Start-ups launched by former employees, known as spinouts, are often touted for their superior performance compared to other new ventures. However, recent research conducted by UCLA presents a different perspective. The study reveals that parent firms, which identify and implement ideas internally, outperform spinouts.

When employees depart from parent companies to start their own ventures in the same industry, they may find themselves competing against a newly established enterprise set up by their former employer. This competitive dynamic puts spinouts at a potential disadvantage.

Uncertain dynamic

Spinouts do possess certain advantages due to knowledge transfer from their parent companies. They benefit from insights into business operations, target markets, and supplier relationships. However, parent firms can leverage their abundant resources and time to implement higher-quality ideas and effectively set up new enterprises.

The research, based on census data from 30 states, meticulously tracked employment and ownership patterns within industries. The findings showed that, on the whole, new establishments of parent firms exhibit superior performance metrics. They tend to be larger, experience faster growth, and have higher survival rates. Intriguingly, parent companies also demonstrate a higher tendency to close down their new ventures.

This is attributed to the concept of opportunity cost, wherein they allocate resources that could be used elsewhere in the organization. An underperforming new establishment becomes a costly venture for the parent firm. Moreover, spinouts may take longer to assess their viability, contributing to their persistence even in suboptimal conditions.

A mixed bag

While spinouts initially have a higher probability of survival at around 64% compared to 59% for new establishments of parent firms, this difference diminishes as both types of ventures mature. By the time they reach seven years of age, the gap in survival rates becomes negligible.

In conclusion, the study challenges the prevailing notion that spinouts invariably outperform other start-ups. Parent firms’ ability to leverage internal resources and implement higher-quality ideas grants them a competitive edge. This research contributes valuable insights into the dynamics between spinouts and their parent companies in the entrepreneurial landscape.

“If you look at the prior literature, we are always comparing spinouts with other kinds of new firms and finding that spinouts do better,” the authors conclude. “But your previous parent firm itself could be your competitor.”

The study also highlights the process of selection within a parent company for managers, who are tasked with deciding whether to internally implement new ideas. Because of a parent company’s resource deployment opportunities—in other words, the many projects for which they could allocate time, money, and energy— there are greater selection pressures, particularly at the exit selection stage.