THE FUNDING OF NEW VENTURES IN “NORMAL” AND “ABNORMAL” PERIODS
Ram Mudambi, Temple University
Monica A. Zimmerman, Temple University
Principal Topic
The liability of newness suffered by entrepreneurial ventures is well established in the literature (e.g. Stinchombe, 1965). However, the extent of this liability varies systematically with the fortunes of the industry in which the venture operates. This liability is in part due to a lack of legitimacy. New ventures operating in new industries lack legitimacy at the firm level and at the industry level. New ventures in growing industries lack firm-level legitimacy, but they can use the legitimacy of the industry (Zimmerman & Zeitz, 2002).
The entrepreneurship literature has identified a number of factors as hurdles to the survival and growth of new ventures. Resource constraints are among the most crucial of such hurdles (e.g., Bhide, 2000; Starr & MacMillan, 1990; Welsh & White, 1981; Zhao & Aram, 1995). During the Internet bubble, Internet-based startups differed from the stereotypical new venture in that they were able to acquire substantial resources despite their violation of or disregard for traditional performance benchmarks. In fact, many performance benchmarks were often turned upside down, and new Internet-based ventures attracted resources despite their poor performance (King, 2000; Mudambi & Zimmerman, 2002).
In this study, we argue that once the industry becomes established, after a point, firm newness can become an asset. In other words, the perception of the industry can become exaggerated so that a bubble forms. In such a period, investors disregard traditional measures of weaknesses of new ventures and begin using option calculus where variance has a positive value. In this context, the effects of newness can become quite perverse. We hypothesize that, after controlling for the effects of firm-specific variables, the liability of newness disappears in a bubble period.
Method
We studied this phenomenon by examining the funds raised by matched samples of IPOs in SIC 7300 during two time periods—1993–1995 and 1998–2000. The former period serves as the control ‘normal’ period, while the latter period is the test or ‘bubble’ period. We collected data using SEC S-1/ SB-2 and 10-K filings, as well as IPO.com data.
Results and Implications
The main contribution of our research is that it examines the impact of firm level variables upon firm performance and the influence of the perception of the industry. We explain some of the irrationality of investment in Internet-based new ventures during a bubble period. We determined that in other periods of time, many such investments would have been considered just plain bad decisions.
CONTACT: Monica Zimmerman Treichel, Temple University, Fox School of Business and Management, Philadelphia, PA, 19122; (T) 215-204-6876; (F) 215-204-3080; monica.treichel@temple.edu
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