Summary
- A new NBER working paper investigates the importance of founding members to the long-term success of start-ups.
- Start-ups with higher-than-average skills and experience among founders and early joiners are more likely to perform better.
- Losing founding members can significantly reduce performance, especially among smaller teams, B2B businesses, and start-ups that are older than five years.
Introduction – Founding Teams and Start-up Performance
Start-up success hinges on many factors, but most would agree that the skills and experience of the founder and initial founding team are key. But less clear is whether these core individuals remain pivotal to the business as it grows. A new NBER working paper explores how founding teams impact the post-entry dynamics of start-ups. They find:
- Start-ups launched by better skilled and more experienced founding teams produce superior firm performance in survival, employment, revenue and labour productivity.
- Losing founding members has negative and persistent implications for a start-up’s success, especially in teams with fewer than five members.
- A founder is more important to the long-term success of a business than early joiners, but losing an early joiner still has a significant detrimental impact.
Theory – Accumulating Organisational Capital
Entrepreneurship literature offers two contrasting theories on the relative importance of founder teams to the overall success of a firm. Both argue that a founding team’s human capital is critical to early start-up success, but they diverge over its longer-term importance.
The argument for replacing founding teams post inception is that individuals may lack the appropriate skills to build and grow a business. Or, once business ideas are sufficiently developed, founding teams may be less critical, and so outsiders with suitable skills are required for a firm to remain competitive. From this perspective, losing a founding team member would have little or no persistent effect on the post-entry dynamics of the firm.
The authors of the NBER paper think differently. In nascent businesses, the founding team is actively engaged in the formation of organisational capital (values, norms, reputation, customer relationships etc.) that may be inalienable from the team itself. Such capital likely grows as founding teams collaborate and develop team-specific complementarities. Losing a founding team member, therefore, means losing accumulated organisational capital.
Methodology and Data – The Premature Death of a Founding Team Member
The authors use administrative matched employer-employee data from the Longitudinal Business Database (LBD) and the Longitudinal Employer-Household Dynamics database (LEHD). They combine these with business tax information covering all start-ups with paid employees established between 1990 and 2015.
The authors collect information on the number of employees, payroll, industry, firm age and revenue. They establish how founding teams (all individuals with positive earnings in the first year of operation) affect the employment, revenue, labour productivity and survival of start-ups (firms with age zero).
They also distinguish between founders and early joiners. Founders are those who earn wages in the first quarter of the firm’s operations and are among the three highest-paid workers in the firm during the first year (for sole proprietors, it is the business owner and top two highest earners). Early joiners are those who appear at the start-up in the first year of operations.
To proxy human capital differences, the authors use prior earnings of each founding team member, computed as the individual’s most recent full-quarter earnings before joining the start-up. In all, they collect data on over 6mn start-ups and 72mn founding team members.
To establish how founding teams influence firm performance, the authors use the premature death of founding team members as an exogenous event. It allows them to estimate changes in start-up outcomes for firms experiencing the exogenous event relative to twin start-ups that do not. The Census provides this data, and ‘premature’ reflects a death before the age of 60 when the individual had positive earnings in the previous quarter.
Results – Founding Members Matter
The authors begin by exploring the relationship between the human capital of founding members and firm performance. They find that start-ups with better skilled and more experienced founding teams enjoy faster employment and productivity growth and are less likely to exit (Chart 1).
Source: Paper, page 37
Subsequently, they estimate the effects of losing a founding member via premature death. The impact is negative, persistent and statistically significant (Chart 2). Start-up employment, revenue, and labour productivity falls sharply in the year a team member is lost and the impact is felt for at least another ten years. These firms are also 12 percentage points more likely to exit the market within one year of experiencing the death shock.
Source: Paper, page 39
Losing a founder impacts the firm significantly more than losing an early joiner – the impact on revenue is four times greater. Nevertheless, losing an early joiner also has a statistically significant negative impact on firm performance over the subsequent five years.
Business-to-business (B2B) firms depend more heavily on business relationships. Therefore, it is unsurprising that losing a founder in B2B start-ups is more disruptive than in business-to-consumer (B2C) firms. The negative impact is 38% and 72% greater on employment and revenue, respectively.
Finally, losing individuals from smaller founding teams (five or fewer members) is more significant than from larger founding teams. According to the authors, all these results support the high significance of the loss of organisational capital that comes with losing a founding team member.
Results – Losing Members Becomes More Costly Over Time
Interestingly, the authors find that the negative impact of losing founding members is smaller when a start-up is young. Specifically, for start-ups aged between zero and five, losing a founding member is 15% and 13% less damaging to employment and revenue, respectively, relative to firms aged six to 11.
The authors offer two explanations. Firstly, founding team members who remain at a start-up after (say) five years are more likely to be those who earned more in the year of inception. These members probably have greater skills and experience and so are more valuable to the company. Second, founding team members accumulate work experience and firm-specific human capital as the firm ages, leading to a larger negative impact from their loss.
Bottom Line
Start-ups contribute disproportionately to job creation, innovation and productivity growth. Yet only a fraction survive. Those that do are typically the ones that grow only modestly and, according to this research, invest in building a strong founding team. This is because the team members become increasingly aligned to the ethos and values of the start-up and are therefore less substitutable as the company ages.
These findings contrast other entrepreneurship literature, which argues founding members become less ‘fit for purpose’ as the company outgrows their skillset. To combine the two lines of thought, then, perhaps the most successful start-up is one whose founding members are both skilled and experienced but who also remain critical of existing business ideas and can develop new skills as the firm grows.
Citation
Choi J., Goldschlag N., Haltiwanger J., Kim J., (2021), Founding Teams and Startup Performance, NBER, (28417) https://www.nber.org/papers/w28417
Sam van de Schootbrugge is a macro research economist taking a one year industrial break from his Ph.D. in Economics. He has 2 years of experience working in government and has an MPhil degree in Economic Research from the University of Cambridge. His research expertise are in international finance, macroeconomics and fiscal policy.
(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)