Entrepreneurs often lack the resources and funding to kick-start their ventures, leading them to contact family and friends for initial support. However, this raises a crucial question: Is it beneficial for a startup to be backed by individuals close to the founder, offering them a chance to be part of something potentially groundbreaking?

Recent research by three professors from the Indiana University Kelley School of Business suggests that such close financial ties can influence founders to adopt more cautious growth strategies and be reluctant to take risks. This study explored how accepting funds from personal connections affects an entrepreneur’s inclination towards risk.

Donald F. Kuratko, who holds the Jack M. Gill Chair of Entrepreneurship and serves as the executive and academic director of the Johnson Center for Entrepreneurship and Innovation, stated that the study was designed to assess how these financial contributions impact an entrepreneur’s approach to risk. He highlighted that when the relationship between an entrepreneur and an investor deepens, as it often does with family and friends, the entrepreneur might feel a stronger guilt over business decisions that could lead to failure.

Greg Fisher, a professor of entrepreneurship, added that this sense of guilt could prompt founders to make more conservative decisions regarding their venture’s growth, which might contradict the fundamental entrepreneurial spirit of innovation and risk-taking.

“family and friends” financing is a predominant method of raising initial startup funds. This informal funding route is not only more accessible compared to other forms of investment but also typically comes with more lenient terms. However, there are drawbacks, notably the potential strain on personal relationships if the business fails to meet growth and success expectations. This risk of damaging close personal ties can lead entrepreneurs to opt for safer growth strategies.

The study, titled “Funding-source-induced Bias: How social ties influence entrepreneurs’ anticipated guilt and risk-taking preferences,” is set to be published in the Journal of Business Venturing. It includes contributions from Regan Stevenson, an associate professor of entrepreneurship and management; Emily Neubert, an assistant professor at Texas Christian University; and a Kelley Ph.D. alumna, who spearheaded the project.

By examining a sample of 193 entrepreneurs active in various incubator and accelerator programs, the researchers developed a model to test how the strength of an entrepreneur’s relationship with their investors—mainly when these investors are family or friends—affects their anticipated guilt in making strategic decisions. This guilt, in turn, correlates with a tendency to make less risky growth choices.

The research introduces the term “funding-source-induced bias,” describing a bias in entrepreneurial decision-making that stems from the entrepreneur’s relationship with their investor. This bias leads to guilt when considering risky options. Thus, entrepreneurs who secure funding from close family and friends are more likely to pursue less risky growth strategies to avoid this guilt.

This study highlights the potential downsides of family and friend funding and provides insights into how these financial relationships impact entrepreneurial decision-making. By shedding light on this aspect of the investor-entrepreneur relationship, the research aids entrepreneurs, mentors, and educators understand how investment sources can shape business strategies and decision-making processes.

Emily Neubert commented on the significance of this research, expressing hope that it would inspire further investigations into how different funding sources influence entrepreneurs’ decisions and actions. Exploring the less discussed aspects of the investor-entrepreneur dynamic is crucial for fostering a deeper understanding of the complexities involved in startup financing and its effects on business strategy.

More information: Emily Neubert et al, Funding-source-induced bias: How social ties influence entrepreneurs’ anticipated guilt and risk-taking preferences, Journal of Business Venturing. DOI: 10.1016/j.jbusvent.2024.106453

Journal information: Journal of Business Venturing Provided by Indiana University