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The effect of business failure

A business disaster!

The effect of business failure

In my last blog I looked at the attitude of VCs towards entrepreneurs who had experienced business failure. In this blog, the effect of business failure, I would like to consider how business failure effects business owners themselves.

Attitudes towards failure

If we believe some gurus who pontificate on the subject, business failure is not a failure at all. It is a form of success from which business owners learn vital business and life affirming truths.  They say “It only makes you stronger” – and believe entrepreneurs are all the better for it!

Business owners should, therefore, have no fear of failure and can expect to rise up stronger and better for the experience. Is this true in the real world, or are these just platitudes?

Different types of owners

I don’t think it is possible to arrive at a simple answer to the question that applies to all business owners. Business owners come in all shapes and sizes. Consequently, and one would expect them to have different reactions to failure.

I hope the following hypothetical stories about two very different business owners will illustrate my point.

Owner No 1

The first hypothetical owner is a 22-year old computer programmer who considers herself to be a modern high-tech entrepreneur. She has launched a startup with VC funding aiming at the teenage market. None of own money has gone into the venture, largely because she has none. Her business is a website, which she herself has built. She is single with no dependents and she lives in a big city. She does not own a house and has put up no security for the funding secured.

The VCs who have funded her consider her to be extremely bright with a good understanding of the market she is aiming at. However, they installed a financial manger to oversee the growth of the business, retaining our entrepreneur in a senior technical and marketing role.  She has 40% of the shares in the business.

Owner 2

The second owner is a 50-year old married man with two teenage children. His is a traditional engineering business, which he owns all of. He started thirty years ago with a loan from a high street bank. The loan is secured over the owner’s home.

The business has made losses over the last six years. To fund the losses the owner has used an ever-increasing overdraft facility from the bank, secured by second mortgage over his home. The bank also has a fixed and floating charge over the business assets.

The owner lives in a provincial town, where his children are at a fee-paying school. He is well known in his local community.  He drives a smart car (on lease) and some in the community resent (and are jealous of) his apparent success.

The businesses fail

Let us assume that, despite their differences, both our businesses fail. What do you suspect will be the effect on our two owners?

I suggest the following is a reasonable assumption of the outcomes:

The high-tech startup

After two years trading the VCs decide that although the business appeared promising, its business model is fatally flawed. They decide not to advance further funding. The business is liquidated with the VCs suffering losses of £200,000. Some unsecured creditors also lose money.

The young entrepreneur is bitterly disappointed that “her baby” has been closed down. Naturally, she feels a sense of loss. Her pride is wounded and she feels some mild embarrassment among her immediate circle of close friends. But, the business was being run by a professional manger, so, perhaps, it wasn’t really her fault. She does not know the unsecured creditors personally and feels that their loss is just the risk of doing business. Consequently, she loses no sleep over them.

Although she is out of a job, she has suffered no capital loss and has sufficient savings to live without an income for a while. On the positive side, she has two or three other ideas for start-ups brewing. The VCs have expressed initial interest in these ventures. She has also had an offer of work from a computer programming company.

After a month or so she starts to regain her confidence and continues to mix freely with her friends and business associates. Her life has not changed. Her confidence and sense of well-being is boosted further by what she reads about failure being merely a steppingstone to success, etc., and from the support of her business colleagues. She accepts what has happened to her with equanimity. She has always considered herself to be a modern high-tech entrepreneur. After all, isn’t what has happened to her the same as what has happened to many other successful entrepreneurs? She feels confident her next business will be bigger and better and can’t wait to launch her next startup.  

The engineering business

Inevitably, the lender bank becomes increasingly nervous about its outstanding loans. Following several unsuccessful attempts to find alternative funding, the owner is advised that he will be breaking the law if he continues trading and he instructs his accountant to call in a liquidator.

The bank replaces the liquidator with its own Receiver. The business is wound up. The Receiver, under power of the bank’s mortgages and charges, sells the family home and all the business’s assets. There is a substantial shortfall for unsecured creditors.

The family moves to rented accommodation. The business owner considers bankruptcy. His children are moved from their fee-paying school.  The business owner’s marriage comes under severe strain and he separates from his wife.  

He doesn’t read internet articles about the positives of business failure. Consequently, he feels ashamed of the failure of the business for which he blames himself. He is embarrassed about the losses of his creditors, many of whom he knows personally. As a result, he doesn’t mix as freely in his local community or with his friends (most of whom are business-related) as he had done in the past. 

His doctor diagnoses him with depression. He believes he will never be able to regain his former social or financial position.  One of his main concerns is that he is too old to get a job. In short, he is stranded in no man’s land.

What are the effects of business failure?

Yes, business failure can be a positive for some business owners. But it can also be a life-shattering disaster for many others. It is obvious that our hypothetical business owners will be affected in very different ways by the failure of their particular businesses.

So, what do you think are the effects of business failure? Do you think the outcome is dependent on who you are and the circumstances of your life and business? Can we generalise about the effects? Or do you think it is always negative for the owners? Are you convinced by gurus who romanticise the effects of failure?

Or is this a cultural issue, different in, say, the US than it is in the UK?

Next blog

In my next blog I will continue with the theme of business failure and look at how different countries consider it.

Further reading

See also:https://www.freeforumofideas.com/blog/attitudes-towards-business-failure/

And: https://www.freeforumofideas.com/blog/how-countries-view-business-failure/

You could also refer to FAQ 3.37:  https://www.freeforumofideas.com/faq/37-what-is-the-survival-rate-of-small-businesses/

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Attitudes towards business failure

An extreme reaction to business failure

Attitudes towards business failure

Recently I came across this quote:  

“It is obvious why some entrepreneurs in the UK aren’t prepared to take risks.  When they are successful…people hate them, and when they fail … people hate them’.

It got me thinking about the different attitudes towards business failure, particularly the differences between the US and the UK.   It seems to be accepted in most business circles that the UK has a much less tolerant attitude towards business failure than the US. I wondered though whether this was true, or just an assumption loosely arrived at. I wondered also whether there was recent research on the topic.   

Acknowledgement

Pursuing my thoughts I found the research paper Attitudes of Venture Capital Investors Towards Entrepreneurs with Previous Business Failure by Jason Cope, Frank Cave and Sue Eccles.(Lancaster University Management School Working Paper 2004). A lot of what I say here is based on this paper and I would like to acknowledge my use of their material.  I will refer to this research as the “LUMSWP”.

Personal and external

Business failures affect those who fail personally, as well as the attitudes of outside parties towards those who fail. These attitudes are, of course, interconnected. In a country where entrepreneurs feel ashamed of their business failures, their contemporaries’ attitude towards them are also likely to be negative. It seems these attitudes are deeply cultural. Although there is evidence of recent changes in attitudes in some countries, national generalisations still seem to hold true.

However, in this blog I will leave aside the more personal attitudes towards business failure among the population at large. I look instead at how professional investors (VCs) consider the previous failures of those entrepreneurs who seek finance from them.  

Investors’ response

It’s common sense to believe that the response of VCs to start-up funding applications will be based not only on the perceived viability of the business idea and plan, but also on how the VCs feel about the persons promoting the idea (the entrepreneurs). So how is this response affected by the fact that the entrepreneur has had a previous business failure? This is important because many start-ups are promoted by entrepreneurs who have, in fact, failed in previous business ventures. The LUMSWP focuses on this question.

Business failure rates

About 65% of small business start-ups fail in the first three years. This figure is true for both the UK and the US.

VC investment start-ups are thought to have a better chance of success. Here only 40 % of their investments fail in the first three years.

VCs believe the major cause of failure is bad management and management’s inability to understand the size and accessibility of the marketplace. In contrast, where VCs were personally involved in the management, failure was primarily attributed by those VCs to external causes. This included such things as the level of competition and changing market dynamics.

Previous writing 

The LUMSWP looked at previous writing and research on this subject. It considered the belief of previous writers that VCs considered any failure of the company was a personal failure of the entrepreneur. Also, where there was personal failure, whether VCs would back an entrepreneur or venture team that had an uninspiring track record.

George Deriot, a well-known figure in the US VC industry, took a negative view. He said: “A grade-A man with a grade-B idea is better than a grade-B man with a grade-A idea.”

The LUMSWP examines whether these beliefs were true. It says: “Such findings have major significance in terms of the present study and will be explored subsequently in relation to the research findings.”

Attitude generally towards failure

The LUMSWP interviewed two dozen venture capitalists in the US and the UK. Their views were not always totally consistent. On the question of VCs’ attitude generally towards business failure it has this to say:

“On the whole, it appears that the decision to invest in an entrepreneur is not negatively affected to any significant degree by a previous experience of failure. A number of factors shape the decision to invest. Many of these can prove more important than the recognition that the entrepreneur has failed in the past.”

The LUMSWP quotes various VCs’ views on this matter as follows:

“If the business is sound, and the technology is sound in our view, we would pick someone who has been round the loop before, given that they had a sensible reason for the failure.”

“With entrepreneurs I think people are more inclined to bet on people who don’t have proof one way or another about whether they can be winners. I think that they are more concerned about the quality of the idea than they are the quality of the management of the entrepreneur.”

“I wouldn’t hold a failure against somebody. Investing in an entrepreneur who has experienced failure as opposed to a new starter depends entirely on the concept”

Having start-up experience

On having previous start-up experience, the LUMSWP has this to say:

“An interesting issue to emerge from the data is that previous start-up experience, either good or bad, is an important aspect of VC investment. An entrepreneur’s experience with previous start-up ventures and new ventures should not be neglected as a source of advantage.”

It quotes a VC as saying:

“Personally, I would prefer to back a failed entrepreneur, subject to seeing what the failure was, rather than a new starter.”

And another:

“In many respects, failure is a positive experience. Failures are not necessarily bad, because they teach you things.”

“What is apparent from these comments” says JUMSWP “is that VCs are often interested in entrepreneurs who have a range of experiences, rather than merely investing in people who have a history of success.”

Differences between the US and the UK

On the question of the general cultural differences in attitude towards business failure between the US and the UK , the LUMSWP says: “The US is more sympathetic and supportive of entrepreneurs and entrepreneurial activity in general, and this is reflected in a more tolerant attitude towards failure.”

One of the specific reasons for this difference according to the LUMSWP is the concept of “churning management”. This idea is that entrepreneurs will quickly pass on managerial control of the business to someone more qualified for this role. This idea is prevalent in the US. To quote LUMSWP:

“In highlighting potential distinctions between the UK and the US in terms of VC investment, Mark (a US VC) describes a key difference between the two countries, namely the concept of churning management.

“(In the US) … it is very rare that we would actually have a conversation here in Silicon Valley where the founders say, “oh, I am going to take this company public”. It is much more normal for him to say “I will take this to this stage. And then I will recruit somebody to take it to the next stage and then we will recruit somebody to take it public.”

In the UK this idea of “giving up one’s baby” is not so common.

Entrepreneurs’ attitude towards their own failure

An important factor in determining how VCs view business failure is the their attitude towards their own failure.

To quote the LUMSWP:

“Simon (a US VC) confirms the need for VCs to adopt a positive, healthy attitude to failure. ‘So, if you don’t talk about it and you don’t have a healthy attitude towards it, there is always this kind of underlying dynamic going on, but you are just avoiding the real key issues.”

A related issue that VCs feel is important is the ability of entrepreneurs to be honest about their failure. For example, they need to recognise that they entered the market at the wrong time.

Matthew (a UK VC) says: “There was some reason why the business idea was flawed and they need to admit that they just got it wrong. Perhaps, they got in at the wrong time. If it wasn’t an error of execution specifically, then I would rather go through the transaction with someone like that’.”

Conclusions of the LUMSWP research paper

The conclusions of the LUMSWP’s findings are as follows:

  1. Contrary to many previous studies, the entrepreneur is not necessarily the most important factor in the VC’s decision-making process. This is true even when considering proposals from entrepreneurs who have previously experienced failure.
  2.  The quality of the concept or opportunity is paramount. A primary reason being that any perceived weaknesses in the entrepreneur can be supplemented. This will usually be by the introduction of an experienced CEO and/or senior management team.
  3.  Entrepreneurs need to be able to provide a sensible and coherent reason for the failure. If they recognise their own limitations and are willing to ‘stand aside’ if necessary, then the ability to receive future VC support is not jeopardised to any significant extent.
  4.  VCs do not always perceive entrepreneurs to be the primary cause of venture failure. This finding is contrary to several previous studies on the subject.
  5.  The majority of the VCs adopt a tolerant, flexible and open-minded attitude to entrepreneurs who have experienced failure. The VCs are keen to understand the circumstances in which the failure occurred.
  6.  VC’s decision to invest in an entrepreneur is not negatively affected to any significant degree by a previous experience of failure. Other influential factors, such as a high-quality concept, can offset this aspect of their track record.
  7.  However, if an entrepreneur has experienced multiple failures and very little success then this seriously brings into question the entrepreneur’s abilities and the viability of their proposal.
  8. Attitudes of VCs towards previous business failure in the US and the UK do not diverge greatly.

Important research  

The LUMSWP is obviously very important and interesting research. It refutes the widely held view that major differences exist between US and UK attitudes towards business failure. This is particularly true of the attitude of professional investors. It also shows that in both countries many factors are considered when investors make their start-up funding decisions. Interestingly, previous failure of the promoting entrepreneur is usually not a major one.   

In my next blog I will look at the more personal aspects of business failure. Namely, how business failure is considered by the community at large in different countries and how these attitudes affect business owners.  

Further reading

See also: https://www.freeforumofideas.com/blog/the-effect-of-business-failure/

and: https://www.freeforumofideas.com/blog/how-countries-view-business-failure/

You could also refer to FAQ 3.37:  https://www.freeforumofideas.com/faq/37-what-is-the-survival-rate-of-small-businesses/