What is the impact of early relationships for new entrepreneurial ventures that are trying to innovate? Is there any risk of unwanted knowledge transfer? Over the past decade, research work has emphasised that early-stage partnerships promote the success of new ventures in a variety of ways, such as reducing initial resource constraints or facilitating the access to potential investors, commercial or research and development partners, the media and customers. Conceptually, these research studies have framed the formation of early relationships as an effective strategy that new ventures can and should employ to accelerate their development and reduce the early-stage constraints.
While such relationships can indeed play a critical role in the development and growth of new ventures, experienced entrepreneurs and investors would agree that the effect of such relationships might not always be positive, beneficial or desirable. In line with this, a group of researchers at University of Washington, Harvard Business School and Columbia University, led by Emily Cox Pahnke, examined how network relationships can negatively impact early-stage ventures. In a recent working paper (see reference), the researchers explore how indirect relationships via intermediaries can have negative outcomes for the ventures.
Empirically, the authors examine a unique dataset consisting of 22 years of product introductions and patents in the US minimally-invasive medical device sector, where they analyse every relationship between the new entrepreneurial ventures and their venture capital (VC) investors. The study shows that “indirect ties to competitors impede innovation, and that this effect is moderated by several factors related to the intermediary’s opportunities and motivation to leak important information”.
This is to say that ventures might face competitive information leakage via indirect relationships.The authors say: “Early ties may necessitate substantial transparency to partners. At the same time, young firms’ low-power position gives them little say in their partners’ subsequent tie formation. Thus a young firm’s existing partners, in pursuit of their own agendas, may seek to engage the firm’s competitors, and there may be little the firm can do to discourage the formation of these indirect ties to competitors.
The results of this interesting study provide valuable implications for entrepreneurs exploring or engaging in early-stage investment relationships. Not all types of relationships are beneficial and this is particularly so early in the development of the venture. Entrepreneurs should pay attention to their prospective investors and take into account the potential risk of investors that back direct competitors.
However, the results are also particularly interesting for VCs and corporate investors. In fact, as the authors suggest, “as they seek to maximise economic returns, venture capitalists should consider backing competitors in the same sector to develop expertise and channel information to ‘home-run’ candidates so as to amplify the skewed distribution of returns. High-reputation investors are partially constrained by prior actions, but high-status investors may have no qualms about leaking information.”
Reference
Pahnke, EC, McDonald, R, Wang, D, and Hallen, B (forthcoming) Exposed: venture capital, competitor ties, and entrepreneurial innovation. Academy of Management Journal.
Boris Battistini is a senior research fellow at the Swiss Federal Institute of Technology (ETH Zürich) and an associate at Metellus, a venture capital firm based in Zürich, London and San Diego. Email: boris.battistini@metellus.ch. Martin Haemmig is an adjunct professor at CeTIM at UniBW Munich and Leiden University. Email: martinhaemmig@cetim.org Semiconductor entrepreneurial support network in the US: Networks of each firm going public with the members of its entrepreneurial support network – firm lawyers, investment banks as proxied by investment bank lawyers, independent directors not affiliated with a VC firm, and VC directors. Each line indicates a pair, or dyad, relationship between a firm and a member of its support network. The lines are colour-coded to indicate the particular firm-actor dyad. The concentration of experts across all support mechanisms to a few hotbeds sees partnering across the nation.
Semiconductor financiers go across the nation for deals: This capital intensive industry is clustered in a few innovation hotbeds. Silicon Valley is the centre of the semiconductor industry, and accounts for over 60% of all 44 initial public offerings (IPOs) in this industry from June 1996 to 2000. When adding the San Diego area, Texas and Boston/New York, they represent almost all VC-backed semiconductor startups that went public in the US. The huge investment sizes and special know-how also require large investment firms across the continent, which is much less seen in the internet and software space.
Silicon Valley semiconductor ecosystem as a global role model: The concentration of the Silicon Valley support network in this industry is visible – 61% of the semiconductor firms going public, 68% of the firm lawyers, 70% of the investment banks, 49% of the VCs, and 48% of the non-VC directors (domain experts) that sit on the board are located in Silicon Valley. Non-VC directors often work at the large semiconductor firms, such as Intel, AMD, National Semiconductor, Fairchild and so on.
All that matters is within a few miles: This close-up view of Silicon Valley and the semiconductor industry shows the degree of clustering in this industry, revealing micro-locational variations in the geography of firms and all the actors involved in IPOs. Nearly a quarter of all VCs in the country sitting on semiconductor startup boards are within a one-mile radius on Sand Hill Road. The law firms representing semiconductor firms going public are even more tightly clustered around Page Mill Road in Palo Alto. Because Silicon Valley is the centre of the semiconductor industry, over half of all semiconductor startups are found within a 7.5-mile radius.