Social capital and small-firm Entrepreneurs

MBA HR ProfessionalsWhat does “social capital” mean?

Social capital is the expected collective or economic benefits derived from the preferential treatment and cooperation between individuals and groups. Although different social sciences emphasize different aspects of social capital, they tend to share the core idea “that social have value”.

The term capital is used by analogy with other forms of economic capital, as social capital is argued to have similar (although less measurable) benefits. However, the analogy with capital is misleading to the extent that, unlike traditional forms of capital, social capital is not depleted by use;[50] in fact it is depleted by non-use (use it or lose it). In this respect, it is similar to the now well-established economic concept of human capital.

Social Capitalism

Social capital is also distinguished from the economic theory social capitalism. Social capitalism as a theory challenges the idea that socialism and capitalism are mutually exclusive. Social capitalism posits that a strong social support network for the poor enhances capital output. By decreasing poverty, capital market participation is enlarged.

Relation with Entrepreneurial Success

A growing number of studies is finding that social capital can contribute to entrepreneurial success. Pull apart the data, though, and some of the results seem to contradict each other. So does social capital help? And what kind, and in what circumstances?

Wouter Stam, Souren Arzlanian and Tom Elfring tackled these questions by doing a “meta-analysis” of 61 independent samples that looked at the social capital-performance link in the small firm context. They found overall solid support for the performance benefits of entrepreneurs’ social capital, but also teased out the kinds of network relationships that were most effective in different circumstances.MBA Graduates

“Social capital is embedded in the personal networks of entrepreneurs – those of family members, friends and business contacts. These ties are critical to the development of small firms,” they said.

A closed network generates trust and social support from members

“Compared to executives in large firms, entrepreneurs in small firms are more directly involved in daily firm operations, they have greater discretion in decision-making, and they more frequently perform key boundary-spanning roles. Their social capital may thus importantly influence small firm performance.”

Relationship between types of capital

The following stylized model illustrates the relationship between the three capitals.

Relationship between types of capital

Key Types of Social Capital

They considered three key types of social capital – strength of ties, gaps in networks, and network diversity– and aligned these with conditions that might moderate the effects of social capital – whether a firm was young or old, low- or high-tech, or in an emerging or established economy.

The strength of ties concerns the frequency and closeness of interactions with others and they can offer interesting trade-offs. Strong ties increase the willingness and ability of network contacts to provide needed resources, but they also require a lot of effort to maintain. Weak ties, on the other hand, provide access to more novel information because they are more likely to connect the entrepreneur to people from distant social circles.

Structural Holes

Gaps in networks, or “structural holes”, are the lack of direct relations between the entrepreneur’s contacts. This provides an opportunity for the entrepreneur to bridge ties between otherwise unconnected others, and increase access to resources. In contrast, a closed network generates trust and social support from members.

Diversity rather obviously refers to the extent to which an entrepreneur is connected to a wide range of individuals and organizations located in different positions or industries.

Overall, the study confirmed that social capital creates value for small firms. “The observed effect sizes are comparable to those for personality traits and substantially greater than the impact of human capital on performance,” the authors found. In particular, “weak ties, structural holes and network diversity were all positively related to performance.”

However, not all types of social capital had the same performance implications. Weak ties had a significantly smaller impact on performance than structural holes, while neither was as significant as network diversity. It thus appears that small firms benefit most when entrepreneurs form sparse networks to a wide range of actors, which offer greater opportunities to access and recombine diverse resources.

The authors also found that the optimal type of social capital varied across different types of small firms. New firms benefited more from networks with structural holes and weak ties, while older firms performed better when ties are dense and strong. Structural holes and network diversity were also more advantageous in high-tech industries than in low-tech ones. And weak ties and network diversity yielded stronger effects in established economies, whereas strong ties mattered more in emerging economies.

Relation with Investors

The start-up community of investors and their associates tends to be characterized by cohesive networks for several reasons. New ventures are highly risky and network cohesion mitigates risk because it signals reputation. For example, an entrepreneur is more likely to successfully get the attention of investors if they make contact with the investor through a trusted referral such as a well known attorney specializing in start-up law, your professors at IBS, help from staff at the IBS Centre, your membership in the Council for Entrepreneurial Development, among others. Cold calls and emailing your business plan are highly unlikely to result in making a successful contact in the venturing community either with Angels or venture capitalists. Under conditions of high cohesion in the investor community, one way for an entrepreneur to mitigate investor cohesion in brokering terms and conditions is to seek term sheets from geographically different regions such as Research Triangle Park (RTP) and Silicon Valley (SV). While cross region syndications are becoming more common, in theory regional differences in all likelihood will dampen the probability of network cohesion. However, such brokering strategies may result in relocating as investors typically require geographically local control.

“For entrepreneurs, the results clearly indicate the importance of cultivating personal networks rich in bridging social capital, but also reveal that distinct networking strategies are needed at different points in time and different industries and countries.

Contributed by Suchin Kulshrestha, (Class of 2008, IBS Hyderabad)

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