The calculus doesn’t make sense. Every year investors pour billions of dollars into U.S. startups in the hopes of striking it rich on the next Facebook. But the odds of hitting pay dirt are exceedingly low.
So why take that risk?
It’s a question that captivates Shai Bernstein, a faculty fellow at the Stanford Institute for Economic Policy Research and an associate professor of finance at the university’s Graduate School of Business.
“The fact that ideas, some of them may seem completely implausible, get funded at all is both fascinating and difficult to explain,” he says.
Now, thanks in part to the availability of fresh sources of data in the digital age, Bernstein is finding answers — not just to mystery of long-shot gambles on unproven ideas, but also to a host of unknowns surrounding the flow of money in business innovation.
Through his research, Bernstein has explored how investors in the earliest stages of a company’s life pick their bets. They look first to the identities of the team behind the new business, before evaluating the idea itself or the names of other current investors.
That discovery is hugely significant, and reflective of how quickly data is changing the game for researchers like Bernstein. Until recently, it was impossible to measure interactions between investors and young companies. Now there are online platforms like AngelList, which matches startups with potential investors and was willing to conduct experiments with Bernstein and his fellow researchers.
Bernstein has also used data in novel ways to challenge popular ideas about the financial world. It’s long been a matter of considerable debate, for example, as to whether venture capitalists add value to young companies beyond their pocketbooks. By rigorously analyzing data on patent filings and direct airline flights between a VC hub and the location of a startup, Bernstein and his peers offer strong evidence that the amount of face time investors spend with their portfolio companies increases the odds of an IPO or acquisition.
In other research, Bernstein has shown that private equity buyouts aren’t the bum deals they may be thought to be, but instead add value and improve firm operations. He’s also revealed that the methods companies use to innovate change once they go public. He’s looked, too, at the dark side of the financing equation: when a company files for bankruptcy, forcing it to liquidate can have far more harmful effects on jobs, local real estate and nearby businesses than if the company were allowed to reorganize and benefit from a second chance.
“It’s phenomenal,” says Bernstein, “what we can do today that wasn’t possible even five years ago because of the extraordinary availability of new data.”
Overcoming Barriers to Entrepreneurship
Bernstein’s fascination with the flow of money in business, and to startups specifically, dates to the late 1990s, when he joined the Israeli army.
“That’s when I became curious about technology,” says Bernstein, adding that his foray into tech wasn’t by choice. “The army in Israel has a privilege that Google and Facebook don’t have. They select whoever they want and you go — no bargaining over salary or negotiating whatsoever.”
It was at the height of the dot-com boom, when many of his fellows became entrepreneurs after their tours of duty ended. His own exit timed perfectly with the bursting of the Internet bubble and Bernstein watched as the flow of investor money dried up overnight.
“I was struck by the suddenness of it all and how devastating it was,” recalls Bernstein, then just 22 years old.
Bernstein had long harbored an interest in academia and the freedom it allowed to “ask questions and have complete autonomy.” After a brief stint writing code for an Israeli tech company, followed by a 6-month backpacking hiatus in South America, Bernstein earned a BA in math and economics at Ben Gurion University and then an MA in financial economics from Hebrew University of Jerusalem. Shortly after graduating from Harvard with a PhD in business economics in 2012, Bernstein joined Stanford’s business school faculty.
Along the way, Bernstein discovered a passion for understanding how businesses behave, especially as that behavior relates to finances. But while many like-minded peers were focused at the time on the roots of the global financial crisis in 2008, Bernstein was preoccupied with the earlier dot-com bust.
“I kept going back to the experiences of my friends during the bursting of the Internet bubble and the sudden disappearance of sources of capital to companies,” says Bernstein.
That fixation drives his research into entrepreneurial finance, where Bernstein is now looking at the impact the financial crisis had on business innovation. He’s also in the early stages of a study that relies on Brazilian government data on employers and employees to answer what might be the Holy Grail of government economic policies: Who is most likely to become an entrepreneur, especially when economic opportunities arise?
“Entrepreneurship is an important phenomena and finance can be a significant bottleneck,” says Bernstein. “Understanding the intersection of the world of finance and the world of innovation is both interesting and non-trivial.”