertain.

2. 2. 1. Unit of analysis In entrepreneurship research, choosing units of analysis often boils down to whether the entrepreneurial venture can be regarded as a “single homogeneous unit” or not (Parker, 2004, 4). However, this question has been answered differently by researchers at different times, culminating in the overview by Hindle (2004). For example, Cressy (1992) and Minniti and Bygrave (2001) as well as Parker (2004) assume homogeneity and treat entrepreneur and venture as the same. Similarly, Vromen (2001, 188) believes that evolutionary economics generally treats “firms as if they were agents sui generis”. Despite this observation, contributions to an evolutionary theory of the firm also reflect a more individualistic angle by stressing the possible heterogeneity of entrepreneurial agents (cf. for example Witt, 2002 or Cohendet et al., 2000). On account of actor heterogeneity, Sarasvathy et al. (2003) claim it is essential to differentiate between venture firm and entrepreneur. In contrast to the latter, Bygrave (1989) remarks that, for a start-up, and probably even more so before founding, the entrepreneur and the venture often are the same. This is simply because the entrepreneur may likely be the only person involved in the venture’s development at this time. This leads to a differentiation across unfolding development stages of ventures. For concepts concentrating on early life phases (as this thesis does), it may well be reasonable to consider the entrepreneur the acting unit instead of the

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venture organization. However, beyond the mere quantitative aspect of how many people are involved in the business, the issue of reductionism is also inherent, two issues being important in this respect. Firstly, Hindle (2004, 583) argues that entrepreneurship may be “insolubly holistic in nature”. The author addresses the issue of whether the individual entrepreneur will constitute a viable unit of analysis without over-simplification due to separation from the environmental and internal context of institutions, markets, stakeholders and employees. In fact, the cognitive constructivist discussion below will show that the single entrepreneur has to be separated from the environment for epistemological reasons. This is partly due to subjective construction of reality driven by individual ontogeny and experience learning during adulthood. Hence, the individual entrepreneur may constitute the most sensible unit of analysis. This would also suit the integration of individual background and subjective experience found to be relevant in empirical entrepreneurial inquiry, for example, in entrepreneurial opportunity recognition (Shane, 2000) and strategy formation (Lafuente & Salas, 1989). A holistic analysis of collective action at the organization level would possibly fail to track these subjective components in entrepreneurial action and also appears not to be a reasonable option from an epistemological perspective (also cf. Fallgatter, 2002, 38). Having said this, however, when travelling down the individualistic road instead, the above reductionism problem has to be tackled. Secondly therefore, environmental context needs to be addressed in terms of how, in particular, interaction between the entrepreneur and potential financiers will be integrated into the individualistic position to be pursued in this paper. “Individual entrepreneurs do not live and operate in vacuums. They are part of complex systems” (Hindle, 2004, 584). Fortunately for this integration task, it is not necessary to merely stick with the simplistic dichotomy of either completely individualistic or totally holistic concepts (Udehn, 2002; also cf. Geue, 1997, 66p. and, in particular, Nelson Spivey, 1997 for a discussion of individualistic and collective concepts from a constructivist perspective). Rather, there are various concepts of methodological individualism. These range from strong forms, where the individual is seen as existing in a Robinson Crusoe-like world, free of social context, to weaker forms, which consider individuals as socio-cultural beings shaped by the socio-institutional history of society (Udehn 2002; also cf. Harper, 1996 and Butos & Koppl, 1997). However, the socio-institutional embeddedness of human behaviour has to recognize the individual character of reality construction as a cognitive given. In light of what has been said, the following points may be put forth.

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(1) Epistemologically, the unit of analysis should be the individual entrepreneurial agent in the process of financial resource acquisition. Having said this, it is assumed that individuals act within a social and institutional context. This does not imply “any break with methodological individualism, however. Society and culture are subjective phenomena existing only in the minds of individuals” (Udehn, 2002, 487; also cf. Maurer & Schmid, 2002, 23). For the relevance of institutionalized rules (such as investment screening criteria in the financial domain) as an antecedent or explanans of individual action, it is insufficient to simply refer to the objective and universal existence of institutions. Therefore, an alternative concept will be required to reconcile institutionbased human interaction with the proposed individualistic approach. (2) In contrast to a total subjectivism in social exchange, the integration of the institutional environment and social interaction will be made up of elements of social construction theory. Social construction theory stresses the emergence of institutional communalities and inter-subjective alignment of individual reality constructions by acts of communication and similar everyday life experiences (cf. 2. 3. 2.). Inter-subjectivity is also of central significance when conceptualizing the relation between individual entrepreneurs and their new ventures. (3) To cautiously simplify the empirical research concept, inter-subjectively shared resource acquisition activities are assumed within the single new venture.16 This concept is also supported by the views of Witt (1998) as well as of Shepherd and Krueger (2002). Both address the situation of a shared view or mental model of the business opportunity and exploitation concept in a small new venture. It is reasonable to assume such intersubjectivity in the case of small new ventures with few organization members and close everyday communication. In practice, the empirical case studies predominantly feature cases of new ventures founded and run by single entrepreneurs anyway. Thus, whenever this thesis mentions the ‘entrepreneurial agent’ or entrepreneurial behaviour in the fundraising process, this will mean the above simplified coherent unit of analysis.17 Next, the suggested individualistic perception of the environment will be elaborated upon. For this kind of individualistic approach, Udehn (2002) presumes that a thick cognitive psychology framework needs to be employed. This is also the case in the following chapter examining human perception and the individual construction of reality. 16

17

This step is also taken since intra-organizational group dynamics of founding teams are not the focus of this study. Note that a population of different new ventures will still feature substantial heterogeneity on account of individuality in ventures’ development histories.

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2. 2. 2. Individual perception and cognitive construction of reality For a neurological-cognitive discussion of human perception, discernment, and processing of external stimuli, Roth (1995) demands neutrality with respect to the epistemological perspective pursued. However, in the interest of space and readability, results implying individual construction of reality will be stated along the way rather than culminating at the end of the chapter. This chapter will explain 1) that the concept of an objective and iconic perception of the environment does not hold, 2) that perception of the external environment is individual, and 3) that individual knowledge about the environment is fallible. This will pave the way for understanding the fund-raising struggle in new ventures and the need to gain legitimacy and acceptance from external financiers due to the lack of complete knowledge about the venture’s future prospects.

2. 2. 2. 1. Objective perception and the individualistic alternative When addressing epistemology, the focus will be more on “how” cognition emerges rather than on “what” it is that we conceive (cf., for example, Hejl, 2000). However, it will soon become clear that the former will have essential implications on the qualities of the latter. The course of argumentation follows the reasoning of Roth (1995 and 2000). A positivist concept of the outside world requires human perception and cognition to establish an objective ‘one-to-one’ representation of objects and phenomena (Mir & Watson, 2001 also cf. Koch, 1996a). This form of realistic representationalism based on Cartesian as well as Lockean empiricism tradition (cf. Grint, 1998 and Bennett & Hacker, 2003) would have to follow through across two steps according to Roth: the reception of environmental stimuli by human sense-organs (1), and the internal processing of these stimuli by the human brain (2). Only then would stimuli perception result in an internal iconic mirror image of the outside world. These respective relations between external stimuli and sense-organs and, in turn, sense-organs and internal processing inside the human brain, will be looked at now. In the course of analysis an alternative explanation will be developed, as the above realistic representation does not in fact hold.

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Environmental stimuli − sense-organs (step 1) The human brain has no direct access to the external world (cf., for example, Rosenzweig et al., 1999). Rather, access is established by sense-organs connecting the reception of stimuli of different modalities to the central nervous system. Environmental stimuli are characterized by their modality with corresponding forms of energy (such as visible radiant energy, sound vibrations, mechanical energy, etc.) as well as by their intensity, timing, and location (ibid., or Driver & Spence, 1999). On the one hand, different sensory receptor organs allow discrimination between the different forms of stimulus energy. On the other hand, a receptor cell, following the processing principle of transduction, converts energy impulses into changes in the electrical potential across its membrane (Rosenzweig et al., 1999; also cf. Roth, 2001a). There are two important aspects here. Firstly, stimuli are converted by transduction into a uniform neuronal code representing sensory events (this will be dealt with later when the processing relation between senseorgans and the brain is explored). Secondly, receptor cells in sense-organs possess only a limited range of responsiveness to stimuli energy to be transduced (this is a standard argument in human cognition theory, for example, in Rieschel, 2000). This selectiveness towards sensorial stimuli within a specific range reflects the respective survival needs of the species (Hejl, 2000). Roth (1995) therefore draws the interim epistemological conclusion that any representation of the external world within the human brain is already ex ante, namely at the moment of stimuli reception, limited to producing only a selective image.

Internal stimuli processing by the human brain (step 2) Traditional behavioural stimulus-response concepts are accused of being misleading and problematic with regard to a general explanation of stimuli reception and their further processing (see, e.g., Treisman, 1999 or Singer, 2000). Their deficiency originates in the argument that our environment is far too complex for the idea of highly specialized receptors to work (cf. Roth, 1995 and Miller, 1999). A neuronal specialist concept would ultimately run into a numerical problem and a problem of brain space (Singer, 1995 and 2000 as well as Roth, 2001a and vd. Malsburg, 2002). If there were single special receptors for each environmental state in the process of stimuli perception and object identification, this would require a virtually limitless number of different

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receptors integrating infinite combinations of stimuli characteristics and spatial rotations (cf. Singer, 2002 and Logothetis et al., 1995). To explain stimuli reception, processing, and object identification, cognitive research offers concepts differing from traditional stimulus-response processes. Broadly speaking, these concepts involve two related ideas. Firstly, receptors in sense-organs are not as highly specialized as assumed in the past (Roth, 1995). Rather, receptor cells feature broadly tuned response properties that can detect different stimuli of the same modality. Their further evaluation is left to a complex downstream processing and evaluation system (cf. Singer, 1995; Driver & Spence, 1999; and Roth, 2001a). Secondly, research has put forward an integrated competition hypothesis, assuming that (competing) grouped ensembles of neurons are involved in stimuli perception and representation (cf. Humphreys et al. 1999; Treisman, 1999; Singer, 2000; and Markowtisch & Daum, 2001). Each respective neuronal cell is able to participate flexibly in different dynamic ensembles. For example, a cell able to detect coloured contours can contribute to the identification of different objects at different times (Singer, 2000). If external stimuli content is not represented in highly specialized receptor cells but rather in ensembles of cells, then the above numerical problem would also be solved. The reason for this is that the same cells can be used to represent (parts of) different objects at different times. However, one important issue then remains to be addressed. This is referred to as the binding problem (for and overview see vd. Malsburg, 2002, 58; also cf. Treisman, 1999 and Singer, 2002). “The binding problem in perception deals with the question of how we achieve the experience of a coherent world of integrated objects. In brief, how do we specify what goes with what and where” (Treisman, 1999, 91). This challenge requires the brain to assemble dispersed multi-modal representations from different regions and functional areas of the brain (cf. Humphreys et al., 1999 and Rosenzweig et al., 1999). This associative processing is assumed to be located mainly in the cortex (Roth, 2001). How this exactly works is still a matter of debate in neuroscience with different exploratory theses offered. For example, Treisman (1999) assumes that attention plays an important role in integrated object identification in complex multi-object environments (for the relevance of attention in visual perception also cf. Miller, 1999 and Rees & Frith, 1999). Researchers in Singer’s circle propose a synchronization hypothesis relating to the above dynamic ensembles of cells grouping together (see Singer, 1995 and 2000). This is assumed to be based on second-level neuronal interrelations within the downstream

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processing system in different regions of the brain, in particular the iso-cortex. The grouping of neurons ‘firing together’ is influenced phylo- and ontogenetically as well as by individual experience-based knowledge evolution (Rieschel, 2000). Neurologically, new individual experience may be considered the result of interaction between emerging neuronal association structures and external stimuli data (Rizzello, 2001, 8). A successful grouping of neuronal cells is assumed to be established by a synchronized discharge of neurons within an ensemble of cells; in turn, this allows coherent differentiation and object identification. This synchronization process has its roots in the works of Hebb (1949) who developed the idea that object identity is represented in the structural relation of groups of cells. This has an important epistemological consequence. The representation of the external environment at a higher structural relation level (rather than by specialist receptor cells) again rules out an objective representation of the environment as a mirror image. “What we think of as a property of things is, in the first instance, a property of the mind’s taxonomic framework” (Butos & Koppl, 1993, 307). This is further clarified in the following section.

Uniform transduction code and the internal process of active construction of meaning What has been said above leads to the implication that the representation of environmental objects at the structural relation level is the only possible explanation left (Roth, 1995). This is because multi-modal integration of stimuli reception requires unspecific neuronal coding. In consequence, this uniform code does not contain any specificity of the original external stimuli (only intensity and quantity are coded, cf. ibid. or Hejl, 2000). Integrated object identity and meaning therefore has to be represented in structural relations. Even more importantly, undifferentiated neuronal coding also implies that object identification and any attachment of meaning to this neuronal code must be generated internally within the brain’s neuronal circuits. The attachment of meaning to stimuli and making inferences will also depend on in which functional area of the brain neuronal code is processed (this is in fact a fundamental and often cited argument of constructivist reasoning, cf., for example, Schmidt 1991; Roth, 1995; or Hejl, 2000). Quantitatively, the argument of a solely internal generation of meaning is further strengthened. Only 10 to 20% of all neuronal synapses establish modality-specific relations at the sensory reception level. The remaining 80 to 90% belong to second-level linkages within the human brain’s associative processing and evaluation areas (cf. Singer, 2000; Hejl,

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2000 and Roth, 2001a report similar figures of neuron quantities). The former 10% are associated with the domain of stimuli-induced responses while the latter 90% highlight the overwhelming relevance of internal processing and evaluation leading to Singer’s apt remark that ‘up to 90% of brain power is used for internal monologue’ (Singer, 2000, 185). Hence, “the process through which individual knowledge is gathered begins only with the acquisition of quantitative data. In order to reach the useful information, one needs to give to these data a qualitative meaning, through an internal constructive process” (Rizzello, 2000, 140; also cf. vd. Malsburg, 2002, 58). This attachment process cannot generate a passive representational realistic image but requires an active internal construction of reality (Roth, 1995).18 Stimuli processing is therefore not merely passive but rather an active self-generated brain activity, which is only partly induced and modulated by the presence of external stimuli (cf. Roth, 1995 and Goebel et al., 1998).19 At first sight, the implicit, more or less minor role of triggering external stimuli constitutes openness. However, the brain’s operation is ultimately self-referential. This is not simply because it is disconnected from the external world as it requires a sensory interface. Rather, the brain tests and tries out alternative explanations of stimuli it has received (vd. Malsburg, 2002, 48). In fact this ‘hypothesis testing’ occurs frequently as a structuring activity of the cortex (Singer, 2002). This process is fundamentally selfreferential as the unit disseminating and testing competing explanations of external sensations and the unit evaluating the trial results are the same, i.e. the human brain left with only internal concepts and categories of evaluation (cf. Roth, 2000 and earlier Schmidt, 1991). Thus, this semantic closeness and self-referentiality does not mean a blind flight but rather a recursive process of trying and testing (Roth, 2000). Apparently, neither does a centre in the human brain exist in which stimuli responses are compiled to produce a realistic image. Rather, the brain works as a decentralized neuronal system, in which stimuli processing, modulated by existing neuronal associations, is located in different regions (cf. Hejl, 2000 and vd. Malsburg, 2002). All categories and principles of this modulation are internal as they utilize individual 18

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This active internal construction of stimuli content may also function as a bridge between perceptive sensory gaps which naturally occur because human perception is not a continuous process; rather perception depends on the brain’s own operating frequency (cf. in particular Poeppel, 1985, 41p.). This internal activity was also observed by Chapman et al. (2000), who compare a classic behavioural stimulus-response model of pain perception with a more suitable constructivist concept. The latter appreciates individual differences in the experience of pain based on differences in past personal experiences of pain stored in memory.

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pre-existing knowledge (Singer, 2000 and Rieschel, 2000). This individualistic character of reality construction is further described in the next chapter.

2. 2. 2. 2. Sense-making of the environment and individual memory The associative network from which meaning construction of perceived stimuli derives is specific to the individual human brain. This leads to the general idea that perception of and knowledge about the external world will differ across human agents (e.g. Becker, 2000 and Hejl, 2000). Or as Rizzello (2000, 140) puts it: “Even when two individuals face the same data, the resulting interpretations may differ, because their schemes are genetically different and because they have lived through different experiences”. This individuality in stimuli processing and perception of the outside world is also found in the above integrated competition concept of synchronized cell ensembles. Singer (2000) argues that any dynamic grouping of neuronal cells is based on individual pieces of knowledge represented in the synaptic network (also cf. Bundesen, 1999). This grouping process works robustly without knowing ex ante what object is to be identified. Here, pre-existing pieces of knowledge function as important associative templates in the process of reality construction. Since internal constructions are based on pre-existing categories established during the individual’s previous exposure to reality and are thus a result of ontogeny, Roth (2000) argues that the brain and its constructions are themselves a product of reality. The main product, which is an integrated self and personality the brain refers to as the bearer of action, emerges in late ontogeny (ibid.). Essentially, this points out that individual constructions of reality are also bound to the social conditions and contexts the individual actor has experienced and travelled through so far in socialization processes (cf. Rieschel, 2000; and earlier Piaget, 1983). This results in a cognitive-constructivist individualism that stresses subjectivity in perception and interpretation of the external environment. At the same time, perceptual individualism will enable the integration of socio-institutional context precisely because pre-existing internal concepts and categories moderating perception have emerged under social conditions (cf. Roth, 2001 and section 2. 3. 2. below). The store of internal concepts employed in the process of reality construction will carry both highly idiosyncratic episodes of personal experience as well as common, socially shared experience elements gained in socialization and interaction in society. The cognitive-neuronal component corresponding to these experiential

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episodes and knowledge elements is human memory. In particular, new sensational experiences in stimuli perception and the lens of human memory are interrelated through the course of time. On the one hand, ‘memory is our most important sense-organ’, making it the most important modulator of human perception (Roth, 1995, 60). On the other hand, memory content is updated by new perceptive experiences. This interdependence of perception and memory is illustrated in figure 2–1.

(a) stimuli identification and integration through lens of existing neuronal synaptic structures

human memory structures

perception of environmental stimuli

(b) enhancement & impediment of synaptic wiring in associative memory (foundation and validation of memory content)

figure 2–1: interdependence of stimuli perception and human memory

There are two important individualistic elements in the role of memory in the perception process (cf. (a) in figure 2–1): First, there is the use of memory templates for integrated stimuli recognition and object identification (cf. the knowledge-based synchronization of cell ensembles in the above discussion of the binding problem). The second aspect is the evaluation of incoming perceived stimuli utilizing episodic and autobiographic memory. This latter aspect will now be briefly addressed. The hippocampus gate and surrounding parts of the cortex are assumed to function as the organizer of conscious declarative memory; moreover, the hippocampus is possibly also responsible for recalling and recollecting memory data (cf. Maguire et al., 1997;

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Marsel Mesulam, 2000, 60p.; and Roth, 2001a, 160). These memorized pieces of experience data contribute to the construction of perception depending on the stimulated brain region giving meaning to transduction code (Roth, 2000). This process remains to some extent unconscious. The emotional limbic system performs pre-evaluations of new stimuli constellations. In particular, the episodic and personal autobiographical memory will be involved in the pre-evaluations because of the strong neuronal relations between these memory parts and the limbic system (Roth, 2001). The use of individual memory templates in stimuli representation and their evaluation based on personal memory suggest that individual perception over time is path-dependent, resting on compiled knowledge stored in memory (cf. Rieschel, 2000). Rizzello (2000, 139) states that “in the processes of acquisition and use of knowledge, the human mind acts using innate schemes which influence the external sensorial perceptions through a process of association of the stimuli to previously classified perceptions” (also cf. Streit, 2001, 4 for this transformation of physiological stimuli). Singer (2000) concludes that such memory classifications bring order to the individual’s knowledge of the world. In particular, meaning will be attached to external stimuli only by internal means as the individual brain gives “significance to external data by means of personal and idiosyncratic interpretation” (Rizzello, 2001, 11; also cf. Nicholson & Anderson, 2005, 155). In addition to the use of memorized knowledge and personal experiences in path-dependent perception processes, Rizzello (2000) also addresses the significance of stimuli input for the development of memory structures (cf. (b) in figure 2–1 above). This is because memory content changes through the course of an individual life-time on account of recursive feedback about how reality constructions have worked in interaction with the environment. Memory content as associative knowledge is represented in the synaptic wiring of neurons. Modulation of neuronal associations functions via neurotransmitters constituting dynamic plasticity (cf. Singer, 1995). Here, the hippocampus is subject to continuous reorganization induced by newly incoming sensational experiences during an individual’s life (Roth, 2001a, 161). Principally, sources of developing associative knowledge comprise phylogenetic preconditions, ontogeny, and neuronal modifications during adulthood (cf. Singer, 2000 and Roth, 2000). In particular, the development and modulation of pieces of knowledge about financing issues may occur in two ways: 1) in general terms in secondary socialization when becoming acquainted with financing institutions like banks (cf. 2. 3. 2. below), and 2) in specific terms during the financing process in new venture formation. During this process, further experiences with the financial domain are made in interaction with potential financiers.

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New sensory pieces of information, in particular those relating to consequences of previous actions, may be assimilated. This assimilation further validates the neuron connections which have been involved in generating that piece of information, because the underlying construction of reality has been confirmed. The other scenario is an accommodation of cognitive knowledge structures if the corresponding construction of reality has been disconfirmed (Kaisla, 2003; cf. Becker, 2000 for the principle notion of assimilation and accommodation processes and vd. Malsburg, 2002, 48 for the cognitive processes behind this). At the neurological level, all association learning processes are either enabled by impediment and enhancement of existing synapses or by the establishment and reduction of new connections between neurons. To sum up, the discussion above suggests a dynamic interrelation between perception and individual memory. It is this interrelation which makes up subjectivity in individual agents’ perception of reality. However, subjectivity in stimuli processing and the active, meaning-constructing role of the brain will also have a further important consequence for entrepreneurs’ attempts to raise funding from potential financiers, i.e. the fallibility of all knowledge about the social world gained in previous social interaction.

2. 2. 3. The fallibility of knowledge and the viability requirement It has been stated above that the brain actively experiments and tests perceptive expectations in the process of reality construction. At the neurological level, this experimentation apparently results in different mental images of perceived stimuli every few seconds (Koch, 1996; also cf. Singer, 2000 as well as Poeppel, 1985, 60p.). This ‘switching’ activity is an important cognitive-neuronal principle for autonomous human creativity. This autonomous, brain-generated creativity of agents will render knowledge about the future development of social systems fallible (cf. Geue, 1997, 91). Cognitive creativity implies that the behaviour of other agents can never be completely foreseen ex ante in social interaction (cf. Shackle, 1961, 43 and Buchanan & Vanberg, 2002, 122p.). First of all, following from stimuli perception and processing, the most apparent reason for the fallibility of knowledge is the impossibility of perceiving reality fully and objectively. However, the explanation would not be complete if it only stressed these simple limitations of the brain’s processing capacity as reflected in concepts of bounded rationality. Bounded rationality neglects creativity in human cognition (cf. Kiwit et al., 2000 and Rathe & Witt, 2000). Human cognition is not passive, merely adapting to changes in

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the external environment, but creatively produces alternative views of reality. In this context, Butos and Koppl (1997, 340) remark that “whereas the rules governing the classificatory functioning of cognitive activity are in principle finite, the various permutations of interpretation that can be constructed are limitless. This means that the mind can not only reorder its perceptions of reality, but also create new theories about reality”. It may be the above continuous testing of perceptive alternatives by the human brain that constitutes the neuronal explanation for human creativity.20 However, Roth (ibid.) asserts that, generally, very little is known about the neuronal basis of human creativity. Having said this, the representation of perceptive images in dynamic ensembles of cells may provide the flexibility to generate alternative world views, for example when exposed to potentially conflicting object identifications (e.g. the famous Rubin vase, cf. Singer, 2000). Schmidt (1991) speculated that it may be precisely this indeterminacy and neuronal flexibility which constitutes the human advantage in solving complex problems. For human interaction in social systems this implies a kind of indeterminacy of agent choice of action, depending on which of the creatively generated alternative perspectives is favoured. Rizzello (2000) concludes that perception therefore becomes a main source of the unpredictability of human behaviour for others. This results in the above argument in favour of a general fallibility of knowledge about the world from the perspective of one individual (further details of human creativity leading to uncertainty can be found in Koch, 1996). This is an important additional argument that goes beyond mere bounded rationality concepts (cf. Mahoney & Michael, 2005, 36p.). The departure from rational choice theory is not simply a quantitative problem of limited brain power available for information processing. Rather, the reason for deviation is essentially endogenous and qualitative. It is the above subjective, creative construction of reality by human agents themselves which brings about an unpredictable open-ended social environment (also cf. Harper, 1996, 110 and Koch, 2002, 6). In this environment, actors are uncertain about what may occur in the future of a social system (cf. Budzinski, 2003, 220 and O’Driscoll & Rizzo, 1985, 2 for this endogenous

20

In addition, neuronal plasticity with the aid of electro-chemical neurotransmitters which modulate synaptic connections between neurons by impeding or enhancing impulses also seems to play a role in human creativity (Roth, 2001). Neuronal plasticity allows the association and combination of perceived stimuli and internal pieces of knowledge in different ways said to be the basis of divergent creative thinking.

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uncertainty). Such (true or structural) Knightian uncertainty refers to situations where not all possible future states of the world are known and no occurrence probabilities may be attached to potential outcomes (see Sarasvathy & Kotha, 2001, 5; also cf. Brouwer, 2000; Gifford, 2003; and Alvarez, 2005 for a further discussion of Knightian uncertainty in entrepreneurship). Because of the fallibility of human knowledge about the external environment, the approach to this body of knowledge must be more instrumentalist and pragmatic than positivist. Instead of a positivistic view, experienced individual and social context may merely lead to a kind of taken-for-granted common-sense realism (cf. Hejl, 2000 and Rieschel, 2000). Such pragmatism can only correspond to a sufficiently workable fit between the construction of reality and its unobserved external counterpart. It is of lesser importance whether the constructions completely correspond to objective true reality or not (Becker, 2000).21 However, constructions of reality and expectations are not pointless or random (O’Driscoll & Rizzo, 1985, 32). They need to be viable in human action. Finding out about the primary viability of individual constructions again has its cognitive roots in the brain’s active construction and subsequent testing of alternative views of reality. This will contribute to the stock of fallible knowledge about reality (cf. Hunter & Ainlay, 1986). Individual constructions are said to possess viability if they function like a key to a lock of ontologically unknown properties (cf. Becker, 2000). Finally, it has to be conceded that the fallibility of knowledge may also not be overcome through learning processes. In any case, associative knowledge assimilation and accommodation processes do not constitute an objectively improved fit between constructions of reality and the unobserved features of the external world (for this and the following cf. Koch, 1996 referring to Engels, 1989). The need for viability primarily refers to experiencebased reality constructions based solely on internal and self-referential evaluation criteria at the individual actor level. However, it also applies to inter-subjectively perceived institutional artefacts or social entities like firm organizations (cf. the discussion in Becker, 2000). To sum up, the fallibility of both individual and socially shared knowledge will inform the exploration of fund-raising processes in new ventures to be carried out in this thesis 21

This is in fact a general theme in constructivist reasoning, based on v. Glasersfeld’s famous lock-and-key metaphor (ibid.).

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in two ways. First, entrepreneurs will not be able to progress towards successful acquisition of external financing with certainty. All individual knowledge accumulated throughout the fund-raising struggle will remain a fallible interpretation of experience (cf. Butos & Koppl, 1997). The outcomes of the process will be open-ended. Second, constructions of the new ventures, which entrepreneurs communicate to external financiers, will not be accepted per se. This is because the constructions’ future prospects are uncertain, too. Rather, these constructions will also require social viability measured by evaluation criteria representing fallible societal knowledge of what works and what does not (Becker, 2000, 172 and Siegenthaler, 2000, 243; cf. Geue, 1997). This will be followed up in the discussion of social interaction in 2. 3. 2. below.

2. 3. Subjectively rational action and inter-subjective interaction This chapter integrates the above notion of individual constructions of reality based on subjective experience into an understanding of human action. Chapter 2. 3. 1. describes a concept of subjectively rational behaviour which is commensurable to the above epistemological perspective. Then, 2. 3. 2. will address the issue of social interaction and the potential for inter-subjectivity. The former is the central epistemological ingredient to the concept of fund-raising action as variation-selection with imperfect foresight. The latter will contribute to an understanding of the interaction between the environment of potential financiers and entrepreneurs seeking funding for their ventures. In particular, the possibility of inter-subjectivity in the institutional domain of venture financing will be an anchor of the exploration of broad patterns in fund-raising processes.

2. 3. 1. Subjectively rational action and its cognitive antecedents Ryall (2003, 936) defines the subjective rationality of actors as follows: “An agent pursuing a well-defined set of objectives is said to be subjectively rational when she selects actions that appear optimal given the available facts and, where these are lacking, given her own subjective assessments” (cf. Mahoney & Michael, 2005, 36pp. proposing a notion of subjectively rational action in entrepreneurship). However, note from chapter 2. 2. above that there will be no ‘objective facts’, as individual agents will have to rely solely on their own experiential categories of the external environment in every situation.

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Having said this, such action is still rational from the standpoint of the individual agent. Note though that this subjective rationality principle is more or less non-refutable empirically (Vanberg, 2004, 3). This is because it refers only to “‘local’ subjective consistency of human action, ‘local’ in the sense that reference is only made to the agent’s purposes or preferences and beliefs at the moment of choice” (ibid, 2; also cf. Kappelhoff, 2004 for such inescapable purposefulness of individual action). Local consistency here refers to both the individual and the situation at the moment of choice (Vanberg, 2004, 2; also see Vanberg, 1994, 27 and Shackle, 1961, 8). Subjective rationality may be understood as the individual and situational compatibility which Vanberg refers to as local. Subjective rationality is the only possible consequence of the subject-driven construction of external reality by human agents. For rational choices to be made with certainty, the objective perception of the environment as a point of reference is epistemologically lacking (Koch, 1996, 26 and Handlbauer, 2000, 140p.; both dismiss the idea of an objective recognition, analysis, and objectively rational solution of problems). Such a point of reference would pertain to a goodness of choice and consequential rationality of means-ends relations which are completely adequate to the objectively perceived environmental context (Kaisla, 2003, 246p.). For objective rationality of action to hold, two essential performances are attributed to the human brain upon which choice of action is made (cf. Becker, 2000, 162pp. and Oetsch, 1996, 40). Firstly, agents must possess perfect knowledge and “see the world in the correct way” (Vanberg, 1994, 26; cf. Mahoney & Michael, 2005, 35). Secondly, based on this perfect perception of the external situation, actors are able to calculate univocal means-ends relations potentially resulting in optimal choice behaviour. Since this is cognitively impossible, only subjective consistency of individual constructions of the environment and individual choice of action remains (see again Vanberg, 2004).22 This subjective consistency of perceptions, their evaluation, and subsequent action refers to cognitive antecedents of choosing a course of action. This will be looked at in more detail now. The concepts of Krueger (2003), and Hesse and Koch (1998) will be discussed in particular. This will be an important foundation for the analysis of fundraising activities of entrepreneurs over time. Krueger’s elementary notion of cognitive

22

Also cf. the notion of subjective models of environment in Kerber (1997, 51) and the lack of universal, subject-independent planning information as pointed out by Koch (1996).

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antecedents of entrepreneurial behaviour will serve as a basis for empirical exploration of entrepreneurs’ intentions to try to raise external financing (cf. 4. 4. where the concept of entrepreneurial intentions will be discussed in detail). Hesse and Koch’s model will contribute to an understanding of the time-consuming character of the fund-raising struggle to unfold as a process of cumulative variation and selection.

2. 3. 1. 1. Cognitive antecedents underlying entrepreneurial action Krueger’s elementary concept of cognitive layers underlying entrepreneurial behaviour originates in general cognitive psychology. It appreciates that cognitive processes may mediate between perceptions of the external environment and action relating to it. For example, entrepreneurial opportunities are actively enacted and constructed by the individual rather than being passively observed in a more universal way. Moreover, potential exploitation action is also assumed to be based on such individual perceptions and reality constructions (cf. Krueger, 2003, 116). Furthermore, subjective imagination based on previous personal experiences and perception of current information may be employed in developing novel business conceptions (Witt, 1998, 163). This kind of subjective experience knowledge is part of individual memory structures (cf. 2. 2. above) which constitute the bottom layer of deeper cognitive structures in figure 2–2; these structures reside far below the surface of observable human behaviour (Krueger, 2003, 110).

agent’s behaviour observable surface behavioural intentions

beliefs and attitudes

deeper cognitive structures

figure 2–2: cognitive antecedent layers of human behaviour (compiled from Krueger, 2003, 109pp.)

Choice of action in particular will also have its roots in past cognitions corresponding to expectations and plans as behavioural antecedents (cf. Koch, 2002, 5). While plans and

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other intentional elements, as well as personal beliefs and attitudes, are semantic representations of knowledge ultimately expressed in behaviour, the underlying deeper structures are mainly symbolic in nature (cf. figure 2–2 and Krueger, 2003, 107 and 128).23 These structures embrace mental models of various kinds, including cognitive maps that integrate causal maps as well as procedural subsets like scripts and schemata, e.g. of a restaurant visit (cf. Jenkins, 1998, 232). Mental models are relevant cognitive constructions representing the individual brain’s view and understanding of the extract of external reality the model relates to (cf. Al-Diban, 2002); a single mental model is maintained as long as it has primary viability and generates plausibility of external reality (ibid.; also cf. 2. 2. 3. above). In general, the level of beliefs and attitudes, which lie underneath behavioural intentions (as in figure 2–2), may influence the perceived feasibility and desirability of alternative courses of action (cf., for example, Reitan, 1997 or Krueger, 2000; see also chapter 4. 4. for details). An example of such beliefs is individuals’ assessment of self efficacy, as “a judgement of one’s capability to accomplish a certain level of performance” (Bandura, 1986, 391). An entrepreneur’s personal efficacy or individual ability cognition entails mental concepts regarding the knowledge and competences needed to create a new venture (Mitchell et al., 2002) These cognitions will be specific, for example, to the respective tasks of organizing a new business or acquiring financial and other resources for it (cf. Baron & Ward, 2004, 555). In the entrepreneurial context, behavioural intentions relate to the above beliefs in so far as “intentions require the belief that the behaviour is feasible and the belief that the behaviour is desirable” (Krueger, 2003, 109). Furthermore, mediated by beliefs and attitudes, behavioural intentions may be driven by mental schemata at the deeper structure level referring to subjective knowledge structures (cf., for example Bird, 1992). In contrast, intentions themselves reside closer to the surface of expressed behaviour (as depicted in figure 2–2). Intent is “a cognitive state immediately prior to the decision to act” (Krueger, 2003, 115). Intentionality may be characterized as “a state of mind directing a person’s attention ... toward a specific object (goal) or a path in order to achieve something” (Hindle, 2004, 589p.; also cf. Bird, 1988). For example, intentions are assumed to be implemented by human agents envisioning the image of the intended 23

From the cognitive-neurological perspective, these deeper structures may be viewed as relations largely relating to personal episodic memory and non-declarative memory (cf. Anderson, 1996, 144).

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action and its aim, and then envisioning how to achieve this (e.g. as in Beach’s theory of image; Beach, 1990).24 Finally, intentions, though a reasonably good empirical predictor of human behaviour (Krueger, 2003), do not always lead to the proposed behaviour. Likewise, actions do not always lead to the intended results. For example, Jenkins and Johnson (1997) found that quite often small business managers had entrepreneurial intentions (measured as “a desire to increase the revenue and profit performance of the business”, ibid., 897), but did not achieve the intended entrepreneurial outcomes. In addition, the corresponding case of achieving entrepreneurial growth outcomes without significant prior entrepreneurial intentions also occurred (ibid.; also cf. Bhide, 2000). This may suggest that entrepreneurial action will neither be completely determined by the external environment; nor may it follow pure voluntarism with complete knowledge and foresight (cf. Jenkins and Johnson 1997, 896). In the end, both extremes would result in entirely foreseeable and determinable agent behaviour, should action follow an objective rational choice algorithm from which any action may be deduced ex ante (cf. Hodgson, 1996, 218). Hesse and Koch (1998) particularly address the issue of determinism and the predictability of human action. In their concept of individual action, the brain’s autonomous creativity and the subjectivity of perceptions of the environment rule out the idea of completely deterministic action following an observable algorithm (cf. Koch & Fallgatter, 2000, 79).

2. 3. 1. 2. A concept of creative subjectively-rational action Hesse and Koch (1998) developed a behavioural model located between the two extreme positions of determinism and complete voluntarism. Refuting a completely ‘voluntaristic’ notion, the authors argue for subjective rationality of action based on fallible individual knowledge. However, this must also not result in environmental determinism. This is because human creativity relates to external restrictions and the above pragmatic approach to one’s own knowledge imperfection. A similar notion is put forward by Harper, who also combines elements of “creative freedom and selective control with feedback” in his entrepreneurial concept (Harper, 1996, 86). The 24

Note that effectuation research has also shown that entrepreneurial thinking often also works the other way around by starting with given means at hand and then imagining what ends could be ‘effectuated’ and attained by them (cf., for example, Sarasvathy & Kotha, 2001).

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introduction of Hesse and Koch’s concept also highlights additional aspects of human action not yet addressed.

intended and unintended consequences of previous action (tn-1) contributing to fundamentals of action in tn

(1) fundamentals of action

tn

principle of cognitive creation

(2) mental situation

tn

principle of rationality

tn

(3) realization of action

intended and unintended consequences of action (tn) contributing to fundamentals of action in tn+1

figure 2–3: concept of individual action at one moment in time (adapted from Hesse & Koch, 1998, 424; also cf. Koch, 1996, 31 and originally Hesse, 1990)

The concept concentrates on the essential elements of action and its antecedents at one moment of time at which action is taken. However, the authors have also suggested a dynamic extension of their concept. This dynamic perspective is already hinted at in the illustration above. (Un)intended consequences of previous action in tn–1 are evaluated by the cognitive-constructive apparatus of the human brain. In turn, these evaluations feed into current action at tn and so forth (see also the above assimilation and accommodation procedures within human memory). This dynamic aspect will be followed up in 4. 3. below, where fund-raising action is considered as a time-consuming process. For a single action at one point in time, the concept features both the element of creative enactment of novel possibilities for action (principle of cognitive creation; cf. figure

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2–3) and the fallible selection of alternatives (principle of rationality in choosing from alternative courses of action). The creativity principle has an essential consequence for the concept of human action and for the form of subjectivism the concept pertains to (also cf. Mahoney & Michael, 2005, 34 for the relationship between subjectivity and creativity). In static subjectivism, one could come up with a precise prediction of an agent’s bundle of action alternatives at hand; this is because it is assumed that “antecedent conditions of tastes and knowledge of the relevant constraints in conjunction with the law of constrained utility maximization” are known (O’Driscoll & Rizzo, 1985, 22p.). Thus, static subjectivism is consistent with Hempel and Oppenheim’s general covering-law model of explanation. This concept features logical preconditions known with certainty and a covering law, which together allow an explanation to be derived logically (ibid., 22). However, Hesse and Koch argue that this is not possible due to cognitive creativity as the human brain comes up with novel associations in an autonomous process. Hence, no precise deductive inference can be made from the individual fundamentals of action to the complete range of alternatives in the logic of mental situation (cf. figure 2–3 and the above rejection of a complete environmental determinism of human action). This is similar to what O’Driscoll and Rizzo have coined dynamic subjectivism (see also the description in Rizzello, 2000). The concept of individual action is subjective in so far as an agent’s assessment of internal mental and physical states as well as external environmental conditions are subjectively constructed corresponding to his or her fundamentals of action. These fundamental components of action embrace individual knowledge, cognitive theories, and genetic preconditions similar to the sources of knowledge outlined in the above examination of human memory; these elements broadly correspond to the levels of deeper cognitive structures and human beliefs in the above layer concept of action antecedents. Another important element in cognitive processes prior to action are spontaneous intrapersonal states and procedures, e.g. the agent’s mood and level of emotional arousal (cf. the mental situation in figure 2–3). It has been argued that emotional evaluations influence perception. In particular, the assessment of decision situations may be affected by spontaneous emotional pre-evaluations, which impact on the essence and quality of alternative behaviours assembled in the mental situation (cf., for example, Ciompi, 2000 and Dopfer, 2004, 184). At the neuronal level, this pre-evaluation corresponds to the unconscious-implicit, affective processing of external stimuli and internal states leading to an important general observation: Behavioural intentions and elements of rational

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action plans and their execution are only one type of content of the conscious mind amongst others such as sensory images of the environment, emotions, and internal physiological needs (cf. Roth, 2001, 157). All these perceptive and internal elements − which are also present in Hesse and Koch’s concept − may also be integrated into a coherent course of action at the neuronal level. This is because possibly perceptive elements, internal states, as well as cognitions of plans and intentions may follow the same uniform neuronal transduction code. Some researchers assume that the neuronal code pertaining to perception is essentially of the same matter and substance as neuronal coding of the above internal action plans, intentions, emotions etc. (cf. Prinz, 2000 and Roth, 2001a, 411). For the content of perception, the function of the code is the mental representation of environmental stimuli. In the case of internal action plans, coding may pertain to representing intended future states of the world (ibid., 412). This principle of common coding supposes the two codes to be compatible with perceptions triggering potential behavioural processes in an integrated neuronal code form (ibid., 412, referring to Jeannerod’s concept of integral coding of perception and action, cf. Jeannerod, 1997). Prior to choosing an action and executing it, the brain may repeatedly go through a tentative internal evaluation loop based on the above integrated neuronal code. This is indicated in figure 2–3 by the dotted line recursively connecting the tentative evaluation and realization of action alternatives to the fundamentals of action. This loop relates (constructed) information from the external environment and information about internal states with stored knowledge templates so as to interpret the two stimuli sources and to make a consistent choice (Roth, 2001a, 417pp.; also cf. Fallgatter & Koch, 2000, 87 and Dopfer, 2004, 183p.). This consistency between choice of action, the individual’s cognitive foundation for acting, and the appreciation of the emotional circumstances also characterizes Hesse and Koch’s principle of subjective rationality. The repeated internal creation, evaluation, and final selection of an action within a single trial action sequence is coined ‘Handeln in einer Gegenwart’ by the authors (Hesse & Koch, 1998). It does not state a universal algorithm of choosing from an objective, well-defined set of alternatives that could be completely observed from the outside (Koch, 1996, 32; see also 2. 3. 1. above). Rather, it only claims that the final realization of action corresponds to the best identified alternative from the perspective of the individual agent. Building on the subjective rationality of individual agents, the next chapter will deal with interaction between agents, in particular the potential for inter-subjectivity and social reality construction in

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interaction processes. This lays the epistemological ground for the later conceptualization of fund-raising processes that are to evolve alongside external restrictions in the financial environment of potential venture financiers.

2. 3. 2. Social inter-subjectivity and agent interaction The above individualistic concept of perception and other subjective antecedents of action stressed “observer-relative features of the world” (Searle, 1995, 9). However, even though “perception is built from inferences from our experience and memories, so that we construct our own realities” (Nicholson & Anderson, 2005, 155), it will be claimed that inter-subjectivity and relational human interaction are possible. This potential for inter-subjective similarity of cognitive elements amongst individuals may have several reasons. Generally, inter-individual elements exist because of similarities in the cognitive development of individual actors (Gehrau, 2002, 263). This development relates to the sources of individual, but socially related, cognitive knowledge throughout secondary socialization and everyday social life. Having said this, however, cognitive representations will never be completely identical in two individuals (Rieschel, 2000, 124). This is partly because socialization and experience are not perfectly universal to members of society. The social reality experienced by different cultural groups and individuals will be different as well (Hunter & Ainlay, 1986, 23; see also Granovetter, 1985 for a description of this socio-cultural embeddedness). Therefore, social interaction features the need for aligning individual interpretations of reality. Yet, at the same time, interaction also possesses the potential for this alignment. This will happen through acts of communication, utilizing socio-cultural similarities stored in people’s mental models of the social world as a bridging anchor (cf. Budzinski, 2003, 222). The tension between individual cognitive differences and inter-individual communalities is important with regard to two issues of social cognition theory, which addresses behaviour in terms of person-environment interaction (cf. Mitchell, et al., 2002, 96): first, an at least partially common comprehension of the external situation across interacting individuals and second, the interpretation of individual behaviour by others, in particular the social understanding and acceptance of an agent’s action by society members. The latter is in essence a question of legitimating, which is a conditio sine qua non in social interaction. “Legitimations are a functional requirement; no human society can exist without them” (Hunter & Ainlay, 1986, 27).

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Legitimations are necessary because of the principal uncertainty in social life resulting from the impossibility of grasping reality in a completely universal manner. The need for acceptance will be discussed in 2. 3. 2. 2. within the context of the social construction and societal evaluation of phenomena such as entrepreneurial action, new venture organizations, or the risk pertaining to them. However, before doing this, an elementary understanding of how inter-subjectivity may emerge in dyadic human interaction should be developed.

2. 3. 2. 1. Alignment of reality constructions in interaction processes The reality to be inter-subjectively experienced will be constructed in social interactions (cf. Boyce, 1996, 5). “If there were no relationships there would be no meaningful discourse; and without discourse there would be no intelligible ‘objects’ or ‘actions’ or means of rendering them doubtful” (Gergen, 1999, 221). However, the above individualistic cognitive perspective has made clear that any reality construction remains within the boundaries of the self-referential individual brain (see 2. 2. above). Therefore, any inter-subjective construction of reality in a dyad can only be conceptualized as a process. Within this process, the two individual reality constructions potentially become assimilated in the course of communication and interactivity (cf. McWhinney, 1984). This process of alignment is aggravated by two contingencies (in a dyad). These are the subjective interpretations of the two agents and their reflections of the situation, including the action of the vis-a`-vis (Rieschel, 2000, 122; cf. Koch & Fallgatter, 1998, 24). For human interaction to work in the light of this ‘double contingency’ (Luhmann, 1984, 149 or Koch, 2002, 7), a ‘consensual interface’ is required (Rieschel, 2000, 122). According to Hejl (1992, 126) this kind of consensual interface is based on emerging synchronized interpretations of individually perceived perturbations. They refer to both vis-a`-vis action and situational context. Obviously, such compatibility does not mean a perfect parallelism of individual cognitive interpretations and expectations related to the interaction process. Rather, consensual bridging elements between two self-referential units refer to ‘oriented situations’ (Maturana, 1982, 73) to which each unit is structurally linked (also cf. Maturana & Varela, 1987). For example, such social interaction may occur in processes of inter-organizational co-operation (cf. Koch & Fallgatter, 1998) or between a potential stakeholder and a new

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venture founder (cf. Yamada, 2004). In each of these two contexts, there is the issue of functional consensus about the domain of cooperation (for the former example) and the domain of activities of the new venture respectively. Within this dyad, domain consensus will be a “socially reached agreement” (ibid., 299). The central catalyst for establishing an inter-subjective and compatible consensual interface will be socio-institutional (interpersonal) rules guiding dyadic interaction and the social construction process in general (see Bender & Westgren, 2001, 1351 and Budzinski, 2003, 222 again; also cf. Nicholson & Andersson, 2005). In this respect, communication and the use of language as “a carrier of sociality” (Frosh, 1989, 124) are also assumed to be an important facilitator (cf. Searle, 1995, 3).25 In summary, the process of communication within socio-institutional contexts can be considered a ‘reciprocal offering and incorporation of socially sensible offers of meaning by cognitively self-referential agents’ (Rieschel, 2000, 130). Reciprocal communication of offers that make social sense is only possible if the interpretations of the interaction are partly similar, bearing the potential for further assimilation in the course of conversation (ibid.). At the aggregate societal level, this similarity emerges in the context of societal socialization processes.

2. 3. 2. 2. Social construction and social acceptance of behaviour General socialization and shared social meaning At the societal level with a plurality of actors, conversations in everyday life reinforce social meaning and assumptions about external reality. These assumptions are communicated and shared continuously, allowing inter-subjective, though not objective, reality to emerge (Hunter & Ainlay, 1986, 14p. and originally Berger & Luckmann, 1972, 22pp.). This means that the process itself rests on inter-subjective social meaning, which is reinforced repeatedly in societal interaction. Social meaning is reflected in the form of typified elements in individual cognitive structures. These typified elements are formed through generalized social experiences and internalization of inter-personal rules present in socio-institutional contexts (cf. Budzinski, 2003, 222 and Kiwit, et al., 2000, 3). In particular, existing social typifications become internalized by individual agents 25

Language may reduce complexity in interaction as it “guides our sense of social reality, by framing, filtering, and creation to transform the subjective into a more tangible reality” (Nicholson & Anderson, 2005, 155).

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in preceding socialization processes to allow social interaction with others (Hunter & Ainlay, 1986, 17). Of particular importance for the purposes of this thesis are processes of secondary socialization where individuals are introduced to new parts of social life or sub-worlds which feature domain-specific, decentralized socio-institutional context and specific conventions of social meaning (cf. Hunter & Ainlay, 1986, 22; for the cognitive perspective of domain specificity cf. Hirschfeld, 1994). For the subject under study this may include acquaintance with commercial banks and their demands or contacts with the equity market. Acquaintance with socio-institutional contexts in the financial environment provides the basis for exploring possible similarities and broad patterns in fund-raising processes of new ventures.26 This is because entrepreneurs face similar, partially inter-subjective, external constraints implicit in these typifications (for example bankers’ demand for collateral to secure loans). The internalization of these socio-institutional rules does not necessarily only commence when a venture opportunity is exploited but rather at an earlier stage, e.g. when banking experiences are made as a private consumer or during previous managerial or entrepreneurial endeavours.

Social construction of entrepreneurial ventures and their risks It is argued that entrepreneurial business ideas and new venture organizations (like any other project or organization) can only be considered as socially constructed rather than as objectively perceived and evaluated entities (cf. Shenav & Weitz, 2000, 377 for the socially constructed nature of empirical objects). This is because the entrepreneurial phenomenon as a “set of beliefs about entrepreneurship” is itself a social construct (Nicholson & Anderson, 2005, 155; also cf. Downing, 2005). New ventures emerge ‘bottom-up’ from the individual activity of entrepreneurs who recognize and exploit opportunities and at the same time they are constructed and constituted ‘top-down’ within the institutional environment, e.g. in the form of societal attributions constituting the role of an entrepreneur or regulatory demands upon the entrepreneurial organization (cf. Scott, 1995, xviii; Scott, 2001, 195; and particularly Kappelhoff, 2004, 30pp. for the general notion of bottom-up emergence and top-down constitution of actors in the 26

For example, adults in market economies, who became acquainted with banking institutions in secondary socialization, will likely expect that a bank will require a reasonable chance of repayment of a loan with interest.

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evolution of social systems). In particular, the genesis of an entrepreneurial venture “involves the social construction of new social entities” (Aldrich & Martinez, 2003, 359). The chances and, in particular, risks associated with new venture projects will be at the centre of this construction in interaction processes within the socio-economic environment. Risk is also part of the overall evaluation and social construction of new ventures, in particular for those operating in new industries (ibid.).27 “Since the identification of risks is entirely a social process, risks do not exist in objective reality, but in the collective consciousness of cultures; risk is thus a cultural phenomenon, not a physical one” (Rosa, 1998, 21). Since risk occurs as a societal construct, ultimately “our perceptions of risk, our choices of which risk to be concerned about are equivalent to the risk itself” (ibid., 21). In light of this, a positivist concept of risk analysis which is produced on grounds of positivistic ontology and realism epistemology, appears unsuitable (ibid., 20). Instead of a favourable balance of chances and risks derived from this kind of positivistic analysis, the creation of new realities by new venture founders will require inter-subjective plausibility as well as socio-economical acceptance (Nicholson & Anderson, 2005, 154). Plausibility and acceptability may be constructed and evaluated using existing socio-institutional yardsticks. In fact, this is the epistemological foundation of new venture legitimacy as stressed by Zimmerman and Zeitz, (2002, 415): “Legitimacy provides a basis for decision making that is different from [complete, M.G.] means-ends rationality ... Most of the time, people do not have clear and complete evidence that a given action is best ... In the face of such uncertainty, social systems evolve prescribed scripts, rules, norms, values, and models that are socially reinforced throughout the system and that come to be accepted by social actors as legitimate ... When faced with uncertain decisions (as so many decisions are), social actors refer back to this stock of scripts, rules, norms, values, and models in order to proceed”. Such constraints represented by interpersonal rules may become relevant to cognitive antecedents of entrepreneurs’ actions in two ways (cf. Budzinski, 2003, 222 for this and the following points). Firstly, interpersonal rules may have been internalized by agents in the above mentioned secondary socialization processes. Secondly, rules (such as 27

Similarly, the sense-making of newly emerging technologies, as well as attributions of utility or risk that go with these new developments, are also constructed in communication processes (cf. Dollhausen 1997, 99; Rosa, 1998; and Hargadon & Douglas, 2001).

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institutionalized demands by potential financiers for investment profitability and business plan provision) may be seen as pure data to be included in entrepreneurs’ choice of action. These pieces of data may represent societal meta-preferences; they typically entail sanctioned incentives and disincentives to be reckoned with in individual action planning (see, for example, Knight, 2000, 17; also cf. Scott, 2001, 195 or Budzinski, 2003, 224 for the partial alignment of behaviour that may result from this). Particularly important for the purposes of this thesis are sanctions by potential financial resource owners refusing funding to entrepreneurs who do not conform with, e.g., economic efficiency demands for an investment’s profitability (cf. Becker, 2000, 172). Principally, this partially rule-based interpretation and social evaluation will limit the room for manoeuvre for creative action and novelty (cf. Aldrich & Martinez, 2003 and Kappelhoff, 2004, 21p.). This will be a central element of the functioning of invariant legitimacy restrictions to shape the fund-raising processes of entrepreneurs (see chapters 3. 3. and 4. 2. 1.). To conclude the epistemological discussion, this social construction and evaluation, which is based on viable, inter-subjectively shared norms, also rules out solipsism. This is precisely because not all views of the world, including imaginative ideas of novel venture opportunities by pioneering entrepreneurs, are equally valid and pursuable in social discourse (cf. Rosa, 1998, 22).

3. New ventures: definition, financing needs, and legitimacy Following the epistemological notion of social construction of new venture projects, chapter 3. 3 explores the need for legitimacy to initiate resource exchange relationships with external stakeholders. The need for new ventures to gain legitimacy arises primarily because of their dependence on both acceptance and resource support by external audiences, e.g. potential financiers (cf. Delmar & Shane, 2004). Therefore, before addressing new venture legitimacy, 3. 2. will look at external resource requirements of new ventures, and in particular, the need for external funding. First of all, however, it will be necessary to define and characterize new ventures more precisely (3. 1.). The definitional characterization suggests that the fund-raising and legitimizing challenge will be particularly relevant for new ventures with their liabilities of newness.

3. 1. Definitions and characteristics of new ventures The following discussion of definitions and characteristics of new ventures within the context of entrepreneurship serves to introduce the types of new ventures that are focused on in this study. This preparation will be taken further in chapter five which addresses the framework for selecting case study objects.

3. 1. 1. The general theme of entrepreneurship First of all, there is apparently no one single definition of entrepreneurship that all authors in the field agree upon. The diversity of definitions has often been addressed in the past (e.g. in Amit & Glosten, 1993; Brazeal & Herbert, 1999; Shane & Venkataraman, 2000; Watson, 2001; or Fallgatter, 2002). The fuzziness of defining the core of entrepreneurship is due to the many aspects that may be relevant to it. However, positively speaking, these multi-faceted aspects also make entrepreneurship a fruitful interdisciplinary field of research (Parker, 2005, 2). The theme has indeed attracted attention from other fields of research, which have provided definitions from their respective perspectives (Shane, 2005, 6). In agreement with Fallgatter (2002, 14p.), it may therefore neither be sensible to strive for a single definition that suits all research projects. Such an overarching definition would not be useful in practice. Nor should a definition aiming to establish the relevant area of research be too narrow. This is because this kind of definition may unduly

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exclude other aspects. To avoid these two definitional extremes, an integrative framework of entrepreneurship will be briefly introduced. The second step is to place within this framework a working definition specific to the analysis of financial resource acquisition in entrepreneurial ventures. Shane and Venkataraman (2000, 218) introduced a framework for entrepreneurship by defining the field “as the scholarly examination of how, by whom, and with what effects opportunities to create future goods and services are discovered, evaluated, and exploited”. Within the three building blocks of entrepreneurial activity − opportunity discovery, evaluation, and exploitation − raising initial financing pertains to the latter two. This entails the evaluation of venture opportunities by entrepreneurs and, in particular, external resource owners, and attracting resources from them for exploiting these opportunities. Legitimizing and obtaining funding will be concerned with a central evaluative puzzle present in entrepreneurial endeavours: On the one hand, the entrepreneur needs to gain external legitimacy for an opportunity which he or she has discovered and aims to exploit. On the other hand, the opportunity only exists because those who now need to be taken on board to provide resources did not discover it, or at least did not want to exploit it on their own. In other words, the lack of objective knowledge helps opportunity discovery but impedes exploitation: “The information dispersion and uncertainty that give rise to the existence and discovery of entrepreneurial opportunities make it difficult for entrepreneurs to acquire the resources they need to pursue them” (Shane, 2003, 161). Therefore, in light of the above puzzle, a suitable working definition relating the latter two of the above building blocks is provided by Stevenson and Jarillo (1990). Their definition focuses on the dilemma of pursuing an opportunity on the one hand and the potential need to convince external resource owners on the other hand: “Entrepreneurship is a process by which individuals − either on their own or inside organizations − pursue opportunities without regard to the resources they currently control” (ibid., 23). In fact, this characterization has been used frequently and has established a kind of watershed definition (Wilson & Appiah-Kobi, 2002, 46p.). It has its origins in Jarillo (1989, 134; also cf. Stevenson, et al., 1989), who argued that “the essence of entrepreneurship is seen precisely in the ability and willingness to use external resources”. However, in addition to the above working definition of entrepreneurship, there are also other, more detailed, dimensions of new ventures themselves, which need to be consid-

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ered in order to be able to define the focus of this study. For example, the need for financing may imply a certain size of planned operations and degree of growth willingness by the founder(s), as otherwise only little, if any, external funding may be required. Moreover, additional dimensions of new venture formation and development such as size of the venture, its age, or the origin of its factor combination are relevant as well. These dimensions help to differentiate new ventures from established firms. As such they offer differentiations necessary for concept building and empirical case analysis.

3. 1. 2. New ventures versus established firms (definition I) 3. 1. 2. 1. Principal challenges in defining new entrepreneurial ventures It has proven difficult to arrive at dimensional classifications of growth-oriented entrepreneurial versus small businesses, imitative versus innovative start-ups, or young versus established firms. This is due to the large variety of types of businesses across many industry sectors (cf. Storey, 1994, 8p.; Curran & Blackburn, 2001, 7 and 9p.; and Fallgatter, 2002, 28p.). For example, referring to the dimension of small firm size, Storey (1994, 8) remarks that “there is no single, uniformly acceptable definition of a small firm ... because a ‘small’ firm in, say, the petrochemical industry is likely to have much higher levels of capitalisation, sales and possibly employment, than a ‘small’ firm in the car repair trades”. Similarly, Curran and Blackburn (2001, 9) note that measurements of factors such as number of employees or financial turnover will tend to be sector-dependent. For dimensions such as age − and probably others too − ‘exact criteria to narrow down ... young firms may not help; neither would an isolation of the age dimension nor of turnover, number of people employed, or growth hold, due to firm heterogeneity’ (Fallgatter, 2002, 28). Similar problems have been noted in defining small businesses (which are also important here since most new firms start small). However, there have also been attempts to tackle this heterogeneity by using general qualitative economic themes like uncertainty, innovation, and evolution for a definition of the small, and, at the beginning, new business (e.g. Wynarczyk et al., 1993). Also, other criteria like small market share, owner-management, and independence have been employed to accompany statistical definitions of the small business (as by the UK Bolton Committee; cf. Storey, 1994, 9 or Curran & Blackburn, 2001, 13p.). However, these authors (ibid., 14) also note that such general descriptions aiming to catch the character and structure of small businesses are also problematic, because the differentiation may

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3. New ventures: definition, financing needs, and legitimacy

not be precise. In addition, organizational structures of individual firms may change over time (e.g. Witt, 2002, 3), and even drawing a clear distinction between small business and entrepreneurship appears to be difficult when taking this kind of process perspective (cf. Bhide, 2000 and Fallgatter, 2005, 62). In light of the problems associated with generally applicable definitions of new firms, this study will employ differentiations specific to the financing issue, together with careful classification criteria of the central dimension of young and new versus old and established firms. Applying this cautious approach, the central dimensions of venture size, legal status, factor origination, innovation-orientation, and age, as well as the possible financial resource needs corresponding to them, will be addressed in turn. The choice of these differentiation criteria is derived from the study’s focus on the fundraising processes of young and small ventures, in which entrepreneurs build the business from scratch. It is this type of emerging and infant venture for which resource acquisition and legitimizing challenges may be most critical as compared to larger and more mature organizations operating on existing resource bases (cf. for a general overview of the criticality of this phase for resource acquisition, legitimizing, and development: Brush, 2001; Newbert & Tornikoski, 2003; and Gruber & Henkel, 2004).

3. 1. 2. 2. Definitional dimensions of new ventures in this study New venture size, independence, and origination The actual as well as the initially planned size of a venture is important for studying financial resource acquisition in so far as the planned size will (partly) determine how much external funding will be needed. Also, actual size may reflect how much financing has been put into establishing the venture to date. For example, financial resources might have been instrumental in achieving a certain production capacity or level of employment. In terms of (a minimum) planned size of venture operations a purposive differentiation relating to the issue under study will be used. This study will concentrate on ventures which need external financing in order to implement their initially planned business idea. The empirical study is made up of data on founders who ‘were seeking financial support’ but had not yet ‘received financial support’ to fund their business (Aldrich, 1999, 78 for these and other indicators of venture establishment activities; see also the

3. 1. Definitions and characteristics of new ventures

51

theoretical sampling strategy employed in the empirical study in 5. 1.). Apart from planned initial size, the (maximum) actual size of the venture is also critical. This is because the study aims to exclude large ventures that, though still fairly young, have already made significant progress towards becoming an established organization, because they have, for example, already attracted significant financing. Therefore, an additional limit of actual size will be employed. The new ventures that this study pertains to do not have more than two (full time equivalent) employees (not counting the current owner-managers). This is at the lower end of the EU micro-enterprise size category of 0–9 employees (cf. Curran & Blackburn, 2001, 22). This cautious quantitative criterion will be further accompanied by other qualitative criteria relating to the characteristics of firm establishment (for the strategy of combining quantitative with qualitative limit criteria cf. ibid., 16). These criteria reflect the independence of the business and the origination of its factor combination. With respect to focal fund-raising processes, those ventures that already have an external resource base sufficient to implement their business idea will be ignored. Consequently, new ventures which utilize a pre-existing financial resource base because they are not legally independent “in the sense of not forming part of a large enterprise” (Storey, 1994, 9), will be excluded from the analysis. Furthermore, Koch and Kuhn (2000, 6; see also Aldrich, 1999, 101p. and Fallgatter, 2002, 27) provide a systemization of new ventures made up of two dimensions: type of initiator and pre-existence of a resource system. The latter differentiates between new ventures which develop a new, ‘original’ combination of factors and those that employ a ‘derived’ factor combination, e.g. in management buy-outs or spin-offs. Such derived ventures are excluded from the analysis because of the specific character of their resource origination and possible pre-existing resource exchange relationships (cf. Schwarz & Grieshuber, 2003, 31pp. for a similar differentiation approach). In particular, the options to access financing as well as the legitimizing challenges of derived ventures will differ from those of single entrepreneurs starting their venture projects from scratch (Zimmermann & Zeitz, 2002, 416 and Fallgatter & Brink, 2006, 8; also cf. Curran & Blackburn, 2001, 16p.). Moreover, the problems of resource access and legitimization facing young ventures may differ from those of older, more established entities (cf., for example, Aldrich, 1999 or Tornikoski, 2005). Because of this, venture age may well be the most important of all dimensions differentiating between new ventures and established organizations.28

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3. New ventures: definition, financing needs, and legitimacy

Age of new ventures When only a specific period of time in the firm development process is concentrated on (in this case the infancy stage of new ventures), a temporal differentiation will be needed. However, sketching out a time frame between emerging, but not yet existing organizations, and established mature organizations is difficult because of the indeterminacy of the firm organizing process. “Firm founders do not instantaneously establish new firms, but create them through a series of actions − obtaining inputs, conducting product development, hiring employees, seeking funds, and gathering information from customers − undertaken to different degrees, in different orders, and at different points in time, by different firm founders” (Delmar & Shane, 2004, 385; also cf. Carter et al., 1996). This observation shows that, as with the size variable, there is no clear picture for defining a young venture in contrast to an emerging or an old venture. This is not only due to the above heterogeneity of development sequences but also because of sectoral differences (Fallgatter, 2002, 28p.).29 Consequently, a cautious maximum age limitation in combination with qualitative criteria relating to the analytical domain under study would seem a more sensible approach to take. The differentiation that will be employed is based on a lack of established financial resource exchange. This study addresses young ventures that have not yet reached a stage where they have become independent of external financing and achieved operational break-even of the new business. This is argued to be a sign of youth and lack of settled establishment of a new firm. Brachtendorf (2004, 4) argues that firms are young until financial sustainability from internal operational cash flows is achieved. This definitional differentiation is followed here. As with the size dimension, this definition of young (in the sense of not fully established) firms is accompanied by a cautious maximum firm age. This study pertains to firms which are no more than 1. 5 years old, calculated from the time of founding indicated by the formal establishment of a legal entity (the choice of this criterion to describe the point of birth of a new venture is explained in 3. 1. 4.). This time period is a cautious choice as the relevant literature assumes firms to be young up to the age of 28

29

Later, in the discussion of new venture emergence, the definition of existing new ventures towards the other end of the time scale will be addressed. For example, a biotech start-up might have relations with final customers and break even only after clinical trial stages running over many years. In contrast, a successful new services firm might reach that point a lot earlier.

3. 1. Definitions and characteristics of new ventures

53

three to five or even up to seven years (for an overview see Tornikoski, 2005; also cf. Fallgatter, 2002, 29). To sum up, the following working definition is meant to guide the theoretical sampling of case study objects in chapter five. It demarcates existing new ventures subject to financial selection exerted by potential financiers.30 Such ventures start from scratch, are independent, have no more than two employees, are less than 1. 5 years of age, and still require external financial resources to implement their business concept before their internal cash flows break even. The main dimensions pertaining to this definition are summarized in figure 3–1.

Differentiation criteria of new ventures in this study legal independence and original factor combination established legal entity venture age < 1.5 years venture size < 2 employees (full time equivalent) need for external financing to establish the venture

figure 3–1: definition criteria of new ventures in this study

Beyond their definitional value, factors like the small size and relative newness of recently founded firms also have important implications for the resource acquisition process of such ventures. The main characteristics discussed in the relevant literature will be briefly summarized next. These characteristics are liabilities of newness, smallness, and adolescence. These liabilities will pave the way for understanding legitimacy needs and difficulties in raising initial financing (in particular cf. Singh et al., 1986 discussing how the issue of liability of newness relates to the legitimacy of new organizations).

30

Cf. chapters 4. 2. and 4. 3. below for more details on the concept of financial resource selection.

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3. New ventures: definition, financing needs, and legitimacy

3. 1. 3. Characteristics of new ventures in contrast to established firms Empirically, one of the most striking differences between new and old firms is the higher mortality rates of the former. Gruber and Henkel (2004, 2) remark that, depending on industry sector, up to as much as 70% of new firms do not survive the first five years. Given this empirical evidence, it is not surprising that researchers have attempted to understand the reasons for this apparent survival struggle of newly founded firms. Firm age as a predicting variable of organizational mortality has been explored in numerous studies, in particular, those that analyze cohorts of new firm populations from an organizational ecology perspective (for an overview see, for example, Hager et al., 2004, 160p. or, for earlier contributions, Levinthal, 1991, 397). Hager et al. (2004, 161), however, also remark that more recent studies have also explored additional factors of organizational mortality beyond the age variable alone. Stinchcombe (1965), who first articulated such problems of liability of newness, already saw that age in itself would possibly not lead to such high failure rates of new as compared to older organizations. “Rather, the liability of newness was the culmination of a variety of conditions, problems and organizational characteristics that typically accompany youth” (Hager et al. 2004, 161). Likewise, small size in itself, which is another popular predictor of firm failure, may well not be the problem. Rather, the diagnosed liabilities of newness and smallness are themselves fuelled by the specific characteristics of new and small ventures (cf. Gruber & Henkel, 2004, 3). The problematic characteristics identified to be most important in the relevant literature are summarized below. Figure 3–2 also includes a third liability that entrepreneurs may have to bear. This is a liability of adolescence on a start-up’s further way to full market establishment. Analytically, problems pertaining to the three liability dimensions may be differentiated into internal and external deficiencies.

Liability of newness In young ventures the organization itself, and the founder at its centre, constitute a novel configuration (cf. Fallgatter, 2004, 11). The typical problems pertaining to the liability of newness of such ventures are assumed to have their origins in this novelty. It causes both internal and external problems such as those described in figure 3–2. Decisions by resource providers such as suppliers, investors or potential employees to enter into exchange relationships with the new venture will depend on judgements of organizational

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55

liability form

internal problem area

external problem area

liability of newness

lack of established organizational structure adequate to external market characteristics; scarcity of management time and resources to implement organizational role duties and competences; initial costs of defining and implementing intra-organizational roles and processes

liability of adolescence

problems to implement full scale business operations; continuing problems to implement viable and efficient organizational roles and processes; lack of financial funds to follow through with organizational establishment

underdeveloped exchange relationships and dependence on social interaction with strangers; lack of access experience and reputation to initiate new relationships; generally unknown organizational entity to external parties; lack of proof of business concept; lack of trust in firm abilities and offerings; lack of reputation of entrepreneur as a professional lack of sustained acceptance of planned full scale business concept; problems with second round resource acquisition due to persistent uncertainty about long-term viability of business conception

liability of smallness

vulnerability to unfavourable market conditions due to resource poorness; difficulties to adapt market entry and business strategy because of limited financial flexibility; competence gaps through low specialization of labour because of lack of human resources

reliance on attracting external resources in critical situations

figure 3–2: characteristic liabilities of new venture organizations (compiled from Aldrich & Fiol, 1994; Morris, 2001; Hager et al., 2004; Gruber & Henkel, 2004; and Tornikoski, 2005)

reliability, for example that all financial obligations will be met by the new venture (cf., for example, Lounsbury & Glynn, 2001). Here, new ventures’ initial difficulties in portraying internal stability and viability of organizational structures will hamper the establishment of external exchanges. The new venture’s initial isolation from exchange relationships also means that there are neither established partners that could document external acceptance, nor are there existing external resource holders that already have social exchange ties with the venture and might be willing to substitute a lack of trust in infant organizational structures by other, e.g. personal, forms of credibility. These institutional and social capital theory arguments have been put forward by Delmar and Shane (2004, 386) and Hager et al. (2004, 160). Gruber and Henkel (2004, 3) provide a good summary of the problems relating to underdeveloped exchange ties. In particular, the authors argue that “relationships have to be created by new firms, yet without possessing the access, experience, reputation, and legitimacy of established firms” (ibid.).

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3. New ventures: definition, financing needs, and legitimacy

Liability of adolescence Liability of adolescence provides an important differentiation to the liability of newness notion. The latter argues that failure rates of new organizations decline monotonically over time since newness problems are most severe at the time of founding and decrease thereafter. In contrast, the former concept combines empirical observations that “the risk of death for an individual organization is initially quite low and increases with time, reaching a peak at a point referred to as adolescence, and then subsequently declines” (Levinthal, 1991, 401; similar results have been reported by Bruederl & Schuessler, 1990 and Jungbauer-Gans, 1994). The explanation for this delayed mortality risk is assumed to be that, at the beginning, new organizations “are bolstered by initial stocks of resources and reserved judgement from supporters and decision makers that allow for a ‘honeymoon period’. Once the stock of resources is depleted, however, risk of demise increases” (Hager et al., 2004, 184). For the individual new firm, the compelling argument explaining its survival immediately after founding is that “not only are firms typically founded with some stock of financial capital but, often, with many other sorts of assets” (Levinthal, 1991, 400). The idea here is that new ventures survive in the beginning because entrepreneurial projects are turned into new organizations only when resources are in place to make sure that the firm has a fair try towards achieving market entry and will not go bankrupt overnight. In many cases this will involve liquidity provided by the founder’s personal savings (cf. Aldrich, 1999, 75). This means that resource selection pressures exerted by financiers denying funding must not necessarily result in a complete wipe-out right at the beginning (or full external selection as it is called by Henderson & Stern, 2004, 41; cf. chapter four below). A prominent example of this is the rise of e-commerce start-ups and the later market shake-out (cf., for example, Rovenpor, 2004). Rather, the delayed mortality hazard hints at an extended period of financial resource selection some time after a firm’s birth. This is taken account of in the theoretical and empirical research concept in this study, at least to some extent.31 This is because venture cases are analyzed which still struggle to raise external financing some time after they have been founded.

31

There are obvious limitations to the duration of longitudinal analysis in a thesis project.

3. 1. Definitions and characteristics of new ventures

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Liability of smallness Typically new ventures that start small do not have as broad a resource base as established large ventures. However, a broad base of financial and also other, e.g. human, resources, may prove useful. This is because of the above uncertainty about the future development of a new venture, which may require flexibility to adapt to changing or surprising environmental conditions. One problem of small size is the lack of this resource base (cf., for example, Gruber & Henkel, 2004, 3p.). In particular, this problem is compounded by the low level of slack resources functioning as a kind of buffer. Such a buffer would allow a firm to survive temporarily unfavourable market conditions or ad hoc internal problems (cf. Morris, 2001, V or Carson, 1985). Finally, small ventures operating on narrow financial resource margins also lack the possibility to experiment so as to find out what works and what does not when entering the market. These possible problems also contribute to an understanding of the fund-raising struggle of new ventures because they highlight the limited room for manoeuvre of new ventures with few existing financial resources. In particular, there may be invariant minimum liquidity restrictions to channel the search for funding (cf. chapter four below). This chapter has explored the main characteristics and problem issues of new ventures in comparison to established firms. However, difficulties in acquiring resources do not exist exclusively after the birth of a new firm, but may already arise prior to founding. Therefore, a differentiation in this respect is also necessary.

3. 1. 4. Infant ventures versus emerging ventures (definition II) The empirical isolation of an identifiable sequence of stages of venture development is still a topic of debate. This is due to the heterogeneity of new ventures and because of the fuzziness of the development process (cf. Aldrich, 1999, 76; Reynolds & Miller, 1992, 408; or Carter et al., 1996, 154). However, this study does not focus on a detailed sequence of phases of new venture development. Having said this, the ventures under study still need differentiation. Since this study concentrates on existing young ventures, the point of birth of a new venture, which marks the transition from organizational emergence to existence, is central to the analysis. In particular, a definition needs to be derived as to what differentiates an existing infant venture from an emerging one. Moreover, differentiating

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3. New ventures: definition, financing needs, and legitimacy

between the conception of an entrepreneurial project and the start of firm gestation activities prior to founding is also relevant.32 This is because fund-raising activities may already commence prior to firm founding. The empirical case study will also look at entrepreneurs’ actions to obtain external funding and experienced financier feedback during firm gestation. In contrast, perceived resource acquisition problems influencing the formation of entrepreneurial intentions prior to gestation will not be covered here.33 Rather, this study will examine fund-raising processes where entrepreneurs have already made efforts to found a venture (this is from the beginning of firm gestation onwards). Differentiations already established in the relevant literature will be followed to elaborate required definitions of firm birth and the beginning of gestation. A seminal concept to identify emerging organizations has been put forward by Katz and Gartner (1988). Their starting point was the consideration that organizations are purposeful boundary-maintaining activity systems “with input-output resource ratios fostering survival in environments imposing particular constraints” (Katz & Gartner 1988, 430 referring to McKelvey 1980, 115). Therefore, an organization has both structure and process components. The factors relating to these components identify existing organizations and help to identify those coming into existence; Katz and Gartner (1988, 431) put forward four properties of emerging (and existing) organizations. The four properties − intentionality, resources, boundary, and exchange − are depicted in figure 3–3. These organizational components have then been used to characterize different idealtype stages of the organization development process, for example in relation to the seminal concept of the organization creation process by Reynolds (1994). This concept involves the four phases conception, gestation, infancy, and adolescence. The differentiations between the phases may be used for the above-mentioned definitions required for this study. An overview of how organization components may relate to development phases of new ventures is provided in figure 3–4. The figure also presents the definitional concept employed in this study within the context of approaches taken in other studies.

32

33

Cf. figure 3–4 below for a characterization of firm conception, gestation, and infancy; gestation activities are defined as “actions taken in order to develop a business structure and operational procedures for the purposes of creating a new firm” (Newbert, 2005, 56). Readers interested in this aspect may refer to Brown and Kirchhoff (1997).

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structural components of organizations boundary

developing a boundary as barrier conditions between organization and its environment (e.g. formal incorporation; physical cues of existence); establishing organizational identity beyond its creator

resources

assembling resources to create an organization; integration of physical resources procedural components of organizations intentionality

intention to create an organization; seeking information applicable to the objective of creating a new organization

exchange

initiating recurring and beneficial resource exchange relations with external environment

figure 3–3: properties of organizations (compiled from Katz & Gartner, 1988; Carter et al., 1996; Aldrich, 1999; and Tornikoski, 2005)

Tornikoski’s recent work, which follows the concept of Katz and Gartner, defines the end of the organizational emergence process and the beginning of the new organization infancy stage as the point in time at which all four organization components (or organization properties) have been completed and are in place (cf. Tornikoski, 2005, 28 to 30 as well as Katz & Gartner, 1988, 433). The presence of the components of intentionality, boundary, resources, and exchange is measured by corresponding gestation activities (cf. figure 3–4).34 In contrast to this approach, this study will characterize organizational infancy not by the completion of all four organization components. Rather, a differentiated concept of ’two plus two components’ will be employed. Namely, to qualify as an existing new venture, two of the four organizational components will need to be completed while the other two components will only require initiation. In this case study only those venture formation projects which have completed activities relating to ‘intentionality’ and ‘boundary’ and that have initiated (but not fully completed) the components of ‘resources’ and ‘exchange’ are considered existing infant organizations.35 The rationale behind this is the following. The components intentionality and boundary (completion level) as well as resources and exchange (initiation level) relate to underlying gestation activities. Activities relating to 34

35

In fact, a multitude of different firm gestation activities may be related to the four theoretical components that characterize organizations. For example, activities like ‘serious thoughts about business’, ‘rented/leased facilities/equipment’, ‘created a new legal entity’, or ‘received money from sales’ may be indicators of intentionality, resources, boundary, and exchange components measuring the emergence or, if completed, existence of new organizations (Aldrich, 1999, 78). The differentiation between the categories of activity progress ‘not yet initiated, initiated, completed, not relevant’, corresponds to Carter et al. (1996, 155).

GESTATION

INFANCY

new organization: all four components completed

ADOLESCENCE

new organization

new organization: all four gestation markers completed (personal commitment; financial support; sales; hiring)

new organization: "started" status: various start-up indicators

new organization: first sale indicator marking founding success

new organization: gestation markers related to all four components completed

gestation markers as component new organization: 1) completion of end of firm youth: break even from measures: a) boundary: initiated legal entity; full registation with operational cash flow achieved; full boundary building actvities (e.g. authorities; office space; corporate completion of search for external administative permissions); b) identity; communication of official finance; exceeded firm size and intentionality: communicated existence; 2) initiation of 'sought age limitation for infancy (see business idea to others (e.g. to exernal finance' (purposive 3.1.2.) potential co-founders, employees, sampling of cases) or financiers)

org. emergence: gestation markers as component measures; one but not all four components completed various gestation markers (Newbert, 2005) various gestation and precursor activities at least one but less than four gestation markers (cf. new organization stage)

end of firm youth: additional full 2+2: boundary & intentionality: 2 components intiated (boundary & completion of (financial) resources completed; resources & exchange: intentionality) & exchange component to break initiated but not completed at birth even firm gestation activities (stand alone or as measures of components of organizations)

org. emergence: at least one but not all four components

components of organizations (intentionality, boundary, resources, exchange)

CONCEPTION

pre-organizational emergence

figure 3–4: stages and properties of new venture creation (compiled from Katz & Gartner, 1988, 433; Reynolds & Miller, 1992, 408p.; Carter et al., 1996, 157p.; Aldrich, 1999, 77; Gartner et al., 2004; Newbert, 2005, 62; and Tornikoski, 2005, 29p. and 165)

THIS STUDY

Reynolds & Miller (1992)

Carter et al. (1996)

Tornikoski (2005); Katz & Gartner (1988) Newbert (2005); Gatewood et al. (1995)

THIS STUDY

Tornikoski (2005); Katz & Gartner (1988)

STAGES OF ORGANIZATION CREATION

60 3. New ventures: definition, financing needs, and legitimacy

3. 1. Definitions and characteristics of new ventures

61

mere intentionality and boundary may be may be “low-threshold” activities (Aldrich, 1999, 78), requiring only little or no material support by external audiences. In contrast, achieving a sale or obtaining a bank loan (exchange and resources components) need the active support of others, in this case paying customers or the willingness of a bank to provide credit to the venture. This means that the threshold of activities referring to these components may be comparatively higher. In particular, such activities may be instrumental to legitimation with financiers and fund-raising success. This would potentially result in an unsuitable mix of definitional criteria and influencing factors on the feasibility of raising sufficient funding and gaining legitimacy. Therefore, it is preferable to determine venture existence not by initial business success with customers or resource providers, but by minimum criteria of formal external visibility and founder commitment. These criteria refer to the two components to be completed: boundary and intentionality. Corresponding to these two components, passive activity indicators of venture existence will be employed which, if completed, mark the beginning of venture infancy (cf. figure 3–4).36 The point of birth of a new organization (i.e. the transition from gestation to organizational infancy) is marked by its formal legal and administrative existence and passive acceptance. This is considered the point in time where the new organization is ‘visible and institutionally tangible’ for external actors within the economy as it possesses an identifiable boundary (cf. Koch, 2005, 11).37 As depicted in figure 3–4, boundary indicators will be used, such as ‘obtained necessary registrations and permissions from authorities’, ‘obtained office space’, and corporate identity markers (name, logo, office address, phone listing).38 The establishment of a legal entity already documents intention and irreversible commitment to the venture (cf. Delmar & Shane, 2004). In addition, for 36

37

38

Activities pertaining to the other two components must not have been completed. In particular, for purposes of the theoretical sampling logic of the empirical study, entrepreneurs have sought external finance, but must not have completed this task. To ensure that the case selection framework is not confused with a general definition of infant organizations, note that infant ventures may not even need external finance. For the purpose of the empirical study only, case ventures must have a need for external finance. Note that the establishment of a legal entity and other gestation markers referred to below have been used as legitimizing factors in empirical studies of new venture legitimacy (as in Delmar & Shane, 2004 or Tornikoski, 2005). However, passive indicators of formal existence are assumed to interfere least with the feasibility of raising funding from potential financiers. This is because the latter may demand indications of commercial proof of concept and profitable prospects (e.g. in the form of existing customer demand) rather than mere formal existence of the venture. These activities pertain to typical markers of firm establishment; cf., for example, Newbert (2005, 64).

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3. New ventures: definition, financing needs, and legitimacy

the completion of intentionality, founders are required to have communicated the official existence of their business to others (e.g. to potential suppliers or patent offices). Finally, the beginning of venture gestation is reflected by the initiation of boundarybuilding activities (e.g. preparing for administrative permissions) and intent to start a business; this will be captured by the point in time at which the business idea has first been communicated to others, e.g. to potential co-founders or strategic partners (cf. the gestation column in figure 3–4; the definition of ventures to enter the case study and the time frame of the empirical analysis will be followed up in chapter 5. 1.). Having introduced the types of new ventures relevant to this study, the next step will be to discuss the need for external financing that entrepreneurs may have in order to be able to establish their venture.

3. 2. External financing needs of new ventures Chapter 3. 2. 1. will introduce general characteristics and challenges relating to the utilization of resources in new venture formation. Then, 3. 2. 2. addresses implications of financial resource needs for the theoretical and empirical research concept. Finally, 3. 2. 3. concentrates on possible consequences of financial resource poorness for the development of new ventures. This will provide an understanding of the relevance of external selection pressures from potential financiers to the struggle to obtain funding.

3. 2. 1. Resource needs of new ventures in general In the strategic management literature, the topic of firm resources has gained increasing attention as the resource-based view has advanced. This perspective is also reflected in definitions of what resources actually are. Wernerfelt (1997, 119) characterizes resources broadly as “anything which could be thought of as a strength or weakness of a given firm. More formally, a firm’s resources could be defined as those (tangible or intangible) assets which are tied semipermanently to the firm”. A more detailed collection of resources is provided by Brush (2001, 67), who puts forward six different types of resources: human, social, financial, physical, technological, and organizational. However, it is worth noting that the above resource types are not all of the same quality and character. Resources may be characterized by differing degrees of complexity, ranging from simple to very complex (Brush, 2001, 67). Simple

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resources would be, for example, mostly “tangible, discrete, and property-based”, while very complex resources are thought of as “intangible, systemic, and knowledge-based” (ibid.). Some resources are applied directly to the production process (utilitarian resources) while others are used to obtain other resources and are thus flexible, such as social or financial capital (called instrumental resources; ibid.). Founders of new ventures typically lack both sufficient utilitarian and instrumental resources. “Unlike existing firms, few (if any) entrepreneurs will initially possess a collection of resources comprehensive enough to establish an operating business. Instead, most (if not all) entrepreneurs will undoubtedly need to acquire additional complementary assets” (Newbert, 2005, 57; also cf. Lichtenstein & Brush, 2001, 37). In particular finance may be required as it is instrumental for making progress: “Because the exploitation of an entrepreneurial opportunity requires the acquisition and recombination of resources before the sale of output from that recombination, it must be financed” (Shane, 2003, 161; also cf. Mellewigt & Witt, 2002, 97). Therefore, the primary task of the founder of a new venture will be to construct a resource base, which may be a complex and time-consuming challenge when starting nearly from scratch (cf. Brush, 2001, 65). Thus, in contrast to a strategic resource-based perspective, “in the early stages of new venture development it is the identification and acquisition of resources − rather than deployment or allocation activities − that is crucial for the firm’s long-term success” (Lichtenstein & Brush, 2001, 37). This entrepreneurial challenge prior to concerns about achieving sustainable advantages through unique resources is further emphasized by Brush (2001, 64): “Strategies for attaining competitive advantages emphasize developing and configuring existing resource strengths into a valuable and unique resource base. But what if you do not yet have a legacy of resource strengths? Entrepreneurs in emerging organizations must first assemble resources, and then combine them to build a resource platform that will yield distinctive capabilities” (for the absence of a point of departure for resource based strategizing in new ventures also cf. Fallgatter, 2002, 168). It is this primary task of resource acquisition which the study is devoted to. In addition, there may also be challenges to identifying and quantifying the resources needed to establish a new business venture in the first place. The central challenge to any exact ex ante identification and specification of resource needs to establish a new

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venture will be a lack of predictability (cf. Stevenson & Gumpert, 1985, 90).39 Stevenson and Gumpert further remark: “Given the rapid pace of change in today’s world, one must assume that in-course corrections will be necessary” (ibid.). Therefore, in the beginning, myopic entrepreneurial actors, who are “hampered by ignorance and environmental complexity as they grapple with uncertainty, ... can assemble what they think they need, but whether their choices match up successfully with selection forces is an open question” (Aldrich & Martinez, 2003, 365). Similarly, Fallgatter (2004, 18) argues that ‘there will be no safe and objective knowledge about future resource needs in entrepreneurial ventures’. This implies that, when the fund-raising struggle is being analyzed, changes in financing needs will have to be tracked over time.

3. 2. 2. Financing needs and their implications for the empirical study For purposes of building the research concept, it will be important to clarify what factors other than perceived restrictions and external selection pressures from potential financiers may influence fund-raising intentions over time. These influencing factors are exogenous to the empirical research concept and, hence, will have to be taken into account. This will allow isolation of effects of perceived legitimacy restrictions and selection feedback from financiers on patterns of entrepreneurs’ financing intentions as they evolve over time. The main potential influence on the formation of intentions to raise funding will be the desirability of external financing as it is perceived by the entrepreneur in the first place. Desirability is reflected by the entrepreneur’s external financing needs to build the venture. It is also reflected by the entrepreneur’s preference order of financing sources. Both will need to be kept track of because of the above-mentioned potential difficulties in identifying resource needs and subsequent changes over time. These influences exogenous to the research concept are depicted in figure 3–5 (also cf. chapter 4. 4. 3. 2. below addressing perceived desirability as a rival orientation within the framework of fund-raising intentions and external selection influences). The components that may determine external financing needs are: the founders’ personal financial commitment (a1), the financial resource requirements of the business to be set

39

Also cf. the role of entrepreneurial pioneers in combining resources in novel ways stressed by Schumpeter (1934).

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desirability of external financing perceived by the entrepreneur: (a) initial personal and operational financing requirements and changes over time (1) amount of personal financial investment by venture founder (to be deducted from overall financing requirements) (2) financial resource needs of initial business conception (e.g. industry specific resource requirements of business operation and market entry) (3) financial resource needs in relation to founder growth aspirations

(b) initial financing preferences and changes over time (1) founder’s type of finance preferences (2) founder’s capital structure preferences

figure 3–5: determinants of financial resource needs and preferences (desirability of external financing)

up (a2), and founders’ growth aspirations for the venture (a3). These possible determinants will be addressed in 3. 2. 2. 1. Then, 3. 2. 2. 2. will cover funding source and capital structure preferences (b1 and b2).

3. 2. 2. 1. Exogenous determinants of external financing needs Personal financial commitments of founders “This financing process can and does include financing by the entrepreneur herself. In fact, in the vast majority of cases, founders finance the exploitation of entrepreneurial opportunity out of their own savings” (Shane, 2003, 161 referring to data presented by Aldrich, 1999; see Shane, 2003, 162pp. for a further overview of studies on ventures’ needs for financial resources). Therefore, to determine the external financing needs of a new venture over time, overall financial resource needs will have to be adjusted by deducting the capital provided by the entrepreneur or founding team to arrive at a net figure (cf. figure 3–5 above and also Bloomberg & Letterie, 2005, 179 for a similar concept). In the analysis of the acquisition process of external financial resources, the amount of personal savings put into the venture’s development will have to be taken into particular account (also cf. the study by Heirman & Clarysse, 2005 who analyze the imprinting effects of initial financial resources on the early growth of new researchbased ventures). For example, a ‘wealthy’ entrepreneurial team may operate mostly independently of external financiers’ demands and will thus be less affected by external selection pressures in the short term. Hence, when analyzing pressures from financial

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selection on the fund-raising process, substitutions of external financing needs by personal investments must be tracked.

Characteristics of the business operation and industry of the new venture However, financing needs of new ventures do not differ only because of variations in the levels of personal investments by their founders. Mellewigt and Witt (2002, 86) have stressed that resource needs may be derived by looking at the businesses’ core products and mode of market entry. In particular, resource demands of new ventures will be industry specific. While high-tech start-ups have been found to have financial capital requirements of sometimes more than one million US dollars, most independent business owners in other sectors will need far less (Aldrich, 1999, 103). Generally, ventures have been categorized as no budget, low budget, and big budget founding, depending on the financing volume they commonly require (Kuckertz, 2006, 25). The above-mentioned high technology ventures belong to the big budget group while the other two groups are commonly said to feature, e.g., personal services and retail ventures (ibid.). This specificity of financing requirements to the characteristics of the planned business operation and the industry sector it belongs to is therefore also included amongst the determinants in figure 3–5 above.

Growth aspirations of founders Central to the magnitude of funding needs to establish a new venture will also be the growth willingness of its founder. Cosh et al. (2005) found that whether a firm seeks external finance or not depends on the type of firm it is. In particular, the authors report that “firms with stronger growth objectives are much more likely to seek external finance” (ibid., 31). And within these types of new firms, the personal and professional objectives of their founders may differ (cf. Davidsson, 1991). In principle, most new ventures start small as far as their requirements for external funding and human capital are concerned; in particular, most of them will also stay small not least because their owners do not strive for radical growth (cf. Aldrich, 1999, 102p. and for a general overview Storey, 1994). To sum up, in order to gain an understanding of founders’ growth aspirations within the context of their intended actions to raise funding, outcomes must be measured against the entrepreneurs’ specific objectives (cf. Bucar, 2004, 38). For example, a founder may refrain from asking for substantial external funding not

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because he believes convincing external financiers to be unfeasible, but because he does not need much funding to implement his modest growth objectives with the venture.

3. 2. 2. 2. Financing source and capital structure preferences Studying preferences of financial deciders for a specific form of financing over others has a long tradition in the field of finance; in particular, this includes analyses of financial pecking orders of managerial agents in comparison to owner-managers (cf., for example, Myers et al., 1976 or Myers & Majluf, 1984). The general pecking order argument runs as follows (cf. Myers, 2000). Due to a presumed asymmetric distribution of information between firm and investor, firm actors will begin to fund new projects using internally generated cash flows first and only then finance remaining needs externally. This pecking order is opted for since costs of external finance increase whenever investors face asymmetric information (cf. Shane, 2003, 165p. for entrepreneurial resource acquisition challenges in face of information asymmetry). Moreover, having external financiers on board may lead to a loss of control over the firm’s affairs because of financial covenants (cf., for example, Sapienza et al., 2003). This loss-of-control issue has further implications for the preference order of financing. When financing externally, firm agents are assumed to prefer debt financing over equity financing because the latter dilutes the share of ownership, a concern particularly prominent with firm founders and small business owners. For example, this issue has been put forward by Changanti et al. (1995) in their analysis of predictors of capital structure decisions by small venture owners, by Lindstroem and Olofsson (2001), and Cosh et al. (2005). In particular, Lindstroem and Olofsson (2001, 152) argue that a likely aversion by founders towards external control may lead to one type of external financing to be preferred over the other and specific preferences for the overall amount of external financing. Again, since these factors may influence the evolution of fund-raising intentions, they will need to be tracked. To sum up, perceived needs and preferences for external financing may represent rival explanations of changes in entrepreneurs’ fund-raising intentions alongside external restrictions and selection pressures exerted by potential financiers. The detailed strategy for gaining an understanding of this rival reasoning will be addressed in chapter 4. 4. 3. 2. (also cf. Yin, 2003, 27 for the appreciation of possible rival explanations in qualitative case studies). The next step is to highlight the availability of external funding

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for the growth and continued development of new ventures. This will show how important it is for entrepreneurs to acquire the necessary funding from external financiers in order to establish their venture projects.

3. 2. 3. Financial resources and the development of new ventures The fundamental significance of resource availability is described succinctly by Mathews (2002, 32): “The firm’s resources set limits to what the company can do ... [r]esources then are the basic constitutive elements out of which firms transform inputs into outputs, or generate services”. The super-ordinate relevance of resources leads to the diagnosis that a considerable share of firm heterogeneity may be explained by differences in resource bases (ibid.). This heterogeneity, in particular in terms of performance, is also found in the small business sector and possibly also in newly emerging ventures (cf. Storey, 1994, 112 for the former and Katz & Gartner, 1988, 431 for the latter). Fistly, what may happen when entrepreneurs do manage to assemble substantial financial resources for their new ventures will be examined (3. 2. 3. 1.). Then the scenario when funding is lacking will be considered (3. 2. 3. 2.). This second scenario will also contribute to an understanding of possible effects of selection pressures from the financial environment on new ventures and their fund-raising struggle.

3. 2. 3. 1. Implications of financial resource availability Financially speaking, “new ventures with more capital are more likely to survive, grow and become profitable because capital provides a buffer that entrepreneurs can use to respond to adverse circumstances” (Shane, 2003, 162). This positive verdict is further supported by other studies. These studies have focused at least partly on what financial capital can do to boost the establishment of new ventures. Westhead (1995) found that increases in employment in independent UK high-tech firms were positively influenced by previously obtained external capital. Similar findings have been reported by Bruederl and Preisendorfer (1998) for a German sample of new ventures; the authors also report positive correlations between the amounts of capital invested and aggregate sales over three years. Apart from these indicators of establishment, initial capitalization also appears to influence business strategy. For example, Shrader and Simon (1997) have shown that market entry strategies partly depend on initial capitalization. New firms with little capital predominantly pursue market-niche entry strategies; in contrast, firms

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equipped with a lot of financial capital were found to follow roll-out strategies targeted at much larger market segments. Many further examples could be added to this40 And generally, aggregate variables such as profitability or growth rates appear to be positively influenced by increasing amounts of initial capital, be it from the founder’s own pockets or from external sources (cf., for example, Reynolds & White, 1997; Taylor, 2001; or Engel & Keilbach, 2005).41

3. 2. 3. 2. Impacts of financing constraints It is argued that there are two principal concepts to describe situations where financial and other resources are not available to young ventures. The first concept has been far more common while the second notion is less explored. Having said this, the latter concept deserves more attention because of its considerable practical and empirical relevance. The two concepts differ in their ascertainment of the consequences of resource-poor situations. The first concept embraces studies that concentrate on new venture failure and mortality due to a lack of resources, in particular financial resources. The second concept argues that resource unavailability also has specific impacts on existing new ventures with complete failure only being one of many possible scenarios. There are ventures out there which fail to assemble the funding they need to establish their business as initially planned, but which are still in existence. This is particularly important for studying possible implications of external financial selection pressures on entrepreneurs’ internal selection of fund-raising intentions in existing new ventures (cf. chapter four and five below). In the following two sections the first concept will be touched upon and then the case for the second concept will be argued.

40

41

Good overviews of further studies in this area may be found in Mellewigt and Witt (2002) and Shane (2003). Note though that causality may also be reversed. This may be because (signs of) profitability, revenue growth, or innovation output may be instrumental to obtaining large amounts of capital, in particular equity funding. This is also hinted at by the above-mentioned study by Engel and Keilbach (ibid.) who conclude that, in this case, higher innovation output of entrepreneurial ventures is not so much driven by high volumes of equity funding, but rather a result of the screening criteria of venture capitalists; hence, it may be that innovation output drives funding rather than vice versa.

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Lack of funding and new venture failure The first concept focuses on the issue of ultimate firm failure due to severe resource insufficiencies. This view is also implicit in the notions of liability of newness, smallness, and adolescence introduced above. Moreover, entrepreneurial project failure has also been implicit in the transition from organizational emergence to existence where many nascent entrepreneurs drop out of the process (see above). Even though a lack of finance may be a common problem, other resources such as adequate human capital may also be difficult to attract, which could also lead to to early firm failure (cf. Pasanen, 2005, 97). However, adverse conditions may arise later again, for example when firms run out of cash in face of problems with market establishment requiring higher financial efforts (cf. Rovenpor, 2004, 70p.). Here, existing capital buffers have to be viewed in a ratio relative to operational cash needs; this is done using the famous ‘burn rate’ indicator, measuring how fast ventures run out of cash and die (cf., for example, Garbi, 2002). Such failure scenarios were common in the e-commerce shakeout following the burst of the new economy bubble (cf. Rovenpor, 2004, 53). In general, for both emerging and existing firms, those with limited or insufficient resource endowments (particularly capital) apparently have the lowest chances of survival (cf. Aldrich & Martinez, 2001, 45 and, e.g., Lussier, 1995 for the lack of capital at start-up). Moreover, general studies on various causes of new venture failure have been surveyed by Rovenpor (2004, 70pp.) as well as Fallgatter (2002, 151p.) and Pasanen (2005, 97). An important finding of these studies is that failure trajectories often feature a range of interrelated problems which finally lead to failure (ibid., 102; also cf. Fallgatter, 2002). This leads to multi-causal failure scenarios in which the reluctance of potential financiers, who may worry also about the other problem areas of a venture in such scenarios, may be central. So pressures from financial selection may well cause full external elimination of new ventures. However, insufficient availability of capital, which falls short of initial financing plans, may not automatically lead to new venture insolvency; hence such external selection may often only be partial.

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Lack of full initial funding and continued venture development Rather than considering only the dichotomy between survival versus death, the second concept concentrates on resource unavailability within the context of existing ventures that have survived up to that point. There may in fact be more differentiated possible paths of negative development within the above dichotomy. In particular, when external funds fall short of original financing plans, such paths may embrace for example degeneration, adaptation, or compensation processes which alter and perhaps deform founders’ initial business plans (for a general overview cf. Mosakowski, 2002); however, these processes refer to still existing, though struggling, new ventures. For example, Hager et al. (2004, 163) take up Cyert’s contention that organizations which suffer from an increasing reluctance of the environment to support them have two general options at hand apart from disbanding their activities. These possibilities are to scale down operations or, as Cyert puts it, find a different ecological niche (Cyert, 1978). In other words, entrepreneurs may find that their original business conception cannot be implemented due to external financiers’ reluctance to provide support. In face of this, entrepreneurs may decide to adapt to make do with a smaller financial resource base than initially intended. Similar underlying thinking is implicit in v. Kalkreuth and Murphy’s finding that the adjustment of resource needs and capacity is interdependent with perceived constraints to acquire financial resources by small businesses (v. Kalkreuth & Murphy, 2005, 7 and 24; also cf. the ‘strategy follows finance’ notion in Kuckertz, 2006, 23p.). Overall, these assumptions put forward that disbanding a new venture or its forced closure because of insolvency may only be extreme outcomes of fund-raising processes which ran into difficulties. And it will be issues like the above adaptation to a smaller scale of financing which will be explored in the examination of external financing intentions over time.42 To sum up, the following needs to be considered in the theoretical and empirical research concept in chapters four and five. This thesis will develop a more elaborate concept of potential implications of external selection pressures than the above dichotomy. This is because the active role of entrepreneurial agents suggests that there is not 42

This active role of the entrepreneur may be further strengthened by referring to research on firm closure itself. New and small firms cease to exist not only because they go bankrupt or are liquidated by external forces, but frequently also because the entrepreneur or owner-manager deliberately decides to disband the firm (cf. Pasanen, 2005, 94; Hager et al., 2004, 160; and Storey, 1994, 79pp. for the specific case of small, owner-managed businesses).

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only external selection but also internal selection choices made by entrepreneurs themselves. The leeway for such choices has been sketched out by resource dependence theory. The concept argues that organizations (new and mature) will be restricted by resource interdependence with other organizations and actors (cf., for example, Tornikoski, 2005, 86). This is because “the need for external resources determines the degree of dependence on the environment” (ibid., 86 referring to Boyd, 1990). In particular, it has been argued that the specific extent of dependence will be characterized by the magnitude of the resource’s availability, its criticality to the organization, and the discretion over its use (cf. Pfeffer and Salancik, 1978, 46 and, e.g., the resource salience model of Lichtenstein & Brush, 2001). With regard to this Jawahar and McLaughlin (2001, 402 referring to Pfeffer, 1982, 193) conclude that “organizations must attend to the demands of those in its environment that provide resources necessary and important for its continued survival”. This means that the simultaneous need for and scarcity of financial (and also other) resources will make the legitimated acceptance by critical resource owners essential for new ventures. In particular, financiers’ demands for legitimacy are part of the specification of the external selection environment in which ventures’ fund-raising processes unfold over time. Consequently, the next chapter addresses new venture legitimacy. 3. 3. Legitimacy of new ventures and the acquisition of resources When aiming to explore external selection forces on fund-raising processes, it is necessary to develop a notion of what these forces are and how entrepreneurial attempts to raise funding relate to them. These forces are interrelated with typical pressures of direct market competition between new entrants and established firms and will often work in concert with them (for a general overview cf. Aldrich, 1999). However, in the case of new ventures external selection may also precede market competition when resource support is denied to start-up projects because they lack legitimacy. For example, potential investors may play a gate-keeping role for new business conceptions to enter the market (cf. Lounsbury & Glynn, 2001, 546 and also Brouwer, 2000 for selection pressures by investors). This means that the principal pressures of resource selection on new ventures may be quite distinct from traditional selection pressures from intra-industry competition. It is argued that legitimacy theory would be a suitable framework for studying these specific pressures of resource selection in the early life phase of new ventures. In particular, financial resource owners may deny resource support to those ventures which lack the legitimacy demanded.43

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Organizational legitimacy is an established concept to describe the external acceptance and support pressures on organizations. While originally stemming from general institutional and social theory, the concept has also been dealt with by researchers of the emergence and development of new ventures, both at the population and individual organization level (for an excellent overview see Aldrich, 1999 or Aldrich & Baker, 2001). Gaining legitimacy from vital stakeholders and society in general has frequently been viewed as paramount for new, in particular innovation-oriented, ventures (cf. amongst many others Aldrich & Fiol, 1994; Lounsbury & Glynn, 2001; Zimmerman & Zeitz, 2002; Shepherd & Zacharakis, 2003; Delmar & Shane, 2004; Tornikoski, 2005; Newbert, 2005; Fallgatter & Brink, 2006).44 Further, Aldrich and Fiol (1994, 645) asserted: “Among many problems facing innovating entrepreneurs, their relative lack of legitimacy is especially critical, as both entrepreneurs and crucial stakeholders may not fully understand the nature of the new ventures, and their conformity to established institutional rules may still be in question” (as an example cf. Aldrich & Baker, 2001 discussing the legitimizing and establishment struggle in internet start-ups). In respect of its importance to new ventures, the particular rationale for employing legitimacy theory to conceive the fund-raising struggle of entrepreneurs is the following. First, the specification of the selection environment around this struggle will have to take account of the distinct character of initial support for venture projects as financial resources are selectively allocated to them. In this respect, the legitimacy notion provides the epistemological anchor for understanding the demands of potential venture financiers and their decision-making, which will be different from completely rational choice (cf. 2. 3. 2. 2. below and Zimmerman & Zeitz, 2002, 415 for this epistemological basis). Second, legitimacy theory also provides concepts to describe possible legitimizing actions or options that may be available to the entrepreneur in face of the demands of financial resource owners. Together, constraining legitimacy demands and their own legitimizing possibilities may contribute to understanding entrepreneurs’ perceptions of the viability of their fund-raising plans over time. Employing a framework of organizational legitimacy based on institutional theory is preferred over other concepts. This is because of the following reasons. 43

44

The terms legitimacy demands, requirements, or expectations will be used interchangeably. The term legitimacy requirements has been used in the seminal paper by Suchman (1995) while ‘demands for legitimacy’ may be found in Stone and Brush (1996), though having a broader meaning there. In addition, researchers have observed that a lack of legitimacy increases the likelihood of new venture mortality as well as of failures to establish resource exchange (e.g. Shane & Foo, 1999; Newbert & Tornikoski, 2004).

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The two most closely related theoretical concepts to new venture legitimizing and reputation building strategies are general signalling and trust notions (cf., for example, Aldrich, 2000). “Outsiders cannot see all of a firm’s reputation-building activities when they make reputational assessments ... and so must rely on signals” (Reuber & Fisher, 2005, 59). In finance theory, however, signalling is mostly concerned with the issue of agents’ opportunistic information disclosure and action in situations of asymmetrically distributed information between the better-informed entrepreneur and external financiers (cf., for example, Heitzer, 2000, 150; Schefczyk, 2000, 47; Denis, 2004, 310; and Schulte, 2005, 491). This said, beyond opportunism risks, it is also genuine external market uncertainty in the course of market establishment which “makes resource providers unable to evaluate the potential of new ventures” (Shane, 2003, 167).45 Moreover, there may also be internal uncertainty in the course of setting up new businesses. In particular, Shane (2003, 167) stresses that “the ability of entrepreneurs to exploit specific opportunities, and the value of these opportunities themselves, are largely unknown prior to their exploitation” (also cf. Sapienza & Gupta, 1994, 1616p. for uncertainty relating to entrepreneurs’ tasks and the adequacy of their competences; for the latter also see Low & Srivatsan, 1995, 65p.).46 Overall, the evaluation of new ventures by potential financiers suffers not only from an asymmetric distribution of available information, but also from the unavailability of information within a context of uncertainty (cf. Stouder & Kirchhoff, 2004, 369 who argue that “uncertainty mainly derives from the unavailability of useable information in start-up firms”; also cf. Shane & Stuart, 2002 and Mason & Stark, 2002 for this). Therefore, an adequate framework will have to go beyond considering the new firm solely as an issue of opportunistic agency (cf. Witt, 2002; Alvarez, 2005 and, in particular, Kuckertz, 2006, 104p.). In this respect, the institutional concept of new venture legitimacy allows financiers’ critical attitude towards investing in venture projects to be captured, not only because of opportunism but also because of uncertainty concerns about the viability of the business and the qualification of its founder. Finally, note that 45

46

See Grichnik and Kraschon (2002, 28) and Kuckertz (2006, 55) as far as market uncertainty is concerned. In their discussion of trust in entrepreneurship, these authors also stress that “economic theories of organization, and in particular, principal-agency theory, have focussed on issues of opportunism and paid less attention to the issue of competence” (ibid.); also see Mellewigt and Witt (2002, 102) and Alvarez (2005, 30 and 35) pointing out that contracting structures between ventures and financiers may not only be aimed at combating opportunism but also at deficiencies in management competences and business uncertainty (also cf. Fallgatter, 2002, 35).

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the concepts of entrepreneurial marketing and investor relations may also be less suitable for studying fund-raising processes of infant ventures struggling to attract initial funding from the environment. Entrepreneurial marketing is mainly directed at competing for customers (cf. Morris et al., 2002, 3). Investor relations are concerned with firms already publicly quoted on the stock exchange or who at least have existing relationships with external equity financiers (cf. Achleitner & Bassen, 2001 and Kollmann & Kuckertz, 2006). Chapter 3. 3. 1. offers a differentiation of the general concept of organizational legitimacy. The specific focus on the struggle to gain legitimacy for new ventures is also addressed. Then, 3. 3. 2. discusses legitimizing action, exploring potential sources of legitimacy at both the industry and firm level. Such sources may be employed in different principal legitimizing options and contribute to the capabilities to gain legitimacy as perceived by the entrepreneur. Here, two fundamental views on organizational legitimacy will also be introduced. The institutional perspective argues that legitimacy is conferred upon the organization by the environment. In contrast, the managerial agency perspective assumes that legitimacy can be actively acquired by manipulating the legitimacy expectations and assessments of external resource owners. This distinction will be important to the further theoretical and empirical research concept. This is because it will be argued that an understanding of fund-raising processes will have to focus on entrepreneurs’ financing intentions in view of those legitimacy demands of potential financiers which constitute invariant constraints. These legitimacy restrictions will have to be conformed to for legitimacy to be conferred and funding to be provided by external financiers (as suggested by the institutional perspective). Finally, chapter 3. 3. 3. discusses differences in the difficulty to legitimate between different types of resource exchange with external resource owners. This will help to further specify the principal barriers to attracting external funding as perceived by the entrepreneur.

3. 3. 1. Legitimizing challenges in new ventures 3. 3. 1. 1. Definition and characterization of organizational legitimacy In the early 1990s, Elsbach and Sutton (1992, 700p.) noted that the concept of legitimacy had become almost an ubiquitous theme in organizational theory. Originally, the legitimacy notion has its roots in general social and socio-institutional theory (cf. in particular Parsons, 1960 but also the works of Max Weber on the legitimation of power

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and the development of authority in political systems as explained in Scott, 2001, 59). For the context of organizational change processes Milne and Patten (2000, 3 referring to Parsons, 1960 175p.) remark: “The utilization of resources from a larger social system, that could be allocated elsewhere, must be accepted as legitimate by members of that larger system”. Therefore, any activity by groups of society relying on the commitment of societal resources will require legitimacy.47 Broadly, organizational legitimacy has been characterized as the acceptance of an organization by the environment (cf., for example, Dowling & Pfeffer, 1975 or Meyer & Rowan, 1976; also cf. Fallgatter & Brink, 2006, 4 for an overview of definitions of organizational legitimacy). Moving beyond this general description, Suchman’s seminal definition of legitimacy has been introduced as a working definition in the first chapter of this thesis. For readers’ convenience this definition is reproduced so as to go into more detail from there. Legitimacy may be characterized as the “generalized perception or assumption that the actions of an entity are desirable, proper or appropriate within some socially constructed system of norms, values, beliefs, and definitions” (Suchman, 1995, 574).48 The definition goes beyond the pure cognitive side of just being understandable as an organization in consonance with the cultural environment (cf. Suchman, 1995, 573). In addition to the comprehension of an entity, legitimacy also has an evaluative side requiring that the entity is desirable and acceptable. This evaluation is performed against the background of inter-subjective, socially constructed beliefs and rules (ibid., 573, also cf. the above notion of decision-making based on legitimated criteria by Zimmerman and Zeitz, 2002, 415 as well as Newbert and Tornikoski, 2004, 2). Within the social construction of legitimacy, the perhaps most important issue in Suchman’s definition is the perceptive character of legitimacy; legitimacy is a perception held by external observers.49 During the emergence and establishment of a venture 47

48

49

Concerning the composition of these groups, theory has addressed different levels of legitimacy: the legitimacy of single organizations, populations of organizations (e.g. within a specific industry sector), and communities (see Aldrich & Martinez, 2003 for a discussion of legitimizing at these three levels; also cf. Van de Ven, 2005 for population level legitimacy). In fact, this definition appears to be a kind of accepted standard reference employed by institutional and entrepreneurship researchers (see, for example, Barron, 1998; Aldrich, 1999; Scott, 2001; Zimmerman & Zeitz, 2002; Newbert & Tornikoski, 2003; Tornikoski, 2005). This external observation stands in contrast to concepts like organizational identity (as the beliefs of members about their organization) or organizational image (defined as members’ beliefs about how externals view their organization); for these differentiations see Reuber and Fischer (2005, 58).

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organization, the venture’s survival primarily depends “on the perceptions of external stakeholders, rather than on actual financial performance” (Delmar & Shane, 2004, 388; also cf. Elsik, 1996, 345). In principle, legitimacy will always be a “reaction of observers to the organization as they see it” (Suchman, 1995, 574). Thus, “legitimacy ultimately exists in the eye of the beholder” (Zimmerman & Zeitz, 2002, 415). In agreement with Scott (2001, 59), legitimacy should thus not be considered as a “commodity to be possessed or exchanged but a condition reflecting perceived consonance with relevant rules and laws, normative support, or alignment with cultural-cognitive frameworks”. Consequently, legitimacy reveals itself when external audiences accept the organization and provide resource support. Because of this, the existence of legitimacy may be noticed only retrospectively (Tornikoski, 2005, 34). This also has consequences when it comes to the question of how to actually research the general construct of legitimacy. Researchers studying the legitimacy of new ventures are faced with the challenge that legitimacy as such is hard to observe, being an abstract judgement or assumption held by societal audiences (ibid.; also cf. Zimmerman & Zeitz, 2002, 417). Tornikoski (2005, 34) is therefore perfectly right to admit that, if looking at a large number of different ventures, it is virtually impossible to measure legitimacy rigorously. Having said this, in respect of the focussed empirical concept pursued in this study, legitimacy itself will not be used as a construct. When exploring the evolution of fund-raising intentions in face of external requirements for legitimacy, entrepreneurs’ sense-making of legitimacy demands within the context of their chances to obtain resources will be of primary importance. This study focuses solely on the legitimacy demands of providers of financial resources. This stakeholder group will follow more ‘self-interested’ demands, e.g. for profitable investment opportunities. These are different from the demands of other societal stakeholders. Therefore, it is necessary to differentiate between different types of legitimacy. 3. 3. 1. 2. Different types of legitimacy Domain and industry specificity of legitimacy demands Concerning demands of immediate stakeholders of organizations, Suchman (1995) remarks that legitimacy requirements are context-dependent and vary across industries (also cf. Ruef & Scott, 1998, 880 and Zimmerman & Zeitz, 2002, 415).50 Bucar (2004, 23) 50

For example, demands for moral legitimacy will be much more salient with the biotechnology industry than they might be for the car repair services sector.

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therefore stresses that those differentiations of legitimacy may be most useful which conceptualize legitimacy by categorizing relevant social actors. In particular, Ruef and Scott (1998) as well as Baron (1998, 209p.) conclude that researchers should differentiate between the different forms of legitimacy and clarify which form of legitimacy they are looking at. This study solely concentrates on perceived challenges to gain pragmatic legitimacy with the resource owners in the financial domain.

Categorizing different types of legitimacy The concept of pragmatic legitimacy will be best characterized by contrasting it with other theoretical forms of legitimated acceptance, i.e. moral and cognitive legitimacy. However, before addressing these types of legitimacy as described by Suchman (1995), it is worth noting that other differentiations may also be found in the relevant literature. An overview of the three possibly most prominent categorizations of different forms of legitimacy is provided in figure 3–6.51

cognitive legitimacy

evaluative legitimacy

Scott (2001)

cultural-cognitive l. (legitimacy) – comprehensibility via established cognitive schemata

normative l. – compliance with relevant social expectations; regulative l. – conformance with legal rules

Aldrich & Fiol (1994); Aldrich (1999); Aldrich & Martinez (2003)

cognitive l. – acceptance of organization as taken for granted feature of the environment

socio-political l. – moral conformity with cultural norms and values; regulatory conformance with governmental rules and regulations

Suchman (1995)

cognitive l. – comprehensibility and taken-for-grantedness of the organization by externals

pragmatic l. – evaluation resting on self-interested rationale of an organization’s most immediate audiences; moral l. – normative evaluation of organizational characteristics and activities

figure 3–6: different categorizations of legitimacy types relating to organizations (compiled from Suchman, 1995, 578pp.; Aldrich, 1999, 232pp.; Scott, 2001, 52pp. and 60pp.; and Aldrich & Martinez, 2003, 368)

The categorizations − despite some differences − appear fairly similar overall. All of them are based on a differentiation between qualities of requirements and sources of 51

Further categorizations may be found in Elsbach (1994) or Ruef and Scott (1998).

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conformity with current societal belief systems. Scott (2001, 59 and 61p.) in particular, who argues from an socio-institutional viewpoint, stresses that the pillars of legitimacy refer to corresponding institutional frameworks which provide different sources of legitimacy if the underlying cognitive-cultural, normative, and regulative institutional rules are visibly adhered to. All three conceptions also follow a distinction into the broad compartments of cognitive comprehensibility and evaluative conformance (cf. figure 3–6). Suchman’s categorization with its pragmatic legitimacy has been chosen for the following reason. It more specifically takes into account the critical evaluation by the most immediate stakeholders and exchange partners of an organization such as its suppliers, customers, employees, and, particularly, financiers. Pragmatic legitimacy is based “on the self-interests of the external audience” (Tornikoski, 2005, 34). It is required when an organization wants to initiate resource exchange with these stakeholder audiences. Hence, Suchman (1995, 578) and also Tornikoski (2005) view pragmatic legitimacy as a kind of exchange legitimacy. Here, legitimacy is considered as “support for an organizational policy based on that policy’s expected value to a particular set of constituents” (Suchman, 1995, 578). For example, the business conception of a new venture may be of value to a potential financier looking for profitable investment opportunities. To meet pragmatic legitimacy requirements, the organization’s offers have to benefit the evaluators. In the financial environment, the assessment of evaluators is assumed to be based on pre-investment or credit screening criteria employed in the financial community.52 The principal rationale of demands for pragmatic legitimacy (such as those of potential financiers) stands in contrast to other notions of evaluative acceptance such as moral legitimacy. Moral legitimacy is rather more “sociotropic”, demanding a general conformance to the norm and value systems of societal evaluators (Suchman, 1995, 579). For example, the features and activities of a new chemicals firm may be evaluated for their correspondence to general ecological values but also for compliance with regulatory standards. The former operates on the basis of binding expectations (if equipped with sufficient sanction power) while the latter functions by the enforcement of regulative rules (cf. Scott, 2001, 52 and figure 3–6). Both moral and regulative legitimacy are more concerned with general societal welfare, while pragmatic legitimacy focuses on narrower self-interest relating to a specific resource exchange context (Suchman, 1995, 579). 52

This will be addressed in detail in chapter 4. 2. below.

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What these forms of legitimacy have in common is that they all require the organization to pass an evaluation before acceptance or active support is granted. This is different for the construct of cognitive legitimacy. Cognitive legitimacy is not based on the interests of evaluators (ibid., 582). “Knowledge of an organization provides cognitive legitimacy regardless of whether that knowledge is positive, negative, or neutral” (Shepherd & Zacharakis, 2003, 151). Rather, this construct refers to the comprehensibility of the organization, i.e. the entity merely has to be understandable in the cultural context (Suchman, 1995, 573). Legitimacy here has its roots in a widely shared frame of reference (Scott, 2001, 61). Ultimately, the achievement of cognitive legitimacy leads to a kind of taken-for-granted acceptance of an organization, meaning that everybody understands and some even imitate its features and activities (cf. Aldrich & Martinez, 2003, 368). Compared to imitative ventures, acquiring cognitive legitimacy (and other forms of legitimacy) is assumed to be more difficult for ventures operating in novel sectors (ibid.). An example of this may be new ventures that started to offer disease management and e-health services at the end of the 1990s in Germany. At first, the offers of such ventures may have appeared uncertain or vague to patients not knowing what disease management actually is. Note though that the offers of these firms may also have been controversial on normative-moral and socio-political grounds (e.g. concerns about intimidation of the sensitive doctor-patient relationship or about data protection and medical quality). Such concerns might well have hampered the commercial success of these firms. And, in principle, it must be taken into account that non-economic demands or concerns may impede the commercial establishment and expansion of new ventures (cf. Granovetter, 2000, 244p.).

3. 3. 1. 3. The need for new ventures to gain legitimacy The legitimacy requirements that populations of organizations face will change over the span of their life (Aldrich, 2000, 216). And in no situation will the internal establishment of a running venture and accompanying external societal support be achieved automatically and ad hoc. Rather, initial legitimizing may be seen as a process during the emergence and early development of a new venture (cf. Gartner, 1993, 232 and Bucar, 2004, 19). Legitimacy has to be gained in a time-consuming process. Once obtained, it has to be maintained over time (and repaired in cases where it has been lost; cf. Suchman, 1995, for these three generic types of legitimating). Maintaining legitimacy

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is more of a concern to established organizations. It is assumed that maintaining legitimacy is often easier than obtaining it, because “once conferred, legitimacy tends to be largely taken for granted” (Ashforth and Gibbs, 1990, 183). Unlike established organizations, new ventures, which fist need to gain legitimacy, do not have a well-known company history. Having virtually no organizational history puts new ventures at a disadvantage in comparison to established firms. At the same time, legitimacy is essential to attract external support for new organizations. Entrepreneurship researchers have argued that some kind of minimum threshold of legitimacy may have to be gained first, so as to be able to garner resources from the external environment (see Bucar 2004, 19p. and Zimmerman & Zeitz, 2002, 414). Note also that the legitimacy threshold for such active resource support, e.g. by risk-bearing investors providing finance, may be higher than the level of legitimacy required to merely win passive acceptance by a general audience (cf. Suchman, 1995, 575). In particular, “legitimacy improves chances of acquiring all of the various resources needed to survive and grow, such as capital, technology, managers, competent employees, customers, and networks ... the legitimacy-resource-growth relationship is especially critical to new ventures seeking resources, since there is typically little past economic performance on which the holders of resources can economically and rationally judge them” (Zimmerman & Zeitz, 2002, 416; also cf. Shane, 1999, 143p. and Reuber & Fisher, 2005, 57 who argue that the track record of new ventures may be too short to evaluate their quality). Moreover, organizational structures, business relationships, and routines which underpin future performance will also be immature due to a lack of operational experience (ibid. and Stuart et al., 1999, 315p.). In terms of legitimacy, new ventures have to gain corresponding consequential and essence legitimacy, which are both absent initially (for these two concepts cf. Suchman, 1995). In the financial domain, essence legitimacy may refer to the underlying character and structure of an organization, providing the basis for its activities and financial outputs. Such externally visible outputs in turn help to generate consequential legitimacy documenting previous accomplishments and performance which are valued by externals, e.g. adequate production and marketing concepts that generate acceptable sales and profit figures (cf. ibid., 580 and Aldrich & Baker, 2001, 227). Viewed from the perspective of external resource owners, demands for legitimacy arise when resource allocation decisions have to be made in contexts of uncertain future performance (Stone & Brush, 1996, 633). Since new ventures lack visible final performance upon which legitimacy

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assessments may be based, resource owners have to infer from underlying components the possible future essence and consequential performance of a venture. The legitimacy of new ventures may be questioned by external resource owners in terms of three general components: 1) the emerging or infant organization as a prototype of a new organization; 2) the reliability and managerial potential of the founders as novice professional entrepreneurs in their business; 3) the venture’s product or service offer if it is new to the market. The former two components will be on the agenda for all new ventures, regardless of whether they imitate existing businesses or whether they establish innovations in entirely new sectors. Product and service offers will require additional legitimizing efforts, mainly when they are innovative. This is because their cognitive and normative legitimacy has not been achieved yet with no precedents that have established acceptance already (Aldrich & Martinez, 2003). The first two components are inter-related since, in the beginning, the founder will be the central actor who represents the venture and its business conception when liaising with potential external partners. It will be mainly the founder’s task to create new constituencies that value the new organization and attract general support, fostering the process of gaining legitimacy (cf. Suchman, 1995, 587). Pragmatic acceptance may be scrutinized, e.g., by potential financiers doubting that routines will be properly implemented and entrepreneurial competences are in place in a new venture. Note that here the legitimacy of the new venture is questioned not necessarily because it offers novel products or tries to master innovative production methods, but simply because it is a new business organization not yet fully established in the market. This newness of every organization coming into existence has already been stressed by Gartner et al. (1992, 17) who remark that the “change from the emerging organization to the existing organization is not the ‘growth’ of certain variables, but an entirely new reconstruction, a ‘gestalt’ ... of particular organizational characteristics and the interrelations among them”. One reason why the successful outcome of this ‘birth’ process is uncertain is the heterogeneity of the ways founders go about this organizing activity and the central role they play in it (cf. Burton, 2001). Therefore, it has been argued that it is also the founder person who is in the focus of external selection pressures demanding legitimacy (cf., in particular, Pendergast, 2004). Because of this, the entrepreneur must also display competence as a practitioner. For example, potential financiers may ask for personal reputation and references from previous employments.

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In addition to this, initial cognitive, regulatory, and moral legitimacy will also have to be gained for innovative venture projects. For example, pioneering high-technology entrepreneurs first have to gain societal acceptance for their new products or services against the background of established general conventions and measures for technology evaluation (cf. Das & vd. Ven, 2000, 1301; for the general issue of technology acceptance see also Kollmann, 1998 or Venkathesh & Davis, 2000). Therefore, the legitimizing challenge for innovative ventures may be larger than for imitative ventures (cf., for example, Samuelsson, 2001 or Aldrich & Baker, 2001). Having said this, this study does not aim to compare the legitimacy challenges of the two groups, because it is impossible to separate the two groups ex ante as innovation may only be identified ex post (cf. Aldrich & Martinez, 2003). However, it will be captured by the empirical study that entrepreneurs striving to establish an innovation may perceive legitimacy requirements as being difficult to meet. This may contribute to entrepreneurs’ judgements about the respective chances of alternative fund-raising plans being viable. The perceived difficulty in convincing potential financiers may not only rest on how severe their demands are. It may also be important how entrepreneurs rate the qualities of their own venture project when it comes to impressing external financiers. This will be discussed within the context of principle options to gain legitimacy and possible legitimizing sources.

3. 3. 2. Options for legitimzing action and potential sources of legitimacy Principal theoretical options to legitimate with external audiences will be discussed in 3. 3. 2. 2., while 3. 3. 2. 3. concentrates on the construction of legitimizing accounts to signal conformance to legitimacy demands. Before that, the next chapter introduces a brief characterization of legitimizing action.

3. 3. 2. 1. Characterizing legitimizing action Tornikoski (2005, 88) defines legitimizing behaviour within the context of emerging new venture projects as those “behaviors and actions intended to overcome the liabilities of newness and to succeed in creating a new organization”. Based on this general definition, a working definition may be put forth, which concentrates on legitimizing with the financial environment: Legitimizing action in the process of acquiring external

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finance is any activity intended to convince externals to provide financial support. In particular, the purpose of ‘conforming’ legitimizing action is to portray the venture in such a way that it signals conformance to the perceived legitimacy requirements of potential financiers. In contrast to Tornikoski’s definition, the focus of what legitimizing behaviour entails is narrower here, concentrating on activities to prepare and pursue communication and interaction with potential financiers in order to convince them. Furthermore, note that − in agreement with Aldrich and Baker (2001, 212) − it will not be claimed here that entrepreneurs will ordinarily plan a route to gain legitimacy (i.e. a legitimizing strategy) in detail (also cf. Fallgatter & Brink, 2006, 20). However, founders will engage explicitly and/or implicitly in activities that may convince externals to provide financial support. Deliberate actions undertaken to convince external financiers to provide support are explicit. However, taking Tornikoski’s definition, amongst the activities to ‘overcome liabilities of newness and establish a new organization’, many general activities will mainly be regular organizational grind (cf. Witt, 2002 for the notion of organizational grind). Entrepreneurial activities such as developing a business plan or establishing a legal entity for the venture might implicitly propel legitimacy. However, these activities might not have been undertaken by the founder predominantly for the purpose of legitimating but rather to develop the venture operationally (also cf. the two arguments by Delmar and Shane, 2004 and 2004a, discussing the role of business plans as a source of legitimacy and as a managerial tool for planning). Beyond this internal managerial and external legitimating role of business plans, there are many more activities that may fall into one or both of the categories. In principle, therefore, when exploring entrepreneurs’ perceived chances of obtaining funding, it will be essential to find out whether an activity or feature of the venture is perceived to facilitate external financing or not.53 Moreover, for purposes of examining the views of entrepreneurs it will be important to concentrate on what entrepreneurs themselves include in the perceived capability to legitimate with external financiers. Researchers will need to avoid confusing this with elements or activities which theoretically might legitimate but which founders do not consider in such a way. This is important because what contributes to the focal construct of fund-raising intentions will be demands of

53

The case study method to be pursued is believed to be a suitable instrument for exploring the underlying perceptions and views of entrepreneurs (cf. chapter 5. 1.).

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financiers and capabilities to legitimate with them as they are perceived by the entrepreneur. Thus, within the context of theoretical concept building, at this point only a preliminary orientation of potential sources of legitimacy may be provided. This orientation may be employed as a cautious guide in the empirical exploration of entrepreneurs’ views.

3. 3. 2. 2. Principal legitimizing options This chapter will discuss principal options or modes of legitimizing action. In particular, these options will be put into the context of two fundamental concepts of the legitimizing struggle, an institutional perspective and a perspective stressing entrepreneurial agency. With regard to the domain of venture financing, these two perspectives prepare the ground for arguing that the fund-raising in single new ventures will be predominantly concerned with legitimacy restrictions which will demand conformance (and which may not be changed or manipulated by individual entrepreneurs).54

Principal modes of legitimizing Conforming to external legitimacy expectations is only one of the legitimizing options covered in the relevant legitimacy literature. Others are the options to ‘select’, ‘manipulate’, and ‘create’.55 The four principal options relating to gaining legitimacy are characterized in figure 3–7. The option to conform relates to an institutional perspective which “conceptualizes the environment in terms of understandings and expectations of appropriate organizational form and behavior that are widely shared” (Newbert & Tornikoski, 2003, 2). These understandings and expectations may put legitimizing pressures on new organizations to adapt their business idea, organizational structure and conduct, making them looking like established organizations. Such pressures towards organizational isomorphism may stem from dominant customers, suppliers, or potential and existing shareholders (cf. Davidsson et al. 2004, 2). Conformance to external expectations has been considered a precondition for gaining legitimacy. “In order to succeed, organizations need to adopt 54 55

Cf. in particular chapter 4. 2. 1. below where this will be discussed in detail. In legitimizing strategies some of the options may also be combined, e.g. selecting those types of financiers whose demands are easiest to conform to (cf. Zimmerman & Zeitz, 2002, 423).

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principal legitimizing options conform

generating conformity to the expectations and demands of the organization’s pre-existing external audiences

select

picking those audiences from the environment, which are likely to accept and support the organization in its current form and practices

manipulate

influencing and changing expectations and demands of external audiences to achieve legitimacy

create

establishing novel institutional bases of legitimacy, particularly for new organizations in new sectors

figure 3–7: principal options to gain legitimacy (compiled from Suchman, 1995 and Zimmerman & Zeitz, 2002)

legitimated elements conformed by social institutions” (Newbert & Tornikoski, 2003, 2). With respect to attracting initial finance the authors argue further: “By having a set of legitimated elements conform to the expectations of the investors, an emerging organization is legitimated and will increase its chances to be financed” (ibid.). In case external financing is required, the only room for manoeuvre may root from the fact that different groups of financiers might have differing demands.56 Here, the organization might have the possibility to select a favourable part of environment from which resources may be attracted more easily. For reasons explained below, conforming and selecting are the main options considered in this study. The composition of the manipulation option in this thesis corresponds to the view of Zimmerman and Zeitz, which differs slightly from Suchman’s description. For Zimmerman and Zeitz “manipulation involves making changes to the environment to achieve consistency between organization and environment” (Zimmerman & Zeitz, 2002, 422); one example is political lobbying of organizations in one industry to influence changes in legislation. In contrast to this, Suchman also puts actions to influence the perceptions of the organization held by stakeholders under the umbrella of the manipulation option (cf. Suchman, 1995, 591pp.). This seems suitable as long as such impression management through advertising and image improvement also alters (or manipulates) the underlying evaluation criteria for external legitimacy assessment. However, when impression management techniques merely impact on how externals perceive the organization, they are assumed to fall in the conform category. This means trying to signal consonance to external demands by portraying the organization in a specific way. Because of 56

Cf. chapter 4. 2. on possible differences between the demands of equity and debt financiers.

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new ventures’ lack of ‘facticity’ such conformance signals will be particularly relevant to entrepreneurs (cf. chapter 3. 3. 2. 3. below). Similar to the manipulation option, the creation option also puts organizations in the position to alter the environment. The creation option even allows organizations to create a new legitimacy environment by establishing novel socio-institutional rules on which society may base its evaluations of legitimacy (cf. Zimmerman & Zeitz, 2002, 422). The authors assign this option particularly to new innovative ventures operating in new industry sectors where no established rules, socio-cultural values, and norms yet exist and thus external stakeholders lack specific evaluation criteria (ibid.; also cf. Sanders & Boivie, 2003 for the problems financial stakeholders have to evaluate ventures in novel sectors). Here, so-called institutional entrepreneurs are assumed to be able to challenge and destroy existing institutionalized traditions of best practice and norms at the industry level. Internet entrepreneurs who have revolutionized the traditional retail industry may be an example of this (cf., for example the case of Amazon in Zimmerman & Zeitz, 2002, 423).57 For a further exploration of when manipulation and even the creation of the institutional environment may be possible and when conformance may be demanded, it is useful to refer to the larger context of two super-ordinate perspectives on organizational legitimacy.

Institutional and agency perspectives of legitimizing The institutional perspective of legitimacy and the strategic or agency perspective hold different views about which of the above legitimizing options will actually be available to organizational agents. An overview of the two principal perspectives is provided in figure 3–8. For new ventures, the above two perspectives describe two quite different paths to overcoming their liability of newness and gaining legitimacy (cf. Tornikoski, 2005, 15): a) by guiding and controlling the environment and b) by adjusting to the environment. In the strategic agency strand of the relevant literature (originating in the resource dependency notion of Pfeffer and Salancik, 1978), legitimacy may be actively acquired 57

“Institutional entrepreneurship refers to the practice of creating norms, values, beliefs, expectations, models, patterns of behavior, networks, or frames of reference consistent with an organization’s identity and current practice, and then getting others to accept these norms, values and so forth” (ibid., 423; also cf. Maguire et al., 2004, 657p.).

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institutional view

strategic view

legitimacy of organization

conferred by external societal stakeholders

actively managed and acquired by organizational agents

evaluation of legitimacy status

evaluation based on established external criteria

evaluation influenced and 'managed' by agents in pursuit of organizational interests

environment-organization relation

environmental-deterministic

managerial-voluntaristic

principal option for legitimizing

conformity

manipulation and creation

figure 3–8: institutional and strategic agency perspectives of legitimation (compiled from Pfeffer & Salancik, 1978; Suchman, 1995; Beckert, 1999; Milne & Pattn, 2000; Scott, 2001; Downing, 2005; and Tornikoski, 2005)

from external stakeholders via legitimizing activities. The institutional theory strand considers organizational legitimation predominantly as a passive adjustment to institutional pressures within the environment which “produce an ‘iron cage’ and create tendencies towards isomorphism within the organizational field” (Milne & Pattn, 2000, 4; also cf. DiMaggio & Powell, 1983). In essence, legitimacy in the institutional perspective will be conferred upon the organization by externals (Milne & Pattn, 2000, 2); the role that managerial agents play in this is assumed to be marginal. In contrast to this, the agency perspective stresses the non-deterministic aspects focussing on “the ways in which both individuals and organizations innovate, act strategically, and contribute to institutional change” (Scott, 2001, 75; also cf. Zimmerman & Zeitz, 2002, 420). The two views would seem to stand in contradiction to each other, not only in the specific domain of legitimacy but also in terms of general institutional concepts. However, they may be reconciled, constituting a field of conflict in which elements of both views prevail. In fact, Scott (2001) views the two perspectives as inter-related and compatible issues.58 On the one hand, established institutional rules will influence and put bounds on the form and behaviour of new ventures (in particular by the vehicle of legitimacy requirements demanding conformance). On the other hand, single new ventures and entrepreneurs’ actions to establish viable business concepts reproduce and validate these social rules (see Downing, 2005, 187 in his excellent account of the co-production of business conceptions of new ventures by both external demanding 58

Theoretically, this compatibility has been revealed by Gidden’s structuration concept in which the duality of social structure is both a (restrictive) platform and a product of social action (ibid., 75).

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stakeholders and entrepreneurs). Thus, in the relation between economic agents and their environment there will be possible directional influences that may go both ways (cf. Kasperzak and Koch, 1996, 735). It is essential to note that this interrelation between external prescriptive rules and their everyday reproduction by agents is not completely deterministic, leading to purely ‘adaptionistic’ entrepreneurial action. First, there is the epistemological evidence from chapter two that societal rules are also based on fallible knowledge which opens up room for the innovative, strategic action mentioned by Scott above. Conversely, if socio-economic institutions were to host perfect knowledge, there would be no room for social and economic institutional innovation (cf. Baumol, 1995). The second reason that contributes to elements of human agency is the interpretative character of the agents’ perception and interaction with the environment as they apply and reproduce existing social rules. As Scott (2001, 76) has aptly put it: “Between the context and the response is the interpreting actor” and agency is present in “the interpretative processes whereby choices are imagined, evaluated, and contingently reconstructed by actors in an ongoing dialogue with unfolding situations” (ibid., 76 citing Emirbayer and Mische, 1998, 966; also cf. Aldrich & Martinez, 2003 on the emergence of innovations by entrepreneurs). The above-described fallibility of established institutional rules, however, does not imply that entrepreneurs may implement novel business conceptions in a completely deliberate way. Two main reasons may be put forward to dismiss complete voluntarism. First, for strategic agency to hold, a strong intention-outcome relationship will be required, allowing agents to deliberately pursue their interests (cf. Beckert, 1999, 778). However, agents will be hampered by imperfect foresight and uncertainty. In particular, legitimizing and fund-raising action pointing into the future will not result in a deliberate collection of legitimacy and finance. The second argument stresses that the power resources and management time of a single new venture will be finite (cf. ibid. for the role of power in legitimizing and institutional change).59 In particular, within a short time horizon, individual organizations may not be able to create new or manipulate

59

At the community or population level, groups of venture organizations may well be able to manipulate their institutional environment (cf., for example, the collaborative lobbying and legitimizing strategies in Aldrich, 1999 and Zimmerman & Zeitz, 2002). However, note that the focus in this study is at the level of the individual new venture where the necessary power resources will likely not exist.

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established institutional rules.60 This sets limits to a voluntaristic legitimizing of innovative business opportunities clashing with established institutions (cf. Hargardon & Douglas, 2001). The apparent conflict constituted by external institutional determinism and voluntaristic strategic agency seems to oscillate between the two extreme end points which are however never reached due to the reasons put forth in the preceding paragraphs. This is summarized in figure 3–9 relating to the above two principal views on organizational legitimacy.

socio-institutional determinism

voluntarism of agents

institutional iron cage ruling out ‘illegitimate’ deviations

deliberate implementation and legitimation of innovations and corresponding institutional change

objections to complete determinism • epistemological fallibility of established socioinstitutional framework

(potential for agency)

• subjective interpretation and autonomous creativity; partial institutional manipulation through agents with sufficient time and power resources

(requirements for conformance)

objections to complete voluntarism • insufficient time and power resources for an active, completely deliberate modification of institutions • imperfect intentionoutcome relation due to incomplete knowledge of agents

figure 3–9: conflict of legitimation between institutional determinism and voluntaristic strategic agency (based on Harper, 1996)

It is believed that fund-raising processes may be understood by focussing on the invariant legitimacy constraints exerted by demanding external financiers. Therefore, the further development of the theoretical and empirical research concept concentrates on perceptions of possible legitimizing sources to demonstrate conformance to these demands. In addition, the leeway to select from specific types of resource owners within, e.g., the financial domain will also be addressed. 60

Cf. chapter 4. 2. 1. below for details on this basis for reconstructing patterns in (fairly short-term) fund-raising processes of individual ventures.

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3. 3. 2. 3. Gaining legitimacy by signalling conformance The conformance option to gain legitimacy has been briefly introduced in relation to figure 3–7 above. This chapter will address categories of legitimating sources to signal conformance to external resource owners.

General and selective conformance approaches Generally, conforming legitimizing strategies follow the principle of compliance to stakeholder demands (e.g. Bansal & Roth, 2000). In particular, conforming action to gain pragmatic legitimacy will involve meeting stakeholder needs and expectations, addressing their pragmatic interests to make it possible to establish exchanges with them (Suchman, 1995, 587). However, before planning activities to generally conform to legitimacy demands of resource owners, entrepreneurial agents might think about which specific resource owners to approach for support (e.g. within the financial environment). In this respect, Zimmerman and Zeitz (2002, 423) note that principal legitimizing options may be combined, in this case selecting external audiences whose expectations may be easiest to conform to (a strategy of legitimizing by selective conformance). For example, in a tight human resource market for software engineers, a software start-up may concentrate on trying to recruit appreciative young engineering students or graduates. This may be because experienced older professionals in the software industry may demand higher and more secure salaries as well as stable and reliable working conditions which the start-up is not able to offer. “Pragmatically, selecting a favorable environment is usually a matter of market research: The organization must identify and attract constituents who value the sorts of exchanges that the organization is equipped to provide” (Suchman, 1995, 589). The select option therefore abstractly entails “to select among multiple environments in pursuit of an audience that will support current practices” (ibid., 587), e.g. the unstable working conditions and possibly less reliable payment practices of the above start-up. Demonstrating conformance to gain legitimacy involves challenges for new ventures because they lack ‘facticity’. Therefore, they may have to rely on signalling conformance through legitimizing story accounts.

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Signalling conformity through legitimizing story accounts It has been said that an emerging new venture gains legitimacy “when it reaches conformity with the demands of immediate audiences by exhibiting legitimated elements” (Tornikoski, 2005, 16). This will need to visibly conform to external expectations and normative beliefs (Zimmerman & Zeitz, 2002, 418; also cf. Lounsbury & Glynn, 2001, 550). For new ventures, however, visibly documenting that they will be a beneficial and appropriate exchange partner will be difficult as this ultimately requires an established record of consistent performance, for example financially or operationally. Yet, as noted above for the struggle to gain legitimacy in the first place, new ventures will not have such an established record. However, the entrepreneur may have some initial personal competences and resource capital already put in to develop the venture (e.g. existing patents providing an intellectual property base for a planned high tech start up; cf. figure 3–10 below for a systemization of further entrepreneurial capital components). “In addition to having intrinsic value, these attainments are often signals ... of a young company’s abilities” (Stuart et al., 1999, 317). Such a technological patent base may help to demonstrate future advantages over competition and innovating capability. Generally, founders may try to document that they will meet the performance expectations of financial resource owners by such initial contributions to capitalize on in view of a later full establishment of the venture. However, the future value of this capital “depends on its future use” (Loasby, 2002, 21), which, is “the imagined, deemed possible” (Shackle, 1979, 26). Overall, the business conceptions of new ventures will entail an image of its future, which is unknowable, but which entrepreneurs still may imagine (cf. Lachmann, 1976, 59). In terms of future performance it is only this abstract imagination which founders can bring to the negotiation table when approaching potential financiers. Gaining legitimacy by reaching consonance on pragmatic expectations and cognitive understanding will depend considerably on communication between the venture and its resource owner audiences (cf. Suchman, 1995, 586). In the general case of communication between organizations and stakeholders, the contribution of possibly legitimating elements as well as the perceptions and attributions of legitimacy, will essentially be symbolic (ibid.; also cf. Elsik, 1996 and Milne & Patten, 2000). The essentially symbolic nature has its roots in the assessment that observations of factual behaviour and character of the new firm will be based on interpretative frameworks (as argued, e.g., in Lounsbury & Glynn, 2001).

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In this context of symbolic communication, Lounsbury and Glynn (ibid., 545) suggest that “stories are an integral part of the process by which founders construct new ventures” (for entrepreneurial story telling also cf. Aldrich, 1999, 99; Shane, 2003, 186; and the more recent writings of Downing, 2005 and Nicholson & Anderson, 2005). Such stories may be employed in verbal and written accounts such as presentations by the entrepreneur, written business plans, or personal discussions with stakeholders (cf. Suddaby & Greenwood, 2005, 35pp.). The role of such story accounts is described further by Lounsbury and Glynn (2001, 546): “Given that most start-ups lack proven track records, obvious asset value, and profitability, stories can also provide needed accounts that explain, rationalize, and promote a new venture to reduce the uncertainty typically associated with entrepreneurship”. Such accounts portraying the entrepreneur’s business conception are therefore considered a mediator or broker between visionary entrepreneurial intentions and potential stakeholders (ibid., 546; also cf. Sooklal, 1991 and Hanlon & Scott, 1995). For purposes of gaining legitimacy, these stories, and the legitimating elements within them, “must align with audience interests and normative beliefs to enable favorable interpretations of a new venture” (Lounsbury & Glynn, 2001, 550).

Potential sources of legitimacy in entrepreneurs’ story accounts The principal categories of legitimizing sources, which entrepreneurs may perceive to contribute to their chances to obtain external resources, are depicted in figure 3–10. This will offer an approximate theoretical notion for analyzing the capabilities to legitimate as they might be perceived by entrepreneurial agents. The role of legitimizing sources as an essential ingredient of entrepreneurial story accounts is highlighted by Lounsbury and Glynn (2001, 550): “We argue that it is the extant stocks of entrepreneurial resource and institutional capital that shape the content of stories”. These symbolic stocks refer to firm-level and industry-level sources of legitimacy (ibid., also cf. Zimmerman & Zeitz, 2002, 419 for this differentiation). Lounsbury and Glynn (ibid., 548) see the above venture-specific resource categories as contributing to the stocks of firm resource capital.61 In the case of emerging ventures, this might include such things as personal savings or patents that the founder brings into the venture. In addition, in the case of existing infant ventures that have commenced 61

This broadly corresponds to the construct of organizational capital employed by Fichman and Levinthal (1991, 398).

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venture level source capital (for legitimizing) technological capital

competitive technology base and know-how

intellectual capital

commercial property rights and protected trade marks

human capital

competences and qualifications of founder team

social capital

founders' personal contacts of benefit to the business

initial financial capital

investments of personal savings portraying commitment

industry level institutional capital industry legitimacy

degree of acceptance of the industry; e.g. acceptance of standard product and service offers within the industry

industry norms and rules

reference points for accepted and appropriate behaviours within the industry; e.g. quality standards

industry infrastructure

reservoir of industry resources that may be utilized by new ventures; e.g. skilled labour, technology standards

figure 3–10: potential sources of legitimizing accounts (adapted from Lounsbury & Glynn, 2001, 547p.)

with market entry and partial legitimizing, first sales records or contracts with business partners typically contribute to the stocks of organizational capital. A further common area contributing to firm resource capital is likely to be the founders’ human capital and collective ability to cover the various management competences required to run a new business (cf. Newbert & Tornikoski, 2003). Here, the founder team may demonstrate competence by providing references from previous occupations or educational certificates (cf. Suchman, 1995, 588 or Tornikoski, 2005, 365). Another organizational component contributing to the legitimizing position of the venture is documented endorsements, e.g., by customers vouching for the quality of the new venture’s services and products (see Reuber & Fischer, 2005 for reputation signalling via customers; also cf. Stuart et al., 1999). In the financial domain, for example, an entrepreneur may find it easier to convince banks to provide credit when the venture already has pilot customers or is supported by other external equity financiers. Therefore, it is commonly recommended to insert such components of firm level resource capital into business plans to document at least partial ‘facticity’ of the venture project and the existence of a substantial springboard of resources to turn an opportunity into a profitable business in the future (cf., for example, Timmons & Spinelli, 2004). Institutional-level capital consists of three central industry-level components: “industry legitimacy, industry norms and rules, and industry infrastructures” (Lounsbury & Glynn, 2001, 548; also cf. Zimmerman and Zeitz 2002, 419p.). As indicated in figure 3–10

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above, new ventures operating in an established industry may “use the industry’s standards, norms, practices, and technologies; the past actions of industry members; and so forth to acquire legitimacy” (ibid., 419). Elsbach (1994, 65) adds that such industry-level institutional references may document adherence to socially accepted “institutional structures (legitimated hierarchies and roles), institutional procedures (legitimate rules and processes), [and, M.G.] institutional goals (legitimate goals or outcomes)”. For example, new biotech ventures may document that they have begun to set up research operations in line with clinical standards for the preparation of drug testing trials. This may enhance procedural legitimacy in the absence of output measures, in this example market pharmaceutical drugs ready to be sold by the firm (for a general overview cf. Suchman, 1995, 580; relating to the construct of procedural legitimacy also cf. Elsik, 1996 and Grichnik & Immerthal, 2005, both referring to Luhmann’s ‘Legitimitation durch Verfahren’). Finally it should be noted that the legitimizing contribution will likely differ across industries as well as over time, in particular when industries are newly emerging. For example, the internet sector may have suffered (perhaps temporarily) from decreasing legitimacy with financial investors after the IT-crash in 2000/01. This may have made it difficult for new ventures in that sector to gain legitimacy (other examples may be found in Zimmerman & Zeitz, 2002, 419). For such cases Lounsbury and Glynn (2001, 547) suggest to stress distinctiveness of the venture from the general sector. Conversely, for industries with a good legitimacy profile, new ventures should document conformance to their industries’ standards and practices. Beyond these industry-level differences, entrepreneurs may perceive differences in their potential to gain legitimacy, e.g., based on differing characteristics of their venture and the context of relationships with potential financiers. This will be addressed in the following chapter to conclude the discussion of potential legitimizing sources that entrepreneurs may think of during the fund-raising struggle.

3. 3. 3. Possible differentiations in the challenge to gain legitimacy Principally, the difficulty in gaining legitimacy with external resource providers may vary across new ventures and their resource acquisition needs. This heterogeneity of new ventures with regard to their legitimizing struggle may stem from differing legitimizing potentials of the ventures (cf. Aldrich, 2000). Also, the situation of resource

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acquisition may vary as resource owners may be more or less critical evaluators. Possible ideal-type differences of new ventures and their resource acquisition situations are depicted in figure 3–11, indicating whether it might be relatively easier or harder to gain pragmatic legitimacy.

easier to legitimate

harder to legitimate

(1) development status of venture

existing infant organisation

emerging pre-organization

(2) novelty character

imitative; existing industry or service sector

innovative; new sector

(3) resource exchange situation

exchange as spot transaction

exchange requires long term commitment

(4) magnitude of resource availability

high (many sourcing alternatives available)

low (few potential sources to acquire desired resource)

(5) relation to resource provider

potential resource provider belongs to personal contact network of venture founders

potential resource provider is a stranger to venture founders

figure 3–11: ideal-type differences in pragmatic legitimizing (compiled from Suchman, 1995; Brush, 2001; Ionnides, 2002; Shane, 2003; and Delmar & Shane, 2004)

The illustration assembles some ideas which have already been touched upon throughout chapter 3. 3. Some brief summarizing comments on these ideas shall suffice, concentrating on the new ideas introduced in the illustration (these are mainly resource exchange situation, resource magnitude and, in particular, exchange partners in relation to founders’ personal networks).

Differentiations (1) to (4) (1) The pronounced difficulty in gaining legitimacy for emerging ventures in the gestation phase follows a fairly straightforward theoretical argument. As Delmar and Shane (2004) have pointed out, emerging ventures have to be assessed based on perceptions of vague future potentials. This is because they are not yet able to refer to any substantial performance history in terms of established external business links, up-and-running production and organizational structures, as well as proof of successful market entry (cf. Tornikoski, 2005). For this kind of venture project, liability of newness problems will be most severe. In contrast, existing infant ventures have reached the stage of formal ‘facticity’ and have possibly accumulated more firm-level resource capital (cf. figure 3–10 above).

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(2) The greater challenges to gaining legitimacy for innovation-oriented ventures acting as pioneers in new sectors are also dealt with in the relevant entrepreneurship literature (cf. the references above). Generally, for such ventures not only obtaining pragmatic support from financiers but also gaining cognitive and normative-moral acceptance may be unsure. Suchman (1995, 579, 582, and particularly 587) rates that organizations employing uncertain and vague new technologies in their business models (like internet start ups in the early days of the sector), or whose offers and objectives are controversial, not yet well known, and accepted by consumers in general (perhaps as for stem cell firms) will find it most difficult to gain legitimacy. (3) Not only the characteristics of the venture, its development status, and novelty character but also the type of resource and the corresponding exchange characteristics may differ and result in different legitimating problems. Recall that the ways in which external resources may be acquired by a new venture are manifold. According to the extensive list of Morris (2001, VI), resources may be, e.g., purchased, borrowed, shared, rented, leased, bartered, licensed, contracted, or attracted by partnering. These approaches will also result in different resource exchange or transaction situations. Furthermore, how resources will be acquired may also be related to the type of resource to be exchanged with externals. For example, the procurement of raw materials for production from market supply may be anonymously settled with an immediate repayment in value kind (i.e. paying the price for the materials). In contrast, the exchange situation will be quite different in the case of a strategic investor providing equity finance to a new venture in exchange for access to a novel technology. However, there are not only differences across types of resources. The exchange of financial funds as a resource also features significant internal differentiation ranging from long-term equity financing (e.g. by the above strategic investors, venture capitalists, or by business angels) to short-term borrowing via bank overdrafts or temporary credit card financing (cf. Stouder & Kirchhoff, 2004). Basically, the possible range of exchange types reaches from pure anonymous spot market transactions to long-term inter-organizational relationships with significant commitment of both exchange parties (cf., for example, Ionnides, 2002, 133 and 137 or Hite, 2005, 114). In terms of the legitimizing challenge to new ventures, Suchman (1995, 587) has argued that the greatest difficulty in gaining legitimacy may be when relationships will be lengthy and difficult to exit (also cf. Ionnides, 2002, 137 for differences in exit options in different exchange situations). In the financial domain, perhaps venture capitalists

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would find it hard to exit an investment in a poorly performing new venture because of limited exit options for exiting via initial public offering, trade sale or other ways (cf., for example, Gompers & Lerner, 2003 on exiting options available to venture capitalists). Generally, the profitable settlement of contracts with financiers in the future will be clouded by uncertainty (cf. Harper, 1996, 96 on the structural uncertainty in future contracts with third parties). At the same time, short-term exit may be restricted. “[T]he very logic of long-term contracts is the restriction of the exit option of the resources that are linked to the venture in this form of contractual arrangements” (Ionnides, 2002, 137; in practice, exiting before contract completion will be related to specific pre-specified situations, for example when missing performance milestones or delays in interest payments; for the former cf., for example, Brachtendorf, 2004). (4) The difficulty to gain legitimated support from potential financiers may also vary depending on the magnitude of the availability of the resource needed (cf., again, Pfeffer and Salancik, 1978, 46 and Brush, 2001). The difficulty to legitimize may be higher when only few potential options to acquire a resource exist. In particular, the availability of alternative potential financiers to be approached for funding the new venture may contribute to the entrepreneur’s perceived capabilities to legitimate with potential financiers.

Differentiation (5): the role of personal networks (5) In the process of identifying potential providers of needed external financial resources, new venture founders may assess their own social contacts (cf. Brush, 2001, 74). This activation of personal ties may be more important as compared to established firm organizations. This is because new ventures suffering from isolation will not have any established inter-organizational links to financiers and other resource suppliers yet (cf. the above external liabilities of newness and Hager et al., 2004, 160p.). However, as individuals, founders of new ventures have established social relationships with others, i.e. personal networks as “the set of persons to whom they are directly linked” (Aldrich, 1999, 81p.; also cf. Lechner & Dowling, 2003). In general, the existing social structure of personal relationships of the entrepreneur may contribute to the chances of acquiring external resources (cf. Greve, 1995, 4; also cf. Shane, 2003, 181, and Wilson & Appiah-Kubi, 2002, 45). Such personal relationships may allow entrepreneurs to more easily tap resources that others control and shape the

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resource acquisition process (cf., for example, Lin, 2002 and Hite, 2005, 114p). In particular, capitalizing on personal contacts to obtain financial resources may enhance financing chances because of the uncertain character of the venture itself.62 In such uncertain situations, agents may turn to previous relationship episodes as a compensatory orientation for the conduct, trustworthiness, and personal reputation of the exchange partner (cf. Podolny, 1994, 459 as well as Brush, 2001, 75; also cf. the relationship episode perspective on personal trust in Kautonen, 2005). In contrast, when trying to liase with a complete stranger (as is the case when entrepreneurs approach potential financiers on a cold contact basis), the potential exchange can not bank on such episodes and legitimizing may be harder (cf. figure 3–11 above). However, it is worth noting that not all personal relationships to others are equally beneficial per se. The value of network ties will be context dependent (Aldrich, 1999), e.g. depending on the development stage of the venture (cf. Lechner & Dowling 2003).63 In terms of access to finance, Jenssen and Koenig (ibid.) found that weak ties play a more important role than previously expected in the relevant literature. Their study found that finance flows through weak and strong ties at similar frequencies, while previous literature expected a much higher importance of strong ties for financial (and other material) resource access (ibid., 1040p. and 1043p.). Speculating about the reasons for their finding, the authors put forth the idea that exchanging funds will not necessarily require strong personal relationships (ibid., 1043). Adding to this, perhaps the amount of finance sought may also play a role. Whenever a significant amount of money is required for a new business, perhaps strong ties are less frequently asked for support because they won’t be able to provide such large amounts of finance. In contrast, weak ties, e.g. from lasting previous business relationships of the entrepreneur, may provide access to potent funding organizations directly or indirectly through a brokerage role.

62

63

Also cf. Tornikoski (2005) for the legitimating potential of entrepreneurial networking and Suchman (1995) for the relevance of personal reputation in legitimizing activities. A frequently mentioned example of this refers to the access to additional information through personal networks in the venture formation phase. Here it is argued that strong ties such as intense relationships to close friends or relatives may be less useful to provide information because of redundancies stemming from the similarity of the contact and knowledge base between close friends or relatives and the entrepreneur (ibid. or, e.g., Jenssen & Koenig, 2002, 1040) Note, however, the mixed results that the latter put forward concerning information flows through strong ties.

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Overall, the flow of financial funds via existing personal network contacts or other newly established exchanges with strangers may well be situation-dependent. Hence, also for personal contacts the differentiation suggested in figure 3–11 may only be ideal-type. Regarding focal fund-raising attempts, the views that founders hold about possible sources of finance, both from their personal networks of strong and weak ties as well as about the universe of potential financiers in general may be explored.

3. 3. 4. Summary The possible differentiations in the general difficulty new ventures face to gain legitimacy conclude the description of the legitimating challenges of new ventures. It has been said that, due to their liability of newness, new ventures may find it hard to gain legitimacy with external audiences. At the level of the single venture, individual founders may face legitimacy requirements that will have to be conformed to so as to gain legitimated status. In cases where more than one audience offers a resource needed for venture establishment, some flexibility is offered with the option to select from different demanding audiences. There are two important aspects from this principal challenge to gain legitimacy which readers should take with them into the next chapter. Firstly, the possible needs to demonstrate conformance with legitimacy requirements of potential financiers provide an important orientation to explore and discern behavioural patterns in entrepreneurs’ creative fund-raising attempts as they evolve over time. Secondly, such elementary patterns may not only be shaped by perceived restrictions based on legitimacy demands. They might also be related to perceived legitimizing sources defining what single entrepreneurs might have available in order to convince potential financiers. In this respect, chapter 3. 3. has discussed possible firm-level and industrylevel sources for crafting legitimating story accounts that may help to portray conformity. These principal sources may provide starting-points for exploring entrepreneurs’ views throughout the financing struggle. In particular, it will be examined in how far perceived external legitimacy demands on the one hand, and internal capability potentials to legitimate on the other, may contribute to the overall perceived ability to convince potential financiers to provide funding. The latter may be an important antecedent of continued fund-raising intentions of entrepreneurs seeking initial funding for their ventures.

4. Financiers’ legitimacy demands and the evolution of entrepreneurs’ fund-raising intentions Chapter four develops the specific research concept for analyzing the resource acquisition struggle in new ventures. The aim is to arrive at theoretical orientations relating to how entrepreneurs’ fund-raising intentions unfold throughout the financing process. These orientations will guide the empirical exploration in chapter five in order to derive propositions for future research. To meet this objective, chapter four proceeds as follows. Chapter 4. 1. relates to the overall research interest of this thesis. The chapter introduces the need for an evolutionary perspective of the entrepreneurial fund-raising struggle. Evolutionary concepts in the study of entrepreneurship will require an appreciation of both process and context (cf. Aldrich & Martinez, 2001). Consequently, chapter 4. 2. describes the financial environment surrounding the focal fund-raising process. In particular, the chapter discusses possible invariant legitimacy demands of financial resource owners and the external resource selection pressures they may exert. In practice, these restrictions will come about in the pre-investment screening of different types of potential financiers. Chapter 4. 3. develops a central notion of cumulative entrepreneurial action to raise funding in the face of the restricted environment described above. Internal variation-selection activity by the entrepreneur in the process of trying to raise funding will be followed up in 4. 4. Chapter 4. 4. develops theoretical orientations for the empirical study to follow. Internal variation-selection by entrepreneurs may involve, for example, adjustments in the amount of finance sought or in the potential financiers to be approached. Finally, to capture such adjustments, 4. 4. will discuss a more differentiated conception of abstract internal selection in the course of entrepreneurial action. Specifically, the above internal selection choices throughout the financing process will be conceived as the development of specific fund-raising intentions. These intentions may change over time as the fundraising struggle unfolds. This may be because the entrepreneur tries to find alternative solutions to the financing problem in face of possible difficulties to convince financiers. To explore changes in intentions towards external financing, a framework of entrepreneurial intentions will be applied to the specific task of acquiring financial resources for a new venture. In particular, it will be discussed how selection pressures and perceived restrictions constituted by financiers’ legitimacy demands may contribute to adjustments in entrepreneurs’ fund-raising intentions. This will facilitate the empirical exploration in chapter five.

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4. 1. Understanding financial resource acquisition as a process This chapter introduces the elementary idea of how entrepreneurs’ efforts to seek finance may be seen as a time-consuming phenomenon. Starting from the broad research interest of this thesis, 4. 1. 1. shows that it will be necessary to take a process-oriented perspective in the analysis. Therefore, possible theoretical process-oriented concepts that could assist in this analysis will be considered in 4. 1. 2., culminating in the abstract notion of universal Darwinism from evolutionary economics which will be employed later. As will be shown in 4. 1. 2., entrepreneurial attempts to acquire initial finance are actually quite heterogeneous and fuzzy, evolving into an open-ended uncertain future. This may leave the discussion short of a theoretical point of departure to look for possible similarities in the fund-raising activities of entrepreneurs. In this respect, 4. 1. 3. introduces the idea that recognizable broad patterns in fund-raising processes may essentially stem from stable external restrictions in the financial environment. From there, chapter 4. 2. later sets out to elaborate the contextual elements of this environment.

4. 1. 1. Inquiring into the fund-raising struggle of new ventures The dynamic perspective of this study Essentially, the implicit problems entrepreneurs face in identifying financiers that will back them originate from structural uncertainty in possible future market transactions with externals (cf. Harper, 1996, 96). Therefore, the original business idea at the start, and the resource acquisition plans within it, is no static blue-print that can simply be instantly implemented. Rather, it may evolve over time as things may not work out as initially planned (cf. Witt, 2000, 740). This does not mean that only few entrepreneurs will ever attract finance. In fact many firm founders and owner-managers eventually do (Cosh et al., 2005). The point is that when they eventually attract funding, this might be only after a sometimes longwinded search process, deviating considerably from initial financing plans. Generally, Stam & Garnsey (2005, 18) summarize that “the few new firms that manage to grow to a substantial size often do not grow in a continuous way”, to some extent due to resource shortages. It will therefore be interesting to learn more about how entrepreneurs try to come up with viable funding solutions for their venture projects. Recall also from

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chapter one that this thesis is indebted to the following broad research questions in this context; the need for a time-consuming approach may be derived from these questions: • Since securing funding for a new venture may be a problem, how do entrepreneurs go about seeking solutions? • How do entrepreneurs make sense of their environment of potential sources of funding? And how are the demands of potential financiers and any experienced hesitation to provide funding perceived by entrepreneurs? • Finally, how do their financing attempts unfold in face of the difficulties they are up against in terms of finding a financier for the venture? In relation to questions like these, Aldrich and Martinez (2003) have asked how entrepreneurs may be able to acquire scarce resources. In this respect, Newbert and Tornikoski (2003) or Delmar and Shane (2004), for example, have studied what factors may legitimate new ventures so as to gain external acceptance and resource support. Compared to such normative issues of how to actually succeed in acquiring resources, the approach of this thesis is modest, appreciating the uncertain and open-ended character of the resource acquisition struggle.64 Thus, assuming that legitimacy and external financial support may not be gained at once, a process-oriented, theoretical concept will be required to describe entrepreneurs’ fund-raising attempts over time (also cf. Fallgatter, 2004 who demands a time-consuming perspective of entrepreneurial action). This will be further established in the next section.

The need for analyzing financial resource acquisition over time Essentially, because of path dependencies and irreversibility, it may be argued that entrepreneurial, and in fact any other economic, action must take into account the category of time (Geue, 1997, 52). In particular, choosing a course of action “is always interconnected with the sequence of past choices ... [and is thus; M.G.] essentially a historical phenomenon, not something ahistorical and unconnected as viewed by RC theory” (Kaisla, 2003, 260). Time itself may therefore be seen as “a flow of events” (O’Driscoll & Rizzo, 1985, 3) in which current perceptions may differ from those in the past on account of accumulated experience relevant to perceptions of the environment 64

This corresponds to the principal point admitted by Suchman (1995) that it may be quite hard for researchers of organizational legitimacy to come up with normative recommendations for effective legitimizing strategies in detail.

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and the formation of expectations and behavioural intentions. Time has an influence here since “time cannot pass without modifying knowledge” (Rizzello, 2000, 140). For the financial resource acquisition process of entrepreneurs, for example, rejections by potential financiers may impact upon future choices concerning who should be approached for funds or what amount should be asked for. In particular, from the above and chapter two we know that it may be inappropriate to assume perfect knowledge about financing sources, which would allow instantaneous resource acquisition. Rather, the situation of the entrepreneur involves real-time problem solving (Harper, 1996, 81p.).65 The next chapter will address possible theoretical concepts to capture this problem-solving process.

4. 1. 2. Possible process-oriented perspectives 4. 1. 2. 1. Life-cycle concepts in new venture development and financing Financing issues of new ventures and growing young businesses have been studied in relation to general life-cycle concepts of firms (cf. below and, for example, Heitzer, 2000, 11). Moreover, general problems faced when trying to acquire resources have also been related to the life-cycle notion (Brush & Manolova, 2004, 274). Therefore, at first sight such concepts may be a suitable point of departure for the required process-oriented perspective. Firm life-cycle concepts are characterized by the idea of a pre-determined, sequential unfolding of firms over their lifetime (e.g. vd. Ven & Poole, 1995, 514). For example, in the classic concept of Churchill and Lewis (1983), new ventures are founded in the initial existence phase, and then ideally follow through subsequent survival, success, take off, and resource maturity phases.66 Essentially, these theoretical concepts suppose that “the principles of organizational emergence and growth are similar for all organizations” (Aldrich, 1999, 198). Two groups of life-cycle models exist, i.e. developmental and stage concepts (ibid., 198p.). Developmental concepts describe the unfolding of a new firm from the situation 65

66

The notion of real time is asymmetric and irreversible in contrast to Newtonian time employed, e.g., in neoclassical concepts (ibid., 105). Other concepts have put forth different phase categories around the overall life-cycle of birth, growth, stagnation, degeneration, and death (for an overview see, for example, Manstedten, 1997 or Stam & Garnsey, 2005).

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at founding. Stage concepts also “assume a developmental sequence, but modify the developmental model by asserting that an organization pauses at various stages, during which managers and members might take adaptive actions” (ibid., 199). The latter concepts take account of the role of firm founders and managers in the change of the organization as it develops over time, e.g. as they have to master crises typical for specific stages or accompany the change of organizational structures in different stages of development (e.g. as in the concepts of Greiner, 1972 and Manstedten, 1997; also cf. Mellewigt & Witt, 2002 as well as Stam & Garnsey, 2005, 5). However, agency in these stage concepts is restricted in that it only relates to the prescribed stage pattern and at each stage specific problems or changes occur in all firm organizations. Such change throughout stages featuring different specific problem issues has also been addressed in entrepreneurial financing research. For example, researchers in entrepreneurial finance have analyzed typical problems in seed and start-up financing during the pre-founding and early-existence stage, as well as expansion and later-stage financing to fund further expansion, and, in the end, also turn-around financing in stagnation or even degeneration situations. It seems that, overall, an approximate correspondence between general firm life-cycle stages and financing issues is portrayed, resulting in life-cyclebased financing policies (cf. for example, Heitzer, 2000, 11 or Schulz, 2000). Hence it may be that early financial resource acquisition also follows such stages through initial seed financing and start-up financing. However, at the same time it has been admitted that such concepts of specific financing phases may only be ideal-type and that it may not be possible to derive specific financing rules for each phase (ibid., 9). Regardless of their merits in systemizing entrepreneurial and corporate financing issues, this realization indicates that it may be difficult to employ such a general and rigid concept of predetermined development stages and corresponding financing steps to a study of the struggle to raise initial funding. In addition, life-cycle concepts of firms also face considerable criticism in general. The principal criticism of firm or organizational life-cycle concepts concerns their analogy to the life-cycle of organisms (as was put forth by Penrose, 1952, 806). The essential difference between firm organizations and living organisms is that firms do not follow a stereotyped, gene-like unfolding from their birth; consequently their life-cycles will feature heterogeneous temporal characteristics (Witt, 2002). Firm life-cycle concepts assume ill-informed “immanent logic, rules, or programs that govern the entity’s development” (vd. Ven & Poole, 1995, 515; also cf. Fallgatter, 2002, 177). The analogy

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pertaining to an ideal, quasi “natural unfolding of organization structures and processes” (Aldrich, 1999, 198) has also been doubted by Mueller (1999) and Koch (2005). Rather, the contingencies inherent in firm development may lead to firms remaining at a certain life-cycle stage, not going through all prescribed stages, or going through them at differing paces and in different ways (cf. Davidsson, 1985, 211p. and Stam & Garnsey, 2005, 5). Overall, the notion of new ventures following a pre-determined sequence with corresponding financing issues will be too ‘neat’ to be a useful theoretical concept for examining open-ended fund-raising struggles. This is because the general similarity between new firms, which is inherent in the concept’s prescribed unfolding mechanism of the firm and its financing, neglects the contingencies in the evolution of new ventures (Witt, 2002). With regard to this, Stam & Gernsey (2005, 5) argue that “there are no invariant phases of activity as new firms emerge; instead there are common requirements for development into an economically viable unit, achieved in a variety of ways”. In light of this, a concept is required which appreciates the developmental contingencies and heterogeneity in individual new ventures. Instead of the determinism of life-cycle concepts (Fallgatter, 2002, 171), uncertainty fuelled by actors’ cognitive creativity will have to be handled theoretically in the exploration of attempts to raise funds from the environment of potential financiers. Here, “an evolutionary approach is much more contingent, as it assumes that organizations do not follow a fixed path of development. Instead, external events interact with an organization’s own actions to drive the pace, pattern, and direction of change” (Aldrich, 1999, 198). In particular, evolutionary notions commonly include the feature of ambiguity and uncertainty (ibid.), allowing processes such as financial resource acquisition or general firm development to evolve into an open-ended future alongside history-dependent and specific environmental conditions. The next chapter will introduce the elementary evolutionary framework on which the further specification of the empirical investigation will be built.

4. 1. 2. 2. The universal Darwinian principle of BVSR as a meta-concept It may be the above environmental conditions and influences which prevent all new firms surviving throughout the entire life-cycle. At the same time, smooth and successful establishment of new ventures may also be impaired internally by creative entrepreneurial choices made with imperfect foresight regarding the above external conditions.

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Evolutionary categories of variation introduced by new ventures and selective retention by the environment seem intuitively applicable in such contexts (cf. Kerber, 2004, 75). Furthermore, evolutionary notions are considered to be able to model both external and internal firm selection as well as entrepreneurial and managerial variation activity (cf. Aldrich, 1999 or Henderson & Stern, 2004). Therefore, they might also be useful for studying the specific issue of financial resource acquisition in the establishment struggle of a new venture (cf. Aldrich, 1999, 22 for the notion of struggle relating to selection pressures from resource scarcity). However, research into evolutionary economics has developed numerous different models related to the natural evolution of species and development of organisms with varying degrees of proximity to the biological original; and ultimately the use of any evolutionary biological analogy continues to be a topic of debate (cf. for example, Foster, 1997, Eldredge, 1997, Knudsen, 2004; or Buensdorf, 2005). A central problem in applying biological notions to socio-cultural or economic evolution is the prevalence of purposeful human action, though based on imperfect and fallible knowledge, with no equivalent in the biological sphere (cf. for example, Hodgson, 1996, 214). It will be argued that the notion of universal Darwinism will be a suitable meta-concept for socio-economic analysis (cf. Schweitzer & Gilgermann, 2005). This is because it is based on on the general Darwinian principle of blind variation and selective retention (BVSR) which does not require that a narrow biological analogy be followed (cf. Knudsen, 2004, 77 and Allard, 1967, 196 arguing that “there is no requirement that these mechanisms be specifically biological in nature”). First, 4. 1. 2. 2. introduces universal Darwinism. Here, the above analogy debate will also be addressed. This will involve the reconciliation of non-random, purposeful human variation towards selection pressures on the one hand, and the blindness of this variation with respect to securing selection success on the other hand. Second, the building blocks for applying the Darwinian BVSR framework to the financing struggle will be introduced. This will lay the ground for further concept-building regarding entrepreneurs’ fund-raising attempts over time in chapters 4. 3. and 4. 4.

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Darwinian BVSR processes in the socio-economic domain In short, the central idea of universal Darwinism is that biological evolution follows the abstract principle of BVSR and other social, artificial, and cognitive systems are also assumed to evolve according to this general principle (Hodgson & Knudsen, 2004). The idea of a universal Darwinian meta-concept was coined by Dawkins (cf. Dawkins, 1983), however its abstract roots may be traced back to Campbell’s vision of general selection and his evolutionary epistemology based on the BVSR notion (cf. Hodgson & Knudsen, 2004, 283 and Cziko, 1995, 303; see Ziman, 2003, 41 for the BVSR acronym; also cf. Campbell, 1965). Campbell’s view already contained the idea that Darwinian evolution by BVSR may offer explanations beyond the original biological domain (ibid, 24). This potential was also reflected upon by early discussants of Darwin’s theory and even by Darwin himself, who hinted at the idea that his principles may also be applicable in the social and other domains (cf. Hodgson & Knudsen, 2004, 283; Knudsen, 2004 and, in particular, the discussion in Marciano, 2005). Cziko (1995, 308) highlights the range of application by stating that general knowledge creating constructive selection may involve “the creation of new variations, whether they be organisms, antibodies, patterns of neuronal connections, behaviors, thoughts, concepts, or computer algorithms” (also cf. ibid., 305 and Perkins, 2003, 159p.). Advocates of human voluntarism and agency will object to this ubiquity of blind trial and error, because purposeful human action may allow for other ways to learn and create knowledge than blind variation and independent external selection as in the biological domain. The next step is to illuminate this reservation, clarify the meaning of blindness, and show how this objection is dealt with in the application of universal Darwinism in this thesis. A good point of departure for this will be the definition of generalized Darwinism by its most prominent contemporary advocates. Hodgson (2003, 5; also see Hodgson & Knudsen, 2004) defines the overall concept of Darwinism as “a causal theory of evolution in complex or organic systems, involving the inheritance of genotypic instructions by individual units, a variation of genotypes, and a process of selection of the consequent phenotypes according to their fitness in their environment”. Basically, in the specific context of biology this concept refers to the selective retention of genetic instruction code (genotype) expressed in living organisms like humans or animals (phenotype) facing the selection environment. The underlying genetic code varies on account of imperfect genetic reproduction processes introducing

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(random) mutations (cf. for example, Hodgson, 1996; Junker & Hossfeld, 2001; or Gould, 2002). Regarding the domain under study, for evolutionary aspects in organizations within socio-cultural contexts Aldrich (1999, 23) has defined: 1) variation as the change of organizational routines, competencies, or form; 2) selection as the “differential elimination of certain types of variations”; and 3) retention as entailing that “selected variations are preserved, duplicated, or otherwise reproduced”. Furthermore, variation has been differentiated into purposeful and blind variation, the latter being independent of the selection environment (ibid.). In respect of such blindness, critics of biological analogies have argued that in the socio-cultural domain, e.g. in man-made organizational change processes, the mechanism of blind genetic variation, which does not act upon experienced selection forces, does not hold (e.g. Witt, 2002). Witt further argues that the external natural selection mechanism would have to be substituted here by internal selection, as human agents try to accommodate the selection environment (ibid.). Moreover, “humans may manipulate the criteria or environment of selection” (Hodgson, 2002, 267; also cf. Rizzello, 2000, 135). For the domain of organizational change, managers may try to anticipate changing external market conditions and act both proactively to ‘build’ environments in their favour as well as reactively, adapting to individually perceived environmental conditions (cf. ibid. and Hesse & Koch, 1998, 428 for the former and Witt, 2002 for the latter). In particular, in the process of financial resource acquisition, agents may aim to construct and communicate their business idea so that it better appeals to financial resource owners in order to gain legitimacy. Furthermore, new organizations may also try to manipulate institutions at the industry level in collaborative efforts to improve profitability and attract funding. Generally, a purely ‘adaptionistic’ concept will therefore be misleading (cf. Kappelhoff, 2004). Overall, as Koch (1996, 41p.) has put it, human agents are both participants and active engines of socio-economic evolution. In this evolutionary process, agents’ actions appear not to be solely random, but intentional at least to some extent. This means that a concept which considers the fund-raising struggle as a purely random mutation process would be too simplistic. The advantage of universal Darwinism is that it does not resemble this biological analogy.67 The point with universal Darwinism is that it refers to the 67

And it seems therefore too strong a criticism that universal Darwinism inevitably neglects the importance of human intentional variation, considering managerial and entrepreneurial agents merely as passive agents (in contrast to Buenstorf, 2005, 10).

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abstract principle of BVSR and not to the specific mechanisms of biological evolution (Knudsen, 2004, 76p.). There is no need to argue the case for BVSR in the socio-cultural domain by referring to a biological analogy. This would also not be useful due to the differences (such as those stated above) in the evolution of the two spheres (ibid.).68 There will indeed be purposeful action by human agents towards the selection environment they perceive. Having said this, the essential epistemological reason why BVSR is applicable is the following. Such action is based on imperfect perception of and knowledge about the environment so that intentional variations in the cultural domain will be blind as to their future selection success (Kappelhoff, 2003, 10 and 2004, 17p.; also cf. Cziko, 1995, 305pp.; Jablonka, 2003, 29; and Schurz, 2005, 421 for blindness in cultural evolution due to imperfect human foresight).69 Blind variation is open and uncertain in ways “that guarantee improvements in fitness over the initial form” (Perkins, 2003, 165). In particular, “a great deal of sociocultural variation is blind with respect to individuals’ or organizations’ needs” (Aldrich, 1999, 23) and “selection of variations follows from their consequences, not from the intentions of those who generated the variations” (ibid.). In other words, human agents will not be able to foresee the results of their intentional behaviour (cf. Hayek, 1967). In essence, there is a difference between the intentional freedom to act and the efficiency of this action here (Aldrich, 1999, 23). Principally, even though the admittance of Lamarckian elements may allow the preservation of acquired characteristics in the social domain, this does not lead to an objective and increased fit on account of the efficiency of the variation action (cf. Koch, 1996 for this idea and Rahmeyer, 2004, 110 for the essence of the Lamarckian concept). In the words of Cziko (1995, 306): “In all instances of fit to a system it is ... hindsighted selection and not foresighted variation that is the key to adaptive advance”. Thus, also in the social domain, Dawkin’s adaptive complexity (Dawkins, 1983) emerges by virtue of hindsighted selection. Hence, because of the blindness towards future selection success, the contention that biological evolution 68

69

The above definition of general Darwinism by Hodgson and Knudsen even entails the possibility of a Lamarckian retention of acquired characteristics allowing the modification of the instructing code to be preserved (cf. Buenstorf, 2005, 3). This is because Darwinism and Lamarckism may not be considered mutually exclusive (cf. Hodgson, 2003, 5; also cf. the earlier discussion in Knudsen, 2001 as well as Wilkins, 2001 for the case of socio-cultural evolution). Rather, to Hodgson the strict independence of variation and selection confined to the biological domain falls into the area of Neo-Darwinism or Weizmannism (ibid. and Knudsen, 2002, 444; for the biological claim of Weizmann also cf. Cziko, 1995, 177). The original discussion in economics goes back to the debate between Penrose and Alchian.

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is Darwinian and cultural evolution is Lamarckian is misleading: Lamarckian transmission or ex ante instruction from the environment does not explain any adaptive fitness; rather (preliminary) adaptive fitness comes about by ex post Darwinian selection, also in this domain (cf. Cziko, 1995, 176p.). To sum up, the concept of blindness of variation used in this thesis does not refer to the independence of intentional action from the selection arena but to the lack of foresight concerning future viability of the variations purposefully created. Because blind variation refers here to outcomes and not to the original purpose of action, it may embrace both intentional and ‘random’ action (Hesse & Koch, 1998, 427; also cf. Vromen, 1995 for the relevance of intentionality and Mokyr, 2003, 64 referring to Campbell’s view of ideas that occur to people in an unpredictable manner). Deriving an interim conclusion, it is believed that the universal Darwinism BVSR notion is suitable to depict socio-economic and other artificial (as opposed to biological) evolutionary processes in line with the epistemological implications of chapter two above. In a nutshell, BVSR rejects the idea of a deliberate full establishment of a new venture, smoothly solving all financing problems and adapting perfectly to environmental conditions. At the same time, the concept does not fall back into the inappropriate analogy of biological evolution with only random genetic mutation and independent natural selection. The next section will prepare the ground for the later specification of the BVSR meta-principle and its application to the issue of entrepreneurs’ financial resource acquisition efforts at the level of the individual new venture.

Relating the Darwinian meta-principle to domain-specific theoretical concepts The above-described preparatory work will involve two elementary aspects: 1) introducing the rationale for linking the BVSR concept and the notions of new venture legitimacy and entrepreneurs’ fund-raising intentions; 2) establishing that the abstract notion of Darwinian BVSR may also be used for analysis at the level of individual entrepreneurial ventures and not only for addressing phylogenetic aspects of the evolution of firm populations. Universal Darwinism encapsulates the BVSR notion as a cross-domain meta-principle. Therefore, BVSR itself is neutral to any specific context. However, if this is the case, a specification for the respective domain under study will be required (cf. Kappelhoff, 2004, 15). This is essentially because the specific mechanisms of selection as well as the

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operation of variation and retention will vary across domains. “There are bound to be many detailed mechanisms in the social world that are not found in biology. Consequently, the application of general Darwinian principles cannot do all the explanatory work for the social scientist. Darwinism alone is not enough” (Knudsen, 2005, 396). Rather, “Darwinian principles provide a general explanatory framework into which particular explanations have to be placed” (Hodgson & Knudsen, 2004, 285). These principles provide a modest explanation of how knowledge and adaptive order emerge in BVSR processes. As such, “Darwinism provides a compelling ontology, it is a universal metatheory in which specific theories must be nested” (Hodgson, 2002, 278). For purposes of studying financial resource acquisition by entrepreneurs, the BVSR principle will therefore require additional concepts in order to capture the functioning of variation, selection, and retention in the context of new ventures struggling to obtain the funding necessary to become fully established. As far as mechanisms of external selection are concerned, the above notion of new venture legitimacy will be utilized. For this selection environment, in particular, legitimacy demands of external financiers may constitute selection criteria relevant to the domain of initial new venture financing. Furthermore, the hesitation of these resource owners to provide funding will impose selection pressures on new ventures. In their struggle to obtain legitimacy and initial financing, entrepreneurs will engage in fundraising attempts over time. These attempts will unfold as a process of cumulative variation-selection following the BVSR principle (see 4. 3.). In particular, entrepreneurs may make selective changes to fund-raising intentions in the course of the financing struggle as they receive feedback from potential financiers. Note that the focus will be on fund-raising attempts of entrepreneurs within individual new ventures and not at the population level. Therefore, in conclusion of 4. 1. 2. it will be necessary to explain how BVSR may be applicable to evolutionary aspects at the level of the individual entrepre-

neur and his or her new venture.

BVSR processes at the single organization and entrepreneurial agent level

Essentially, Cziko (1995, 305) believes that Cambell’s evolutionary selectionist ontology of BVSR offers a convincing principle also at the individual level, applicable to many domains: “Campbell would thus have us to believe that all problem solving, all skills, all adaptive physiological and neural changes, all useful cultural beliefs and

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practices, and all scientific and cultural progress have at their roots cumulative blind variation and selection − phylogenetic (among organisms), ontogenetic (within organisms), or both − of the same general type proposed by Darwin to account for the evolution of species. The findings, theories, and rationale for selectionist explanations of puzzles of fit reviewed in this book [the source of this quotation; M.G.] suggest that such a universal selection theory should now be taken seriously”. However, as to the applicability of BVSR to evolutionary phenomena ‘within organisms’, it has to be asked how cumulative variation and selective retention occurs at the individual level. In this respect, a useful starting point would be to differentiate between exogenous environmental selection forces and endogenous, internal selection. Essentially, there may be two types of selection forces which are exerted upon core evolutionary units such as organizational routines, techniques, competencies, or products within the evolution of firms: external selection and internal selection (cf. for example, Aldrich, 1999, 22p., Kappelhoff, 2004, 16, Mokyr, 2003, 55pp., and Henderson & Stern, 2004 who particularly refer to the example of products and technologies). External selection stresses the environment as a selection force (such as market pressures from competitors or customers choosing from competing offers; cf. Buenstorf, 2005). These forces eliminate or retain product offers of firms in the market (Henderson & Stern, 2004, 39). Internal selection reflects selective forces within the firm organization as selective retention decisions about the firm’s products or technology use (to stay with the above examples) are arrived at by the organization’s members. There are two central issues to internal selection: the relevance of specific internal selection criteria in addition to those of external selection, and internal selection activity against the background of external selection pressures. Kappelhoff (2004, 12p.) stresses that the role of firm organizations is two-fold: on the one hand it faces external market selection, on the other it is itself an arena of internal selection, e.g. for product innovation and other projects.70 The choices to intensify innovation efforts and pick certain projects are assumed not only to follow members’ preferences and goals within the organization, but also relate to perceived market selection

70

For example, new entrepreneurial initiatives by front-line managers for product innovation may compete within the organization, as higher level management selectively scrutinizes and endorses project initiatives against the background of both personal and organization-wide goals and rules (cf. the corporate entrepreneurship concept of Burgelman, 1991 based on a V-S-R framework; also cf. Henderson & Stern, 2004, 41p. and Floyd & Wooldridge, 1999).

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forces in the competitive environment (cf. Henderson & Stern, 2004, 42). Therefore, taking into account this differentiation between external and internal selection, there may in principle be different interlinked levels of selection which are both internal and external to the firm organization (for a general overview see Kappelhoff, 2004, 16p.; also cf. Bergh & vd. Goudy, 2000 and 2003; Rizzello, 2000; Hodgson & Knudsen, 2004; as well as Koch, 2004). Within this context, the focus will be directed at individual agents within firm organizations at the ground level of this selection hierarchy.71 At the bottom end of these multiple levels of selection, Vromen (2001, 200pp.) has suggested a multilevel selection theory also involving the individual agent; this is in addition to firm organizations and surrounding general market and industry-specific institutions at levels above individual agents (also cf. Rizzello, 2000, 147p. for selection at the individual agent level). Corresponding to the above internal selection arena, which captures organizational interests and selection rationale, the inclusion of the individual agent level highlights that the preferences, goals, and expectations of internal members of a firm organization may not be homogeneous. This would indicate that evolutionary processes in relation to firm organizations cannot be solely viewed from the perspective of the firm as a holistic unit in the process. Therefore, ideally, the bottom level should be the individual agent. In view of the cognitive constructivist perspective taken here, this point is agreed with. Having said this, as suggested for the elaboration of suitable units of empirical analysis in 2. 2. 1. above, a reasonable simplification will be made for the case of fund-raising processes in new ventures. As noted earlier, for the case of raising initial funding for new and small venture projects, the actor referred to in the analysis is the ‘entrepreneur’. Financing matters (expectations, plans, decisions) are assumed either to be inter-subjectively shared by the few members involved in the venture organization or, often, the entrepreneur will be on his or her own in managing the venture anyway (for additional reasoning see 2. 2. 1. above).72

71

72

Also cf. figure 4–1 in chapter 4. 2. 1. below where the financial selection environment will be introduced. While intra-organizational decision-making is excluded from the analysis, this would be an interesting research issue, e.g., as young firms grow into large organizations with many members and differentiated structures. Here, the organization as an internal selection arena, as well as phenomena of group selection, may be addressed by future research (cf., for example, Campbell, 1994, 32p. as well as Kappelhoff, 2004 for a general overview of group selection phenomena in the context of organizations).

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Therefore, internal selection choices of entrepreneurial agents themselves will be at this bottom level underneath the financial selection environment. These choices throughout the fund-raising process are in accordance with (inter-) subjective preferences and perception of which action will be adequate in relation to the financial environment (also cf. Mokyr, 2003, 62 for a similar view). This time-consuming activity involves trying to obtain funding in order to exploit the venture opportunity perceived. The genesis of a technical invention has been modelled by Hesse and Koch (1998) in a similar way and their concept will be adapted here to the case of fund-raising processes. To prepare for the later application of this variation-selection concept in chapter 4. 3., the introduction of the Darwinian BVSR principle will be concluded by briefly sketching out how the above selection choices from created variations may be conceived at the entrepreneurial agent level. The central idea of Hesse and Koch’s variation-selection concept based on the above notion of ‘Handeln in einer Gegenwart’ (ibid. and 2. 3. 1. 2. above) is that agents’ autonomous creativity will generate alternative variations to solve problems in the invention process, e.g., resolving technical incompatibilities or meeting financial budgets (also cf. Aldrich, 1999, 22 and 4. 3. 2. 2. below for the idea of creating alternative solutions to problems). Agents will then selectively choose from these alternatives according to their preferences and what they believe to be viable in the perceived technical and social context (Hesse & Koch, 1998, 428; also cf. the idea of ‘selection in advance’ by inventors in Geisendorf, 2004). In essence, the Darwinian evolutionary logic of differential selective retention from a pool of variants at the population level therefore occurs at the focal individual entity level as well. This is because not only do different agents or entities within a population come up with and embody variations facing environmental selection. Rather, also single agents will generate different alternative solutions they imagine over time. These alternative possible courses of action will then be differentially selected both internally and, ultimately, also by external selection forces (see also Butos & Koppl, 1997, 355 referring back to the Hayekian relation between individual agents’ expectations, action plans, and external competitive market selection). Such external restrictions on the evolutionary financing process of new ventures are essential because blind creative variations of fund-raising attempts by entrepreneurial agents cannot be anticipated in detail (cf. below). Therefore, any theoretical explanatory concept has to be modest, aiming only to identify broad patterns in the entrepreneurial financing and legitimizing struggle alongside possible stable restrictions.

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This will be argued in the next chapter when introducing the approach of pattern reconstruction and explanation in evolutionary processes.73

4. 1. 3. Pattern exploration in the context of invariant restrictions Epistemologically, it has been pointed out that the ultimate destiny of any new venture is uncertain and will thus be impossible to predict in detail (see Bouchikhi, 1993, 555; also cf. Hesse & Koch, 1998, 420 and Kerber, 2004, 74). In particular, the idea has been introduced that this uncertainty has its roots primarily in creative human agents themselves (see chapter 2. 2. 3. above and also O’Driscoll & Rizzo, 1985, 2 as well as Vanberg, 2004, 16; also cf. Koch, 1996, 21 stressing the independence of human cognitive creativity from deliberate volition). At the cognitive level, e.g. to solve the problem of attracting financing to a planned new venture, the universe of potential courses of creative action is boundless, rather than a pre-determined identifiable set to choose from (cf. Koch, 1996, 33). Because of this, it is not possible to predict human action in detail by observation of preceding preferences and deduction from a general covering law (O’Driscoll & Rizzo, 1985, 23; also cf. chapter 2. 3. 1. 2.). However, Vanberg (2004, 16) stresses that while agent behaviour and outcomes of social processes may not be predicted precisely, this does not preclude analysis of these phenomena; the analysis objective must only be more modest than detailed prediction of outcomes. In appreciation of this obligatory caution in research for the social sciences, two related general analysis approaches have been suggested: 1) reconstruction and understanding of agents’ past action and social processes ‘in principle’, and 2) a more forward looking heuristic explanation of principal patterns (cf., for example, Witt, 1987; Bouchikhi, 1993; or Geue, 1997 for the first approach; see O’Driscoll & Rizzo, 1985; Hesse & Koch, 1998 − who actually point out both approaches − and Vanberg, 2004 for the second approach). The first approach has its roots in Weber’s method of understanding (cf. Weber, 1972). It is based on the idea that researchers may understand and explain social action through 73

In agreement with Vromen (2001, 201; also cf. Bouchikhi, 1993, 558), there is more than “reconstructive downward causation” from (higher) external levels of the selection hierarchy (e.g. external market or resource owner selection). The point is that searching for similarities across heterogeneous new ventures and creative entrepreneurial agents (as mandated by Aldrich, 2000) may only be based on common environmental constraints that allow observable similarities to arise.

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an idealized reconstruction of the contextual problem situation perceived by the agent (Geue, 1997, 76). The reconstruction of environmental context and description of social action allows the meaning of action intended by the agent to be retraced (cf. Lamnek, 1995, 33). The focus on (originally) intended meaning of action plans is important here because actions may have both intended but also unintended results (cf. for example, Geue, 1997 71pp. referring to Lachmann’s ‘kapitaltheoretische Methode’ which interprets the course of investment action and subsequent results by looking at initial expectations and intended plans). In other words, functional finality is inexistent in action processes; rather, openness has to be assumed, leaving the achievement of agents’ objectives uncertain (cf. Fallgatter, 2004, 17p.). In this respect, Holland (1992, 20) recommends that “it is the process of becoming, rather than the never-reached end points, that we must study if we are to gain insight”. Emanating from Geue’s starting point of a reconstructed problem situation, Koch (1996, 51p.; see also Hesse & Koch, 1998, 420) therefore generally suggests a reconstructive analysis of chains of identified problems − trial and error attempts to solve them − further problem deferral and so forth. Based on the reconstruction and principal understanding of individual action under uncertainty, accordant forward looking explanations of approximate patterns in evolutionary processes may then be derived (Geue, 1997, 77). The idea that this second evolutionary approach builds on the first one has been suggested by v. Hayek (1967) referring to the concept of pattern explanation or explanation in principle (cf. v. Hayek, 1972, 16p.). This modest approach is commensurable to the above notion of dynamic subjectively-rational behaviour (O’Driscoll & Rizzo, 1985, 27). This is because it relates approximate explanatory schemata to process events in the course of agents’ actions without pre-determining specific outcomes (ibid.). Rather, explanations will originate in institutional boundaries which “enable us to narrow the range of possible action to some specifiable class” (ibid., 32), while within this appreciating the open-ended nature of action choice due to untraceable agent creativity (ibid.; note also the rejection of a pure constraint choice model in Hesse & Koch, 1998). Focussing on institutional boundaries and other restrictions (cf. below) has been recommended as a point of departure for process reconstruction and evolutionary analysis of principal patterns in a number of different themes and this point will also be followed here (cf. Hesse & Koch, 1997 and 1998; Rizzello, 2000; Kerber, 2004). The usefulness of focussing on boundaries in such analysis has been strengthened in particular for boundaries relating to institutionalization. Geue (1997) notes that the reconstruction of

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problem situations and solving processes should involve the institutional background of the situation (also cf. Scott, 2001, 194 for a general overview on the restricting role of institutions and Udehn 2002, 489 asserting that social institutions may in principle be included in the situation of the individual agent as an explanans of action). The essential point with institutional boundaries is that they are believed to reduce the uncertainty of what can happen (see Harper, 1996, 103 who uses the term bounded uncertainty; also cf. Fallgatter & Koch, 2000, 89 for a similar argument). This is because “only the existence of institutions leads to individual representations of a given context of interaction that are to some degree inter-subjectively compatible (though not identical) and therefore make the process of action and response to some degree predictable and expectable” (Budzinski, 2003, 222; also cf. the discussion of inter-subjectivity in social interaction in 2. 3. 2. above). To sum up, this possible reduction of uncertainty due to institutional boundaries also facilitates reconstructive pattern exploration in evolutionary processes in which agent action is involved (cf. Rizzello, 2000). And Koch (1996, 76) considers the existence of stable institutional boundaries and other restrictions to be a central assumption in such analyses. Such restrictions − as the more rigid or stable context variables in evolutionary change processes − limit the range and define a space in which agents’ creative action unfolds (ibid.). In particular, invariant external restrictions, which agents cannot influence and change within the time frame and actor focus of the analysis, may be the most important explanatory factor (ibid., 77p. and Hesse & Koch, 1998, 428).74 This is because creative variation-selection activity by agents may be assumed to unfold alongside such invariant restrictions in continuous problem perception and preliminary problem solving (ibid.; also cf. Hesse & Koch, 1997 and Kerber, 2004, 74). Examples of this may be constraining research and development budgets and technical restrictions in product development processes or restrictions set by external resource owners in efforts to acquire finance for a new venture project.75

74

75

The factors that determine the degree to which restrictions may be influenced by economic agents and the resulting variability of restrictions will be addressed later. Note that there may be more restrictions than institutional boundaries alone. Generally, for the case of economic agents acting on markets, invariant restrictions from a range of spheres may be relevant, such as from the natural (biological/physical), socio-cultural, economic and institutional environment (cf. Koch, 1996, 79pp. and also Burns & Dietz, 1995, 353p.; see also 4. 2. 1. below). For the entrepreneurial mobilization of financial resources that are to be acquired from external societal resource owners, however, invariant restrictions from the financial domain will be of primary importance.

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With this focus on stable restrictions to support the search for regularities in endogenous change processes in the entrepreneurial firm (cf. Witt, 2002), this thesis relies on the principal approach of reconstructive pattern explanation. The study is, however, less concerned with explaining patterns of long-term development of firms. Rather, the contribution of this thesis will be to help develop a framework for understanding the initial fund-raising processes during the earliest phase of a new firm’s life. For this purpose, it will be necessary to describe the object of analysis (entrepreneurs’ fundraising action over time) and to elaborate the relevant restrictions context (the financial environment) as the central element from which identifiable patterns emerge (cf. Koch, 1996, 51).76 The former will be addressed in 4. 3.; the latter will be elaborated next.

4. 2. The restrictions and financial selection environment Following an overview of the financial restrictions environment (4. 2. 1.), 4. 2. 2. will suggest constraining legitimacy demands that financial resource owners might have as they engage in pre-investment evaluation of new ventures. Finally, 4. 2. 3. will conceptualize the financial selection pressures exerted by potential financiers.

4. 2. 1. Overview of the restrictions environment It will be important to have an understanding of the societal environment in which financial resource acquisition takes place, because “consideration of the social system in which a new venture operates is an important complement to the economic model of the new venture” (Zimmerman & Zeitz, 2002, 415). Furthermore, according to the authors, “such a system constitutes the environment in which the organization operates and with which it needs to demonstrate consistency” (ibid.). This demand for legitimated conformance is mirrored in an evolutionary perspective which “represents the firm’s environment as the source of selection forces that actually determine whether significant others choose to do business with the new entrant” (Stam & Garnsey, 2005, 5). Similarly, in his work on the challenge of emerging venture organizations to gain legitimacy with societal stakeholders, Tornikoski (2005, 86) conceptualized the environment “in terms of the 76

Note that the process to attract external finance may also be channelled by another contextual restriction that will be introduced. This will be the minimum amount of external finance required (and related to this the constraint for the entrepreneur to maintain a minimum level of personal liquidity during the process; cf. 4. 4. below).

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other organizations with which an organization engages in exchange relationships” and for which legitimacy will be a prerequisite. From this reduction of the environment to the issue of acceptance and external resource support, the interest of this thesis is further focussed on initiating first financial resource exchanges with resource owners external to the new venture. This further conceptual reduction in studying entrepreneurs’ cognitions relating to this environment follows Hindle’s recommendation that researchers interested in entrepreneurial cognitions and behaviour ought to provide “adequate but not excessive context” (Hindle, 2004, 585; also cf. the notion of requisite holism by Rebernik & Mulej, 2000). As introduced above, the inclusion of context around entrepreneurial action will zoom in on stable restrictions constituted by financiers’ legitimacy demands on which selection decisions about supplying funding to new ventures may be based. Note that these immediate resource selection pressures and restrictions at the capital market level will themselves be embedded in the wider socio-cultural and natural restrictions environment. Figure 4–1 summarizes the restrictions environment to be elaborated in the course of 4. 2. and 4. 3.

circumjacent natural and general socio-cultural level (III)

natural restrictions socio-cultural restrictions

[b] competitive sales market selection financial resource and sales market level (II)

[a] financial resource selection by external financiers (based on preinvestment screening criteria)

BVSR process of financial resource acquisition and legitimation

Tgest conception

Tbirth gestation

Ti1

individual new venture level (I)

Ti2 infancy

t adolescence

figure 4–1: financial restrictions and selection environment (based on Koch, 1996 and 2004)

Fund-raising processes in new ventures are located at the bottom of this selection hierarchy (level I; see 4. 3. below). At this level, cumulative and blind variation-selection

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activity to resolve the challenge of attracting initial financing will be pivotal. Beyond labelling the level of analysis it is necessary to include the higher level selection environment in the analysis as well (cf. Koch, 2004 and Hodgson & Knudsen, 2004, 300pp.). An important aspect in this respect will be how invariant legitimacy restrictions and selection pressures by potential financiers (level II) are perceived by entrepreneurial agents at level I.77

Restrictions in the market for financial resources (level II) In the immediate environment from which financial funds are to be acquired at the market level (level II in figure 4–1 above), potential financiers will evaluate the pragmatic legitimacy of new ventures as an investment project before engaging in resource exchange relationships. Recall from 3. 3. above that the acquisition of resources from a larger social system will necessitate gaining legitimacy against the alternative that the resources strived for may be allocated elsewhere. Resource owners will not provide financial support to all entrepreneurial projects in need of external funding (cf. Brouwer, 2002, 93p. and, for an example of the German venture capital market, Frommann, 2006, 76). This struggle will inflict financial selection forces on new ventures at level I. Overall, the societal environment surrounding new ventures may be considered to some extent as an institutionalized context “in which there are rules by which selection is made” (Rizzello, 2000, 147). In face of this, entrepreneurs may have to pass a market contest of entrepreneurial imaginings (Witt, 1998, 169p.). This contest may involve multiple stages to convince various immediate stakeholders of the new venture to buy into the business idea. The selection process implicit in this struggle for initial support may commence even before a new firm actually enters the sales market competing for customers (cf. Lounsbury & Glynn, 2001, 546 and also the concept of sequential barriers to new venture establishment in Korilloff, 2000, 61p.). Here, the early gate-keeping role of potential financiers is in the focus of the analysis. This is accentuated at level II in figure 4–1 above, which differentiates between financial resource selection and general sales market selection via direct competitive forces in one’s industry. The distinctiveness of financial resource selection as a relevant selection force may be reasoned as follows. 77

Later, this thesis will explore how these restrictions may factor into entrepreneurs’ intentions to search for external funding.

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At a very early stage, Schumpeter and Knight established that entrepreneurs are not merely self-selected but chosen by financiers (Brouwer, 2002, 92p.). In Knight’s view, uncertain investment discovery by financiers comes to the fore (ibid.), which Dimov (2004) sees as a kind of second-order recognition and evaluation of uncertain venture opportunities before their market establishment. It is estimated that financial resource selection pressures on new entrepreneurial ventures will be most severe in the early phases of gestation and infancy when the entrepreneur has to attract initial financing for the project.78 The evaluation and ‘pre-selection’ by financiers constitutes a kind of short cut or test of the venture’s future market prospects. In general, in evolutionary processes in the social domain agents will follow ‘short cuts’ to constitute vicarious selectors (Cziko, 1995, 164p.). These vicarious selectors exhibit evaluations − in this case of an entrepreneurial venture project. These evaluations occur (at least partly) prior to the actual future selection in the real environment − in this case competitive selection as the firm enters the market (also cf. Koch, 2004, 79).79 New venture projects communicated to potential financiers may be denied resources and be selected in face of supposed future competitive forces which these ventures are not believed to be able to withstand successfully. It is this pre-evaluation by financiers which demarcates the concept of financial resource selection from general selection pressures from direct competition in the sales market.

Circumjacent natural and socio-cultural restrictions (level III) In society, normative and regulatory requirements for conformity constitute a framework for market competition as well as for the financial domain relevant to new venture funding. These requirements as socio-cultural restrictions are located at level III in figure 4–1. In a simplified view, socio-cultural restrictions are considered to contain not only informal restrictions such as societal customs and conventions, but also legal institutions. For example, a new biotech venture will have to conform to ethical norms and legally prescribed medical standards and clinical trials, which will have an impact 78

79

This is also indicated at level II in figure 4–1, depicting the diminishing reliance on external funding. However, note that not all new ventures will be exposed to selection forces exerted by external financiers. Those who do not require any external finance for their establishment will directly face the struggle of competitive selection in their respective industries. As an illustration of Campbell’s (1965) vicarious selection principle, Cziko uses the example of an aviation simulation experiment. Selection (variation and further selection) of a designed flying apparatus occurs in this pre-test experiment, rather then in later full-scale everyday use.

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on financing requirements and challenges to establishing the firm in the marketplace. Furthermore, the financing process of this and other ventures will also be governed by legislation pertaining to the financial domain, such as capital market rules relevant to debt and equity financing of new ventures. To name one example, the implementation of the Basel II Accord and the regulation implemented by the German Bundesamt fuer Finanzdienstleistungsaufsicht (BAFIN) prescribe credit rating requirements to the German banking industry (cf. the edited volumes by Achleitner & Everling, 2002 and 2004). In contrast to the commercial banking sector in Germany, regulation of private equity and venture capital is argued to be lower (cf. Schefczyk, 2004, 72); also, personal lending and business angel investments will be fairly informal (cf. below). Overall, formal and informal restrictions at the socio-cultural level (level III) will partly determine evaluation and capital allocation practices employed by financiers (level II). In developing the conceptual orientations for the empirical analysis of fund-raising processes, the focus will be on these evaluation and screening criteria employed by different types of financiers (cf. 4. 2. 2. below). Capital market regulation or norms of tolerable financial risks in financial investments are assumed to be implicit in these screening criteria. This also includes the natural (biological and physical) restrictions which limit economic action of financiers and entrepreneurs, constituting a selection field for viable socio-economic activity. Despite the above reservations, this principal notion of downward causation as far as the financing of individual ventures is concerned will help to understand fund-raising processes over time. This is because socio-cultural restrictions at level III as well as financiers’ legitimacy demands at level II will constitute a fixed frame for, fairly shortterm, fund-raising processes in individual ventures (cf. Koch, 1996, 82p. for a similar reasoning in the case of economic policy-making; also cf. Sloane, 1988, 221pp. for the basic idea of fixed surrounding structures). Central to this argument will be the variability − and in particular invariance − of restrictions from the perspective of the object under study, i.e. the individual entrepreneur seeking funding for his or her venture.

The potential invariance of external restrictions on fund-raising processes The variability of restrictions is determined by the costs of influencing and changing them and, as such action will be time-consuming, the amount of time available to generate these changes (for this and the following cf. Koch, 1996, 76p.). Restrictions are

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invariant to focal entrepreneurial ventures when the costs of change to be incurred are prohibitively high, and when the available resources of scarce management time are insufficient to achieve changes (also cf. Burns & Dietz, 1995, 353). Conceptually, the degree of variability will therefore depend on the time horizon of the analysis (a), as well as on the influencing power and potential of agents to incur the necessary costs of change (b).80 (a) Since the variability of restrictions depends on temporality, it is necessary to specify the time frame of the study (cf. Koch, 2004). The theoretical concept pertains not to the complete life-cycle of a venture, but solely to the early period of initial fund-raising.81 Seeking first financing is assumed to occur during the pre-founding and early development phase of a new venture, usually lasting less than two years (cf. Carter et al., 1996 and Stouder & Kirchhoff, 2004). Correspondingly, the empirical concept concentrates on initial financial resource acquisition of existing new ventures in their infancy phase (the specific time frame of the case study indicated at the bottom of figure 4–1 will be addressed in the empirical research concept in chapter 5. 1.). The exclusive focus on initial fund-raising results in a fairly short time horizon of the analysis in which many external restrictions will be invariant to the new venture. Moreover, the focus is on individual new ventures in their infancy. Such ventures will frequently be quite small, in particular in terms of their resource base, suffering from the above liabilities of newness and smallness. This will also limit their power to influence the restrictions surrounding them. (b) It has been argued that small businesses will regularly lack the power sources to influence their environment actively as compared to large established firms (Curran & Blackburn, 2001; also cf. Fallgatter, 2002, 328 and Maguire et al., 2004, 658 who argue that it will be much more likely that large firms act as creators of new institutions). In particular, Stevenson and Gumpert (1985, 91) argue that new and small firms have limited control over the environment’s “social demands to appropriate use of resources”. Tornikoski puts forward a similar argument for the pre-founding gestation phase: “A pre-organization does not have the power to decide which characteristics or qualities would legitimate it. This decision is made by the immediate audience of the pre-organization” (Tornikoski, 2005, 36). 80

81

Also cf. the discussion of the institutional perspective of organizational legitimacy in 3. 3. 2. 2. above. Nor does the concept relate to several rounds of seed, start-up, expansion, and bridge financing over many years but solely to securing initial financing.

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It has to be appreciated, however, that Zimmerman and Zeitz (2002, 422) have considered two examples of new venture legitimating by institutional manipulation and creation within the financial domain. The authors have argued that, at the time of their initial public offering, biotech ventures have been able to redirect investors’ attention from the ventures’ lack of profitability towards potential scientific and medical advances that could boost future profits. Furthermore, new e-commerce ventures are believed to have created new norms for company valuation focussing less on positive cash flows and more on parameters such as customer growth or even website click rates. Having said this, however, it might well be that financiers’ underlying expectations of positive investment returns were not manipulated or completely negated in these examples. This is because investors possibly still held risk-return expectations and only agreed to accept increased risks of delayed break-even in view of formidable possible profits in the future. Therefore, from the perspective of the biotech and internet ventures, this might rather have been impression management activities trying to signal conformance to underlying institutionalized demands for profitability by portraying their future prospects. Furthermore, even if new evaluation rules had been created, it is likely that this institutionalization of new subordinate standards for company valuation will take some time and involve many venture financing projects (perhaps it might even have required industry-wide media coverage of such novel evaluation methods, e.g., in investor magazines or finance journals). Thus, it might be supposed that a single entrepreneurial venture may not be able to obtain finance within a short period of time by creating novel financial environments for its legitimation. Overall, for the individual infant venture, its lack of establishment, influencing power and available time will likely result in costs of changing external restrictions that are well beyond their powers; hence, these restrictions are likely to be invariant to them. These restrictions within the financial environment will be discussed next.

4. 2. 2. Potential financiers and their legitimacy demands Chapter 4. 2. 2. 1. provides a brief overview of the universe of potential external sources of finance to new ventures. Then, 4. 2. 2. 2. goes on to elaborate typical pre-investment screening or evaluation criteria employed by different financiers. Apart from assessing the chances of potential investment opportunities, screening also aims to reduce market and business uncertainty as well as agency risks stemming from information asymmetry.

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These criteria constitute pragmatic legitimacy restrictions to a new venture which has to overcome this hurdle in order to attract funding. This is because financial resource owners will expect that funding the venture will benefit their interests and aims (both financial and non-financial). In this respect, the venture must offer adequate financial performance potential and survival chances. Chapter 4. 2. 2. 3. concludes by discussing the potential degree of inter-subjectivity and institutionalization of the above screening and evaluation criteria that may channel fund-raising processes in new ventures.

4. 2. 2. 1. Sources of finance and financiers’ pre-investment evaluation External equity- and debt-financing sources As noted earlier, new ventures are likely to require financial and other resources from outside. The dependence on seeking external financing arises because of limitations to internal financing in face of lacking cash flows from the business (see Gompers & Lerner, 2003, 267; Denis, 2004, 304; and Schulte, 2005, 483; also cf. Grichnik & Kraschon, 2002, 9). In this situation, external financiers may provide required funds. Generally, (external) financing is characterized by managing the interactions and cash flows between firm and financier in order to fund necessary capital expenditure and working capital requirements; in particular, new venture financing may be seen as an institutionalized exchange and cooperation relationship between entrepreneur and external financiers which follows the principle of reciprocal exchange (ibid., 7p.). Equity financiers provide funds for an unlimited period and take a shareholder position, participating in a share of the new firm’s future profits and losses (ibid., 9; also cf. Nathusius, 2001, 20p. and Schulte, 2005, 472). Debt financiers will provide funds temporarily, as creditors to the firm. In return they will be entitled to receive interest and repayment of the loan. This claim is independent of the financial result situation of the firm (ibid., 472p.; also cf. Thommen & Achleitner, 2003 for this general characterization of debt financing).82 A number of possible sources of equity and debt financing exist while other sources will be insufficient to fully serve the initial financing demands of new ventures.

82

Note that hybrid financing forms also exist that feature elements of both equity and debt instruments; cf. Haeger and Elkemann-Reusch (2004) for an overview.

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Denis (2004, 304) argues that three primary external sources of equity financing will be available to entrepreneurs, namely venture capital funds, business angels, and corporate strategic investors. Furthermore, friends and family of the entrepreneur may be an additional source of equity funding (e.g. Stouder & Kirchhoff, 2004, 354 and Brachtendorf, 2004, 25). The latter may also provide finance in the form of debt on an informal basis while commercial banks are an institutional source of debt financing for new ventures. Finally, public sources from new venture support policies may also be available to newly founded ventures. In principle, there are of course further funding sources. However, these sources may be too limited to meet a substantial share of a new venture’s financing needs over time. To some extent, a new venture might be financed from the entrepreneur’s personal efforts and pocket, e.g. sweat equity, moonlighting, commitment of personal savings, or personal credit card financing; however, although entrepreneurs’ own money plays an important role in the funding of new ventures in Germany (Brachtendorf, 2004, 19), this may only be sufficient for very small business start-ups and part-time entrepreneurial activities (ibid. and Kuckertz, 2006, 23p.; also cf. Winborg & Landstroem, 2000 and Stouder & Kirchhoff, 2004 for the above bootstrap financing methods used by entrepreneurs).83 The elaboration of the environment of financing sources therefore concentrates on the following sources of equity and debt financing84: venture capitalists (1), business angel investors (2), friends and family (3), banks (4), and the state via public enterprise policy-making (5). (1) Venture capital investors manage “pools of capital that focus on equity or equitylinked investments in privately held, high growth companies” (Gompers & Lerner, 2003, 267; similar definitions of venture capital are provided, e.g., by Denis, 2004, 304 or Kuckertz, 2006, 35 who also provides an overview on the diversity of definitions that stress different aspects to constitute venture capital). Furthermore, Welpe (2004, 17) defines venture capital as being a temporary, i.e. exit-oriented, investment in unlisted high growth firms with the aim of participating in increasing firm value. Venture capitalists commonly follow purely financial aims (Kollmann, 2005, 75) and German institutional venture capital investors have been assumed to expect an annual return of 15 to 25% (Schefczyk, 2000, 25). These substantial return expectations lead venture capitalists to 83

84

Also recall that this study concentrates on new ventures which require external funding beyond capital infusions by the entrepreneurs themselves (cf. 3. 1. 2. 2. above and 5. 1. below). For a similar structuring cf., for example, Brachtendorf (2004); also cf. Cosh et al. (2005, 3p.) for a typical distribution of external funding sources which have been approached by young businesses.

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pursue only investment opportunities with significant growth potential. Correspondingly, new ventures which do not manage to display this potential may find it difficult to attract funding from financial venture capital sources. Apart from financial venture capitalists, strategic corporate investors may also provide equity capital to new ventures, e.g. through shareholdings within the context of strategic alliances or acquisitions (cf. Denis, 2004, 307). Furthermore, by definition, corporate venture capital investors are large, established firms which provide financial and other resources directly to new ventures (Witt, 2004, 260). In contrast to financial venture capitalists, these investments follow strategic aims beyond financial return expectations. These aims are mainly related to accessing important know-how and technologies of the new venture (ibid., 263p. and Brachtendorf, 2004, 35p.). In addition to these institutional sources of equity, informal funding from private individuals also exists. (2) Angel investors are “high net worth individuals who invest their personal capital in a small set of companies” (Denis, 2004, 307). In addition, Brettel (2005, 233) stresses that business angels make direct equity investments in firms without formal intermediaries such as venture funds. It has also been noted that business angels may be a sensible source to seek funding from for emergent and infant ventures. This is because angel investors are believed to invest significantly in seed and start-up-stage projects because of the potential to contribute actively to the project’s market establishment (Fenn et al., 1997). Unlike passive return-seeking private investors, business angel investments involve active support of the new venture’s management (Brettel, 2005, 234; also cf. Brettel et al. 2000 who also provide an overview of the different support services offered by German business angels). An important difference to institutional venture capital investors is that private business angels also pursue non-financial aims with their investments, i.e. they appear to follow hedonistic but also altruistic investment motives (cf. Sullivan & Miller, 1996, 33). In an empirical analysis of German business angels Brettel (2005a) reports that financial return expectations and non-financial aims carry about equal weight. (3) Friends and family as private financing sources from the immediate social environment of entrepreneurs may also have non-financial objectives. These aims may be connected to the personal relationship between entrepreneur and financier, e.g. the wish to support the entrepreneur in his or her project (Brachtendorf, 2004, 25 for this and the following). Friends and family members may take equity positions in ventures but may also provide debt capital (e.g. in the form of private loans, Schulte, 2005, 479). This

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source may be tapped on a rather informal basis and capital redemption as well as modalities of dividend or interest payments may also be quite vague. However, in principle it should be assumed that friends and family financiers will also expect to get their money back with adequate return (Brachtendorf, 2004, 25). And similar to other external financiers, they will be concerned about the failure risks of the new venture (cf. Stouder & Kirchhoff, 2004, 370). Unfortunately there is little evidence and reliable knowledge about the corresponding financing criteria of friends-and-family financiers as the process is highly informal (cf. Brachtendorf, 2004). Because of this unclear evidence, friends-and-family financiers are not considered further within this context to avoid inappropriate speculation as to their evaluation criteria. The relevance of friends and family as sources in terms of requests for funding and financing volume may also be limited (cf. ibid., 24 as well as Stouder & Kirchhoff, 2004, 367). To sum up, they will be treated as internal entrepreneurial funds (corresponding to Berger and Udell, 1998) beyond the focal issue of raising external financing. (4) New and small firms have no access to the bond market to access debt (cf. for example, Schulte, 2005, 477). Therefore, in general, all debt of these firms will be non-traded commercial debt (Berger & Udell, 2003, 299p.). Here, debt from commercial banks is a typical source of external finance that entrepreneurs plan to acquire (cf. Stouder & Kirchhoff, 2004, 370; also cf. Geiseler, 1999 and Schulte, 2005 for the German case). However, banks may often be asset-based lenders, demanding security and collateral to reduce the default risk of loans (Stouder & Kirchhoff, 2004, 370; also cf. Schulte, 1999). This is because of the limited upside participation in the firm’s success and the low margins in small and new firm lending (for the former cf. Grichnik & Kraschon, 2002, 13; for the latter see Mason & Stark, 2002, 4). Because new ventures and entrepreneurs will frequently not offer a strong asset base with potential inside collateral or other personal assets to pledge (cf. Berger & Udell, 2003; Shane, 2003; or Schulte, 2005), it has even been argued that bank financing will often not be a substantial option to new, in particular risky, high-technology, ventures (cf., for example, Denis, 2004 or Schefczyk, 2004). Of course, banks also use other lending methods than asset-based lending, for example credit scoring (Berger & Udell, 2003, 308pp.). However, also for these instruments new ventures face liability of newness problems because of the anonymity of approaching a bank as a stranger and lack of financial and business track record of the new firm (Schulte, 2005, 476). Nonetheless, debt financing by commercial banks is much more often used than equity financing via venture capital with its narrower focus on high-growth start-ups (ibid., 475; also cf. Brachtendorf, 2004).

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(5) Finally, apart from funding via private financiers, public sources also play a role in Germany. These financial resources emanate from state entrepreneurship policy-making and involve both equity and debt instruments (Brachtendorf, 2004, 40; cf. Koch et al., 2001 and Schirmeister & Paessens, 2005, 109pp. for an overview of public new venture support programs and institutions). The reasoning behind such public interventions has been argued to be capital rationing in the seed and start-up financing segment of the capital market (cf. for example, Guiso, 1998 or Cowling, 2002 for a discussion of this and Frommann, 2006 for the German case in particular). Beyond this, public policies to foster new venture creation follow other objectives than those of profit-oriented private financiers. Because of the commonly assumed positive economic effects of the many existing small firms and the importance of new business creation, new and small business support schemes also aim at enhancing structural economic change, creating new jobs, and speeding up innovation diffusion (Brachtendorf, 2004, 40, also cf. Schmeisser & Galler, 2001, 113). Differentiating between general economic and industry-specific support programs, the latter particularly focus on the promotion of technology innovation (ibid.). In the implementation of enterprise policy initiatives public institutions often cooperate with private financiers such as banks or venture capitalists (Koch et al., 2001, 33 and Schirmeister & Paessens, 2005, 110).

Rationale of external financiers’ pre-investment evaluation Like societal resource owners with self-centred interests in other domains, also financiers will only provide resources and consider those new ventures legitimate which are perceived to benefit their pragmatic interests. For some of the financiers briefly introduced above, these interests will be predominantly (in the case of venture capitalists or banks) or partly (in the case of corporate venture capital investors or business angels) financial and profit-oriented.85 Moreover, non-financial interests (e.g. access to technology, creation of jobs, or support of the founder in his or her new occupation) appear to be relevant, too. With regard to all of these aims, the different groups of financiers all demand that the new venture should not fail because otherwise, neither financial nor non-financial objectives can be fulfilled. And “this wariness of external sources even extends to family and friends” (Stouder & Kirchoff, 2004, 369 in their

85

Note that institutional financiers may also follow non-financial aims at least to some extent (cf. Schmeisser & Jahn, 1999, 50).

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analysis of US data) as “friends and family hesitate to invest, probably because the uncertain and risky nature of business start-ups frightens them as much as it does bankers” (ibid., 367).86 On top of the above widespread concern about venture failure amongst external resource owners, for-profit financiers will have additional financial performance demands in terms of expected returns on equity investments or financial robustness to serve their repayment and interest expectations. Therefore, for a new venture to become accepted in the business community within market economies, it has to be expected to become a profitable and commercially viable new business in the future (cf. Beckert, 1999 and Delmar & Shane, 2004). Financial resource owners will be concerned about the survival and performance prospects of new ventures essentially because new venture (and other) financing relationships principally involve a capital commitment by the financier and uncertain future equivalents in return by the founder (Grichnik & Kraschon, 2002, 8). In particular, the future proceeds that the entrepreneurial project will provide (namely dividends as well as interest payments and debt redemption) are uncertain. Therefore, in contrast to spot market transactions which are settled immediately, problems of genuine market uncertainty (or risks) about the future success of the new venture and opportunistic behaviour in a situation of asymmetrically distributed information will be eminent (cf. Kuckertz, 2006, 104). Because of this, financial resource owners do pre-investment screening, trying by themselves to evaluate the venture’s prospects and quality of information provided by the entrepreneur; they also engage in drawing up contracts and, later, post investment monitoring (cf. for example, Shane, 2003, 174 or Stouder & Kirchhoff, 2004, 369).87 Empirical studies have found that institutional equity investors are predominantly concerned with the above market risks rather than agency risks (cf. Fiet, 1995 and Kollmann, 2005, 75).88 This may be because agency risks can be handled via formal 86

87

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Judging from national GEM data, German private individuals may be, at least, no less risk averse than Americans (cf. Sternberg et al., 2006, 6 and 19). Note also that issues of opportunistic behaviour in the post-investment phase (e.g. moral hazard problems) are not of interest here as the focus is on entrepreneurs’ seeking to initiate financing in the first place. Moreover, suppliers of debt to new ventures also “face a highly uncertain lending situation with minimal borrower information” (Stouder & Kirchhoff, 2004, 369) and substantial market and business risks in terms of fluctuation in sales and competition (Schulte, 2005, 491).

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contracting while market risks are less controllable (cf. Mason & Stark, 2002, 5p. and Bayens et al., 2005, 5). Such future market risks pertain to possibly severe competition and low market attractiveness in terms of volume and growth (Kuckertz, 2006, 56p.).89 In addition, internal risks about the venture’s operations and the competences of the entrepreneur also exist (cf. the discussion in the introduction of 3. 3. above). The screening criteria employed by financiers in order to control ventures’ information disclosure and to address their genuine market and operational risks will now be discussed.

4. 2. 2. 2. Screening and evaluation criteria of external financiers The pre-investment phase in new venture financing To begin with, financiers’ screening activities and the sources of information employed will be put into the temporal context of the financing process. Firstly, from the external financiers’ perspective the overall financing process may be divided broadly into distinct ideal-type periods: a pre-investment phase before capital is provided and a contractual relationship is established, and a post-investment phase which the financial contact runs through up to disinvestment (cf. for example, Brachtendorf, 2004, 43 for the institutional equity investor’s case). Similarly, the debt financing process has been categorized into the phases of pre-financing decision-making, contractual relationship, and final redemption (Schulte, 2005, 488). Secondly, within the pre-investment phase further subordinate phases have been identified. For the venture capital domain, the established procedural categories from the empirical studies of Tyebjee and Bruno (1984) and Fried and Hisrich (1994) are commonly referred to (cf. Wright & Robbie, 1998 and also Kuckertz, 2006).90 These studies differentiate the pre-investment period as follows: deal origination (identification of investment possibilities), deal screening, deal evaluation, and deal structuring. Regarding possible legitimacy restrictions on entrepreneurs’ fundraising attempts, the deal screening and deal evaluation phases will be the most important. Here, Fried and Hisrich’s study (also cf. Pankotsch, 2005, 46) highlights that the pre-investment phase can be differentiated into an initial rough evaluation (first phase

89

90

Here, Shepherd (1999, 628) found that venture capitalists do address such market risks in their screening criteria. And apparently, their suggested approximate phase categorization still holds empirical validity, albeit that there may be recursive feedback loops in a seemingly linear pre-investment process (cf. Feeney et al., 1999 for the former and Wright & Robbie, 1998 for the latter).

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evaluation) upon first contact with the new venture project and a more detailed evaluation (second phase evaluation including due diligence) of those investment opportunities that passed the first hurdle (also cf. Nathusius, 2001, 77p. for a similar differentiation).91 In deal screening (or first phase evaluation), important, easily accessible criteria are checked, such as the venture’s industry, development stage, and funding requirements; however, an initial judgement may also be made about product-related technological, market-based, and managerial aspects (Pankotsch, 2005, 46; see also Kuckertz, 2006, 69). Only a fraction of initially screened investment opportunities are then considered by venture capitalists for further intensive deal evaluation and other financiers also commonly show quite high rejection rates (cf. 4. 2. 3. below). Similar to venture capital financiers, banks also appear to engage in multiple screening stages where different information sources are analyzed before credit is granted (cf. for example, the study of Grill, 2006 on the German Sparkassen, a major bank lender to new firms in Germany).92 Also, public financiers may implicitly follow these evaluation procedures when they co-operate with private financing institutions. Little is known about the procedural approach of informal private financiers, in particular kinsman-like relational sources of funding. However, the study of Brettel et al. (2000) has established that at least in the case of German business angels, a two-step screening and evaluation process similar to that of venture capitalists seems to be followed. In contrast to institutional investors, the pre-investment evaluation process of business angels may, however, be less elaborate (Brettel, 2005, 248). With regard to the basic general evaluation process, potential investors are reported to make use of several information sources. Frequently, the most central source is assumed to be the new venture’s business plan; this is a written document that describes the business concept and strategy of the new firm over a planning schedule of up to five years (Kuckertz, 2006, 70). The paramount importance of business plans has also been stressed, e.g., by Kuratko and Hodgetts (2001, 289) who state that “the business plan is the minimum document required by a financing source”. And because the business plan, or even just the executive summary included in it, is a commonly tapped main source in 91

92

Note that first phase evaluation and second phase evaluation correspond to the deal screening and deal evaluation phases in Tyebjee and Bruno’s conception. This thesis will use the term selection criteria to cover both criteria employed in first and second phase evaluation, because, ultimately, ventures will have to pass through both to obtain funding. For the importance of the ‘Sparkassen-Finanzgruppe’ in this area see Schindlbeck and Diringer (2002, 109).

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the above severe first phase evaluation (Kuckertz, 2006, 69p.), it may be “the first − and possibly only − substantial contact that the entrepreneur has with a potential funder” (Mason & Stark, 2002, 3; also cf. Shepherd & Douglas, 1999). Business plans also appear to be an important source of information in the evaluation process from an empirical perspective (see for example Manigart et al., 2000 for the case of European venture capitalists, and Brettel et al., 2000 as well as Grill, 2006 for a discussion of this aspect with respect to German business angels and banks). Beyond business plans, equity financiers also employ additional information sources throughout the pre-investment evaluation process. For example they will communicate with the venture’s management, question potential suppliers and customers, visit the venture’s office and production premises, or talk to employees, often in co-operation with external consulting sources (cf. Manigart et al., 1997; Schefczyk, 2004; Pankotsch, 2005, 46p.; and Brettel, 2005, 249). The evaluation process of banks may often follow less intensive information gathering and processing due to the high screening costs relative to the limited return potential of debt instruments. However, banks do discuss the venture’s concept with founders and may consult external experts familiar with the new venture; banks also check the founders’ personal creditworthiness in relation to securing a prospective loan (cf. Schmeisser & Jahn, 1999, 51 and Schulte, 2005, 497). Having introduced the general temporal context and the information base of financiers’ pre-investment screening, the next step will be to look at the evaluation criteria that financiers consider when deciding about providing finance to a new venture.

Empirical pre-investment screening criteria in new venture financing As noted above, financiers will expect new ventures to be commercially viable and, as far as financial aims are pursued, potentially profitable. Similarly, at this fundamental level, Vesper (1996, 241) argues that when deciding about providing funding, “to some degree all ... audiences will care about central issues such as viability, potential profit, downside risk, likely life cycle time and potential areas for dispute and for improvement”. The focus on evaluation and selection criteria faced by entrepreneurs seeking initial finance will be on these central issues of concern to external financiers. Criteria which may be related to the central expectations of external financiers have been successfully employed as legitimating factors of new emerging ventures in a study by Newbert and Tornikoski (2003). The authors based their study on founder human capital,

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collective team ability, and commercial quality of the venture opportunity. These constructs are argued to correspond to demands of what makes a legitimated venture project, e.g., in the eyes venture capital investors (ibid., 5). However, it will also be important to appreciate that there are different types of financiers. This is because, as Vesper (1996, 241) further notes, “beyond that [the above central issues; M.G.], however, different audiences will care about different details”. With regard to this, potential differences in the selection criteria and their relative importance to different types of financiers will also be addressed. Overall, such differences may occur between financiers providing equity as opposed to debt, offering personal informal as opposed to formal access to funds, and following financial versus non-financial aims (cf. below for further explanations concerning such differences). The evaluation criteria of new-venture financiers presented in figure 4–2 have been compiled from relevant literature on the funding decision-making process of different financiers. It goes without saying that empirical criteria have to be condensed and paraphrased for such compilations (cf. Kuckertz, 2006 for a similar approach). Figure 4–2 shows typical, financially oriented screening categories or central criteria (on the left) and exemplary sub-criteria per category (on the right).93

evaluation criteria of external financiers

possible sub-criteria for screening

ability of management

managerial track record; industry experience; business skills; team characteristics; personal reputation

product characteristics

distinctiveness of product offer; competitive advantage; potentially strong market position; pilot customer and general acceptance

market characteristics

market growth; market volume; business cycle situation; intensity of competition; entry barriers to others

financial return potential

return on investment; time to break even

financial robustness

projected margins and cash flow; potential collateral

figure 4–2: pre-investment evaluation criteria in new venture financing (compiled from various sources as indicated in the following two sections)

93

Cf. Brettel (2002); Mason and Stark (2002); Gleissner (2002); and Kuckertz (2006) for an overview of possible sub-criteria of equity and debt financiers.

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Similarities in evaluation criteria between different financier sub-domains Similarities may be identified at the level of the above central issues regarding commercial viability and potential, which all financiers may be concerned about. As equity financiers, venture capitalists and business angels both make investments to participate in the success and capital gains of the venture project they fund (Mason & Stark, 2002, 5). Accordingly, these financiers are assumed to concentrate on factors that are believed to influence this success in terms of substantial market chances and failure risks to be managed (ibid.; see also Brettel, 2002, 313 who diagnoses both ‘progressive’ market potential and concerns about downside risks as being relevant to German venture capitalists). In particular, empirical evidence shows that venture capitalists and business angels are concerned about founders’ management capabilities, the venture’s product offer, and the market it operates in as noted in figure 4–2 (ibid. and Mason & Stark, 2002; also cf. Riquelme & Watson, 2002 for the relevance of these central criteria in the investment decision-making of venture capitalists). The importance of management ability of the founders in terms of managerial track record and industry experience is referred to frequently in venture capital studies, e.g. in Muzyka et al. (1996) and Manigart et al. (1997) for the European case. The relevance of the venture’s founders has also been verified for the case of German venture capitalists (Brettel, 2002) and business angels, who find characteristics of the management team to be most important (Brettel et al., 2000). Moreover, product and market characteristics that indicate substantial rapid growth prospects and potential to withstand competition are also relevant to these equity investors (cf. for example, Fried & Hisrich, 1994 and Manigart et al., 1997 for venture capitalists; cf. Feeny et al., 1999 and again Brettel et al., 2000 for informal angel investors).94 Corresponding to these high expectations of market potential, venture equity investors demand substantial financial return potential. This appears to hold for institutional venture capitalists (Muzyka et al., 1996 or Mason & Stark, 2002) but also for business angels. For business angels, financial return expectations were found to be dominant or at least amongst the most important criteria (cf. v. Osnabrugge, 2000 and Brettel, 2005a).

94

In relation to the product position and market environment, knock-out criteria may also be relevant as venture capitalists hesitate to invest in ventures with limited differentiation of their products or services and in markets with heavy price competition (cf. Kuckertz, 2006, 77).

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Banks as a main provider of debt also appear to be concerned to some extent with founder management competence as well as product and market related characteristics in order to assess the viability and profitability of new venture projects. For example, credit checks consider the industry familiarity and business competence of founders, as well as the market potential of products and the economic situation of the market the venture operates in (cf. for example, Stuhlinger, 2002 and Darazs, 2004 as well as Grill, 2006 for evaluation procedures by two major banking institutions in the German new and small business credit market). Here, the relevance of founder, business, and market-related factors is apparent in typical new venture credit rating criteria that banks have implemented within the context of the Basel II regulation. Dimensional ratings are employed in bankers’ internal credit ratings, e.g. management and business (organization and product/service offer), industry sector, risk situation, and financial sub-ratings (Gleissner, 2002; also cf. Schindlbeck & Diringer, 2002, 110p. for an overview of dimensions of rating criteria; these rating dimensions also feature similarity to evaluation dimensions in general credit rating procedures relating to established firms − cf. for example Schmeisser & Jahn, 1999, 50). Public support of new ventures (e.g. public lending or co-financing instruments for growth-oriented ventures) employs selection criteria pertaining to the overall non-financial aims of entrepreneurship policy programs. Frequently, these relate to the founder (e.g. gender-specific), regional, or industry focus of the programme (ibid.). However, strictly speaking, new venture conformance to these criteria will contribute little towards the evaluation of the commercial viability of the venture project. In this respect, entrepreneurs will often have to meet the pre-investment criteria of banks or institutional equity investors (Schirmeister & Paessens, 2005, 110). This is because of the abovementioned collaboration between public and private financing institutions (an example of this is the so-called ‘house bank principle’ in instruments of the KfW Mittelstandsbank in Germany). To sum up, financiers may be concerned about similar principal criteria to assess new venture viability, expansion potential, and financial prospects. These criteria relate to the competence of the persons managing the venture, the marketability of its product offer, the characteristics of the targeted customer market (e.g. in terms of volume, future growth, or competitive pressures), and corresponding financial risk and return considerations. These criteria show that new ventures at least will be required to provide some indication of potential future success. This is also reflected in some of

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the sub-criteria as in figure 4–2. While ultimate market success is uncertain at pre-investment stage, financiers look, for example, for initial market acceptance of the venture’s products (e.g. pilot customers or a reputable distribution partner) and relevant founder track record (cf. Brettel, 2002, 313). Beyond these principal similarities, cross-investor differences also exist in the application of these central criteria in detail, their relative emphasis to different financiers, and in the use of additional criteria (also cf. Mason & Stark, 2002). Note also that the importance of some evaluation criteria may be specific to the venture’s development stage and industry (cf. for example Brettel, 2002, 312p. for the former and Baeyens et al., 2005 for the latter).

Differences in evaluation criteria between different financier sub-domains Comparing venture capitalists and business angels, it has been argued that business angels care more about management-related characteristics while venture capitalists are comparatively more concerned with market-related potential and risk issues in pre-investment evaluation (cf. Mason & Stark, 2002, 5p. for this and the following).95 Mason and Stark discuss several reasons for the stronger emphasis of business angels on management characteristics as compared to market issues: • focus on non-financial aims like personally satisfying active involvement or altruistic support requires trustworthy and inspiring management team (cf. v. Osnabrugge & Robinson, 2000) • additional concerns about trustworthiness and competence of management because of less elaborate contracting • sufficient industry experience to address market risks straight away. In empirical terms, management characteristics appear to be the most crucial criterion for providing funds or not (also cf. Brettel, 2005, 248 in particular for the case of German business angels). It has also been asserted that business angels put less emphasis on financial returns and related financial data of the new venture than institutional venture capital or banking financers (v. Osnabrugge & Robinson, 2000). In particular, banks are assumed to place specific emphasis on financial considerations when making credit decisions regarding new venture projects (Mason & Stark, 2002). 95

Remember that concerns about management ability are also of importance to venture capitalists, in particular to European and German ones (cf. above). But business angels are considered to put an even greater emphasis on this issue.

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Lending to new businesses deviates from banks’ procedures of lending to established firms because financial performance data commonly used when rating existing corporate clients is lacking (Schulte, 1999, 96). Instead, qualitative, managerial business plan data and financial projections have to be considered. However, in this assessment it has been argued that aspects of managerial competence to build a growing business and corresponding market potential carry less weight as compared to equity investors (Mason & Stark, 2002, 4 for this and the following). This is because of the aforementioned low margins and limited upside participation in lending to new and small firms. Banks are therefore inclined to reduce risks to offer credit to businesses that may fail, rather than trying to avoid missing lending opportunities to new businesses that succeed (cf. Deakins, 1999 and Cowling, 2002 for these two possible types of errors in bank lending). In terms of evaluation criteria, it is argued that bankers’ assessments focus upon the underlying projected financial robustness of the suggested venture, e.g. a proper gearing ratio with sufficient equity capital and substantial tangible assets that offer security (cf. Burns, 2001 and Schulte, 2002, 56 for the principal function of equity to take on debt). In addition to screening for the robustness of a new venture’s financial structure, banks also commonly demand up-front collateral to be pledged in order to combat credit default risk (see Mason & Stark, 2002, 4 for this ‘potential for collateral’ criterion; also cf. Ewert et al., 2000 and the characterization of bank financiers in 4. 2. 2. 1. above). In this chapter, both similarities and specific differences across different groups of financiers have been described. The differences may offer potential to entrepreneurs to pick an adequate financial audience (cf. 3. 3. above for the select option in legitimating action). For example, new ventures with little growth ambition in established industries may find it easier to convince bankers to provide a loan than venture capitalists to provide equity. This may be because bank lenders are far less demanding in terms of rapid growth prospects because plain debt offers lenders limited upside participation anyway. Furthermore, within the respective financier groups there may be reasonable inter-subjectivity of selection criteria. This will be further discussed next in conclusion of chapter 4. 2. 2.

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4. 2. 2. 3. Stability and inter-subjectivity of financiers’ evaluation criteria To begin with it should be noted that − in accordance with chapter two above − it is not holistic evaluation criteria themselves which make investment and credit decisions, but rather financial actors like angel investors or bankers employing evaluation criteria in their decision-making. This has been pointed out, for example, by Tyebjee & Bruno (1984, 1063) for the case of pre-investment screening criteria in the venture capital domain. The authors use a modelling concept in which evaluation criteria are treated as antecedents to the venture capital manager’s risk-and-return perception of a suggested investment; this perception in turn is assumed to influence final investment decisions. From a conceptual perspective, pre-investment screening criteria would be less suitable as legitimacy restrictions on fund-raising processes, if, say, different venture capitalists employed completely heterogeneous assessment criteria which changed frequently and which were applied by individual financier actors in a totally subjective manner. Therefore, the issue of in how far reasonably coherent and stable evaluation criteria may exist within respective financier communities also needs to be addressed (i.e. in the banking, venture capital, or angel investor domain etc.). From an institutionalist’s viewpoint, this may in fact be a question of the extent of institutionalization of such criteria. Typically institutionalization is characterized by some kind of sanctioned regulative-normative element and degree of shared understanding which features durability (cf. Hwang & Scott, 2005, 204; Scott, 2001, 48 and 51p.; for a characterization of institutions and their functions see also Geue, 1997, 79pp.). To identify institutionalization, the seminal paper by Zucker (1987, 448) considers elements from the institutional environment (e.g. passing of law or professionalism) as well as possible consequences of institutionalization as possible indicators. Mirrored against such indicators, on the one hand there may be signs of institutionalization in financiers’ evaluation criteria. For example, elements of professionalism in some sub-domains of the financial environment may indicate institutionalization (see below), or isomorphism may be a visible consequence of it. An example of the latter may be that new ventures will typically have to provide business plans, because they are demanded by formal financiers such as venture capitalists or bankers (cf. above and also Picot et al., 1989 and Castrogiovanni, 1996 arguing that preparing business plans may often follow typified demands of external stakeholders).96 However, on the other hand, institutional 96

However, also cf. Gumpert and Lange (2003) for heterogeneity in the use of business plans by financiers.

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contra-indications may also be eminent in the application of pre-investment evaluation criteria. For the above features of stability and inter-subjectivity of evaluation criteria as legitimacy restrictions, both elements pro as well as possible reservations will be addressed.

Temporal stability of evaluation criteria Basically, the long-term stability of any societal evaluation may be doubted because it will have to rely on fallible socially constructed criteria (cf. Koch, 2003 and Hwang & Scott, 2005, 204 on institutional durability and change). For the case of financiers of entrepreneurial ventures, Brouwer (2002, 102; also cf. Rovenpor, 2004, 54) has noted that investors’ decisions also suffer from fallibility and underlying evaluation criteria may be adjusted in face of failing investment projects. In an analysis of the German venture capital industry after the high technology downturn, interviews with German entrepreneurs found that venture capitalists’ evaluations had become more severe after the downturn as compared to the time of the e-commerce and tech boom (Kollmann & Kuckertz, 2004, 54p.; also cf. Rovenpor, 2004). Authors as far back as Tyebjee and Bruno (1981) already warned that screening criteria may be cyclic in the venture capital industry. However, both issues may concern mainly the stringency of the pre-investment evaluation process by these financiers rather than changes in the underlying evaluation criteria themselves. Furthermore, substantial criteria changes may only emerge over a longer period of time, where the failure of many new ventures in a sector (such as internet technology) may prompt instability of evaluation criteria as a whole in the financial environment. This thesis does not analyze such, at least medium-term, processes of institutional evolution at the financial market level. Rather, such changes may be of limited relevance to the short-term focus on the fund-raising processes in individual new ventures. In particular, in this constellation, criteria changes induced by the individual venture itself are probably highly unlikely (cf. 4. 2. 1.).

Inter-subjectivity of evaluation criteria within financier sub-domains In relation to the above fallibility of pre-investment evaluation, there may also be only partial inter-subjectivity since there cannot be a canon of criteria to identify with certainty successful new venture projects to be financed. In particular, because of the above market and business risks that are difficult to control and foresee, financiers will have to

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rely on their “own judgement about the prospects of the opportunity presented by the entrepreneur” (Shane, 2003, 167). Here, early US studies on institutional venture capital managers’ decision-making found that there may be heterogeneity in the management and investment approaches of venture capitalists (Tyebjee & Bruno, 1984, 1065) as well as subjectivity in their evaluation and investment decisions partly relying on intuitive feeling (Hisrich & Jankowicz, 1990, 49). This may be even more pronounced amongst business angels, where the heterogeneity of investment experience and sophistication may be substantial (cf. Gompers & Lerner, 2003, 292) and where investment criteria may be less accurately defined (Kollmann, 2005, 75; also cf. Lindsay & Craig, 2002 arguing that intuitive investment decisions may be even more common in angel investing as compared to institutional investors). However, other studies have also identified aspects supporting the inter-subjectivity of evaluation criteria. This relates most notably to the exchange of experiences and communication within respective financier communities as well as to professionalization within financial sub-domains such as venture capital or banking. Parhankangas and Landstroem’s (2002, 9p.) main argument is that inter-subjectivity and isomorphism of investment practices in the venture capital industry arise as “venture capitalists will look to the venture capital community to determine what is acceptable behaviour in their relationship with the entrepreneur” (ibid., 9). Furthermore, the authors note that practices and norms may become shared in “occupational socialization processes” (ibid.). Similarly, Sanders and Boivie (2003, 167) point out that professional education and training of institutional investors and bankers function to disseminate experience knowledge across financial communities. This may lead to an increasing standardization of evaluation and investment practices to handle the uncertainty of new venture financing. In relation to this professional standardization, Brettel (2002, 305) and Kuckertz (2006, 74p.) note that investment decision criteria of venture capitalists appear to be fairly similar in comparative international studies. This may have its roots in the dominance of established US practices that have been adopted by junior venture capital markets established later in other countries (ibid.). As far as banking is concerned, Mason and Stark (2002, 12) found substantial similitude in bankers’ selection of new venture projects and they conclude that “this is likely to reflect the structured approach used by bankers to make lending decisions which is increasingly standardized between banks”. Not least, this may be because of the aforementioned Basel II regulation. Moreover, markets for rating advisory and consulting

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services have evolved in Germany around Basel II. Here, rating-related knowledge is diffused across both capital providers and particularly small and medium sized firms (cf. Becker & Grunert, 2004 and Janssen, 2004). In addition to such indications of standardization and professionalism in the domains of both institutional equity and debt, similarities in the screening criteria themselves have been found, too. Beyond the above similitude in bankers’ evaluations, venture capital managers’ assessments have also been studied. Riquelme and Watson (2002) analyzed the belief structures of UK venture capital managers concerning their implicit theories on new venture success and failure in order to elicit relevant assessment criteria. Most notably, similar patterns have been found for the above central managerial, product, and market-related characteristics (cf. ibid. pp. 403–405 where the authors elaborate on specific criteria patterns relating to these characteristics such as managerial track record, product competitive advantage, and clear market demand). Also, Reid and Smith (2003, 115) found similarities in the risk assessments of venture capital managers. This relates particularly to those central commercial factors affecting new venture viability and profitability. And finally, the above seminal paper by Hisrich and Jankowicz also notes that, despite the relevance of individual intuition, there appear to be general similarities in venture capitalists’ investment appraisals, in particular the relevance of management team quality and focus on the uniqueness of the venture’s core products (Hisrich & Jankowicz, 1990, 49). To sum up, on the one hand, unlike other institutional settings where past or current behaviour is assessed for conformance, the evaluation of new venture projects will primarily entail judging the uncertain future of the new venture. This may result in a kind of fuzziness of the underlying pre-investment evaluation process. On the other hand, the relevance of central management, product, and market characteristics as evaluation criteria may well be shared to a substantial extent within financial sub-domains, in particular within formal venture capital and banking. These partly institutionalized criteria constitute socially constructed beliefs of what works and what does not with regard to establishing a commercially viable and profitable new venture. It would not be prudent to consider the detailed application of pre-investment evaluation criteria to be inter-subjectively shared by all agents within a financial sub-domain. Having said this, assuming partial institutionalization of central criteria dimensions and their stability in the short-term appears to be a reasonable point of departure for exploring the contextual conditions of fund-raising processes. In conclusion of 4. 2., chapter 4. 2. 3. conceptualizes the selection pressures exerted by potential financiers as a result of their pre-investment evaluation.

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4. 2. 3. Pre-investment screening as external selection Overall, external evolutionary selection pressures on new ventures may be manifold. “Selection processes are experienced through the firm’s interactions with resource providers (including investors, the knowledge environment, and labour sources), co-producers, customers and competitors and regulators” (Stam & Garnsey, 2005, 5; also cf. Nelson, 2003, 72 for different selection forces, criteria, and mechanisms in the evolution of innovation). In face of this, Nelson (ibid.) contends that there will be different selection arenas and it may therefore be a good idea to focus on specific aspects of selection. In this study, the focus will be on selection pressures from financial resource providers and, in 4. 3. below, internal variation-selection activity by entrepreneurs throughout the fund-raising struggle. Section 4. 2. 3. 1. characterizes external financial selection within the context of the above pre-investment evaluation process. In particular, external financial selection events will be pointers taken up by entrepreneurs struggling to obtain funding. Finally, 4. 2. 3. 2. will sketch out the unit of selection as critical financiers evaluate entrepreneurs’ applications for funding.

4. 2. 3. 1. External selection pressures on fund-raising processes External financial resource selection (or financial selection) may be defined as differential elimination pressure on certain variations of new venture projects through the denial of financial support (following the general characterization of selection in the social domain by Aldrich, 1999, 23; also cf. Burns & Dietz, 1995, 353 who consider differential resource allocation as being a selection force in a similar way). This definition also follows Price’s selection concept as discussed by Hodgson and Knudsen (2004, 293). It entails Price’s notion of subset selection as picking “a subset of elements from a set, according to a criterion of preference or excellence” (Knudsen, 2002, 444; see also Price, 1995). For external selection in the financial domain, this preference judgement may be based upon the above pre-investment evaluation criteria. Beyond this, Hodgson and Knudsen (2004, 293) stress that subset selection needs to be amended by an element of retention through time. This means that, in line with general selection theory, two sets may be conceived, an anterior set from which selection is made in the course of environmental interaction and a resultant posterior set (ibid.). In this course not all variations relating to the anterior set will survive (ibid., 284). In the socio-economic domain this originates particularly from the scarcity of financial and other resources and

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their selective allocation (cf. Aldrich, 1999, 32).97 As to the implications of financial resource selection, both consequences in content and quantitative relevance may be considered. Concerning the consequences of selection, the selection pressures on new ventures will permit entrepreneurs to acquire resources and gain legitimacy for some variations but not for others (Brush & Manolova, 2004). For example, initial business ideas of overconfident, inexperienced founders may envision rapid consumer market entry with substantial advertising budgets and corresponding exaggerated amounts of first-round venture capital financing to be attracted. However, venture capitalists’ evaluation criteria and financing practices may not allow businesses to be established in this way (i.e. the combination of seed stage status lacking managerial experience, proof of operational feasibility and pilot customer acceptance on the one hand, and high amounts of initial seed financing asked for on the other hand). Basically, “[s]trong selection pressures may thus

quash

individual

variation

in

solutions

chosen

to

startup

problems”

98

(Aldrich & Martinez, 2003, 364).

Quantitatively, selection pressures may be severe since substantial rejection rates in external financiers’ pre-investment screening seem common. For the two-step evaluation process of German business angels Brettel (2005, 248) notes that about 90% of venture projects are rejected and for institutional venture capitalists rates are assumed to be similar, if not higher (cf. Cosh et al., 2005 for the extent of refusal in entrepreneurial and small business financing). Taking the above implications of financial resource selection a step further, these external pressures turn out to materialize as follows for entrepreneurs. Following the categorization of selection event implications in newly emerging industries by Henderson and Stern (2004, 46), two forms of external selection may be differentiated: a) full external selection as the complete extinction of an organization and b) partial external selection which only has a partial impact on the organization or influences only a singular element of the business organization, e.g. the suspension of a

97

98

Note though that potential resource allocations perceived to be superior to competing alternatives will still be pursued; i.e. there is no conflict with the fecundity of selective dissemination, e.g. of innovative business formats (cf. Mokyr, 2003). Also cf. Aldrich (1999, 28p.). and Davidsson et al. (2004) for further examples of external pressures driving new organizations towards isomorphism. Further, 3. 2. 3. 2. above presented possible business consequences of external resource owners’ hesitation to provide funding.

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product line facing poor customer acceptance.99 Recall also from 3. 2. 3. above that the refusal by potential financiers to provide funding may result in both complete venture failure as well as fractional downscaling of operations or the possibility of compensation through alternative financing means. This differentiation between full and partial external selection is strengthened by Burns and Dietz (1995, 354) who distinguish between absolute and relative selection, suggesting that there may be occasions of complete disaffirmation by the environment as well as comparatively minor partial rejection ‘relative’ to other entities who are found to operate more efficiently. Finally, Vromen (2001, 193p.) differentiates between ultimate selection caused by the environment and proximate causes which are internal to the entity upon which environmental selection forces are exerted. Vromen’s essential point is that it is the existence of a further mechanism beyond ultimate external determination which allows human agency in how agents behave in the social and market environment (ibid., 193 and 196p.). And in favour of internal selection Witt (2001, 18) stresses that “elimination by competitive market pressure is only the last resort by which less competitive firm behavior is eliminated. Usually, entrepreneurial self-sorting, anticipation of competitive disadvantages, and diverse sorts of imitative and innovative learning induce firms to change before they are selected out”. The scope for internal selection by entrepreneurial and managerial agents is also addressed in the above concept of external selection forces by Henderson & Stern, 2004 (also cf. the discussion of competitive and managerial selection in Knudsen, 2002). Such internal selection describes selective choices by firm founders or management about, e.g., product offers or financing intentions. Thus, in contrast to external selection theory, which stresses the external environment as the main selection force, internal selection theorists “view managers ... as the primary agents of evolutionary change because they decide whether individual products and technologies are retained or eliminated” (Henderson & Stern, 2004, 39). However, though these theories differ, “they describe tightly interwoven processes” (ibid.). Following up on the introduction of external and internal selection in 4. 1. 2. above, the essential point is the following. It is the existence of only partial external selection which principally allows internal entrepreneurial and managerial variation-selection activity. “Because environmental selection

99

The authors discuss the example case of the development of the US computer industry and the products offered by firms in this sector over time.

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need not to equate with organizational failure, it is important to ask if the death of some of the firm’s products [this is the authors’ case example; M.G.] prods it to learn about its environment in ways that affect its future decisions about internal selection” (ibid., 40). In the financial domain, partial selection by the first financiers approached may not lead to immediate elimination of venture projects. For example, after rejections from one group of financiers, e.g. venture capitalists, founders may ask other types of financiers for funds or adapt their business plan to make do with less funding.100 In essence, each event of financier rejection may point at an incompatibility between entrepreneurial agents’ judgement of the venture project and the demands of external resource owners in the financial domain (for this conflict also cf. Budzinski, 2003, 324p. and Shane, 2003). At the focal individual venture level, these sanctioned partial selection events feed into the creative, yet blind variation-selection activity throughout the fund-raising process. As to the specific concept of external financial selection in this chapter, the origin of selection, the criteria on which it is based, and the way in which it is done during pre-investment evaluation have already been touched upon in 4. 2. 2. However, what has been omitted so far is a conception for the actual functioning of selection and retention over time during the fund-raising struggle. This may sound trivial to financial practitioners. Financiers merely choose investment projects from the business ideas presented to them. To evolutionary economic theory building, however, this discussion is important in order to circumscribe socio-cultural evolution in comparison to biological evolution (cf. Jablonka, 2003, 39).

4. 2. 3. 2. External financial selection and internal selection choices In relation to the above definition of financial resource selection from created variants, the overall notion of subset selection resulting in a posterior set of retained variants has been introduced. This concept is based on the seminal contribution of Hull et al. (2001). In particular, the authors (ibid., 526p.) stress that selection means to pick variations as they interact with the environment and Hodgson and Knudsen (2004, 293) provide the following definition: “Selection involves an anterior set of entities, each interacting with 100

Moreover, Hodgson and Knudsen (2004, 294) assume that internal managerial selection involves “perceptions of efficacy rather than the test of the external environment”. This means that founder management may make changes to fund-raising plans and the overall business conception over time as it perceives new attempts to establish the business with corresponding funding to be more effective than previous attempts to attract funding from potential financiers.

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their environment, thereby transformed into a posterior set, where all members of the posterior set are sufficiently similar to some members of the anterior set, and where the resulting frequencies of posterior entities depend upon the properties of the members of the anterior set evaluated in their environmental context”. Note that this temporal notion based on Price (1995) encapsulates both subset selection and successor selection to contribute to evolutionary processes. A particular implication of this will be that variation and selective retention will not need to rely on the narrow biological analogy of replication as inheritance with imperfections in order to generate variation. Rather, the BVSR concept has been understood to allow variations by creative agents contributing

to an anterior set and their posterior internal and external selective retention.101 From Hodgson and Knudsen’s definition above, two inter-related issues relevant to financial resource selection may be derived: (1) selection from phenotypic variants of new venture projects as interactors with the environment and (2) successive retention through the passage of time. (1) As the business ideas of entrepreneurs move from the conception phase to implementation, they are expressed within the vehicle of new ventures, entailing developed prototypes and later product offers, sales and marketing activities, production procedures etc. (cf. Dawkins, 1982 for the concept of ‘vehicle’). This means that it will be entrepreneurial ventures themselves which are to face environmental selection forces such as competitors with alternative technical solutions, customers critical about the firm’s products, and sceptical financiers (cf. level II in figure 4–1 above). In the financial domain, external resource owners will come across this expressed form of entrepreneurs’ business ideas interacting with the environment. And even though their vicarious selection by proxy-variable may occur prior to full-swing competitive market selection as a kind of short cut (cf. again Cziko, 1995, 164p. and also Campbell, 1994, 31pp.), this selection may still be based on a phenotypic new venture project rather than on the purely cognitive contemplation of a business idea. In evolutionary terminology, therefore, selection in the financial domain may also be based on observed new venture projects as interactors (cf. Mokyr, 2003, 62p. for the case of technique; see

101

Note also that this may allow new variants to emerge from sources outside the process of selective replication itself (cf. Hodgson & Knudsen, 2004a). In other words, subset selection in an evolutionary process commencing at one point in time may not necessarily have to be considered to root deterministically from a fixed anterior set from which everything that follows will originate (as in Knudsen, 2002, 445).

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also Hodgson & Knudsen, 2004, 288 and 293 and Kappelhoff, 2004, 9 and 22p.; finally cf. Matthews, 2002, 41 differentiating the firm as a phenotype vehicle).102 Selective retention from a phenotypic vehicle that interacts with the environment is pointed out particularly in the dual notion of replicator (code) and interactor; here, the replicator is considered a carrier in which code is expressed and from which differential retention emanates (cf. Hull, 1988; Fleck, 2003, 250; Kappelhoff, 2004, 22 and also Hodgson & Knudsen, 2004, 295 who specifically discuss firms as interactors). With respect to the underlying mechanisms of endogenous change processes initiated by individual agents, in their concept of cumulative variation-selection Hesse and Koch (1998) have noted that cognitive creativity to generate variations and make selective choices from them will be sufficient to get the evolutionary process going. Having said this, to suggest an idea as to what this selective replication from variants may look like in new venture projects, one might refer to the notion of business conceptions. Abstractly, a business conception will be “a subjective interpretation of the entrepreneurial opportunity and the venture’s approach to exploit it” (Buenstorf, 2006, 11). Furthermore, an entrepreneurial business conception at the very beginning of firm genesis may be characterized as a cognitive frame of interrelated core components of the new business. In particular, this may entail its business model (i.e. the way the business is to earn profits) as well as the planned core product offer, envisioned target customers, and set up of central business operations (see Witt, 1998, 167; also cf. Caspers, 2002 for the evolution of business conceptions in the internet economy over time).103 For example, during the formation of the internet economy, potential financiers may have selectively retained newly emerging business conceptions, e.g., of providers of online auctions. At the same, the founders of these ventures might have changed their business conception as they made selective choices to adjust or even abandon their external financing plans. For example, entrepreneurs might have eliminated some of the planned service offers of the business as they adapted to a lower amount of planned funding. Or they might have scaled down the planned scope of their market roll-out, altering the format of their business conception. As to the relation between the emergence of organizational routines and business conceptions, Buenstorf (ibid., 12) remarks 102

103

In essence, this will mean group selection, in this case of (newly emerging) firms (cf., for example, Campbell, 1994, 32 and Kappelhoff, 2004 for a discussion of this implication of selection from phenotypes). See Bieger et al. (2002) for a definition of business conceptions and, in particular, the notion of core business models.

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that the two are closely related as “a shared business conception provides meaning to the firm’s routines”. This means that the notion of business conception may be complementary to the construct of firm routines (ibid.). Measured by the requirements of fidelity, fecundity, and longevity for proper replication units (cf. Knudsen, 2002, 449), business conceptions may be rated as follows (for a deeper discussion of conceptions versus routines see Witt, 2001). For one thing, like routines, business conceptions are abstract cognitive frames that may host elements of tacit knowledge difficult to be replicated by others (cf. Buenstorf, 2006, 12). And worse than routines, business conceptions are more complex, being an abstract integrative frame. However, in contrast to routines, business conceptions are much closer to the elementary surface of what a new firm basically does (e.g. the concept of a bakery, tax consultancy, car manufacturer, or online auction platform − i.e. formats of businesses which after some time may even become institutionalized and are now taken for granted). Therefore, it may be easier to detect and reproduce them than routines implicit in organizations. The fidelity of selective replication is strengthened by social conformity and institutionalized understanding of what could be commercially viable business and organizational formats of, e.g., online travel agencies or fast food restaurants (cf. Hodgson & Knudsen, 2004, 289). Regarding financial selection, it may be argued that, on the basis of institutionalized knowledge of what makes business success, economic agents will attempt to copy from those new ventures which showed signs of such commercial success. This is in line with Mokyr (2003, 62), who argues that “the ability of an innovator to market an invention, and to persuade others of its qualities, contributes to its chance of reproduction”.104 Finally, the elementary commercial orientation inherent in business conceptions may also propel the fecundity of replication as argued by Mokyr for the case of replicating techniques. In essence, techniques as the basis of product inventions and business conceptions as the basis of commercial innovation may spread because “each society is capable of producing many more products, in many more ways, than it actually does” (Mokyr, 2003, 62). And this goes with the implicit reasoning that innovators perceived to generate pioneer rents will attract followers so that their business conceptions may be copied more often (cf. ibid.).

104

Note that such institutionalized, inter-subjective understanding may also enhance stability and longevity of business conceptions.

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As pointed out in 4. 1. 2., this selective replication of variants will be Lamarckian in so far as the business format underlying a new venture does not unfold deterministically, but rather may change over time throughout venture establishment. This element of retained changes in the course of time is assumed to be common in general in sociocultural evolution (cf. below). And this Lamarckian element exists because of the above differential replication from phenotypic interactors which embody acquired characteristics obtained over time. “In living beings all genotypic change occurs at conception, but this is not the case in other systems ... Thus the ‘memome’ can ‘acquire’ characteristics during the lifetime of the vehicle, and pass them on − hence the long literature on the ‘Lamarckian’ nature of cultural evolution” (Mokyr, 2003, 63; also cf. Jablonka, 2003, 40 and Koch, 2005, 8 particularly comparing the evolution of living organisms and entrepreneurial firm genesis). One does not have to specifically buy into the idea that the only retention mechanism could be the gene equivalent, as in Dawkins’ meme concept which Mokyr refers to.105 Rather, the important point is that retention occurs from an observed interactor unit which, in principle, may have experienced changes over time. This selective retention from observed phenotypes may hold for both external and internal selection as stressed for the case of routine evolution by Hodgson and Knudsen (2004, 294): “By internal and external mechanisms some routines are copied more than others. The frequencies of posterior routines thus depend upon the actual or perceived properties of the anterior routines”. Underlying this process, there may be a range of possible inheritance and retention mechanisms, depending on the socio-cultural object evolving (cf. Jablonka, 2003, 40). This issue of retaining selected variations through time will now be addressed for both internal and external selection. (2) In internal selection by human agents (in this case entrepreneurs in new ventures), variants may be retained in human memory as in the cognitive concept of cumulative BVSR processes to be discussed in 4. 3. (Hesse & Koch, 1998; also cf. Mokyr, 2003,

61). In addition, selected variants may be inter-subjectively shared and preserved within the vehicle of firm organizations, e.g. in formal plans or in standardized operational procedures (for a general overview of this in the organizational domain cf. Aldrich, 105

In fact, there may be many different mechanisms in the socio-cultural domain by which knowledge may be retained and transferred (cf. Buenstorf, 2005, 22). Such means of retention and transfer are discussed in numerous works (e.g., vd. Ven & Garud, 1994 for procedural structures of variation, selection, and retention in technological evolution; Aldrich, 1999, 23pp., 30pp. and 340 concerning social retention mechanisms; also cf. Jablonka, 2003 or Fleck, 2003). And these mechanisms need not mirror biological reduplication for which there is no equivalent in the social domain (cf. Schurz, 2005, 420).

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1999, 22 and Kappelhoff, 2004 for the existence of symbolic code outside genes). For the particular case of entrepreneurial ventures, Buenstorf (2006, 13p.) notes that entrepreneurial business conceptions may be inter-subjectively shared and sustained with adaptations over time. This may function by communication and personal interaction between entrepreneur and employees. Overall, the internal mechanisms of retention in the memory of the entrepreneur, and the sharing of meaning within the nucleus of the new venture organization, may be the fundament to ‘record’ substantial changes throughout the fund-raising struggle at the individual venture level. In particular, these preservation mechanisms can be the basis on which focal selective retention of variants of business conceptions may rest. Such variants may be creatively generated and intended by entrepreneurs as difficulties encountered in acquiring external funding may prompt adjustments over time.106 Preservation in external selection processes follows from selective retention of phenotypic interactors observed by others. However, as a retention mechanism, this has to feature specific characteristics. In line with the above characterization of subset selection, there must be some similarity between the elements in the anterior set and the retained elements in the posterior set. Namely, this has to be some “crucial material or informational features that correspond to, or are derived from, features of a corresponding member of the anterior set” (Hodgson & Knudsen, 2004, 292). This similarity may be assumed in the typical case of successor inheritance (e.g. successive management teams passing on and keeping firm routines).107 Alternatively, similarity may be established via a mechanism coined ‘enduring identity’ by Hodgson and Knudsen (2004, 292). For endurance identity, which cannot rely on the bridging concept of succession, it is required that the ‘copying process’ features sufficient characteristics of the selected variants to be copied. For example, this may be the imitation of the core strategy or business model of a venture-capital-backed pioneer firm by followers in a novel industry sector. This may be facilitated by the “the cohesive nature of the replicator-carrying unit” (ibid., 295), in this case the new firm (cf. Aldrich & Martinez, 2003, 361p. and their concept of imitative reproducers). Note that this precondition of similarity and linkage between the two sets must be fulfilled not only for external selective retention but also for internal selection and reproduction within an organization. Here, however, 106

107

Implicit in this is that internal selection activity follows from feedback interactions of the new venture with the environment over time (cf. Jablonka, 2003, 40). Cf. Knudsen (2002) and Buenstorf (2005, 14) for further examples.

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the assumption that crucial informational features may be passed on to sustain a core of similarity appears reasonable; this seems to hold in particular for the focal case of internal retention within the single entrepreneur’s mind and within a small new venture.

4. 3. Entrepreneurial variation-selection in fund-raising processes So far in chapter four, the discussion has concentrated on mapping the immediate environment of restrictions and financial selection on new ventures trying to obtain initial external funding. Now, attention will be turned to the entrepreneurial fund-raising struggle itself (cf. level I in figure 4–1 above). As depicted in the time bar at the bottom of figure 4–1, the initial fund-raising process may commence during firm gestation and through early infancy. Activities of founders committed to establishing their venture may incur product development costs as well as founding and other launching costs. Correspondingly, seed and start up funding may be required (see, for example, Schulz, 2000, 8p. or Heitzer, 2000, 12p.; also cf. Mellewigt & Witt, 2002). Throughout their search for external financing entrepreneurs will face the above two-step initial screening and detailed evaluation process of financiers (cf. 4. 2. 2. 2.). Based on the above information sources commonly used by financiers, entrepreneurs may present their new venture projects in presentations and personal discussions, as well as through written business plans and other documentation communicated to potential financiers. In this context potential legitimizing sources such as those outlined in 3. 3. 2. 3. above may be utilized. In particular, during this interaction, entrepreneurs will receive feedback from potential financiers. This selection feedback and perceived demands of financiers may feed into further fund-raising attempts by entrepreneurs. The adequate approach to coming to an understanding of this process is argued to be cumulative blind variation and selective retention as a dynamic concept of subjectively rational entrepreneurial action (4. 3. 1.). Building on this, 4. 3. 2. develops a notion of trial variation and notional concretization of action as described by Fallgatter (2004). Within this concept, internal selective choice of action by the entrepreneur may be conceived as the formation and evolution of intentions to raise external funding.

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4. 3. 1. Creative variation and selective choice in entrepreneurial action To understand the initial financing struggle of entrepreneurs, the universal Darwinian notion of BVSR has been suggested as an adequate procedural approach.108 Beyond an epistemological understanding of new venture establishment and resource acquisition as a process of blind variation and selective retention, the BVSR concept needs to be integrated into a procedural concept of subjectively rational action. Such a concept has been suggested by Hesse and Koch (1998), based on their core concept of ‘Handeln in einer Gegenwart’ as presented in 2. 3. 1. 2. above. This concept will be applied to the specific case of entrepreneurial action over time (as has also been suggested by Fallgatter, 2002, 328 and 2004, 25).109 Hesse and Koch’s concept of creative individual action unfolds in the context of external environmental restrictions and selection pressures such as those in the financial environment. This is illustrated in figure 4–3, depicting cumulative entrepreneurial variation-selection action at the individual venture level.110 Elaborating on figure 4–3, two related issues will be addressed. First, an explanation of where variation and selection occurs in this concept of cumulative action over time will be given. Second, the time consuming character of action within the external restrictions environment will be looked at. In short, the principle of cognitive creation entails the variation component and the selection component is present in the principle of rationality (cf. figure 4–3 and Hesse & Koch, 1998, 425). The former relates to the generation and variation of action alternatives while the latter points at the individual agent’s role in making selective choices on the course of action (also cf. Butos & Koppl, 1997 and Rizzello, 2000 for endogenous variation and selection at the individual agent level).

108

109

110

Note that Campbell considered that his BVSR concept was also applicable to human creative thought and problem-solving (cf. Cziko, 1995, 310 and Campbell 1960). The relevance of creative blind variation and selection in entrepreneurial action to assemble resources and establish an organization has also been stressed by Aldrich and Martinez (2001); also cf. Harper (1996, 274pp.) whose “falsificationist entrepreneur” concept follows a similar reasoning. Further examples of a similar notion of cumulative variation-selection by agents in technical innovation processes may be found in Vincenti (2003). There is one adjustment here to the situation described by Hesse and Koch (1998, 426). In figure 4–3 the selection context of individual action over time solely depicts external selection factors. The internal selection factors mentioned by Hesse and Koch (individual aims, intentions) are considered to be included within the principle of rationality and the selective realization of a course of action.

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external selection and restrictions environment (resource and sales market selection; general socio-cultural and natural restrictions)

tn-1

fundamentals of action (1)

mental situation (2)

tn

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realization of action (3)

principle of cognitive creation

mental situation (2)

tn

principle of rationality

fundamentals of action (1)

principle of cognitive creation

tn-1

realization of action (3)

... t

figure 4–3: cumulative variation-selection in human action (adapted from Hesse & Koch, 1998, 426; also cf. 2. 3. 1. 2. above)

Variation is fuelled by the switching and testing activity of the human brain in perception and interpretation processes (see 2. 2. 3. above). As such, producing creative output as an autonomous activity of the brain (Hesse, 1990, 64) may originate from “spontaneous variation in the functional activity of the excessively unstable brain” (Cziko, 1995, 139 referring back to the discussion about the origin of inventions by William James; also cf. Hesse & Koch, 1998, 424 and Mokyr, 2003, 64).111 This activity is the source of variety in the possibilities for action; it is based on alternative perceptive and other expectations such as possible consequences of different actions related to supposed characteristics of the situational environment (see Hesse, 1990, 64; also cf. Koch, 1996a, 31 for this endogenous variation based on testing different subjective constructions of external reality which Cziko, 1995, 136 aptly described as following a “mental competition of beliefs”). While varying perceptive interpretations offered by the brain appear spontaneously, alternative courses of action, which partly build upon these interpretations, are also deliberately chosen from by the agent; therefore, as has been hinted at above, creative variation-selection in individual action comprises both random elements 111

Note that in contrast to Cziko’s depiction of restless inventors and their sudden inspirations, to Hesse and Koch autonomous creativity is a principal cognitive functional activity permanently performed by the brain.

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and deliberate purposefulness (Hesse & Koch, 1998, 427p.; also cf. Cziko, 1995 referring to the ‘creativity with cumulative selection’ notion of Ernst Mach). Hesse (1990, 64) summarizes that ‘alternative courses of action are thus created by the choosing subject’. Selection of action will be based on an evaluation of possible actions (taking place in (2) ‘mental situation’ in line with the principle of rationality; cf. figure 4–3). As explained in the discussion of subjectively rational action, individual choice from possible action plans created, means that the agent will choose the alternative consistent with his or her fundaments of action (including preferences, expectations relating to the environment, as well as behavioural capabilities). These possible trial actions may be considered as “hypotheses drawn upon experience and their selection is based on partly subjective evaluation of their respective successes or failures to achieve what is aimed for” (Kaisla, 2003, 250). Essentially, internal selection of action entails two interrelated issues: a) what is desirable in terms of aims and preferences and b) what is feasible in view of expected, possibly challenging, environmental conditions and one’s own capabilities. This feasibility orientation in face of environmental restrictions is also implicit in the cumulative variation-selection notion (see Hesse & Koch, 1997 and 1998, 426p.; also cf. the notion of matching internal entrepreneurial capabilities and external requirements in Cohendet et al., 2000, 107). Regarding feedback experiences about environmental restrictions and selection pressures, the cumulative character of internal variation-selection action emanates from the fact that the consequences of previous action are subjectively interpreted by the agent (Kaisla, 2003, 250). This will involve both unintended and intended consequences of previous action to feed into the fundamentals of action at one moment in time. In the time consuming concept depicted in figure 4–3 this is indicated by the arrows pointing from the realization of action in tn–1 into the fundamentals of action in tn (and similarly from tn into tn+1 etc.). In this cumulative sequence of single actions, human memory will function as a kind of knowledge repository of experienced action results to be ‘inherited’ over time (Hesse & Koch, 1998, 425; also cf. the role of human memory as a retention mechanism in 4. 2. 3. 2. above).112 Cognitively, these accumulated pieces of experience knowledge reside at the deeper structure level as illustrated in figure 2–2 (also cf. Rizzello, 2000, 145 for selection by agents to be based on existing cognitive

112

Also cf. Shane (2000) and Mitchell et al. (2000) for the relevance of prior knowledge to the perception of entrepreneurial opportunities and of the availability of resources in particular.

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structures). Remember also from the discussion in 2. 3. 1. 1. that these cognitive structures behind the fundaments of action further contribute to the formation of beliefs and attitudes as antecedents of behavioural intentions. Moreover, prior to acting, agents may go through loops of tentative trial actions, reconciling their fundamentals of action and the evaluation of alternative courses of action with the intent to act (cf. 2. 3. 1. 2. above where the cognitive basis for this tentative loop has been introduced). In figure 4–3 this is resumed and indicated by the dotted line which recursively links the mental situation (where possible actions are evaluated corresponding to the principle of rationality) and the fundamentals of action. This concept of evaluative trial-variation and notional concretion of action plans will be further elaborated next in 4. 3. 2. (following a concept of entrepreneurial action over time in Fallgatter, 2004). This will contribute towards building the specific conceptual basis for understanding how experienced restrictions and financial resource selection may relate to entrepreneurial fund-raising intentions. In particular, a paramount issue in 4. 3. 2. will therefore be to show that internal selection as the notional concretion and choice of a course of action corresponds to the formation of intentions to act in a specific way (eliminating other alternatives).

4. 3. 2. Trial variation and selective choice of action over time Figure 4–4 puts the emphasis on the above two connections between entrepreneurs’ fundamentals of action and their choice from action alternatives: (1) cumulative reflection of previous actions feeding into agents’ current fundamentals of action and (2) notional trial-variations and concretization of action plans based on this fundament. Fallgatter’s concept relates to entrepreneurial action in general; in figure 4–4 entrepreneurial action refers to the specific case of fund-raising action. Building on the model of Hesse and Koch, the trademark of the trial-variation and cumulative-realization notion is that results of entrepreneurial action do not follow a given, algorithmic means-ends nexus due to the underlying uncertainty and open-ended nature of the entrepreneurial process (ibid., 18). Rather, based on their judgement, agents are assumed to subjectively anticipate possible outcomes of potential courses of action. Choosing and pursuing a course of action will then be geared to these anticipations in accordance with the agent’s goals and expectations. This thought process, in which tentative actions are imagined and thought through, is depicted in loop (2) in figure 4–4.

trial-variation

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anticipation of possible consequences

(2)

notional concretization of action

execution of action

(1)

realization

reflection entrepreneurial resource acquisition action

figure 4–4: entrepreneurial action as trial-variation and selective implementation over time (adapted from Fallgatter, 2004, 23p.)

The uncertain consequences of the action that is finally pursued may later be compared with the above anticipations (ibid., 22). Over time, a sequence of trial variations, realizations of actions, and reflections will materialize (cf. loop (1) above). Overall, this may follow a process of problem construction – trial problem-solving attempts – partial solutions – and problem deferral (cf. Koch, 1996, 51 or Hesse & Koch, 1998, 431; also cf. O’Driscoll & Rizzo, 1985, 36).113 Variation arises with the help of cognitive creation as “people actively attempt to generate alternatives and seek solutions to problems” (Aldrich, 1999, 22). At the same time, “problem solving implies an investigation towards selecting and justifying action” (Landry, 1995, 318). Problem-solving takes time since a detailed problem structure in terms of both the target condition aspired to and the means to get there may be lacking (see Fallgatter, 2004, 19p. for the venture establishment process in general; also cf. Landry, 1995, 316). Next, the above two loops will be discussed in detail.

113

As to the problem case of attracting initial external financing, this may evolve alongside a perceived problem situation of having to convince potential financiers.

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Reflection of realized past actions over time (1) The reflection of actions that have been executed will be based on cognitive constructions of the environment at which these actions have been directed. In particular, based on the assimilation and/or accommodation of perceived environmental stimuli, human agents will experience and interpret confirmation or disconfirmation of their subjective expectations. These concern the make-up of the external environment and the impacts of their actions (see Budzinski, 2003, 216 for this feedback mechanism through action).114 In this thesis, the epistemologically modest BVSR notion has been favoured to describe what may be considered experiential learning from previous action. There has been criticism as to whether cognitive learning processes may be adequately described by the elementary mechanism of selection and inheritance (Buenstorf, 2005, 4). While cognitive-neuronal processes are surely more complex, however, the epistemological limitations of human agents do not allow an alternative to the notion of selective retention of trial variations with hindsight. In particular, concepts of providence and instruction do not appear to be adequate to explain adaptive complexity (Cziko, 1995, 281pp.). Regarding the only remaining explanation, the use of the notion of ex post hindsight is also evident elsewhere. This goes beyond the evolutionary constructivist stance, e.g. in Popper’s principal argument of adaptation through sequences of trial and error (cf. Popper, 2000). And so may learning by individual agents be assumed to come about via trial and error (cf. Popper, 1972 as well as Hayek, 1967 and Harper, 1996).115 Notwithstanding these limitations of imperfect perception, individual agents will still draw their own conclusions from action outcomes for future purposeful behaviour (cf. Rizzello, 2000, 143). At the heart of this reflection of past action, “the disclosing consequences are interpreted by the individual, and as the individual can perceive reality only through her subjective understanding, the degree of success or failure partly remains a subjective matter as well” (Kaisla, 2003, 250). This stresses two aspects of environmental feedback in the form of action consequences: first, the ex post factual external selection or ‘error’ feedback by the environment and, second, its internal subjective interpretation and further processing into future selective choices by the acting agent (ibid.).

114 115

Cf. Rizzello (2001, 9) for a treatment of cognitive perceptive feedback mechanisms. Recall that, however, the epistemological position put forth in chapter two does not presume any progress towards objective truth and outcome success.

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Such external feedbacks may be interpreted as being ‘positive’ or ‘negative’ (i.e. confirming environmental expectations through successful action or disconfirmation and related failure; cf. Budzinski, 2003 and Newbert, 2005, 61 arguing that feedback learning may have its roots in both success and failure). Positive interpretations may result in a kind of reinforcement learning in which activities are repeated or reinforced as confirming or beneficial action consequences have been perceived (Perkins, 2003, 165; also cf. Samuelsson, 2001). The case of negative feedback as trial and resulting error has been assumed to lead to selection-based learning from the above partial external selection events which reveal mismatching agent expectations about the action-environment quality (Henderson & Stern, 2004). The latter scenario of negative selection feedbacks will be particularly relevant as entrepreneurs face financiers who refuse to provide funding (cf. 4. 4. 3. 3.).

Trial variations and notional concretization of action (2) While loop (1) stresses trial and error learning from feedback on factual prior action, the second loop stresses the agent’s attempts to think through tentative future action ex ante, based on experiences accumulated so far (cf. Fallgatter, 2002, 327 arguing that trial variations will be affected by the entrepreneur’s prior experience knowledge). Essentially, this reflects Campbell’s selection theory of thinking as “substitute trial and error” (Cziko, 1995, 140; cf. Lorenz’ similar concept of ‘Denken als probeweises Handeln’ as referred to by Koch, 1996, 24).116 This notional short cut comes in handy in so far as it allows human agents to forfeit their notional theories instead of themselves (cf. Popper, 2000). In figure 4–4 thinking as substitute trial and error is conceived by the loop linking anticipations of possible consequences to notional concretisations of possible courses of action (cf. Shackle, 1961, 9 stressing that “the outcomes by comparison of which an act is chosen from amongst rival acts must be imagined outcomes”). The above “trials are viewed as representing the individual’s subjective conjectures about causal connections” (Kaisla, 2003, 250; also cf. Kerber, 1997, 51 and Gatewood et al., 1995). This is because such conjectures implicitly underpin any anticipation of consequences. Broadly 116

Underpinning this also cf. Pauen (2001) for the cognitive precondition that in addition to externally stimulated perceptions, internal action plans, behavioural imaginations, and intentions may also be possible content elements of conscious mind.

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speaking, these causal presumptions may be contained in the agents’ model of the environment and their action plans relating to this model.117 Finally, in the trial-variation loop, the evaluation of anticipated consequences and the further concretization of action prior to its execution will follow the above dual structure of the agent’s preferences and goals and the feasibility of action to be taken towards reaching these aims (again cf. Kaisla, 2003, 250 for this essential point). Next, it will be reasoned that this evaluation and choice from trial actions may be adequately understood through the concept of intention. Selective concretization of trial actions as intention formation In evolutionary terminology, the trial loop of anticipation and gradual evaluative concretization contains agents’ internal selection from imagined variants of potential action. In behavioural terms, this variation and focal internal selection of action is implicit in the agent deriving intentions to act from the above evaluation.118 This means that the abstract evolutionary notion of internal selection from created trial variations may be represented in the formation and change of intentions throughout the fund-raising process. The fruitfulness of this conception will be argued in the following four elementary points (also cf. 4. 4. below, where the use of intentions models in entrepreneurship is addressed in detail). 1) In chapter two, intent was seen as being a cognitive state prior to acting (cf. 2. 3. 1. 1. above). The qualitative result of the formation of intentions is assumed to include a mental image of the intended behavioural goal, together with the envisioned way of getting there (cf. Bird, 1988 for the entrepreneurial context). Intention is directed towards a specific goal to be achieved (Hindle, 2004, 589). And since there may be various action possibilities of varying supposed merit in terms of achieving this goal, intention formation will involve behavioural selection (also cf. the notion of ‘concretization of instrumental intentions’ in Guenther, 2001, 162). Finally arriving at the above image of aspired goals and selected course of action believed to lead there, the cognitive intention formation process brings about this selection through the above-mentioned repeated loop of anticipation and concretization. This is explained in the next point. 117

118

In fact, in Fallgatter’s original illustration (Fallgatter, 2002, 327 and 2005, 23), this is included by reference to the general action model of Guenther (2001, 114p.). Note that there are models with a basic structure similar to Fallgatter’s concept which also make use of the intention construct; cf. for example, Hindle (2004, 589) and the concept of Forbes (1999).

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2) The evaluative concretization of trial courses of action is based on anticipations of possible consequences in terms of achieving the agent’s behavioural aims (see above). The accord of goals and adequate actions as effective means to attain them has been conceptualized in various ways: a) goals and means to get there are derived simultaneously (Heirman & Clarysse, 2005), b) existing means prompting subsequent goals (as in effectuation theory; e.g. Sarasvathy, 2001) and, most commonly assumed for intentional behaviour, c) given goals and means to be derived from them (Krueger, 1993, 16; also cf. Brush, 2001 for the case of resource acquisition). However, although the order of the two elements may vary, in the end all three concepts involve the following argument. For intentional behaviour to materialize, both adequateness to the agent’s goals and their attainability within a course of action will be reconciled by the agent. This means that, in line with the above evaluative concretization of trial actions, a necessary antecedent of intentional action is the belief that the envisioned action would serve the agent’s goals and, at the same time, is considered feasible (see, for example, Rivis & Sheeran, 2003 for an overview or Krueger, 2003, 109 and Linan & Chen, 2006 for recent accounts from entrepreneurial intentions research). Note in particular that this has also been argued to hold for the specific case of entrepreneurial resource acquisition (cf. Reitan, 1997). 3) Intentions, though purely cognitive, are also substantial in terms of actual internal selection action pursued by the agent. This is because intentions are considered to be the most important influencing factor of actual behaviour, even though this behaviour may not lead to the intended results (cf. for example, Boyd & Vozikis, 1994, 64 or Krueger, 2003). Here, the above-described sequence of trial variation, realization and reflection of action over time may also be accommodated within the intentions context, as intentions may change over time (Bird, 1992). This may be particularly relevant in face of unintended outcome events experienced during the entrepreneurial process (cf. Jenkins & Johnson, 1997). Such unintended consequences and possible subsequent adaptations of intentions may relate to erroneous anticipations as to the feasibility of the a priori envisioned goal-action combination (also cf. Fallgatter, 2004, 20 for such continuous adaptations of means and ends). This underscores the idea that, in a process-oriented approach, intentions will be cognitively constructed, transforming interpretations of external events into behaviour (Krueger, 2000, 9). 4) Finally, it has to be appreciated that trial variation and realization of action over time will also be characterized by contextual factors which exert selection pressure on

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agents’ trial variations (Fallgatter, 2004, 23p.). For the focal aspect of internal selection in face of external selection pressures and restrictions, this is also reflected in the notion of intentional behaviour and its antecedents (cf. Becker, 2000 arguing that agents’ intentional action will consider the institutional context within which the action has to prove viable; Koch, 2002 particularly stresses that external selection criteria will be appreciated in humans’ intentional choices of action). Beyond these principal issues referring to institutional restrictions and external selection forces, the above central desirability and feasibility antecedents of intentions also take into account environmental and other contextual factors, in particular norm-driven social acceptance criteria such as financier demands (for a general overview cf. Krueger, 2003 or, in particular, Rivis & Sheeran, 2003). Therefore, a framework of entrepreneurial intentions may also be of benefit for exploring the focal aspect of cumulative fund-raising trials to evolve alongside external restrictions and selection events. Consequently, chapter 4. 4. sets out to develop conceptual orientations concerning entrepreneurs’ fund-raising intentions within the struggle to acquire initial external finance. This elementary intentions-based framework will provide the necessary conceptual orientation for the empirical exploration in chapter five.

4. 4. Evolving fund-raising intentions: exploratory theoretical orientations The elaboration of conceptual orientations of entrepreneurs’ external fund-raising intentions is structured as follows. In contemporary entrepreneurship research the analysis of entrepreneurial new venture creation and other entrepreneurial behaviour is frequently based on intentions models originating in mainstream social psychology (cf., for example, Krueger, 2000; Sharma et al., 2003; Lee & Wong, 2005; Mair & Noboa, 2005; Zhao et al., 2005; Linan & Chen, 2006; see Baron & Ward, 2004 for a general overview). Thus, 4. 4. 1. will refer to the body of literature in which entrepreneurial intentions models have been applied. The framework in these models offers insights into the functioning of entrepreneurial intentions in founding a venture in general. However, these general concepts are not tailored to the specific task of raising initial funding for a venture project. Hence, the next two chapters develop a specific framework of external financing intentions. Chapter 4. 4. 2. provides a brief overview of the exploratory framework. The different conceptual orientations will be elaborated in detail in 4. 4. 3.

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4. 4. 1. General entrepreneurial intentions models as a reference Based on Bird’s original account of entrepreneurial intentions, Boyd and Vozikis (1994, 64p.) stress that new venture creation will involve conscious and purposeful acts towards starting a new business (also cf. Linan & Chen, 2006, 3). Basically, “starting a business constitutes a complex, distal behavior” (Krueger, 1993, 5). As such, this behaviour will be planned to a substantial extent since action to found and establish a new venture may hardly be considered to follow simple stimulus-response (ibid.; also cf. Krueger, 2000 noting that the decision to become self-employed will commonly be conscious, voluntary, and purposeful; also cf. Greve, 2001). In particular, intentions will be an essential influencing factor for firm founding to materialize and for the course of action in this entrepreneurial process (cf. Mair & Noboa, 2005, 2 and Bird, 1988). This is because intentions are an important predictor of planned behaviour (Linan & Chen, 2006). Intent itself is assumed to be influenced by different factors contributing to a set of intention antecedents (ibid., 3). In short, models of entrepreneurial intentions study possible antecedents of how it comes about that individuals found their own new venture. In particular, they aim to explain intent to start one’s own business through constructs corresponding to perceived antecedents of intent. This intent is then related to taking action to found a venture; this is reasonable since if intent is absent, founding action will be improbable (Baron & Ward, 2004, 555 and Mair & Noboa, 2005, 2). Some of the antecedent variables employed in modelling entrepreneurial intentions have been adapted from Ajzen’s seminal framework of intentional behaviour developed within general social psychology. In addition, the specific case of entrepreneurial intentions research has also been based on Shapero’s prior work on entrepreneurial events, a concept, though developed independently, resembling Ajzen’s framework (Krueger, 2003, 117 and Linan & Chen, 2006, 4).

Roots of entrepreneurial intentions concepts: entrepreneurial event model and theory of planned behaviour The conception suggested by Shapero (1985; also cf. Shapero and Sokol, 1982) argues that the entrepreneurial event, that is the initiation of entrepreneurial behaviour (Krueger, 2003, 117), will emanate from the intent to start a venture based on a “personally credible opportunity” which is both desirable and feasible to the agent (ibid.; also cf. Krueger, 1993, 5). The model proposes that entrepreneurial intentions are influenced by perceived venture desirability and feasibility together with a propensity to take action (cf., for

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example, Mair & Noboa, 2005, 2p. or Krueger, 2000, 7; see also figure 4–5 below). The original model and later refined versions have been tested for a number of samples and found good overall empirical support in terms of explained variance in entrepreneurial intentions (cf., for example, Scott & Twomey, 1988 and Krueger, 1993 for a test of the original model; cf. Krueger, 2000 and Krueger et al. 2000 for discussions of refined versions; in addition, cf. Reitan, 1996 and 1997 and Mair & Noboa, 2005, 2 for further specific refinements). Refined versions of Shapero’s model also consider cognitive intentional antecedents (and the exogenous factors contributing to them) which have been elaborated in Ajzen’s seminal theory of planned behaviour − TPB − (also cf. the recent writings of Linan & Chen, 2006, 4 who, though concentrating on TPB in their empirical analysis, discuss the linkages between the constructs in both models and argue that the two appear to be compatible). The theory of planned behaviour (Ajzen, 1991, 2001 and 2002) has been argued to be applicable to a wide range of purposeful behaviours (Krueger, 2000, 7; cf. particularly the meta-analyses of TPB in Armitage & Conner, 2001 and Rivis & Sheeran, 2003 who point out various target behaviours to which research has applied the TPB concept). Because of this widespread use, TPB is also employed more widely in entrepreneurship today than Shapero’s notion (Linan & Chen, 2006, 4). In essence, TPB has its roots in research into the link between personal attitudes and behaviour (Kruger, 2003, 116; also cf. Kim & Hunter, 1993). TPB claims that intentions explain action in specific contexts and function as a moderator between attitudes and behaviour (Mair & Noboa, 2005, 2). In other words, intentions themselves are assumed to be moulded by underlying beliefs and attitudes (Sharma et al., 2003, 2; also cf. the antecedent layers in figure 2–2 in 2. 3. 1. 1. above). In terms of distinct constructs, TPB considers both social and personal influencing factors that may help to understand the formation of intentions and, ultimately, behaviour (e.g. Rivis & Sheeran, 2003, 218 and Boyd & Vozikis, 1994, 64). These antecedent constructs of intent are primarily assumed to be personal attitude towards the target behaviour in terms of personal attraction, perceived social norms, and a construct of behavioural controllability (Ajzen, 1991; Reitan, 1997; Rivis & Sheeran, 2003; Krueger, 2003; Linan & Chen, 2006).119 With respect to the formation of entrepreneurial intentions, 119

In the chronology of Ajzen and Fishbein’s research programme, their earlier theory of reasoned action added the notion of social norms to the explanation of intentional behaviour. Later, TPB introduced perceived behavioural control as an additional explanatory factor (cf. Ajzen & Fishbein, 1980 and Ajzen, 1991).

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Reitan (1997, 4) has illuminated these three theoretical constructs in the following simplified questions about founding one’s own business: “Do I want to make it?; Will others approve of it?; Can I make it?”. In short, personal attraction reflects the individual agent’s positive or negative personal evaluations concerning a focal behaviour, in this case initiating entrepreneurial behaviour to start one’s own business (see, for example, Kolvereid, 1996 and Krueger, 2000, 10p.; for a general overview cf. Rivis & Sheeran, 2003, 218). Such individual attitudes towards performing a behaviour comprise both affective (e.g. like or dislike, pleasance) and evaluative attributions (e.g. the personal benefit or profitability of becoming an entrepreneur) (Linan & Chen, 2006, 4). In relation to performing a behaviour, social norms “are conceptualized as social pressures that people perceive from important others” (Rivis & Sheeran, 2003, 218). Such norms refer to “the perception that ‘reference people’ would approve of the decision to become an entrepreneur, or not” (Linan & Chen, 2006, 4). Note that social norms refer to a specific reference group relating to the target behaviour under study (Krueger, 2000, 11). For external financing intentions, this may entail perceived pressures from potential financiers. Finally, perceived behavioural control represents “the perception of the easiness or difficulty in the fulfilment of the behaviour of interest (becoming an entrepreneur)” (Linan & Chen, 2006, 4). The construct is closely related to Bandura’s self-efficacy notion which has been characterized as the agent’s judgement of capability in relation to a task (cf. 2. 3. 1. 1. above; see also Ajzen, 2002 for TPB and the self-efficacy construct). Both constructs relate to perceived capabilities to perform a behaviour and not so much to evaluative outcome expectations and their attractiveness (Boyd & Vozikis, 1994, 67; also cf. Bandura, 1984 and Gist, 1987 for these differences). Behavioural controllability therefore also contributes to Shapero’s notion of perceived feasibility. In fact, TPB’s behavioural control notion as well as self-efficacy and agents’ feasibility judgements are all concerned with “the sense of capacity regarding the fulfilment of firm creation behaviours” (Linan & Chen, 2006, 5).

Illustration of a model of general entrepreneurial intentions Overall, entrepreneurship research has provided a refined version of Shapero’s framework which also integrates the above TPB constructs into a model explaining entrepreneurial intentions (cf. Krueger et al., 2000 and Krueger, 2003 as well as Mair & Noboa,

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2005). In particular, Shapero’s perceived desirability has been explained by personal attraction (personal desirability) and social norms (social desirability) while feasibility has been related to collective and personal self-efficacy (see Krueger, 2000, 10–12). In terms of the overall model structure, entrepreneurial intentions are conceived to be influenced by desirability and feasibility attitudes towards entrepreneurial behaviour (Sharma et al., 2003, 2). And these attitudes themselves are affected by beliefs about for example self-efficacy and relevant social norms (also cf. Linan & Chen, 2006, 7 for this layered structure of beliefs-attitudes-intentions in contrast to other conceptions). Consequently, any exogenous social and personal influences are assumed to impact upon intentions only indirectly by influencing antecedent desirability and feasibility attitudes (Krueger, 1993, 16 and 2000, 8; see also Shepherd & Krueger, 2002; cf. Lee & Wong, 2005 and Linan & Chen, 2006, 3 for examples of possible environmental and personal exogenous influences). The overall model framework of entrepreneurial intentions is depicted in figure 4–5.120 The central antecedent attitudes of perceived desirability and feasibility are further characterized as follows. Perceived desirability refers to “the degree to which one finds the prospect of starting a business to be attractive” (Krueger, 1993, 8) and, in addition to this valuation, beneficial (similar to the affective and evaluative dimensions of personal attraction in TPB above). Perceived feasibility includes the extent to which an agent assesses that a target behaviour will “feasibly lead to the desired outcomes” (Sharma et al., 2003, 2). This perception of feasibility will be influenced by underlying beliefs about the entrepreneur’s efficacy when it comes to initiating behaviour to start a business (as in figure 4–5). To sum up, conceptions similar to the intentions framework in figure 4–5 have been found valuable in a range of specific entrepreneurial contexts above and beyond explaining entrepreneurial behaviour to found a new business in general. Examples are corporate entrepreneurship (Shepherd & Krueger, 2002), small business succession (Sharma et al., 2003), and social entrepreneurship (Mair & Noboa, 2005; also cf. Krueger, 1993, 7p. who some time ago recommended an exploration of intentions in 120

As far as other constructs not yet introduced are concerned, the figure also includes propensity to act and possible precipitating factors. Propensity to act may moderate the relationship between attitude antecedents and intentions. It refers to the innate tendency to take action which may vary across people (Mair & Noboa, 2005, 4; also cf. Krueger, 1993, 9 and 12). Contextual precipitating factors are influences which “precipitate the realization of action into behavior” (Krueger, 2000, 10). Such factors may be, e.g., available time budgets (ibid.).

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exogenous factors (personal + environmental)

personal desirability perceived desirability perceived social norms

intention

action

perceived self-efficacy perceived feasibility

propensity to act

precipitating factors

perceived collective efficacy

figure 4–5: model of entrepreneurial intentions towards venture formation (adapted from Krueger & Brazeal, 1994; Krueger, 2000 and 2003; and Mair & Noboa, 2005)

relation to specific contexts such as type of venture or industry). It has also been supposed that “intentions models offer a coherent, parsimonious and robust framework for pursuing a better understanding of entrepreneurial processes” (ibid., 5) and the above applications seem to indicate that this still holds empirically. Furthermore, findings suggest that entrepreneurial intentions appear to be based on only a few critical antecedents (these are mainly perceptions of desirability and feasibility) which facilitate or inhibit the formation of intentions. And exogenous factors are viewed to impact upon intent through these antecedents (see above and Krueger, 2000, 8). Therefore, intentions frameworks may enable an exploration of the influence of various supposed exogenous influences on these antecedents and, in turn, on intentional entrepreneurial behaviours (cf. Krueger, 1993, 16 for this possibility). Because of the suggested range of application to different intentional behaviours of entrepreneurs and its flexibility to explore different exogenous influences, the above intentions framework serves as a good reference point. It will thus be the point of departure for exploring the specific case of obtaining external finance as a central task within the intentional process of starting and funding a new venture.

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4. 4. 2. Overview: exploratory framework of fund-raising intentions Extension of existing entrepreneurial intentions concepts It has been pointed out above that intentions models have been directed at differing types of ventures intended to be launched. However, intentions have not yet been related in detail to specific entrepreneurial tasks within the new venture founding-, establishment-, and further-development process.121 Krueger (2000, 18; also cf. Krueger, 2003, 119p.) claims that this would, however, be a good area to study. This is because the path of founding and establishing a new venture will generally involve many different steps within a long-term process (also cf. Lee & Wong, 2005 and Kyroe & Carrier, 2005). In this process, the existence of entrepreneurial intentions to commence with founding activities is only a first step (Linan & Chen, 2006, 3) while the above further steps along the way will also involve making behavioural choices based on an intentional process (Krueger, 2000, 18). And here “the intentions model should also help us understand specific aspects of a new venture” (ibid.). This means that intentions will be more fine-grained than the mere intent to take action to start or continue a business or not (cf. Davidsson, 1991 and Krueger, 2003, 119). For example, intent may be directed at tapping a specific market segment or distribution channel (ibid.). It may also be directed at taking specific action to assemble the necessary financial resource base. Following this path, exploring fund-raising intentions thus not only relates to existing entrepreneurial intentions concepts but may also contribute to their further development by exploring a distinct task within new venture establishment. The above approach of multiple steps within a complex process also implies that an investigation into the temporal dimension of continued and possibly changing resource acquisition intentions will be fruitful. In particular, positive arrangement cognitions of resource availability that feasibly contribute to entrepreneurial intentions to found a venture (as in Mitchell et al., 2000) may be further investigated for their continuity or change over time. Here, the suggested analysis strives to offer a first exploration of this specific aspect. In a general investigation of continued entrepreneurial efforts to grow a venture or simply carry on with an existing business, Davidsson (1991), Brown and Kirchhoff (1997), and Wiklund and Shepherd (2000) have found it valuable to take a similar temporal approach. This was done by analyzing intentions and their antecedents 121

That said, note that entrepreneurs’ perceived self-efficacy has been analyzed in relation to different instrumental tasks in the venture creation process; cf. Kickul and D’Intino (2005).

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above and beyond the snapshot of intentions towards the singular act of founding a venture. Overall, despite the fact that entrepreneurs may change intentions over time in complex behavioural process like those above, this is still a fairly unexplored aspect (Krueger, 2003, 119). This entails intensifying the use of process models in entrepreneurship and entrepreneurial intentions research in particular (cf. Krueger, 1993). In this respect, the following framework will also appreciate the temporality of implementing task-specific entrepreneurial intentions.

Tentative framework of fund-raising intentions In temporal terms, the framework depicted in figure 4–6 commences from the beginning of firm gestation and venture establishment activities for which external funding may be needed (cf. Tgest in figure 4–6).122 However, in particular, the focus will be on the time-consuming struggle to attract initial external funding in existing infant ventures up to the point in time of break even (marking the end of new venture infancy). Concerning the existing new ventures under study, this thesis will not explore whether obtaining external funding may appear feasible to entrepreneurs at the outset of gestation (probably it will since, without the belief that funding will be feasible, entrepreneurs would not have engaged in firm gestation and financing efforts in the first place). Rather, the framework pertains to the struggle of actually attracting desired external funding, i.e. it investigates the implementation of initial external financing intentions in the gestation and early infancy phases of existing new ventures. It explores whether these intentions are sustained or how they may change over time (cf. above and Krueger, 2000, 18 for this kind of research perspective on the implementation of intentions and changes over time). In essence, the struggle emanating from the need to attract external funding constitutes a problem situation upon which the fund-raising struggle unfolds. In this problem situation, on the one hand, external funding is desired, but on the other hand, the exact path to gaining legitimization from and winning the resource support of external financiers is uncertain (cf. Lindstrom & Olofsson, 2001, 164p. and Stouder & Kirchhoff, 2004 who have derived empirically that acquiring initial funding is indeed perceived as a problem by early-stage entrepreneurs). To study this open-ended process, the framework in figure 4–6 will be employed as an orientation, mapping out a possible structure

122

This will be the retrospective element of the empirical analysis; cf. figure 5–1 in 5. 1. below.

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for conceiving focal fund-raising intentions. It contains the constructs to be analyzed for their relevance to the problem situation perceived by case entrepreneurs and to possible changes of their intentions throughout the problem-solving process. In particular, the role financial selection events play, based on legitimacy demands in the form of screening criteria, will be explored as potential influencing factors on entrepreneurs’ intentions towards seeking funding during venture establishment.

precipitating factors

perceived desirability of external funding T02a-c

fund-raising intentions

perceived financier demands

fund-raising action

propensity to act T01a

T03

T01b

perceived feasibility of external funding

perceived capability to raise funding

feedback signals over time Tgest conception

Tbirth gestation

Ti1 infancy

Ti2

t adolescence

figure 4–6: orienting framework: entrepreneurs’ fund-raising intentions over time

In the next chapter (4. 4. 3.), the different components of the framework will be elaborated on. This will offer distinct theoretical orientations (TO) for empirical exploration. First (4. 4. 3. 1.), the perceived feasibility of attracting external finance is addressed in the context of perceived financier legitimacy demands and the perceived capabilities to legitimize with external financiers (cf. TO 1a and 1b on the left-hand side in figure 4–6). In addition, the relevance of a restriction which captures the idea that a minimum level of funding may be required to preserve liquidity will be also be introduced. Second, 4. 4. 3. 2. addresses fund-raising intentions. In particular, it will put forward ideas as to possible changes of these intentions over time (TO 2a, b, and c; cf. Figure 4–6). To be able to study such focal changes, the conception will track alterations of entrepreneurs’

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financing needs and preferences (perceived desirability) as well as fluctuations in propensity to act. This is necessary because the latter two aspects may offer plausible rival reasoning regarding changes in entrepreneurs’ financing intentions. Third, 4. 4. 3. 3. further describes how the struggle to convince potential financiers may unfold in relation to the above intentions. This chapter lays the ground for a study of how, if at all, selection feedback from potential financiers becomes relevant to continued fundraising attempts of entrepreneurs (cf. TO 3 in figure 4–6). Note that the exploration of possible impacts of selection pressures concentrates on intention changes as the cognitive locus of internal selection, and less on resource acquisition action itself. Also, the framework is not fully recursive in the sense that actual resource acquisition behaviour is assumed to deliberately cause a specific feedback to occur which would have already been recursively included ex ante in fund-raising plans. Rather, because the path to obtaining external funding is uncertain, entrepreneurs may go through iterative attempts to convince financiers, experiencing feedback signals throughout this struggle (cf. the model in Mitchell et al., 2000, 976p. for a similar conception of non-recursive procedural feedback). In figure 4–6 this loose link is indicated by the dotted line to represent potential outcome feedback, originating in previous action (this corresponds to the reflection of past actions in Fallgatter’s concept of entrepreneurial action over time − cf. 4. 3. 2. above).

4. 4. 3. Conceptual orientations for empirical exploration The theoretical (or conceptual) orientations to be elaborated may help to take a first step towards developing both (retrospective) descriptive and, ultimately, also broad predictive patterns in future research; this is because they explore both external and internal antecedent dimensions of entrepreneurs’ intentions (cf. Krueger, 2003, 119 for this explanatory rationale). Before moving to the particularities of the specific theoretical orientations to be explored, this is a good point to briefly reflect upon two limitations of this approach. First, note that in contrast to general entrepreneurial intentions models, the tentative framework of fund-raising intentions does not hypothesize about any causal explanations (which is why directional causal arrows have been omitted in figure 4–6). Nor does the empirical case study in chapter five serve to proof any hypotheses. Rather, the modest objective of the qualitative empirical exploration is to derive propositions for

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future research in the first place. This cautious exploratory approach seems wise since the above tentative framework derived from adjacent intention, finance and legitimacy theory has not yet been applied to the phenomenon of continued intentions to seek external funding over time. As such, it can provide only an initial approximate orientation for the qualitative case study analysis to be conducted in chapter five. Mair and Noboa (2005) have followed a similar approach in their case analysis of intentions in social entrepreneurship. Miles and Huberman (1994, 20p.) have recommend theoretical orientation frameworks (such as that in figure 4–6) to be used in qualitative research. Theoretical orientations guide qualitative empirical inquiries by providing orienting or sensitizing concepts from prior theoretical development (Yin, 2003, 28p.; Creswell, 2003, 134p.; cf. also Curran & Blackburn, 2001; chapter 5. 1. below offers further methodical reasoning for the use of theory in the qualitative case study design to be pursued). Second, the suggested investigation will be limited to the focussed, analytical components of intentionality while more intuitive elements may have to be ignored (cf. Boyd & Vozikis, 1994, 63 and Bird, 1988, 444 for these two principal dimensions of intentions). These elements may be difficult to observe for the researcher, simply because such intuitive elements may stay unconscious in part, not even accessible through introspection by the acting agents themselves (cf. Hindle, 2004).123 Note also in this context that it will neither be possible to make precise predictions about what fundraising action entrepreneurs may pursue exactly, nor will it be an option to infer intentional entrepreneurial action from its results (also cf. Fallgatter, 2004 for this). Rather, the focus can only be on a broad understanding and reconstruction of planned actions to seek funding and their possible antecedents. In essence, the result may be a heuristic method for understanding approximate patterns of changing fund-raising intentions over time.

123

However, on the positive side, any intentions to act that arise spontaneously may still be acknowledged based on underlying attitudes which may be reflected as long as the intent pertains to a conscious, planned behaviour (Krueger, 2000, 9).

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4. 4. 3. 1. Perceived feasibility of acquiring funding (TO 1a and 1b) The first two theoretical orientations consider what may contribute to the perceived feasibility of entrepreneurial action to acquire external funding for a new venture project. With respect to this task, it seems worth exploring both how entrepreneurs perceive their own capabilities to convince financiers (TO 1b below) as well as their perception of normative acceptance hurdles set by potential financial resource providers. It will be argued that the perception of normative acceptance hurdles constitutes a kind of reference hurdle to which any judgement of capability to acquire finance may be related. Put simply, this will involve asking: ‘Can I do what it takes to obtain external finance’?

TO 1a: perceived financier demands for legitimacy TO 1a suggests that, amongst other elements, perceived financier demands for legit-

imacy may be relevant to the perceived feasibility of fund-raising (cf. figure 4–6 above). It is worth exploring entrepreneurs’ judgements as to whether acquiring funding will be possible; and concerning what may contribute to these judgements, one may want to look at how difficult it will be in the eyes of the entrepreneur to meet financiers’ demands. Within this context, perceived feasibility reflects the entrepreneur’s perception of his or her ability to obtain initial finance for the new venture project from external sources (cf. Mair & Noboa, 2005, 3 as well as the original concept of Shapero and Sokol, 1982 for an equivalent characterization of the feasibility construct in relation to founding behaviour in general). At this general level, the above authors (also cf. Mitchell et al., 2000) also include other, e.g. human and social, resources in their definition of feasibility perceptions. In contrast, within the focus of this thesis, perceived feasibility specifically relates to the task of feasibly attracting financial resources. Perceived financier legitimacy demands in initial venture financing refer to the entrepreneur’s belief about how severe financiers’ pre-investment screening will be. The entrepreneur’s views on financier expectations are assumed to consist of two linked aspects: a) the actual screening criteria and procedural demands perceived to be relevant (e.g. having to present a business plan), and b) the perception of how hard financiers will make it to meet these demands and to overcome this acceptance hurdle. The former may in part resemble the common central criteria dimensions discussed in 4. 2. 2. 2. above (founder competence, marketability of firm product offers, and financial risk-return considerations). The

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latter is conceptualized as the perceived intensity of this hurdle (see Kouriloff’s notion of ‘intensity of barriers to business creation behaviour’ on which this conception is based, Kouriloff, 2000; also cf. MacMillan et al., 1986). The intensity of barriers may range from absolute to minor (Kouriloff, 2000, 61). According to Kouriloff (ibid.) absolute barriers may even lead to termination of the target behaviour under study (starting a business; in our case trying to obtain finance); minor barriers may not have such an inhibiting effect.124 There are a number of theoretical contributions that help to understand why and how financier legitimacy demands (and the acceptance barrier they pose) may contribute to entrepreneurs’ feasibility perceptions of obtaining external finance. First of all, in research into antecedents of intentional behaviour to start one’s own new business, feasibility perceptions have been argued to be influenced by perceptions about the accessibility of external, including financial, resources and the possible barriers this may constitute in the eyes of potential founders (see Mair & Noboa, 2005, 10; also cf. Mitchell et al., 2000 and Kouriloff, 2000). The proposed influence may work for both evaluative dimensions. Positive beliefs about resource availability may propel perceived feasibility while negative beliefs may be detrimental. Correspondingly, it may be reasoned that beliefs about financier legitimacy demands as a central aspect to financial resource accessibility could also be important for perceived feasibility of financial resource acquisition in particular. In addition, research into the TPB social norms construct as a possible intentional antecedent provides further reasoning. Financier legitimacy demands are similar to the social norms construct in TPB. This is because they also refer to normative social expectations with regard to carrying out a specific target behaviour and whether it will be acceptable to external audiences or not (cf. 4. 4. 2. above). In TPB models, this social influence on behavioural intentions is conceptualized as an injunctive social norm “concerned with perceived social pressure, that is, the person’s potential to gain approval or suffer sanctions from significant others for engaging in a behaviour” (Rivis & Sheeran, 2003, 219). Here, engaging in action to acquire finance involves the entrepreneur asking for funding for the new venture project with its specific characteristics (including the competences of the entrepreneur). And the above perceived social pressure will be about whether this activity may find approval or 124

An empirical example of where such a hurdle may have been perceived as quite intense is discussed in Schulte (1999). The author refers to the empirical case of German start-up entrepreneurs perceiving substantial risk aversion, lack of interest, and hesitation of commercial banks to fund new, in particular innovative, ventures.

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not.125 With regard to attracting external financiers to the venture, the important point is the following. Because fund-seeking intentions relate to a target behaviour for which the active support of external others will be essential, the relevance of social pressure to the formation of intent may be assumed to go beyond traditional, socially trimmed perceptions of desirability.126 Essentially, to feasibly perform fund-raising behaviour the approved support of external financiers is required. Therefore, perceived social pressure imminent in financier legitimacy demands ought to be explored within the context of perceived feasibility of intended fund-raising.127 This perception will be based on the entrepreneurs’ individual past experiences which may be inter-subjectively shared to some extent (cf. Reitan, 1997 inquiring into where we learn that entrepreneurship is feasible and desirable). Concerning the way in which experience-based beliefs about financier legitimacy demands may be explored in relation to perceived feasibility, Reitan (ibid., 5) offers a further useful differentiation. Stored experience on societal demands or norms may have been fuelled both by direct personal experiences as well as by indirect experiences gained from the new venture projects of other entrepreneurs (i.e. descriptive social norms referring to observations of what of others do; cf. Rivis & Sheeran, 2003, 219p.). How severe entrepreneurs perceive legitimacy demands to be will be broadly explored in the case interviews based on the following dimensions: a) beliefs about the criteria content of financier screening (e.g. ‘What do you think financiers will look for when they decide about providing a loan or offering investment to an entrepreneur?’) and b) consequential beliefs about the intensity of the barrier that financiers’ screening criteria may pose to obtaining funding (e.g. ‘How difficult will it be to meet the demands you perceive?’). In a first step, both a) and b) may be openly explored against the background of the above direct past personal or professional experiences (including in-process feedback from potential financiers in relation to the current new venture project) and indirect

125

126

127

For example, an entrepreneur who tries to establish a venture which will use a new technology of still uncertain merit may be concerned about whether banks will offer credit to such a venture; cf. figure 3–11 in 3. 3. 3. above which pointed out that it may be more difficult to legitimize when the venture’s offers are novel and uncertain. Also cf. the above distinction between active support and passive external acceptance in legitimizing. Note that financier legitimacy demands would be relevant in their subjective perception by the entrepreneur (cf. Elsbach, 1994, 57p.; also cf. Reitan, 1997, 4 as well as Davidsson, 1991 and Koch, 1996, 78 for the relevance of exogenous influences such as environmental restrictions or social norms, as they are subjectively perceived).

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experiences from the observation of others. Only then may the pre-investment screening dimensions (which have been elaborated from entrepreneurial finance theory in 4. 2. 2.) be probed for in a second step, asking about the entrepreneur’s views on their relevance. Perceived feasibility is to be elicited by asking questions based on how sure the entrepreneur is that external start-up funding can be obtained (Krueger, 1993, 11 applies the degree of certainty of obtaining finance as one indicator of perceived feasibility in relation to general entrepreneurial intentions; cf. Stouder & Kirchhoff, 2004, 366 and Reitan, 1997 for similar indicators).128

TO 1b: perceived capabilities to raise funding

While TO 1a concentrated on perceived external financier demands, TO 1b is concerned with the entrepreneur’s beliefs about his or her own capabilities to effectively engage in fund-raising behaviour. In particular, TO 1b provides guidance regarding the possible contribution of capability beliefs to the entrepreneur’s feasibility attitude as regards external financing (cf. figure 4–6 above). Perceived capabilities represent agents’ beliefs regarding the competences, skills, knowledge, and other capacities required for acquiring financial resources (corresponding to the definition of ability cognitions in relation to creating a new business in Mitchell et al., 2000, 978 and Baron & Ward, 2004, 555). Note that, in the authors’ definition, thoughts about competences and capacities are viewed in relation to what is required for the focal target behaviour (also cf. Bandura, 1977, 193). In our case, these requirements are represented in the criteria and procedural demands in existing practices of pre-investment screening (cf. Smallbone et al., 2003, 2 indicating concerns about the ability of loan applicants to prepare business plans that conform to “the required formal format and detail required by bankers”). This reference to external demands in the cognition of capability to engage in a behaviour is also reflected in the notion of self-efficacy, which will be a central component of perceived capability (see below). Self-efficacy refers to the perception of capability to perform a task, including the reflection of future obstacles (cf. Krueger, 2000, 11 and Boyd & Vozikis, 1994, 66). As such, self-efficacy has been said to be less concerned 128

The strength of a case study approach will be to explore and identify construct elements relevant to entrepreneurial agents in the real world. These could then be used to build indicator scales for measuring theoretical constructs in the future.

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with the expected desirability of the outcomes of behaviour according to the agent’s preferences, i.e. valence (ibid.). However, as noted earlier, perceived efficacy does entail the agent’s judgement as to whether he will be competent to achieve a certain level of performance in that behaviour. And for this judgement, external financier demands as to what is expected to be displayed or done by the entrepreneur when asking for funding may well be relevant (see Gatewood, 2004, 154p. who argues that such instrumentality judgements not only entail internal ability considerations but also refer to environmental and situational constraints; see also Brown & Kirchhoff, 1997, 6 who argue that an entrepreneur’s “resource acquisition self-efficacy should be related to his or her perception of abundance of the resources in the environment”). The following additional reasoning can be put forth to argue that perceived capabilities may be relevant to entrepreneurs’ assessment of whether financing activities may be feasible or not. Regarding entrepreneurial intentions, cognitions of one’s abilities have been found to influence the business creation decision (see Mitchell et al., 2000). Within this context, self-efficacy as the perceived capability to pursue a specific target behaviour (Krueger, 2000, 11) has also been said to explain perceived feasibility of that behaviour and the formation of the intent to act (cf. Boyd & Vozikis, 1994, 63). For the feasibility of entrepreneurial intentions this has been pointed out in the above model in figure 4–5, based on the works of Krueger and colleagues as well as Mair and Noboa. Krueger (2000, 7) stresses that “if we see ourselves as competent we are more likely to see a course of action as feasible”. In addition to perceptions of the level of efficacious personal competence, the above concept needs to take into account possible further capacities that founders may perceive to be relevant to the fund-raising task. These may include: a) collective efficacy perceptions, b) available personal networks that may be viewed to ease legitimizing and funding, and c) perceived legitimizing sources of the new venture project itself. a) Collective efficacy, i.e. the perceived competence of other persons who team up with us, may also contribute to perceived feasibility of action to set up an entrepreneurial project and assemble the necessary resources for it (Shepherd & Krueger, 2002, 172). In the situation of acquiring external funding for an existing new venture, this may include the competences of existent co-founders (who, for example, are better skilled to put together and give a high quality management presentation to potential investors). b) Personal networks of entrepreneurs have been considered to impact on perceived feasibility of entrepreneurial behaviour in general and resource access in particular

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(Mair & Noboa, 2005, 4); they may also be relevant to the specific task of obtaining funding which may work via network contracts (cf. the most recent contribution by Giannetti & Yu, 2007 who argue that favouritism and connections will be relevant to capital allocation). From the viewpoint of the entrepreneur, this may be encapsulated in cognitions about the possession and potential use of social contacts (cf. Mitchell et al., 2000, 977). The entrepreneur may perceive legitimizing via these relationships as being less difficult, making financial resources more easily available (cf. (5) in figure 3–11 in chapter 3. 3. 3. above). c) Finally, in the above discussion of entrepreneurial legitimizing action in 3. 3. 2. 3. it has been argued that potential firm- and industry-level sources of legitimacy may contribute towards gaining initial legitimacy with financiers. Because fund-raising behaviour will also involve legitimizing activities in order to portray the new venture project in a way favourable to financiers’ interests, existing (or lacking) legitimizing sources may also contribute to entrepreneurs’ perceived capabilities to feasibly acquire funding. For example, a perceived lack of an initial customer base as a reference may make the entrepreneur feel that it would be difficult to demonstrate conformance to financier demands for proven marketability of and customer demand for a venture’s product offers. Next, an overview will be provided of how the components considered for a perceived capabilities construct will be explored. This will entail the self-efficacy component, covering the personal capacity of the entrepreneur and, briefly, the other above-mentioned capacities (personal networks, collective efficacy, and instrumental legitimizing sources of the venture itself). Self-efficacy beliefs are task-specific (Krueger, 2003, 125) as they relate to the perceived level of capability to execute a certain behavioural pattern (see Boyd & Vozikis, 1994, 67 and Brown & Kirchhoff, 1997, 6 who define resource acquisition self-efficacy as “the self-belief or perception about a person’s ability to raise or gather the required resources”). For the purpose of this study, the exploration of personal efficacy perceptions will be related to the task of obtaining finance but not to other resources. For the empirical exploration of perceived capabilities, existing self-report indicators of entrepreneurs’ perceived financial sophistication from the US Panel Study of Entrepreneurial Dynamics (PSED) will be used as a broad orientation. Financial sophistication captures entrepreneurs’ and small business owners’ perceived financial management knowledge and understanding of financial elements and processes pertaining to a new and small business (Katz & Cabezuelo, 2004, 372p.). Amongst other aspects, it also entails competence perceptions about preparing financial data for potential external financiers

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(cf. ibid., 376).129 Indications of financial sophistication offer a first orientation here since a central ingredient of individuals’ efficacy beliefs is their perceived level of relevant skills and situation-specific knowledge (cf. Krueger, 1993, 11 and Reitan, 1997, 8).130 With respect to personal network contacts that may be part of positive capability beliefs, the question of whether entrepreneurs enjoy existing direct and indirect private or professional contacts to potential financiers and financial intermediaries will be explored (cf., for example, Greve, 1995 for a straightforward analytical structure and use of possible direct ties and boundary persons in entrepreneurship). These ties may be financiers ‘in person’ (e.g. a private business angel) or agents who work with an institutional financier and are personally linked to the entrepreneur (e.g. ‘somebody from the local bank I know from the sports club’). Moreover, Mair and Noboa (2005, 4) note that not only may immediate relationships to financiers be of help but also personal contacts to people in business incubators, small business support agencies or technology centres. In addition to having such personal contacts, their supposed instrumentality to obtaining funding will also be probed within the context of perceived capabilities. In a new venture, it could be the case that more than one person may have such personal contacts. Therefore, an examination of whether entrepreneurs believe that others close to or within the new venture may support the fund-raising process with their personal network contacts as well as with their skills and knowledge will also be included (collective efficacy). Finally, the last suggested dimension of perceived capabilities has been legitimizing sources of the new venture itself. For investigating this dimension, the potential sources of legitimizing (see 3. 3. 2. 3. above) and their possible differentiations from 3. 3. 3. will be employed (consult in particular figures 3–10 and 3–11). It may be asked in how far the features of the venture project will convince potential financiers. Here, for example, existing sales records, reputable customer endorsements or a unique product technology protected by patents may contribute to entrepreneurs’ beliefs in their capabilities to impress potential financiers. 129

130

Further orientation for the entrepreneur’s competence assessment to obtain funding is provided by Brown and Kirchhoff (1997) who point out some indicators of efficacy beliefs specific to acquiring external finance. This also involves past mastery experiences which, if truly positive, may reinforce the level of perceived efficacy (Shepherd & Krueger, 2002, 172). Possible questions therefore look into prior indirect observational or direct personal experiences, e.g., relating negotiations with banks to arrange a private loan or talking to investors about funding in the context of previous professional work experience. Note that such experiences, be they positive or negative, will be made not only prior to but also during the focal financial resource acquisition process under study.

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Invariant minimum threshold of external funding and personal liquidity Finally, another firm-level source in the legitimizing challenge has been existing financial capital from personal savings of the founder. In particular, above and beyond demonstrating the founder’s commitment, such liquidity infusions to the venture offer additional leeway. This is because such personal investments make the task of acquiring funding from outside the venture less urgent and give the entrepreneur time to find an external financier. Conversely, the entrepreneur may need to obtain a minimum amount of external funding for the new venture at some point while securing a threshold level of liquidity. For example, a venture which is to operate an industrial production facility will require a certain minimum volume of capital expenditure to be financed net of personal investments by the founder(s). This operational constraint concerning the new firm’s production that has to be set up and run may well put an additional invariant restriction on the course of the fund-raising process. To explore how this restriction may take effect, the following point of departure would seem to be appropriate. The need to obtain a threshold level of external funding within a limited period of time might be relevant to the perceived feasibility to acquire sufficient funding. Theoretically, the impact of this constraint is taken into account in the resource criticality dimension of resource dependence theory (cf. 3. 2. 3. 2. above; also cf. Reitan, 1997, 275 pointing out that perceived feasibility will be reflected in the belief that sufficient capital for the venture project can actually be acquired). For example, the critical need to gather a minimum amount of money urgently may make the entrepreneur less certain that it will be possible to succeed with the funding process at all.131 So far, possible aspects that could contribute to the perceived feasibility of external financing have been suggested. Next, an orientation for investigating possible changes of entrepreneurs’ fund-raising intentions over time will be developed.

131

Note that this need for a minimum level of funding does not so much pertain to desirability. In contrast to the envisioned overall amount of external finance, the minimum funding requirement can not be varied by the entrepreneur.

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4. 4. 3. 2. Changes in fund-raising intentions (TO 2a-c) The next two chapters address possible changes in entrepreneurial intentions during the struggle to acquire initial external financial resources. With respect to offering an orientation for how such changes may come about, 4. 4. 3. 2. prepares the ground for an exploration of the relevance of shifts in perceived feasibility (TO 2). Second, 4. 4. 3. 3. looks into the possible role that feedback signals from potential financiers may play in this context (TO 3). Concentrating on possible antecedents of behavioural intentions and action plans of entrepreneurs may allow some elementary patterns to be discovered with regard to how entrepreneurs actually manoeuvre in the financing struggle. Chapter 4. 4. 3. 2. proceeds as follows. The first section characterizes the notion of fund-raising intentions as well as perceived desirability and feasibility as their possible two elementary antecedents. Here, the reason why perceived feasibility is in the centre of the analysis will be introduced. The second section presents the theoretical orientations for facilitating the empirical exploration of changes in financing intentions and of the focal feasibility construct as well as other potentially relevant factors. At the end of the chapter, other possible rival influences on intention changes will be discussed. This is done in order to differentiate between these influences and the founders’ reasoning of the feasibility of external financing throughout the process.

Introduction: characterizing intentions towards external financing and its desirability and feasibility Fund-raising intentions may be influenced not only by feasibility perceptions, but also by the desirability of seeking external financing.132 In this context, perceived desirability may be characterized as the perceived affective and evaluative attractiveness of taking action to acquire external funding for a new venture (based on the characteristics of general desirability noted earlier). The personal desirability of external funding for the entrepreneur may refer to the need for external funding as well as to the entrepreneur’s financial source and capital structure preferences (see below). Note that personal desirability may well be the central factor driving the genesis of intentions to found a business or acquire external funding in the first place (cf., for

132

Cf. figure 4–6 above where possible rival influences are depicted in italics.

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example, Linan & Chen, 2006 stressing that the initiation of behavioural intentions will often be driven mostly by personal desirability of the behaviour). Having said this, the relevance of desirability may be different when it comes to the implementation of intentions to acquire finance during the fund-raising struggle (for a differentiation between identifying resource needs and their later acquisition from potential suppliers cf. Brush, 2001). Brush suggests that “to assemble necessary resources, an entrepreneur should break the process into two steps, first specifying what resources are needed and, second, identifying and targeting potential sources or suppliers of resources” (ibid., 72p.; also cf. Krueger, 1993, 16 who indicates a similar relational structure between goals and derived means). The idea is that before and at the very beginning of venture gestation, fund-raising intentions may be primarily driven by desirability considerations. This said, during the focal struggle to raise desired funding, feasibility may deserve more attention. Here, the entrepreneurs in the existing ventures under study are already committed to trying to establish their venture and acquire the necessary funding for it. As has been noted earlier in 3. 2. 2., financial resource needs and preferences may change over time and therefore perceived desirability will be tracked (cf. the section at the end of the current chapter). This will allow feasibility shifts in the context of evolving financing intentions to be explored. Next, in order to be able to study the continuity and change of these intentions over time, they need to be characterized more precisely. In particular, this study is interested in exploring not only the mere continuity (or discontinuity) but also possible changes of existing financing intentions in new ventures. Entrepreneurs’ fund-raising intentions are defined as the intent to take action towards obtaining initial financing from potential financiers for the purpose of funding a new venture project (the structure of this definition corresponds to the characterization of general entrepreneurial intentions − see above; for the notion of obtaining initial external financial support see, e.g., Reynolds & Miller, 1992). Traditionally, entrepreneurial intentions (here to start a new business in general) have been conceptualized as a dichotomous variable merely covering the existence or absence of such intentions in an unconditional concept with no behavioural alternatives (cf. Kouriloff, 2000, 60 and Linan & Chen, 2006, 4). However, this is rather arbitrary since intentions are more finely graded with different levels of effort and commitment to an intended behaviour within the context of alternative courses of action (ibid. and Krueger 1993, 14).133 This 133

For example, a person may wish to become a full-time entrepreneur with substantial growth aspirations for the business while another founder only intends part-time self-employment.

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need for differentiation also holds for the case of external funding intentions placed in a context of alternative options such as self-financing, financial bootstrapping, or adjusting capital expenditure so that less external funding would be required. In addition to the above dichotomy, focal external funding intentions will therefore be further characterized by the amount of initial external funding sought and the type of financier (or financing source) from which the entrepreneur intends to obtain the money (based on the above general characterization of assembling resources in Brush, 2001). From a procedural perspective, substantial changes in these intentions may for example involve the entrepreneur reducing the amount of external funding sought or moving to an alternative group of potential financiers to be approached within the process.

TO 2a to TO 2c: changes in external financing intentions over time TO 2 explores adjustments of entrepreneurs’ financing intentions, in particular in the

context of shifts in perceived feasibility. The latter refers to the degree of certainty with which the entrepreneur is convinced that he or she will be able to secure desired funding (cf. the characterization of the feasibility construct in 4. 4. 3. 1. above). Shift here means an increase or decrease in the financing chances in the eyes of the entrepreneur. Because the focus is primarily on external restrictions constituting a challenging hurdle, the study looks at the consequences that perceived declines in feasibility may have during the search for financiers. Further, it will be interesting to explore in which circumstances entrepreneurs keep up their substantial financing plans, and when agents adjust or even give up their intentions to try to attract external finance. The conjecture that perceived feasibility may be relevant to changes in intention will be reasoned in the theoretical orientations (TO 2a, b, and c) to follow. Overall, it has been argued that perceptions of feasibility partly explain behavioural intentions as in figure 4–5 above (cf., for example, Shaphero, 1982, Krueger, 2003; or Mair & Noboa, 2005 again concerning general entrepreneurial intentions). In particular, Krueger (1993, 6 following up from Shapero’s original ideas) suggested that it may require a minimum level of perceived feasibility of a target behaviour for intentions towards that behaviour to occur. Viewed from a procedural perspective, it therefore seems reasonable to explore the idea that existing intentions may be discontinued should perceived feasibility fall below a threshold level during the financial resource acquisition struggle (cf. TO 2b below for this ‘extreme’ adjustment of external financing

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intentions). Furthermore, the idea has been pointed out that entrepreneurial agents respond to resource constraints during the venture establishment process (cf., for example, Mosakowski, 2002). The perception of these resource constraints may be expressed in a perceived diminishing feasibility to obtain them. Here, in-process responses may involve adjustments in entrepreneurs’ prior intentions to engage in attempts to acquire a specific amount of resources from external sources (TO 2a; also cf. Krueger, 2000, 18 suggesting that changes in perceptions of feasibility and desirability may result in corresponding changes in the basis of entrepreneurial intentions). Finally, TO 2c will explore deviations from financier sources that the entrepreneur has approached for funding so far (e.g. abstaining from further attempts to attract risk capital from venture capitalists). To facilitate the empirical exploration of possible elementary patterns in this process, the three orientations listed above will now be described in more detail. 1) TO 2a: reductions in the intended volume of external funding In short, TO 2a explores in how far entrepreneurs may reduce the amount of external finance sought in face of declining feasibility to raise funding. It has been found that entrepreneurs and small business owners try to sidestep perceived difficulties in obtaining formal equity and debt finance by non-standard means of bootstrapping to fund operations (cf., for example, Winborg & Landstroem, 2000, 235 and 237). Procedurally, this might well involve adjusting the planned volume of external institutional funding to be acquired from, e.g., a bank. Here, v. Kalkreuth and Murphy (2005, 7pp.) point out that in small businesses (including young firms), financing plans for capital expenditure and other spending items are adjusted to possible perceived capital constraints. Corresponding to reductions in the intended amount of external funding, the reasoning of Winborg and Landstroem and of v. Kalkreuth and Murphy encapsulates two main ideas: a) compensation by bootstrap financing and/or b) downsizing planned business operations in order to adjust financial requirements. In fact, for new ventures which are still in the phase of preparing and initiating full-scale business operations, the two ideas are closely linked. In terms of financial bootstrapping, Winborg and Landstroem (2000, 244) have identified a range of methods that may be applied by entrepreneurs. For example, the following methods may be found (ibid.):

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• hiring personnel temporarily at lower salary instead of permanent employment • granting lower salary for entrepreneur and management • employing relatives at non-market salary • taking on or continuing assignments in another business • funding via delaying payment from early business partners and suppliers • running the business from home. For the empirical investigation the use of these and other methods will be looked at to understand changes in standard external financing intentions and corresponding use of operational bootstrapping measures. Similarly, a reduction in efforts to acquire external funding may take place together with a corresponding adjustment of planned investments in the establishment and expansion of business operations (for a general overview of this argument cf. Hager et al., 2004, 163 and 3. 2. 3. 2. above). Such reductions will also be explored within the context of adjustments to prior investment aims, e.g. as expressed in previous business plans of entrepreneurs. Such cutbacks or deferrals may concern budgeted items such as production capacity, manning level, or advertising budgets (for a general overview, cf. Bhide, 2000).134 It is also conceivable that external financing plans will be abandoned completely (rather than just reducing them to a lower volume). This will be addressed next. 2) TO 2b: continuation or termination of external financing intentions TO 2b inquires into the circumstances in which entrepreneurs may give up or continue

to pursue their current intentions during their search for external funding. For purposes of orientation it is put forth that intentions may be abandoned in cases where the agent considers action to attract sufficient external funding unfeasible after substantial declines in perceived feasibility. Recall that such beliefs may arise against the background of the above invariant restriction of a minimum level of external funding and liquidity; the possible minimum of required funding reflects that there may be a limit to downsizing planned business operations while having to preserve a minimum level of liquidity puts a constraint on the time left to find financiers. The rationale for analyzing entrepreneurs’

134

Note that such changes in financing and investing intentions refer to the forward-looking aspect of deliberately adjusting to perceived declines in feasibility. It is this future-oriented intentional aspect of internal entrepreneurial selection which is focussed on, rather than concurrent shortterm operational responses to an existing lack of funding (e.g. having to let initial personnel go or close the business because of problems with the credit line from the bank).

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decisions to give up their external financing intentions during the process broadly corresponds to the analysis of sequences of venture formation gone through by nascent entrepreneurs. Nascent entrepreneurs who gave up their intentions to found a business in the emergence phase have been characterized as those that “have tried and tested out their ideas and found that they would not work according to their expectations” (Carter et al., 1996, 152; also cf. Korunka & Kessler, 2005 who particularly stress the role of negative environmental feedback in decisions to give up). Emerging concerns that implementing their desired business or financing concept might not be possible could be cognitively reflected in feasibility perceptions that have diminished from feasible at the outset to unfeasible. This may be reasoned as follows. Emanating from the idea that intentions are an intersection of desirable and feasible behavioural opportunities (cf. Krueger, 2003, 118), it has been suggested that in order to elicit intent, perceived feasibility and desirability may each have to be above some threshold level (see, e.g., Krueger, 1993, 6 and 8). Thus, feasibility and desirability antecedents may be multiplicative rather than additive (cf. Krueger, 2003, 116p. and Reitan, 1997 who conceptualized intentional antecedents in this way). Of course, it should be acknowledged that this potential threshold effect has only been articulated for the formation of entrepreneurial intentions in the first place rather than for their later perpetuation over time (be it during the struggle to establish a venture in general or in the financing process in particular). However, it seems fair to kick off the exploration of continued fund-raising activities with this orientation. This is also backed by Kouriloff (2000). The author (ibid., 61) suggests that perceived barriers which make venture establishment look unfeasible to entrepreneurs may result in in-process termination of hitherto existing entrepreneurial efforts.135 3) TO 2c: turning to other potential financiers TO 2c refers to the intuitive idea that there may also be changes in the potential fi-

nancier sources to be approached throughout the search for finance. To offer some input 135

Abstractly, the above study of start-up sequences by Carter et al. (1996) also hints at the possibility that events of perceived unfeasibility may not only inhibit the initiation of start-up intentions, but may also contribute to terminations of entrepreneurial endeavours later on (see also Fallgatter, 2005, 67p. referring to Gimeno et al., 1997 for the relevance of threshold effects for continuation decisions; also cf. Davidsson, 1991 who inquired into the factors that may influence the continuation of entrepreneurial growth efforts in existing businesses). Note finally that Davidsson (ibid.) and Fallgatter (2005, 68) stress that it will be subjective, reality-as-perceived factors which influence entrepreneurial intentions and growth orientation.

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for the empirical exploration, one idea may be that entrepreneurs may turn their backs on currently approached group(s) of financiers, no longer believing that they will be able to convince financiers from this group. In particular, turning away from one’s preferred first source of external funding will be explored later.136 Here, desirability considerations may have driven the intentional choice of approaching a specific financier group first. However, entrepreneurs may turn to another financier group as they become less certain that it will be possible to obtain, e.g., venture capital during their quest for funding.137 It seems reasonable to follow this broad orientation in light of both conceptual reasoning and initial empirical evidence. Whilst there may be substantial similarity in the cannon of financier screening criteria dimensions, differences in emphasis and the importance of criteria specific to particular sub-domains might well exist (cf. 4. 2. 2. 2. above). In view of this, it might make sense to turn to specific potential financier groups during the process. In particular, such procedural changes are backed by the above basic legitimizing strategy of selecting a more favourable domain with demands that may be easier to conform to than the expectations of financiers approached so far (cf. Zimmerman & Zeitz, 2002 and Suchman, 1995; see also 3. 3. 2. 3. above). Furthermore, empirical evidence of source changes in attempts to obtain external funding is provided in a study on discrimination in the access to bank finance by ethnic minority entrepreneurs in the UK (cf. Smallbone et al., 2003). Within different communities of ethnic minority entrepreneurs, the authors report that Afro- Caribbeans where most active but least successful in seeking bank loans (ibid., 6). In particular, outright rejections by bankers and other obstacles were experienced by those entrepreneurs who approached the banking system asking for credit.138 Furthermore, in face of such perceived obstacles, Afro-Caribbeans were found to turn most often to alternative potential sources of last resort lending for compensation; for example, these alternatives were debt financing via ethnic community ties or grant funding via public sources (ibid., 5 and 11; also cf. Winborg & Landstroem, 2000 for the use of such relationship- and 136

137

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Recall from 3. 2. 2. 2. above that entrepreneurial agents may have a preferred pecking order of external financing. Note that the broad orientation introduced, does not presume what this preferred first source will be or which alternative financier group entrepreneurs may turn to; this is because there will be a substantial amount of heterogeneity here. Note that from the authors’ case study material it seems that these experiences affected both feasibility- and desirability-related considerations (cf. ibid., 7).

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subsidy-based financing alternatives amongst small businesses in general). The above findings as to why entrepreneurs may perceive difficulties in accessing bank finance (perceived racial discrimination) and the sources they may turn to alternatively (community-based and public sources) are specific to the case of ethnic minority entrepreneurship. Beyond this, however, patterns of turning to alternative sources of funding may also be analyzed for other new ventures.

Identification of changing intentions and feasibility perceptions In preparation for the case study in chapter five, it is necessary to have some orientation as to how entrepreneurs’ financing intentions and feasibility perceptions may be tracked in the fund-raising processes to be explored. First of all, in order to establish a reference point for the investigation of changes in intentions, entrepreneurs’ initial external financing intentions from the start of firm gestation onwards will be explored. This will be identified by inquiring into how much money entrepreneurs had planned to raise originally and from which desired sources (cf. Stouder & Kirchhoff, 2004, 360 who employ similar questions). Furthermore, adjustments to these intentions and shifts in feasibility to emanate from this point onwards will be explored from both directions: a) openly asking about the consequences of possible shifts in the feasibility of obtaining the planned funding and b) inquiring into the reasons that entrepreneurs might have for making adjustments to financing intentions.139 With respect to tracking intent itself, three concepts may be looked at (Linan & Chen, 2006, 7; also cf. Armitage & Connor, 2001): (1) intention as wish (’I want to ...’); (2) self prediction (’How likely it is that one does ...’, e.g., asking a venture capitalist for funding); (3) direct behavioural intent (’I intend to ...’). The case interviews of this study will frame questions corresponding to the latter two concepts in order to understand external financing intentions over time (such combinational approaches have also been taken in the relevant literature; cf., for example, Chen et al., 1998). The third concept (in contrast to the first one) seems to be more neutral in terms of appreciating

139

Stouder and Kirchhoff’s longitudinal study features a similar inquiry approach to illuminate first year financing problems of entrepreneurs (ibid.). The authors asked about plans for acquiring desired funding, how certain agents are to be able to obtain it, and the outcomes of requests for funding during the process. Note that their study applies these indicator questions within a quantitative design. In contrast, in the qualitative case study interviews of this thesis, such questions will provide only a broad orientation for exploring entrepreneurs’ views.

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both desirability and feasibility antecedents contributing to behavioural plans. In addition, in a reconstructive procedural exploration it will also be possible to reflect the actual fund-raising actions of entrepreneurs which may differ from previous behaviour. This may also allow changes in the intentions behind these changes in actions to be explored. The second concept is useful for purposes of illuminating specific financing intentions within the context of alternatives by concentrating on the likelihood to take action in a specific direction (cf. Krueger, 1993, 7 for a treatment of alternative action scenarios in the conception of intentions). In static terms, perceived feasibility has been associated with the degree of certainty or strength of belief in the ability to obtain desired external funding as currently assessed by the agent (cf. above and, in particular, Krueger, 1993, 11 employing a time-specific indicator of the agent’s current certainty judgement). Procedurally, an examination of how these assessments might change over time (decreasing or increasing in comparison to previous beliefs), or whether they may stay the same will be carried out. This will first be addressed with open questions, inviting entrepreneurs to give the reason why they became less (or more) certain that they would be able to acquire external finance. For focal decreases in feasibility, only when entrepreneurs’ views on how certain they are to obtain funding have been explored, will perceived problems or difficulties with lacking support of financial resource providers be probed into (following a similar concept of identifying problems perceived by the entrepreneur in the start-up process in general; see Brush & Manolova, 2004, 273pp.).

Other possible influences on changing intentions: personal desirability and propensity to act As stated above, guidance for identifying potential additional influences upon changing external financing intentions will be addressed at the end of this chapter. Only then will a proper reconstruction and identification of patterns that are of interest for this study be possible. Tracking other influences will be particularly important for perceived personal desirability, since it is a typical antecedent of intent. For the specific case of external financing intentions, personal desirability may entail both perceived needs for external funding as well as a personal preference order regarding different sources of financing and the venture’s capital structure. These two components have been addressed in chapter 3. 2. 2. above (cf. figure 3–5). In short, in terms of determining perceived needs

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for external funding, financial requirements of the business to be set up (capital expenditure, working capital, etc.), the founder’s growth aspirations, and personal investments by the entrepreneur have been addressed (cf. 3. 2. 2. 1.). These factors may contribute to the initial desirability of external funding. However, funding needs may of course also change over time, e.g., on account of changing growth objectives of the entrepreneur (cf. Baum, 2003, 607) or because of operational circumstances. In particular, the capital investments by the founder and external financing received have to be tracked; this will follow the concepts in Stouder & Kirchhoff, (2004, 358) and Cosh et al. (2005, 12). Moreover, possible influences of pecking order and capital structure preferences that may impact upon the potential financiers approached during the financing struggle will be checked. Rather than assuming a theoretical pecking order without reservation, tracking founders’ preferences for specific types of finance and resulting capital structures without theoretical prepossessions is given preference (following the open exploration approach of Changanti, 1995, 9). This is because there may be differences in preferred pecking orders and capital structures influenced by the specifics of individual firm cases (for this likely heterogeneity see Sapienza et al., 2003 and Stouder & Kirchhoff, 2004, 354 stressing that “equity and debt are often blended in strategic ways for personal reasons”; also cf. Garmaise, 2000 and Fairchild, 2004, 481 for deviations from the standard pecking order within the context of venture capital). Finally, a common impact upon the formation of behavioural intentions is assumed to be the entrepreneur’s propensity to act. This innate tendency to act may differ from person to person (cf. Mair & Noboa, 2005, 4). Whilst likely to be mostly important for the formation of intentions to act in the first place, this must still also be tracked throughout the fund-raising process (as depicted in figure 4–6). Operationally, propensity to act captures the entrepreneur’s commitment to achievement-oriented behaviour and preference for taking control over life events through action (see Krueger, 1993, 9 for an indication of ‘propensity to act’ which is used as an orientation here).140

140

As a further orientation, the cognitive planning style notion in Bouckenooghe et al. (2005) will be borrowed from. This notion tracks in how far entrepreneurs go through detailed planning before taking action. In particular, the aim is to check whether reduced intent to continue with action to seek funding may have to do with the tendency to go back to ‘contemplative planning’ rather than with decreasing feasibility of obtaining funds.

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4. 4. 3. 3. Selection feedback from potential financiers (TO 3) Following on from the previous chapter, 4. 4. 3. 3. further addresses what may happen during the process as the entrepreneur approaches external financiers for funding. In particular, the consequences of financial selection signals from potential financiers as they are perceived by the entrepreneur will be looked at (cf. figure 4–1 in 4. 2. 1. above). Possible impacts of partial financial selection on internal selection decisions implicit in changes of intended financing action are also sketched out in figure 4–6 above. Here, the depicted feedback line from the results of fund-raising action, back to intentional antecedents, captures the general verdict that entrepreneurial agents will reflect on and interpret the outcomes of their previous actions (cf. 4. 3. 2. above).141 During these attempts, the central information received by the entrepreneur will be feedback signals from potential financiers. From the viewpoint of the entrepreneurial agent, such signals may be characterized as “new information or new awareness of existing information” (McMullen & Shepherd, 2003a, 2); for example, this may be information about how severe financiers’ demands may be and how well the entrepreneur’s venture project may be able to meet them. As feedback signals are interpreted by the agent, they may become relevant to cognitive antecedents of behavioural intent (ibid.). Similarly, Shepherd and Krueger (2002, 173) stress that “human judgement is shaped by feedback arising from ... experiences”. Reitan (1997) points out that there are different views as to the impact of negative direct and indirect experiences on initiating entrepreneurial behaviour. On the one hand, “negative or disconfirming information from the environment has in general been proven to act as a detriment” (ibid., 5 referring to Learned, 1992). On the other hand, Reitan stresses that there is also evidence that negative information does not necessarily impede entrepreneurial start-up behaviour (ibid.). As far as cognitive antecedents of behavioural intentions are concerned, the internalization of new reality may imply “both an assimilation to structures, and an accommodation of structures” (Landry, 1995, 327), leading either to confirming continuity or accommodative adjustment of behaviour hooked up to these cognitions. Therefore, the basic question worth addressing for intended fund-raising action is: Under which circumstances do perceived environmental feedback signals lead to adjustments and when do they not? Consequently, this study will explore the 141

For a similar notion see Bhave’s well known model of the entrepreneurial process which also entails a strategic market feedback loop (Bhave, 1994).

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orientation that perceived negative feedback from potential financiers may be relevant to changes in intended financial resource acquisition action in contrast to the view that such feedback will not prompt such adjustments (TO 3; cf. Yin, 2003, 27 and 29 for utilizing such rival theoretical orientations in case studies). The next section will first present some brief points in case for the contrasting view that signals will not contribute to adjustments. Second, arguments in favour of the view that signals will have an impact are to be discussed. Finally, how consequences of feedback signals in the financing struggle will be identified in the empirical exploration will be addressed.

Interpretation of environmental feedback signals by entrepreneurial agents Two principal aspects may explain when entrepreneurs do not adjust to external signals they receive: the characteristics of the signal and how it is received and interpreted by the agent. Regarding signal characteristics, noise and ambiguity are argued to be important. In an extensive empirical study, Parker found that adjustment of beliefs held by entrepreneurs to noisy market signals was only modest; i.e., entrepreneurs gave “much greater weight to their prior beliefs when forming their expectations” (Parker, 2004, 2). Regarding entrepreneurial action based on these expectations, there was also only little adjustment of entrepreneurial effort to such signals. In general, ambiguity of feedback signals may prevent adjustments from being meaningful: “Ambiguity in the feedback from their efforts makes it difficult for founders to decide what worked and what did not” (Aldrich, 1999, 101). When feedback is received and interpreted by the agent, existing views may persist despite the fact that new experience made suggests that existing beliefs are incorrect (Budzinski, 2003, 218). Assimilation to structures may be more common than accommodation as distorting feedback is treated as purely situational or accidental (ibid.). For example, agents may still believe in their overall chances to obtain funding as a rejection from a single financier is considered as a misconception of an isolated financier case. Budzinski further argues that it is the agent’s subjective cognition itself which contributes to this persistence (ibid.; also cf. chapter two above and Kaisla, 2003, 250 pointing out that interpretation of success and failure of past action will be subjective).142 142

For entrepreneurial cognition biases such as simplification heuristics or framing effects may also play a role here (cf., for example, Mitchell et al. 2000, 976pp. or Lichtenstein et al., 2003, 23). This said, this study will, however, not attempt to make detailed contrasting propositions as to the exact cognitive circumstances in which biased assimilation and negligence of singular feed-

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The discussion now moves to the view that financial selection signals may indeed contribute to changing subsequent resource acquisition attempts. With regard to this, it may be explored whether intended external financing action may be adjusted when a wider variety of negative financier feedback is repeatedly experienced. This may be reasoned as follows. Beginning with the principal possibility that feedback may have an impact, entrepreneurs or managers in established organizations are argued to “interpret incoming market feedback and make ... forward-looking decisions as to whether to kill or sustain existing offerings and whether to intensify the search for new technological variations” (Henderson & Stern, 2004, 42). Equivalently, within the context of financing, agents may make forward-looking decisions as to whether to adjust the approach to funding their venture (as discussed for the forward-looking intentions changes in 4. 4. 3. 2. above). Because of the above lack of insight on account of structural uncertainty, negative selection feedback, e.g. from potential financiers, “reveals errors in managers’ understanding of the external environment” and thus may challenge existing beliefs (ibid, 52; also cf. Budzinski, 2003, 227 arguing that, in interaction with the competitive environment, agents gain insight into the appropriateness of their beliefs). This said, when errors revealed through environmental feedback on the entrepreneur’s efforts are rare, change may not be very likely. However, as “firms experience a wider variety of negative events, they are more likely to conduct deep analysis of the underlying causes, often leading to significant change” (Henderson & Stern, 2004, 52). The approximate pattern that more than a single negative feedback event may be needed is also supported by Harper (1996, 274). He argues that expectations and behavioural plans are revised in case of frustration by the market in particular when agents experience repeated substantial disappointment in the external environment (also cf. McMullen & Shepherd, 2003, 149 who point out that signal strength as a relevant antecedent to agents’ belief and attitude changes is centrally composed of the quantity of information). To sum up, Henderson and Stern (2004, 52) posit the abstract view that “the cumulative number of partial external selection events in a firm’s past will increase its future internal selection rate”. It is this broad orientation following from Henderson and Stern’s as well as Harper’s rationale which may facilitate the empirical exploration of the consequences of rejections by potential financiers throughout the fund-raising process. back signals may prevail. This is because concentrating solely on such detailed presumptions of cognitive biases and risk attribution would not be suitable for this study’s focus on the broader overall financing process and modest approximate patterns within it.

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Identifying perceived financier feedback and financing action in the study The analysis of TO 3 will require exploring entrepreneurs’ reactions to negative financier feedback in particular. In this respect, fairly open interview questions will again be administered to reconstruct and follow entrepreneurs’ reported stories about how they sought external funding for their venture projects. Here, their reasoning will have to be explored both for cases where negative feedback did not result in changes of the fund-raising activities afterwards as well as for cases where negative feedback did have an impact. For this purpose, typical questions to identify perceived feedback signals in the financing process pertinent in the relevant literature will be used. In the course of recapitulating the financial resource acquisition struggle of interviewees, an account of which potential financiers have been asked throughout the process, when these inquires were made, and how financiers have been contacted will be documented (following the approach of Stouder & Kirchhoff, 2004, 360 and 376). In terms of feedback received, Stouder and Kirchhoff also ask what answers from different potential financiers have been received so far (using the following categories in their questionnaire: ‘was the answer from the financier yes, no, or is the request still pending’; ibid., 362). The exploration of signals in the qualitative case study interview will take the analysis from these basic categories, probing further into the views of the entrepreneurs and how they interpreted received feedback in light of the further financing search that followed afterwards. In practice, negative signals may be direct rejections by financiers as well as perceived lack of interest, critique or scepticism about the competence of the entrepreneurs and the prospects of their projects (cf. Schulte, 1999 who found that entrepreneurs described the adversity of banks to fund new ventures in similar ways).143 To study the consequences of experienced financial selection feedback, signals will be explored by openly asking what entrepreneurs made of received financier feedback and what they did in turn. An examination will be carried out as to whether entrepreneurs have actually adjusted their approach to obtaining external financing and if not, why 143

The feedback received from potential financiers approached by the entrepreneur will be in the focus of the exploration of external selection signals. However, in addition, entrepreneurs seeking funding may also make indirect experiences with the screening and selection process of new venture financiers. For example, agents may approach consultants, chambers of commerce, or other new venture support institutions, to find out about the demands of potential financiers. Such indications of selection pressures from the financial domain will also be taken into account in the case study interviews.

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not. In practice, this may be indicated by revisions of business plans during the process, by actually switching to another type of potential financier, or by making efforts to do without external funding (e.g. adapting one’s market entry strategy in terms of advertising or capacity build-up). For purposes of exploring the consequences of external selection signals, it seems sensible to probe not only for mere intended or planned adjustments, but also for actual changes in intended resource acquisition action. This is because in contrast to the former, the latter will require real efforts to be made. Reconstructing and understanding changes in intentional action will still contribute towards eliciting focal underlying intentions here. This is because “if we are to try, we must first intend to try” (Krueger, 2000, 8). For the empirical identification of changes in entrepreneurial action to obtain external finance the approach of Cosh et al. (2005, 4) will be followed. The authors focus on ‘non-trivial efforts’ to acquire external funding, excluding accidental queries. When looking at entrepreneurs’ actions in relation to received financier feedback (in addition to behavioural plans), other influences on the implementation of intentions into action have to be tracked. Research on entrepreneurial intentions to start a business − and the actual realization of that intent into a new venture − has pointed out that there may potentially be additional precipitating factors which facilitate or, if lacking, inhibit the situational realization of action (see e.g. Krueger, 2000, 10). Typical precipitating factors in this context are available time and other personal circumstances (ibid.). In terms of entrepreneurs’ activities to seek finance, lack of time may inhibit the initiation of changes in fund-raising action. This study will look at available time budgets for applying bootstrapping alternatives or searching for new potential financiers from a completely new sub-domain, which may require a new, tailor-made business plan (e.g. switching from banks to business angels). For the investigation of time budgets, some of the indicator questions covering entrepreneurial use of time in Owen and Greene (2004, 104pp.) will be employed. Checking for precipitating factors will be particularly important when exploring the cases where negative feedback from financiers did not lead to actual changes in action to obtain external financing. Here, the absence of deliberate adjustments may simply be because of lacking management time for actually implementing revised fundraising intentions.

5. Multiple case studies of fund-raising processes in new ventures Chapter five covers the empirical study of entrepreneurial fund-raising intentions within the initial financing process of new ventures. Chapter 5. 1. addresses the realization of the empirical study. In 5. 2. below, the results of the study will be presented and discussed on the basis of empirical evidence collected from the multiple cases.

5. 1. Case study design and data collection Chapter 5. 1. develops the case study design employed. First, the multiple case design to be used must be defined (5. 1. 1.). In particular, the chapter establishes why it makes sense to explore fund-raising processes using a qualitative case study approach. Second, 5. 1. 2. addresses how data has been collected from multiple cases of new ventures seeking external finance.

5. 1. 1. Multiple case design 5. 1. 1. 1. Exploring fund-raising processes with case studies A case study, e.g. on a problem in organizational behaviour, is a “detailed investigation, often with data collected over a period of time, of one or more organisations or groups within organisations, with a view to providing an analysis of the context and processes involved in the phenomenon under study” (Pauwels & Matthyssens, 2004, 126; see also Hartley, 1994, 208p.). As such, “a case study is an empirical inquiry that investigates a contemporary phenomenon within its real-life context” (Yin, 2003, 13 and Ghauri, 2004, 111; also cf. Shane, 2000, 453 as far as studying real-world entrepreneurial phenomena is concerned). Case study approaches have been employed on numerous occasions in previous entrepreneurship research. This includes the investigation of problems similar to the subject of financial resource acquisition over time (procedural problem structure involving changes in entrepreneurial action over time; interaction with environmental context). For example, Luokkanen and Rabetino (2005) studied strategic change processes in response to environmental dynamism using longitudinal case studies. Pasanen (2005) looked into case studies of new venture failure trajectories (partly due to legitimizing problems with external audiences). Finally, Lichtenstein and Brush (2001) have explored the assembly and combination of salient resources in longitudinal case studies of growth-oriented new ventures.

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Essentially, a case study represents a research approach or strategy rather than a specific technique of data collection (Lamnek, 1995a, 7; also cf. Yin, 2003 or Ghauri, 2004). As such, a case study design was opted for because of the characteristics of the questions to be studied and the research situation pertaining to these research questions (cf., for example, Brannen, 1992; Lackner, 2002, 99p.; or Creswell, 2003 for the rationale of choosing an empirical research approach from the universe of quantitative and qualitative approaches in this way). There are two principal dimensions to making this choice: (1) the status quo of research on the issue to be studied and (2) the availability of data. (1) Entrepreneurs’ internal selection decisions and resource acquisition action as it evolves over time represent fairly unexplored territory in entrepreneurship research. Entrepreneurship research seems to be lacking in elaborated procedural theories in this area upon which further theory may be specified and tested in quantitative empirical settings. Case studies are suitable for this kind of research situation because they are “tailor-made for exploring new processes or behaviours or ones which are little understood” (Hartley, 1994, 213). As such they are central to creating hypotheses in the first place and may thereby contribute to the development, elaboration, and refinement of theory (ibid.; also cf. Eisenhardt, 1989). This thesis therefore opts for an exploratory, qualitative case study approach following the reasoning of Mair and Noboa (2005) as well as Lichtenstein and Brush (2001) in their study on assembling and utilizing strategic resource bundles in new ventures. Lichtenstein and Brush (ibid., 39) have chosen to conduct exploratory, qualitative case studies because of the limited empirical validation of resource based theory in the context of entrepreneurial ventures. Mair and Noboa opted for a case study approach because entrepreneurial intentions had not yet been empirically studied for the specific area of social entrepreneurship. Corresponding to these arguments, studying evolving entrepreneurial intentions specific to external funding is assumed to benefit from a case study approach in a similar way. (2) It has been stressed that there are problems associated with studying evolutionary issues in entrepreneurship because representative samples of emerging and infancystage new ventures are difficult to obtain (Aldrich & Martinez, 2003, 393). Curran and Blackburn add that owners of existing small businesses (let alone emerging ones) are hard to access, one reason being that there “are no up to date lists of existing small businesses available” (Curran & Blackburn, 2001, 60). When studying external financial resource acquisition, gathering a representative sample from the population of all newly emerging ventures in Germany would only yield a fraction of entrepreneurs currently

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seeking external funding (similar to the reasoning of Aldrich & Martinez, 2003 concerning approaches to studying the evolution of innovative new ventures). This may result in a situation where there may be an insufficient ratio of data points to variables to be analyzed in the financing struggle of new ventures; in such a situation, a case study design would seem to be appropriate while survey or experiment methods may be less adequate (cf. Yin, 2003, 13 and Ghauri, 2004, 112).144 To sum up, adequate representative longitudinal data to research external financing processes in new ventures may be difficult to obtain and incur substantial costs (Bergman et al., 1991, 9; also cf. Curran and Blackburn, 2001, 65 pointing out that methodical design, sampling, and data collection need to correspond to the resources available to the entrepreneurship researcher). Therefore, a case study approach, which does not depend on a statistical generalization logic from representative samples (cf. Yin, 2003, 32 and 47 and below), would seem to be more appropriate for the purpose of this thesis. In addition to these principal methodical considerations, case studies are also suitable for exploring changes in entrepreneurs’ external financing intentions over time. Case studies allow the analysis of complex change processes through time, particularly in reaction to external pressures (Curran & Blackburn, 2001, 59; Hartley, 1994, 211; also cf. Lichtenstein & Brush, 2001, 39 stressing that case studies are “especially appropriate to gaining insights into organizational phenomena over time”). Most importantly, the research interest of case studies may be directed at selection decisions that social agents make in the cases studied; these selective choices specific to the context of the respective cases are in the centre of exploratory case reconstructions in social science research (Bruesemeister, 2000, 62). In this thesis, case studies will facilitate the exploration of entrepreneurs’ selection decisions implicit in changing intentions throughout the financing process. Here, a case study approach is suitable to address the research questions as to how entrepreneurs go about obtaining external funding in face of difficulties and how financiers’ demands and rejections are dealt with (cf. Yin, 2003, 22 as well as Ghauri, 2004, 110p. for the strength of case studies in terms of addressing ‘how and why questions’ such as those above or inquiries into why founders may refrain from previous financing plans in face of received rejections).

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Note also that statistical generalizations from samples consisting only of entrepreneurs seeking external finance may suffer from a sample selection bias because of the non-randomness of entrepreneurs seeking external funding or not (see Cosh et al., 2005, 7).

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Finally, the chosen research approach seems also adequate to the constructivist perspective taken here. This is because the epistemological stance of the case study approach is adequate to depart from “time and human objective reality to a more context-bound objective reality ... in which the social world is understood from the point of view of the individuals who are actively involved in the events that are investigated” (Pauwels & Matthyssens, 2004, 127). In such an approach, the researcher needs to pay attention to the perception and construction of facts by agents. And the exploratory, open-ended stance of a qualitative case study design is an adequate framework for this (cf. Lamnek, 1995a, 20p.). Next, the focus and logic of the case study design to be pursued will be addressed.

5. 1. 1. 2. Definition of the multiple case design Components of the case study design and use of preliminary theoretical orientations Developing and defining a multiple case study design involves a number of components (following Yin, 2003, 21p.; also cf. Ghauri, 2004 and Pauwels & Matthyssens, 2004): 1) the research questions to be investigated; 2) the study’s propositions (if any), theoretical orientations, or exploratory purposes; 3) the unit of analysis and replication logic of the chosen multiple case design; 4) the procedures to be employed for analyzing evidence and its interpretation. The research questions and objectives to be pursued have been addressed in chapter one (see also 4. 1. above). The theoretical orientations within the framework of financing intentions have been covered in detail in 4. 4. 3. In contrast to ethnographic or grounded theory approaches, prior development of theoretical concepts is an important preparatory step in case study design, providing important guidance for empirical data collection and analysis (cf. Yin, 2003, 28p.). At the same time it is essential to allow theory development and refinements to emerge from the empirical cases in a balanced interaction between data and theory (Creswell, 2003, 134p.; also cf. Lamnek, 1995, 129 and below). In qualitative, more exploration-oriented research, it is essential to keep this balance. Therefore, the specific use of the above theoretical orientations in the empirical analysis will be briefly clarified below. This classification of theory use in case studies will also inform the definition and design logic of the selected multiple case units which will be addressed thereafter (the criteria and procedures for case analysis will be covered in 5. 2. 1. below).

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This study employs a broad theoretical framework based on the notion of entrepreneurial intentions in a way similar to the empirical study of Mair and Noboa (2005). This means that specific behavioural intentions will be investigated within the context of their possible antecedent attitudes and beliefs within a perceived environmental context. In qualitative case study (or other) approaches, such broad, preliminary concepts may be derived from existing adjacent theoretical concepts or prior initial empirical evidence (Lamnek, 1995, 120pp.). However, note that this needs to be done in a way that “permits use of a priori theoretical frameworks, but which keeps a particular framework from becoming a container into which the data must be poured” (Creswell, 2003, 134p.). This means that such a priori theoretical elements should be considered merely as orienting or sensitizing concepts (ibid. and also Curran & Blackburn, 2001, 41) whilst different or new categories may emerge from real-world empirical data collected in the cases. For example, it is not known exactly what kind of financier feedback signals will have an impact on entrepreneurs’ external financing intentions. One speculation is the above idea that an accumulation of repeated negative feedback will be important; however, it could also be that other signal characteristics are found to be relevant in the case analysis. In general, qualitative data from the multiple cases to be studied may allow research to find out about relevant categories (be they similar to a priori orientations or novel) and typical constellations between them; from there, theoretical propositions may be derived as desiderata for later theoretical testing (cf. Lamnek, 1995, 121p.). For practical purposes, case studies offer insight into the interaction of a wide range of factors with the aim to identify and elaborate typical incidents (cf. Ghauri, 2004, 115p. and also Lamnek, 1995a for a general overview); analytical patterns may be derived from this, which help to develop theory by refining a priori theoretical orientations and adding new, sometimes contrary, aspects. Therefore, the case design to be pursued aims to further specify and refine the above framework (cf., for example, Creswell, 2003, 135 or Pauwels & Matthyssens, 2004 for using case studies in this way; also cf. Curran & Blackburn, 2001, 41 for the approach of kicking off with some loose key concepts for initial orientation, and then refining these concepts based on the empirical data gathered).145 As a final result of this project, propositions for later testing may be arrived at. This will allow explanatory theory on entrepreneurs’ intentional action in the struggle to obtain initial funding for their new ventures to be developed (cf. Hartley, 1994, 213; 145

In addition, the broadly explored empirical categories pertaining to focal theoretical constructs may be useful later for designing indicator scales within future quantitative studies.

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Pauwels & Matthyssens, 2004, 126 and Ghauri, 2004, 115 for the function of multiple case studies as a first step in the research process to generate propositions and contribute to initial theory-building).

Unit of analysis and replication logic of the multiple case design This study will gather and explore empirical material about search processes for external funding from eleven new ventures (cf. 5. 1. 2. 1. below for details). It will be necessary to define what the cases and units of analysis to be investigated actually are in relation to the above central research questions (cf. Miles & Huberman, 1994, 27 and Yin, 2003, 22 and 24 calling for the cases for analysis to be defined in this way). One may look at the initial external financing struggle of new ventures as a singular case design of the seed and start-up financing segment of the German capital market; here, the new ventures under study would be embedded in the case as multiple units of analysis. However, the research focus is on changing financing intentions of entrepreneurs trying to establish their ventures and not on capital market aspects. Therefore, such a market-level perspective is unsuitable since this would make it difficult to concentrate on entrepreneurs’ individual financing plans and decision making during the establishment process of their ventures. Instead, the new ventures to be studied will be considered as multiple cases, each containing a single unit of analysis (cf. ibid., 40 and 42p. for the structure of embedded designs with multiple units of analysis in a single case versus alternative conceptions of a single unit of analysis within multiple cases). Conceptually, the unit of analysis for each of the eleven cases will be the external financial resource acquisition process the new venture goes through. The option of choosing a specific process as a case unit (as opposed to a person, organization, policy etc.) has been pointed out by Yin (ibid., 23) and Lamnek (1995a, 6; also cf. Miles & Huberman, 1994, 40 stressing that a qualitative study may concentrate on a specific process within an administration or organization). Because initial financial resource acquisition is the common process to be explored in all new venture cases, a comparison of them will allow similarities and differences in entrepreneurial intentions to be studied in a structured way (following a similar argument in Shane, 2000, 454). The underlying logic behind the analysis of multiple cases is the following. The rationale for conducting multiple case studies is to take in multi-faceted data from different individual cases: “typical cases validate an emerging theory; atypical cases will

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tell for predictable reasons where deviations occur” (Pauwels & Matthyssens, 2004, 129). The result of such an approach may enable analytic generalizations rather than a statistical sample-to-population generalization (Miles & Huberman, 1994, 27p.). The particular idea of using comparative cases is to replicate a phenomenon such as entrepreneurial search processes for external funding in a systematic approach (Ghauri, 2004, 114; also cf. Lamnek, 1995a, 23 stressing that action patterns may be explored by choosing similar case contexts). The logic of this approach is similar to that of multiple experiments in which an attempt is made to replicate results under similar conditions (Yin, 2003, 47). Take the botanic example of an experiment about plant growth under different conditions of light and water supply. In some of the replication attempts, conditions will be reproduced, while in others conditions will be deliberately varied in a systematic way (e.g. depriving plants of light): the former attempts strive for a literal replication of results under similar conditions and the latter complementarily try to establish contrasting or deviating results for known reasons, i.e. a theoretical replication (cf. ibid. and Pauwels & Matthyssens, 2004, 129). In order to allow analytical generalizations and reconstructions of broad patterns to be derived, the design of multiple cases of external funding processes essentially follows a literal replication logic in which entrepreneurs are explored in a contextual situation which is similar in all cases. This situation is characterized by attempts to obtain funding from the environment of potential financiers with fairly similar demands and screening criteria within financier sub-domains and varying specific demands across different sub-domains (cf. 4. 2. above). In particular, the developed theoretical frame in TO 1 to TO 3 above serves to identify the constellations in which possible phenomenon patterns

may be found and replicated literally (see Yin, 2003, 47 for employing the obligatory theoretical frame of multiple case designs in this way). Overall, the selection of cases for literal replication require prior knowledge of some outcomes of the initial attempts to obtain external funding in these ventures (for a general overview cf. ibid., 52). In practice, the cases to be selected for the study thus all feature existing infant new ventures which: a) need external funding, b) have experienced rejections from potential financiers and c) were all still in the process of seeking initial external funding (cf. Smallbone et al., 2003, 6p. for a similar rationale to pick cases of entrepreneurs still in the process of seeking finance in order to study the impacts of difficulties to obtain external funding). In addition to these main cases, one contrast case has been taken as an atypical case. An atypical case supports the exploration

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of initial theoretical orientations since it may feature differences to the other cases for known reasons (Lamnek, 1995, 193p.; also cf. Yin, 2003, 54 and above). The contrast case features a venture founded from an existing and established franchising concept. The founder was substantially supported by a consultancy and matching agency, which matches franchise systems and interested franchisee founders. In particular, the contrast case features an established business format including an investor contact that has been provided to the entrepreneur by the matching agency. This means that the position of this entrepreneur in terms of obtaining the necessary funding may be much better than in the other cases. This allows a contrast situation to be studied, where little negative investor feedback has been received at the outset.

5. 1. 2. Data collection Moving on to the collection of case data, the question of how the above selection of adequate cases was actually made will be addressed next. This follows a theoretical selection procedure customary in qualitative research designs. The criteria employed to select cases will be described first, then the procedure pursued to find suitable new ventures will be presented.

5. 1. 2. 1. Case selection framework and procedure Rationale for choosing the venture cases to be studied Basically, the selection of empirical objects to be studied follows from the above replication logic of the multiple case design. The selection of comparable cases was made on conceptual grounds, pertaining to the above up-front theoretical development (as suggested in Miles & Huberman, 1994, 28; also cf. Brannen, 1992, 7 and Dawson, 2002, 51). In practice, this means that “respondents are selected to fit the rationale underlying the research project” (Curran and Blackburn, 2001, 63; see also Ghauri, 2004, 112). Such a ‘theoretical sampling’ (conceptual or purposive sampling) approach as is common in qualitative research does not depend on statistical representativeness in order to offer convincing analytical generalizations (Curran & Blackburn, 2001, 63; also cf. Lichtenstein & Brush, 2001, 39).146 146

Note that the term ‘sampling’ is somewhat unfortunate within the context of multiple case study designs which follow a replication and not a sampling logic (Yin, 2003, 47). However, the term theoretical sampling is very common in qualitative research literature.

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In consequence, the actual number of cases in a multiple case design “is not a quality criterion as statistical significance is not the idea” (Pauwels & Matthyssens, 2004, 129). Rather, the number of cases collected was derived from a consideration of the elements of financial search processes to be studied. On the one hand, looking at only two or three cases would not be enough to explore in what circumstances rejections from financiers lead to changes in external financing intentions and when they do not. On the other hand, this study’s interest in the resource acquisition processes is not concerned with impacts of a wide range of exogenous factors such as the venture’s age, the gender of its founder(s), or the industry it operates in, etc. Thus, it is not necessary to have tens of cases to cater for multiple replications of the impact of such factors. Therefore, this study analyzes data the above eleven cases provide (including the contrast case); the exact number was of course also determined by the willingness of appropriate new venture founders to be available for interviews (cf. the case selection procedure in 5. 1. 2. 2. below). With respect to the conceptual dimension of the selection procedure, cases had to meet certain filter criteria, following a specific selection framework (cf. Lichtenstein & Brush, 2001, 39).

Filter criteria for case selection The following filter criteria were employed in accordance with the multiple case design for purposes of acquiring new venture cases (excluding the contrast case). The conceptual criteria were checked for in an initial phone call with potential interview candidates; the first round of interviews was conducted shortly thereafter. The checking questions applied were based on the definition of new ventures under study as specified in detail in chapter three above147: • founding of new firm with completed legal entity (1) • origination of factor combination and legal independence (2) • infant firm age (3) • infant firm size (4) • initiation of search for initial external funding (5) • still existing need for initial external funding (6). 147

Readers are referred to the definitional sections 3. 1. 2. 2. and 3. 1. 4. 1., which defined the existing infant ventures under study in contrast to both established adolescent firms and emerging venture projects. These sections also highlighted why these specific definitions are used in this study.

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(1) Since the focus of the study is on existing new ventures in their infancy, potential case interviewees were asked whether their venture project had already been formally founded. Following from figure 3–4 in 3. 1. 4. above (also cf. Stouder & Kirchhoff, 2004, 363), it was checked in particular whether the entrepreneur had officially registered with the required tax and other public authorities, obtained the required permissions to do business, and installed at least two of the above four identity markers − if applicable (firm name; logo; office address; independent phone listing). Recall from 3. 1. 4. above that these passive boundary completion criteria of mere administrative existence and external presence have been preferred over business-related criteria such as first sale, hire or finance. This was because of their minor relevance to legitimating with potential financiers. Ventures not yet founded according to these boundary completion criteria were not considered for interview.148 (2) Furthermore, existing new ventures were checked for the origination of their factor combination and legal independence. Ventures that were not legally independent as a subsidiary or branch of a larger enterprise or which were founded from an existing enterprise (e.g. via firm succession, spin-off or buy out etc.) have been excluded. (3) Entrepreneurs were asked for the age of their venture counted from the time of legal establishment as specified above. Entrepreneurs with firms older than 1. 5 years were not invited for interview. Recall from 3. 1. 2. 2. above that the age criterion has been applied as a cross-check together with further qualitative criteria ensuring that no fully established adolescent ventures were selected for the case study; this concerned particularly the issue of full financial establishment. In this respect, entrepreneurs were asked whether their firm still required external funding before it became sustainable to such an extent that monthly cash receipts exceeded expenses on a regular basis (closely following the approach of Stouder & Kirchhoff, 2004, 359; also cf. Lindstroem & Olofsson, 2001 suggesting a similar break even definition be used in empirical entrepreneurship research). The case study only considered new firms which had not yet reached cash flow break even as just specified. In addition, the entrepreneurs were asked about whether further external funding was needed − see criteria five and six below.

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It should be noted that one of the case firms selected was in the legal status ‘in course of formation’ at the time of case selection; a second case firm was about to complete legal establishment, however official registration was finalized the following week; this was before the first interview with this firm took place.

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(4) Similar to the age cross-check criterion, the entrepreneurs were asked about firm size. Only firms with no more than two employees (full time equivalent), excluding the founder(s) and current owner-manager(s), were considered.149 The conceptually driven character of the case selection process is especially explicit in the last two criteria. (5) Another requirement was that the entrepreneur had already started to seek external funding, having asked at least two potential financiers (excluding founding partners, relatives, and personal acquaintances). They were also asked when this was (similar to Stouder & Kirchhoff, 2004, 358; also cf. Cosh et al., 2005 suggesting to inquire into complete financing search sequences). Moreover, only those entrepreneurs were invited for interview who had experienced at least one rejection from potential financiers. In fact, some of the cases finally picked for the study had actually received much more refusals. Note also that the study picked venture cases from different industries with heterogeneous financing requirements. This follows the principal idea of multiple case studies to collect a divergent range of data for the research problem to be analyzed. However, all firm cases were located in Germany in order to match the capital market context and restrictions environment surrounding them. (6) Finally, only those entrepreneurs were considered for interview who indicated that they still needed external funding to establish their firm financially and that they planned to continue their acquisition of funding in the near future (as in Stouder & Kirchhoff, 2004, 358).

Case selection procedure The following procedure was followed in order to find case study objects suitable for this study. Entrepreneurs and owner-manages are often difficult to access for entrepreneurship- and small business researchers; in particular, access may be problematic when approaching entrepreneurs on a cold call basis (Curran & Blackburn, 2001, 66). To make the situation even more difficult, this study concentrates on sensitive financial matters concerning founder persons and their businesses, which is likely to make successful access even harder to achieve. At the same time, qualitative interviews (e.g. as part of a case study) require mutual trust between interviewee and researcher; therefore, approaching a possible interviewee via a third party known to the interview candidate is 149

In fact all but two case study ventures did not have any employees at the time of the first interview. And of the two that did have personnel, each employed a family member on part time basis and (in one of the two cases) an apprentice. These employees were paid from the founders’ investments in the firm; the firms had no external financing at this time.

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beneficial and acceptable (Lamnek, 1995a, 68; also cf. Hartley, 1994, 216). Consequently, this study identified case candidates via organizations within the German entrepreneurship community which are frequently in direct contact with new ventures that seek external funding. Overall, some ten different organizations such as technology centres, incubators, technology transfer offices at universities, new venture support networks, and matching agencies were approached. To identify possible cases, letters were sent to the above organizations. These letters described the project as a case study on the fund-raising process and start-up financing of young new ventures in Germany. Then, possible venture candidates themselves were approached by mail in this indirect way via the above organizations. In particular, the letters to entrepreneurs, which informed them in some detail about the study, clarified that all personal and company data would be treated anonymously (cf., for example, Dawson, 2002, 153). The letter also informed entrepreneurs that they would be called within the next few days to be invited for interview if suitable (cf. Curran & Blackburn, 2001 suggesting a similar procedure for qualitative entrepreneurship and small business research in general). During these calls, the six case selection criteria from above were gone through to decide which new ventures would finally be considered for the study. At the end of these calls, the first round of case interviews was arranged. The further concept describing how interview data and other records were collected for the cases will be addressed next.

5. 1. 2. 2. Time frame of data collection and case interviews Time frame of data collection Corresponding to the focus of analysis, the central unit of data collection was interviews with the respective entrepreneurs trying to acquire external funding (cf. Yin, 2003, 59 for systematically choosing units of data collection and analysis in case design). Frequently, case studies are used like a review, utilizing past records and interviews with persons involved in the case (Ghauri, 2004, 111). This would have meant approaching new venture cases which had completed their initial external fund-raising (be it successfully or not), merely looking back on the entire process ex post. However, the validity of such a review of past processes without further precautions would suffer from substantial retrospective biases.

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Such biases refer to possible distortions of reported information by respondents, in particular when a single interviewee recalls long finished past events or activities which occurred many years earlier (cf. Mair & Noboa, 2005, 4). For example, in fully retrospective approaches such contaminants may concern ex post rationalizations of activities with hindsight or a distorted sequencing of events in a reported story (cf. Tyebjee & Bruno, 1984, 1065 for the domain of financing decisions and Krueger, 1993, 6 regarding the formation and implementation of entrepreneurial intentions). Therefore, instead of analyzing distant, ex post facto aspects, it seems better to opt for a more contemporaneous investigation approach (cf. Palich & Bagby, 1995 who recommended this for research into the entrepreneurial process in general). This also appears to be true for entrepreneurial cognitions such as changing intentions together with their underlying attitudes, and Krueger (1993, 6) suggests that “intentional processes such as entrepreneurship are best understood by tracing subjects through the process”. Similarly, to diminish the problems of a “rose coloured glasses syndrome”, Hindle (2004, 586 and 587p. for the following) suggests that “we will do better to interview entrepreneur Jill while she is actively engaged in, say, the start up phase of her business than in asking for a retrospective war story years after Jill Inc. has become a global success”. Even though this study does not examine success factors where this problem may be most severe, the above recommendations will still be valuable for exploring financial resource acquisition and the role of negative financier feedback. Therefore, this study pursues an approach of data collection and analysis which attempts to limit unavoidable retrospective aspects to some extent. This will be done by using a combined retrospective-longitudinal design of the data collection process. It is important to understand that, conceptually, the planned exploratory reconstruction of broad patterns in fund-raising processes means that a retrospective stand will have to be taken, looking backwards at the emergence of change events. At the same time, empirical data collection benefits from a contemporary collection of data pertaining to these changes (see Bergman et al., 1991, 6 for this essential distinction between conceptual research strategy and the type of data to be collected). With regard to data collection, a longitudinal effort allows a fairly “fresh sense-making of organizational participants” to be studied (Lichtenstein & Brush, 2001, 39 studying resource acquisition and allocation by entrepreneurs; also cf. Lichtenstein et al., 2003, 31 suggesting that a longitudinal qualitative approach could reveal changes of entrepreneurs’ perceptions and behaviour throughout the new venture gestation and establishment process in general).

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Ideally, for the focus of this thesis, this would entail gathering a large number of case studies of emerging new venture projects and then tracking the resource acquisition process of those ventures which are eventually founded and need external finance. Moreover, it would be best to follow the financing attempts of these entrepreneurs very closely, perhaps interviewing them as frequently as every other week or once per month over a long period of time (such as in the collaborative project of Lichtenstein & Brush, 2001 which concentrated only on a handful of cases). However, here a choice had to be made between obtaining a decent multiple case design and extensive data collection from entrepreneurs. For the latter it was feared that gaining access to a substantial number of appropriate entrepreneurs would be extremely difficult with an approach demanding substantial time from entrepreneurs (recall from the above that gaining access to entrepreneurs demanding some of their time is a challenging task anyway; also cf. Ghauri, 2004, 113 supposing that researchers may well need to blend theory with some pragmatism in selecting cases and perhaps also in the range and depth of data collection).150 Hence, this path might have resulted in only a very small number of cases being studied intensively. Rather, a longitudinal data collection approach was opted for. This approach featured two rounds of interviews during the infancy phase of the venture cases at the time when they were in the process of seeking funding. This put fewer demands on interviewees so that a larger number of cases could be studied. The data collection structure pursued was conceptualized in line with the specification of the time boundaries of the cases (see Yin, 2003, 26). The temporal structure of the case design is depicted in figure 5–1.

retrospective phase Tgest conception

longitudinal phase Tbirth Ti1

gestation

Ti2 infancy

t adolescence

figure 5–1: time boundaries of case design and collection of interview data

The focus of the cases is on the financing processes in existing infant- but not yet adolescent new ventures. Above and beyond this, it needs to be appreciated that 150

Note that such a view is also advisable with regard to the research resources available, in particular when an empirical project is to be conducted by an individual researcher (cf. Dawson, 2002, 49 and Curran & Blackburn, 2001, 65p.).

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entrepreneurs’ financial resource acquisition attempts may already have commenced before the venture was founded. With this in mind, the starting point of the analysis is limited to the beginning of venture gestation as defined in figure 3–4 above.151 In the case studies, the two rounds of interviews were conducted at Ti1 and Ti2 (see figure 5–1). Determined by the case selection criteria described in 5. 1. 2. 1., the first round of interviews took place during the ventures’ infancy phase. From the point in time of the first interview, the period back to the beginning of gestation was retrospectively explored for prior attempts to gain external funding.152 More importantly, the first round of interviews also discussed the views of the entrepreneurs on raising initial external finance at that particular point in time, and how attempts were planned to be continued in the future. With this approach, fairly contemporary data on financing intentions and entrepreneurs’ perceptions and beliefs was collected (as called for above). Then, the second round of interviews investigated what happened between Ti1 and Ti2. This allowed a comparison to be made between entrepreneurs’ reported outlooks on the fund-raising process from Ti1 and their views in the second interview. In particular, this made it possible to explore potential changes in external funding intentions in view of the feedback from potential financiers that might have been obtained in the meantime. Similar to the time frame employed in the longitudinal case study in Smallbone et al. (2003, 6p.), the second round of main interviews was conducted approximately one year after the first. The first round was conducted in the second and third quarter of 2006. The second round was carried out between the second and third quarter of 2007, so that the time period between the two rounds was about ten to twelve months. Finally, it should be pointed out that the part of the analysis based on retrospective data still required further measures to ensure the validity of the case design. This will be addressed within the discussion of how the case interviews and the collection of supplementary case data were conducted.

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Even earlier considerations about possible financier demands and the feasibility of raising funding from other sources during the conception phase have been excluded for reasons already noted above. Note that the gestation phase of new ventures may often take no more than 12 months (cf., for example, Carter et al., 1996) so that, together with the above limitation on venture age and the presumption that fund-raising activities may not necessarily come first in the gestation phase, the retrospective part of the analysis is restricted to a reasonably short period of time.

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Case interviews and supplementary data As just described above, two rounds of case interviews were carried out. Interviews in the first round (Ti1) were conducted both via phone and face to face (it was up to the interviewees to chose whether interviews were to be face to face or, alternatively, as a telephone interview). The interviews in the second round (Ti2) were all phone interviews. In total, six of the eleven interviews in the first round were face to face. All interviews were conducted in German. The average interview took approximately 60 minutes, ranging between 35 minutes and about 90 minutes (qualitative interviews often differ in duration simply because of the heterogeneity in interviewees’ responses; cf. Lamnek, 1995, 66). In respect of the sensitive and confidential financial data collected, it was optional to interviewees whether the interview would be tape-recorded or not. Four interviewees allowed their interviews to be recorded on tape (cf. ibid., 68 and Yin, 2003, 92 for the possibility of and concerns about tape recording case interviews). In the other interviews, notes were taken by the author of this study.153 Interviews were done with the person(s) mainly responsible for financing decisions and fund-raising issues. In most of the cases (eight in total) the venture was managed by only one founder person; in these cases this person was invited for interview. In three cases, the venture had been founded by two or three persons. In these cases, it was possible to talk to the person in the business mainly responsible for the external fund-raising process, this person thus acting as a spokesperson.154 In one of these cases it was possible to talk to all of the founders (in this case two). On the one hand, the above discussion about using preliminary theory has brought up the concern that this should be done carefully, only offering some broad orientation for qualitative interviews. This is because, from a social constructivist perspective, the interview will be constructed by both interviewee and interviewer. The researcher should let the interviewee openly present the story from his point of view in his own categories and language (De Geer et al., 2004, 328; also cf. Lamnek, 1995, 91). On the other hand, some pre-defined structure and standardization will be needed in multiple case designs in order to enable cross case comparisons to facilitate replication (Miles & Huberman, 1994, 35; also cf. Curran & Blackburn, 2001, 73 pointing out that 153

154

In particular, the interview was interrupted at certain points so as to take notes of important interviewee statements, avoiding interviewer recall biases in the data. Recall the above discussion of a possible inter-subjectivity of fund-raising matters amongst the entrepreneurs in a small new venture.

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using completely unstructured interviews in entrepreneurship research runs the risk of provoking interviewee resistance). Therefore, these authors recommend that a combined structured approach, leaving substantial room for unstructured, investigative inquiry is often advisable (ibid.; also cf., e.g., King, 1994, 16p. or Lamnek, 1995a, 56 for the two extremes of full standardization and non-standardization between which a choice has to be made). In appreciation of both of the above concerns, this study follows a semi-structured interviewing approach. A semi-structured line of interviewing has been chosen because the characteristics and scope of entrepreneurs’ views on fund-raising are only poorly understood to date (cf. King, 1994, 16p. arguing that semi-structured qualitative interviews are appropriate in such research situations). The semi-structured interviews conducted provide room for unimpaired story reports by interviewees as well as enabling them to respond to specific questions following a prepared structure to facilitate comparisons (ibid. and De Geer et al., 2004, 329). The particular phases of the interviews followed the approach of De Geer et al. (ibid.) with an open-ended free description phase prior to a focus phase which featured more specific aspects. Focus interviews (cf., for example, Merton et al., 1990) are suitable for situations where all interviewees are in a similar position or engaged in a similar process such as seeking external funding for their venture (cf. Lamnek, 1995a, 69). Furthermore, focus interviews also resemble the above dual perspective as they may still preserve some open-ended character as well as featuring prepared questions at certain points (Yin, 2003, 90p.). In this study, the interviews followed five different phases (e.g. as in De Geer et al., 2004; also cf. King, 1994): warm-up, free description, focus, control, and final phase. As is common procedure in interviewing, the interview is framed by an initial ‘ice breaking’ or warm up phase in which the entrepreneurs were invited to talk about their businesses and the origin of their business ideas.155 The interviews were concluded by a final phase which addressed remaining issues. At the end, the conversation was moved away from sensitive aspects of the financial situations of their ventures, towards a discussion of the entrepreneurs’ general views on the German capital market for obtaining outside financing for start-ups at that time (cf. King, 1994, 22 for this closing strategy).

155

In the second interview round, this entailed a short chat about how the business had developed since the first interview.

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The initial warm up phase was followed by encouraging interviewees to talk about the fund-raising process they had gone through so far (cf. Lichtenstein & Brush, 2001 for a comparable story frame for mapping entrepreneurial processes to assemble and allocate resources over time). This often also included asking the entrepreneurs to provide an impromptu overview of the current financing situation and future direction of where to continue seeking finance in the future (free description phase). This phase mainly featured open-ended questions letting the interviewees offer their views on the fund-raising process (cf., for example, Herzog, 1996, 23p. for differentiating between open-ended and closed questions in social research). The focus phase addressed specific aspects of the financial resource acquisition process (barriers to and options for raising external funds; possible sources of external funding and received feedbacks from financiers; entrepreneurs’ intentions towards external financing over time).156 Even though the issues discussed in this phase were fairly specific, each area of interest was also recommenced with open-ended questions. Initiating the topical main interview with open-ended questions, postponing the use of preconceived, theory-driven closed questions, allows the researcher to try to understand the every-day common sense of interviewees and adapt to it (see Lamnek, 1995, 130 and Yin, 2003, 60). Only then were narrower follow-up and probing questions featured.157 For this, the study’s overall research questions and theoretical orientations were transferred into a case study protocol providing an interview outline that was used in the field for each individual case (cf. Yin, 2003, 74 and 90 for using a preparatory case protocol in this way). In particular, the interview focus zoomed in on entrepreneurs’ external funding intentions over time and how changes came about. To explore the rationale of interviewees it was preferred to address this only indirectly by understanding the entrepreneurs’ reports on how they had gone through the funding process (see Becker, 1998, 58p. and, in particular, Hindle, 2004, 583p. noting that more insight may be gained by asking what an entrepreneur is doing rather than asking why something is been done).158 156

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Note that since one cannot analyze everything, the focus has been on the main turning points during the fund-raising struggle, e.g. the events that followed a rejection by a central potential financier that the entrepreneur was hoping for (cf. Stam & Garnsey, 2005 for this principal consideration to be made in the research of development processes). The specific questions asked at this later point of the interview followed a line of inquiry based on the theoretical orientations prepared (cf. 4. 4. 3. above). In addition, to give the main interviews a conversational character and avoid the use of directional and unnatural academic language, a preparatory pilot interview was conducted in order to identify some categories and issues that entrepreneurs might talk about when telling their fundraising story (following the approach employed in the entrepreneurial intentions study of Jenkins & Johnson, 1997).

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Following De Geer et al. (2004, 329; also cf. Pauwels & Matthyssens, 2004, 129), in the control phase, the reported views and comments of interviewees were checked. This was done by posing the above questions from another angle in a slightly different way than asked before (this angle was to progress to a general perspective on financing possibilities of start-ups in Germany which, in the final phase, concluded the interview; see above). In addition, probing questions had already been featured in the prior two phases so as to validate interviewees’ initial responses (cf. Miles & Huberman, 1994, 37 for using follow-up probing). In addition to the case interviews as the central data source, other sources of data were also utilized. These included the case ventures’ web sites and other presentation material that had been used by entrepreneurs to present the venture project to external financiers, e.g. versions of the ventures’ business plans where available (cf. Yin, 2003, 85pp. for the benefits of using different sources of evidence).159 Such supplementary sources of data have been included to enhance validity (cf. De Geer et al., 2004, 326 and 333p.; Pauwels & Matthyssens, 2004, 129 or, for a general overview, Curran & Blackburn, 2001 on the use of data triangulation from multiple case data and different data sources within them in order to improve validity). Such precautions not only help to address the above retrospective biases beyond the longitudinal approach to collect fairly recent data. They also serve to combat self-reporting biases that may contaminate evidence solely derived from interview data. In interviews (as well as in other data collection approaches such as postal surveys) self-report measures are commonly used which are based on “reports about the participants who are being measured. Typically, the participants make their own judgements ... In a sense, this is second-hand information because relevant behaviour is not being observed directly by the researcher” (Herzog, 1996, 76; also cf. Tyebjee & Bruno, 1984 who note that such self-report biases may be of particular concern when interviewees report on the success, failure or sequential course of their own action over time such as required in this study). However, the above precautionary measures and the strength of the multiple longitudinal design may help to at least partly address such drawbacks.160

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Essentially, talking to external financiers who had been approached by the entrepreneurs would have been useful as well. However, this was not pursued because it would have threatened the accessibility and willingness of entrepreneurs’ to provide deeper insights into their own financing plans and fund-raising behaviour. Alternative direct field observation also ultimately relies on judgemental interpretations of the researcher (Herzog, 1996, 76).

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Overall, validity may not only be threatened merely by possible retrospective and selfreporting biases, but is rather of principal concern (for this and the following cf. Miles & Huberman, 1994, 278pp. discussing validity and reliability concerns in qualitative research). Therefore, in addition, case study designs particularly need to address construct validity. This type of validity is concerned with the correct application of indicators to catch the presence of theoretical constructs in the real world (Yin, 2003, 34p). On the one hand, qualitative approaches (such as this study) are to a substantial extent concerned with developing appropriate indicators of theoretical constructs from social reality data in the first place (Lamnek, 1995, 144p.). On the other hand, preliminary theoretical concepts prepared for conducting a qualitative study still necessitate documentation of how the constructs implicit in them will be detected in the empirical analysis. Here, the tentative indications provided in 4. 4. 3. above were employed to catch the central constructs (including changes of them), namely external financing intentions, perceived feasibility to obtain funding, and financier feedback. In this respect, the use of multiple cases and different sources of data is commonly argued to help enhance construct validity (e.g. Curran & Blackburn, 2001). The use of multiple cases striving for a logical replication of evidence may also contribute to the external validity of the design (Yin, 2003, 34 and 37). In contrast, internal validity is less of a concern in an exploratory case study approach (cf. ibid., 36). However, future researchers will need to take account of this when it comes to deriving propositions as a possible final result as described in chapter five. This study takes on board other possible influencing factors on financing intentions to be kept track of in the preliminary theoretical framework that serves as a guide for initial exploration. This may help future researchers to avoid chasing what may be spurious relationships which might hamper internal validity. Finally, to address reliability concerns, a preparatory case study protocol was used for this study in which the research questions, the data collection procedure pursued, and the interview outline to be used in the field for each case have been documented (the slightly less elaborate protocol procedure followed a refined suggestion from Yin, 2003). In addition, the evidence obtained has been documented in individual case reports (similar to the procedure outlined in Shane, 2000).

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5. 2. Case study results: preliminary patterns in fund-raising processes Before moving to a discussion of the results of the multiple case study project, 5. 2. 1. outlines how the collected case evidence was analyzed. 5. 2. 2. then presents a descriptive overview of the characteristics of the individual venture cases and their fund-raising process over time. Following on from these chapters, results will be presented, discussed and interpreted in 5. 2. 3. to 5. 2. 5 in the form of a comparative cross-case analysis as is common in multiple case studies (cf., for example, Yin, 2003, 148).

5. 2. 1. Approach to analyzing multiple case evidence Carrying out data analysis in a systematic and structured manner is essential since qualitative case studies often suffer from a lack of rigour (Pauwels & Matthyssens, 2004, 126). On the one hand, a rigorous approach may be achieved by employing a prepared structure for data collection, in particular ex ante theoretical development and orienting indicators (cf. above), and then applying this structure in the analysis of data, too (cf., for example, Ghauri, 2004, 117 or Shane, 2000). On the other hand, the tendency to overrate evidence favourable to one’s preparatory theoretical concepts and to discount disagreeing evidence needs to be avoided at the same time (cf. Herzog, 1996, 128 for this ‘confirmation bias’). In particular, case analysis requires awareness of disconfirming observations as well as an effort to scan for contrary evidence (Curran & Blackburn, 2001, 41; also cf. Yin, 2003). With these precautions in mind, the principal idea of analyzing evidence from multiple case sources is to conduct crosscase comparisons, striving to establish similarity patterns between them in order to achieve thorough analytical replications (see the final step of the analysis process below). To implement this idea in a systematic and structured way, the following common analysis procedure has been taken (following Ghauri, 2004, 118–120; also cf. Pauwels & Matthyssens, 2004, 135p.). First, a preparatory step identified broad themes based on the qualities that emerged from data. In particular, this step tried to merely describe and pre-structure narrative stories of the fund-raising processes of the case entrepreneurs and their sense-making of the financial environment (cf. Ghauri, 2004, 118). Thus, analysis at this stage was less driven by the structure provided in the pre-developed conceptual orientations. Rather data was sorted according to identifiable themes that emerged from the data itself. This was done independently for each individual case. Central themes that emerged from

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individual case data were interviewees’ comments and reports on the characteristics and status quo of their ventures, financing needs and plans, perceived financing possibilities and obstacles, views about certain types of financiers, and reported experiences with financiers (a connecting theme was also identified which contained comments on financier feedback and financing plans over time). Above and beyond these themes, broad chronological story accounts were prepared which described the fund-raising attempts that the case entrepreneurs had gone through up to Ti2, i.e. the time of the second round of interviews (see Ghauri, 2004, 118 for employing such narrative chronologies, in particular to facilitate longitudinal analyses). Here, time-ordered displays of data within cases were used to systemize entrepreneurs’ initial financing plans, steps taken to approach investors, interaction with potential financiers, as well as turning points and changes in the direction of fund-raising attempts. For each process case a critical incident chart was sketched out to record central and influential events in the course of the fund-raising processes along a time line (see Miles & Huberman, 1994, 110p. and 115 for the use of descriptive time-ordered displays to understand extended processes over time; also cf. Hartley, 1994, 221). This initial identification of emergent themes over time provided the fundament for understanding broad patterns of entrepreneurs’ intended behaviours and their views and rationale concerning their fund-raising attempts (cf. Lamnek, 1995a, 26 who stresses that this will also prepare the ground for a systemization of behavioural patterns in comparison to other cases). In this way, the descriptive compilation of time-ordered events also facilitated the later analysis of the reasons why changes in external financing plans may have occurred and what the consequences of financier selection feedback may have been (see Yin, 2003, 125 for this further analytic use of chronologies). Second, individual case data of process elements, plans, and behaviours was sifted through, rearranged, and coded into categories and sub-categories which came up in the themes in step one (cf. Hartley, 1994, 220; Strauss & Corbin, 1998, 167pp; and Lichtenstein & Brush, 2001, 40 for this resorting of broad thematic and chronological data into more specific descriptive categories). These categories derived from the cases were reconciled with pre-developed conceptual categories derived from the above theoretical orientations so that data could be coded into categories in a consistent way (see Ghauri, 2004, 118p. for the conceptual rearrangement of narrative chronological data; see also Pasanen, 2005, 102 for the classification of conceptual elements into emergent categories). Essentially, coding means the arrangement of data into concepts and categories

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so that their interpretation is facilitated with regard to a study’s theoretical framework and overall research questions (Gauri, 2004, 119).161 In practice, “use of tables to search for patterns, or grouping of similar topics, helps to explore the data” (Hartley, 1994, 220 referring to Strauss’ data interrogation approach; also cf. Yin, 2003, 134 who recommends the use of simple word tables to give a structure to verbal accounts of case data). In particular, at this stage, conceptually ordered displays were employed (cf., for example, Miles & Huberman, 1994, 128 for such displays).162 In a third step, the above within-case conceptual displays were merged into various conceptually ordered cross-case matrix displays as described in Miles and Huberman (ibid., 178). These displays were used to elicit process similarities between cases; for example, a meta-matrix was compiled to identify similarities in the elements contributing to entrepreneurs’ perceived chances of obtaining external funding across the cases (also cf. Lamnek, 1995a, 27 for the use of cross-case comparison tables to derive theoretical typologies on the basis of inter-case similarities). Another table displayed fluctuations in entrepreneurs’ perceived chances of acquiring funding and changes in the external financing plans pursued over time. Here, an auxiliary time-ordered meta-matrix to relate change patterns to the temporal structure of the fund-raising process cases was used.163 In addition, case-ordered displays have been prepared for certain categorized themes in order to identify differences between characteristic sub-groups of cases (cf. ibid., 187p. for such displays where data is organized according to groups of cases). For example, cases where the search for funding has been given up by the entrepreneurs have been compared to those cases were this did not happen. In this initial step of cross-case analysis, finally uncommon or conflicting themes in the data have also been scanned for. As mandated above, during the interrogation of 161

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In particular, a freehand approach to map and code cognitively based interviewee statements (e.g. beliefs about one’s chances to obtain funding or demands of investors) was employed (cf. Hodgkinson et al., 2004 and also Strauss & Corbin, 1998, 102pp. for open coding procedures). For example, a conceptually ordered display was elaborated for the different categories of entrepreneurs’ reported external financing plans entailing the pre-defined categories amount of intended external funding, type of financier to be asked, and the intended timing of approaching financiers (the latter category emerged from the data). Note that such time-ordered formats were merely used to accompany the main conceptual displays. This is because this study aims to identify broad patterns of changing financing intentions in view of external restrictions which shape the evolutionary internal variation-selection process at the individual venture level. It is believed that this focus will be more fruitful than attempting to identify typological patterns of common sequential phases that initial fund-raising processes in new ventures might form (also cf. Strauss & Corbin, 1998, 167 for principal scepticism regarding the detailed identification of a sequential order of phases in complex social processes).

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cross-case data, contrary and uncommon evidence has also been taken account of in partial refinements of overall cross-case categories (cf. Hartley, 1994, 220 for this precautionary interim step). For example, it appeared that the category of financier screening criteria alone was insufficient to capture entrepreneurs’ sense-making of the financial environment. In particular, this was because perceived magnitude of sourcing possibilities emerged from the data as an additional category. This repeated comparison of data and theoretical considerations, in which insufficient categorizations and conceptual connections are amended or eliminated, is an important fundament for deriving final multiple case replications (Pauwels & Matthyssens, 2004, 137). The fourth and final step of the analysis procedure follows on from the prior step of initial multiple case analysis. To establish results and reach conclusions, communalities and typical differences across the cases were filtered out. The study followed the mixed approach of Ghauri (2004, 121) suggesting that both matching empirically grounded patterns from the case data with a priori theoretical orientations as well as conceiving newly emerging patterns by matching cross-case similarities may be applied (cf. Yin, 2003, 117 and also Pauwels & Matthyssens, 2004 for the logic of pattern matching). This pattern-matching logic was based on the displays that were elaborated in step three above. In particular, resulting theoretical themes were prepared by refining and integrating major categories which featured similarity across the cases (cf. Strauss & Corbin, 1998, 143p. for this approach). Conceptual cross-case displays facilitated literal replications and contrasting case ordered displays catalyzed the formulation of theoretical replications regarding typified differences between cases for identifiable reasons (Yin, 2003). The format used for reporting on the results obtained in the multiple case study follows the suggestion of Yin (ibid, 148; cf. Pasanen, 2005 where this format was also applied). The report is presented as a cross-case analysis with the following chapters to be devoted to the different relevant cross-case issues: 5. 2. 3. addresses perceived chances to gain external funding and relevant underlying perceptions of obstacles, potentials, and possibilities; 5. 2. 4. and 5. 2. 5. cover entrepreneurs’ initial external financing plans and changes throughout the fund-raising process as well as the impact of experiences made in interaction with potential financiers. This means that, in this format, only abbreviated, summarized information on each individual case will be presented. This will be done in the next chapter, which provides a brief descriptive overview of the characteristics and fund-raising attempts of the individual ventures in the multiple case study. Further

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detailed individual case evidence will be presented dispersedly, encapsulated in the conceptual cross-case analysis (see Yin, 2003, 148 again for this particular form of report).

5. 2. 2. Case vignettes: description of ventures and their funding attempts The venture cases in the study come from various sectors, both industry and services. Some of the business ideas are imitative in nature, however there are also innovationoriented venture projects. In some of the cases, founders also have other employment, and try to establish and run their ventures part-time. All ventures were founded by males. The age of the founders varies considerably, some are in their twenties, the oldest is fifty-eight years old. The initial volume of external funding aimed for ranged between 10, 000 euros and more than three million euros. However, (apart from the contrast case), only two ventures managed to acquire external funding, in one of these cases far less than planned in the beginning. In three cases, fund-raising attempts were terminated completely as no funding was obtained. In the rest of the cases, the founders were still trying to raise finance at the time of Ti2. Firm A offers software for repairing and tuning personal computers of both private and corporate clients. The venture’s innovative software robot is to work online so that no on-site service will be necessary. The venture was founded by a serial entrepreneur also working as a software consultant.164 The firm was legally established in Q2/2006, gestation activities commenced in early 2005. For market entry and roll out, the founder initially planned to raise more than two million euros of external finance from venture capitalists, but would require approximately 0. 5 million euros at least.165 During the financing process, the entrepreneur approached more than forty potential financiers, including venture capitalists, business angels, public financiers, and banks (in order of application for funding during the search process).166 To date (that is at the time of Ti2), the venture has not attracted any external funding. The software product is not on the market yet and the firm has no customers.167

164 165

166

167

If not explicitly indicated, all ventures were founded by a single founder person. In agreement with the interviewees, exact financing needs will not be disclosed in order to preserve financial confidentiality. Sometimes, case entrepreneurs approached different types of financiers simultaneously. This will be discussed later in the cross-case analysis of fund-raising processes. If not stated otherwise, none of the case ventures have generated customer business and revenues.

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Venture B is an internet start-up which plans to establish innovative demand-based online platforms (e.g. for travel and real estate services). So far, only a platform for the travel industry is online. The venture’s business concept emerged from a regular concept for an auction platform, which the founders had initially planned. The firm was founded in Q2/2006 by two students still at university. Initial preparation of the business concept started in Q1/2005. The founders had initially unsuccessfully tried to raise more than one million euros of venture capital. However, they managed to obtain business angel funding of approximately 100, 000 euros in Q3/2006.168 In the course of the financing process, the entrepreneurs had applied to more than thirty venture capitalists, business angels, and banks for funding. Today, the business has two employees and has generated first revenues from advertising and travel bookings by customers. For purposes of expansion, the founders plan to obtain second-round funding at a later stage. Venture C sells a range of public relations services to a specific group of target customers, namely associations, clubs, and other non-profit organizations. The firm also markets a local public relations magazine, featuring projects from the above groups of clients. The founder required around 10, 000 euros of funding and managed to acquire a bank loan in Q3/2006, meeting his financing needs completely. In the process, the founder had talked to three different banks before obtaining credit. The venture was founded in Q1/2006 after a preparation period of five months. Up to Ti2 in 2007, the founder has attracted initial customers for advertising projects and has published the first two editions of his PR magazine. Venture D aims to produce and sell special caravan vehicles based on a novel extension technology invented by its founder. The entrepreneur has worked in the automotive industry, but is currently unemployed. The entrepreneur has been trying to establish the venture since Q3/2005 but has not advanced further because of a lack of finance. His venture project requires substantial pre-financing for vehicle production (approx. 750, 000 euros for the first vehicle). The founder has been unsuccessful to date in obtaining any external finance, having asked more than twenty banks (and in connection with this also public sources), strategic investors, and venture capitalists. The founder of venture E wanted to offer e-health services via the internet. This would have included consultation, educational seminars, and information to patients suffering 168

Simultaneously, the founders also secured a small loan to fund their own equity investment in the business.

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from cancer. The founder had planned to co-operate with other medical practitioners from outside his business. Venture E was founded in Q1/2006. However, efforts to become established in the market were terminated at the end of 2006 after attempts to raise funding failed. The entrepreneur had unsuccessfully approached numerous venture capital firms for funding in three different thrusts up to Q4/2006. Venture F is in the airline industry. The business plans to offer sightseeing flights to private customers but also to commercial clients. The envisioned flight operation is to use a microlight plane. The business was founded in Q3/2005, planned as part-time self-employment (the founder has regular employment as an electrical engineer with a large telecommunications firm). The founder was self-employed before in the entertainment industry during his university days. In the financing process, the venture had applied for a loan of around 100, 000 euros to about half a dozen different banks. All attempts have failed and today the founder is thinking about leasing his microlight plane in order to be able to start business operations. Before this, however, the founder needs to resolve legal problems he has with his licence to offer sightseeing flights from a small German airport. Venture G was established by a serial entrepreneur who has been working in the electronic equipment industry for a long time. The venture sells micro LED-lamps, in particular as camping equipment. Activities to start the business commenced in late 2004 and the firm was legally established in Q1/2005. The original plan was to acquire about 200, 000 euros of business angel funding to set up production of LED-lamps on a larger scale. As a minimum overall capital expenditure, approximately 50, 000 euros were required to establish a small prototype production. The founder approached around fifteen business angels and (later) banks, asking for both equity and debt funding. These attempts failed and the founder established his business (in particular a small production facility) through additional self-financing. In 2007, the business has acquired initial small customer orders for LED-lamps at trade fairs, but has no proper series production as yet. The founder is currently not actively seeking external funding anymore. The founder of venture H is a trained software programmer. His idea had been to sell online games like multi-player adventures and fantasy RPGs (role-playing games). The business was founded in Q1/2006 after a gestation period of about one year with substantial interruptions. The founder also works from time to time as a freelance programmer for other firms. He had planned to obtain approximately 40, 000 euros to finalize

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software development and production, as well as to finance initial advertising efforts. The venture was rejected by about half a dozen banks that had been approached for a loan. Other sources of funding were not sought. The fund-raising process (and further efforts to establish the company on the market) was terminated in Q3/2006. Firm I was founded by an SAP consultant. The founder invented a dynamic software tool for product development and production planning. The application may be used in industrial production contexts and bridges between computer-aided design for construction and computer-aided planning in production scheduling. The firm was founded in Q1/2005 and employs one apprentice and a relative as a secretary. These employees and necessary software development work are financed from the founder’s own money. In addition to the equity investments of the founder, the initial business plan included approximately 150, 000 euros of bank credit. However, the founder did not manage to obtain any loans from banks. Later attempts to attract public funding to the venture also failed. At Ti2, the founder had changed his strategy and is currently in the process of seeking external equity funding from business angels or venture capitalists. To date, the software is not yet ready for sale and the founder still needs to put in money from his consultancy work every month in order to keep the firm on track. Venture J plans to build production facilities for recycling industrial waste from the metalworking industry. The business utilizes a novel recycling concept and intends to sell recycled material to industrial clients. In addition, the business concept is designed to generate revenues from disposal of the above industrial waste. The venture was established in Q1/2006 by three founders with a commercial and industrial background. Venture J is a growth-oriented industrial start-up which required substantial funding. Initially, the entrepreneurs aimed to obtain more than three million euros of venture capital funding to build a large recycling facility in Germany. The smallest economically viable production facility (as a pilot site) would still require investments of about 200, 000 euros. The founders approached more than thirty venture capitalists and potential strategic investors from the metalworking industry. These attempts were unsuccessful. As this high volume of funding could not be obtained, later on, the founders reduced their planned external funding considerably to get started at all. The entrepreneurs are currently trying to attract business angels or public financiers to the business, but to date no external funding has been obtained to continue establishing the venture project.

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The contrast case X is a franchise start-up based on an established franchise of fast food restaurants. The entrepreneur founded his franchise outlet in Q3/2006. During the establishment and fund-raising process, he was supported by a matching agency (cf. the introduction of the contrast case above). The founder planned to acquire about 150, 000 euros in bank loans to open his restaurant; he reckoned that at least 80, 000 euros would be needed. He was rejected by the first bank he asked, but did get a loan from the second one to start his fast food restaurant as initially planned. The vignettes reveal that − despite a substantial time period of searching − case entrepreneurs often seem to struggle to obtain funding, having sometimes unsuccessfully approached many different financiers for varying amounts of money. Moreover, as will be examined below, this also involved substantial departures from original fund-raising plans throughout the process. While some have given up seeking external funding completely, the majority of ventures were lacking any external funding even at Ti2. However, it also stands out that these entrepreneurs were still trying to raise funds. In order to understand the course of these fund-raising processes, it will be necessary to conceive how the entrepreneurs evaluated the potential funding sources in the financial environment and the situation of their venture with respect to seeking initial funding. From a qualitative research perspective, such processes can be described “as a series of evolving sequences of action/interaction that occurs over time and space ... within a set of conditions or situational context” (Strauss & Corbin, 1998, 165 and 167). Theory may begin to be developed by linking categories when relating process and contextual structure (see ibid., 198). Following from this, first 5. 2. 3. derives results from how case entrepreneurs perceived their respective fund-raising situations and the environmental context of potential financier sources. Building on this discussion of contextual conditions and how their perception may feed into case entrepreneurs’ reasoning of fundraising attempts, second the main chapters to follow (5. 2. 4. to 5. 2. 5.) will analyze these attempts over time. In particular, the analysis strives to derive preliminary conditions in which fund-raising plans and action changed or remained the same respectively.

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5. 2. 3. Entrepreneurs’ sense-making of their financial environment To describe the perceived environmental context of potential financier sources, entrepreneurs’ sense-making of their chances to obtain external funding emerged as the central category in the examination of multiple case data (cf. ibid., 147 for the procedure to pick a central category). In particular, the situational context will be elaborated with respect to the conditions which contribute to make case entrepreneurs feel sure, uncertain or sceptical of being able to acquire funds. To foreshadow the main results arrived at, the empirical category of perceived chances to obtain funding is suggested to reflect the above theoretical orienting construct of perceived feasibility to acquire funding. Furthermore, from the empirical analysis, two concepts have been derived which underlie the feasibility construct: perceived external financial munificence and internal funding capabilities. Methodically, this has been elaborated as follows. Firstly, two empirical categories have been found in the data which reflect perceived external factors contributing to funding chances in the eyes of entrepreneurs. Namely, these are challenges from financier screening (1) and perceived magnitude of funding sources (2) (cf. 5. 2. 3. 1. below). Furthermore, internal factors pertaining to the individual venture project have been found relevant to the sense-making of funding chances. These are venture project characteristics (3) and perceived funding flexibility (4). These categories feature both elements that enable and impede chances to obtain funding (cf. 5. 2. 3. 2.). To enhance clarity, a condensed matrix with typical elements which enable or impede fund-raising chances in the eyes of interviewees is depicted alongside these four external and internal categories (cf. figure 5–2). This preview illustration has been drawn from the cross-case conceptual displays in 5. 2. 3. 1. and 5. 2. 3. 2. For example, interviewees reported that the need to present an already established initial base of pilot customers or the obligation to provide collateral when asking for a loan are central external elements detrimental to the chances of acquiring finance. This said, funding chances appeared to be propelled by the perceived flexibility to take time to look for possible alternative, perhaps smaller, funding sources. In practice, such flexibility was sensed by the entrepreneurs, feeling, for example, that they had enough personal savings or other income which allowed continuation of the search for funding. In contrast, lacking personal financial reserves and the need for heavy up-front investment (e.g. in industrial production facilities or product prototypes) are considered as impediments. This is because they limit the time window for searching and constrain the

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perceived fund-raising chances enablers

impediments

challenges from financier screening

(none - viewed as challenges)

requirements for: acceptable project risk; display of existing core business (customer references, vendors); existing product; provision of collateral; industry and management experience

magnitude of funding sources

alternative external funding sources possible

inaccessibility of certain financier types (due to required volume of funding, growth potential or development status)

venture project characteristics

competitive product; high market potential; industry experience; existing references; indirect contacts to investors

lack of existing business, product and customer base; product and business concept difficult to conceive; lacking collateral

funding flexibility

flexibility through continued personal funding and low current operating costs; possibility of gradual funding and operational development

lack of financial reserves; need for substantial up-front investment in production and prototyping

external

internal

figure 5–2: systemization of external and internal categories of perceived funding chances

flexibility to make do with smaller initial funding volumes from alternative sources. The careful reader may have spotted that the latter flexibility argument goes beyond the ex ante orientations developed in 4. 4. 3. 1. above. Empirical category building also involved considerable refinements and augmentation of pre-developed theoretical orientations. Note that, even though the above orientations of perceived financier legitimacy demands and internal capability to acquire resources offered valuable orientation for categories (1) and (3), the novel empirical categories (2) and (4) provided substantial additional insight into entrepreneurs’ reckoning of fund-raising chances and attempts. These two novel categories take account of the potential for alternative funding solutions and the perceived flexibility to adjust to them. Secondly, in a further step, it has been possible to integrate the two external categories (1 and 2) into a concept of financial munificence (following Brown & Kirchhoff, 1997), and the two internal ones (3 and 4) into a notion of perceived internal funding capabilities (for the methodical approach to refine and integrate categories into theoretical

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concepts via selective coding see Strauss & Corbin, 1998, 143pp.; also cf. Ghauri, 2004). The elaboration of the external financial munificence concept from the empirical categories will be addressed next in 5. 2. 3. 1. Then, in 5. 2. 3. 2. the development of the two internal categories and their integration into perceived funding capabilities will be discussed. Finally, a description will be provided as to how perceived feasibility to obtain funding is reflected in the entrepreneurs’ judgement of funding chances. Here, 5. 2. 3. 3. will reason further why perceived feasibility may be associated with financial munificence and funding capabilities. As a result, preliminary propositions and operational indicators will be suggested to inform future research.

5. 2. 3. 1. Funding sources and screening challenges: financial munificence As hinted at in figure 5–2, two distinct external categories appear to underpin entrepreneurs’ perception of their chances to attract outside funding: challenges set by financier screening and the scope of possibilities to obtain funding. The two categories will be elaborated in turn from what the interviewed entrepreneurs reported in the discussion of the funding processes of their own ventures and financing new ventures like theirs in general. In particular, the cross-case displays on challenges from financier screening and magnitude of sourcing possibilities have been compiled from the interviewees’ reasoning of funding chances at the time of the first interview (i.e. Ti1).169 At this point in the analysis, the focus is on the constellation of external and internal conditions that contribute to perceived funding chances rather than on how these chances may have changed throughout the fund-raising struggle (the latter will be in the focus of 5. 2. 4.).

Perceived challenges from financiers’ pre-funding screening In essence, the challenges category reflects entrepreneurs’ views about the potential financiers’ decision making process when deciding about providing equity investment (or debt) or not. In particular, it contains interviewees’ beliefs as to what makes it easier or more difficult to win funding from potential financiers for a venture like theirs in general. The first thing to note is that from the interviewees’ perspective on financier judgements, only aspects which impede chances and make fund-raising more difficult

169

At the time of the first interview all entrepreneurs had already approached some financiers but were still seeking initial external funding (cf. the case selection criteria above).

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have been reported (this is also why this category was labelled ‘challenges from financier screening’ from the standpoint of the entrepreneurs). However, the dimensions of this category show that the intensity of perceived challenges varies across different financiers (the dimensions of a category refer to the range in which category properties vary; Strauss & Corbin, 1998, 101). The intensity ranges from de facto knock out expectations of financiers (e.g. the requirement for collateral − see below) to issues which may be negotiable or which may be compensated for by other factors, e.g. the perceived preference of financiers for only moderate commitments in first-round funding. In this section, the focus will be on the content of external conditions and the perceived fundraising challenges they appear to constitute. The external challenges reported in the cases have been compiled in the conceptual cross-case display in figure 5–3.170 Two general considerations which have been omitted in the cross-case display should be noted. First, interview reports showed that case entrepreneurs were aware of the need to present a business plan to financiers and in fact all entrepreneurs had prepared one.171 Second, the case entrepreneurs appeared to appreciate that their venture project had to demonstrate the potential to be profitable to either equity or debt financiers. As one founder put it, ‘well, first of all, of course, you need to convince them that your business will eventually be profitable, making sure that they get their money back with profit’.172 Beyond these general considerations, the following specific sub-categories of challenges have been identified in the cross-case analysis from figure 5–3: a) need to demonstrate existing initial business relations (at least to some extent), in particular with production, sales and distribution partners, b) requirement for existing customer references or at least documentation of potential customer interest, c) need for existing product or prototype (were applicable), d) proof of industry and business experience. In addition, it was reported that asking for high volumes of funding would also be problematic (e) and that the obligation to pledge collateral makes it difficult to acquire adequate credit from banks (f). These sub-categories of the challenges category, which have been arrived at 170

171

172

VC = venture capitalists; BA = business angels. The information in parentheses indicates that a

challenge has been reported to refer only to a certain type of financier or specifically to potential financiers of a new venture in general. Entrepreneur H reported that he had prepared only a rudimentary written business plan document which required further elaboration. Quotes from the interviews have been translated by the author; all interviews were conducted in German.

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perceived challenges from financier screening A

demand for existing business partners, initial customer base and investors; high concern of equity financiers about downside risks; focus on small initial financial commitment (VC; BA)

B

need for management competence and initial external partners supporting business establishment; aversions of financiers against high initial funding volume is a challenge; attractive, yet plausible profitability projections are key (VC; BA)

C

proof of sufficient industry and business experience; need for possible pilot customers for service offer; need to show ability to acquire enough customers to repay loan; need for collateral (bank) need to demonstrate technical and operational feasibility of product design and production; required proof of marketability (general); need for collateral (bank and public support)

D E

proof of market potential required; need to present customer references for existing venture business; industry knowledge

F

need for existing business or collateral to reduce risks; obligation to provide collateral (bank)

G

need to present product prototype, market access and interested customers (BA and bank); substantial demand for collateral (bank); impossibility to raise large sums of funding (general)

H

business experience required; may need to provide show case games and reference projects; demand for collateral

I

need for industry experience and marketable product; principal need for collateral (bank)

J

need for industry experience; good business plan (general); financier concerns about high volume of funding (general); need for collateral (bank)

X

industry and business experience required; need for sound business concept with proven market demand

figure 5–3: perceived challenges from financiers’ pre-funding screening

in axial coding, will be presented in turn (for the use of axial coding see ibid., 123pp. or Creswell, 2003, 106).173 In this presentation, frequent reference will be made to figure 5–3 and readers are invited to follow up specific case entries there. After presenting empirical categorizations derived in the analysis, the results will be discussed from a conceptual perspective in an interim summary. a) need for initial business relations to external organizations In venture projects A and B the requirement to show that considerable steps to establish the business have already been completed was considered most challenging. In particular, it was believed that potential equity financiers expected entrepreneurs to demonstrate that

173

Note that it is common in conceptual cross-case displays like the one in figure 5–3 to transform case level entries into condensed summarizing phrases or words pertaining to identified sub-categories and categories (Miles & Huberman, 1994, 179).

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the project’s initial establishment was already supported by other business partners willing to do business with the venture (case B). For example, this could be associations which represent possible business customers (in case B associations of travel agencies), technology partners, or suppliers. Entrepreneur A stressed that operationally ‘everything should be clear in advance before investors step in’ and that financiers even seem to expect the venture to already have found other investors − ‘nobody wants to be first’ as he summarized it. Entrepreneur G also considered that a venture offering a product like his to consumers (the venture planned to sell energy-efficient and powerful lamps) will particularly need to present initial sales and distribution partners. In his view such partners are required to be presented because investors want to see that other experienced players in the market believe in the prospects and potential of the venture and its products. Similarly, venture D needed production partners for its production of caravan vehicles with innovative spatial extensions. The founder suspected that, to convince potential financiers, the venture would probably have to prove that at least one vehicle producer had agreed to co-operate. Furthermore, entrepreneur D explained that this was because one can only demonstrate that customer demand for the product really exists if a larger organization is operating in the same market as a partner. A venture like this would need to demonstrate marketability of its product anyway, and if not via a large production or sales partner, then at least some initial interested customers who would consider buying the product might be required to convince investors. b) documentation of actual and prospective customer demand The need to demonstrate to potential financiers at least some initial customer demand was also felt in other cases. Entrepreneurs C and F believed that if a new venture was to offer a service, it may need to show initial demand of customers who are actually going to buy and use the service. Founder C, offering public relations services to associations, clubs, and other organizations, pointed out the need for new services firms to communicate that they would have sufficient customers to become profitable and be able to repay a loan or investment with interest. Moreover, founder E stressed that it would be necessary to provide actual customer references for the venture project to be financed and not for some adjacent activity a founder has pursued in the past. The entrepreneur’s venture planned to offer medical education services to cancer patients and the founder had worked in this area before as an employee of an American hospital care organization. Similarly, interviewees A and F appeared to be most sceptical about their funding chances at that time, supposing that most financiers almost seem to expect references of

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paying customers for a venture’s offers. This is challenging in so far as cases A and F required the funding to be able to offer their service in the market in the first place (venture A required funding to finalize development of its software robot and founder F needed the money to buy necessary equipment). Case entrepreneurs G and I (and D above), which also required money to fund initial market entry or to finalize product development in the first place, also believed demonstrating customer demand to be necessary. However, in contrast to cases A and F they reckoned that for ventures at such a development stage it might be sufficient to present potential customers, demonstrated by referring to first inquiries of potential buyers (e.g. at trade fairs) or independent market studies (as reported in cases G and I). c) presentation of existing product or prototype This may be more of a concern for those cases which plan to offer industrial or consumer products rather than for services start-ups. Founder D reported that venture projects like his particularly suffer from financiers’ and other outsiders’ doubts about product technology and that the product can actually be physically produced. For his innovative caravan vehicles he claimed that ‘you are a nobody until you have the first vehicle on the road’. In his perception, potential financiers expect at least an elaborated product design, if not a prototype. His strategy to meet this was to move forward to acquire patent protection on his spatial extension technology in vehicles (see 5. 2. 3. 2. below). Similarly, founders G, H and I also pointed out that it would probably be necessary to present an existing or nearly completed product or production prototype (in particular to bankers). In contrast to case G, the latter two cases both planned to sell software. Entrepreneur H stressed that bankers may require from ventures in the electronic entertainment industry to provide show case games or trailers to judge their quality in comparison to other software already on the market. Similarly, for venture I, which planned to develop and market SAP-related product development and production accounting software, it was reported that it might be necessary to at least demonstrate initial functionality of the software judged against standard software tools for enterprise resource planning. Founder J’s view on product (and customer) references differed from the other cases. The entrepreneur reckoned that it would be sufficient to have a competently prepared business plan in which the planned product offer, its production, and the customers it targeted were thoroughly described. However, this also seemed to be partly due to the

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specific characteristics of his venture project. The venture planned to offer industrial recycling products which would require large recycling and production facilities to be built from scratch. Understandably the founder appeared to hold the view that for such a business at this development stage, it would be impossible to demonstrate an existing product with actual customer references for it (and correspondingly only a competent description of the ‘plans of the business’ may be asked for by potential investors). In contrast, the service ventures within the set of cases rather appeared to be at the other end of the scale, where existing initial customers and (consequently) existing service offers might need to be demonstrated to convince financiers.174 d) proof of founders’ industry and business experience Financiers’ expectations with respect to industry and business experience of a venture’s management were frequently mentioned by interviewees across the different cases (B; C; E; H; I; J; X). For those who did not mention proof of industry and business experience it was felt (after later probing) that this was occasionally (in case A and G) because, to these founders, this seemed to be of no concern as they were experienced business men.175 In cases where requirements to demonstrate industry and business experience were perceived, interviewees reported that this entailed demonstrating to investors that one is well versed in the industry one operates in (e.g. by previous education or professional occupations in one’s vita).176 This may be in terms of knowing sales and distribution channels and who to sell which product to on the basis of in-depth knowledge of the demands of target customers (cases C, E, H and I). Above and beyond this market dimension of industry knowledge, in case B the two founders thought that the main challenge was to demonstrate competence to run an internet business with a specific industry focus (in this case initially travel and leisure). Furthermore, founder E stressed that it would also be important to show knowledge of the ‘do’s and don’ts’ in the industry, in particular if the potential investor is an expert in the industry as well (in this case medical services). Finally, founder X (the contrast case) thought that bank 174

175

176

See below for possible inter-industry heterogeneity of perceived funding challenges relating to product and customer references. This interpretation may well be integrated into the later conception of perceived fund-raising chances. This is because the construct not only contains challenges from financier screening but also perceived funding capabilities of the entrepreneur (in this case perceived sufficient industry and business experience to meet investor expectations). Note that the two sub-categories were merged into one. This was because experience or skilful competence in running a business was regularly viewed in the specific context of the respective entrepreneur’s own industry.

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employees expected him to show that he would be able to run the franchise outlet (an Italian fast food restaurant). In addition to market and business related challenges, interviewees also perceived challenges rooting from the financial expectations of potential financiers. e) and f) constraint of moderate funding and need for collateral Case entrepreneurs appeared to be concerned most about the hesitation of both equity investors and bank lenders to take risks. To the interviewees, two concrete issues impeded the acquisition of adequate funding in particular: financiers’ reservations about providing large amounts of funding (mainly equity financiers) and the demand for collateral or other security, e.g. equity commitments by the founder, when asking for loans. Interviewee A presumed that venture capitalists and business angels were mostly concerned about possible ‘downside risks’ with a focus on providing only small amounts of initial funding, if at all (’everybody wants to invest very little initially to avoid losing money’). Similarly, the entrepreneurs in case B reported that at that time (i.e. at Ti1), attracting high volumes of equity funding was a problem. Furthermore, founder G said that he knew beforehand (from prior self-employment) that ‘it would be virtually impossible to raise large sums of money’. He therefore tried to obtain far less than desirable, even though higher initial funding would have been more economical so as to avoid inefficient production of only very small lots. Corresponding to this scepticism, founder C argued that one advantage of his small services start-up was that it required only little external funding (in this case no more than 10, 000 euros) which he believed to be easier to obtain than larger amounts. The challenge to obtain sufficient funding, which may be constituted by financiers’ aversion to providing larger sums of initial funding, was mainly articulated for equity funding (cases A, B, G and also E and J) but also for the size of loans from banks (case C as well as founder G again, who approached both potential equity investors and banks). With regard to obtaining bank loans, interviewees frequently mentioned bankers’ demands for substantial collateral as being a specific obstacle (cases C; D; F; G; H; I; J). This was the case for the majority of cases who, up to Ti1, had tried to fund their venture through bank loans. There were only two cases in which this obstacle was not perceived. In the contrast case, neither the required funding volume nor possible needs for collateral were reported as problematic. This was because entrepreneur X believed

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that the required volume of funding for his outlet ‘is just normal for this franchise and hence banks will know about it, also because of the matching agency’s assistance in the funding process’. In case B, the founders only required a small loan to back their own share of equity to be invested. Reportedly, securing this loan was not viewed as problematic, because of the low amount of money to be borrowed.177 With regard to those cases to which collateral was a challenge, the entrepreneurs considered real estate or private guarantees as typical means to offer security to banks; however, commonly in these cases, as is probably often the case in new venture formation, such means were reported to be lacking (see 5. 2. 3. 2. below). Founder F and G also supposed that having a business set up and running may mean that banks would not insist on collateral or at least it may offer additional means of security from the established asset base of a running business. However, this was exactly what was lacking in these cases at this point in time. Finally, founder D reported that, in relation to the need for collateral, banks and also public sources often demanded substantial equity investment by the entrepreneur himself before support would be granted. This also makes funding from these sources difficult for entrepreneurs in the view of interviewee D. Having gone through the challenges perceived by the case entrepreneurs, a conceptual discussion of the findings will follow next.

Conceptual discussion of the screening challenges perceived The discussion of findings first summarizes cross-case similarities and also takes into account differences between the cases as to the details of the challenges perceived. Second, the findings will be discussed in relation to the conceptual orientations on financier screening criteria which have been suggested as possible legitimating demands or perceived barriers to fund-raising in TO1a above. The sub-categories (a) to (f), which emerged from the data, suggest that there is similarity in perceived challenges from financiers’ screening across the multiple cases studied. The interviewees perceived the concrete financier demands emanating from their principal commercial expectations as challenging. The entrepreneurs seemed to be concerned most with financiers’ concrete demands for factual and external validation of the venture’s commercial prospects (exiting business partners, customers, and product; documented 177

Whether providing collateral or other security may be a challenge to venture founders in general was not reported for this case.

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founder industry experience) as well as with concrete demands rooting from financiers’ risk control measures (limited funding volume and demand for security). The focus on modest funding requirements was mainly a challenge for those ventures seeking substantial equity funding. Demands for security (in particular collateral) reflect a typified barrier to obtaining bank loans which was reported in the cases that sought loan funding. This suggests that there are also differences in some of the challenges perceived across the individual ventures. This may not only be for case entrepreneurs having different sources of external financing in mind.178 Rather, differences in perceived challenges may also arise because some of the projects concerned less capital-intensive services ventures (e.g. C, E and F) while others (e.g. D, G, I and particularly J) planned to offer industrial products, sometimes still in the product development stage. Despite the methodical concession that one needs to abstract from some detailed aspects of individual cases (cf. Ghauri, 2004), these aspects of cross-case variation deserve consideration. The differences between services and industrial venture projects are also reflected in the perceived demands for proof of customer demand and initial progress in market establishment (i.e. sub-categories b and d). While interviewees from the former group perceived that such ventures might have to present already existing service offers with initial customer references, the latter group articulated that it may be possible to get away with elaborated product descriptions or (near completion) prototypes as well as with market research documenting potential customer demand. In fact, this may simply show that these entrepreneurs’ followed conventional wisdom in that one cannot be required to present existing business with paying customers when the funding is needed to complete product development and initiate production and market entry in the first place. However, note that these entrepreneurs still appear to perceive that some sort of preliminary external and factual validation of market demand and competitive product quality may be required. Thus, the character of the underlying challenge still appears similar overall and it may just be the intensity of this challenge that differs. This is because the product-oriented entrepreneurs feel that less is demanded of them by financiers in terms of operational and market establishment. From a conceptual perspective, such differences will therefore not rule out the suggestion that perceived challenges from financier screening are a coherent dimension.

178

Cf. the above differences between different sub-domains of financiers to new ventures.

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Rather, the evidence discussed shows that the perceived extent of these challenges may in fact vary across entrepreneurs as their ventures feature differences themselves. The differences on grounds of industry (services vs. production) and development stage just discussed are also dealt with in the relevant entrepreneurial finance literature. In particular, industry and stage differences are seen as sources of heterogeneity in financiers’ application of what may otherwise be fairly similar screening criteria dimensions (cf. 4. 2. 2. 2. above and Brettel, 2002, 312p. and Baeyens et al., 2005). The interim summary will be concluded by discussing the external challenges identified in the case data in the context of the above theoretical orientation of financier screening criteria from the relevant entrepreneurial finance literature.179 Roughly speaking, the preliminary results in this part suggest that case entrepreneurs’ concerns about challenges rooting from financiers’ decision making reflect typical screening criteria dimensions. The discussion of empirical studies on financier pre-funding screening in 4. 2. 2. 2. showed three typical criteria dimensions: marketability and market potential of the venture’s product offers, founder competence and experience, and financial risk/return considerations. From the above sub-categories of perceived challenges, it appears that case entrepreneurs concerns approximately reflect these demand dimensions. Underneath this, however, the data suggests that the emphasis of what case entrepreneurs consider as challenging for new ventures seeking funding is on a specific type of criteria. Namely, interviewees perceive the challenges to access external funding sources to have their roots in the more palpable requirements of financiers rather than in the abstract expectation for, e.g., growth potential, competitive advantage, or risk adjusted returns. In the product and market dimension, the relevant literature stresses that equity financiers focus on market potential and a potentially strong market position of the venture’s products; in particular, investors are said to look for unique selling propositions guaranteeing competitive advantage (cf., fore example, Manigart et al., 1997 and Brettel et al., 2000; for similar criteria in banks’ credit checks cf. Schmeisser & Jahn, 1999). Rather than reporting such abstract demands as being challenging in themselves, case entrepreneurs considered concrete requirements for proof of initial customer references, 179

The idea of this is not to develop theoretical patterns as a proof − as this case study is not explanatory. Rather, the comparison of cross-case similarities with the prepared orienting concepts facilitates both proposing relations between theoretical constructs and suggesting indicators for their operationalization (cf. Ghauri 2004, 121).

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established relations to business partners in the market and finalized factual product development to be possible impediments (see above). Perhaps such concrete demands in the end reflect the above abstract criteria and financiers may also inspect existing initial customer demand to evaluate market potential and growth prospects (as also suggested in 4. 2. 2. 2. above). A similar rationale was also articulated in the cases where one’s proven industry experience was considered as a required indicator of the venture’s capability to develop a strong and profitable market position (cf. the discussion of sub-category (d) above). The perceptions of case entrepreneurs concerned concrete demands for relevant industry-related experience and competence while softer criteria such as leadership competence or determination and commitment were not reported as challenging (cf. Kuckertz, 2006, 73 and 75 for the moderate relevance of these criteria to financiers, in this case venture capital investors, and the difficulties for financiers to evaluate founders’ management quality anyway). There is at least some evidence in the views of interviewees that they considered these concrete challenges to reflect financiers’ abstract decision criteria and preferences. For example, founder D appeared to be aware that financiers demand business partners with market expertise because they are interested in evaluating the underlying market and profit potential of the venture. Entrepreneur A expressed the strong view that financiers concretely insist on existing products, customers, and business relationships because of their concern about downside risk (cf. Brettel, 2002 again for German venture capitalists focussing on potential chances but also on failure risks in their investment screening). This reflection of the possible underlying rationale of concrete criteria also emerged from the data for the financial risk/return criteria dimension. Here, the concrete requirement for collateral was regularly put forth. This has also been prominent in the empirical literature on bank lending to new ventures (cf. Mason & Stark, 2002). In particular, founders G, E, F and I seemed to believe that bankers’ focus on securing collateral and avoiding credit defaults was because of their perceived principal aversion to taking risks as also discussed in the relevant literature (cf. ibid. and Schulte, 1999). In addition to perceived challenges from financiers’ screening, a second external category emerged from the data. This category also contributes to entrepreneurs’ sensemaking of the financial environment they need to attract funding from. The perceived magnitude of funding sources encapsulates founders’ views on the spectrum of possible external funding sources which may potentially be available for new ventures like theirs.

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Perceived magnitude of external funding possibilities Within the discussion of their own ventures’ position and the fund-raising situation of similar new ventures in general, case entrepreneurs also expressed views about the principal range of financiers that might offer seed and start-up funding. Unlike the attributions about financier screening criteria, the second external category of interviewees’ perceptions of the financial environment entails both enabling and impeding aspects with regard to raising funding. For example, in some cases it was reckoned that overall, numerous financiers might be open to providing funding to new ventures. Having said this, it was also believed that certain types of financiers might not be available at all for seed or start-up stage ventures; or interviewees did not know about alternative sources. The principal dimensions of this category refer to entrepreneurs’ statements about the range and depth of possibly accessible sources of external funding that interviewees were aware of. The category built from these statements is labelled perceived magnitude of funding possibilities. A display of the case-level statements found is presented in figure 5–4.

perceptions on magnitude of sourcing possibilities A

(-) impossibility of obtaining sufficient loans from banks; (-) widespread hesitation to fund early stage development (VC; BA); (+) however, large VC market when venture more advanced

B

(+) know many fund-raising alternatives that may be tapped, in particular for lower volume of funding

C

(+) public small business support instead of bank loan; (-) growth potential too small and too low for risk capital

D

(+) many funding possibilities out there, in particular public support schemes

E

(-) no access to bank credit for internet start-ups

F

(-) too small for venture capital; problematic industry with risky image for start-ups in the eyes of banks

G

not reported

H

(-) unaware of other sources than bank loan (no alternative options considerable)

I

(-) limited supply and poor access to standard bank loans for start-ups

J

(+) many alternative sources of funding

X

(+) many funding sources for franchise businesses

figure 5–4: perceived magnitude of possibilities for external funding

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5. Multiple case studies of fund-raising processes in new ventures

Even though the ventures had not yet succeeded in attracting external funding by Ti1, entrepreneurs B, D and J in particular reported that in their situation many alternative funding sources might still be available.180 The entrepreneurs of venture B, who appeared very familiar with different venture funding sources181, stressed that they saw many possible alternatives to raise money (e.g. business angels and other private investors, public funding schemes for entrepreneurs, e.g. in combination with bank loans). They reported that this held in particular when looking only for a moderate amount of initial funding (the founders had looked for substantial venture capital before but now believed that a smaller amount of funding would be a lot easier to raise). Venture J had approached many potential financiers (private persons and venture capitalists in the beginning). The entrepreneur felt that despite the fact that none of the investors approached up to Ti1 could be convinced, the venture idea still might be interesting to the financial community. And he thus believed that there were enough other potential investors and funding alternatives out there for innovative ideas like the recycling project of V. Entrepreneur D pointed out that there were many different regional and national public support programmes in particular, that have funding available for innovative new ventures. Also there were sources of risk capital for projects like his. In addition, in some cases certain types of financiers were believed to be unsuitable at this stage who may be available later or to whom there may exist alternatives. Founder C reported that, should he be unable to obtain a bank loan, there would still be the possibility for him to obtain public financial support as an alternative. Furthermore, C thought that his project would not be large enough for risk capital investors. Similarly, Founder F supposed his project to be too small for venture capitalists (both in terms of potential operational size and funding volume) but considered business angels to be an alternative (a path he had not pursued as yet in Ti1). At Ti1, founder A appeared to be quite critical about the availability of equity capital from venture capitalists or business angels, arguing that these financiers may be reluctant in general to provide meaningful seed or start-up funding. However, he considered that it might be worth trying to advance his project further and approach other venture capitalists later. This was also documented in the then current version of the venture’s business plan which planned a round of venture capital funding at a later point in time. 180

181

In the contrast case, the founder also saw considerable funding possibilities. This was in particular because in an established franchise chain, the network of franchise organization and its franchisees may potentially offer various external funding alternatives. They had both attended entrepreneurship courses at university.

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There has also been evidence of a supposed limited general availability of bank loans to certain types of new ventures. Founder A reckoned that banks would just not offer that much money to a high tech start-up (he planned to raise more than two million euros) and Founder E judged that banks might not provide credit to innovation-oriented internet start-ups (the venture mainly offers online educational seminars, information, and consultancy to patients). Beyond these particular concerns, founder I reckoned that there was a limited supply of bank credit to new ventures in general in Germany, arguing that certain commercial banks, in his view, seemed not to look at entrepreneurs at all. To sum up, interviewees appeared to hold fairly strong beliefs that certain types of financiers may not be an option at all because of the venture project’s size (cases C and F), development status (A), funding demands (A and F) and industry (E and F). Irrespective of whether these specific views are actually true, perceiving limitations in the venture funding universe seems reasonable from what is known about the investment and credit policies of institutional financiers (also cf. Cassar, 2004 for the main argument that certain sources of finance might not be available to new ventures on a large scale). In particular, it is articulated that venture capitalists might only invest in certain stages and industries, rejecting projects outside these profiles straight away (cf., for example, Kuckertz, 2006, 69). Also the rating procedures of banks might discount, if not knock out, ventures from certain industries or with a rudimentary project status (cf. Berger and Udell, 2003).182 To sum up, the findings reveal that the case entrepreneurs held both positive enabling and negative impeding perceptions concerning the general availability of external funding sources for new ventures including their own. This hints at the existence of a concept reflecting the perceived extent to which financial resources appear to be available to entrepreneurial agents. Procedurally, the availability of alternative funding sources independent of prior unsuccessful funding attempts seemed particularly relevant (e.g. to entrepreneurs B and J). Conceptually, the availability of specific resources in the environment required by an organization is also included in the resource magnitude notion as put forward in resource dependence theory. Resource magnitude represents the availability of a resource in terms of the existence of alternative sources (e.g. angel capital instead of formal venture capital), the number of suppliers, or possible full substitutes (cf., for example, Lichtenstein & Brush, 2001 and also Pfeffer & Salancik, 1978, 46). As in the 182

For example, founder F had experienced outright rejections from banks saying that, on principle, they would not provide credit to firms in the aviation industry because it is too risky.

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5. Multiple case studies of fund-raising processes in new ventures

range of views expressed in the cases, a high perceived magnitude would indicate the belief in the existence of various alternative sources of external funding with many existing suppliers. In contrast, perceived reliance on only one possibly available type of funding with few suppliers may be represented by a low magnitude.

Summary of perceived financial environment: external financial munificence The last sub-section discussed evidence from the cases relating to the potential availability of alternative types of financiers to a new venture. The earlier sections of 5. 2. 3. 1. addressed the issue that, above and beyond this potential availability, entrepreneurs perceive challenges to obtaining funding from financiers’ pre-funding screening of potential investments in new venture projects. In the end, both empirical categories (perceived challenges from financier screening and magnitude of sourcing possibilities) may contribute to reflecting the overall accessibility of external funding perceived by entrepreneurs. Hence, they may be integrated into an overall category of interviewees’ perceptions of the accessibility of the financial resource environment. This integrated and refined category entails entrepreneurs’ perceptions in terms of possible suppliers of external funding and the difficulty of winning their financial support, judged by the demands they have for suitable new venture projects. It is suggested that this category of overall accessibility may be conceptualized in a construct of perceived external financial munificence. “Generally, environmental munificence is the scarcity or abundance of critical resources needed by ... firms operating within an environment” (Castrogiovanni, 1991, 542). So far, environmental munificence notions have been used for the perceived access to external resources in general (cf., for example, Brown & Kirchhoff, 1997 discussing the influence of resource munificence on entrepreneurial orientation and Castrogiovanni, 1991 for its use in strategic management theory). As a result of the study in this thesis, it also seems useful to specifically address the perceived scarcity or abundance of financial resources for initial new venture funding − in short perceived external financial munificence. Note also that Castrogiovanni (ibid., 544) has already advised future researchers that it may be fruitful to apply the munificence concept to the perceived access to specific resources, in particular pointing out that “examination of specific resource acquisition efforts would require environmental analysis at this resource pool level” (ibid., 545). The above evidence further indicates that, in addition to the perceived principal magnitude and availability, which is at the core of environmental munificence in the study

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of Brown and Kirchhoff (1997), perceived obstacles to actual resource access (the challenges dimension) may also be relevant. In consequence, when developing indicators for operationalizing the construct, both dimensions ought to be taken account of, inquiring into perceptions of both venture funding sources and how easy or difficult these financiers will make it to tap them. In consonance with the above authors, the focus is on entrepreneurs’ perceptions here (see ibid., 5). And Castrogiovanni (1991, 556) supposes that using subjective measures may “yield stronger relationships with specific decisions and actions” (such as perceptions of the financial environment and entrepreneurs’ choices during the fund-raising struggle in the focus of the study at hand). Finally, this study also offers additional insight with regard to the relevance of perceived environmental munificence to specific aspects of the entrepreneurial process. Brown and Kirchhoff (1997, 6) stressed that the level of perceived resource munificence may be important to entrepreneurial orientation, i.e. the formation of venture projects in the first place. The authors reasoned that the more resource munificent the environment is perceived to be, the more likely will engagement in entrepreneurial activity be (ibid.). In addition to this view, this thesis will suggest a more specific financial munificence construct manifest in the above two categories of magnitude of funding sources and perceived challenges from financial screening (cf. proposition P 1a in 5. 2. 3. 3. below). In particular, perceived financial munificence may also contribute to perceived fundraising chances and entrepreneurs’ financing plans during the initial fund-raising struggle of existing venture projects (and not only at the time of formation). In particular, the evidence suggests that temporal financial munificence perceptions may also be valuable in understanding how fund-raising attempts evolve during the venture establishment process. This will be followed up further in 5. 2. 3. 3. below. There, the external financial munificence concept will be further discussed together with a construct of internal fund-raising capabilities. This is because both may contribute to entrepreneurs’ perceptions of overall fund-raising chances.

5. 2. 3. 2. Venture characteristics and funding flexibility: fund-raising capabilities Two internal categories also emerged from the case data with regards to the nexus between the new venture and its financial environment. One category reflects perceived enablers of and impediments to fund-raising which pertain to the characteristics of the new venture project (perceived venture project characteristics). In addition to specific

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5. Multiple case studies of fund-raising processes in new ventures

characteristics of the project relevant to convince potential financiers a second internal category also showed up in the data. In entrepreneurs’ sense-making of what facilitates and what inhibits successful resource acquisition from the financial environment, perceptions about their flexibility and/or inflexibility in the search for funding also appeared to be important (perceived flexibility in fund-raising). For example, in the interviewees’ eyes, existing personal liquidity reserves help fund-raising chances as they give time for future searching for external funding. First the venture characteristics category will be addressed, followed by a discussion of the flexibility issue.

Venture project characteristics perceived as being relevant to convince financiers The display in figure 5–5 shows interviewees’ reasoning of elements of their own venture projects considered to be relevant for raising funds. These project characteristics entail advantageous and problematic elements, both of the new venture itself as well as of the entrepreneur as a person.

perceived venture project characteristics A

(+) convinced of customer need and high market potential; experienced founder team; (-) lack of customer references

B

(+) existing strategic partners; unique business concept; often new bridging contacts to potential investors; (-) difficulty to understand novel business concept

C

(+) common service offer in established market; PR project references; collateral to offer from existing current account; (-) little entrepreneurial experience

D

(+) unique product technology; attractive return potential; prospect of patented product with licensing potential; (-) no established business; short of collateral; product difficult to conceive

E

(+) industry experience, in particular references from previous occupation; (-) no paying customers yet; internet based-service is problematic for others to believe in

F

(+) good service offers; (-) lacking existing business and collateral

G

(+) belief in excellent prospects of target market; business experience of founder; existing business partners (production; distribution); (-) lack of production prototype, customers and collateral (+) growing online gaming market; (-) lack existing software gaming prototype; no collateral

H I

(+) industry contacts and experience; positive personal target market feedback; (-) lack of software prototype and real customers; difficulty to communicate software product to bankers; not enough collateral to offer

J

(+) good business idea in a rapidly growing industrial recycling market; industry expertise of founder team; (-) concern about own business skills to deal with potential investors

X

(+) established and successful franchise concept known to banks; support of matching agency in fund-raising process; (-) difficulty to demonstrate business skills

figure 5–5: perceived venture project characteristics

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245

The display shows that both abstract and concrete enabling and impeding factors were reported in the cases. In particular, in the process of analyzing and categorizing what interviewees said (the result of which is the display in figure 5–5), two aspects stuck out with regard to judgements about their own potential to convince financiers. First, on the one hand, entrepreneurs, who were all still searching for funding at Ti1, reported problems pertaining to concrete shortcomings of their venture projects, making it difficult to convince financiers (e.g. lack of existing customers to actually demonstrate market potential).183 These judgements seem to be made relative to attributions of financier expectations (see the discussion below). Second, on the other hand, case entrepreneurs often perceived fairly abstract advantages as to what their projects have going for them when trying to acquire funding (e.g. being convinced oneself about the quality of the business concept or the venture’s possible market prospects). These two aspects will be discussed in turn. Interviewees considered their lack of concrete established business relations within a running business and existing product offers to be essential operational drawbacks for the fund-raising process. In particular, founders A, E, G and I were concerned about the fact that their businesses were short of customer inquiries that they could refer to when talking to financiers. Entrepreneur I reported that he knew that people in the industry might be interested in the software; however, he argued further that since the software was not ready at Ti1, he did not have any real customers at this time to show that it would sell. A similar thinking appeared in cases A and G. Both entrepreneurs believed in the market prospects of their business idea. However, at the same time they understood it as a problem that they had no reasonable customer references to present. Furthermore, founder E reported that he was lacking ‘paying customers’ for his venture’s service offer. He said that he could tell potential investors about many satisfied participants from medical seminars he had done for his previous employer; but in his view such outdated references ‘don’t count’ when trying to attract funding for a new venture. Finally, founders D and F put forth that their venture projects had the disadvantage that they didn’t have an ‘existing business’ in terms of customers and an existing line of service offers (case F) and construction and manufacturing partners (case D). The entrepreneurs reported that this was a problem since their projects may appear risky. This was because of lacking revenues from the business (case E) and because of few real 183

There were also occasions where business partners or a pending patent were already in place and interviewees felt these achievements to ease the fund-raising task.

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5. Multiple case studies of fund-raising processes in new ventures

steps taken to set up product construction and initial manufacturing in collaboration with other firms (case D). From a theoretical point of view, it appears that some of the impediments reported in the cases represent typical liabilities of newness at the heart of legitimating problems common to new ventures (cf. chapter 3. 1. 3. above). For example, entrepreneurs apparently saw the lack of proof that their business concept generated market demand through pilot customers or the fact that they had no existing business track record and relationships with other firms as impediments to obtaining funds (cf. Hager et al., 2004 and Gruber & Henkel, 2004). This is also underscored by the cases where external business partners, customers of existing service offers, or an accepted (pending) patent application existed (cf. cases B and G regarding business partners; see cases C and D as far as customer references and patent endorsements are concerned). These elements have been reported as advantageous to the fund-raising task. Founder C argued that his existing references from small public relations projects he had already completed would make it easier to obtain a bank loan. Entrepreneur D stressed that ‘in particular the nearly finalized patent should be interesting for financiers and show technical feasibility of the planned vehicle extension product’. Status of development and characteristics of a venture’s product and service offers have also been reported as possible impediments. Interviewees G, H and I expressed concerns that their uncompleted product development and production process would make fund-raising more difficult. Founder H felt that bankers did not believe in the quality of his planned line of PC games because he had no example game to show. Founder G was not so much concerned about the fact that the quality of his lamps might not be appreciated. His concern was rather that he could not demonstrate a prototype for regular batch production which some financiers may ask for. As in case H, interviewee I also found that it was a substantial problem in the fund-raising process that his software was not ready yet. This was mainly because, in his eyes, it is difficult anyway to present the qualities and prospects of a novel software product to bankers. Such difficulties pertaining to supposed scepticism or lack of understanding of a venture’s product offer and underlying business model were also reported in other cases. In case B, it was pointed out that the novelty of the venture’s internet-based ‘demand-side’ business and revenue model might be difficult to understand and thus a specific problem when approaching financiers. Founders D and E reported similar impediments relating to

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the novel character of their product and service offers. They both supposed that potential financiers might be sceptical about their vehicle extension technology (case D) and online medical education and consultation (case E) because these concepts were new and not yet established, both operationally and in the market place. For example, interviewee E stressed that this made it difficult to convince investors, because traditionally people consider seeking medical consultation as something to be face to face between doctor and patient. Such problems relating to possible scepticism about new products and services have also been pinpointed in the discussion of gaining legitimacy (cf. 3. 3. above). These legitimating problems of firms (such as cases B, D and E) employing a new technology or a novel business concept (cf. Suchman, 1995, 587 or Aldrich & Martinez, 2003) may not exist in imitative start-ups. In contrast to the impediments in the three cases above, founder C argued that he had the advantage of offering common and established public relations services to a specific group of customers. In addition, for the contrast case it particularly stands out that founder X saw himself in a good position to find a financier because he could rely on a well-known and successfully established franchise business concept. This study does not focus on the particularities of legitimizing in innovative versus imitative ventures or specific legitimizing ‘success factors’. However, it should be noted that typical liability of newness problems within the struggle to gain legitimacy with potential financiers were still perceived. With regard to this, concrete internal enablers and especially impediments appear to be relevant to entrepreneurs’ own position in the initial financing of their venture projects. There, it begins to show that interviewees’ sense-making of their ventures’ advantages and disadvantages is often related to the external financier demands they perceived (cf. the discussion of perceived principal challenges from financier pre-funding screening). This was observed not only for the above operative elements such as customer references, existing product offers, or industry experience that financiers were perceived to demand. In particular, this constellation was also found for the demand for collateral when asking for a loan. Here many interviewees (cases D, F, G, H and I) reported that they considered their projects’ lack of collateral to be a problem in view of bankers demand for security (e.g. lacking firm assets that may be secured or personal collateral they may have to offer).184 Note at this point that the coding procedure of data used, 184

In addition, founder C estimated his position as being quite good with respect to obtaining sufficient loans. This was because he would be able to offer adequate collateral as his required funding was so low.

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5. Multiple case studies of fund-raising processes in new ventures

pertaining to interviewee statements, strictly differentiated between interviewees’ external attributions of financiers’ screening criteria (’banks want collateral’), statements referring to characteristics of their ventures and their own person (’I have/do not have any collateral to pledge’), as well as derived evaluations of these conditions (e.g. ‘I therefore think that it is difficult to get a loan’). Having clarified that these attributions do not stem from identical statements in the interviews, the main conceptual orientation suggested in the discussion of TO 1 (cf. 4. 4. 3. 1. above) can be appreciated within the context of the empirical evidence. In 4. 4. 3. 1. it has been suggested that both demands of financiers as well as potential capabilities to convince financiers may contribute to entrepreneurs’ perception of funding chances and intentions. Above, this orientation had been developed from the injunctive social norm construct within the theory of planned behaviour. There, external social pressures have been conceptualized in terms of the agent’s perceived potential to gain approval from others (cf. Rivis & Sheeran, 2003). As has just been derived from the empirical external challenges and internal venture characteristics categories, there is evidence that case entrepreneurs do consider both external demand pressures and internal conformance characteristics of their venture projects as relational conditions (e.g. ‘I don’t yet possess the customer references that may be expected by potential financiers’). The potential usefulness of this understanding will later be reflected in propositions P 1a and P 1b. It will be suggested that perceived fund-raising chances may be associated with both perceived external financial munificence (with challenges from financier screening as one dimension) and internal funding capabilities (with its venture characteristics dimension). In addition to the concrete internal enablers and impediments discussed, the case entrepreneurs also perceived other, more abstract characteristics which might enable the acquisition of funds. These characteristics also seem to be thought about in the context of investor preferences, e.g. for potentially profitable venture projects with a competitive product in a growing market. In a sense, this also reflects the following theoretical assumption that meeting perceived legitimacy demands to convince profit-oriented financiers also involves gaining a kind of pragmatic exchange legitimacy where financiers have to value what a venture might offer to them (cf. 3. 3. 1. 2. above and Tornikoski, 2005). In the discussion of the possibility to raise funding for their projects, founders A, G, H and J believed that their ventures targeted growing markets with considerable market potential (volume and growth) and that this might also help in obtaining finance

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(cf. figure 5–5 above). For example, founder G argued that he saw excellent prospects in a market which offered a high potential sales volume; however he further stressed that the only problem with this was that financiers often don’t see these prospects. Entrepreneurs H and J put forth that their markets (online gaming and industrial recycling) would be growing and that this would help to convince financiers. In addition, interviewee A also believed his online PC repair service would meet existing customer needs in a uniquely cost-efficient way; this gave him an advantage over the competition, who offered their repair services the traditional way at much higher prices. Such unique aspects of their business models and products were also pointed out in cases B and D (unique ‘demand-side’ internet portal and novel extension technology). To sum up, founders seem to consider that such prospective commercial vantages of their venture projects give them chances to find financiers because they appeal to what investors generally look for. This is further validated by the available business plans of case ventures which usually also emphasize these amenities in the communication to potential financiers. And while interviewees were concerned that lacking concrete proof of these prospects would be an impediment to funding, the firm conviction in the overall commercial prospects of their ventures apparently contributed to their belief that, though difficult, finding investors was still possible (at Ti1). Finally, it is important to note that, in terms of elements reported to enable the acquisition of funding in the future, personal network contacts seemed to be less important than supposed in the exploratory orientation (see the discussion of TO 1b in 4. 4. 3. 1. above).185 However, this might have been because at Ti1 the case entrepreneurs had already started the search for funding (and existing contacts had possibly already been exhausted). In other words, it may rather be that personal network contacts contribute to entrepreneurs’ perceived capabilities to raise funding at the formation of the process at origin (e.g. as in the discussion of specific entry scripts of entrepreneurs where network contacts to gain resource access are considered to be particularly relevant at start − as opposed to during the later venturing process; cf. Mitchell et al., 2002, 12). Similar to the limited relevance of personal network contacts in fund-raising processes already under way, there is also little evidence that perceived own immediate competences (e.g. presentation skills; financial management literacy) or lack of them is substantially relevant to case entrepreneurs’ 185

The only evidence found in the data was the founders of B who believed that their contacts to a local business development agency and their university’s entrepreneurship community might help in obtaining funding. At the other end of the scale, a lack of further personal network contacts was not reported as a specific impediment.

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5. Multiple case studies of fund-raising processes in new ventures

sense-making of their ability to raise finance.186 Again such elements might rather be relevant to entrepreneurs’ perceived efficacy to obtain funding in the earlier conception phase, i.e. prior to the time of actually being in the process of seeking funding.

Perceived flexibility in fund-raising In addition to the above venture project characteristics category, a second category of internal enabling and impeding elements has been identified. Evidence emerged showing that perceived flexibilities and inflexibilities are also relevant to the sense-making of future fund-raising chances. These enabling flexibilities and impeding inflexibilities fall into two broad sub-categories: a) perceptions regarding the flexibility of establishing operations including current expenses and b) perceptions concerning the availability of compensatory personal liquidity. In the interviewees’ eyes, enabling elements, which have their roots in these sub-categories, offer flexibility in terms of the time available and the volume of funding acceptable within the future search for funding. Towards the other end of the scale, when these elements are lacking, this is perceived to limit the scope of future fund-raising attempts, possibly impairing chances to acquire sufficient finance. Figure 5–6 shows what was reported in the cases with regard to flexibility in fund-raising. In cases D, G and J the interviewees felt that the funding task may be hampered by the fact that a substantial amount of up-front funding would be indispensable to establish operations. Founder D was concerned that it would be quite expensive to build his first vehicle prototype and thus his options would be limited when approaching potential financiers. Entrepreneurs G and J expressed similar concerns because of the production they needed to set up for their business ideas to be fully implemented. In particular, J reported that this would make it more difficult to fund his business as compared to services start-ups. In some of the other cases the operational establishment characteristics were quite different. In case B the interviewees reported that they thought it would be quite possible to find financiers in the end, not least since they would be able to carry on with seeking funding for a longer time. This was because their business did not cause a great deal of expenses at that time; their venture operated at very low fixed costs so 186

Only interviewee J worried about the possibility that the quality of his management skills might be a problem for convincing potential financiers. In the other cases, neither possible impediments nor enabling elements were reported in this respect.

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flexibility in fund-raising A

(+) income from consultancy work; possibility of winning partners and funding venture development step by step

B

(+) could stay afloat with lower funding from other sources (low fixed costs)

C

(+) do not need very much money (flexibility in timing and funding volume)

D

(+) state unemployment support (flexibility in timing); (-) high required up-front funding to build prototype vehicle sets limits

E

(-) limited personal savings available for the venture constrain search process

F

(+) low capital expenditure needs and current job (flexibility in timing and funding volume)

G

(-) need for certain level of funding to start large scale batch production

H

(-) erratic income from media freelancing limits time window to find financier

I

(+) personal savings and income from other consultancy work (flexibility in timing)

J

(-) certain level of initial funding required in contrast to service start-ups

X

(+) personal savings and family support (flexibility in timing)

figure 5–6: perceived flexibility in fund-raising

that they could manage to stay afloat, also because of their low costs of living for themselves. Moreover, they could survive with lower funding because they might easily adjust their business plan to a lower scale and pace of build up (establishing and extending the internet platform; marketing efforts). Similarly, founder C reported that ‘he himself and his business would not need very much money to survive’. As far as flexibly establishing and extending business operations is concerned, founder A stated that it would be possible to develop his venture step by step, attracting investors over time, perhaps with smaller amounts of investment in the beginning (which was already accounted for in the venture’s adjusted business plan at Ti1). The time to find financiers in the future was also enhanced and constrained by the liquidity available to the venture. This was not so much because of the level of financial reserves of the ventures themselves, but more in terms of the personal liquidity of their founders which might have been available to compensate for a longer search for funding in the future. This liquidity concerned both the possibility (and impossibility) to infuse substantial further personal savings already existing or to provide income generated from other jobs or unconventional sources. Founders A and I stressed that it helped their fund-raising attempts that they could develop their venture further in small steps with money they had saved or with income generated from consultancy work they did and

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which they could spare for their ventures. Moreover, founder X reported that the support by his family allowed him to calmly search for adequate funding while entrepreneur D said that he still might find financiers because he could keep searching while living on state unemployment support. Conversely, in cases E and H the two founders were concerned about their lack of financial leeway. Founder E felt that, in his case, the future process to find adequate investors was complicated by the fact that he didn’t have many financial reserves left for his project and his family. Similarly, founder H reported that he would need to find a financier fairly soon, as he was running out of money. At this time, he lived from infrequent freelancing jobs. He did not seek full-time employment because he wanted to have enough time to write the code for some of the multiplayer games he intended to sell. However, he also believed that he could not carry on forever this way. Summarizing the findings pertaining to the category of the perceived flexibility of funding, the reasoning of founders appears to concern the perceived criticality of external funding to their venture projects. In resource dependence theory, criticality of a specific resource refers to a kind of devil’s advocate notion, asking “what would happen if the resource were not available” (Pfeffer and Salancik, 1978, 46). In the particular context of external fund-raising, impeding and facilitating factors stemming from this criticality underlie entrepreneurs’ perceived flexibility. In cases where financial reserves (especially from the founders’ pockets) appeared to be lacking or where finance was more critical because of substantial financial requirements, the perceived flexibility to obtain funding in the future may be constrained. Here, limited financial bolsters may not allow it to continue the fund-raising process calmly in the future or to withstand much more financier rejection (as discussed generally for the liability of smallness of new ventures; cf. 3. 1. 3. and Morris, 2001 or Gruber & Henkel, 2004; also cf. the discussion of perceived liquidity constraints and capital requirements as perceived barriers to entrepreneurial activity in Ho & Wong, 2005, 4). Conversely, there are other cases with more advantageous liquidity conditions. Here, personal liquidity to spare for the venture project or adaptation potential to make do with less funding in the build up of business operations offer additional time and allow liasing with financiers only willing to offer a lower amount of finance.

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Summary of internal conditions to obtain sufficient funding: internal fund-raising capabilities Overall, the evidence gathered suggests that perceptions of flexibility in finding financiers, together with the above perceived venture project characteristics, constitute what may be termed perceived internal fund-raising capabilities. This internal construct may be adjacent to external financial munificence in case entrepreneurs’ overall sensemaking of their chances to be able to raise sufficient funding from potential financiers. Therefore, in agreement with Brown and Kirchhoff (1997, 5), entrepreneurs’ perceptions about the availability of funding possibly also entail beliefs that they can acquire finance beyond the overall accessibility of finance to new ventures in general (also cf. Kemp et al., 2002, 26). With regard to acquiring resources, in their study of entrepreneurial orientation Brown and Kirchhoff (1997) use a construct of resource acquisition self-efficacy in addition to environmental munificence. This construct mainly deals with entrepreneurs’ perceptions about their own skills and abilities as to obtaining certain resources. However, the above case evidence suggested that beliefs about personal competences and skills (personal abilities) are less relevant in a context where the search for funding has already commenced. Rather, during the process, and after previous unsuccessful attempts to raise money, flexibilities to continue searching for a financier and convincing features of the project appear more important to entrepreneurs. Here, the reasoning of their perceived potential to convince financiers is mainly driven by beliefs about characteristic advantages and disadvantages of their ventures and the financial leeway as to the future search process. This may be what reflects entrepreneurs’ perceived capabilities to raise funding.187 In this respect, it also seems a fair view that founders might consider the qualities (and problems) of their venture project and business conception when reasoning about convincing others to invest money or to provide a loan later during the venture establishment process (cf. Kickul & D’Intino, 2005 discussing a resource marshalling phase where others need to be convinced and which is to come after phases where the venture idea is conceived and the business is planned; recall also Newbert & Tornikoski, 2004 stressing that the quality of the business opportunity may be instrumental to convincing investors).188 Together with the above notion of external financial munificence, the 187

This extension beyond personal abilities of the entrepreneur is also why the construct has been labelled fund-raising capabilities rather than perceived abilities or self-efficacy.

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perceived internal fund-raising capabilities may contribute to entrepreneurs’ perceived chances to obtain sufficient funding. This will be reasoned in the next chapter, suggesting propositions for future theory building.

5. 2. 3. 3. Feasibility of fund-raising: external munificence and internal capabilities (P 1a and P 1b) Firstly, entrepreneurs’ judgement about their chances to obtain external finance will be discussed. At the empirical level, the central ‘perceived chances’ category appears to be what corresponds to the construct of ‘perceived feasibility of fund-raising’. Secondly, it will be put forth that the degree to which acquiring sufficient external finance is considered feasible may be associated with entrepreneurial perceptions of the level of financial munificence of the environment and their individual fund-raising capabilities. The elaboration of these two points will allow an appreciation of entrepreneurs’ sensemaking of the financial selection environment. This will be in terms of restrictions perceived by entrepreneurs and the room for manoeuvre defined by these constraints.

Reasoning of fund-raising chances as perceived feasibility of external financing In 4. 4. 3. above, perceived feasibility has been said to reflect in how far entrepreneurs think they will be able to acquire sufficient external funding for their ventures. Furthermore, it has been suggested there, that this may be represented by how certain one is of obtaining this funding. There was also a central phenomenon in the data, which pertains to thinking about the fund-raising task in a similar, but slightly different way. In their own terminology, the case entrepreneurs appeared to think about external finance in terms of the chance they had of raising funding successfully. In particular, entrepreneurs’ judgements of chances entailed not only attributions of difficulty but also statements of relative easiness (e.g. entrepreneurs reporting that it would be difficult to get the needed money from potential investors or statements that they saw good chances to obtain funding). Note that entrepreneurs’ attributions not only pertained to how hard or easy fund-raising would be to do as an activity, but also to the 188

Having said this, it also needs to be stated that the case data gathered is not suitable to analyze (let alone reject) the relevance of beliefs in personal skills and competences for perceived fundraising capabilities at the formation of intentions to found a venture in the first place. This is simply because the early conception phase has not been focussed on in the case study.

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chances of achieving a certain level of performance (i.e. to convince potential financiers). In addition, some of the case entrepreneurs thought about their chances to convince particular types of financiers as compared to other funding sources. Finally, the interview data featured judgemental statements of future funding chances in comparison to entrepreneurs’ previous views. This may partly have been because the study explored interviewees’ reasoning of their individual fund-raising processes over time. It would therefore go too far (and possibly produce an artefact) to presume from the data that entrepreneurs regularly thought about future fund-raising chances relative to how chances had been judged in the past. This said, the case evidence does suggest that entrepreneurs’ judgements of funding chances may change over time. In particular, the judgements of founders entail evaluations of chances to attract funding from the type(s) of financiers they had approached up to that point in time as well as estimations of chances to convince other potential financiers in the future. This will be followed up in detail further below in chapter 5. 2. 4., where perceived changes in fund-raising chances throughout the search process for funding will be analyzed. For the time being, the focus is on reported evaluations of entrepreneurs’ fund-raising chances at Ti1. The evidence obtained from the data is summarized in the display depicted in figure 5–7. The display shows reported perceptions of chances to raise external funding and how difficult interviewees thought it would be. In the case interviews, entrepreneurs were invited to complete and found these views with further reasoning (and often interviewees already did so when reporting on their chances). The reported reasoning pertains to the above four categories of enablers and impediments (challenges from financier screening and magnitude of funding sources; venture project characteristics and flexibility in fund-raising). This rationale of considering their chances in this way is shown in a condensed form in parentheses (see figure 5–7). From the display, it appears that core enabling and impeding elements contribute to entrepreneurs’ views as to what makes it difficult to attract funding and where there may be funding options for the future. In particular, this part of the analysis tried to order the cases into two groups, those where chances were perceived to be quite good (cases B; C; D; J; X) and a second group where entrepreneurs were rather sceptical or more doubtful about their funding chances (A; E; F; G; I).189 This case-ordered display (cf. 189

Note that case H could not really be placed in either of the two groups. The founder’s view basically boiled down to the idea that, on the one hand, it would be difficult to get a loan because he would need to offer collateral which he did not have. On the other hand, he said he believed that somehow he would find a banker who appreciated the prospects of his software project.

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perceived chances to obtain external funding A

relatively difficult to convince potential financiers currently (customer references and existing business partners), however not impossible in the future (possibility to gradually build the business and acquire funding in small steps)

B

good options to obtain funding and establish the venture (endorsement by business partner; possibilities to adapt funding concept; many alternative possibilities)

C

likely to manage to acquire the money needed (collateral in place; existing project references)

D

hard time to obtain loans so far (lack of existing product and collateral worries banks); still certain to attract investors to the business idea from elsewhere (quality of patented product technology and possibility to fund production with strategic partner)

E

only few chances left to raise funding sufficient to carry on (constraining financial reserves; venture project not advanced enough for external funding - particularly market establishment)

F

sceptical about chances to get an adequate loan from a bank (problem with demand for collateral); don't need much money and perhaps private credit or business angel investment possible (alternative possibility and corresponding flexibility in funding)

G

very difficult to get substantial bank and other financing (collateral; existing production); knew about difficulties beforehand; perhaps funding via strategic production partner (alternative possibility)

H

became worried over time that getting bank credit might be more difficult than initially assumed (collateral; show case games); however, other banks may be asked in near future

I

only moderate chances to obtain enough funding from banks (collateral demand of banks; overall lower chances than believed at start since business idea was less convincing than initially assumed); still possible to obtain funding (quality of business idea judged by positive market feedback); 'every idea has its time' and financiers may be found later (personal investments offer flexibility); public support as alternative (alternative possibility)

J

still positive about chances of obtaining funding (strength of business concept and good business plan), though imagined fund raising to be easier in the beginning

X

‘99%' sure to get funding (established franchise concept accepted by banks in the past; supportive matching agency)

figure 5–7: perceived fund-raising chances of entrepreneurs

Miles & Huberman, 1994) suggests that the following two themes exist in the data, which relate the external and internal categories discussed to the central category of ‘perceived fund-raising chances’. First, the doubts of the second group mainly stemmed from problems entrepreneurs perceived their individual ventures to have with concrete screening criteria of financiers (e.g. collateral, proof of customer references and existing business partners). Often, these problems had been experienced in previous attempts to approach financiers prior to Ti1 (see further below). However, most of the entrepreneurs in this group still saw options to find financiers after Ti1. Chances were perceived to be particularly poor where the founder reported that he did not see such options since he was lacking the flexibility of financial reserves to keep searching much longer or considered the status

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of his venture project to be too poor to convince other investors (case E and, to some extent, also case H). The above options, which in the other interviewees’ eyes, gave them some chance in the future, mainly refer to perceptions of sourcing magnitude and funding flexibility. For example, there were perceptions such as the possibility to attract a smaller volume of credit as a personal loan (case F), alternative funding through a business partner (case G), or as part of a research project to be supported by public funding (case I). Second, such future options, which stem from perceived windows of opportunity based on alternative sourcing possibilities and entrepreneurs’ flexibility, were also found in the first group of cases. Beyond this scope, the entrepreneurs who had been fairly positive about their chances to attract funding also considered certain characteristics of their ventures to favour them. For example, the founders of B were optimistic because of the visibility of the strategic partner that had already been won to support their project. Founder C stressed that he could offer adequate collateral and relevant references and that this would boost his position when applying for credit. Founder D was fairly sure that the pending patent for his innovative product might yield him the desired funding in the end. Founder J believed in the strength of his venture project and business plan which had done well in a business plan competition. In the contrast case, founder X appeared to be very sure that he would be able to obtain funding because of the perfected franchise concept which had been supported by banks in the past (in the case of other franchisees). Finally, perceived feasibility, understood as the perceived chances to raise enough funding to establish the venture, features a structure similar to the perceived feasibility of starting a new business as a whole. For the latter, believing in one’s ability to access the complete range of resources required to start a business has been argued to be relevant to perceived feasibility (cf. above and, e.g., Mair & Noboa, 2005 again). For the former, entrepreneurs’ belief in their chances to put together an adequate basis of funding by convincing external financiers has been found relevant in this study. From the above core elements pertaining to entrepreneurs’ reasoning of these chances, and the results of chapters 5. 2. 3. 1. and 5. 2. 3. 2. above, two propositions may be arrived at in the following section.

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Propositions for entrepreneurial perceptions of the financial selection environment (P 1a and P 1b) 1) Proposition P 1a In the analysis of case evidence regarding entrepreneurs’ sense-making of the financial environment, two external categories have been retained. One category reflects perceived challenges from the demands of potential financiers in their screening process of acceptable venture projects. A second category deals with the perceived magnitude of funding possibilities. Both categories comprise enabling and impeding elements that seem to be relevant to entrepreneurs’ reasoning as to whether acquiring sufficient funding appears feasible to them. In particular, these categories have then been suggested to constitute the construct of external financial munificence of the financial environment surrounding new ventures. Furthermore, for the acquisition of resources by entrepreneurial ventures in general it has been hypothesized by Brown and Kirchhoff (1997, 6) that “the more munificent the environment, the greater the firm’s opportunity to acquire those resources”. Moreover, as far as the viewpoint of the entrepreneur on this is concerned, the authors further suggested that “the more the small business owner believes that resources are abundant and available in the environment, the more secure the owner should be about his or her ability to acquire resources” (ibid.). Finally, it has also been argued that a supportive resource environment might be relevant for entrepreneurs to perceive opportunities to start and establish a venture (cf., for example, Mitchell et al., 2002, 12); this may also be suggested for the specific case of chances to get a conceived venture funded properly and the availability of the needed finance to be attracted from the external environment.190 From the results of the multiple case analysis and the adjunctive discussion in the literature, the following proposition (P 1a) may be put forth: P 1a: Perceived feasibility to obtain initial funding for a new venture is associated with the degree of external financial munificence perceived by the entrepreneur. The proposition suggests that feasibility perceptions are underpinned by how munificent the entrepreneur considers the environment of potential financiers to be. In particular, it 190

Note that environmental munificence has also been thought to positively influence the range of options available to management in a general business strategy context (cf. Castrogiovanni, 1991, 543).

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is supposed that the higher the entrepreneur perceives the financial munificence of the environment to be, the more feasible will acquiring initial funding be considered by the entrepreneur. With regard to a possible operationalization of external financial munificence the following guidance may be provided in light of the case evidence. To operationalize munificence, Brown and Kirchhoff used two indicators on a rating scale, in particular the “owner’s perception of the extent to which the providers of financial capital are interested in businesses like the respondents’” (Brown & Kirchhoff, 1997, 7). This item might also be used for the financial munificence construct. With this indicator, both entrepreneurs’ perceptions about the availability of finance to new businesses in the industry the firm is to be established in, as well as the access to funding for ventures with a particular, possibly early stage, development status may be reflected (recall that both have been found to be relevant in the case evidence). Beyond entrepreneurs’ views on possible constraints from lacking interest of financiers, the case analysis also showed that the perception of the range of alternative possibilities to obtain funding was important, too. Hence, researchers may consider a second indicator to capture beliefs about resource magnitude by asking for the extent to which founders perceive a wide range of funding possibilities to be available for businesses like their own. The approach employed by Brown and Kirchhoff focuses solely on the general magnitude of available resources. However, the above case analysis suggests that, not only were the existence of capital and the broad interest of the financial community to provide it to new ventures of concern to entrepreneurs. In addition, it has also been found that perceived financier expectations as to the particular performance and characteristics of venture projects mattered (the above screening challenges category). Here, it appeared that entrepreneurs were both aware of abstract demands of financiers regarding the market potential, managerial competence, and risk level of a project as well as concerned about concrete requirements which emanated from these demands. This finding suggests that additional indicators should be employed which reflect the extent to which entrepreneurs perceive the screening criteria of potential financiers as making fund-raising more difficult. Furthermore, it seems that a merely dichotomous measure, which just reflects whether an entrepreneur perceives (or does not perceive) financier demands that may constitute difficulties to attracting funding, may be inadequate. Rather, in order to allow more differentiated degrees of difficulty to be stated by respondents, indicators pertaining to

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5. Multiple case studies of fund-raising processes in new ventures

this category may also be put on the rating scale following the operationalization and measurement concept of Brown and Kirchhoff above.191 In particular, one may use construct indicators that capture the perceived intensity of barriers to venture founding (as in Kouriloff, 2000). Here, the focus may be on barriers pertaining to raising sufficient financial resources (for this also cf. Kemp et al., 2002 who developed measures specific to the challenge of assembling resources for new ventures). Kemp et al. measured the difficulty of entrepreneurs to acquire resources for their businesses as part of a differentiated rating scale (for financial munificence the intensity of barriers to acquire financial resources may be concentrated on). Finally, the category of perceived financier screening challenges also indicates that different financier demands may be relevant to entrepreneurs. Hence, researchers interested in specific perceived limits or barriers to financial munificence may also include the perceived extent to which entrepreneurs believe that these singular demands may make fund-raising difficult (e.g. demands for proven market/customer demand, collateral, proof of industry experience or business skills). 2) Proposition P 1b In their sense-making of external financing chances, entrepreneurs also held beliefs about the enabling and impeding aspects regarding their individual position to obtain funding. In particular, these were perceived characteristics of their venture and their own potential financial flexibility. The former may reflect possible advantages and disadvantages as to convincing potential financiers. The latter reflects possible adjustments that might facilitate the process of seeking external funding in the future (flexibility in the amount and timing of funding). In 5. 2. 3. 2. above, these two categories were integrated into the construct of perceived fund-raising capabilities. Similarly, for creating and establishing ventures in general, it has been suggested that both externally oriented aspects and internal factors may play a role in the decision making of founders (e.g. Kouriloff, 2000 and Mitchell et al., 2000). Brown and Kirchhoff (1997, 5) supposed that entrepreneurial activity is both influenced by perceived external munificence of the environment to make resources available and the entrepreneurial firm’s own ability to acquire them.192 Moreover, Mitchell et al. (2000) established 191

192

Note that adjectives as labels to anchor both ends of scale ratings have to be applied consistently when constructing an overall rating scale for financial munificence with items reflecting both the funding magnitude beliefs and perceived financier screening challenges. More precisely, as noted in 5. 2. 3. 2. above, the latter will essentially be about entrepreneurs’ beliefs in their ability to acquire the resources.

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the relevance of both external arrangement cognitions and internal ability cognitions for venture creation decisions and antecedent perceived opportunities. It seems worthwhile to investigate a similar structure for the specific activity of acquiring funding for the venture. From the case evidence analyzed, therefore, a second proposition on the beliefs that may underpin perceived feasibility may be formulated. P 1b: Perceived feasibility to obtain initial funding for a new venture is influenced by an entrepreneur’s belief in his or her fund-raising capabilities. As suggested by the proposition, it may be expected that higher levels of (or stronger beliefs in) fund-raising capabilities as perceived by the entrepreneur positively influence feasibility perceptions. In comparison to the above venture creation and entrepreneurial orientation studies, the evidence that emerged from the multiple case study exhibits two different aspects. These aspects may be of particular interest to researchers taking a procedural perspective with respect to perceptions of feasibility of entrepreneurs’ plans to obtain resources throughout the initial establishment process (and not only within the context of the original venture creation decision at the start). Firstly, building the business and assembling financial capital for it took time in the cases under study and it was unknown at the outset what kind of financier may be found. In light of this, perceived flexibilities (and inflexibilities) were important to the case entrepreneurs’ evaluation as to whether external funding would be feasible in the future. In particular, flexibilities in terms of their liquidity position and the time window available to find financiers, as well as in terms of the amount of funding that may be sufficient, appeared to play role. To operationalize this dimension of the funding capabilities construct, the perceived extent to which entrepreneurs feel that they have enough liquidity and time left to find financiers for their venture projects could be examined. A second indicator may be the degree to which entrepreneurs believe that they can manage to fund the venture with less external finance than initially planned. Secondly, a process approach also involves considering entrepreneurial ventures seeking funding where some steps to establish the ventures have already been taken or where the venture already exists. It seems logical that, in the case of ventures that are already in the initial establishment process, the perceived strengths and weaknesses of the venture projects may also come to play a role in entrepreneurs’ evaluation of funding chances in addition to beliefs about personal skills and competences relevant to obtain funding. To take account of this aspect, the following further indicators to operationalize perceived funding capabilities

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5. Multiple case studies of fund-raising processes in new ventures

may be drawn from the case evidence. The analysis has shown the possible relevance of both abstract advantages (such as an entrepreneur’s belief in the quality of their business idea and its market potential)193 as well as − in relation to these abstract characteristics − concrete problems with the new venture project (e.g. lacking references of business and market establishment including endorsements of third parties; lacking collateral). Within the context of approaching financiers for funding, one may therefore ask about the extent to which entrepreneurs perceive that they will be able to convincingly demonstrate to potential financiers that: a) their project has good market prospects; b) their product/service offer will be competitive; and c) their project offers adequate profit potential at an acceptable level of risk to financiers. In addition, the founders could be asked about in how far they feel that: a) their product development is advanced enough to convince financiers; b) they have enough business and sales partners to prove initial establishment; c) they have enough references from potential/existing customers; d) they have sufficient collateral to offer to convince financiers. The evidence suggests that entrepreneurs may be concerned with typical liability of newness problems and lack of firm-level legitimizing sources. Additional items may therefore be generated from this concept as is pertinent in the relevant literature and discussed in chapter three above. For ventures already in the fund-raising process there is little evidence that perceived competence and skill advantages or disadvantages have been relevant to the case entrepreneurs’ perceived feasibility of fund-raising at Ti1 (i.e. in fund-raising processes already under way in existing ventures). This said, perceived competences may be relevant at the initiation of start-up behaviour. Therefore, future researchers who build a construct of funding capabilities to be used for capturing the fund-raising process including its initiation by the entrepreneur, may also employ indicators where respondents rate the adequacy of their skills, knowledge, and competences to convince investors or bankers (e.g. based on Kickul & D’Intino, 2005 who have efficacy items for a variety of instrumental venture establishment tasks including fund-raising).194 For purposes of operationalizing the dependent construct of perceived feasibility to raise sufficient funding, one may apply the ‘perceived certainty of acquiring the necessary

193

194

For the latter, industry-level legitimizing sources (such as the growth prospects of the industry or market) may also play a role (cf. chapter 3. 3. above). Direct and indirect personal network contacts to potential financiers may also be included here as they could make entrepreneurs feel that it would be more feasible to acquire sufficient funding in the beginning (and vice versa in case of lacking personal contacts).

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funding’ items from Krueger (1993) or Stouder and Kirchhoff (2004). In addition, the way the case entrepreneurs talked about their prospects of raising funds revealed that considering feasibility in terms of perceived chances of obtaining required funds might also be useful. In the end, it may not make that much of a difference apart from trying out which wording may be closer to entrepreneurs’ everyday terminology in use (perceived certainty or chances). Finally, future researchers may also think about the option of collapsing some of the munificence and funding capabilities indicators into a single scale. This may be because, in the end, perceived financier screening challenges (as a part of munificence) and new venture characteristics relevant to convince financiers (as a part of capabilities) constitute two sides of the same coin, i.e. the specifics of the fund-raising hurdle one needs to overcome and the abilities relevant for this (cf. Brown & Kirchhoff, 1997, 13). In order to properly establish an empirically valid detailed constellation between the financial munificence, funding capabilities, and feasibility constructs, further empirical investigation will be needed. In particular, this will require a specifically tailored methodical design which allows the researcher to identify and discriminate between the different elements involved and the constructs they may represent. From the result of this study, it seems that external munificence and internal capabilities together underpin an abstract judgement of perceived feasibility, i.e. a sense-making of funding chances based on these perceptual factors. This is summarized in figure 5–8.

perceived feasibility of fund-raising

external financial munificence

internal fund-raising capabilities

environmental and other contextual restrictions to fund-raising

figure 5–8: feasibility of fund-raising and underlying beliefs about financial munificence and funding capabilities

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5. Multiple case studies of fund-raising processes in new ventures

Perception of possible restrictions to entrepreneurial fund-raising and the munificence and capabilities constructs Examining perceived restrictions on fund-raising processes has to follow a dynamic perspective (see 5. 2. 4. below). However, some preliminary understanding may also be derived from the static analysis that has just been carried out in 5. 2. 3. This is in particular with regard to the perception of possible external restrictions constituted by financier demands and the corresponding perceived managerial scope within these environmental and operational constraints. The restrictions and existent leeway may pertain to both external and internal elements within the context of the focal fund-raising task. This is also indicated at the bottom of figure 5–8, suggesting that possible environmental and contextual restrictions in the fund-raising process are perceived as constraining impediments implicit in the two constructs of external munificence and internal capabilities. It appears that, to the case entrepreneurs, two constraint themes exist regarding the external funding task. First, at least some of the perceived concrete challenges from financier screening may constitute barriers or restrictions that have to be conformed to (most prominently bankers’ demand for collateral, but also the demand to demonstrate sufficient customer demand and industry experience). In the eyes of the entrepreneurs these expectations particularly constrained certain funding options as founders perceived their venture project to have a problem with these demands (e.g. being short of collateral). Moreover, in the empirical category of the perceived magnitude of sourcing possibilities some options have also been ruled out by some of the founders for their ventures. However the substantial inter-subjectivity of these views may be doubtful. For example, the view of founder A that it may be almost impossible for seed- or early-stage founders to obtain high-volume debt or equity funding, may not be shared by others. Having said this, the view that obtaining large amounts of capital straight in the first round of funding may be impossible was also articulated in other cases (cf. above). Second, perceived limitations to adjust the amount and timing of funding may pose additional constraints. In particular, these more operational constraints may pertain to invariable minimum financing needs for setting up venture operations as well as to limited financial reserves of the entrepreneur and his or her venture. There is also preliminary evidence of how case entrepreneurs perceived possible leeway for acquiring external funding. This may be where entrepreneurial variation-selection

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activity during the fund-raising struggle might take place. In particular, alternative funding sources were perceived as part of the perceived magnitude of sourcing possibilities. The alternatives may come into play in future fund-raising attempts as previously approached sources appear inaccessible. Furthermore, internally, founders may perceive potential flexibility in their funding concept. This may be because there is additional time to find adequate financiers in the future (currently sheltered by existing financial reserves) and also because the amount of funding founders could make do with may be varied. To sum up, the suggested constructs of financial munificence and funding capabilities may offer a preliminary frame to think about and develop a detailed, empirically grounded concept of an evolutionary restrictions environment of the initial fund-raising struggle in new ventures. With these preliminary propositions to describe entrepreneurs’ sense-making of the financial selection environment, the analysis of case evidence now moves on to discuss the fund-raising attempts of entrepreneurs throughout the initial financing process.

5. 2. 4. Patterns in initial funding-raising attempts over time 5. 2. 3. above discussed how case entrepreneurs make sense of the contextual structure surrounding the fund-raising task. The initial fund-raising process of entrepreneurs is placed within this context of structural conditions. In particular, these conditions may be assumed to be the essential ingredient for describing this process (cf. Strauss & Corbin, 1998, 166p.). The presentation of the case venture vignettes already showed that there were considerable changes in case entrepreneurs’ activities to acquire initial external funding (cf. 5. 2. 2. above). The following analysis will concentrate on such critical changes throughout the process, which often incurred substantial deviations from the initial financing plans of entrepreneurs. This will entail looking at shifts in actions during the process, trying to understand what stayed the same and where changes occurred (cf. ibid., 168 for describing social processes in this way). This analysis will be done as follows. In a first step, 5. 2. 4. 1. describes the types of shifts in terms of fund-raising processes which emerged from the data. In particular, this will involve changes in external fundraising plans as case entrepreneurs struggled to obtain the intended external funding. The subsequent chapters will then analyze how these changes came about and how they related to entrepreneurs’ sense-making of the above context of structural conditions

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pertaining to the fund-raising task. Chapter 5. 2. 4. 2. provides an overview of the reasoning of the changes in fund-raising intentions as reported by the case entrepreneurs. In 5. 2. 4. 3. and 5. 2. 4. 4. the findings will be interpreted and discussed so as to suggest propositions for future research.

5. 2. 4. 1. Types of changes in intentional fund-raising attempts In the case interviews, entrepreneurs reported on central turning points in their activities to raise external funding for their ventures. The first part of analyzing case evidence sets out to broadly describe and categorize the types of changes that occurred during the fund-raising struggle. In particular, data has been categorized in order to filter out typical changes that occurred across cases. This elaboration of possible cross-case similarities is based on a prior preparatory step which looked at the ‘fund-raising story’ of each individual case (cf. the methodical procedure for analyzing case evidence in 5. 1. above). The central empirical category of changes entails reported shifts in action plans and aims for raising funding. Recall that the cases studied refer to the implementation of already existing financing intentions rather than their origination and formation in the first place. A retrospective exploration of these intentions over time may therefore also look at self-report data on intentional fund-raising attempts and changes in these attempts as they occurred in the course of events (cf. the discussion of how to identify entrepreneurs’ financing intentions in the cases in 4. 4. 3. 2. above). The interview often included a discussion of what the entrepreneurs deliberately did to acquire funding, including the intentions implicit in their actions. This allowed changes in their fundraising plans over time to be illuminated as well as providing an understanding of the possible differences between what interviewees intended to do and what they actually did. The identified types of changes are depicted in figure 5–9. The display shows the sequence of reported turning points at which substantial changes occurred for each case (beginning with the initial financing plans of the entrepreneurs). The numbering of reported change events (e.g. A1 to A3) is in time order of occurrence. The sub-category to which a change event belongs to is indicated in italics (e.g. (B1) volume).

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reported changes in fund raising plans over time A

initially: sought substantial equity funding from venture capitalists (VCs); (A1) source: switched from asking only VCs to approaching business angels (BAs) additionally; (A2) volume: reduced amount of funding asked for (parallel to A1); (A3) source: started to approach some banks for credit and public support via consultant contact

B

initially: planned large scale venture capital and angel funding; (B1) volume: lowered volume of requested funding; (B2) timing: postponed further fund-raising attempts to reposition business conception; (B3) abandonment: stopped seeking external funding after successfully obtaining finance, however far less than intended in the beginning

C

initially: aim was to obtain small bank loan to fund start of the business and initial capital expenditure; no procedural changes occurred during the short search for funding; (C1) abandonment: obtained desired funding as initially planned and ceased further fund-raising activities

D

initially: first idea was to acquire bank and public funding for production of three caravan vehicles; (D1) source: stopped asking banks for credit and tried to find production partner to finance initial vehicle production; (D2) source: gave up idea to finance the project via partner, intended to ask VCs instead in order to finance part of equity requirements or whole project without public support

E

initially: establishing broad base of equity funding (VCs and BAs); (E1) abandonment: gave up venture project completely after failing to obtain funding

F

initially: tried to obtain bank loan to fund the venture; (F1) volume: withdrew from plan to acquire commercial bank loan for the business, instead - intended to obtain funding via asset leasing to reduce capital expenditure and finance remainder via private credit

G

initially: planned to finance start-up activities, in particular initial production, via BAs as 'coentrepreneurs'; (G1) source: changed to attempts to obtain credit from bank; (G2) timing: did not immediately approach banks but tried to win strategic partners and build product prototype first; (G3) abandonment: no further attempts to obtain external funding later on

H

initially: tried to fund venture through loan from bank; (H1) timing: postponed search for funding to continue development of software prototype; (H2) abandonment: stopped project later on since finishing gaming software on time appeared impossible

I

initially: initial idea was to go to a bank and get a loan; (I1) source: later tried to finance the venture project through public funding; (I2): source: current plan (Ti2) is to try to find equity investor (BA or, if there is no alternative option, VC) for the project together with a business partner; (I3) timing: interrupted search in order to refine business concept to be presented to potential investors (in combination with (I2) above)

J

initially: high volume, seven-digit funding through VC or strategic investor; (J1) source: later started to approach banks and possible public financiers in addition; (J2) volume: deliberately changed strategy on amount of funding towards modest funding volume to 'get things going at all'

X

initially: complete external funding through bank credit; no change of funding plans during fundraising process; (X1) abandonment: obtained funding as initially planned

figure 5–9: types of changes in fund-raising intentions of entrepreneurs

Three different types of changes (the sub-categories of the central change category) have been identified in coding and subsequent analysis. In short, there were changes in the amount of funding applied for from financiers (volume), the intended type of financier (source), and the planned time of funding (timing). The former two categories correspond to the theoretical orientations in 4. 4. 3. 2. above. The latter timing sub-category emerged from the data as a new aspect. It captures incidents where fund-raising attempts were deliberately postponed by entrepreneurs at some point in the process, thus deviating from previous plans. The following sections will describe the three types of

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changes as they took place in the cases as outlined in figure 5–9. Furthermore, the figure also shows that, apart from these changes within continuous fund-raising processes, there were also cases where fund-raising attempts were terminated completely at some stage (the sub-category ‘abandonment’). These incidents will be described at the end of the chapter.

Changes in intended sources of funding (source) The cross-case display in figure 5–9 shows that in most of the cases, entrepreneurs experienced difficulties to find financiers for their ventures and made changes to their initial plans. This is with the exception of only two cases: case C and the contrast case (X). And even in the third case in which the founders did manage to obtain initial external financing (case B), the realized funding (of approximately 100, 000 euros from business angels) deviated considerably from initial plans to gather a much higher volume of formal venture capital funding. Changes in the type of potential financier source entrepreneurs intended to approach were reported in cases A, D, G, I and G.195 In some of these cases (A, D and I) more than one shift in the types of financiers to be approached took place. On the one hand, the changes initiated by entrepreneurs involved moving to a new domain of financiers, substituting previously approached potential financiers, e.g. giving up on trying to ask banks for a loan and approaching potential strategic investors instead (as in D1; other incidents where such substitutions occurred were A3, D2, G1, I1 and I2). On the other hand, in some cases new potential financiers were approached in addition to the existing fund-raising strategy. In these cases, entrepreneurs at some point started to approach different types of financiers in parallel (A1 and J1). Overall, in terms of type of financing (i.e. equity vs. debt), there were cases which initially planned equity funding and then tried to obtain bank loans or public funding later on (cases A, G and J). There were also incidents where looking for bank credit was stopped and where founders turned to potential equity investors instead (cases D and I).

195

In case B, the founders approached both venture capitalists and business angels right from the beginning, but concentrated more on business angels later on in the process.

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Changes in the intended volume of funding (volume) A second type of change was reductions of the initial volume of external funding aspired to in interaction with potential financiers.196 In one case this occurred in combination with a shift in attention to another source of funding (entrepreneur A reduced the originally planned amount of first-round funding as he started to approach not only venture capitalists but also business angels). However, in the other cases (B, F and J), deliberate reductions in the volume of funding asked for occurred independently of source changes. Often, these changes involved substantially cutting initially desired external funding (e.g. reductions by 50% or more). In 4. 4. 3. 2. above, two possible routes for this have been considered: a) moving to various instruments of bootstrap financing (and a corresponding lower volume of standard external funding) or b) scaling down planned capital expenditure and expenses for operational build-up in face of supposed future difficulties to obtain external capital (cf. v. Kalkreuth & Murphy, 2005). In case incidents A2, B1 and F2 entrepreneurs were found to employ some of the bootstrapping measures discussed in the context of TO 2 above (also cf. Winborg & Landstroem, 2000).197 In case A, the founder took on consulting work outside the venture, preparing to further fund and build the venture step by step with smaller amounts of initial external funding and additional self-financing. The founder of venture I also engaged in external consulting assignments to generate income to be put into the business. However, in this case this was a reaction to the fact that the venture was actually short of funding and did not involve a deliberate adjustment in the volume of external financing planned to be acquired.198 Other bootstrap measures were used in cases B and F. The two founders of B settled for a lower salary for themselves and a relative who was also working for the venture project prior to Ti1 (this was in combination with substantial reductions of planned capital expenditure and advertising budgets in case B − see below). Having unsuccessfully tried to acquire a bank loan in the period prior to Ti1, the founder of venture F changed his funding strategy. In the second interview, the founder reported that he now 196 197

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Increases in the planned volume of funding were not reported at all. Sometimes these measures were newly employed at some point in the process. Or existing bootstrap measures were continued for a longer period of time than originally planned, in the anticipation that external funding would be a greater problem than previously assumed. Different from the situation in case I, recall from 4. 4. 3. 2. above that, for purposes of exploring changes in fund-raising intentions, the focus is on the forward-looking aspect in deliberate reductions of planned funding.

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planned to lease a special ultra-light plane for his business instead of buying it with the proceeds from a bank loan which he never managed to obtain. In particular, the founder reported that he hoped that a special equipment leasing firm which also serves the aviation industry, would be more likely to take the plane as security. In contrast, he believed that a commercial bank would simply not do this because it would not have any market experience with such planes. The founder further supposed that leasing the required plane would reduce funding needs substantially. With this, perhaps even a private loan may suffice to finance the remaining liquidity needs to start service operations without any standard external funding for the venture at all. Other operative instruments of bootstrap financing such as payment deferrals or specific customer invoicing measures were not reported, presumably because they require an up-and-running trading business (which did not exist in the cases examined). However, as the case ventures were all still in their establishment process during venture gestation and infancy, adjustments in the intended volume of financial investments to build the business were found. In particular, in the cases where founders struggled to establish a growth-oriented venture on a lager scale, reductions in planned capital expenditure and scale of operations were reported. This included ventures A and B as well as case J; all had aimed for high volume venture capital financing in the beginning (cf. the initial plans and incidents A2, B1 and J2 in figure 5–9 above). However, in all three cases the entrepreneurs at some point adjusted their ambitious funding targets set down in their original business plans. The founders of A and B reported that they changed to funding their business step by step, now trying to kick off with a much smaller amount of funding than originally aspired to. For example, venture B was now trying to operationally establish and market its planned internet platforms consecutively (rather than in one big roll out), starting with a single pilot platform for travel services. Furthermore, the main founder of J reported in the second interview that they had shifted towards aiming for a much lower amount of initial funding simply ‘to get started at all’. The founders of J were now following the idea of starting with a small recycling facility. However, this would still require six-digit capital investments, though this would be far less than the amount of risk capital funding initially aimed for. The discussion of the possible causes of these changes will reveal that in the three cases (A, B and J) in which such down-scaling of venture establishment and corresponding funding plans occurred, entrepreneurs at some point were concerned that high volumes of equity funding would be difficult to obtain (cf. 5. 2. 4. 2. below where the context of possible causes of these and other changes will be addressed in detail).

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Changes in the intended timing of funding (timing) In addition to adjustments in the type and volume of funding, changes in timing were also identified in the cases. This involved postponing attempts to acquire external financing. Substantial postponements of funding attempts took place in cases B, G and I. This sub-category of adjustments does not refer to operative aspects of ‘entrepreneurial timing’ in the financial establishment of ventures; for example these external aspects might have been ‘temporal tension’ such as waiting time for financier feedback or financing negotiations to be arranged (cf. Bird, 1992 for such temporal structures in the entrepreneurial process). Nor do these adjustments refer to delays resulting from the direct effect of case ventures’ requests for funding to be rejected by potential financiers (the direct consequences of such external pressures on a venture’s establishment are to be discussed in 5. 2. 5. below). Rather, changes in timing were identified in the case data which pertain to internal adjustments on account of entrepreneurs themselves. These changes involve deliberate breaks in their attempts to raise funding. In the first phase of the search process in late 2005 and 2006 the founders of venture B made intensive, though unsuccessful, efforts to obtain funding from a substantial number of potential venture capital and business angel investors. In the first quarter of 2006, further attempts to find investors were postponed for a period of approximately four months (cf. B2 in figure 5–9 above). The interviewees reported that this was in order to reposition the business concept of the venture, deviating from their original auction platform strategy. This process involved revising the venture’s internet performance and developing a new business plan to be communicated to financiers. Similarly, the fundraising attempts of venture I were also put on hold by the founder (cf. I3). This was in conjunction with a re-orientation towards finding potential equity investors to fund the business. Here, the founder reported at Ti2 that he had decided to interrupt the search process so as to adjust the business concept of the venture to become more attractive to potential investors (the process was still on hold at the time of the second interview). The adjustments did not only involve rewriting the business plan but also improving the planned software product of the venture by integrating a novel quality management tool, allowing life-cycle oriented product development. In the context of this augmentation, the founder also tried to arrange a co-operation with a quality assurance organization. Founder G switched from planned business angel funding towards looking for bank credit (cf. G1 and G2). Similar to case I, the founder reported that, before he had commenced with applying for a loan, he had first tried to finish product prototyping and win strategic partners for the project.

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To sum up, three types of changes in entrepreneurs’ purposeful attempts to raise funding emerged from the data: adjustments in the planned source of funding, its volume, and in the timing of fund-raising. The first two types of changes (source and volume) resemble Brush’s principal concept of assembling entrepreneurial resources characterized by the amount of the resource to be obtained and the source of supply (cf. Brush, 2001 and TO 2 above). The third sub-category of changes (timing) is part of what Brush has coined the ‘resource development pathway’ of resource choices and in which order to obtain them (ibid.; also cf. the considerations to try to win strategic support before further fund-raising attempts to be made in cases G and I above).

Abandoning fund-raising attempts (abandonment) In six of the eleven cases, external fund-raising activities have been stopped at some point during the time period observed in the study. However, abandoning external financing ambitions did come about in very different ways in these cases (cf. figure 5–9 above). In cases E and H the founders gave up their unsuccessful attempts to acquire funding for the new venture project. Abandoning activities to get appropriate funding for their ventures also meant giving up the entire project (both entrepreneurs said that they disbanded their ventures because they were unable to obtain sufficient finance). Founder E felt that he had unsuccessfully approached a large number of possible venture capital and business angel investors. He ultimately decided to refrain from future efforts to ask for funding in November 2006. Similarly, founder H gave up seeking funding for the project in the third quarter of 2006 without any successful application for bank credit. In the other four cases the situation was quite different. In cases B and C, the founders stopped looking for further funding, having acquired initial external finance. The entrepreneurs of venture B did not obtain the level of funding they originally planned, however they had adapted their funding needs accommodating for this lower volume of funding. At Ti2, the founders reported that they were now concentrating on building the business and enhancing the firm’s value before looking for additional second-round funding. Likewise, entrepreneur C reported at Ti2 that he started to focus solely on working in his business, having obtained the funding he wanted in Q3/2006. After this infusion of funds he did not think about trying to raise further funding because he currently ‘did not need more money’ (in the period from

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summer 2006 until Ti2). The situation was similar in case X, where the founder achieved the desired funding, finished with the fund-raising task, and started with his restaurant business. Concerning entrepreneurs’ sense-making in these cases of at least partly successful initial fund-raising, it seems that decisions to stop fund-raising efforts emerged as (further) external fund-seeking became less desirable. The founders appeared to be quite pleased with the financial basis they achieved and were now concentrating on building their business operationally. Though no external funding was obtained in case G, this entrepreneur also stopped the search for external funding because it was no longer an attractive option to pursue. The founder of G unsuccessfully sought funding from business angels and later from banks for quite some time. During this process he invested substantial amounts of his own money in the business to develop a small series of product prototypes and a production concept in order to improve his negotiation position with bank financiers (cf. G2 above). After having unsuccessfully approached some banks for loans, he stopped trying to find financiers and switched his attention to the technical and operational aspects of his venture project. It appeared that, from the above efforts to develop a production base, he became increasingly involved in the operations of the small business he had built on the basis of the above product prototypes and rudimentary production of individual pieces. The next chapters discuss in detail how terminations of external funding plans as well as the above changes in the sources, volume, and timing of continued searches for external funding developed.

5. 2. 4. 2. Entrepreneurs’ reasoning behind changes in fund-raising plans In the exploration of how changes in fund-raising plans came about, three empirical categories of entrepreneurs’ reasoning have been discovered. The categories appearing to play a role are: 1) shifts in the perceived prospects of current fund-raising plans, 2) changes in the perceived need for and the attractiveness of external funding, and 3) experiences made with potential financiers. The conceptual display in figure 5–10 provides an overview of what interviewees have reported concerning these categories within the context of continuous changes during their respective fund-raising processes. A second display refers to the particular incidents where plans to raise funds have been abandoned by some of the case entrepreneurs (cf. figure 5–11).

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entrepreneurs' reasoning behind changes in fund-raising plans fundraising changes

perceived chances of current fund-raising plans

external funding needs and attractiveness

experienced feedback from potential financiers

a) VOLUME (A2; B1; F1; J2)

A2: chances to find VC investors much lower than assumed initially; virtually impossible to attract high volume of equity funding without proven concept; B1: came to believe that initial financing plan was far too risky for external investors; F1: very difficult to obtain loan for the project; 'got confirmation that there is no way around collateral'; anticipated banks' concerns about legal problems of the project; J2: possibly better chance to get through with less funding

F1: assumed that lending conditions to the venture would be unattractive in any case; J2: realized that high volume of external equity funding may imply considerable loss of independence

A2: many similar rejections in the end (problematic combination of high volume of equity funding and lacking proof of concept); B1: problem with investment volume became clear from the many negative feedback signals from VCs; F1: recognized that banks regularly insisted on collateral in view of the project's risks; J2: negative experiences with potential investors regarding demands for co-determination

b) SOURCE (A1; A3; D1; D2; G1; I1; I2; J1)

A1: found that there was little chance to obtain venture capital during first stage of the venture project (also cf. A2 above); A3: later learnt that BAs may be equally hesitant to provide upfront funding; took new chance to approach some banks via consultant contact; D1: chances to obtain loan lower than initially thought; D2: asking for public funding now hopeless because of law suit; G1: falsely assumed that BAs would not mind risks of new ventures; I1: thought that getting credit would be easier; opportunity to participate in scientific project with possible public funding I2: possibility to approach equity investors with help of friend; J1: acquiring equity funding much harder than supposed; tried to generate more options by applying for bank loans in addition

A3: gave up asking BAs also because they often seemed to demand substantial control for only minor amounts of investment

A1: was rejected by large number of VCs due to early stage status; thought it would be a good idea to also ask BAs as typical start-up investors; A3: talked to many BAs who generally appeared to be inadequate potential investors; D1: many negative experiences with bankers (and public sources); approached nearly all banks in D.; D2: talks with possible production partners did not materialize in financial support; G1: rejections from BAs all very similar; I1: talked to a handful of banks; found that venture project and collateral offer were not convincing; J1: approached many potential investors; felt that convincing investors was much more difficult than previously thought

c) TIMING (B2; G2; H1; I3)

B2: found that initial business concept did not offer sufficient prospects to convince investors; G2: supposed that banks would be concerned about lack of established business; H1: bankers likely to want to 'see' demo version of PC game; I3: improving commercial prospects of venture required beforehand; simply needs time to revise business plan

figure 5–10: reasoning of continuous changes in fund-raising plans

B2: in particular: alarmed by negative feedback from reputable business angel (an experienced internet entrepreneur); H1: surprised that banks asked for demo software

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fund-raising changes

ABANDONMENT (B3; C1; E1; G3; H2; X1)

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entrepreneurs' reasoning behind changes in fund-raising plans shifts in perceived overall funding chances

external funding needs and attractiveness

experienced feedback from potential financiers

E1: won't find any equity investor in the near future – 'trying something different is useless'; 'cannot get the business going without substantial funds from outside the business‘; H2: was sure at Q3/ 2006 that getting a loan would require first PC game to be almost ready for sale; others would presumably have the same requirements – 'there were no other real possibilities for finance'

B3: 'want to increase firm value before seeking more funding‘; C1: 'feel fine with achieved level of funding'; G3: did not like talking and negotiating with financial investors and banks anymore (once small business operations had been put in place); X1: 'no need for further bank credit at the moment'

B3/ C1/ X1: were funded by external financiers; E1: latest pending requests for venture capital failed like all others did before ('do you have paying customers? – no! – that's it!'); H1: ‘talked to two more banks who basically said the same as the others'

figure 5–11: entrepreneurs’ reasoning behind their abandonment of fund-raising plans

The cross-case data in the displays is sorted by the three types of continuous changes identified (e.g. incidents A1; B1; F1; J2 for changes in the intended amount of funding). The different change incidents A1 to X1 are the same as those in figure 5–9 in 5. 4. 2. 1. above. With regard to understanding how these changes came about, 5. 2. 4. 3. will discuss reported adjustments in entrepreneurs’ perceptions of the prospects and attractiveness of the fund-raising plans they pursued up to the time when the changes occurred (the first two reasoning categories in the above displays). Subsequently, the relevance of feedback received from potential financiers will be explored in 5. 2. 4. 4. (the third reasoning category found to be relevant).

5. 2. 4. 3. Changes in fund-raising intentions and shifts in perceived feasibility/desirability (P 2a and P 2b) Chapter 5. 2. 4. 3. is divided into five different sections. The first two sections of the chapter will discuss how changes of fund-raising plans may be influenced by critical shifts in entrepreneurs’ perceptions of their chances to acquire external funding throughout the process. The first section addresses change incidents that occurred in cases where the founders continued to look for external funding. The second section will focus specifically on the cases where efforts to find financiers (and establish the venture) were abandoned. In particular, the third section of the chapter will put forward a proposition based on the empirical evidence found. Then, in the fourth section, the

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relevance of shifts in the attractiveness of efforts to raise funding will be addressed and a further proposition for describing changes in entrepreneurs’ plans to obtain initial funding for their ventures will be suggested. The chapter will be concluded by a fifth section, covering possible further influences on these changes, which may be of interest to future research.

(1) Changing fund-raising plans and declines in perceived chances to raise funding The entrepreneurs interviewed often talked about initial external funding in terms of the fund-raising plans they had at the beginning of the process and how these plans changed over time. Typically, these plans appeared to be characterized by some idea about the amount of funding to be acquired and the source(s) from which to obtain the money in the near future. Referring to the cross-case display in figure 5–10, adjustments of these initial plans in face of declining funding chances came about as follows, beginning with changes in the volume of funding aimed for. a) volume changes Entrepreneur A initially intended to raise more than two million euros of venture capital funding. He initially believed that, after the meltdown of the German venture capital market at the beginning of the millennium, venture capitalists ‘had a lot of liquidity’. With the substantial market prospects of his venture, he also saw himself in a good position to attract some of this capital. However, in the course of applying for venture capital, by Q2/2006 the entrepreneur reached the conclusion that it would be almost impossible to find a venture capital investor willing to provide that much money for his project. Similarly, interviewee J reported that, in the course of asking potential investors, he began to believe at some point that applying for a high volume of initial funding may impede the successful further establishment of the venture. In the phase that followed, venture J pursued the idea that requesting a less ambitious amount of funding to begin with may be easier. For case A, the founder reported that his initial expectations about the willingness of investors to take risks and provide funding for his venture have been ‘naı¨ve’. In light of this, he tried to ‘reduce the risks for potential investors’ by asking for much smaller, more modest amounts of first-round funding (A2). A similar development has been reported for case B. The founders of B reported that one thing they had learnt when talking to venture capitalists was that, in contrast to the hype about internet start-ups in the past, investors were not willing to provide

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millions of euros to a new, internet-based venture like theirs. The founders said that their initial financing plan had been far too risky for equity investors and so they reduced their ambitions, asking for a lower amount of funding to kick off with (B1). Founder F supposed right from the beginning that obtaining a bank loan for his venture would be hard to achieve because of bankers’ risk aversion and possible demands for security. He had experienced difficulties to get bank credit before when he had tried to found a music business as a student some years prior to founding the venture under study. However, he still gave applying for loans another try with his new project. This was possible due to the fact that the business idea was of better quality and due to the business experience he had gained in the meantime. However, he reported that, after visiting a couple of banks with his new project, he realized that substantial collateral would also be necessary this time. He believed that ‘banks will always put start-ups in the worst risk category and will require collateral before offering loans’. Because of these difficulties, he switched to the idea of leasing some of his equipment. In trying this, he intended to reduce the required credit volume (F1).199 Later on, the founder completely gave up on acquiring a commercial loan for his venture. He had run into legal difficulties with his planned aircraft operations and anticipated that it would be highly unlikely for banks to offer credit to a venture in an uncertain legal situation. Overall it seems that changes in the planned volume of founding partly occurred as entrepreneurs came to believe that the success chances of their initial ‘high volume’ funding strategy may be lower than previously assumed. In particular, the entrepreneurs sometimes began to buy into the view that high volumes of seed or start-up funding are difficult to attract because of the risks to potential financiers involved. Correspondingly, entrepreneurs moved towards applying for less money which might make it easier to convince financiers (as stated explicitly in case J but which may also be implicit in the reasoning behind volume changes in the other cases). As mentioned earlier, this rationale has also been articulated in legitimizing theory, arguing that winning external support may be less difficult when the resource commitments to be made by others are lower (cf., for example, Suchman, 1995). The empirical evidence shows that another strategy to gain legitimacy was also employed in some cases. 199

Note that in addition to this reasoning, the founder also became aware of what he considered to be prospectively bad and unattractive credit terms he would have to accept for a commercial loan to his business. This aspect of an emerging lack of desirability of external funding is discussed further below.

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b) source changes This strategy, which entrepreneurs moved to in some of the cases, entailed trying to switch to an alternative source of funding which may offer more prospects for success (cf. ibid., 1995 and the select option to legitimizing discussed earlier). As to the conditions in which such switches occurred in the different cases, declines in perceived chances (in this case for gaining funding from the group of financiers previously approached) appeared to be particularly relevant. Founders A, D, I and J reported that they had found out that attracting funding from the financier source(s) they had tried to tap before was more difficult than previously assumed (cf. figure 5–10 above). In these cases, entrepreneurs at some point may have became unsure as to whether it would be possible to attract funding from these previous sources. Moreover, interviewees offered additional reasoning to describe the problems they faced with the sources unsuccessfully approached up to that point in time, and which they had turned away from at some point during the fund-raising process. When also turning his attention to informal business angel investors (A1), founder A said that he found that chances to get venture capital were much lower than initially thought (even with a reduced amount of funding asked for). Also, for case J, the interviewee reported that finding equity investors was much harder than originally believed. In both cases the entrepreneurs did not, however, give up completely on trying the sources they had approached before. Rather they started to ask an alternative group of financiers in addition (in case A business angels, in case J banks). Interviewee J reported that, while being increasingly unsure about their chances to find investors, they started to try to generate more funding options by looking for investors and going to the banks simultaneously. Also in cases D1 and I1, the interviewees turned their attention to other funding sources in face of difficulties with their initial funding plans. There, the founders tried to obtain credit from banks in the beginning but later moved on to other possible funding sources completely. Entrepreneurs D and I both reported that they initially believed that it would be much easier to obtain loans from a bank. However, entrepreneur D had found that asking for a high volume of credit (more than one million euros) and his lack of equity and collateral turned out to be problematic in his view. He further reported that he did not want to reduce his funding volume since this would have been unsound, leaving him short of capital in the middle of producing his first caravan vehicles. Instead of adjusting

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the volume of funding, he gave up on asking banks and tried to find financiers elsewhere − ‘from this point onwards I did not bother anymore about applying for a bank loan’, he said. Like in case D, founder I had also experienced problems with collateral as well as with lacking convincingness of his business concept to banks. In consequence of these difficulties, D had switched to asking potential strategic production partners to provide funding for his project but still continued to try to find public support for his project. Later in the process, the founder abandoned his efforts to obtain public funding. Because of a pending law suit with a public organization he had no hope of winning public funding (D2). Founder I turned to pursuing the opportunity to seek public funding in the context of a scientific project he had come across. This change incident is of particular interest in so far as it indicates that changes of potential funding sources did not solely occur on account of difficulties to acquire capital from previous sources. In some of the changes of funding sources in the cases studied, entrepreneurs turned to other potential financiers as a new opportunity which emerged during the fund-raising process. Founder A admitted that he was sceptical about the possibility to obtain funding from banks right from the start of the capital search. In Q1/2007 he met a consultant to the banking industry with many business contacts to commercial banks in Germany. Via this bridging contact he decided to try to talk to bankers about possible funding for his venture project, even though he was still doubtful about bankers’ interest in providing finance to start-up projects (A3). Founder I tried to attract public funding from the above scientific project and a couple of other public sources of new venture funding. As was the case with his trying to obtain a loan for his project, the attempts to attract public funding were also unsuccessful and his fund-raising search had almost run out of steam. In 2007, he met an old friend from university who, in the founder’s eyes, may offer new opportunities to access potential equity investors (I2). This could be by assisting with contacting potential investors and preparing for this. However, in both case A and case I, turning to new potential funding sources was also done against the background of persistent difficulties and unsure prospects of raising funding from the sources approached up to that point in time. Founder A reported that, despite his scepticism about banks, the possibility to talk with bankers was welcome since he found that business angels seem to be as hesitant as venture capitalists to offer equity funding to early stage venture projects.200 Similarly to founder I, the new possibility to find equity investors for 200

An experience which was also made by founder G who then also decided to look for a bank loan instead.

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his project seemed like a way out of the existing funding problems with banking and public sources. For case I this required a complete readjustment of the financing strategy pursued up to that point (preparing a new business plan, integrating new features in the software product and winning new partners − all to make the project attractive to equity investors). To sum up, the case evidence portrays that switching to other possible sources of funding during the financing struggle was an intuitively reasonable strategy to the entrepreneurs. This strategy was pursued by a number of case entrepreneurs who tried to solve their problems to finalize the initial funding of their ventures. The case evidence shows that the course of potential financiers approached by the entrepreneurs did not follow a neat and tidy sequential order, ultimately finding a financier willing to provide support. Often, previous potential sources were abandoned and the entrepreneurs turned to others instead. Sometimes, however, the scope of search was simply widened, with entrepreneurs approaching additional financier sources simultaneously (as in cases A and J). However, in retrospect it also appeared that none of these adjustments led to success. In none of the cases where new groups of financiers were turned to during the process were the founders successful in acquiring funding for their ventures − neither from the prior sources nor from the alternative sources they tried to tap. With regard to how these changes came about in these cases, it seems that they often occurred when founders came to believe that their prior funding approach had lower chances or was more difficult than previously assumed.201 This finding appears to be in line with those of Smallbone et al. (2003) and Stouder and Kirchhoff (2004). These studies also pointed out that new venture founders may experience difficulties with financing sources which seemed promising to them initially (e.g. trying to obtain a loan from the bank). In face of the difficulties experienced with previously approached sources, founders turned to other sources of funding (as described in Smallbone et al., 2003). c) timing changes A final type of changes in continuous fund-raising attempts was incidents where the founders postponed their efforts. Such changes in the timing of fund-raising came about as follows. As noted above, there were four cases where founders reported that they deliberately postponed their fund-raising efforts at some point during the process. 201

This also included the cases where founders explicitly followed new fund-raising possibilities which emerged during the process.

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In two of the cases, the rationale for postponing efforts was based on emerging concerns of the founders that their venture’s current position may be insufficient to convince potential financiers. The founders of venture B (see B2) reported that, around the end of 2006, they concluded that their initial business concept would probably not have enough prospects to convince potential venture capital firms and business angels (the investor sources they had approached up to that point in time). Similarly, founder H reported that, during first talks with bankers, he had found out that they might insist on a finalized demo version of his planned gaming software. He decided to try to finish programming such a version before making further applications for loans (H1); however, this turned out to be impossible later on (cf. the discussion of incident H2 further below). In the other two cases, the concerns of interviewees were more about perceived difficulties to convince the types of financiers they wanted to approach in the future (i.e. after the break in fund-raising efforts). In both of these cases, the change in timing occurred in combination with a shift in the funding source to be approached (G1 and I2). Founder G had intended to switch from asking business angels towards bank loans. In this context he assumed that bankers would dislike the fact that there was no product prototype and production concept with partners, something which he had not established yet at this point. He reported that he had therefore decided to work on some prototype lamps and to invest time in finding a production partner before talking to bankers (G2). Similarly, entrepreneur I decided to take some preparation time to tailor his approach more towards equity investors (I3; also cf. the source change incident I2 above). Founder I thought that integrating new potential strategic partners and features in his software products would offer possibilities to find equity investors; however, he also believed that it would be necessary to update his business plan to make it more attractive to this type of financier (as opposed to banks and public sources which he had approached before). Finally, the founder also noted that, to some extent, this break in fund-raising was necessary because it simply takes time to revise a business plan including an updated concept for his core software product. Beyond this apparently purely operational cause, it may be concluded that timing changes mostly took place as founders perceived difficulties with convincing potential financiers. Founders seemed to have deliberately taken some additional preparation time to improve their situation. This was either because entrepreneurs found that their previous approach was insufficient to attract funding, making some preparatory improvement necessary before continuing with their search. Or it was because entrepreneurs

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switched to an alternative source which, however, required similar preparations to be made. In particular, the entrepreneurs seemed to reckon that it would be instrumental to first make efforts to improve their business plans, the development status of their product, or their base of business partners before approaching further potential financiers. This resembles the stakeholder prioritisation rationale in Danov et al. (2003). The authors suggest that it might be a good idea for new ventures to approach the stakeholders they need to bring on board in a specific order. This may make it possible to convince the more problematic ones, who may be approached last, more easily, and to achieve better terms in negotiations with them. In the cases studied, entrepreneurs G and I tried to win strategic business partners to improve their chances before continuing with their fund-raising search. Also, the other preparatory steps point at a similar reasoning. Though somewhat delayed, in a way these instruments follow Delmar and Shane’s idea of new ventures legtimizing before approaching external resource owners (cf. Delmar & Shane, 2004). In the fund-raising processes of the cases studied, the founders appeared to have particularly focussed on problem issues to win the support of financiers at a time when they had already experienced difficulties with the initial funding of their ventures. However, while having faced problems to find financiers with their previous approach, founders still appeared to be convinced that adjustments would be possible in a way which may allow them to obtain funding successfully (be it a lower amount of funding, a different source, or at a later point in time). This was different in cases where founders abandoned the search for funding altogether.

(2) Complete abandonment of fund-raising plans and shifts in overall funding chances This section concentrates on the two cases of the study, in which the founders terminated their fund-raising and venture establishment efforts, having failed to acquire initial funding. In these cases (E and H), perceived declines in the overall chances to obtain funding seem to be important.202 The relevant empirical evidence may be found in the ‘shifts in perceived overall funding chances’ column of figure 5–11 in 5. 2. 4. 1. above; for the following discussion, readers are advised to refer to this figure to gain an insight into entrepreneurs’ reasoning. 202

The cases where founders successfully managed to attract finance and abandoned the search for further funding were driven by a different influencing factor; namely a lacking perceived need for (further) external funding (cf. the discussion in this respect below).

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First, at the time of disbanding, the founders of ventures E and H seemingly perceived difficulties to attract funding in the way they had tried up to the point where the change occurred (this is similar to the above cases in which entrepreneurs continued to seek funding with a different approach). At this time, founder E believed that he would not be able to attract equity investors in the near term. He had approached many potential investors who all had rejected his business plan, and had no pending investor inquires left at that time. However, the founder was sure that he would require external funding to get his online and consulting services going. In case H, the entrepreneur had continued to approach some more banks for credit, but did not quite get his demo game finished. From his last attempts to talk with banks he understood that this was not enough to convince someone to provide a loan. This was why he then considered it impossible to convince a bank without having a presentable game software almost ready for sale.203 Second, the founders also saw no possibility to side-step these difficulties and to try alternative routes to raise funding. In particular, their limited personal financial flexibility played an important role in this respect. Founder E believed that he did not have enough private resources to invest in his venture project and take it to a level which would impress potential investors (establishment of running internet platform; advertising to attract initial customer traffic). In particular, the founder was concerned that he needed to find someone to provide funding in the very near future, as he lacked sufficient financial reserves to hold out any longer. He also did not think it would be possible to find a bank willing to offer credit to his internet business or to tap any other substantial source of external funding. Similarly, founder H saw himself in a situation where he required a completed game to show. However, at the same time he felt that it was equally impossible to get the necessary programming work done before running out of private cash. Finally, he also seemed to have generalized his experiences, thinking that other potential financers would also require a first PC game to be ready. In comparison to the other cases in the study, cases E and H stand out because the founders came to believe that their overall chances to acquire initial funding had diminished from what initially might have been a ‘more optimistic’ supposed outlook. In TO 2b (cf. 4. 4. 3. 2.) above, it was speculated that there might be a kind of threshold level of perceived chances (or feasibility) for raising sufficient funding that new venture 203

Before these latest experiences with bankers, he had supposed that it would be sufficient for financing talks to simply have a concept for the software to be programmed and a preview of the game plot to show (cf. H1 in figure 5–9 above).

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founders need to believe in before making (further) efforts to raise funding (based on the suggestions of Krueger, 1993 and Reitan, 1997). From the evidence of the two cases just discussed, this is obviously difficult to say. In particular, it cannot be judged whether there is a threshold level for entrepreneurs to initiate fund-raising activities in the first place. Note that the two founders of E and H also in fact initiated and pursued fundraising attempts over some period of time as did the other case entrepreneurs. The design of this study does not make it possible to draw conclusions about a perceived minimum level of ‘fair’ chances to find a financier to initiate fund-raising efforts at all. This is simply because, by definition, there aren’t any cases in the focus of this study in which no fund-raising efforts were initiated (cf. the case selection frame in 5. 1. above). However, as to the conditions to keep up searching for funding in existing ventures, there may still be some interesting insights to be gained from the two ‘disbanded’ cases. In these two cases, the situation was characterized by perceptions that there was essentially little further chance to get sufficient funding in time. In other words, there was a change from perceiving sufficient funding chances towards a distinct view that raising adequate funding became unfeasible. It is conceivable that in between there may also have been some threshold level which was dropped below. However, the shifts seemed to be gradual only to a certain extent, so that it may be misleading to suggest a specific measurable threshold level. Furthermore, the resulting disbanding of ventures was driven by a combination of perceived situational conditions: difficulties with the current fund-raising approach, need to acquire funding quickly due to lacking financial reserves, and no visible alternative sources of funding. In addition to this evidence from the cases, recall that Fallgatter (2005, 68) warned that venture termination thresholds may carry a substantial degree of subjectivity and heterogeneity. There may be subjective-cognitive factors such as one’s commitment tolerance and willingness cognitions which may be relevant to keeping going during the venture establishment process, including financial establishment (cf. Mitchell et al., 2000, 978). The possible subjectivity in entrepreneurs’ assessments of their fund-raising situations (and any changes of financing plans derived from these assessments) also indicates that it may be problematic to make too specific predictions about decisions to continue or terminate fund-raising processes. This is not least because of entrepreneurs’ cognitive creativity in coming up with possible alternative solutions to the fund-raising problem. In consequence, this may also entail the specific changes in continued fund-raising processes, i.e. whether an entrepreneur will reduce the volume of funding, switching to

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a different potential source, or postponing his or her fund-raising ambitions. This prudent contention will be a central point in the following section when it comes to elaborating a cautious proposition. This will be based on a summary of findings as to how different changes in the fund-raising plans of case entrepreneurs took place.

(3) P 2a: changing fund-raising intentions and perceived declines in feasibility To sum up, one important piece of reasoning within the context of changes in fundraising plans over time seems to be shifts in perceived chances to succeed with the concept for acquiring funding pursued so far. In particular, changes in the direction of the search for financiers occurred as entrepreneurs found out that it was more difficult than assumed to win financial support with the previous fund-raising plans. This is also underscored by the two cases (C and X) in which no such changes in fund-raising plans occurred as the entrepreneurs did not develop any major doubts that their current approach may run into difficulties. This is in contrast to the cases in which changes in the amount, source, and timing of funding occurred as shifts in perceived chances to obtain finance with their current approaches were reported. However, in terms of the exact consequences of these shifts, it may be too ambitious to predict exactly which type of change in funding plans would occur. This is also because of the above subjectivity and contingencies implicit in these decisions which may also be found in entrepreneurs’ changes of fund-raising plans in continued fund-raising processes. For example, consider the new business contacts that emerged in cases A and I, which contributed to changes in the direction of the fund-raising process. Overall, the subjectivity and contingencies inherent in entrepreneurs’ fund-raising processes will not allow for a literal replication pattern by suggesting a number of certain non-equivalent dependent variables as proposed detailed outcomes of shifts in perceived fund-raising chances. A non-equivalent dependent variables pattern would require a prediction of specific change outcomes, i.e. that founders change the amount of funding and switch potential sources as well as postpone activities (cf. Yin, 2003, 116p. and Cook & Campbell, 1979 for the concept of non-equivalent variables in organizational change processes).204 But, as has been shown above, we cannot claim that 204

For example, Yin (ibid.) discusses the implementation of a new computer system in an organization which might invoke specific organizational changes from which a systematic pattern may be proposed.

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there are such exact outcome patterns. Having said this, what may be suggested is a broader, more elementary change pattern which is based on cross-case similarities regarding shifts in perceived chances to obtain finance based on previous fund-raising plans. There was considerable similarity between the cases in so far as the occurrence of changes in fund-raising plans may be broadly associated (not in their exact outcomes) with shifts in perceived chances to obtain funding. In particular, these shifts may have resulted in entrepreneurs deviating from their previously pursued fund-raising plans. Essentially, the focus is on the fact that entrepreneurs partially eliminated (i.e. internally selected) their prior plans for funding (or parts of them) in face of perceived declines in current fund-raising chances. This means that our understanding focuses on the fundraising plans which entrepreneurs turn away from, rather than foreseeing what exactly they will move to in their future financing attempts. Essentially, change is understood by the perceived conditions that shape future action plans of agents, constraining the scope of possible actions (as suggested by Strauss & Corbin, 1998). In chapter 5. 2. 3. 3. above, there was a discussion of the idea that perceptions of fund-raising chances may be captured in the construct of perceived feasibility of fund-raising. In the cases studied, intentions to obtain funding appeared to be reflected in the notion of fund-raising plans (see the suggestions for a possible operationalization of fund-raising intentions below). From the findings of how changes in the fund-raising plans came about in the cases studied, the following proposition may therefore be suggested for discussion. P 2a: Changes in fund-raising intentions during the new venture financing process may be associated with perceived declines in the feasibility to obtain funding. In contrast to the theoretical ideas put forth for orientation in 4. 4. 3. 2. above (cf. TO2a-c), P 2a does not specify in detail how funding intentions may be adjusted as the outcome of the change process. Rather, it is only put forward that entrepreneurs change their previously existing fund-raising plans under specific contextual conditions. The perception of these conditions refers to perceived declines in feasibility. With regard to this, two aspects seem important for gaining an understanding of the rationale behind P 2a. First, readers may have noted that P 2a addresses declines in feasibility in particular, but not shifts in feasibility in general (including increases in perceived feasibility to bring about changes in fund-raising intentions). This is since general shifts in feasibility would not be supported by the case data obtained from the fund-raising processes

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studied. There was no evidence that founders (in particular in the successful cases) intensified their fund-raising ambitions (e.g. more funding in a shorter period of time than initially planned) in view of better than initially perceived funding chances. In particular, in the three cases where funding was successfully attracted, the founders did not continue to enhance their external funding just because external funding seemed even more feasible to them than they assumed.205 It appeared from the cases that only different levels of declines in perceived chances to raise funding had an effect on fund-raising plans. Second, regarding the consequences of what may be different degrees of declining feasibility perceptions, two situations have been identified: a) cases where fund-raising intentions changed but where the search for funding continued over time and b) cases where fund-raising attempts were given up completely. Continuous changes in fundraising plans took place as founders lost confidence in the feasibility of their existing funding plans. This may be reflected in a reduction of what may be termed current feasibility. However, here founders still kept searching for funding, believing in the chances of alternative funding routes. In contrast, in situations where founders terminated their attempts, they seemed to have reached the conclusion for themselves that obtaining adequate funding may be impossible after all. This may be reflected in more severe declines of what may be called overall feasibility − although a specific threshold may not be put forth, as discussed above. Together, the two dimensions of current and overall fund-raising chances may constitute different degrees of declines in the perceived feasibility variable in P 2a.206 Regarding the theoretical notion implicit in P 2a (and also P 1a and b), the following may be suggested for future research. It seems that the orienting framework of entrepreneurial intentions and their potential antecedents (cf. 4. 4. 1. and 4. 4. 2. above) can be applied with benefit in research into fund-raising processes of new ventures and their founders. The fund-raising attempts of entrepreneurs unfolded over a considerable period of time in the process cases studied. As is the case for founding a venture in general, the funding sub-processes also constitute a distal sequence of activities that 205

206

Rather, in these cases fund-raising was stopped because no additional funding was needed − see below. Researchers interested in the specifics of continuous adjustments versus termination of fundraising plans may want to ‘unbundle’ the feasibility variable into two variables (i.e. current and overall perceived funding chances); cf. Miles and Huberman (1994, 254p.) for partitioning variables.

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entrepreneurs pursue over time.207 And when it comes to implementing entrepreneurial intentions through a number of steps, Krueger (2000, 18) points out the following: “The choice of intermediate actions is also an intentional process; thus we can examine why certain choices are made”. It seems worthwhile to try to understand these processes by concentrating on entrepreneurs’ intentional plans for fund-raising action as they unfold over time. In particular, in the case of existing ventures, the focus may be on the continued implementation of initial fund-raising intentions in situations where entrepreneurs face difficulties to attract funding. Concerning this issue, the case evidence suggests that the implementation of fund-raising intentions and changes of them over time may be influenced by perceived feasibility as an important antecedent attitude variable. With this in mind, the feasibility declines in P 2a, and the changes in fund-raising intentions they might bring about, may be operationalized as follows. A measure of shifts in perceived feasibility over time may be built on the static operationalization of the perceived feasibility construct from 5. 2. 3. 3. Based on Krueger (1993) and Stouder and Kirchhoff (2004), in 5. 2. 3. 3. above a scale measure of the perceived certainty (or chance) of raising funding for one’s venture was suggested. Taking a longitudinal perspective, this static operationalization of perceived feasibility may be extended by asking entrepreneurs at different measurement points whether the degree of perceived certainty to be able to secure funding had changed. For researchers interested in the detailed kinds of changes in fund-raising intentions it may also be useful to have a range of differentiated items of ‘perceived certainty’ for various sources or amounts of funding (e.g. how certain are you right now that you could obtain funding from a bank/venture capitalists/business angels etc.). In doing this, additional insights may be gained into the deeper structure of perceived feasibility to raise funding from various sources within the financial environment. Entrepreneurs’ fund-raising intentions and changes in them over time can perhaps be documented as follows. As described in 4. 4., funding intentions may be reflected as self-prediction (’how likely is it that you will ask external financiers to fund your venture’) and/or direct intent (’do you intend to approach external financiers ...’). In addition to these conceptions suggested in Linan and Chen (2006), the terminology emerging from the interview data suggests that it may also be a good idea to think about

207

Also cf. Guenther (2001, 115) for the category of complex ‘action programmes’ within a differentiation of types of human behaviour.

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fund-raising intentions by asking ‘Do you plan to ask external financiers for funding’. Note that the term fund-raising plan does not mean the financing plan one may lay out on a spread-sheet, but rather a planned action to acquire funding similar to the above direct intent measure in Linan and Chen. Such a direct measure of one’s intent to raise external funding may be employed as a nominal measure in a dichotomous intention variable (cf. Krueger, 1993). In this way, the continued existence of intentions to raise funding or to terminate may be recorded in a longitudinal approach. For example, at different measurement points the following question may be asked: ‘Do you (still) plan to raise external funding’. Moreover, for more insight, further items may be added to this principal indicator question. Researchers may ask for planned action to tap specific sources (or a specific volume) of external funding at different points in time so as to detect changes. An application of such items in a longitudinal study can be found in Stouder and Kirchhoff (2004) who ask whether entrepreneurs plan to or have already approached banks/venture capitalists/ ... /public sources etc.208 Operationalizing intention via direct intent is neutral to its possible cognitive antecedents; the intent (or plan) to do something may allow it to be driven both by feasibility (I plan to do this because it is what seems workable) and desirability (I plan to do this because it is desirable). This is important as the case evidence obtained tells us that changes in entrepreneurs’ fund-raising plans are not only influenced by feasibility perceptions, but also by shifts in the perceived needs for and attractiveness of external funding. This will be captured in a further proposition which will focus on perceived desirability of external funding. (4) P 2b: changing fund-raising intentions and perceived declines in desirability As reported in the displays in figures 5–10 and 5–11 (cf. 5. 2. 4. 2. above), there was a second empirical category of reasoning behind changes in fund-raising plans. Shifts in needs for external funding and its attractiveness have emerged from the case data in three different contexts: a) in the cases where founders were successful in raising initial funding and abandoned further efforts; b) in one case where fund-raising efforts were abandoned after prior attempts had been unsuccessful; c) in cases where fund-raising efforts were continued but entrepreneurs discarded certain funding options which appeared unattractive to them in the course of time. 208

For retrospective designs, it may be worthwhile to ask about efforts the entrepreneur has actually made, again looking for possible deviations from still earlier fund-raising activities pursued.

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a) In the three cases (B, C and X) in which entrepreneurs did manage to attract initial funding, no further efforts to raise more funding were made afterwards (cf. the ‘abandonment’ category in figure 5–11). At Ti2, founder X reported that he did not momentarily need further external funding. Similarly, founder C ‘felt comfortable with the current level of funding’ and now wanted to concentrate on his business. The founders of venture B appear to have had considerable growth aspirations for their venture which may require further rounds of funding. However, the founders reported that they did not aspire to putting efforts into seeking further capital right now. Rather, they wanted to increase the value of their venture first, in order to be able to make more attractive financing deals later. Overall, from these three cases it seems that the founders stopped fund-raising plans since trying to gather more funding was not attractive to them; in particular, they did not try to obtain more external funding just because it looked like an easy thing to do. b) The development in case G was particularly interesting. Though no external funding was obtained in this case, entrepreneur G also stopped actively searching for external funding because it was no longer an attractive option to pursue (G3). This came about as follows. The founder of G had unsuccessfully sought funding from business angels and later from banks for quite some time. During this process, he had invested substantial amounts of his own money in the business to set up a small production of lamps in order to improve his negotiation position with bank financiers (cf. incident G2 above). Later at Ti2, the entrepreneur reported that his business was now running on a very small scale and may be gradually extended from there, perhaps with some funding from the production partner. He did, however, not actively pursue this funding possibility and had stopped applying for bank loans. The founder reported that ‘he has always been more of an inventor and technician, rather than a manager in a suit negotiating with bankers’. It seemed to him that this initial production and business in place required further operational and technical attention. The founder said that he felt it was no longer attractive to put further efforts into looking for external funding. Similarly, at Ti2, founders A and I reported that, even though they were still looking for funding, at some point they might terminate their efforts. They said that this may be because searching for financiers for their venture was eating up a lot of their time and own money, which they needed to put in the project just to keep it going before investors may be found. Overall, there may well be situations in which fund-raising intentions are given up not just because of difficulties that have been encountered, but also since lengthy and

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tedious searches for financiers make the activity unattractive to entrepreneurs. Diminishing desirability also occurred for specific funding options which entrepreneurs began to dislike during the process and which therefore also contributed to intention changes. c) There were two main themes as to why some founders believed that a previously pursued option for external funding became unattractive to them: first, concerns over a possibly more substantial loss of control over the management affairs of their ventures and second, a feeling that possible financing terms may be unattractive in the end. These shifts in the perceived attractiveness of funding partly contributed to changes in the volume and sources of funding aspired to and approached (cf. the middle column in figure 5–10 in 5. 2. 4. 2. above for the following). Having talked to potential investors, founders A and J were at some point put off by investors’ demand to take over management control to a more substantial degree than initially assumed. Interviewee A said that he found that business angels demanded what to him seemed an unacceptable combination of tiny financial commitments and having a substantial say in the company. Similarly, founder J considered turning to a smaller amount of funding an advantage, because he did not want to let external investors take ‘the shirt off his back’. Finally, founder F also seemed not to be very keen to continue applying for bank loans. He was put off by the possibly bad credit terms should there be a bank prepared to offer credit to his venture at all; in particular, he found that interest rates on loans to start-ups would possibly be unacceptably high in his eyes. In TO 2 above the idea was put forth that, in the process of implementing existing fund-raising intentions, desirability considerations might be less relevant than shifting perceptions as to whether external funding would be feasible. While case evidence indicates that shifts in perceived feasibility were central to changes in funding plans, the data also suggests, however, that desirability aspects may have some relevance as well. It therefore seems inappropriate to suggest to future researchers to solely focus on shifts in perceived feasibility when studying fund-raising processes. Hence, a further proposition to explain changes in entrepreneurs’ financing intentions may be put forward for further analysis. P 2b: Changes in fund-raising intentions during the new venture financing process may be influenced by perceived declines in the desirability of external funding. In combination with P 2a above, future researchers may examine the contention that for fund-raising intentions to develop and to be continued over time, they must be perceived

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as being both feasible and desirable. For the initial formation of intent this has been supposed by Reitan (1997) and Krueger (2003). And for the continuation of funding intentions there is preliminary evidence in the cases that both feasibility and desirability cognitions may play a role. In particular, perceived desirability has been characterized as the perceived affective and evaluative attractiveness of action to obtain external funding (cf. 4. 4. 3. 2. above). In the case interviews, declines in desirability materialized in founders’ worries about losing management control, expected bad financing terms (or better conditions in the future), and an aversion to negotiating with financial investors. Towards the other end of the scale, there was no evidence of increases in perceived desirability that might have led to deliberate increases in the intensity of fund-raising intentions (e.g. striving for bigger deals, talking to more potential investors than before); therefore, P 2b focuses only on declines in desirability but not on shifts of it in general. For the operationalization of perceived desirability over time, a similar structure as for feasibility may be employed. For example, one may employ indicator items to capture how perceived desirability of fund-raising activities may evolve over time. Borrowing from the operationalization of general desirability in Krueger (1993), for example, this may be done by asking in how far one considers seeking external funding for his or her venture attractive and to what extent he or she likes searching for external funding. In addition, researchers might also want to inquire into how the attractiveness of specific sources of funding evolves over time in order to detect shifts which might in turn be related to changing fund-raising plans.

(5) Potential additional direct influences on fund-raising intentions From the case analysis of possible direct antecedent variables to be associated with focal changes in entrepreneurs’ fund-raising intentions, two preliminary factors have been filtered out so far: perceived desirability of external funding and, in particular, perceived feasibility. In conclusion of the discussion of possible direct antecedent variables of funding intentions, two further empirical findings deserve attention in future research; these will now be briefly addressed. First, in 4. 4. 3. 2., propensity to act was addressed as a further influencing factor on entrepreneurial intentions since it captures one’s innate tendency to take action which may differ across entrepreneurs (cf. Mair & Noboa, 2005). While it may well be relevant to the issue of intention formation, there was, however, little evidence in the

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cases that it may be relevant to changing intentions as well. This may be not least because all case entrepreneurs had fund-raising intentions and had taken action to pursue them. This said, the analysis of these revealed another theme worth further investigation. Cosh et al. (2005, 8) suggested that founders of growth-oriented ventures may be more inclined than others to make efforts to attract external funding. In a process perspective, it may be expected that growth-oriented entrepreneurs may change their fund-raising plans more often to meet their financing needs in face of difficulties (cf. Baum, 2003, 611 for a similar rationale). There is also evidence of this theme in the cases studied. It seemed that those entrepreneurs which had substantial growth aspirations for their ventures (in particular cases A, B, I and J − and perhaps also D) also changed their plans to raise funding more often than those with only modest growth aspirations. It may not be growth orientation per se which brings about a higher rate of changes in fund-raising plans. Rather, growth-oriented founders, who require a substantial volume of finance, may be prepared to scan the environment more intensively for different funding options. They may also be more prepared to make changes to their plans to follow through with the venture project they aspire to. Therefore, researchers might want to look at the idea that a higher scanning intensity to seek funding in the financial environment may lead to a higher rate of changes in fund-raising intentions throughout the initial financing process. Second, in two of the cases there were incidents where a completely new fund-raising option came up, more or less accidentally, during the process: founder A, who got to know a banking consultant during the process (and started to consider the option of bank financing) and founder I, who met a colleague from university and then started to pursue the idea of seeking equity financing for his venture. Beyond pronouncing the uncertainty involved in evolving fund-raising processes, such incidents have an impact on changes in fund-raising plans which may not be fully captured by more elementary feasibility and desirability considerations. Note though, that parts of entrepreneurs’ reasoning in such a situation may in fact be captured by the feasibility construct. In both cases, the above changes took place in a context where the founders were concerned about the chances of their current approach to raise funding (reflecting feasibility). Turning to this new option also involved withdrawing from current fund-raising plans (reflecting change in fund-raising intentions). This does not tell the full story of course, as the perceived funding opportunity arising from such accidental incidents is not taken

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into account. However, there have been concepts to integrate such sudden incidents in modelling entrepreneurial processes. Most prominently, there is Bygrave’s ‘triggering event’ notion as part of the set of variables relevant to the formation of decisions to found a venture (cf., for example, Bygrave, 1997). It is worth exploring the idea that such triggering events may also explain an additional share of the variance in changes of entrepreneurs’ fund-raising intentions beyond the influence of shifts in perceived feasibility and desirability. In the overall context of exogenous influences, the frequency perceived of new funding opportunities, which suddenly opened up for single entrepreneurs during the process, was fairly low. Compared to this, there is considerably more evidence of entrepreneurs having dismissed their previous funding plans in face of negative feedback from potential financiers they had approached according to these plans. The relevance of rejections experienced from financiers will be discussed now.

5. 2. 4. 4. Financier feedback and changing fund-raising intentions (P 3) In their struggle to obtain funding, case entrepreneurs received feedback from many different financiers they approached. The first two sections of 5. 2. 4. 4. describe findings concerning founders’ sense-making of these pieces of feedback. On the one hand, it will be addressed how feedback from financiers contributed to the reasoning behind changes in fund-raising plans in the process. On the other hand, the contexts in which feedback signals did not bring about changes will be discussed. After the description of empirical evidence, the findings will be interpreted, suggesting a final proposition regarding the role of negative feedback from potential financiers. This will be done in the third and forth section of this chapter.

(1) Changing fund-raising plans and feedback experienced from potential financiers In the overview of entrepreneurs’ reasoning of changes in their fund-raising plans in chapter 5. 2. 4. 2. above it was introduced that a third category, which contains feedback experiences from asking potential financiers, also emerged from the case data (cf. the overview displays in figures 5–10 and 5–11 in particular). For readers’ convenience, the collected evidence belonging to this category is reproduced in figure 5–12.

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fund-raising changes

experienced feedback from potential financiers

a) VOLUME (A2; B1; F1; J2)

A2: many similar rejections in the end (problematic combination of high volume of funding and lacking proof of concept); B1: problem with investment volume became clear from the many negative feedback signals from VCs; F1: recognized that banks regularly insisted on collateral in view of the project's risks; J2: negative experiences with potential investors regarding demands for co-determination

b) SOURCE (A1; A3; D1; D2; G1; I1; I2; J1)

A1: was rejected by large number of VCs due to early-stage status; thought it would be a good idea to also ask BAs as typical start-up investors; A3: talked to many BAs who generally appeared to be inadequate potential investors; D1: many negative experiences with bankers (and public sources); approached nearly all banks in D.; D2: talks with possible production partners did not materialize in financial support; G1: rejections from BAs all very similar; I1: talked to a handful of banks; found that venture project and collateral offer were not convincing; J1: approached many potential investors; felt that convincing investors was much more difficult than previously thought

c) TIMING (B2; G2; H1; I3)

B2: in particular: alarmed by negative feedback from reputable business angel (an experienced internet entrepreneur); H1: surprised that banks asked for demo software

d) ABANDONMENT (B3; C1; E1; G3; H2; X1)

B3/ C1/ X1: were funded by external financiers; E1: latest pending requests for venture capital failed like all others did before ('do you have paying customers? – no! – that's it!'); H1: ‘talked to two more banks who basically said the same as the others'

figure 5–12: changing fund-raising plans and feedback from potential financiers

Figure 5–12 entails collected evidence across all four types of changes in fund-raising plans (changes in volume, source, timing and abandonment). In their reports on how they went about their search for funding, the case entrepreneurs regularly referred to negative experiences they had made in the course of their attempts to convince potential financiers. In particular, the following two themes (a and b) regarding their sense-making of negative financier feedback signals showed up across the different changes which founders made to financing plans. There was no evidence of positive financier feedback being relevant to changes in entrepreneurs’ fund-raising plans up to the endpoint of the fund-raising process.209 a) quantity (and similarity) of negative financier feedback It appears that entrepreneurs were most concerned about the chances and attractiveness of their existing fund-raising plans when they had encountered much similar negative feedback from the financiers they had approached up to that point in time. This does not only pertain to the fact of rejection, but also to similar feedback as to the perceived reasons why potential financiers refused to offer funding.210 First, financier feedback 209

210

There were only the three specific case events (B; C; X) where funding was offered and founders stopped seeking finance because they did not need any more funding. Readers should note at this point that, strictly speaking, the issue of perceived similarity to other feedbacks would systematically belong to section b) which addresses the characteristics and

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experienced in the context of shifts in chances of previous fund-raising plans will be addressed. Then, the role of feedback experiences and changing attractiveness of external funding is briefly touched upon. The founders of B said that the problems associated with their initially planned funding volume ‘became clear to them’ from the many rejections they had suffered from venture capitalists (B1). In view of their experiences, at Ti1, one of the founders supposed that this was a different time than during the new economy hype and assembling millions of euros of venture capital was nowadays impossible for a start-up. In particular, the originally projected financing volume seemed to be too risky for equity investors. Similarly, entrepreneur A reported that he had approached a large number of potential venture capitalists. On the one hand, feedback was very different with regard to details of his business concept (cf. below). On the other hand, having talked to many venture capitalists, he finally got the impression that he and his venture were possibly at too early a stage for venture capitalists. He contended that these investors did not truly want to invest ‘venture’ capital but often told him that he may came back later when requiring expansion financing after having gained a foothold in the market. At this point, he thought that it may be wise to approach potential business angels, who may be more willing to offer early stage funding, too (A1). Around this time, founder A also changed his tactics, asking for a lower amount of funding when communicating his business plan to potential investors (A2). He reported that this was not so much because he believed that, in comparison to venture capitalists, business angels would traditionally offer lower investment volumes. Rather, from his extensive experiences with venture capitalists and the first presentations of his venture project to business angel audiences, he got fairly similar feedback in the end. To him, it appeared that the combination of a high volume of up-front funding and the early development status of his project was too risky for investors. In case D, the founder’s belief that bankers (and also people from public new venture support organizations) disliked his proposed high funding volume, was also based on the experiences he made. He reported that when he asked for bank or public loans, frequently his high capital expenditure needs for vehicle production was a problem, often in combination with his lack of personal equity and collateral. In his case, this strength of single pieces of feedback received by founders. However, in the case data it showed up in the context of interviewee statements about the relevance of the amount of received feedback, which is why it is described here.

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seemed to be part of the reason why he had turned away from bank loans as a possible source of funding for his venture (D1). Furthermore, he also reported that he had approached all banks in D. (the place where he lives). A similar line of reasoning was found in incident D2 in the same case. The entrepreneur had switched to approaching potential production partners as strategic investors. However, he later withdrew from this idea after his co-operation offer got rejected by the handful of large production partners he could think of. Founder D apparently twice turned away from potential sources of funding (local banks and production partners), at least partly because he felt that there were no more targets in these groups of financiers. Things were slightly different in cases F and G with regard to the number of rejections from potential financiers. Entrepreneurs F and G had both approached a much smaller number of potential bank and business angel financiers before changing their intentions (F1 and G1). The few banks F had approached to get a loan for his new venture project regularly insisted on collateral. He further reported that he had feared this right from the beginning. Founder G said that his feedback from business angels had all been ‘fairly similar’, focussing on the risks of what might go wrong with series production and market entry, and ignoring the substantial market prospects of his venture. Similar to F, he reported that ‘he knew beforehand that it would be difficult to raise substantial funding’. In both cases the entrepreneurs related their initial doubts, which were confirmed during the fund-raising attempts they made, to the fact that they had founded another business before. It may be the case that in these two cases, the founders felt that it would not require many attempts to find out whether their initial funding idea worked or not. Experienced rejections were also relevant in the two cases where the founders abandoned their venture projects. Founder E had approached potential investors in what he called different ‘thrusts of fund-raising attempts’. He had communicated his venture project and business plan simultaneously to a number of investors each time and had gone through this procedure about three times. In particular, the last thrust of attempts was important to his decision to abandon further fund-raising activities. He reported that his latest requests had ‘failed like all others had done before. Potential Investors, if he got to talk to them in person at all, commonly asked: ‘Do you have paying customers yet (for your online medical consultation service). No! That’s it’. As noted above, at the same time, founder E was lacking any own financial reserves to further build his business to the point where he could attract a sufficient initial customer base. A fairly similar picture was found in case H. In the second interview the founder reported that he had

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asked two more banks who basically ‘said the same as the others before’. From there, he was convinced that without a PC game ready to be marketed to show and sufficient collateral, it would be highly unlikely that he could obtain the credit he needed. Finally, prior feedback experiences with potential investors were also found relevant to perceived declines in the attractiveness of specific funding possibilities previously aimed for by entrepreneurs. Founder A was put off the idea of having business angel investors as shareholders of his venture also because of their possibly disproportionate demands for a substantial say in the business and equity stakes in comparison to their low investment commitment (cf. A3 above). The founder explained that he did not know very much about the business angel community before he started to approach business angels in the context of A1 (see above). But he found from talking to a number of them that most angel investors would not likely be the financiers he wanted for his business because of the above worries. As noted above, there was one other case (founder J) where the interviewee was concerned about giving up too much independence to external investors. However, in case J, this appeared to be not only because the founder had made many negative experiences, but also because of the perceived intensity and information content of the feedback (see (b) below). b) perceived strength of received individual feedback from financiers Beyond the pure number of negative feedback signals experienced by entrepreneurs, there is evidence that the ‘strength’ of a piece of feedback is also of some importance. Basically, strength may refer to the feedback’s information value attributed by the entrepreneur. This aspect shows that in some change incidents things like the intensity of the communication with the potential financier or the reputation of the financier sending the feedback were important for entrepreneurs’ reasoning behind changes in fund-raising plans. A further central element of such information characteristics was already addressed in a) above. It seems to be important whether the feedback is similar to other feedback that has been received before, e.g. that most or even all banks demanded collateral. Here, a piece of feedback may be stronger when other financiers appeared to have rejected the entrepreneur on similar grounds before. Note that the impact of these content characteristics of received feedback information solely refer to the mere occurrence of changes in fund-raising plans and underlying beliefs about external financing. Perceived information content in feedback signals is not understood in the sense that positive or negative information of a certain type would lead to a specific kind of adjustment in fund-raising plans.

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Continuing from the above, in case J, the interviewee reported that his doubts as to whether his venture should really take on board external investors with large shareholdings stemmed from the initial experiences he had made with possible strategic and financial investors. The entrepreneur had approached many potential investors and in some cases talked to them intensively. In this context ‘intensity’ means that he had not simply received a letter of rejection. Rather, he had negotiated with these potential investors over a considerable period of time (talks, management presentations) before investors left the negotiation table. To him, these experiences with the investors he had talked to were sometimes quite negative. He understood that if at all, his venture would have to go through several rounds of funding, but would not be granted the initially desired volume of finance. This would have involved accepting that investors would exercise considerable control over the venture’s affairs and handing over a large share of the equity. Founder J reported that avoiding this was an important advantage of having turned towards a lower amount of external funding (J2). As discussed above, in case B, the entrepreneurs found at some point that their initial business concept might not convince investors; and they took some time to revise their business concept as well as their internet strategy (cf. B2). For this, the rejections they had received from potential venture capitalists and business angels also played a role, telling the founders that something was wrong (even after having reduced the volume of funding). However, it was only when they talked to a particular angel investor that they adjusted their business idea and postponed fund-raising. It appeared that this investor, in the founders’ eyes, was an experienced expert in the area of business the founders’ venture was to operate in (the investor was a successful internet entrepreneur). The interviewees reported that the investor convincingly argued that their current business strategy would likely fail. It was this investor who had suggested steering the initial business model of B away from established internet auction formats of competitors. To the founders of B this was a useful piece of advice upon which they had decided to change their business and fund-raising concept as discussed above.

(2) Characteristics of financier feedback with no impact on fund-raising plans It is obvious from the description of the fund-raising processes in the cases studied, that fund-raising plans were not changed after every single rejection received from potential financiers. In order to understand how negative feedback may contribute to changes, it

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is worthwhile looking at evidence where received negative feedback from single financiers did not have an impact on existing fund-raising plans and entrepreneurs’ beliefs about external financing. In particular, it has been said above that case entrepreneurs reported changes in fund-raising plans as they had received a large amount of feedback from different potential financiers. Logically, this also means that in these cases, the founder had approached and been rejected by potential financiers before changes in the intended volume or source of funding took place. In connection with this issue, the following was reported by the interviewees. In particular, insights were gained from reflecting with founder A about his fund-raising efforts in the first phase of the search process. He had approached more than 20 venture capitalists before asking other investors in addition (business angels) and reducing the desired volume of funding. He reported that he did not want to change his approach (including the positioning of his business plan) every time he got rejected by a financier. Rather, he had waited for ‘a critical mass of negative feedback’ before making changes − in this case looking for an additional potential source of equity funding (cf. A1). Furthermore, in terms of the substantial speed of growth and the corresponding high funding volume he had sketched out in his initial business plan, he made the following experiences with potential investors. To him, the initial feedback from potential equity investors had somewhat lacked transparency. On the one hand, at first sight some investors appeared to feel comfortable with the planned rapid market roll out of his business-to-consumer computer repair software through a ‘viral marketing strategy’. On the other hand, other investors seemed to have doubted the prospects of his business concept and were suspicious about the large amount of initial funding it required for the above roll out plan. However, as none of the investors (including the former group) had been willing to offer funding in the end, he started to think about the changes described above. For the other cases, in which a large number of rejections was important for changes to come about, there is only little information in the interview data with regard to why earlier negative feedback signals were just ignored during the process. In some cases (D, F and H) it appeared that founders simply continued to approach the same type of financier source(s) as before, because it did not take much effort to approach further financiers in the same way. For example, in the first interview, founder H reported that he had not been successful in obtaining a bank loan so far, but intended to continue approaching only banks. Only later had he postponed his efforts for some time, trying to

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finish his game demo. And founder D reported that he had approached almost all local banks he knew about and also a number of public sources, because it did not take too much effort for him to do this. In cases B and E the founders stated that they had approached many potential investors simultaneously. Changes had not been made while some requests where still pending, but rather occurred after all inquiries had been rejected. Such overlap in the process of approaching different potential financiers might also have played a role in cases C and X, in which no changes in fund-raising plans were identified. The founders had received only two and one rejection from banks, respectively. However, at the time these rejections were experienced, the founders had already been in talks with further banks which they considered to be promising. Both founders continued to believe in the chances of their approach to obtain bank credit for their ventures. In both cases, the search for funding was far shorter than in the other cases, including case B (the other case where funding was successfully acquired). Finally, note that there were also some incidents where shifts in the perceived chances to obtain funding and changes in funding plans occurred partly without entrepreneurs referring to prior negative feedback. There were two cases where founders believed their chances to obtain funding to have decreased. This was because they faced non-financial problems with their venture projects, but anticipated that these would deter potential financiers, too. Founder D had filed a lawsuit against a public new venture support organization. He reported that he believed that this would ultimately rule out possibilities to raise public support for his venture. Similarly, in Q1/2007, founder F faced legal problems with the aviation licence he required to be able to offer his sightseeing flight service to customers. In the second interview, he reported that he was sure that banks would not offer credit to his venture in face of the uncertain legal situation (cf. D2 and F1 in figure 5–10 above). Furthermore, when entrepreneur G had actually stopped actively seeking funding, this seemed not so much because of sceptical financiers and tedious negotiations with them, but rather more because he simply preferred to concentrate on the operative side of his venture (cf. G3 in figure 5–11 above). Finally, in the cases where founders had made new commercial or private contacts and addressed alternative sources of funding with their assistance, this was in a situation where prior fund-raising attempts had failed (A3; I2). However, these changes in fundraising plans were also influenced by the described trigger events in the two cases (also see the discussion in 5. 2. 4. 3. above).

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(3) P 3: changing fund-raising intentions and indirect effects of financier feedback In particular, two issues have to be taken into account when interpreting evidence from the cases studied: First, from what has been just said at the end of the last section, it seems that there are other external factors which also contribute to changes in fundraising plans. This is because changes were made without particular reference to prior negative feedback. In consequence, for any hypothesis about the possible influence of financier feedback on future funding plans, it will have to be taken into account that such a hypothesis cannot fully explain the future direction to be taken by founders in the process. Second, there is a substantial number of change incidents where negative feedback from financiers was relevant to entrepreneurs’ rationale to change their approach to seeking finance. Third, there was likewise evidence that entrepreneurs suffered rejections from potential financiers, which apparently did not make any difference to the further course of their fund-raising attempts. With this in mind, the question raised in TO 3 (cf. 4. 4. above) may be addressed. There, it was asked whether agents would

adjust their fund-raising efforts to feedback signals they received. Derived from the above findings on the impact or lack of impact of perceived feedback signals, there are likely to be differences between the various pieces of feedback received. Furthermore, more importantly, there must be some step of sense-making by the entrepreneur to give significance to these differences and decide about future fund-raising plans in a differentiated manner. In other words, the empirical results obtained do suggest that a relationship between financier feedback and fund-raising plans (and action) cannot rest on simple stimulus-response, as has already been suggested for the general process of founding a business of which fund-raising is one part (cf. Krueger, 2000 and Linan & Chen, 2006).211 Methodically, this evidence suggests that in an explanation which simply relates feedback directly to changes in funding intentions, something is missing as some intervening construct might be in the background (cf. Strauss & Corbin, 1998, 131 and Miles & Huberman, 1994, 259 for the rationale of identifying possible intervening variables between proposed relationships in general, and for effects on organizational change 211

Moreover, there is case evidence in the initial funding efforts studied that this has often been a distal process, running over a considerable period of time. Even where case entrepreneurs ultimately gave up on their founding project, this was not as an immediate, direct response after negative feedback from the first financier they had asked had been received (cf. cases E and H above).

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processes in particular). In psychological and management theory, refinements of the simple stimulus-response framework have been proposed, which capture the intervening step of complex sense-making of stimuli received by human agents; for example as in the S-O-R-C framework (stimulus-organism-response behaviour-consequences; cf., for example, Staehle, 1999, 155 and also Guenther, 2001, 112). Beyond this principal idea of intervening interpretation as an antecedent to behaviour, it has been suggested above that changes in fund-raising intentions may be associated with underlying shifts in the perceived feasibility and desirability of external funding (cf. 5. 2. 4. 3.). Regarding the relevance of feasibility and desirability for intentional behaviour, it has been argued that they may channel agents’ interpretation of external events into behaviour; furthermore, these events may lead to changes in intentions only when they induced shifts in feasibility or desirability attitudes (cf. Krueger, 1993, 9 and 4. 4. 3. 3.). In the context of external feedback signals, this indirect influence of external factors on intention may also offer a reasonable preliminary explanation of the findings in the case data. As elaborated above, some founders changed parts of their fund-raising plans as they came to believe that it would be more difficult than initially thought to obtain funding from a specific source, that there were specific problems with the planned high volume of funding, or that lacking collateral and market establishment would be an impediment. Across these cases, such shifts in beliefs occurred in the context of financier feedback, which entrepreneurs referred to in their reasoning of changing financing plans (as depicted in the cross-case displays 5–10 and 5–11 above). In addition, in the cases where founders had given up seeking funding completely, there is also evidence that this decision came about at least partly with their cumulative negative feedback from financiers in mind (cf. the discussion of incidents E1 and H2 above). Overall, Seligman’s main contention that efforts will only be held up by agents facing adverse signals if the desired action still looks feasible, appears to offer some explanation for the development pattern in these two cases (cf. Seligman, 1990). To sum up, in the development of the change incidents pointed to in the previous paragraph, prior negative feedback might have evoked shifts in perceived feasibility. In other situations, rejections by financiers had no impact, possibly because they did not lead to shifts in founders’ feasibility attitudes towards fund-raising (nor in their underlying beliefs about external financial munificence and internal fund-raising capabilities).

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In view of this, it is proposed that negative feedback signals from external financiers may influence fund-raising intentions only indirectly by altering the perceived desirability and feasibility of external venture funding. This is similar to the general presumption by Shepherd and Krueger (2002, 173), that task-specific feedback may contribute to shifts in perceived task feasibility. P 3: Perceived negative feedback signals from potential financiers may influence changes in fund-raising intentions only indirectly via perceived feasibility or desirability of external funding. Feedback from financiers may have an impact upon both feasibility and desirability perceptions. In contrast to earlier theoretical orientations in 4. 4. above, there was evidence that desirability perceptions may also change and shape the fund-raising process, e.g. as entrepreneurs learn about possible threats to keeping control over their ventures or about unfavourable financing terms which do not appeal to them. And with respect to founding a new venture in general, McMullen and Shepherd (2003, 169; also cf. McMullen & Shepherd, 2003a, 2 and Fiet, 1996) have noted that signals from the environment may influence perceived desirability and feasibility of entrepreneurial action. Regarding the financing task, this also hints at the possibility that other contextual and environmental factors exist which may influence the feasibility and desirability of fund-raising as well. On the one hand, proposition P 3 will merit further attention in future empirical research on how entrepreneurs go through the fund-raising struggle over time and, in particular, how adverse financier feedback may be dealt with by them. While feedback signals may be important to shape future financing efforts, on the other hand they will not explain all variance in perceived feasibility and desirability, nor in fund-raising intentions themselves. In the cases studied, there were changes in fund-raising plans and their perceived chances, which did not occur because of negative financier feedback. Rather, changes took place because founders had non-financial problems with their planned business and anticipated that this would hamper chances to raise funding.212

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Note that, in terms of explaining changes in actual efforts to raise funding, precipitating factors did not seem to play a role. This may have been because of the design of the empirical study, which only looked at broad themes of substantial changes in the direction of fund-raising processes.

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While these examples from individual cases teach us that proposition P 3 cannot explain all changes in the searches for funding studied, these examples however do not warrant establishing further propositions. It appeared that issues like legal or operational problems with the business or new contacts triggering alternative funding opportunities were highly individual to each case. These issues may therefore not be replicated literally. As such, they account for considerable heterogeneity and uncertainty not open to more detailed explanation. Acknowledging this cautious note, researchers may proceed to focus on the impact of negative feedback signals from financiers, which showed a fair extent of similarity across the cases. This is not least because challenges to convince financiers are a common concern to new ventures with needs to attract external funding from the same financial environment. Perceived feedback signals from financiers may be operationalized as follows. First of all, one may stay with the above definition of signals suggested by McMullen and Shepherd (2003a, 2) in the context of entrepreneurial opportunity recognition. Beyond characterizing signals as awareness of new information, it is important that they have been personally experienced by the entrepreneurial agent in the course of seeking financing. The conceptualization of proposition P 3 implies a differentiation between perceiving a feedback signal and its further processing in which it is interpreted by the entrepreneur (similar to the distinction between signal perception and interpretation in McMullen & Shepherd, 2003, 156). In particular, as a result of this interpretation, attitudes towards raising initial funding may change or not, depending on the characteristics of the feedback experienced. In practice, a conceptualization of indicators which capture perceived feedback from potential financiers may borrow from Kemp et al. (2002). Apart from other measures of barriers perceived by entrepreneurs, the authors employed indicator items that explicitly address barriers and problems with resource acquisition (most prominently finance), which have actually been experienced by entrepreneurs. Beyond this, if they want to look into perceived financier feedback in more detail, researchers may try to define indicators appreciating that some feedback signals have an impact on attitudes towards fund-raising and some do not. For example, one may attempt to track feedback signals from potential financiers in a notion that may be labelled ‘experienced financier adversity’, which entrepreneurs have come across over time. Here, indicator items may be constructed in such a way that they

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reflect which kind of feedback pattern may have an indirect effect on fund-raising intentions and which may not; e.g., if it is assumed that the number of negative feedback signals is important, then a high/low degree of financier adversity would correspond to a larger/smaller amount of negative feedback. This said, it has also been warned above that evidence on when exactly feedback will influence fund-raising attitudes, and in turn intentions, is somewhat limited. For example, it is unclear whether there is a tolerable threshold number of negative feedback signals and declines in feasibility − and if there is, what the threshold prompting entrepreneurs to change their fund-raising intentions may be. Therefore, a cautious approach will be required which should be tailored to a further exploration of this issue. It is clear from the empirical data that not all feedback signals lead to changes in fund-raising plans. The above description of findings threw up some preliminary ideas as to the conditions in which financier feedback had an impact (or not, respectively). These ideas may offer some theoretical bearing on the conditions which contribute to changes in the direction of fund-raising processes. A central theme in the data was that the number of prior negative feedback signals mattered to entrepreneurs, no longer believing in the prospects of their previous approach to raise funding. For negative feedback in particular, one may suppose that two mechanisms may drive entrepreneurs away from continuing to approach specific sources of funding. Either this may be because the pool of potential single financiers has diminished as the entrepreneur has approached everybody for finance and been rejected. Or he or she reckons from the rejections suffered so far that it would not make sense to try further, because there are insurmountable barriers to convince financiers to provide funding. In the case data there is less evidence for the former. Only in case D had the founder approached a small group of specialized production partners as possible strategic investors, been rejected, and moved on to other funding sources; here, rejections led to switching sources as the prior group of potential financiers was only very small. There is substantially more evidence of the latter. As addressed above, due to feedback signals, founders often became worried at some point that a group of financiers for example would dislike high volumes of required investment or would insist on collateral for a loan. Overall, investigating the number of negative feedback events deserves further empirical attention. In particular, one may follow Harper’s understanding that it is repeated disappointment and rejection by others which results in entrepreneurs’ revising their expectations and the action plans based on them (cf. Harper, 1996, 274). Moreover, this

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further cautious exploration may be done under the umbrella of the concept of Henderson and Stern (2004, 52). The authors suggest that entrepreneurial (and other managerial) agents’ changes of action plans and elimination of previous ones are increased by growing adverse feedback from the environment. The concept allows further cautious exploration in so far as it does not presuppose an ex ante threshold extent of negative feedback at which changes occur. Moreover, the cases have also shown that not only the quantitative extent of negative feedback may play a role, but also the characteristics of its contents. Most importantly, it mattered whether the reasons for financiers’ rejections were perceived to be similar. For example, this congruence was reflected in perceptions that banks regularly asked for collateral or that a high volume of funding is detrimental to convincing potential equity investors. In addition to similarity across feedback signals, some of the feedback incidents in the cases suggest that the conceivability of feedback might also play a role, e.g. in terms of financier reputability and expertise or the intensity of personal communication with financiers. In line with this, there is at least some evidence that entrepreneurs, conversely, did not adjust their attitude towards fund-raising in periods where signals from financiers appeared to contradict each other or where feedback from a single financier seemed dubious and not representative. While detailed patterns remain unclear, it is only fair to advise future explorers of the subject to take into account that both the quantity and the quality of feedback signals may be important (as has been suggested by McMullen & Shepherd, 2003, 155 for entrepreneurs’ beliefs preceding entrepreneurial action). In particular, it may be interesting to calibrate future empirical measures towards possible patterns as to when entrepreneurs begin to generalize from financier feedback received, or, in cases where feedback is ignored, carry on in the same way as before. For the former, signal quantity and similarity may be an assumption to start with. For the latter it has been noted that ambiguity in the feedback from entrepreneurs’ action may undermine agents’ visibility as to which future action − and corresponding adjustment of action plans − may be best (cf. Aldrich, 1999, 101). In these situations, feedback may have no impact as entrepreneurs may stay with their current fund-raising approach and existing assumptions about its feasibility and desirability. Chapters 5. 2. 3. and 5. 2. 4. have addressed in detail how case entrepreneurs make sense of their fund-raising environment and how changes in fund-raising intentions came

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about alongside these contextual conditions. In particular, in the last chapter (5. 2. 4. 4.), the role of feedback from potential financiers was discussed. Following on from this, the next chapter summarizes what may be said about the broader evolution of entrepreneurs’ fund-raising processes unfolding alongside selection pressures from potential financiers.

5. 2. 5. Selection, evolving fund-raising intentions and venture development Since this study focuses on the initial financing process of new ventures, exploring overall new venture development is not looked at in particular. Having said that, it is still a good idea to think about the possible effects of constraints set by external financiers and the evolution of entrepreneurs’ fund-raising plans within the perspective of new venture development. This will allow the functioning of founders’ attempts to adapt to selection pressures exerted by financiers within their overall context to be appreciated. So far, the preceding chapters have addressed evidence of case entrepreneurs’ deliberate changes in their future fund-raising plans in face of perceived difficulties to raise funding and negative feedback from potential financiers. In particular, some founders deliberately reduced the amount of funding sought at some point and decided to live with the fact that their business would develop more slowly. In addition to such internal changes, a further category emerged from the data. This category shows that rejections from potential financiers may also have had direct effects on the financial situation of case ventures and their development.213 From the perspective of existing theory on entrepreneurial finance, this is nothing new. In particular, as noted earlier, a number of empirical studies established that external financing constraints may inhibit the survival and development of new ventures over time (see chapter 3. 2. 3. 2. above). Looking at external constraints to fund-raising rather enables an assessment of the significance of entrepreneurs’ own action choices to give the fund-raising process direction. Particularly, this is as entrepreneurs try to achieve a viable funding position through deliberate changes and revisions of their initial funding plans.

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The category was built from interviewees’ own reports on how the hesitation of financiers to offer funding had affected the establishment and market entry of their ventures.

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Reported direct effects of financier rejections on venture development (external selection) How did the interviewees assess the direct impacts of the repeated rejections they received during their fund-raising processes (and what kind of springboard did the injection of external funding provide to the development of those ventures which were successful in their financing efforts)? There were two related themes as to how denied financial support affected the establishment and further development of business operations in the cases studied. First, it was reported that lacking external funding led to delays in market entry as compared to initial aims and projections. For example, founder A thought that he still had no product on the market because of his financing problems and entrepreneurs F and I referred to an overall temporal delay in getting their businesses going (buying necessary equipment; advertising; hiring personnel, etc.). In particular, founder I said that the lack of funding was the central reason why development of his software product was still not completed at Ti2. If he had been backed by financiers, he could have employed somebody to speed up programming and testing of the software. In addition, lack of finance in some cases also seemed to have impacted on the form of planned market entry (also cf. Shrader & Simon, 1997). Because the initially planned high volume of venture capital funding could not be attracted, the founders of venture B had to limit their market entry, refraining from launching their web business as a multi-platform site straight away. Note that this effect is additional to the founders’ deliberate change of their business concept and reduction in the amount of funding sought. Similarly, venture J also had to significantly reduce its originally planned production capacity (and product line) because it was nowhere near getting the funding required for a larger capacity. Interviewee J reported that beyond this it had been decided to start even smaller, believing that it would be easier to obtain a much smaller amount of funding than initially planned. Second, similar to the first theme, case entrepreneurs did not only think that their market entry was delayed, but also that their whole growth trajectory and speed of development might be affected by financing constraints. Concerns about this were expressed in cases A, B, D, E and G. For example, founder D supposed that with enough initial funding, his first caravan vehicle ‘would already be on the road’ and with this reference, his business would have grown much faster. Moreover, he believed that he would have

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finished the patenting process by now (Ti2). He reckoned that with a first vehicle and patented technology to show, it would have been much easier to convince additional production and distribution partners to boost sales. Founder G also reported that the growth of his business was impeded by lacking external funding as he had to rely solely on self-financing; for example, the size of his operations was constrained by the fact that he had to pre-finance his inputs purely from his own money. Conversely, in the cases where some external funding had been obtained at some point, the founders reported that this propelled the market entry of their business. Though having obtained much less finance than originally planned, in case B the founders had been able to launch their web site with the money. They also commenced with their marketing and public relations efforts to raise awareness and attract customers to their website. By the time of Ti2, the founders had won their fist online advertising orders and bookings of holiday trips by customers. Beyond this, they estimated that in order to launch the second platform (targeted at real estate services), they would need further external funding. Founder C said that he had bought some equipment and, most importantly, finished his first publication project (a local public relations magazine) with his loan from the bank. He also reckoned that this reference project would aid him in the acquisition of further customers. Finally, for the two cases where fund-raising and the whole venture project came to an end, the following should be noted. In cases E and H, the fund-raising process ended when no external funding had been acquired. Most importantly, in both cases the venture projects did not go bankrupt. Rather, the ventures and further fund-raising efforts were terminated by the founders themselves for the reasons described earlier. While it has been noted in the literature that entrepreneurs and small business owners often take an active role in the termination of their businesses (cf. Aldrich, 1999 or, for the small business domain Storey, 1994), in view of their substantial mortality hazard, it is however also a common path of new businesses to go bankrupt. In the latter situation, the role of the entrepreneur is rather passive, and here essentially external forces take full effect, e.g. as investors and the banks will not back the firm (anymore), or suppliers demand to be paid. However, in the former scenario it is the entrepreneur who abandons the commercial endeavour, possibly constrained in his choices by existing reservations of external financiers to offer funding (cf. Pasanen, 2005 differentiating between optional and non-optional new firm closure). The case entrepreneurs’ role in applying continuous changes to their fund-raising plans was even more active. The available leeway for

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this may be defined by the impact that potential financiers might have on entrepreneurs venture projects. With regard to this, it also seems worthwhile considering the specific issue of raising initial venture funding in terms of Henderson and Stern’s notion of full and partial external selection of managerial and entrepreneurial activities in the business domain (see Henderson & Stern, 2004 and 4. 1. 2. 2. above). Full external selection, which results in complete elimination of the venture entity (in this case on account of financing) would rule out entrepreneurs taking matters into their own hands at the point in time selection takes place. This scenario did not occur in any of the cases studied, however it might well have done − this is not the point here. In contrast, partial external selection reflects that while potential financiers rejected requests for funding, case entrepreneurs still managed (and chose deliberately) to hold on and continue with their fund-raising efforts. It was under these conditions that entrepreneurs made selective choices to change their fund-raising plans (and eliminated parts of their previous plans themselves). To gain an understanding of this, it is useful to think about what shaped this potential for internal selection in face of merely partial external selection by financiers. For the empirically observable concept of ventures’ liability of adolescence it has been stressed that young firms may be bolstered in the beginning by resources and other support which they have managed to assemble at founding (cf. Hager et al., 2004 and Levinthal, 1991). In terms of early financial distress, which may impede the continuation of fund-raising efforts and the venture’s survival, the following central theme was found in the cases studied. The ventures studied were in their earliest phases of development, i.e. pre-founding gestation and early infancy. It appeared that it was mainly case entrepreneurs’ self-financing potential from personal savings compared to the low running costs of the venture projects which kept the fund-raising process going. In particular, this provided shelter against the rejections from financiers suffered during this period of time. From the viewpoint of the entrepreneurs, this provided a time window to continue seeking other ways to obtain funding in the ways described above. This was captured in the funding flexibility and magnitude dimensions of perceived feasibility to raise funding. The limitations to this internal flexibility and external magnitude of funding alternatives may be what determine the ‘financial leeway’ which was available to case entrepreneurs within this field of restrictions. In addition to these dimensions, there were also factors which may have defined the room for manoeuvre in terms of the qualities of the venture projects. At one end of the scale, financier screening

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criteria may have been perceived, and at the other end there were the characteristics of the ventures and how they were perceived to rate against these criteria. Together, these two constraining forces in the external munificence construct (financier screening and existing magnitude of funding sources) might have confined the available space for purposeful internal selection choices by the case entrepreneurs. These choices refer to the intentional changes of their fund-raising plans, which have been explored intensively in 5. 2. 3. above. And as external selection exerted by potential financiers did not result in a complete elimination of ventures, adjustments in entrepreneurs’ fundraising plans took place in face of this selection feedback as described in 5. 2. 4. above. In essence, internal selection activity may represent an indirect effect of partial external selection on the venture’s funding position. While such internal choices did shape the course of development of existing venture projects, it would, however, be wrong to conclude that these purposeful choices principally brought case entrepreneurs closer to successfully raising funding for their ventures. Rather, the entrepreneurial ‘manageability’ of the fund-raising task appeared in a quite different light in the cases studied. This will be addressed next, trying to get a grasp of how the evolution of entrepreneurs’ fund-raising attempts in the cases may be understood. ‘Blind’ changes of entrepreneurs’ fund-raising intentions (internal selection) As it has turned out in the cases studied, up to Ti2, three case entrepreneurs had managed to attract initial external funding (including the contrast case). The other eight entrepreneurs had not been successful in obtaining external funding. In two of these cases, the venture projects had been abandoned. Six case entrepreneurs were still trying to find a financier and one entrepreneur (case G) had decided to make do without any external funding, continuing to develop his business more slowly with his own money. In the eight cases mentioned and case B, the founders made a number of changes to their original fund-raising plans, mostly in terms of financing volume and attempted type of funding source. From the interview data it appears that the entrepreneurs did reflect upon the outcomes of their past attempts to convince financiers, as well as on the chances of possible alternative fund-raising actions. This has also been captured in the concept of trial variation and notional concretisation of action (cf. Fallgatter, 2004 and figure 4–4 in chapter 4. 3. 2. 2. above). In particular, entrepreneurs’ reflections included received financier feedback which, in turn, was relevant to decisions about adjusting fund-raising intentions and future search efforts.

5. 2. Case study results: preliminary patterns in fund-raising processes

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With regard to this, normative concepts of reflective and experiential learning suggest that such learning can improve entrepreneurial decision making and lead to more successful opportunity exploitation or venture establishment (cf., for example, the reflective and experience learning concepts in Willem & Van den Broeck, 2007 and Lichtenstein et al., 2003; also the discussion of signal detection theory in McMullen and Shepherd, 2003 seems to point in this direction). It is difficult to reveal exactly where and why agents were appreciative to environmental feedback and where not. At first sight it may therefore be speculated that case entrepreneurs were unsuccessful in raising funding because they did not ‘learn’ over time, e.g. because of overconfidence or other cognitive biases. However, there was substantial evidence of purposeful changes in fund-raising plans, which however failed to succeed. There is no evidence to support the view that entrepreneurs may learn from their past experiences in ways that improve their fundraising strategies, progressing towards guaranteed financial success (cf., for example, Fallgatter, 2004, 17 and the epistemological discussion in chapter two again). Case entrepreneurs purposefully changed their funding plans. However, Aldrich (1999, 23) is quite right to argue that there is a difference between the possibility for mindful and free human action and the efficiency of this action to arrive at the desired results. Here, the concept of blind variation and selective retention with hindsight, which has been discussed in chapter 4. 1. 2. 2. above, still appears to offer the most adequate and cautious understanding of the fund-raising processes as they unfolded in the cases studied. The evidence collected from the cases may well suggest that case entrepreneurs were blind in their purposeful changes of fund-raising plans as to the future success of their efforts. Consider in particular those cases where founders failed to obtain sufficient funding while having gone through a number of consecutive changes; for example as in cases A, D or I, where different sources of funding were approached over time without success. And also in case B, (less than projected) external funding was only raised after substantial revisions of previous fund-raising plans. While the founders adjusted to living with the amount of funding obtained, this may also be described by the above search and construction procedure to problem solving following BVSR (cf. Cziko, 1995, 310 and Hesse & Koch, 1998, 431). This is because obtaining some first-round funding in case B meant to adjust their business ex post to the amount of funding received, rather than acquiring a tailor-made financing volume corresponding to ex ante venture establishment plans to be implemented with certainty. Hence, this may still have followed selective retention with hindsight rather than variation with foresight (cf. Cziko, 1995, 306).

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Finally, if successful initial funding and further venture development came about in the case ventures by trial-and-error problem solving, then the point in time or amount of funding to be raised will likely remain uncertain and unpredictable. Furthermore, if ventures evolved into an open-ended ‘financial future’ from their origination onwards, then it would be impossible to define an ordered sequence of steps in a financing life cycle within a concept of predetermined new venture development phases (cf. the critical discussion of life cycle concepts in new venture financing and development in 4. 1. 2. 1.). Rather, identifiable patterns may be explored where entrepreneurs have made changes and selected fund-raising plans for similar reasons as proposed in P 2 and P 3 above. To this end, it is has been suggested that such changes may come about via antecedent perceptions of the contextual conditions of the fund-raising environment to shape the process (cf. additionally proposition P 1 above). This will be summarized and critically reviewed in the final chapter to follow.

6. Conclusions and implications for research and practice Chapter 6. 1. serves to put the propositions derived from the empirical study in the overall context of the research questions set out in the beginning. With regard to this, 6. 1. also sets forth important limitations of the study, both conceptually and methodically. Finally, in chapter 6. 2., central implications for research and practice will be suggested.

6. 1. Summary of findings and potential limitations 6. 1. 1. In conclusion: summarizing the results of the study In the relevant literature on entrepreneurial finance it was suggested at quite an early stage that the perceived availability of financial resources may be an important determinant of new venture formation in the first place (cf., for example, the overview in Wong & Ho, 2005). In particular, a venture’s financing requirements, in combination with lacking financing power of founders, may constitute a considerable barrier to firm entry (ibid., 3). However, what about those who turned their business idea into founding a new firm entity, and are in the process of seeking initial external funding? With this in mind, this thesis has set out to explore three main issues. First, given that attracting initial funding may be quite hard for new ventures, how do entrepreneurs go about the fund-raising process as they put effort into establishing their venture? Second, within this process, how do entrepreneurs perceive the financial environment from which they need to attract funding? Third, how do these perceptions and founders’ fund-raising activities unfold over time as feedback is received from potential financiers? In addressing these issues this thesis has concentrated on potentially similar environmental and other contextual conditions across fund-raising processes of new ventures. This rationale is based on the idea that the characteristics of initial new firm formation and its financial establishment may themselves be quite heterogeneous across different ventures. In view of this, the exploration of entrepreneurs’ fund-raising efforts as they evolve over time has concentrated on possible external restrictions that may shape the process to some extent, so that broad patterns may be reconstructed. Based on the understanding gained from reconstructing entrepreneurs’ fund-raising attempts in the longitudinal case study, the exploration of the above research issues came up with five propositions (P 1a; P 1b; P 2a; P 2b; P 3). These propositions for future research address

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three distinct areas of the fund-raising processes in existing new ventures: a) entrepreneurs’ sense-making of the financial environment and their own fund-raising situation (P 1 − the perception of contextual conditions surrounding fund-raising processes); b) changes of fund-raising intentions over time and possible shifts in the perceived feasibility/desirability of external funding (P 2 − entrepreneurs’ selective choices of fundraising plans as adjustments are made throughout the process); c) effects of feedback from potential financiers on entrepreneurs’ attitudes towards external fund-raising and their future funding plans (P 3 − unfolding of fund-raising intentions over time in view of external selection pressure from financiers). Derived from these preliminary propositions, the building blocks for future theory development on processes to raise initial funding for new ventures are depicted in figure 6–1.

external selection (full; partial)

exogenous conditions and restrictions

other environmental influences

availability of external funding: financier demands & feedback from potential financiers

other personal and situational influences

(P3)

(P1a; P1b) perceived feasibility of fund-raising (P2a)

internal selection as BVSR of fundraising intentions

external financial munificence

internal fund-raising capabilities

perceived desirability of external funding

changing fund-raising intentions over time

realization of fund-raising action over time

(P2b)

other influence factors (e.g. triggering events; scanning intensity)

Tbirth conception

gestation

t infancy

adolescence

figure 6–1: propositions P 1 – P 3 as possible building blocks for future theory development

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Overall, it seems fair to conclude that contextual conditions set by potential financiers had an influence on the evolution of case entrepreneurs’ intentions to raise external funding over time. Regarding the perception of the environmental and situational context surrounding the process, propositions P 1a and P 1b suggested the following conceptualization of these influences. As to relevant environmental context, perceived feasibility of raising external funding is underpinned by perceptions of challenges from financier screening and the magnitude of possible funding sources (external financial munificence). Moreover, perceived venture characteristics and funding flexibility contribute to feasibility perceptions (internal fund-raising capabilities). In combination with these perceived venture- and founder-related potentials for raising funding, it appeared that the perceived availability of external funding and focal investment screening by potential financiers were important. Having said this, however, other environmental and personal influence factors (as in figure 6–1) might be relevant to changes in fund-raising intentions as well (cf. the limitations addressed below). The empirical exploration revealed four important aspects as to the possible causes of deliberate changes of fund-raising intentions by entrepreneurs (cf. figure 6–1 for the following). First, declines in the perceived feasibility of previously pursued fund-raising plans may be important for purposes of explaining possible continuous changes of future intentions (e.g. in the planned volume or source of external funding); in addition, perceived declines in the feasibility of raising funding at all may contribute to abandoning unsuccessful fund-raising efforts completely (P 2a). Second, it has been found that shifts in the perceived desirability of external funding may also contribute to changes in fund-raising plans during the initial financing process. This may be in particular because specific sources of funding appear no longer worth seeking, e.g. as entrepreneurs become aware of potentially unfavourable financing terms or financial covenants that potential financiers may demand (P 2b). Third, beyond shifts in entrepreneurs’ central attitudes towards raising external funding, there may be further direct influences on financing intentions over time. In the discussion of results it has been suggested that, e.g., trigger events may open up new potential funding options at some point in the process to bring about changes. While such effects may be difficult to capture conceptually, they should not be ignored in the evaluation of the potential explanatory power of P 2a and P 2b. Hence, possible other influences have been signposted as well in figure 6–1 above. Forth, P 3 suggests that negative feedback signals from potential financiers may have an impact on fund-raising intentions, as

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agents initiate changes of their financing plans in face of the experienced feedback. Note, however, that entrepreneurs will not change their funding plans after every rejection they have received from potential investors. In correspondence to general entrepreneurial intentions concepts, such exogenous influences may only indirectly affect fundraising intentions if they lead to shifts in intervening feasibility and desirability attitudes (as suggested in figure 6–1). Any understanding of how focal changes in fund-raising intentions may come about and shape the initial financing process of new ventures can only arrive at approximate patterns. In particular, it may only be explainable that entrepreneurs turn away from their existing fund-raising intentions as the perceived feasibility or desirability of obtaining the previously planned volume of funding from the potential financier sources preferred up to that point declined.214 In contrast, it is considered impossible to develop a theory that can exactly predict the direction which changes made by entrepreneurs will take. While we may be able to broadly understand how agents eliminate certain aspects of fund-raising plans over time, the future direction of the search for initial funding is still open-ended. The reasons for this might also reveal how the overall fund-raising process may be conceived. First, exact predictions of patterns may be ruled out because of cross-venture heterogeneity and procedural uncertainty. For example, individual entrepreneurs may come across new possibilities to tap a source of funding not yet approached, triggering changes of existing plans for potential sources of funding to be approached. Such emergent options may be integrated into entrepreneurs’ creative attempts to seek new solutions to their fund-raising problem (cf. the notion of imaginative variations or responses to unforeseen events in Bhide, 2000, 67). As noted in the discussion of cognitive creativity in human action, such creative variations may not be predicted by observers; their origination is not open to introspection and might not even be consciously articulated by entrepreneurial agents, as might not possible emotional influences (cf. Hindle, 2004). On the one hand, efforts to raise initial funding, like creating a new firm in general, entail voluntary and conscious acts which involve planning to some extent (cf. Linan & Chen, 2006). On the other hand, however, contending that intentions to raise funding do not follow pure stimulus-response behaviour does not mean that there won’t be any other unobservable mental or emotional influences at all. 214

This is also in line with the spirit of internal selection concepts which focus on the elimination of possible courses of action.

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Second, entrepreneurial agents’ imperfect knowledge and foresight itself essentially also contributes to the open-ended character of fund-raising processes. As addressed in the epistemological discussion in chapter two, there is no algorithm for obtaining funding with certainty, which external observers may discover and refer to in order to explain the future direction of fund-raising processes. Rather, it seems sensible to conceive entrepreneurs’ financing attempts and changes in fund-raising intentions over time as a trial-and-error procedure following blind variation and selective retention with hindsight (as has been suggested in 5. 2. 5. above). In light of this, the possible merits of the study’s focus on similar exogenous restrictions on fund-raising processes can be fully appreciated. While an exact prediction of the future direction and outcomes of fund-raising attempts may be unachievable, it seems possible to understand how plans to obtain a certain amount of initial funding from specific sources are eliminated. These plans, which may turn out to be inadequate ex post, may get selected by external selection pressures of financiers, thereby restricting the range of the fund-raising process. Furthermore, where external selection is only partial, entrepreneurs’ internal selection choices eliminate what does not seem to work, as they adjust their fund-raising plans in terms of the volume, sources, and timing of financing. The main perceived restrictions captured in the feasibility construct are financier screening criteria that appear too hard to meet for entrepreneurs as well as minimum funding and liquidity constraints which limit the future flexibility to keep searching for finance (cf. the above concepts of external munificence and internal fundraising capabilities).

6. 1. 2. Conceptual and methodical-empirical limitations In a balanced appreciation of the possible benefits of this study to research and practice, its possible limitations also deserve thorough attention. In this respect, a number of both conceptual and methodical deficiencies need to be addressed.

Conceptual limitations The last point made in the previous section was based on the importance of external restrictions setting limits to raising funding for new ventures; in particular this involved restrictions resulting from financier screening criteria. Concerning such restrictions, the

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empirical exploration revealed that entrepreneurs perceive some concrete commonsense demands, e.g. for collateral or proof of concept in terms of initial customer demand and business partners required for establishing the business. Also, abstract challenges stemming from financiers’ considerations of possible risks involved in new ventures have been perceived. In comparison to this, textbook screening criteria in the relevant literature on entrepreneurial finance say that much more criteria are relevant in the screening process (also cf. 4. 2. above). This suggests that such restrictions may not be completely universal with regard to their perception by entrepreneurs. Therefore, restrictions based on financier screening may not simply be modelled upon default investment selection criteria pertinent in the relevant literature. Rather, there is evidence that declines in perceived chances to raise funding may be caused by the fact that entrepreneurs gradually become aware of some of the screening criteria and how severe demands of financiers actually are. Whilst this study avoided to solely rely on using default criteria, more attention still needs to be paid to tracking how founders learn about certain demands as they approach potential financiers over time. Furthermore, it needs to be appreciated that in comparison to legal or physical restrictions, which are perceived much more binding and visible, financier screening criteria may appear less invariant and universal in their application (cf. Kerber, 1996, 305 for the argument that the impacts of formal legal institutions may be easier to determine because of their legally binding character).215 The preparatory theoretical development in advance of the empirical study has employed a concept of entrepreneurial intentions and their possible central attitude antecedents. This has been considered adequate for a first exploration of broad patterns in how entrepreneurs go about the fund-raising task. Having said this, this broad focus of the chosen elementary cognitive-psychological approach has ignored possible deeper and more specific cognitive influences to explain fund-raising behaviour over time. In this respect, future research may look into the cognitive science based ‘entrepreneurial cognitions toolbox’ offered by Baron and Ward (2004). For example, one may try to employ more advanced tools to elicit entrepreneurs’ knowledge structures by exploring cognitive schemata of financier demands and their pre-investment screening process. In this respect, Mitchell and his colleagues have made important advances in the empirical 215

However, financier screening may become more and more standardized and rule-like, for example in bank lending based on sector-wide credit scoring of small businesses’ loan applications (cf. Berger & Frame, 2007 for the US case) or in credit rating based on financial regulation in the context of the Basel II Accord (cf. 4. 2. above).

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study of cognitive scripts of venture formation and other aspects of the entrepreneurial process. Some of these concepts may also be useful for purposes of studying the fundraising task, e.g. expert versus novice scripts of new venture financing and knowledge about financier demands (cf. Mitchell et al., 2000 and 2002). Overall, such specific instruments may help to drill deeper into potential motivational influences or thinking biases relevant to the formation and evolution of fund-raising intentions over time216 This said, unconscious influences of human creativity and emotions may ultimately remain untraceable. This also means that there are limits to the extent to which detectable shifts in feasibility and desirability attitudes can explain the variance in entrepreneurs’ fund-raising intentions over time. The following should be noted as a final point concerning conceptual limitations. The conceptualization has not differentiated between single entrepreneurial agents and possible other members of new venture organizations within the suggested hierarchy of multiple selection levels. This simplification may be inadequate for more mature and larger organizations, but may be fine in cases where the venture is run by a single entrepreneur as the central decider. However, as a principal issue in model-building, this simplification ignores a possible additional selection arena at the intra-organizational level (cf. Vromen, 2001 and Kappelhoff, 2004). In the context of new ventures this would be selection pressure on fund-raising plans which is exerted within the founder team or between the founder and other employees involved in the venture.

Methodical-empirical limitations In the empirical analysis, this study has made an effort to explore fund-raising processes in new ventures. Empirical results have been derived from a longitudinal case study. In particular, a multiple case study design has been preferred over a single case study approach. A multiple case study strengthens the validity of results, in particular by focussing on cross-case similarities. However, focussing on a single case might have allowed more longitudinal measurement points and a wider range of data sources to be used for in-depth analysis. While there might have been no practical alternative to resolve this trade-off in view of limited research resources, the possible methodical limitations of the chosen methodical design still need to be appreciated (cf. Yin, 2003). 216

E.g. possible framing effects in perceived financier feedback relative to the existing financing situation of the entrepreneur; here, concepts from behavioural finance may be useful − cf., for example, Kahneman et al. (1984).

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Despite the precautions taken in the design of this study, results may still be distorted by sequencing biases and post-hoc rationalizations of choices made by entrepreneurs during the fund-raising process. This problem mainly results from the fact that the study has only two rounds of case interviews and a still substantial retrospective element. Thus the problematic issue of what happens between two measurement points, which may be too far away from each other, needs to be addressed (Downing, 2005, 187). Here, a considerable improvement would be to have more frequent rounds of interviews and track emerging ventures right from the beginning of their activities to raise initial external funding. For example, this may be done in collaboration with large institutionalized panel studies like the Global Entrepreneurship Monitor (GEM) or the US panel study of entrepreneurial dynamics (PSED). These studies have the advantage of also tracking the pre-founding stage. Of course, such a strategy would require a substantial research budget. A somewhat easier approach would be to try to validate the reported decision making rationale of interviewees by asking other entrepreneurs to evaluate their plausibility (similar to the approach of Tyebjee & Bruno, 1984 to validate past investment decisions reported by venture capitalists). Here, it might be a good idea to also talk to financiers that have been approached by entrepreneurs as an additional data source.217 This may further improve the validity of fund-raising sequences reported by entrepreneurs themselves. Finally, as is the case for any qualitative case study design, this study does not aim to provide statistical generalization. Rather, this design is the most adequate one for an initial exploration of fund-raising processes in new ventures and for generating preliminary propositions for future research into this subject. Having said this, the next step needs to be to put the suggested propositions to a litmus test for falsification on the basis of a larger quantitative study of new ventures seeking initial external funding. For example, one may use event history analysis to examine the influence of perceived feasibility (and other independent variables) on the continuation (or abandonment) of fund-raising intentions. Event history analysis allows dichotomous dependent variables over time and the influences of continuous and time variant independent variables to be studied (cf. Davidsson, 2005, 16p.). Having summarized the main results of the study and appreciated its most important limitations, further implications for future research and practice may be derived in conclusion.

217

In the study at hand this has been refrained from for reasons addressed in 5. 1. above.

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6. 2. Implications for research and entrepreneurial practice 6. 2. 1. Implications for future research The core of the exploration presented has been to understand entrepreneurs’ fund-raising efforts over time within the financial environment which may shape but not completely determine the process. In essence, this involved taking an evolutionary approach by integrating context, process, and outcomes as suggested in Low and MacMillan’s seminal research programme for entrepreneurship (Low & MacMillan, 1988; see also Aldrich & Martinez, 2001, 42 considering the authors’ approach to be implicitly evolutionary). Evolutionary theories of the firm naturally take interest in the role of entrepreneurs in the genesis of new firms and their further development within the external selection environment (cf., for example, Cohendet et al., 2000 or Witt, 2002). Furthermore, research has delved into specific processes like the evolution of organizational structures, technological innovations or inventions, which might also be thought of within the overall evolution of new ventures (cf., for example, Aldrich, 1999; the edited volume of Ziman, 2003; Hesse & Koch, 1998; and Carlson, 2003). This study contributes to an evolutionary perspective on new venture development by addressing the core process of assembling the financial resources required for successful venture establishment. It has been shown that, particularly in the early development of new ventures, financial resource selection pressures are important in addition to common sales-market selection and pressures from direct intra-industrial competition. For the description of evolutionary phenomena like organization emergence, innovation, or invention, universal Darwinian blind variation and selective retention is often employed as an ontologically grounded, cross-domain meta-concept. This said, its application requires specification to the issue studied, in particular elaborating the selection mechanisms at work within the domain under study (recall Hodgson & Knudsen, 2004, 285 and Kappelhoff, 2004, 15). In respect of domain context, this thesis has developed a novel framework of external financial selection and, in particular, its perception by entrepreneurial agents. This external selection may be based on the legitimacy demands of potential financiers implicit in their pre-investment screening criteria. Note also that theory on new venture legitimacy will also require such domain-specific specifications as to what might constitute the demands for new venture legitimacy in the eyes of different external audiences.218 So far, only very general concepts of new venture legitimacy exist (cf. Newbert & Tornikoski, 2003; Delmar & Shane, 2004; or Tornikoski, 2005). 218

Cf. Ruef and Scott (1998) again for the domain-specific character of organizational legitimizing.

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More importantly, beyond conceptualizing domain-specific external selection and legitimation pressures, a concept specifying internal variation-selection activity of entrepreneurs during the fund-raising struggle has also been elaborated. This concept understands cumulative selective choices made by entrepreneurs as changes in fund-raising intentions over time. This specification may offer a good starting point for future research into the evolution of sub-processes within the overall entrepreneurial process (e.g. financing; product development; market entry) as well as research into the creation of new ventures and their continued development over time. In particular, the proposed concept offers two building blocks for theory development in this area. These building blocks benefit future research because elaborating domain-specific theoretical constructs and operationalizing variables attached to these constructs will be a prerequisite for any empirical evolutionary analysis of certain aspects of the entrepreneurial process. In particular, an elaboration of variables will have to be carried out in addition to conceptualizing selection at the meta-level. In this respect, first, the notion of perceived feasibility provides a way to conceive entrepreneurs’ perception of external restrictions and selection pressures on the fund-raising process (cf. in particular the external financial munificence construct in P 1a above). Second, proposing perceived feasibility and desirability as possible antecedents of evolving fund-raising intentions offers a way to understand the link between external selection pressures, their perception by the entrepreneur, and their association with subsequent internal selection choices (cf. P 2 and P 3 above). Conceiving abstract internal selection as the implementation and change of entrepreneurial intentions to engage in fund-raising action is reasoned as follows. It has been argued that an intention-based framework “offers a mechanism to assess the relative impact of various hypothesized exogenous influences (e.g., perceptions of resource availability) on intentions, and ultimately, behavior” (Krueger, 1993, 16). Furthermore, the author has suggested that intentions concepts should also aid our understanding of why entrepreneurs make specific choices when trying to implement their general intention to found and establish their own business (Krueger, 2000, 18). In this respect, evolving intentions related to specific tasks to establish a new business may be looked at − as has been done for financing here, but might also be done for other tasks. And as we still seem to have only little knowledge about changing intentions219 (as previously suspected in Krueger, 2000 18), the presented exploration also offers a preliminary understanding 219

Be it to continue a venture in general or to put efforts into developing a new product or seeking funding for it.

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of how changes in task-specific intentions of entrepreneurs might come about (as such the study adds to the results in Brown & Kirchhoff, 1997 who looked at the impacts of perceived resource availability on the initial formation of entrepreneurial intentions). In view of continued difficulties of entrepreneurs to assemble the required resources from external audiences, particularly the suggested idea to consider social norms to influence the perceived feasibility (rather than only the desirability) of a venture’s financial and overall establishment, seems useful (cf. Reitan, 1997, 6 and also Rivis & Sheeran, 2003). The results obtained for the evolution of fund-raising intentions may also be of interest to entrepreneurial finance. Beyond traditional studies on the impact of the availability of financial resources on new venture formation and survival, there is a stream of research which studied how financial constraints may have an impact on the development and growth of existing new ventures, using various performance indicators (cf. 3. 2. 3. 2. above). While financial constraints and their consequences on development may originate from exogenous influences (e.g. as funding is not made available to entrepreneurs), intervening action choices of the entrepreneur him- or herself are relevant as well (cf. the discussion of direct and indirect effects of external financial constraints in 5. 2. 5. above). For example, a venture might have a lower production capacity (as an indicator of development performance) not because the necessary external equity funding was ultimately unavailable, but because the entrepreneur him- or herself chose to reduce planned capacity and the corresponding amount of funding to be raised in face of difficulties experienced earlier in the process (cf. v. Kalkreuth & Murphy, 2005). This active role of entrepreneurs, which is important particularly when external selection is only partial, deserves more attention in the above stream of entrepreneurial finance research. In this respect, it has been shown how entrepreneurs may change their fund-raising plans and with this, either explicitly or implicitly, the planned scale and speed of development of their business. Finally, such changes in initial fundraising plans also offer interesting differentiations with regard to two other aspects of entrepreneurial finance. First, existing theory on the pecking order of static financing choices has considered a number of determinants of entrepreneurs’ preferences (capital structure considerations, financing costs, feared loss of control, etc.; cf. Sapienza et al., 2003; Cosh et al., 2005; or Ho & Wong, 2005). Adding to this, the findings of this study suggest that, once the fund-raising struggle unfolds, entrepreneurs may deviate from their originally preferred

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sources in face of declining feasibility to tap these sources; a similar argument pertaining to financing choices at the time of founding has been put forth by Cassar (2004). The author suggests that one unique aspect of entrepreneurs’ and small business owners’ choices is that certain funding options might not be feasible for new ventures. Concerning the presented findings for the fund-raising struggle itself, it would go too far to suggest that a philosophy of ‘taking the money you can get’ completely determines financing choices of entrepreneurs. Desirability considerations, and classic factors like management control and costs of finance do play a role (recall cases A, F and J in this study). Having said this, however, the influence of feasibility considerations may likewise offer additional insight, in particular for dynamic perspectives on venture financing choices by entrepreneurs. Second, such deviations from initially preferred funding sources towards alternative types of funding also add further differentiation to traditional financing life-cycle arguments. Traditional life-cycle-based financing policies have suggested that seed and startup financing of growth-oriented new ventures usually rest on external equity financing while debt may be available to be added at later stages to reduce capital costs (cf., for example, Heitzer, 2000). However, such an ordered sequence of financing stages, with standard types of financing attached to them, fails to take into account that entrepreneurs and their ventures might substantially deviate from this scheme in their daily struggle to find a financier. The bumpy fund-raising struggles that emerged from the cases suggest that growth-oriented entrepreneurs may well shift, e.g., from high volume venture capital funding towards trying for smaller scale bank financing. Positively speaking, instead of a sequential typology of ordered financing stages of new ventures, future research might want to put efforts into elaborating typologies based on similarities within contextual conditions that constrain certain development trajectories for different categories of ventures and their characteristics. The results of this study may serve as a platform for this in so far as they offer a framework for thinking about how external restrictions to fund-raising might take effect on entrepreneurs’ financing choices and the initial financial establishment of new ventures. The uncertain and principally open-ended nature of fund-raising processes, which discounts the value of life-cycle-based financing policies with pre-determined stages, also makes clear that any normative advice to entrepreneurship practitioners has to be cautious.

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6. 2. 2. Implications for practice Implications for entrepreneurial management The practical advice to be derived from this study appreciates that the entrepreneurs’ fund-raising efforts may follow a blind search and construction process for which there will be no universal normative recipe for acquiring initial funding to be learned from the presented case study results. In particular, individual entrepreneurs may not ensure funding by simply modelling their business concept on advice from popular guides to prepare business plans to be communicated to potential financiers. This contention is similar to doubts about identifying general success factors of venture creation and establishment (cf. Fallgatter, 2005). However, what may be done in the fund-raising struggle is the following. Entrepreneurs may take supposed external selection criteria in the financial environment and feedback from potential financiers as impulses for a continuous reflection of previous fund-raising attempts which did not lead to viable funding solutions. This may be a starting point for further creative search and construction activity to meet the initial funding challenge (see ibid., 68 for the details of the main rationale behind this). To be sure, this does not mean to progress towards funding success with certainty − as noted above such a teleological learning concept has to be rejected. Rather, this means to explore the evolutionary space for possible funding solutions by variation and selection (for this cf. ibid. and Kappelhoff, 2004; cf. vd. Ven & Poole, 1995 discussing teleological notions in the context of other concepts of organizational development). In view of the imperfect foresight in identifying viable solutions to the initial funding challenge, it may therefore be recommended to ensure what may be called adaptive flexibility in approaches to raising initial funding and establishing new venture projects as a whole (also cf. the risk reduction strategies for new venture survival in Shepherd et al., 2000 and the concept of goal adaptation to emerging problems in Baum, 2003). The need for flexibility as a principal normative implication has also been witnessed in other areas, though of course in slightly different contextual forms. For example, in evolutionary economics it has been recommended to economic policy makers to allow for continuous revisions of plans and adaptive flexibility of systems (cf. Koch, 1996, 131p.). Similarly, the necessity for organizational flexibility and capability to change in order to allow variety has also been stressed in non-positivistic strategic and evolutionary management thinking (e.g. in the works of Kirsch, 1997; Malik, 2000; and Steinmann & Schreyoegg,

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2002; also cf. Roepke, 2002 for the area of entrepreneurship). The idea behind this is to allow a wide range of ‘testing’ for what may be viable external financing constructions early on in the process in order to facilitate a timely falsification of unviable solutions (cf. Fallgatter, 2005, 72). In practice, adaptive flexibility suggests that entrepreneurs should make sure that they will be able to approach a range of different funding sources and ensure that different financing constellations would be viable for the venture project. Essentially, this means being ready to make changes to initial plans (also cf. Bhide, 2000, 61pp. discussing the importance of in-process adaptation versus sticking to synoptic long term plans). From the case evidence it emerged that entrepreneurs initiated continuous changes of their fund-raising plans as they were aware of alternative funding options (cf. the ‘magnitude of funding sources’ dimension in P 1a above). These potential sources were switched to as, in the founders’ eyes, it might have been unfeasible to tap existing sources. Furthermore, searches for funding could be flexibly continued in contexts where founders felt that they had sufficient financial reserves (most importantly from personal self-financing) to keep their venture project going and that they were bolstered against rejections from potential financiers. In contrast, efforts were abandoned when perceived feasibility to raise funding declined in contexts where financial reserves were limited and funding alternatives were been lacking in the founders’ eyes. Contributing to possible potentials for flexibility it was also beneficial to feasibility perceptions when projects could be run with little liquidity needs, having to bear only low fixed costs (recall the funding flexibility dimension in P 1b for this). Here, entrepreneurs may design their venture projects in a way that they are viable with lower than anticipated amounts of initial external funding (cf. Mosakowski, 2002 discussing entrepreneurial strategies to overcome resource disadvantages in new ventures in general). This would allow a reduction in the funding volume to be sought, should the originally planned volume of external funds be impossible to acquire (as practiced in some of the cases). Of course, this might be easier for service ventures than, e.g., biotech ventures where there is no alternative to heavy upfront funding of pharmaceutical drug development. Beyond these principal recommendations, the essential strength of the presented study is that it proposes an understanding of how acting entrepreneurs themselves consider such flexibility issues within the feasibility perceptions contributing to continued fund-raising intentions. This preliminary understanding of what makes founders consider fund-raising to be feasible in the venture establishment struggle, may be particularly valuable to

6. 2. Implications for research and entrepreneurial practice

329

consultants or public policy makers supporting entrepreneurs during their fund-raising process. Moreover, entrepreneurial leaders may also benefit from understanding what makes external fund-raising appear feasible and desirable, e.g. as they have to motivate other members of the founder team or employees to continue to put efforts into seeking external funding for their venture projects. This idea may contribute to the intentionsbased concept of entrepreneurial cognitions in venture teams in Shepherd and Krueger (2002; also cf. Witt, 1998 on entrepreneurial leadership and imagination to convince others of a business idea).

Implications for entrepreneurship policy The study presented is valuable to new venture support and entrepreneurial leadership since the suggested propositions give a first idea of how perceived feasibility of fundraising intentions may be strengthened so that agents continue to seek new possible funding options. As addressed above, measures to increase feasibility may point at additional sources of funding which founders did not know about and had not tried to tap so far (i.e. addressing possible information asymmetry about capital market sources available to new ventures on account of insufficiently informed founders lacking financial literacy; cf. Johnson et al., 2000). For example, Stouder and Kirchhoff (2004) pointed out that nascent entrepreneurs often found that obtaining a bank loan for their planned venture was actually quite hard. This may be a typical situation where pointing at alternative sources of funding may keep up feasibility perceptions. Also, entrepreneurs may be supported in managing the organizational- and operational cost structure of new venture projects in such a way that financial distress because of less than expected external funding may be combated; this may also include making sure that sufficient personal financial reserves are in place should the fund-raising process take longer than initially thought. The above principal merit of understanding founders’ feasibility perceptions in the context of entrepreneurial intentions has also been stressed for business formation in general. Krueger (1993, 17; also cf. Reitan, 1997) pointed out that increasing feasibility (and desirability) perceptions of venture creation may positively influence intentions to found one’s own firm. A proper understanding of what makes up feasibility and desirability perceptions and how they influence entrepreneurial intentions will therefore be valuable for entrepreneurship education and new venture support policies; in these arenas

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there could be an attempt to strengthen critical feasibility and desirability beliefs to encourage people to found their own business in the first place (cf. Krueger, 1993 and Forbes, 1999, 427 for the context of policy support to new ventures). However, beyond trying to support firm formation, the above discussion tells us that establishing a new business and successfully raising initial funding for it may not work instantly (also cf. Brush, 2001, 64). Rather, this might require continued efforts and adjustments along the way. Therefore, it will be useful to also know what influences entrepreneurs’ feasibility perceptions as the fund-raising struggle unfolds over time throughout venture development. In particular, critical antecedents of intentional choices to abandon or continue to seek funding and build the young venture may be examined. This may help to respond to Davidsson’s general call for research into continued entrepreneurship (see Davidsson, 1991) beyond the above efforts to encourage venture creation in the first place. The results of the study presented here may be valuable to those involved in the support of existing new ventures (and in entrepreneurial leadership) needing to keep others committed to seeking external funding. Trying to strengthen perceived feasibility of external financing throughout the entrepreneurial process may well be necessary in face of difficulties that may occur along the way. If blind variation and hindsighted selective retention is the only possibility for advance, then continuing intentions to try to raise required funding in different ways may be a necessary (though not sufficient) precondition for obtaining it in the end.

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