Startups can benefit from institutional reforms that lower barriers to formation and growth, increase avenues for raising capital and exiting, and ease liquidation and bankruptcy in case of failure, according to new research by Wharton management professor Valentina Assenova. But these changes have another critical outcome: In countries that implemented such reforms, the average number of firms that tapped venture accelerators increased 17 times.
Assenova details these and other key findings in a new paper, titled “Institutional Change and Early-Stage Startup Selection: Evidence from Applicants to Venture Accelerators,” which was published last month in Organization Science.
With institutional reforms, entrepreneurs “saw a lot more value in partnering with these organizations for networking, for developing new knowledge, and for obtaining additional capital from other sources,” Assenova said in a recent interview with Knowledge at Wharton. (Listen to the podcast at the top of this page.)
An edited transcript of the conversation follows.
Knowledge at Wharton: What was it that led you to undertake this research?
Valentina Assenova: There is comparatively little research that has looked at how various types of environmental changes and institutional reforms affect early-stage startup selection [by venture accelerators]. So, the central question that I examine in the study is, how do institutional reforms affect early-stage startup selection, particularly into venture accelerators?
Early-stage startup selection is a process that we don’t understand very well, both as scholars and as practitioners, in the sense that most of the data that we have out there on entrepreneurship is highly prone to survivorship bias. We’re just seeing the firms that really made it, and those are the outliers. The modal outcome is failure. Moreover, we rarely get a glimpse into those early stages of startup development. There are many reasons why those stages matter. The selection [by venture accelerators] ultimately determines the pipeline of startups that receive funding and resources to grow and develop. Institutional reform relates to regulatory and policy changes that affect the overall startup environment in which entrepreneurs create and develop new firms.
“We rarely get a glimpse into those early stages of startup development.”
Knowledge at Wharton: Generally speaking, what types of regulations and policies affect the ability of entrepreneurs to start new companies?
Assenova: There are several different types of regulations and policies, and some of those will affect certain industries more than others. But the ones that I look at from a comparative and international perspective in the study are reforms that affect the ease of starting, growing and exiting new firms for entrepreneurs.
These regulations have to do with aspects like minimum paid-in capital requirements that are prevalent in many countries, the number of processes and government regulations to incorporate a new company and start operations, as well as bankruptcy, litigation and liquidation procedures to reorganize a company upon failure.
Knowledge at Wharton: Your study looks specifically at startup selection by venture accelerators. What do venture accelerators do? Also, why did you choose to focus specifically on those?
Assenova: Venture accelerators are organizational sponsors of early-stage startups. Other types of sponsors include startup incubators, boot camps, angel investors and venture capitalists. The reason for looking at venture accelerators is that they play a crucial role in startup selection at some of the earliest stages of new company formation. Accelerators typically provide resources and help entrepreneurs learn and expedite the time to failure or success. They’re designed to help with that exploratory process of developing a new product or taking a new technology to market.
These sponsors play a vital role in supporting not only high-growth entrepreneurship, but also selecting and developing promising startups within their local ecosystems. For example, more than 61% of the companies in my sample are based on new technologies. Sponsors [evaluate] the startup teams and their ideas. They turn down over 90% of applicants. They are crucial gatekeepers for that first stage of selection, which will narrow down the startup pipeline [before applicants qualify for] venture capital funding and scaling.
Knowledge at Wharton: How did you go about studying this?
Assenova: [The data for my study came] through a research collaboration between Emory University and the Aspen Network for Development Entrepreneurs (a Washington, D.C.-based global network of organizations that supports entrepreneurship in emerging markets). This research collaboration has been collecting a ton of data on over 13,770 applicants to early-stage venture accelerators across 170 countries. We have the full applicant pools for accelerators in these countries. We can see which of these applicants were turned down. In my study, I also looked at how regulatory reforms in many of these countries influenced which startups were selected [by venture accelerators]. I also looked at [whether those policy reforms] influenced the composition, size, and quality of the applicant pool of startups that applied for resources from venture accelerators.
“Institutional reforms resulted in more applicants per accelerator — on average, roughly 17 times more applicants per open spot in the average-sized cohort.”
Knowledge at Wharton: That’s a huge amount of data that you looked at. What would you say the main findings were, and some of the implications for governments, venture accelerators and others?
Assenova: The findings were aligned with some of our intuition about selection. I looked at how these reforms in various countries affected the size of the applicant pool and the quality of selected cohorts. Institutional changes, for example, resulted in more applicants per accelerator – on average, by between 128 and 136 applicants per program, or roughly 17 times more applicants per open spot in the average-sized cohort.
These institutional reforms created more favorable conditions for starting new firms, for obtaining capital, for growing those firms, and reducing the downsides – the risks of failure – through to recovery from bankruptcy. They resulted in a surge in the number of new companies that were looking for these kinds of resources by partnering with venture accelerators.
The perceptions among entrepreneurs or applicants of the value of partnering with venture accelerators also increased dramatically. They saw a lot more value in partnering with venture accelerators for networking, for developing new knowledge, and for obtaining additional capital from other sources. There was this overall enthusiasm for pursuing venture acceleration as an option.
However, there was also a downside for entrepreneurs. Even though there was a surge in new applicants, there was an increase in the quality of the applicants. Many more of those applicants were now being turned down, so the selection became much more competitive. On average, an applicant’s probability of being selected decreased by between 5% and 7% for countries that implemented only one of these reforms. For those that had multiple reforms, it decreased by about 10%.
It wasn’t all bad news. Of course, for many entrepreneurs, they were thinking, “On the one hand, these conditions are improving, and now I have better prospects of actually growing a company that’s likely going to get funded.” But then the probability of getting these resources becomes much lower because of the competitive pressures.
For the accelerator managers what this means is that the more competitive the selection, the higher the quality of the cohorts that they’re ultimately cherry-picking to fund and develop. Most of those selected cohorts were higher-quality cohorts. They had more patents, more employees, greater revenue generation prospects, and higher planned equity raises.
Knowledge at Wharton: Looking at the map of the countries that you covered, they go from developing economies through more developed economies, to fully developed economies like Canada and Australia. Did you find the same kinds of hurdles existing in all these different markets across the board, or were there different considerations in different kinds of markets?
“[After institutional reforms], entrepreneurs saw a lot more value in partnering with venture accelerators for networking, for developing new knowledge, and for obtaining additional capital from other sources.”
Assenova: There were different considerations across these economies. Some startup environments are very favorable for just getting a company going. For example, Canada is like the U.S. [in that it has] very few barriers to entry. In the U.S., for example, it takes only a couple of days to incorporate a new company. Australia is another example of a high-income economy where it’s easy to start a new firm.
But on the back end, if things don’t go well, how easy is it for somebody to recover the value of their initial investments? There were some instances of reforms that improved the bankruptcy process and resulted in a surge of new applicants to venture accelerators.
The modal economy in the sample was a lower middle-income economy. Examples are countries in South America, sub-Saharan Africa or Eastern Europe.
I looked at India and China as well. India has been very proactive about improving the conditions for early-stage startups. It has consistently, over the observation period in my study, taken a lot of efforts to reduce regulations that are impeding the entry, growth, and exit of new firms.
Knowledge at Wharton: What additional questions does your study raise that you could explore next?
Assenova: There are a couple of important questions it raises. The first is, what is the magnitude of this selection pressure that’s influencing the outcomes that we observe for firms? Much of the entrepreneurship research has been based on success cases. We know that success is not the modal outcome. So, it would be interesting to look at how regulatory reforms influence selections at later stages, such as by venture capitalists, for example, in the U.S., and maybe angel investors.
There’s also an important direction here for future studies, which is to look at the difference between regulatory reforms, and then their implementation at a subnational level. There’s a lot of variation between the laws that get adopted and how they’re enacted locally. So, differences in how national-level reforms are implemented in Silicon Valley or Philadelphia, for example, could be large. [Therefore], looking at subnational differences and how they influence regional ecosystem development and the pipeline of early-stage startups is an important direction for future studies.