Entrepreneurs who take funding from close family and friends are more likely to pursue lower-risk growth options

 

BLOOMINGTON, Ind. – Entrepreneurs often lack resources and funding needed to launch a venture and reach out to family and friends for initial support. But is it always good for a startup when individuals close to the founder are asked if they want to “be on the ground floor of something good?”

New research from three Indiana University Kelley School of Business professors finds that such close ties to investors can lead founders to make more conservative venture growth decisions and make them more hesitant to take risks.

“In this study we were seeking to understand how accepting funds from these individuals influences an entrepreneur’s risk-taking preferences,” said Donald F. Kuratko, Jack M. Gill Chair of Entrepreneurship and executive and academic director of the Johnson Center for Entrepreneurship and Innovation.

“When an entrepreneur’s relationship with an investor strengthens — like with family and friends — the entrepreneur is more likely to anticipate guilt associated with venture decisions as a founder considers whether those decisions could cause a venture to fail,” added Greg Fisher, professor of entrepreneurship. “This often prompts a founder to make more conservative venture growth decisions which can sometimes be antithetical to acting entrepreneurially.”

“Family and friends” financing is among the most commonly sourced startup funding.

The paper, “Funding-source-induced bias: How social ties influence entrepreneurs’ anticipated guilt and risk-taking preferences,” is forthcoming in the Journal of Business Venturing. Other authors are Regan Stevenson, associate professor ​of entrepreneurship and management; and Emily Neubert, assistant professor of entrepreneurship at Texas Christian University and Kelley Ph.D. alumna, who led the project.

Using a sample of 193 entrepreneurs actively involved in incubator and accelerator programs, the researchers tested a model in which an entrepreneur’s strength of tie with an investor – if they were family or friends – impacted the entrepreneur’s anticipated guilt when making strategic decisions, which in turn correlated with that entrepreneur making less risky strategic growth choices.

The research introduces the concept of a “funding-source-induced bias,” which is a bias in entrepreneurial decision making stemming from an entrepreneur’s relationship with an investor, leading to anticipated guilt when making risky decisions. Hence, entrepreneurs who take funding from close family and friends are more likely to pursue lower-risk growth options to avoid such anticipated guilt.

There are advantages to receiving early-stage funding from family and friends – it is often more accessible than other types of funding and offered up with more flexible terms than funding from other types of investors. However, family and friends funding comes with hidden costs. Personal relationships can be strained if venture growth and success expectations are unmet. It is a concern for these strained relationships that prompts entrepreneurs to make more conservative growth choices.

This study draws attention to the less explored side of the investor-entrepreneurship relationship: it examines how funding sources impact entrepreneurial decision making. Since entrepreneurs may pursue investment from a variety of resources, the results help entrepreneurs (and people mentoring or teaching them) understand how their decision making might be affected by their investors.

“By investigating entrepreneurs’ funding-source-induced bias, we shed light on how funding sources influence entrepreneurs’ decisions and actions,” Neubert said. “We hope this study motivates future research into this side of the investor-entrepreneur exchange relationship.”