How do the human resource management practices of small, entrepreneurial firms develop following external financing? Professors Sinéad Monaghan, Martha O’Hagan-Luff and Francesca Di Pietro, Trinity Business School, share their research findings.
With kind acknowledgements to Trinity Business School and AMBA. Originally published under the title Entrepreneurial finance and HR management practices in small firms.
Given their limited resources, we know that small firms draw on funding from external sources to scale-up their growth, improve market positioning and access expertise and support. However, this external financing can also alter the internal dynamics of their organisation in areas such as functional operations, governance or management. One such area which is most susceptible to change is human resource management (HRM) practices. This can be positive, in terms of facilitating talent acquisition, competitiveness and performance, but there can also be significant pressures on small firms to change their growth trajectory and resource configuration.
Different investors, different impact on HR
In our study ‘Entrepreneurial Finance and HRM Practices in Small Firms’ published in the British Journal of Management, we explore HRM practices in the context of Ireland’s most important indigenous sector, Agrifood, in which small, entrepreneurial firms face unique funding challenges. Agrifood firms are encouraged to scale their operations and have access to a number of specialised supports and resources. Nonetheless, many of these firms are also small, family-owned firms operating in niche markets and competing with large international firms. Over a four-month period, we spoke to 34 executives and investors across seven entrepreneurial firms in the Irish agrifood sector and collected additional information from media articles and company websites on the growth and financing of these firms.
Our study recognises that different types of external investors can have a profoundly different effect on firms’ HRM practices, providing important insights for the sector as a whole. Small, entrepreneurial firms approach HRM in light of different time horizons and institutional logics of external investors. Within our study, we explored the influence of six different types of investors on small, entrepreneurial firms: Angel Investors, Private Equity (PE), Venture Capital (VC), Government Venture Capital (GVC) and Corporate Venture Capital (CVC). Investor’s logic – that is material practices, assumptions and values of the firm, in terms of what is perceived as meaningful and appropriate for an organisation – and their investment time horizon prompt changes in the approach to HRM practices within the firm by generating one of three approaches to HRM practices; operational, strategic, and transformational.
Operational approach to HRM
Firms in the early stages of growth who receive funding from angel investors or bank equity tended to adopt an operational approach to their HRM. The short-term investment horizon of angel investors and the early stage of investment is consistent with the relatively underdeveloped nature of the HR function and thus, the need for an operational approach, such as the formalisation of HRM practices to allow for effective staffing and basic training and compensation measures to support their rudimentary or informal HRM systems. However, investors at this stage of the firm tend to have a strong, supportive involvement with the management where they often leverage their own networks to enhance opportunities for expansion, attracting employment or marketing their firm.
Strategic approach to HRM
Firms who receive funding from PE, GVC and CVC investors can access both financial support and expertise around growing the firm. This strategic orientation is also applied to the internal human resources, whereby PE firms facilitate greater growth and development of HRM practices. While existing research shows the potential risks of PE investment to HRM, we find that PE investors advance firm performance and growth through incentivisation schemes and share ownership options, in addition to more direct access to networks of industry experts and talented individuals.
GVC investors tend to have a medium to long term horizon and believe that financial pressure over a shorter period of time can harm the firm’s trajectory, especially in the agrifood business where growth can be slow. Their key role is to provide longer-term funding to small firms, which might not otherwise be available, to plug ‘funding gaps’, and also to support policy of increasing employment and encourage export growth in a key indigenous sector. This logic manifests as a strategic approach to HRM, where they encourage specialised leadership training, expertise in functional growth and networks to emerging firms.
Finally, CVC investors, either had a largely passive involvement with investee companies or enacted major directional change depending on the stake of their investment. Where CVC investor’s investment held a minority stake in a firm, with a medium time horizon, we found that their influence on HRM – and indeed the firm – was strategic and sought to enhance firm value. For example, the small firm could benefit from financial capital, reputation and legitimacy from the corporate partner, while also leveraging their experience and more advanced HRM practices and procedures.
Transformational approach to HRM
For CVC investors who take a majority share in the firm with the intention of a full acquisition, there is evidence of transformational HRM. The CVC enacts major changes post-investment, where the local management is of less importance to a CVC investor than the firm itself. For example, the CEO/founder will often not be expected to remain with the company for a longer period of time after the investment has been made, the mindset and philosophy of employees is altered and the key focus is on initiating the integration of the firm into the overall corporate portfolio. As an established company, they will have operational processes in place and will seek synergies across areas such as finance, HR, marketing and distribution.
Insights for small businesses
The findings from our research provides an insightful reference for small, entrepreneurial firms seeking external financing and shares important information on the different routes of development for HRM practices. While external finance represents an important threshold of growth for a small firm, the institutional logics and time horizon of investors can result in different approaches to the firms’ HRM practices. Our research shows the potential for small, entrepreneurial firms to consider how investment will influence the internal dynamics of their firm and identify ways to maximise the value of their relationship with investors for growth opportunities. Understanding the impact on the internal organisational logic of the firm, via HRM practices, provides a more granular exploration of how external financing affects the growth trajectory of the firm. Our research also has important insights for policy, including greater understanding of the barriers to growth and challenges for small, entrepreneurial firms, including opportunities for a greater breadth of entrepreneurial finance, funding gaps that need to be resolved by government and the relevance of human capital to the financing decision.
Sinéad Monaghan, Martha O’Hagan-Luff and Francesca Di Pietro
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