First published in the Sunday Times on 23rd April 2017.
The most dramatic and painful event in business life is going bust. It is perfectly captured in Schumpeter’s terrifying phrase “creative destruction” — the moment of commercial death often giving rise to new enterprises.
Society overall gains by such chaotic progress, but the particular participants in broke companies do not. Be they investors, suppliers or employees, the consequences of insolvency can be devastating. Yet keeping alive companies that are uneconomic makes no sense. Communist regimes typically prop up industrial concerns that destroy capital and inhibit advances, which is why living standards under such systems are so much lower — just compare North and South Korea.
As a venture capitalist, if none of your bets fail, then you are probably not taking enough risks. I’ve made my share of such mistakes, and feel a mixture of regret, guilt and disappointment over the ones I got wrong. But there should be no disgrace in honest business failure. After all, the founders of Disney, Ford and Mars all suffered bankruptcies before they achieved huge success.
Demonising entrepreneurs who have tried but failed would discourage endeavour and lead to stagnation. Assuming the entrepreneurs behaved properly, then the only crime in such circumstances is giving up altogether.
Why do companies go under? Often mismanagement plays an important part, but it is rarely the sole reason. Too much debt is a big factor, and structural changes in markets and technology shifts are also frequent contributors. Recessions amplify the weaknesses in unsound companies, and can trigger defaults. Fraud, litigation, pension liabilities and competition can all kill otherwise decent businesses. And plenty of companies are simply not viable in the first place.
Of course, companies all ultimately fail because of a crisis of liquidity and confidence. Even if a firm has cash, it may still be obliged to call in the receivers if it cannot meet its obligations, and regulatory requirements. Suppliers withdrawing credit, credit insurers cancelling cover, or directors frightened of wrongful trading, can all push a company over the edge.
There is a big difference between firms going into administration, and changing hands after a restructuring, and being liquidated. The former can produce a more healthy business — the latter means the entire undertaking ceases trading. Of course, even then the assets are usually recycled, and one hopes the employees find new jobs. Equity backers generally lose all their money, and frequently banks and other creditors face heavy write-offs, too.
Hence Agent Provocateur continues under new ownership, although 3i lost its entire £45m investment. The fall in the lingerie retailer’s value was rapid, as is so often the case, it was still carried in 3i’s books at £42m in March last year. I expect Barclays, the secured lender, recovered its entire exposure, and the majority of other creditors and staff would be unaffected.
Who are the actors in such dramas? There are the executive directors — by the end, usually exhausted and demoralised; the non-executives, concerned mainly for their reputations; the investors, probably unhappy but more detached; the bankers — ultimately the party which by withdrawing its support calls the end; and the insolvency professionals, who must be clinical and somewhat ruthless, since, like surgeons, they know that sometimes amputation is necessary to prevent death by spread of gangrene.
Even though we all know that companies are not immortal, the sudden collapse and dismemberment of iconic brands such as Woolworths or BHS still comes as a shock.
But markets are dynamic, and companies survive only while they remain relevant. Putting doomed companies on life support is a mug’s game — prolonging the agony serves no one’s interests. Better to take the heartache early and move on.
Buying companies out of administration can be highly lucrative, but it requires nerves of steel and ready money. Such rescues can pay off handsomely: one business we bought less than a week out of administration paid for itself within a year.
I fear the next few years will see plenty of action on the insolvency front. Lots of companies have taken on too much debt, and sectors such as clothing retail are facing huge structural change. There will be winners and losers, and perhaps a few fortunes boosted or diminished.