Business Closure and Failure

BUSINESS CLOSURE
AND FAILURE
Closure and Failure - Reading
• Storey, Chapter 4
• Birley and Muzyka, Part 10
• Hisrich and Peters, Chapter 17 (4th ed)
• Burns and Dewhurst, pp. 66-71
• Deakins, Chapter 3 (esp pp 59-61)
• Murphy, pp 22-25
• Wickham, Sect 8.5, pp 100-103
• Other articles are referred to in the lecture notes

Closure and Failure:
Some Questions
• What exit routes are available?
• Why do businesses close?
• What is failure?
• What causes failure?
• Which businesses are most likely to
fail?
Closure and Failure:
Some Questions
• Can we predict failure?
• What are the effects of failure?

The Longer Term: the Options
Continued continued organic growth

ownership acquisition
and franchising
management stabilisation
Transfer of sale of equity to external

ownership / investor
management trade sale to external investor
sale to competitor
Harvesting
sale of assets
liquidation and closure
The Owner-Manager: Options and Exit Routes
Personal Investment
Continuing Reduction or Exit
Growth Sale of Shares:

Continuing Stabilisation A.I. M.
VC / Angel
Personal
Involvement Sale of Business
Reduction Delegation
in Management Disposal of Assets
or Exit
Management succession
Liquidation
Patterns of Closure
Voluntary Compulsory
Planned sale Forced takeover

Sale by creditor
Unplanned sale
e.g. to competitor
Voluntary
liquidation Liquidation
Liquidation (e.g. retirement forced by
or to found new creditors
venture) (Insolvency)
Note: the dividing line between ‘voluntary’ and ‘compulsory’ is an issue of perception
SURVIVAL RATES
VAT deregistrations
in year (%)
16
The older a firm, in general the better
its chances of survival:
12
0 12 24 36 48 60 72 84 96 108 Lifespan in months
Business
BusinessDeregistrations
Deregistrations v.
v. Lifespan
Lifespan (U.K.
(U.K.Data)
Data)
The Effect of Recession on Business Survival
% Still Alive
100 88
1974 - 87
80
75
66
60
55
40 1989 - 92
41
20
0 6 12 18 24 30 36
Months
(Source: Barclays)
What causes closure?
Bankruptcy / Involuntary liquidation
5% Closed "to prevent

further losses"
15 %
Other reasons for

discontinuance
"Did not make a go of it"
32.5 %
Source: Watson & Everett: "Defining Small Business Failure"; International Small Business Journal April 93
What is Failure?
The term ‘failure’ is used loosely and may describe any of the
following conditions or circumstances:
• Financial distress
• Voluntary closure due to inadequate returns
• Cessation of trading
• VAT deregistration
• Company deregistration
• Personal bankruptcy
• Insolvency
• Liquidation
Common Causes of Failure
Market Operational
• Market decline (or over-optimism) • Business location

• Increase in competition • Over-ambitious startup
• Loss of competitiveness • Over-optimistic cost estimates
Financial Human
• Overtrading - or a single 'big project' • Imbalance or inadequacy in areas of

• High gearing management
• Under-capitalisation • Loss of interest or drive by owner-

manager
• Inadequate cash management
• Loss of leadership and direction
• Inadequate controls
• Inadequate / inappropriate recruitment
• Excessive drawings
Factors in Business Failure
In a recent study, Deakins found the following factors to be important (in rank order):
1. Lack of knowledge of marketing
2. Competing task demands from family / domestic sources
3. Problems of outlets
4. Lack of market awareness of product / service
5. The costs of business premises
6. Inappropriate business premises
7. Insufficient mark-up
8. Unacceptable risk
9. Change in home circumstances
10. Inappropriate size of premises
Source: Deakins, D., ‘Entrepreneurship and Small Firms’, McGraw-Hill (1996)

Differing Views of Failure
Business owners and external analysts may interpret failure very differently:
Causes of business failure as Causes of failure as defined by

identified by analysts: business owners:
% %
Incompetence/ inexperience 44 Inadequate sales 49.9
Lack of managerial experience 17 Competitive weakness 25.3
Unbalanced experience 16 Heavy operating expenses 13.0
Inexperienced in line 15 Debtor difficulties 8.3
Neglect 1 Stock control difficulties 7.7
Fraud or disaster 1 Excessive fixed costs 3.2
Unknown 6 Poor location 2.7
Factors influencing failure
• Age of firm - the longer the firm is established, the less likely it is to fail
• Size of firm - the larger the firm, the less likely it is to fail
• Growth - firms that grow are more likely to survive
• Macro-economic conditions - failure rates increase during a recession
• Sector - failure rate is higher in some industrial sectors
• People - there is some evidence that failure rate is inversely related to

educational level, age and prior experience of the owner-manager
• Firm type - there is a lower failure rate among franchises
• Location - failure rates are somewhat lower in rural areas
Source: Storey, D.J., "Understanding the Small Business Sector", Routledge, 1994
Failure rates by sector
Failure rate per 10,000 businesses

(Based on Dun & Bradstreet data)
Services (1987) Manufacture (1992)

Veterinary practices 10 Chemicals 60
Funeral directors 11 Food and drink 70
Doctors 24 Textiles 610
Hotels 65 Metals / engineering 650
Travel agents 135
Miscellaneous retailer 290
(e.g. hobbies, gifts etc.)
Source: Greenfield, W. "Developing New Ventures" Harper & Row 1989

Failure Prediction
In broad terms, failure might be as difficult to predict as growth, but the fact that
most involuntary closures are caused by cash insufficiency or insolvency means
that financial data and ratios, where available and reliable, can be used to predict
the risk of failure with some accuracy. These indicators might include gearing,
profitability and performance ratios but also other financial data such as
changes in owner remuneration.
Non-financial indicators
Financial data notoriously suffers from unavailability, inaccuracy or lateness.

Numerous other indicators may be useful in anticipating distress or failure, including:
redundancies
delay in submission of published accounts
audit qualifications
changes in legal form
changes in management structure
reduction in stock levels
issue of round-figure cheques
The costs (and benefits ) of failure
The costs
• Loss of entrepreneur's and creditors' capital with resulting 'domino effect'

• Injurious psychological effects:
- damage to self-esteem
- return to employee status or unemployment and social marginalisation
• Economic effects of reduced national and local tax revenue, increased
social security payments and impact on local economic development
The (potential) benefits
• Failure allows for the release of resources for productive and efficient use
• Failure can be a learning experience - 'an essential development of the

entrepreneurial personality' ( Shapero)
• Hence potentially greater development capability of enterprises founded by

entrepreneurs who have failed previously
" Failure is the opportunity to begin again more intelligently " Henry Ford
The tolerance of failure
The process of failure can be a very valuable learning experience but:
‘ in Britain, our culture is less tolerant of failure and too often highly talented
individuals have not been able to recover from failure’
whereas
‘ in the USA failure is viewed as a learning experience and people can benefit from
failure, can learn from their experience and go on to form successful companies
as a result’
(Deakins)
It is sometimes said that a ‘failure-tolerant culture’ is necessary for the
support of entrepreneurship, both in society at large and within the organisation

Success and Failure
Cave F, Eccles S and Rundle M (2001)

‘An exploration of attitudes to entrepreneurial failure: a
learning experience or an indelible stigma?’
In Proceedings of 21st Babson College/Kauffman
Foundation Entrepreneurship Research Conference,
June 2001
Cope J, Cave F and Eccles S (2004)

‘Attitudes of venture capital investors towards
entrepreneurs with previous business failure.’
Venture Capital, vol. 6, no2/3 April-September, pp 147-
172
Success and Failure
Some speak of the future

My love speaks softly
She knows there’s no success like failure
And that failure’s no success at all.
Bob Dylan (1996?), Love Minus Zero/No Limit,

On Bob Dylan Unplugged

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BUSINESS CLOSURE

• Birley and Muzyka, Part 10

• Hisrich and Peters, Chapter 17 (4th ed)

• Burns and Dewhurst, pp. 66-71

• Deakins, Chapter 3 (esp pp 59-61)

• Wickham, Sect 8.5, pp 100-103

• Other articles are referred to in the lecture notes

• Why do businesses close?

• What causes failure?

• Which businesses are most likely to

• Can we predict failure?

• What are the effects of failure?

Continued continued organic growth

Transfer of sale of equity to external

Continuing Reduction or Exit

Growth Sale of Shares:

Planned sale Forced takeover

0 12 24 36 48 60 72 84 96 108 Lifespan in months

Bankruptcy / Involuntary liquidation

5% Closed "to prevent

Other reasons for

• Voluntary closure due to inadequate returns

• Market decline (or over-optimism) • Business location

• Overtrading - or a single 'big project' • Imbalance or inadequacy in areas of

• Under-capitalisation • Loss of interest or drive by owner-

1. Lack of knowledge of marketing

2. Competing task demands from family / domestic sources

4. Lack of market awareness of product / service

5. The costs of business premises

6. Inappropriate business premises

9. Change in home circumstances

10. Inappropriate size of premises

Source: Deakins, D., ‘Entrepreneurship and Small Firms’, McGraw-Hill (1996)

Causes of business failure as Causes of failure as defined by

• Growth - firms that grow are more likely to survive

• Macro-economic conditions - failure rates increase during a recession

• Sector - failure rate is higher in some industrial sectors

• People - there is some evidence that failure rate is inversely related to

• Firm type - there is a lower failure rate among franchises

• Location - failure rates are somewhat lower in rural areas

Failure rate per 10,000 businesses

Services (1987) Manufacture (1992)

Source: Greenfield, W. "Developing New Ventures" Harper & Row 1989

Financial data notoriously suffers from unavailability, inaccuracy or lateness.

• Loss of entrepreneur's and creditors' capital with resulting 'domino effect'

The (potential) benefits

• Failure can be a learning experience - 'an essential development of the

• Hence potentially greater development capability of enterprises founded by

The process of failure can be a very valuable learning experience but:

It is sometimes said that a ‘failure-tolerant culture’ is necessary for the

support of entrepreneurship, both in society at large and within the organisation

Cave F, Eccles S and Rundle M (2001)

Cope J, Cave F and Eccles S (2004)

Some speak of the future

Bob Dylan (1996?), Love Minus Zero/No Limit,

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