The popular idea of an internet start-up is the solitary visionary with a great idea, or a dorm full of undergraduates working up the next big thing in between marathon video game sessions.
As with many things, the reality is somewhat different. Sure, successful start-up businesses require the core inspirational idea and vision, lots of hard work and in most cases, some venture capital.
But according to UNSW Business School senior lecturer Daniel Schlagwein, another vital ingredient is the accumulated social capital that the founders can bring to the start-up in its earliest phase.
The lonely genius and the undergraduates make for nice stories, but if they lack a wide network their idea could struggle to cut through and get the funding and the other support and resources it needs.
Schlagwein collaborated with colleagues at the universities of Bamberg and Cologne to study how the importance of the social capital of founders influenced the success of new businesses at the early stage of development.
In their mixed-method research, Schlagwein and his colleagues found strong support for the idea that social capital can be as important to success as venture capital or the core idea itself.
Opening the way
“What we found was a clear connection between series-A funding success for new businesses and the social networks of the founding team,” says Schlagwein.
“The research showed that founders with stronger networks and who are more experienced are able to leverage this social capital to access more resources.
“There was clear data that strong networks generated trust which attracted investment and helped in finding resources and the advice which then helped their success.”
In many cases, well-connected founders had ‘mental maps’ of who they would approach for support, and were also aware that these primary contacts could open the way for introductions to secondary contacts.
'Just by looking at your network, and without even necessarily considering the idea, investors form a judgment about the likelihood of success'
– DANIEL SCHLAGWEIN
In accessing these people, recommendations and referrals from primary contacts in the network were crucial in ‘warming them up’ to be more receptive than they would be to a cold approach.
According to the research, founders identified former co-workers as well as present or former investors, employers and mentors as the most helpful types of contact. Such contacts were all points of access for resources such as rooms and technologies as well as mentorial, legal and technical advice.
They were also a source of introductions to other contacts who were able to provide – largely non-financial – assistance. Much of this network activity was conducted online through social networks.
“Just by looking at your network, and without even necessarily considering the idea, investors form a judgment about the likelihood of success,” says Schlagwein.
“This could be a track record of founders’ experience with start-ups, their professional experience in the industry, or their link to influential companies.”
The research is corroborated by Steve Torso, co-founder and managing director of Wholesale Investor, a platform for early stage companies that reaches a base of around 10,000 sophisticated investors.
“Social capital is everything for an early stage business, as it is the networks of the founders which typically helps businesses get their launching pad,” says Torso, whose platform has seen many new internet companies access funds during the past few years.
“Like, trust and respect are the key factors which few people talk about when it comes to raising money. But if these elements don’t exist, it is unlikely that money will be raised.”
The geographical location of the start-up, and the physical proximity of the investors to the founders, is also a factor in finding the necessary support.
“Being in a central location – with Silicon Valley the obvious example – is central to start-up success,” says Schlagwein.
“The location of the investors is also important. They take the view that to invest in a start-up located across the world is too high risk.”
Schlagwein relates the example of a start-up in Germany, in which the founders were told outright that their start-up would be funded, but only on the condition that the operation relocated from Germany to Silicon Valley.
'It is ironic that the success of something which is so global, like an internet business, should be dependent on a narrow geography'
– DANIEL SCHLAGWEIN
“Otherwise, they were told there was no deal,” says Schlagwein. “It is ironic that the success of something which is so global, like an internet business, should be dependent on a narrow geography.
“This is also part of the idea of a network needed for success. You need access to the right developers, to the right talent, at the right time and in the right place, and the reality is that the best ones congregate in one of a small number of locations.”
Torso agrees. “Location is important,” he says.
“Being based in a major city is simply convenient access to networks. In working overseas, we have also found that having traction in Australia, provides a level of credibility when you travel abroad.
“Australia is a small market place, but it can hint at an ability to create traction in other countries with greater populations. The challenge is figuring out which countries that will be. You simply need to go there, meet the market and discover for yourself,” says Torso.
Evolving business models
Schlagwein’s research also yielded some insights into the development of business models in early stage companies.
While the founders and the core ideas were crucial, the business models – or the operational way in which the idea was delivered – was a much more fluid idea.
Instead of being fixed from the beginning, the business models for many of the successful start-ups that featured in the research had been in a state of continuous evolution, largely being re-shaped by the new people introduced to the company and from interaction with investors.
“Founders are distinguishing between a key idea or a vision they are not prepared to change, and a business model – or the operational implementation – which is modified all the time,” says Schlagwein.
“The current generation of start-ups is very empirical in that they do experiments, trying to get to what is a minimal viable product with paying customers; and because it is experimental you could say that in this early phase the business model is quite volatile.”
Investors in start-ups rely on the founders to work through this early phase to arrive at the right business model to take the idea to the market.
“Essentially, success is not just about having the right idea,” says Schlagwein.
“So, given the choice between well-connected entrepreneurs and the group of students in the dormitory, as an investor, I would put money on the group with the experience and the network.”