A strong business plan is most important when investing in start-ups

When making investments, investors look for start-ups that have a strong business plan and a strong management team. A new study in The Journal of Finance reveals that while strong management is important, ultimately a strong business idea matters most to investors. Steven N. Kaplan, Berk A. Sensoy, and Per Stromberg studied two samples of start-ups. The first sample consisted of 50 start-ups that went public in an initial public offering for which there was a very early business plan. The second sample included all start-ups that went public in 2004.

In both samples, researchers found that very few successful start-ups change their business direction. At the same time, many start-ups change management. Ultimately, a bad management team does not necessarily kill a good idea, but a bad idea is rarely overcome by a good management team. On the margin, investors and entrepreneurs should spend more time making sure the business idea is solid.

At the same time, this result does not mean that good management does not matter. Strong management is valuable and important. However, poor management is much more likely to be fixed by new management than a poor idea is likely to be fixed by a new idea.

"Our findings are useful for investors, particularly venture capitalists," the authors conclude. "Results indicate that you should invest in great business ideas. If the founders or management are not getting the job done, be ready to replace them quickly."

Source: Wiley-Blackwell