Why do Companies Fail?
This question is by far the most troubling for many consultants and researchers. For almost half a century, hundreds of studies have tried to understand the causes of business failure and predict its likelihood.
In most cases, the causes of failure originate within the firm. While macro level changes can impact the activity of companies, more on SMEs than on large corporations, it is still within the control of the management to adapt.
Companies who continuously fail to understand their customers and to align their marketing activities are more likely to fail. Poor governance, processes, and the management of resources stand out at important signs of failure. Reduced sales and slowed growth, and even insolvency are the effects, usually captured too late in the process.
The story is not corroborated by early stage entrepreneurs, as surveys show the perceived causes of failure to be external, mostly relating to the availability and accessibility of financial and human capital, or market changes and competition.
This led to the creation of multiple types of models currently employed by lenders, investors, and policy makers to understand the overall impact of their decisions.
The various approaches have enabled generations of professionals to make better decisions, from risk index models which allocate points based on various financial ratios (Tamari 1966, Moses and Liao 1987), to multiple discriminant analysis (Altman 1968), to linear probability modelling and multicriteria methods popular in late 1990’s that introduced non-financial factors to enhance decision making process, and, finally, to the introduction of rough sets and neural networks techniques in early 2000’s will most certainly push our ability to predict even further.
Many organisations and financial institutions have adopted such models and employed them to assess profitability, solvency, credit worthiness, and the risk attached to investing in any given company.
Management: An unmeasurable predictor, and determinant in VC backed companies
As expected, there are substantive difficulties applying the various techniques to early stage and growth companies, commonly backed by VCs. The lack of data, selection bias, subjectivity, and inability to quantify factors which VCs perceive as conducive to business success or failure, especially management expertise, preclude meaningful assessments and leaves this part of the investment sector almost opaque. Furthermore, beyond financial analysis techniques which have inbuilt limitations, this segment continues to advance with a very fragmented body of knowledge.
Financial analysis, and ability to create half-reliable projections, at an early stage, is akin to a creative, art-like, exercise. Models are usually built on a foundation of assumptions in line with management thinking, idealised growth, and, at best, a rudimentary understanding of the market segment and internal limitations. As companies evolve, such approach becomes more reliable and insightful.
The most prevalent perception in the VC ecosystem positions management as the determinant of company success and failure, even ahead of product or technology.
This is not meant to downplay the multitude of factors creating the conditions for failure and vulnerability at a firm level, team, and individual level, yet, the perception is that great management teams will be able to adapt and find, through an iterative process, the best approaches to improve market, financial and organisational performance.
If ‘the jockey is more important than the horse’, then the question remains what are the marks of great management. A review of publications points to the following reoccurring factors capable of signalling management potential within the early stages of business development:
- Successful exits
- Good founding team dynamics
- Team worked together before
- Knowledge, skills, and experiences: managerial and industry-specific
- Ambition and aspiration: growth, innovation, internationalisation
- Positive attitude to risk
At the early stage of business development, it is very difficult to measure or even ascertain the viability of strategies, technologies and, at times, even addressable market potential, more so, in a continuously evolving and competitive environment.