An à la carte menu for corporate failure

First published in the Financial Times on 9th December 2014.

Each sector has its recipe for disaster, such as rent in the restaurant trade and fraud at banks

Why do companies fail? Considering how important this question is to entrepreneurs, investors, and even society as whole, I can find little widely available research into it. If we understood the answer better, less capital would be misallocated and fewer lives wasted by founders in pursuing doomed schemes.

I think start-ups and established businesses typically fold for different reasons. CB Insights published a fascinating study of 101 Silicon Valley postmortems based on submissions from the individual founders, analysing the various reasons for closure. Easily the single biggest cause was a lack of sales. After all, without revenue, every company is bust. This is stating the obvious — but it is extraordinary how many entrepreneurs overestimate the market for their idea. The second biggest explanation was a lack of money — but often I suspect this is a result of other problems. The third was a bad management team. Other factors cited included too much competition, low margins, poor customer service and an uncommercial business model.

I can confirm that a combination of these played a part with every early stage venture I’ve backed which flopped. I was surprised that more Silicon Valley founders didn’t acknowledge flawed technology as a contributor to the demise of their project. All the risks can never all be correctly identified before launching a business; and of course there are usually multiple reasons why a business shuts down. But no corporate death is identical to another — each is a unique tragedy, normally a blend of poor luck and rotten judgment.

So why do established companies go wrong? One can enumerate the principal ones: they can no longer innovate and new rivals steal their customers (Borders, BlackBerry and Nokia); they take on too much debt and banks break them up (EMI); they become distracted by acquisitions and diversifications which underperform (Time Warner and AOL). Most start-ups go broke because of over-optimism; established companies are wrecked by complacency and hubris. As they say, “The path to oblivion often goes through a triumphal arch.”

It is apparent to me that each sector has its particular recipe for disaster. In the restaurant trade, a majority of the operators who founder do so because they take on premises at too high a rent or spend too much on fitting the site out. This leaves them with unbearable fixed costs and liabilities, which eventually crush them. In the food processing sector, operators are ruined by becoming too dependent on one customer — who then cancels their supply contract; or they crash thanks to exposure to major commodity price swings; or occasionally they cease trading owing to factory fires or similar catastrophes. Meanwhile banks are peculiarly vulnerable to fraud, which killed Barings and BCCI among others.

Of course all companies that go down in flames do so because the management made mistakes: the human factor always features prominently. Otherwise, how does one explain the way within the same industry, certain businesses adapt and prosper; others crumble and expire?

Most companies die relatively slow deaths, rather than suffering a sudden collapse; assorted issues gradually drain the enterprise of life, and its leadership of hope. Difficulties usually develop from qualitative matters, such as an inappropriate product offering or faulty facilities, which then translate into financial pressures. Sometimes extinction is inevitable because the business is so fundamentally deficient or structural changes in markets mean the business model becomes uneconomic. But frequently companies can be saved by radical action if the decay is not too extensive. Turnround specialists are the experts at knowing why businesses are broken — and fixing them. I have achieved nothing more satisfying in my career than on those rare occasions where I have helped salvage an ailing company from the Grim Reaper’s scythe.

By necessity, this modest survey of corporate failures is superficial. I would like The Centre for Entrepreneurs, our think-tank, to investigate this vital subject rather more comprehensively next year and see what lessons can be learnt, so that entrepreneurs, investors and policy makers may adopt Samuel Beckett’s advice: “Ever tried. Ever failed. No matter. Try again. Fail again. Fail better.”