One can conceptually divide the entrepreneurial process into two stages. In the first stage, entrepreneurs identify opportunities for profit. In biotechnology, for example, an entrepreneur might see a need for an instrument to sequence DNA rapidly, or might notice the possibility of using a scientific breakthrough to treat some illness. In the second stage, entrepreneurs build firms to develop and provide products and services. Although one tends to expect that the first stage should always precede the second, it is not a necessity. Accounts of the origins of many successful firms, for example, suggest that sometimes an entrepreneur’s efforts to create a firm precede any specific idea of what that firm should do (e.g., Hewlett- Packard; Packard 1995). Hence, we will discuss these stages as distinct, but not necessarily sequential.
Each of these stages captures a portion of the activities conceptualized as entrepreneurship in the literature. Opportunity recognition, for instance, seems consistent with the idea that entrepreneurs combine disparate ideas (Say 1821) and with the definition of the entrepreneur as innovator (Schumpeter 1934). The possibility of profit in both of these cases comes from unusual insight into an opportunity available for exploitation.
The second stage meanwhile captures better the common understanding of entrepreneurship, the notion that the entrepreneur builds and manages a firm. This stage resonates with a different set of definitions of entrepreneurship. For instance, it appears consistent with the conceptualizations of entrepreneurs as combiners of disparate resources (Say 1821; Burt 1992) and as bearers of uncertainty in the economy (Knight 1921). Let us consider the role of social relationships in each stage in turn.
3.3.1 Opportunity Perception
Identifying potentially profitable opportunities requires access to information. But not just any information; profitable opportunities generally arise from access to private information. Two factors contribute to this fact. On the one hand, if those who first discover some bit of data understand their value, they will try to reveal it disclose it to the public, many entrepreneurs may pursue the opportunity and consequently compete away much (if not all) of the available value. Regardless of which of these factors matters more, it is this need for private information that links opportunity recognition to relationships.
Social networks provide channels for the flow of private information. On the one hand, individuals may simply exchange data through the course of interaction.
But even if information holders understand its value and wish to restrict access to it, they may still share it with some of their affiliates because they require these individuals’ cooperation. The head of a laboratory, for instance, might keep those working for her up-to-date on the results of the entire team’s efforts because of to as few as possible. On the other hand, if they do not understand their value and
independencies in their activities. Though that channel would appear limited in its scope, once passed on to members of a laboratory or employees in an organization, information might continue to seep outside these organizational boundaries for other reasons.
Those with the information, for example, might provide it to others in their immediate social circles as a form of favor exchange. Gossiping typically involves a quid pro quo. I will tell you some “secrets” that you did not know if you tell me some that I did not. Despite the apparent innocuousness of such exchanges, they can result in the diffusion of valuable information far beyond its original source.
Although information can and does flow multiple “steps” away from its origin, closer connections – hearing from the source for example rather than from someone who heard it from the source or someone that heard it from someone that heard it from the source, etc. – provide better information. Those nearer to the source tend to receive information earlier than those further away (Burt 1992).
Also, as a message passes through multiple individuals, it tends to accumulate errors (Sorenson et al. 2006). Each person in the chain may fail to recall or have understood the original message, or they may even have incentives to relay inaccurate information.
Because individuals vary in the information that they hold and because information flows more rapidly and with higher fidelity to those nearer in the network, connections to some prove more valuable than to others. In biotech- nology, as in other settings, the most valuable connections are to those employed in the industry. Existing institutions generate most of the important information with respect to business opportunities in any industry. Among those employed in biotechnology, those at commercial biotechnology firms probably have access to more valuable information with respect to these opportunities than those in nonprofit organizations for at least two reasons. First, researchers in nonprofit settings tend to focus on technology that requires much more development before one could deploy it commercially. Second, the norms of publication in the academe mean that much less of the information produced in those organizations remains private (Bernal 1939; Merton 1942; Sorenson and Fleming 2004). Not only do these norms reduce the ability of potential entrepreneurs to profit from this information, but also to the extent that the information still has value, the publications serve as substitutes for social connections to these scientists (Sorenson and Singh 2007).
When one combines the fact that the most valuable information comes from within the industry with the local character of social relationships (in both geographic and social space), one can see that those best situated to identify opportunities for profit are those with prior experience in the industry (often referred to as “spin-offs” in the literature). These individuals have both industry- social connections to others in the industry. It is not surprising therefore that a large share of the entrants into the biotechnology industry have prior experience at another biotechnology firm (Mitton 1990; Haug 1995). Moving beyond spin-offs, those that reside in a region with many biotechnology and pharmaceutical firms seem the next most likely to recognize an opportunity. These individuals tend to specific human capital (Agrawal et al. 2004; Klepper and Sleeper 2005) and dense
have more connections to those in these industries and therefore better access to relevant information flows.
3.3.2 Intellectual Capital
Biotechnology is a knowledge-based industry. As such, the single most important resource required for the success of a biotechnology firm is intellectual capital.
Simply seeing the opportunity for a particular product or service is insufficient.
The founder must have access to the scientific and technical knowledge necessary to develop it.
Acquiring such knowledge is not a trivial task. The knowledge used in biotechnology is not only complex, but also often tacit. Both of these factors increase the difficulty and costs of knowledge transfer. Complex knowledge – there – eludes easy transfer because the recipient of the knowledge cannot easily correct errors or omissions that may have occurred in the transmission process (Sorenson et al. 2006). The transferal of such knowledge therefore typically requires that the sender help the recipient to identify and correct mistakes in transmission. Similarly, the acquisition of tacit knowledge involves either learning-by-doing or intensive face-to-face interaction between the recipient and one who already possesses the know-how. Together, these factors imply that intellectual capital in biotechnology comes from close contact with experts in the field or from being an expert oneself (Owen-Smith and Powell 2004; Stuart et al.
2007).
Consequently, only a small set of people can start biotechnology companies (though clearly they may join teams of others with complementary abilities). One pool of potential founders is found among the faculty and postdoctorates in biotechnology and other closely related fields. They gain the relevant knowledge through learning-by-doing and learning-by-observation in their studies and research (Zucker and Darby 1996; McMullan and Gillin 1998). The other consists of employees at existing biotechnology and pharmaceutical companies (Mitton 1990; Haug 1995; Stuart and Sorenson 2003a). Not only have these individuals usually received training similar to that received by academic entrepreneurs, but also they may have valuable experience in other activities, such as patenting, clinical trials, manufacturing, and building and managing a commercial firm.
Universities and existing firms in the biotechnology and pharmaceutical industries therefore serve as the primary sources of biotechnology entrepreneurs.
In this respect also, biotechnology is little different from other settings.
Research has found that spin-offs – start-ups by those with prior experience in the industry – account for a large share of start-ups overall and an even larger share of successful ones in manufacturing industries such as automobiles (Klepper 2002), service industries such as law firms (Phillips 2002), and high-technology firms such as semiconductor manufacturers (Brittain and Freeman 1985). One question that naturally arises is, why, if these individuals are gainfully employed in the industry, do they choose to leave their jobs for a risky new venture? One recipes in which the results depend sensitively on the steps involved in getting
possibility is that employees simply see an opportunity to capture a larger share of the value of their ideas. Another is that they may gain satisfaction from seeing their ideas reach the market. Consistent with both of these explanations, one sees a strong demonstration effect in rates of entrepreneurship (Sorenson and Audia 2000; Stuart and Ding 2006; Fornahl 2007). In other words, people more commonly found firms when they observe others doing so. Or, they may disagree 2005). Consistent with this notion, one tends to see spin-offs occur in response to changes in the leadership of existing firms in the industry (Brittain and Freeman 1985; Stuart and Sorenson 2003a).
3.3.3 Human Capital
Few entrepreneurs in biotechnology could develop a product or service on their own. It is therefore critical in biotechnology – as in other high-technology industries where the production of intellectual property represents the primary source of value – to enlist able employees. Despite the importance of this resource, little empirical research has investigated how entrepreneurs recruit their first employees and the extent to which these employees affect the success of their businesses. Anecdotal accounts nonetheless suggest that social networks play an important role, as entrepreneurs appear to draw their first employees from friends and family.
To see why social relationships facilitate recruitment, it is useful to consider the problem from the perspective of the potential employee. A vast degree of uncertainty surrounds any new venture. For example, the science underlying the firm’s research may prove a dead end. Or, the market may not accept the product.
Or, the founder may not have the managerial acumen to run a company effectively. Moreover, the potential employee trying to evaluate these risks must also contend with the fact that the entrepreneur has an incentive to exaggerate the firm’s prospects and his own abilities (Amit et al. 1990). If the employee joins the start-up, all of these factors can potentially affect her income and career; she might easily find herself out of a job.
Social relationships can help to mitigate these uncertainties. They do so in at least two ways. First, they allow potential employees to gather private information on the entrepreneur and the probable quality of his venture. They also allow entrepreneurs to locate high-potential job candidates. Since the best people typically already have jobs, they cannot simply advertise positions and expect them to apply (Granovetter 1973). Studies of job search therefore commonly find that people learn about jobs through their social networks (Granovetter 1973;
Fernandez et al. 2000). The importance of social relationships to the process undoubtedly becomes even more pronounced among start-ups, where the firms lack human resource policies and personnel, and where employees face even greater uncertainty regarding the characteristics of the job being offered and the quality of the employer.
with their employers over the future direction of the field (Klepper and Sleeper
Social relationships may also play another interesting role in mitigating the doubts of potential employees. Experimental research has shown that people tend to evaluate more positively things that are familiar to them. Both experimental and field studies moreover suggest that this bias can explain why buyers and sellers frequently exchange repeatedly with the same partners (Kollock 1994; Sorenson and Waguespack 2006). Here, prior interactions with the entrepreneur may lead the potential employee to think more highly of the individual (regardless of his true quality), and therefore to feel sufficiently confident in the venture to join it as an employee despite the many obvious risks.
Given that social relationships can facilitate recruitment, potential entrepreneurs will vary in their ability to mobilize human capital on the basis of their positions.
Employees in the biotechnology industry tend to come from the same two sources as entrepreneurs themselves. First, as with many high-technology industries, universities provide an important source of labor. Recent graduates serve as a source of bench scientists, running experiments and performing the “grunt work”
of biotechnology. Meanwhile, certain faculty members – “star scientists” – provide valuable intellectual leadership and endorsements (Zucker and Darby 1996;
Zucker et al. 1998). Second, employees at existing firms in the industry provide a large pool of labor, already steeped in the specific tacit knowledge that comes with experience in the industry (Sorenson and Audia 2000). Once again, those individuals who either have prior employment experience or have lived in close proximity to clusters of existing biotechnology firms typically have the best networks for mobilizing human capital.
3.3.4 Financial Capital
Equally important to any new venture, and especially to those in businesses such as biotechnology where firms cannot expect revenue for many years, is the availability of financial capital. As in other high-technology industries, the dominant form of funding in biotechnology has been venture capital (Florida and Kenney 1988; Haug 1995). Few investors other than venture capitalists will accept the risks inherent in investing in firms with uncertain prospects and long time horizons to profitability.4
Although important, one might expect financial capital to flow freely across regions, and therefore to have no effect on the location of industry. This expectation, however, ignores one of the key problems facing the venture capitalist (and other investors in private firms): the difficulty of evaluating the quality of the venture. Like potential employees, investors must assess a host of risks surrounding the new venture – the quality of the science, the potential for competition, the managerial ability of the founding team, etc. Social relationships again provide access to the private information necessary to understand these risks better (Sorenson and Stuart 2001). They may also, as with the case of employees,
4 Government research grants, however, do serve as an important source of early stage funding in many countries (see Carsrud, Brännback and Renko, this volume).
bias investors’ assessments in favor of the entrepreneur (Sorenson and Waguespack 2006). In fact, venture capitalists rarely invest in entrepreneurs who have not been referred to them by a known party (Fried and Hisrich 1994; Shane and Cable 2002). Since these relationships cluster geographically, venture capitalists primarily invest in firms located in close proximity – within an hour’s drive or so – of their offices (Gupta and Sapienza 1992; Sorenson and Stuart 2001;
Engel 2002).5 Hence biotechnology entrepreneurs located near concentrations of venture capital firms have an advantage in finding financial support.