Failure and entrepreneurship

13 06 2014

Failure is in the heart of businesses and in the back of the mind of everyone who has ever been involved in starting a new venture. Having started myself from scratch, with little understanding of what lies ahead and a lot of good will to make it work, I notoriously failed because I lacked some basic understanding of what makes a firm fail or succeed. It is not only the hard work: you at least need money, network or both. When you have none, things are tough.

As much as starting up is difficult, going on is sometimes even harder. The crisis in the EU has surfaced a lot of problems. Many good companies operating at low margins found themselves on the brink of bankruptcy and many crossed the line. Cash starvation, bad payment terms, debtor months instead of debtor days, have drawn a bleak operating environment. Many good entrepreneurs found out that, in the end, they cannot survive…

But is it cash alone that causes the firm to fail? Of course cash is the blood of the business and the only reason the company would fail – apart from a deliberate decision of the owner – but it is also the stigma of failure that pushes entrepreneurs, especially in the EU, to ignore the early warning signs and delay taking measures. The EU should consider this matter and allow interventions before it is too late. Further, we should allow entrepreneurs to try again and again.

Why SMEs fail

As is the case for all companies, SMEs would ultimately fail because they cannot generate attractive and adequate cash flows for the owners or investors. Failure in this sense does not necessarily mean bankruptcy, as it is possible to maintain a debt-free company that upon dissolution will have the cash to cover its liabilities. Nevertheless, bankruptcy has been and still is a serious problem in the EU especially during the financial and debt crisis. But before reaching the point of bankruptcy or dissolution, there must be significant reasons that led the organisation to such a dire situation such as:

  1. Lack of adequate cash flows
    1. Ineffective financing and undercapitalisation
    2. Inadequate market for the products
  2. Inefficient management
    1. Lack of strategy
    2. Poor management team and structure
    3. Lack of operational capabilities
    4. Ineffective marketing and sales
  3. Inefficiency of owner(s)
    1. Vanity, arrogance
    2. Fear of entrepreneurial risk
    3. Ignorance, incompetence, lack of professionalism

This is not an exhaustive list and certainly one could argue that depending on the point of view, some of these factors are correlated. However, the point is to show that factors leading to a problematic company would relate to the financial and market environment, the lack of resources and capabilities and especially for SMEs the personality and competence of the owners.

The lack of adequate cash flows due to market conditions and lack of access to financing have been cited as the two most pressing problems on SMEs (European Commission, 2011). Access to finance is a key determinant for business start-up, development and growth for SMEs. These have very different needs and face different challenges with regard to financing compared to large enterprises. The latter have ready access to equity capital markets, which are not accessible to the vast majority of small businesses according to the EC. This lack makes SMEs more reliant on bank lending and similar financial products. In order to foster a functioning finance market for SMEs that takes into account their needs and considering the importance of SMEs within the overall economy, over the past two decades the EC has aimed to develop a comprehensive range of financial policies and instruments to support them with the most appropriate sources and types of financing at each stage of their life.

In the EU though, bankruptcy is severely stigmatised and entrepreneurs are not offered a second chance. The Small Business Act (European Commission, 2008) reported that 15% of all company closures are bankruptcies and some 700,000 SMEs are affected on average each year. Further it is reported that 50% of businesses do not survive the first five years of their life and the economic crisis has only increased the vulnerability of start-up companies (European Commission, 2007). In 2009, bankruptcies in the Euro zone grew by 46% and continued to grow another 5% in 2010 (European Commission, 2011). As 2.8 million jobs are involved on annual basis and bankruptcy leaves debts unpaid and destroys capital, honest entrepreneurs should quickly get a second chance (Wymenga et al., 2011).

Enhancing the survival rate of businesses and encouraging entrepreneurs in financial distress to take action early on is crucial to ensuring the stability of the economy (European Commission, 2011). Therefore preventing SMEs from falling into bankruptcy through advice and negotiation assistance is important to keep businesses afloat. Entrepreneurs faced with financial difficulties are reluctant to seek assistance at an early stage due to self-reliance, reinforced by the fear of losing control over their businesses and inability to admit defeat (European Commission, 2011). Also quick bankruptcy procedures in order to receive a second chance are pivotal to the mitigation of the bankruptcy consequences.

Although only 4-6% of bankruptcies are fraudulent, public opinion in the EU makes a strong link between business failure and fraud. There is a contrast between this and the fact that 81% believes that people that started their own businesses and failed should be given a second chance (European Commission, 2009) (Figure 7). This again should be contrasted to the 46% that believes that one should not start a business if there is a risk it might fail.

These perceptions of failure lead entrepreneurs in distress to not seek early enough advice and financial support in order to enable a recovery strategy. They also make people afraid of the consequences of a (likely) failure of a start-up due to the stigmatisation. This view on failure is in stark contrast to the view in the US where failure is often seen as a valuable lesson. Apart from creating a favourable environment for entrepreneurship, the EU should also try to make sure the existing stock of entrepreneurs can stay in the game.

Barriers to entrepreneurship

Figure 7: Barriers to entrepreneurship (European Commission, 2009).

 

As a bottom line, Europeans need to accept and embrace risk. We need to move away from the idea that a failed entrepreneur is worthless and incompetent. In times of crises, it is this fear that reinforces failure.

Works Cited

[1] European Commission, “SMEs Access To Finance,” European Commision, Analytical Report 2011.
[2] European Commission, “”Think Small First” a “Small Business Act” for Europe,” Brussels, Communication 2008.
[3] European Commission, “Overcoming the stigma of business failure – for a second chance policy,” Brussels, Communication 2007.
[4] European Commission, “A Second Chance for Entrepreneurs,” Brussels, 2011.
[5] Paul Wymenga, Viera Spanikova, James Derbyshire, and A. Barker, “Are EU SMEs recovering from the crisis? Annual Report on EU SMEs 2010/2011,” ECORYS, 2011.
[6] European Commission, “Review of the “Small Business Act” for Europe,” Brussels, Communication 2011.
[7] European Commission, “Entrepreneurship in the EU and Beyond,” Flash Eurobarometer 2009.

 

 

 

 

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