Talk of disruptive innovation is two-edged sword for investment seekers – study

Startup entrepreneurs who pitch their company to investors by talking about how disruptive their technology is and how it will change the world will likely land an investment, but a much smaller one than if they hadn’t hyped up their story, researchers have shown in a study of Israeli startups.

“Disruptive visions are powerful images of the future” set out by entrepreneurs about how their ventures will change and disturb or reorder the market as we know it, the researchers — Timo Van Balen, Murat Tarakci, and Ashish Sood from the Rotterdam School of Management and University of California, Riverside — said in a paper describing their study published in the Journal of Management Studies and Harvard Business Review.

Typically, when pitching their ventures, entrepreneurs use two strategies, said Tarakci, a professor at the Rotterdam School of Management, Erasmus University Rotterdam, in a phone interview.

The first one exalts the entrepreneurs’ track record and achievements. This message is “backward-looking,” with a focus on the past or current accomplishments of the entrepreneur or the venture, he said.

Murat Tarakci, Associate Professor of Innovation Management at the Rotterdam School of Management, Erasmus University Rotterdam (Courtesy)

The second strategy is to lay out a vision of the future: what the venture will do and become and what the entrepreneurs will achieve. Disruptive visions belong to this category.

The question that arises, however, is: “Do investors applaud or dismiss self-claimed disruptors?”

“Should the entrepreneurs actually communicate a disruptive vision, or should they boast about their previous achievements to convince early stage investors? That is what we set out to discover,” Tarakci said in the interview.

To answer the question, the researchers studied 918 startups in Israel that were seeking a first round of funding. They also undertook an online experiment with 203 participants with investment experience.

“Israel is a fascinating country when it comes to entrepreneurship,” said Tarakci, explaining why the researchers performed their experiment in Israel.

The so-called Start-Up Nation has more high-tech startups per capita than any other country, and has developed groundbreaking technologies that are having an impact around the world: Waze, the navigation app, was snapped up in 2013 by Google for $1.3 billion; Netafim, acquired by Mexico’s Mexichem in 2017, sells its drip irrigation systems globally; and Mobileye, a maker of software and chips for autonomous vehicles, was acquired by Intel for a whopping $15.3 billion also last year.

A net greenhouse in Los Pinos, Mexico, the largest greenhouse tomato project in the country, developed with Israel’s Netafim drip irrigation and greenhouse technology (Courtesy Netafim)

Using the database of Start-Up Nation Central, a nonprofit organization that tracks Israel’s technology industry, the researchers asked coders to manually assess if a startup’s profile did or did not set out a vision for disruption of incumbents and markets.

Each “yes” was accorded a point, while each “no” was assigned a zero value.

The study revealed that when entrepreneurs used disruption as their key pitch, they improved their odds of receiving a first round of funding by 22 percent. However, the funding these same ventures with a disruptive vision raised was 24 percent less than if they had not communicated a disruptive vision.

So pitching disruption can actually cost a typical Israeli startup money — some $87,000 in the seed round, and $361,000 in the series A funding round — the study said.

“If we were all rational, what we call cheap talk — when entrepreneurs hype up their companies — shouldn’t have an impact at all,” explained Tarakci. “Investors should be making their decisions based solely on things like cash flow and company valuations. In reality, human nature is more complicated, especially in an environment of uncertainty, when such factual information about the startups is not available and you don’t know if a startup will make it or not.”

In these cases, he explained, investors rely on what entrepreneurs say. They take into account their past achievements and also what is being said about the company’s future prospects.

“Talk of disruption sets out a glorious vision for the future but also raises a question of whether the entrepreneur can actually get there or not, and how easy the journey will be,” said Tarakci. “So, on the one hand investors want a foot in the door to be able to make extraordinary returns in case the entrepreneur’s vision is right, and that is why they will invest in the self-claimed disruptors.”

But the “enchanting promises” of the entrepreneurs aren’t followed blindly, he said. “In evaluating how much to invest, investors take into account the added risks and uncertainties of early stage ventures that promise the hard-to-achieve outcome of disruption, and they invest just a little bit, keeping the door open to make further investments in the venture in the future, when risks and uncertainties become less.”

So the bottom line on how to pitch your startup depends on needs, explained Tarakci. “If you need a lot of money, don’t talk disruption. But sometimes getting investors — who can open doors, provide networks and mentoring — is more important than getting big amounts of money. In those cases a disruptive narrative is what you need.”