What Kind of Logic Gets Startups Funded?
How Should Entrepreneurs Think?
That’s a loaded question. Allow us to elaborate — what kind of thinking or approach do we desire from entrepreneurs in India? Do we expect them to be nimble, agile in their approach? Or, do we expect them to follow a sure, unchanging path to a pre-defined goal? Do we expect them to be the creators of their future or do we expect them to control the future as much as they can predict it? Do we expect entrepreneurs to identify and leverage their current resources, networks, and knowledge and combine them to create the future? Or, do we expect them to be on a quest for means that are needed for the predicted goal? You may notice that these questions depict two distinct approaches or logics adopted by entrepreneurs.
Logics are essentially ‘points of view’. They are deeply held assumptions, which comprise the bedrock for reasoning and, therefore, action[i]. Entrepreneurial logic would, thus, signify the underlying assumptions and reasoning of entrepreneurs. The series of questions presented earlier represent two distinct logics adopted by entrepreneurs — causal and effectual.
Adopting a causal logic, entrepreneurs aim to achieve a fixed goal with a scientific, linear approach. This approach emphasizes a thorough market research with an objective of predicting, and therefore controlling the future. In other words, causation follows the rational choice paradigm, which emphasizes ‘to the extent you can predict the future, you can control it’[ii]. In contrast, effectuation is the logic of non-predictive control, i.e. to the extent we can control the future, we do not need to predict it. Entrepreneurs with an effectual approach inspect the given means to create an end by judicially leveraging these means; goals are flexible or created by the entrepreneur given the means available/gathered[iii]. While effectuation encapsulates nimble, iterative methods, causation is characterized by a linear, definitive approach.
Suppose you are invested/interested in about a startup. Which logic would you expect from the entrepreneur — causation or effectuation? Logically, a nimble approach may be better suited to a dynamic context i.e. a typical reality for startups. Research also tells us that expert (i.e. successful) entrepreneurs adopt effectual logic while creating a new venture. Entrepreneurs’ effectual logic is also associated with development and introduction of radical innovations into the market ii.
Now the interesting part!
We analyzed data from a national level idea scouting competition to investigate the impact of entrepreneurs’ logic on their startups’ outcomes. We picked 69 finalist startups and an equal number of those that failed to make it to the top 75 (these were selected randomly from about 14000 entries). Next, from the application form, we identified and extracted data on fields that gave us a rounded perspective on entrepreneurs’ logics. These included ‘describe your product or service?’, ‘how did the idea originate?’, ‘describe your revenue generation model.’, ‘how do you plan to spread your solution to the target market?’, ‘what are the currently available alternatives to your proposed solution?’, ‘how does your solution compare with the competition?’, ‘who is your primary/target, customers?’, ’what is the addressable size of your target market?’, and ‘what are growth prospects/trends of your target market?’. Two researchers coded the answers as causal or effectual. For each field, they assigned a value ‘1’, if it portrayed causation logic, and ‘0’, if it depicted an effectual one. This implied that all entries (finalists and others) had a causation score i.e. sum of all instances where they depicted causal logic.
As a start, we wanted to examine whether the logics of finalists were different from non-finalists (for the lack of a more politically correct, simpler and shorter term!). An independent t-test confirmed that finalists had statistically higher mean causation score (3.19+/- 1.26) compared to non-finalists (2.19+/- 1.620), t (4.038), p=0.000.
Next, we wanted to know the magnitude of the impact of causation score on the startup’s outcome. For this, we applied binary logistic regression. The results amazed us. We found a positive association between causation score and funding success (See figure below). The explained β of 1.595 (β coefficient: 0.467) implies that one unit increase in causation score increases the chances of selection by 59.5% (Nagelkerke R square: 0.142). In other words, when it comes to funding decisions, entrepreneurs following linear, definitive, causal logic are preferred over those that adopt a nimble, iterative, effectual approach.
These are early findings from a limited data-set. However, they highlight a classical folly in human behavior — the dichotomy between reward vs. desire. While this is based on data from one competition, the evaluation was conducted by investors, incubators and subject matter experts from across various sectors. Therefore, such inclination towards rewarding a causal, linear logic could be a more widespread phenomena. We believe there is merit in delving deeper into this, particularly to examine the influence of other elements and contingencies.
We are guilty of starting with a value laden question, but findings from this study push us to reflect on it. How do we want entrepreneurs to think? The choice is between iterative and evolving effectual thinking, that often leads to radical innovations and creation of the future, vis-à-vis a linear, predictive, causal one that is linked to pursuit of well defined, unchangeable goals. For an innovation and entrepreneurship ecosystem capable of making a noticeable technological, economic, and social impact, it’s not a tough choice!
What do you think? Sound off your thoughts in the comments section below.
[ii] Sarasvathy, S. D. (2001). Causation and Effectuation: Toward a theory shift from economic inevitability to entrepreneurial contingency. Academy of Management Review, 26(2), 243–263. http://doi.org/10.5465/AMR.2001.4378020
[iii] Sarasvathy, S. D., & Venkataraman, S. (2011). Entrepreneurship as Method: Open Questions for an Entrepreneurial Future. Entrepreneurship: Theory and Practice, 35(1), 113–135. http://doi.org/10.1111/j.1540-6520.2010.00425.x