FEATURE
PAPER
Why Networks Enhance New Venture Creation:
A Theoretical and Empirical Model of Social Capital, Overconfidence
And Risk Percpetion
The
following paper was presented at the 2007 USASBE/SBI Conference.
It was written by Donna Marie De Carolis of
Drexel University, Barrie Litzky of Penn State University
and Kimberly Eddleston of Northeastern University.
Abstract
What differentiates the well-connected entrepreneur from the well-connected non-entrepreneur?
Building on prior work, our model suggests that social capital is not enough; that the type of
person involved in network relationships matters to new venture creation. We empirically test the
effects of the interplay of social capital, cognitive biases and risk perception. Our mediated
model is tested using an on-line survey of 269 entrepreneurs. Our results confirm that networks
enhance levels of overconfidence. Overconfidence in turn is directly related to new venture
creation. We find marginal support for the relationship between social capital and risk
perception.
Executive Summary
Anecdotal evidence and research point to the importance of networks in new venture creation.
Entrepreneurs need to meet people, make contacts, secure connections and get information and
resources from numerous sources. Yet, many of us are involved in various networks and never
look for an opportunity. Or, if we happen upon one, we do not pursue it. The question is why?
What differentiates the well-connected entrepreneur from the well-connected non-entrepreneur?
This study finds that being connected is not enough. We find that the type of person in the
network is the key. Networks enhance new venture creation through overconfidence and risk
perceptions. Individual cognition mediates the connection between social capital and new
venture creation. Our findings suggest that it is not enough to be “well connected”. Individuals
with higher levels of overconfidence and lower levels of risk perception are more prone to start
new ventures, and both attributes are enhanced by social capital. Overconfidence may lessen the
overwhelming amount of information and uncertainty. Having a network of people and resources
to rely on, augments overconfidence and new venture creation. Many new ventures might not be
started were it not for the confidence and optimism of the entrepreneur. Finally,
entrepreneurship education will benefit from this and future research in this area. As we prepare
students to become entrepreneurs, they need to be aware of the advantages and disadvantages of
cognitive traits and network influence in order to make the best new venture decision.
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the Entire Paper...
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OF THE WEEK
Estimating
Financial Needs: Start-Up Costs, Proforma Financial Statements,
Cash Flow Statements
Start-Up Costs and Use of Proceeds
One of the first things entrepreneurs should do with respect to financial resources is create a list of start-up costs - costs that will be incurred to get the business off the ground. Examples of such costs include the cost of buying equipment, supplies, and creating an inventory. Other costs, more long-term in nature, include purchase of a building in which to operate (or lease on such property), and anything else that the business will use and require for several years.
Once start-up costs have been estimated, entrepreneurs can determine the total amount of money needed to launch the new venture. Second, they can draw up a plan for how the capital will be spent, once it is obtained. Investors want to see a clearly developed plan for using start-up capital. This plan tells them how the funds they provide will be used, and needless to say, they want to be sure that this money will be put to good purposes - that it will be used only for costs associated with launching the new venture.
Proforma Financial Statements
After an entrepreneur estimates start-up costs and come up with a plan for the use of funds, the next step relative to financial resources is the creation of the venture's projected financial statements. As we noted earlier, such projections are reflected in proforma financial statements - statements that project (usually for three years) the financial condition of the new venture based on information available at the time they are made. As we saw earlier, proforma balance sheets show financial structure of the business (its assets and liabilities), while proforma income statements offer estimates of profit and loss for the new business. Proforma cash flow statements show the inflow and outflow of cash for the new venture.
When entrepreneurs develop their proforma financial statements, most quickly learn two important lessons. First, the estimates of profit or loss shown in income statements depend on the quality of the entrepreneurs' sales estimates. Therefore, accurate financial statements depend on accurate market analysis. In Chapter 9, we will discuss in considerable detail how entrepreneurs can estimate market size and sales for their new ventures. This information is important for creating accurate income statements for the new venture.
Second, the estimates
of profit and loss shown in income statements also depend
on accurate estimates of costs. Most entrepreneurs get into
trouble here because of the natural tendency to underestimate
costs. If you ever find yourself going over your own personal
budget, you are already familiar with this fact of life.
It's important to remember that sales are not generated for
free; rather, they result from activities such as advertising
and hiring people, which generate costs. So, any increases
in sales projected in the proforma financial statements should
be matched by increases in costs. In addition, businesses
in a particular industry tend to have similar relationships
between costs and sales. Therefore, when entrepreneurs create
proforma financial statements, they
should carefully
compare
these
statements
with those
of other businesses in the same industry. Are the numbers
realistic? For instance, if an entrepreneur projects sales
of $1 million per year and plans to hire one salesperson,
but other companies in the same industry average sales of
only $500,00 per year per salesperson, this comparison suggests
that the costs will be higher than the entrepreneur estimates.
Experienced investors know these figures and will cast a
doubtful eye on proforma financial statements that do not
reflect the realities of business in a particular industry.
Cash Flow Statements
As we've tried to emphasize at several points in this discussion, profits do not equal cash flow. For several reasons, the two can get "out of synch" in a new venture. Here, we want to drive home that point once again by explaining in more detail how a business can be profitable yet be insolvent because it has run out of cash. We have already suggested several ways in which this can happen - for instance, customers don't pay promptly while the new venture must pay its own bills on time. But here's another factor. Many expenses in an income statement, such as depreciation, affect profit and loss but did not involve real cash flows. So a business can have a profit or loss through depreciation of assets that is not reflected in actual cash flows. Moreover, cash inflows and outflows don't always occur at the same time as revenues and expenses and incurred. For instance, as we've seen already, sales often occur long before customers pay for those sales, so the sales are recorded on an income statement but do not generate actual cash.
Perhaps a concrete example will clarify this important point. Suppose you started a business to sell audio and computer equipment to students at a nearby university. The first month you are lucky and sell a system that cost you $200 for $500. You enter a profit of $300 on your income statement. But you have offered the purchaser "90 days is same as cash" to close the sale, which means that you have to wait three months to get the cash. If you now have to pay $200 for the system to the distributor, you may face a cash flow problem: you are showing a profit, but are out of cash!
This is why it is so important for entrepreneurs to accurately estimate their new businesses' cash flow as well as its income. To convert information from an income statement to cash flow, follow these steps:
1. Take your net profit and add back depreciation
2. Subtract increases in accounts receivable or add decreases in accounts receivable.
3. Subtract increases in inventory or add decreases in inventory.
4. Add increases in accounts payable or subtract decreases in accounts payable.
5. Subtract decreases in notes/loans payable or add increases in notes/loans payable.
6. The resulting figure is your net cash flow.
But what do you do if your cash flow statement indicates that you are in danger of running out of money? You can take several steps to improve your new venture's cash flow. First, you can minimize your accounts receivable by offering customers discounts for paying quickly, or by limiting the credit that you extend to customers. Second, you can reduce the raw materials and finished products inventory that you hold to meet unanticipated customer demand. Third, you can control spending by avoiding expenditures that are not absolutely necessary. Fourth, you can delay your accounts payable by obtaining credit from your suppliers. None of these steps are easy or pleasant, but they may be necessary to avoid a situation in which the new venture is unable to continue operations because, quite simply, it is totally out of cash.
| Robert
A. Baron and Scott A. Shane. Entrepreneurship: A
Process Perspective 2nd Edition.
2008. Thomson South-Western. p182-184. |
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CONFERENCES
FBD
|
| Who: |
Federation
of Business Disciplines
|
| What: |
34th
Annual Meeting
|
| Where: |
San
Diego, California, USA |
| When: |
March
14-17, 2007 |
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NCIIA
|
| Who: |
National
Collegiate Inventors & Innovators Alliance
|
| What: |
11th
Annual Meeting
|
| Where: |
Quorum
Hotel Tampa - Tampa, Florida, USA |
| When: |
March
22-24, 2007 |
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NI
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| Who: |
NASBITE
International
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| What: |
NASBITE
INTERNATIONAL 20th Annual Conference
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| Where: |
Fairmont
Waterfront Hotel in Vancouver, British Columbia,
Canada |
| When: |
April
1 - 4, 2007 |
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ISM
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| Who: |
Institute
for Supply Management
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| What: |
92nd
Annual International Supply Management Conference & Educational
Exhibit
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| Where: |
Las
Vegas, Nevada, USA |
| When: |
May
6-9, 2007 |
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CFOR
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CFO
Rising
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14th
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Orlando,
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March
18-21, 2007 |
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CALLS FOR PAPERS
AA
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| Who: |
Allied
Academies |
| What: |
2007
International Conference
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| Where: |
Jacksonville,
Florida, USA |
| When: |
April
11-14, 2007 |
Submission
Deadline:
March 1, 2007
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CNU
|
| Who: |
Christopher
Newport University
|
| What: |
"Truth & Consequences" Exploring
Economic Development from Entrepreneurship to Relationship
|
| Where: |
Newport
News, Virginia, USA |
| When: |
September
28-30, 2007 |
Submission
Deadline:
April 1, 2007
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AMA
|
| Who: |
Atlantic
Marketing Association
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| What: |
Atlantic
Marketing Association Annual Meeting
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| Where: |
New
Orleans, Louisiana, USA |
| When: |
September
26-29, 2007 |
Submission
Deadline:
April 17, 2007
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FBD
|
| Who: |
Federation
of Business Disciplines
|
| What: |
Annual
Meeting
|
| Where: |
Hyatt
Regency, Houston, Texas, USA |
| When: |
March
4-8, 2008 |
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