From Eva de Mol – HPE Growth Capital

We all know that successful entrepreneurship contributes to innovation, job creation and profit. However, the stark reality is that most start-ups fail before they can even start to create value. According to Stanford University 60% of these failures is caused by malfunctioning teams. But research into what actually makes a better team – and ultimately, a more profitable start-up – remains surprisingly scant. As a result, most investors rely on the same, outdated approach when screening potential management teams to invest in: their intuition.

My PhD research, which examines the effects of entrepreneurial team composition, provides evidence of what we all have known for years but have been unable to verify: team composition does influence venture performance and specific team member characteristics can make or break a team. Having tracked 800+ entrepreneurs both in The Netherlands and the USA, some of the findings may surprise you. For example, did you know that passion is just as important as start-up experience in predicting performance? That education fails to predict success? Or that fear of failure in teams decreases team efficiency? Other findings confirm earlier work. For example, by now, we probably all know that diverse teams outperform homogenous teams. Speaking of diversity, in this blog, I’ll talk about one of my studies in which I show how diversity in feelings of passion among team members hurts venture performance.

Human capital and passion

Time and time again, passion has been cited as the key ingredient that drives venture performance. Like Paul Graham from Y Combinator states, “We thought when we started Y Combinator that the most important quality would be intelligence. That’s the myth in the Valley. And certainly, you don’t want founders to be stupid. But as long as you’re over a certain threshold of intelligence, what matters most is passion.” Passion is what motivates people, the “fire of desire” that makes entrepreneurs pursue their dreams and make the impossible possible. Also academic work repeatedly confirms that entrepreneurial passion boosts persistence and creativity. Thus, we know that passion is important in explaining entrepreneurial success. But is it more important than prior experience, skills and knowledge – so called human capital? And what happens if team members experience different levels of passion? Can passion also lead to negative outcomes? These were the key questions driving one of the studies that I’ll talk about today. Specifically, the main objective of this study was to examine whether and how rational (human capital) and affective (passion) team member characteristics interact in predicting venture performance.

The results of the study show that entrepreneurial teams with greater human capital do not necessarily perform better. Instead, the positive impact of their human capital is dependent upon the teams’ passion and the extent to which team members share a common vision for the strategy of the company.                                                                                                          These findings make a lot of sense. Let’s take the example of Mike, a friend of mine who is working for a venture capital firm. Mike recently told me about a potential investment, a software company, that he was very excited about. Let’s call it Clocker. When Mike read about Clocker and received the company materials, he was thrilled to meet the team. In addition to the interesting financials, the founding team’s track record was outstanding. The founder and CEO had in depth industry knowledge, worked in the software space for years and led the product division for Salesforce. The CFO graduated from Harvard, had worked for Bain & Company before joining Clocker and showed very strong financial and strategic skills. The VP of Sales was a typical sales tiger who’d worked as an account manager for Microsoft. Finally, the fourth team member was very hands-on, a serial entrepreneur with a successful exit on his resume and some experience with start-up failures. On paper, the team seemed to have all that it would take to successfully scale up Clocker and ensure a nice return on the potential investment. You’ll understand why Mike was very excited to meet the Clocker team.

Nevertheless, when the team members presented their pitch in the boardroom and elaborated on the Clocker growth strategy, Mike was disappointed. The story just didn’t hold. While the founder told Mike that he wanted to expand to the USA and become the next Salesforce, the CTO did not seem to share this passion and ambition. He dismissed the founders’ ideas immediately and argued that he would be too busy with other projects to realize global expansion this year. The problem? The Clocker team members had very different ambitions and goals in mind for Clocker and were not equally passionate about the company. Because of these differences in passion team members did not communicate efficiently and failed to share their knowledge, which ultimately led to a decrease in their performance. Not surprisingly, the Clocker team soon after broke up.

In the example of Clocker, the founder and CFO were both very passionate. They were the ones who spent considerable effort and time in preparing the materials that Mike received and in maintaining relationships within Clocker’s network. Thus, to Mike, it seemed the Clocker team was very determined and passionate to grow the business. However, the situation in the boardroom reflected the reality of how unequally distributed these feelings of passion were among the Clocker team. The VP of Sales was just moderately passionate – he still ran his own sales business on the side – while the CTO was continuously on the lookout for other jobs. Resulting from this passion diversity, or “affective diversity”, the Clocker team had been unable to reach a true consensus about their ambition, vision and growth strategy. This ultimately resulted in bad performance, not only in the boardroom but also through the course of their entrepreneurial journey. The example of the Clocker team shows that a great resume only materializes if team members are willing to share their knowledge and skills.

Summarizing, the key takeaways of this study are as follows:

  • Human capital and passion are equally important in predicting venture performance
  • Greater human capital only leads to better performance if team members share their knowledge and have a common vision for the company
  • Passion in teams can lead to negative outcomes if team members are unequally passionate

The reality is that bad entrepreneurial teams will enter your office. Luckily there’s also good news: investors can incorporate management team assessment into their due diligence practices. Ways to do that? Next to meeting and engaging with the team, significant improvements have been made in the development of suitable assessment methods that investors can use during their due diligence trajectory. In a future post I’ll elaborate on those methods that can be particularly useful to evaluate teams during the investment trajectory.