We all lose if failure is punished too harshly; It is easy to gloat over flops but the fact is that business cannot succeed without risk

November 12, 2013 3:53 pm

We all lose if failure is punished too harshly

By Luke Johnson

It is easy to gloat over flops but the fact is that business cannot succeed without risk

Isuppose we are all fascinated by entrepreneurs going broke. Perhaps it is envy at work, possibly morbid curiosity, in some cases a desire to see justice served – or is it simply that such tales are full of human drama? The massive recent coverage of the fall of Brazilian tycoon Eike Batista, with extensive features in the Financial Times, The Wall Street Journal and Bloomberg Businessweek, is a classic study of how the media love to focus on a collapse – no doubt because it evokes the readers’ interest. Similarly, the bankruptcy of the Quinn empire in Irelandhas received huge attention – Gavin Daly and Ian Kehoe have even written a book on the subject called Citizen Quinn.I would like to believe that educated citizens know such speculators are a vital element in the capitalist system. Without the risk-takers, innovation would be stunted, job-creation inhibited, tax proceeds reduced and society generally poorer. So despite all the losses and collateral damage, big insolvencies will always form a part of progress. The ruin of Sean Quinn and of Mr Batista shows that bigger does not always mean safer when it comes to capitalist ventures.

With hindsight, it appears obvious that certain chancers are doomed to fail. Mr Batista married a Playboy model, parked a $1m car in his sitting room and boasted that he would become the richest man in the world – even though many of his operations had never shown a profit.

But often there is a fine line between winning and losing in business. And systems that punish failure too harshly discourage those who would seek opportunities – thereby making everyone a loser.

As a case study, Steve Oliver, recent winner of the British Venture Capital Association’s chief executive of the year award, is the founder of MusicMagpie. His company is an online retailer of second-hand CDs, DVDs and computer games with almost £100m in revenue and about 1,000 staff. That achievement was built using experience gained from a previous flop – Music Zone, a retailer with more than 100 outlets that went into administration in 2007. Without that setback he would never have created his current high-growth formula. If financiers, suppliers and other stakeholders had demonised him, his recent comeback would not have happened.

How to choose between those who deserve a second chance and those who do not? The key issue is whether the entrepreneur was honest and did their best. For example, both Mr Quinn and his son, Sean Jr, have been jailed for contempt of court following alleged asset-stripping. On that basis, I suggest that only a fool would invest with or lend to them now.

By contrast, I recently met an entrepreneur who runs one of Britain’s fastest-growing companies. It will make several millions of profit this year. Yet he told me he was made personally bankrupt not many years ago. Clearly, he must have been given breaks to recover his fortunes so swiftly. To me, that sort of thoughtful forgiveness is healthy and makes sound economic sense.

Every time I make an investment that goes wrong I vow that I must give up backing risky projects. But once the initial disappointment fades, I remember that almost all my better bets also appeared risky when I placed them. So I continue to make long-odds wagers, knowing some will prove to be mistakes – but confident that occasionally they pay off. Seven years ago when I bought Patisserie Valerie it had revenues of only £5m and was breaking even; most of the management were departing on the sale, and the accounts were rudimentary at best. This year we are projecting £14m of earnings before interest, tax, depreciation and amortisation on revenues increased 15-fold since purchase, with staff numbers up almost 20-fold.

Over-caution in enterprise hinders technological advances and leads to a less prosperous society. A minority of entrepreneurs who default are rogues, but most simply make genuine errors of judgment, or suffer bad luck. Just as the vast proportion of bankers are not crooks or immoral, so a few dodgy bankrupts should not prejudice us against all those who suffer business losses.

Whether in energy exploration or drug discovery, there will be more defeats than victories. But as Winston Churchill said: “Success is not final, failure is not fatal. It is the courage to continue that counts.”

lukej@riskcapitalpartners.co.uk

Twitter:@LukeJohnsonRCP

The writer is chairman of Risk Capital Partners, a private equity firm, and The Centre for Entrepreneurs