How To Measure The Long-Term Growth Potential Of A Startup

Want to launch a business? Start with a short name. A fondness for intellectual property helps, too. Those are among the factors that two economists at the Massachusetts Institute of Technology say can lead to long-term success for startups.

In an article published Thursday in Science, the duo debuted a tool to break down the long-term growth potential of entrepreneurial ventures into key variables. They studied thriving startups in California and found that they share a few characteristics, including short company names. By paying attention to these variables, cities and development organizations can more easily invest in new businesses with the highest chance of success, according to the authors.

Scott Stern, an economist, and his co-author, Jorge Guzman, a doctoral student, found that firms named after their owner were 70 percent less likely to grow over six years, but that those with a short name were 50 percent more likely to succeed. They also noticed that corporations are six times as likely to take off as unincorporated businesses, and that those with trademarks are five times more likely to achieve success.

Two factors included in the analysis, however, were most indicative of startup growth by far. Firms that held patents were 25 times more likely to grow. California businesses that incorporated in Delaware – to take advantage of the state’s favorable tax and legal policies – enjoyed the same advantage. If a firm had incorporated in Delaware and held patents, its growth potential was 200 times higher than a firm that had done neither.

“They've unearthed some interesting variables from the database they've constructed that haven't been prominent previously as predictors of entrepreneurial quality,” said Ari Ginsberg, an expert in entrepreneurship at New York University.

For their analysis, Stern and Guzman used a database program to rifle through 10 years of California business registration records and files from the U.S. Patent and Trademark Office. They picked characteristics that they thought might be indicative of growth and assigned numerals to them – like a “1” or “0” for whether or not a business had incorporated. Then, the team analyzed these variables to see which matched up most closely with an initial public offering or acquisition within six years – their definition of entrepreneurial success for the purpose of this analysis.

“The database-building efforts are very creative,” Ginsberg said. “The data set they have built to map high-growth outcomes to startup characteristics contains an unusually large sample of observations over a significant period of time.”

So what do their findings mean, exactly? The economists don’t explain why certain variables might be related to startup success, or whether there may be other contributing factors. The firms that incorporated or filed for patents also may be those that are started by the most capable people, for example, or that fall into certain sectors such as technology or medicine whose innovations are in highest demand.

But Stern does say his method might be a useful starting point to building a heat map, so to speak, of likely entrepreneurial success in a given community that is based on the quality of firms rather than quantity. He already has done this for the Bay Area in California and detected some intriguing trends – firms in places like Menlo Park, Mountain View and Palo Alto were 20 times more likely to achieve growth in six years than those in a typical city.

Such clusters should come as no surprise to anyone who’s familiar with the explosion of tech and social media startups in Silicon Valley, but Stern says his methods offer a depth of data on contributors to growth that was not previously available. This degree of granularity may help policymakers and economic development organizations refine their focus and better predict which areas have firms with the highest growth potential. Or they could apply the tool retroactively to gauge which of their investments have panned out.

“Very often, even excellent policymakers who are trying to encourage entrepreneurial ecosystems recognize that their job is to set the table, but that those ventures must do the hard work,” Stern said. “A lot of times, they don't know whether particular initiatives have succeeded or not.” He assists with a regional acceleration program through MIT and says the next phase of the project is to find ways to apply this knowledge.

Of course, targeted investment based only on these variables would raise questions about whether other businesses were left behind. Stern and Guzman’s metrics of success – an IPO or acquisition within six years – are not the same measures by which economists might judge family businesses or local coffee shops, which Stern acknowledges. "It would be useful," NYU's Ginsberg said, "to examine how these startup characteristics influence other kinds of meaningful growth besides reaching an initial public offering or acquisition.”