Trust can seem risky but its absence is perilous

First published in the Financial Times on 2nd December 2014.

Putting faith in business partners is a vital first step in any enterprise

Without trust, business is a dangerous undertaking. For some years I have been a substantial but passive investor in a smallish company. Unfortunately it went into administration in June – obviously reducing my shareholding to a negligible value. The founder promptly bought it back on his own in a “pre-pack” procedure – and is about to sell it for at least 10 times that amount, just six months later. He claims the whole sequence of events could not have been predicted. But I do wonder.

For commercial life to function at all, there has to be a general assumption of trust – that partners, staff, suppliers, customers and the authorities will do the right thing by each other. It is impossible to verify every transaction, and check each task: delegation is essential for all operations of scale. Those who are suspicious of everyone have to limit their ambitions, because they assume deceit is endemic. Such a pessimistic approach is a sorry and unprofitable state of human affairs. As Samuel Johnson said: “It is . . . happier to be sometimes cheated than not to trust.”

But to trust in one another is also to trust in a sanctioning authority, a point illustrated in the book How We Invented Freedom and Why It Matters by Daniel Hannan. He argues that trusting strangers is what helped make Britain and America rich. The US and the UK promoted secular democracies and private enterprise. Industrious individuals left their home communities to seek their fortunes – sometimes emigrating and settling in foreign lands – such as America. These endeavours only succeeded because there was a system of effective civil justice, from which outsiders could benefit as much as locals. This attitude contrasted with that in much of southern Europe, where business tended only to be done between known families and in neighbouring regions. This was a lower-risk approach, but it also inhibited growth.

Not long ago I invested in Italy. When it became apparent that a local businessman was stealing from us in a flagrant way, we threatened legal action. The individual laughed and said he looked forward to seeing us in court – in perhaps 11 years, a typical length of time before an Italian claim is decided. Alternatively, he hinted that we could settle amicably now, effectively surrendering enormous value to him. He understood all too well that a deeply dysfunctional legal system can be exploited by the unscrupulous. Such a corrupt structure undermines trust, and thus prosperity. Consequently in countries such as Italy there is a preference for doing business with known counterparties, who are less likely to rip you off. No wonder the country’s gross domestic product is no larger than it was 14 years ago.

The lesson is that the rule of law underwrites every business transaction, and that effective institutions should be a beacon to entrepreneurs. Our privileges under the law have been hard-won, as shown in Ian Klaus’s Forging Capitalism – Rogues, Swindlers, Frauds and the Rise of Modern Finance. Klaus observes that trust in lending, markets, acquisitions, investment and so forth only developed over time. In the 19th- century stock markets, the insurance world and – God forbid – financial journalism were riddled with scoundrels and bad behaviour was rampant. The Financial Times was no exception: its founding chairman was none other than Horatio Bottomley, the notorious promoter who spent five years in jail for fraudulent conversion.

But the entrepreneur has more to fear from inertia than getting bilked. Confidence in the other party is the magic ingredient that empowers an entrepreneurial business to succeed. An absence of trust leads to paralysis. Straight dealing, accountability and transparency are much more about truth and candour than box-ticking and an obsession with regulations. Any partner can betray you and stay within the law if they are assiduous and devious enough. Integrity in your working relationships consists of a broader understanding than the letter of the law. In the end, all that any entrepreneur can do is obey their gut instinct and, perhaps, to follow the example of Charlie Munger, vice-chairman of Berkshire Hathaway and Warren Buffett’s partner, who said: “By the standards of the rest of the world, we overtrust. So far it has worked very well for us”.