Generalists vs. Specialists

Prior research has shown that individuals working at small firms are more likely to become entrepreneurs, but do the skills acquired at a small firm also lead to more successful entrepreneurs?

While tales of successful entrepreneurs emerging from college dorms captured the popular imagination during the 1990s dot-com boom, the vast majority of entrepreneurs enter into entrepreneurship from employment in established firms.

In the study “Do Small Firms Produce Better Entrepreneurs?” University of Chicago Graduate School of Business professor Damon J. Phillips and Jesper B. Sørensen of the Sloan School of Management at MIT examine the relationship between the size of an entrepreneur’s prior employer and the success of the entrepreneur’s new venture.

Using a unique dataset which characterizes the entire Danish labor market, Phillips and Sørensen’s study is the first to systematically examine the relationship between the size of an entrepreneur’s prior employer and entrepreneurial success. They find that entrepreneurs coming from small firms have better initial performance than entrepreneurs coming from large firms.

The authors argue that for an entrepreneurial-minded person, the advantages of working for a small firm, on average, outweigh any advantages associated with working for a large firm. “Do not underestimate the set of skills that you will acquire by working for a small company if you plan on starting your own company one day,” says Phillips.

Breadth and Depth

According to Phillips and Sørensen, there are at least two ways in which the size of the company an entrepreneur previously worked for may affect the success of a new venture: 1) the size of a prior employer may affect a potential entrepreneur’s ability to recognize viable opportunities, and 2) a potential entrepreneur’s ability to execute the tasks associated with running a new business may vary depending on the size of a prior employer.

Given the same quality of idea, some entrepreneurs are better able to assemble resources, implement the appropriate organizational structure, and manage internal and external groups. Prior employment experience can be an important source of such skills.

Phillips and Sørensen study organizational size because they believe it has a number of relevant implications for an employee’s potential success as an entrepreneur.

“ The practices of your previous employer provide important models for a new venture, serving as organizational blueprints,” says Phillips.

The organizational routines of large established firms are less likely to be appropriate models for fledgling ventures than the models that might be gleaned from small firms.

Phillips and Sørensen are careful to give attention to the alternative argument, that entrepreneurs emerging from large firms may be more successful.

A large bureaucratic firm may be less agile and less likely to pursue valuable entrepreneurial opportunities, even when ideas for these ventures come from within the large firm. In addition, the opportunity cost of entrepreneurship may be greater for employees of large firms, which are more likely to offer higher wages and opportunities for internal promotion. Therefore, employees of large firms may be more selective about potential entrepreneurship opportunities.

According to this line of reasoning, individuals who choose to leave large firms do so to take advantage of more valuable opportunities than those who leave small firms, and therefore should be more likely to succeed. Holding constant differences in ability, this approach suggests that entrepreneurs from large firms should be more likely to succeed in new ventures. Since it is difficult to separately identify the value of the entrepreneurship opportunity and the level of the individual’s skills, the net effect of entrepreneurial success based on the prior employer’s size will depend on the balance of the two factors.

For example, employees of large firms generally may be pursuing more promising opportunities than employees of small firms, but have fewer entrepreneurial skills. The routines that employees learn in large, established firms typically are oriented toward taking advantage of what the company already does well, rather than toward exploring new possibilities. New ventures typically need to experiment to find their recipe for success, which puts employees from large firms at a disadvantage.

Larger organizations also tend to have more narrowly defined jobs with less worker autonomy. Employees of large firms have fewer opportunities to develop skills that meaningfully affect the strategic direction of a firm. As a result, the average worker in a large firm has less of an overview of the organization’s vital routines and how they fit together and is not provided with the skills for integrating the large firm’s differentiated skills. These characteristics of jobs in large firms suggest that most employees of large firms will be less likely to have the appropriate skills for entrepreneurial success.

In contrast, experience working for small firms has many advantages. By virtue of the small size and less formal division of labor, employees of small firms are more likely to acquire the breadth of skills and outlook necessary for entrepreneurial success. There also is evidence that small organizations offer more opportunities for employees to upgrade their skills. Thus, to the extent that employees of small firms are more likely to be asked to perform a variety of tasks, they should be more successful when they become entrepreneurs.

“In a small company,” notes Phillips, “you may work on marketing, but you also need to know how to lead and manage others, how to deal with crises, and how to deal with partnerships and suppliers.”

Individuals are more likely to transition into entrepreneurship and succeed if they can integrate a wide range of skills. Skill generalists are more suited to be entrepreneurs, while skill specialists are better suited to be employees.

Tracking Entrepreneurs

The authors used data from Denmark’s Integrated Database for Labor Market Research (IDA). Included in the data are links between employers and employees and a wealth of demographic and labor market information for the Danish population. IDA data is similar to data from the U.S. Internal Revenue Service, as it includes information on employment status, income, and tax revenue.

Phillips and Sørensen analyzed all individuals who left employment in 1994 and were self-employed in 1995. The authors used two performance measures: exit from self-employment in the first year (the failure of the new venture) and self-employment income. For all individuals who entered self-employment in 1995, the authors examined whether they were still self-employed in 1996. The authors took into account the firm size of the previous employer. They also looked at the self-employment income in the first year of self-employment (1995) compared to income from the previous year. They controlled for variables including industry sector, occupation, education, demographic characteristics, wealth, prior income, and tenure with the prior employer.

The authors find that the size of the prior employer has a statistically significant effect on the rate of exit from self-employment in the first year. Their estimates also show that the self-employment income of entrepreneurs coming from larger firms is lower than entrepreneurs coming from smaller firms.

Consistent with their argument, Phillips notes that their findings are strongest for people who leave a company within a given industry and start a new company within the same industry. In contrast to entrepreneurs who found a firm in an industry different from where they previously worked, entrepreneurs founding a firm within the same industry are those for whom the skills and routines of the previous employer should be most relevant.

Long-Term Strategies

“Our results can be attributed to what people learn when working for their past employer, specifically the range of skills,” says Phillips. “The applicability of that skill set seems to be very important for success as an entrepreneur.”

Phillips and Sørensen note that there are alternate explanations that could be tested in their study: if large employers provide exposure to better ideas, entrepreneurs from large firms may have higher failure rates but possess higher income as the few good ideas result in high returns. However, the results suggest that the advantages derived from smaller employers are substantially and consistently more valuable. Moreover, the consistent effect for both indicators of success underscores the significance of the results.

The authors hope that putting a magnifying glass on entrepreneurs and their experiences will help individuals understand how their experience affects their interest in becoming entrepreneurs. For example, there are many institutions trying to facilitate innovation and entrepreneurship. Phillips suggests that such institutions should consider how they can help out a potential entrepreneur from a small firm versus a large firm, and adjust their strategies based on the differences of firm size.

For business school students, Phillips points out: “Over the years, I’ve had conversations with students who eventually want to become entrepreneurs, who are trying to decide whether to work for a large company or a small company. If you have a good idea, our evidence suggests that working for a small firm can help you acquire the execution skills you will need.”