It’s well known that the founding team is crucial to any startup.  It’s also common for the founding team to be friends who have come together to create a business.  New research from Cass Business School explores what impact these friendships can have on the success of a startup.

Sadly, it seems that friendships can be financially costly, as they encourage founders to persist with a business that’s failing, thus costing more money than would be the case if they cut their losses.

This matters because the high failure rate of startups is widely reported, with 20% failing within the first 12 months and 60% going under within three years.  Failure is by no means a negative reflection on the entrepreneurs, but failing to call time on the business is undoubtedly costly.

Rocky waters

The researchers specifically examined startups who had begun to encounter difficult financial circumstances.  They found that when the friendship between founders was especially strong, they were more likely to double down on their commitment to the firm rather than walk away from it.

“Our results indicate the importance of entrepreneurs understanding and managing their team emotions for best decision making,” the researchers explain.  “It also helps explain the continued engagement of entrepreneurial teams who, even when fearful, have hope.”

Emotions understandably play a major role in the success of any startup, and it’s rare for emotions to run higher than when the venture is at the cliff edge facing the prospect of failure.

“We focus on the influence of group fear and group hope because, compared to other emotions, fear and hope are more associated with uncertainty, which is inherent to the decision to escalate commitment to a venture,” the researchers explain.  “We compare a founding team’s fear that a currently failing venture will ultimately increase financial losses to their hope that the venture can be turned around, recover the losses, and ultimately make money.”

Fear of failure

The used real data from 66 different entrepreneurial teams who made 569 different decisions.  They found that hope nearly always trumps fear, with group hope resulting in escalating commitment to the venture, even when it’s failing, and this commitment proving much stronger than the fear of the project failing.

The researchers also tried to measure the level of engagement entrepreneurs had in their project.  This was gauged via the time, effort and attention they gave to their startup.  Would this be able to mediate between fear and hope and the subsequent escalation of commitment versus the desire to stop the venture and cut their losses?

“We employed an immersive laboratory methodology to realistically simulate and observe teams of three business students serving as co-founders of a computer startup,” the researchers explain.  “To examine the dynamic nature of these decisions, we longitudinally tracked each team’s joint level of fear, hope and behavioural engagement through multiple rounds of simulation.”

It seems that the cost of escalating commitment for a failing venture is high, it runs counter to the high value placed on persistence and perseverance in a startup context.  The ability to know when to cut losses and step away is one of those skills that is vital to gain but very difficult to master.  This study reminds us that working with our friends makes this doubly so.