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Nov 18Doug Smith

Why Companies Fail, and How Their Founders Can Bounce Back

Nov 18Doug Smith
Boy In Superman Pose In Midair

Starting a new business is inherently risky. Some are successful, but many fail. Even among my B2B CFO clients (companies ranging in age from startup to 50 years), some may not make it in the long term. I took heart, therefore, when I read a recent post in the HBS Working Knowledge Blog about the positive effects that business failures can have on founders’ future prospects:

“Most companies fail. It’s an unsettling fact for bright-eyed entrepreneurs, but old news to start-up veterans. But here’s the good news: Experienced entrepreneurs know that running a company that eventually fails can actually help a career, but only if the executives are willing to view failure as a potential for improvement.

The statistics are disheartening no matter how an entrepreneur defines failure. If failure means liquidating all assets, with investors losing most or all the money they put into the company, then the failure rate for start-ups is 30 to 40 percent, according to Shikhar Ghosh, a senior lecturer at Harvard Business School who has held top executive positions at some eight technology-based start-ups. If failure refers to failing to see the projected return on investment, then the failure rate is 70 to 80 percent. And if failure is defined as declaring a projection and then falling short of meeting it, then the failure rate is a whopping 90 to 95 percent.

“Very few companies achieve their initial projections,” says Ghosh. “Failure is the norm.”

WHY START-UPS FAIL

Start-ups often fail because founders and investors neglect to look before they leap, surging forward with plans without taking the time to realize that the base assumption of the business plan is wrong. They believe they can predict the future, rather than try to create a future with their customers. Entrepreneurs tend to be single-minded with their strategies—wanting the venture to be all about the technology or all about the sales, without taking time to form a balanced plan.

“And all too often, they do not give themselves wiggle room to pivot midstream if the initial idea doesn’t jibe with customer demand.

“Instead of going into the venture with a broad hypothesis, they commit in ways that don’t allow them to change,” Ghosh says. He cites as an example the failed dot-com-era grocer Webvan, which bought warehouses all over the United States before realizing that there was not enough customer demand for its grocery delivery service.

Next, there’s the matter of timing, a huge issue that can determine whether a company gets funding and whether it achieves the start-up’s elusive measure of success: an exit that involves going public or getting bought.

During the Internet boom, companies armed with nothing more than a PowerPoint presentation of a lousy idea could secure tens of millions of dollars—which sometimes gave them enough time to figure out a viable business plan through trial and error. Eventually successful companies such as Netscape and Open Market went through several business models before finding one that worked. But the opposite was true after the boom; a company could have a great idea and a great team, but still fail to achieve traction due to lack of funding and, consequently, lack of time to let a good model mature. (These days, Ghosh says, start-ups often manage to secure a good team and good financing, they face dozens of lower-cost competitors and fragmented customer demand.)

Funding has the potential to turn a little failure into an enormous one.

“The predominant cause of big failures versus small failures is too much funding,” Ghosh says. “What funding does is cover up all the problems that a company has. It covers up all the mistakes, it enables the company and management to focus on things that aren’t important to the company’s success and ignore the things that are important. This lets management rationalize away the proverbial problem of the dogs not eating the dog food. When you don’t have money you reformulate the dog food so that the dogs will eat it. When you have a lot of money you can afford to argue that the dogs should like the dog food because it is nutritious.”

ENTERPRISE FAILURE CAN BE AN ASSET, BUT PERSONAL FAILURE IS RUINOUS

Still, stubborn entrepreneurs continue to found companies, in spite of the failure rates, which raises the question of why. It’s not as if any of them harbored childhood dreams of launching a search engine optimization software firm.

Sometimes this is due to naïveté and hubris—the notion that their idea simply cannot fail. But savvy entrepreneurs know that running a company that eventually fails can actually help a career. Even failed businesses yield future networking opportunities with venture capitalists and relationships with other entrepreneurs whose companies are succeeding. Ghosh says boards of successful companies often seek out the founders and CEOs of failed companies because they value experience over a clean slate. After all, Henry Ford, Steve Jobs, and Desh Deshpande experienced multiple failures before achieving success.

“How many search engines are out there that really matter now?” Ghosh says. “Just a handful! And yet the people who created all the other ones in the 1990s are not living under a bridge somewhere. Many of them now run the big ones. In Silicon Valley, the fact that your enterprise has failed can actually be a badge of honor.”

Individual failures within a company can be an asset, too, in that they can prevent the whole system from failing—but only if the executives are willing to view failure as a potential for improvement. For instance, if the company’s best salesperson is unable to sign a key customer, then the management is likely to chastise the salesperson for failing. But they could also realize that if the top talent has trouble with the sell, then maybe there is something wrong with the product. Small failures can provide the raw material for improvement.

“The more that you can embrace all the little failures you have, and treat them as ways of improving the system, the less likely that the entire system will collapse,” Ghosh counsels.

That said, Ghosh warns entrepreneurs that failure of an enterprise, product, or initiative and the personal failure of an individual executive are two very different things. While the former is a learning experience that can lead to future opportunities, the latter can damn a career.

A personal failure, as Ghosh defines it, is one in which an individual does something that violates a fiduciary duty, commits a crime, or acts in a way that goes against the normal tenets of morality and fair play. Ghosh cites as example a CEO who fires a bunch of employees in order to pay for his own severance package. In such cases, a manager’s reputation will be tarnished to the point of rendering him or her un-hirable even if the venture was a financial success.
“In a start-up, if a company is doing well and a founder gets greedy and takes more than his fair share, people sort of forgive him,” Ghosh says. “But when a company is going down and you protect your own interests it’s always at the cost of someone else. People don’t forgive that.”

Ironically, a personal failure often occurs because an entrepreneur is trying too hard to avoid an enterprise failure. Trying to keep the venture capitalists happy and the bankruptcy at bay, the founder or CEO will resort to illegal acts such as fraud, or to morally problematic acts such as blatant misrepresentation of the company’s capabilities or prospects when talking to customers or financiers . “And when you do that, you’re then on the slippery slope of taking an enterprise failure and making it a personal failure,” Ghosh says. “Executives do that all the time because they do not distinguish between the two.”

REVISING EXPECTATIONS

Ghosh notes that venture capitalists could help mitigate personal failures by allowing for the expectation of company growing pains. He points out that a baseball player with a .350 average is considered to be a success, even though he has a .650 failure rate. But in entrepreneurial management, there’s a tendency to see things in black and white, rather than looking at the whole picture. And while VCs are likely to recruit an executive with experience at a failed company, they are less patient with individual failures. VCs rarely consider their role in establishing unrealistic expectations or an environment where the ends are more important than the means, he says.

“In any natural system, failure is the engine that causes growth, that causes new birth, that causes anything to happen,” he says. “One of the truly big differences between growing economies and economies that stagnate is the acceptance of failure. If you don’t let forests burn, if you don’t let the old trees die out and the new trees grow, you don’t get a healthy forest. The ability to manage failure so that enterprises fail but people can still succeed becomes one of the tricks of how you build a society that can reinvent itself as the world changes.

photo credit: Superman via photopin (license)

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