Factors Affecting The Success Of Internet Startups

Tuesday, November 9, 2004

Prof. Sea Jin Chang, Korea University (South Korea), http://

Abstracted from: Venture Capital Financing, Strategic Alliances, and the Initial Public Offerings Of Internet Startups
By: Prof. Sea Jin Chang Korea University (South Korea)
Journal of Business Venturing - Vol. 19, No. 5, Pgs. 721-741

The liability of newness.
Internet startups have long viewed an initial public offering as the ultimate measure of success. Yet for many of them, launching an IPO remains an elusive goal, one that only others have managed to achieve. An understanding of what spells the difference between an Internet startup's success or failure would be invaluable. Business professor Sea Jin Chang considered Internet portals and companies involved in e-commerce for products and services founded between January 1994 and June 2000. The study seeks to pinpoint the influence that venture capital and strategic alliances have on a startup's performance, as measured by if and when it undertakes an IPO.

Adding legitimacy.
Startups have a higher rate of failure than established firms for several reasons, including the startup's lack of legitimacy in the eyes of investors and paucity of resources such as cashflow. Because of the added uncertainty surrounding Internet companies and their vulnerability to what some scholars have called the liability of newness, investors are highly skeptical of an Internet startup's prospects. By providing advice, contacts, and financial resources, venture-capital firms lend respectability and legitimacy to an enterprise. The author's review indicates that investors indeed pay attention to the quality of the venture-capital backing when they decide whether to support a startup. In one study, industry and firm legitimacy at the time of an IPO influenced the amount of capital that biotechnology companies could raise. Aligning with prominent partners through strategic alliances in industries, such as the Internet, that have high levels of market and technological uncertainty will also enhance legitimacy. Among Internet e-commerce companies, alliances with firms that provide security devices or search engines, for example, signal trustworthiness to both buyers and investors.

Factors affecting IPO rates.
The author found strong evidence that the reputation of the venture-capital firm and the presence of strategic alliances had a significant impact on IPO success. Companies backed by VC firms with an average IPO rate of 30% enjoyed returns far higher than those funded by venture capitalists with an average success rate of 10%. This suggests that investors use a venture-capital firm's previous IPO rate to measure the likelihood of future offerings' success. The number and reputation of strategic alliances also increased the likelihood of an IPO, with each additional alliance boosting the IPO rate by 1.17 times.

Lessons and limitations.
For entrepreneurs, the results underscore the author's conclusion: the importance of partnering with VC firms having strong reputations and a history of bringing startups to the public market, and the importance of forming strategic alliances with firms that have the social, technological, and commercial resources needed to add legitimacy. However, going public does not necessarily guarantee corporate longevity. Forty of the 90 Internet firms with successful IPOs in the study had gone bankrupt by the end of 2002. Examining the attributes of those that survived would prove insightful, as would further research into the influence that underwriters have in IPO success.

Abstracted from Journal of Business Venturing, published by Elsevier Science, 360 Park Avenue South, New York, NY 10010

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