The forgotten “Valley of death” of failed business

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The forgotten “Valley of death” of failed business

I recently attended an event about the state of the economy of a small EU member-state, where a commercial bank’s representative was discussing their findings on the characteristics of the business that survived the last crisis and are back on the growth path. They made reference to characteristics of higher quality products, new regulation quick adjustments, digital advancements, the identification of industries with higher ROI etc. Much of business and entrepreneurship research draws its conclusions from information about businesses that have survived, largely ignoring those that have failed. This case was not any different.

The sample consisted of a pooled cross-section that only observed the companies that had stayed in business, ignoring those that had exited -due to either bankruptcy, or merger- and drawing conclusions about their common characteristics. Then they typically proceed at pointing at these characteristics and recommend to other businesses imitation for future success.

Much of the research will tend to group the attributes of those that survive and then categorise them into the more successful and the less successful ones. Then they proceed to infer that the common characteristics of those who perform better are the underlying factors of their success. Anybody who has gone beyond Stats 101 will see how this line of thinking can lead to the wrong conclusions. It is like throwing darts on a target and looking into those darts that landed on the round target area, ignoring those that did not land on it, and then after describing them with great precision, to conclude that they tend to be 19-22 grams, made from 90%-95% tungsten and 5%-10% titanium, with a red or blue paper shaft. Following the statistical analysis the imaginary researcher might conclude that those that did better were of red colour, 19g and 90%-10% tungsten-titanium. The problem lies with the probability that the majority of those falling off the target could have been also red, 19g and 90%-10% tungsten-titanium, but have been in fact ignored.

In business, the unsuccessful companies are often referred to as those that didn't make it through the "The Valley of Death", where all the non-surviving start-ups fail. The sad truth is that nobody looks in the “business cemetery” to see the characteristics of the businesses that failed and compare them with those that survived. In fact the most solid evidence we have so far is the importance of start-up capital that can support a newly founded company beyond its third year of trading.
"The more resources they have, the more likely it is that their business will survive, stay in the game, and so have a chance of a future win."

Alex Coad, Julian Frankish, Richard Roberts & David Storey

Other typical characteristics such as the age of the entrepreneur, their gender, their prior experience or education along with any professional advice they might have had seem to have only a limited role to play in their business success. In fact, the systematic finding when access to initial capital is accounted for is that most start-ups fail within their first three years because they did not have enough funding to get by while starting-up.
"Ninety percent of new entrepreneurial businesses that don't attract venture capital fail within three years."

Paul Gompers & Josh Lerner

"What is clear is that access to finance is critical for the survival of new firms. Banks, as major providers of such funding, therefore play a key role."

George Saridakis, Kevin Mole & David Storey

Chance and other unobservables will of course play their role, but it is hard to see a business surviving by chance alone in the long run. History remembers the winners more than it does for losers, and in business research it is even more so. Very few talk about or look into the “invisible histories”, the stories of the majority of start-ups and other businesses that have failed.
"...if collateral is insufficient lenders will not offer finance, so potentially sound projects go unfunded."

James Curran & David Storey

I wouldn’t be surprised if most of the “how to succeed in business” type of books in any given bookstore are full with inaccuracies and false impressions

about “how to succeed in business” that only leads the unsuspecting aspiring entrepreneurs to more future failures. But it is hard to beat a nice inspiring bestseller that let you know the secrets of “how to succeed in business”.
"We want to be told stories, and there is nothing wrong with that – except that we should check more thoroughly whether the story provides consequential distortions of reality."

Nassim Nicholas Taleb

References

Coad, Frankish, Roberts, & Storey. (2013). Growth paths and survival chances: An application of Gambler's Ruin theory. Journal of Business Venturing, 28(5), 615-632.

Curran, J., & Storey, D. (2002). Small Business Policy in the United Kingdom: The Inheritance of the Small Business Service and Implications for its Future Effectiveness. Environment and Planning C: Government and Policy, 20(2), 163-177.

Gompers, P., & Lerner, J. (2002). The money of invention: How venture capital creates new wealth. Ubiquity, 2002(January), 1.

Saridakis, G., Mole, K., & Storey, D. (2008). New small firm survival in England. Empirica, 35(1), 25-39.

Taleb, N. (2001). Fooled by randomness : The hidden role of chance in the markets and in life. London: Texere.

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