Don’t write off a ‘failed’ entrepreneur

‘Failure’ is critical to innovation entrepreneurship

Credit: Sebastien Thibault

Waverly Deutsch

Waverly Deutsch | Feb 18, 2019

Sections Entrepreneurship

I recently received an email from a former student of mine, Mrin. It was a thoughtful debrief on why she had decided to shut down the company I had been coaching her on last year for the Edward L. Kaplan, ’71, New Venture Challenge, an annual start-up competition and accelerator program sponsored by Chicago Booth. The experience was a difficult one for her, and she told me she had trouble disentangling the failure from her personal identity. In her own words, which she has given me permission to share, “I’ve never been more aware of how much I don’t know. And, at the same time, I’ve never learned so much so quickly. Shutting down the company has had me grappling with feelings of failure while questioning my self-worth and abilities.”

What Mrin finally realized is that she had not, in fact, failed. The Merriam-Webster.com Dictionary offers several definitions of the word “fail,” including, and I’m paraphrasing: to lose strength, fade away, stop functioning normally, fall short, be inadequate, be unsuccessful, become bankrupt, disappoint expectations, be deficient in, leave undone, or not pass some test. None of these applies to Mrin’s or any other entrepreneur’s experience in trying to bring an innovation to market and learning that it does not work as a business. To fall short or be unsuccessful requires some agreed upon definition of success. To disappoint expectations means that there are some expectations to disappoint. Mrin did not stop functioning, fade away, or leave something undone. No, in fact, Mrin accomplished a lot. As Thomas Edison said when an associate suggested that it was a shame myriad experiments to produce a nickel-iron battery had not produced any results, “Results! Why, man, I have gotten a lot of results! I now know several thousand things that won’t work.”

Entrepreneurship, especially innovation-focused entrepreneurship, is very much like science—involving a series of experiments that can bring something new and valuable into the world. You cannot learn what product or idea will work without being willing to discover what won’t work. This is known by every successful entrepreneur, most of whom have business “failures” in their portfolios. Before Evan Williams started Twitter, he founded Odeo, the podcasting platform you’ve never heard of. Before Reid Hoffman created LinkedIn, he launched SocialNet, a dating site that didn’t connect. Nick Woodman shuttered EmpowerAll.com and Funbug before clicking with GoPro. 

“Failure” is critical to innovation entrepreneurship. I invested $40,000 in an e-book company that created the largest database of off-copyright texts that existed in the commercial market at the time. I lost every dime. Why? It was 1994. There were no e-readers. Laptops weighed 12 pounds and weren’t fun to carry around. You got on the internet via slow, dial-up connections, and Amazon didn’t exist as a distribution channel. Countless companies launched tablet computers that went nowhere—think Apple’s Newton experiment, which was released in 1993, before a market coalesced around the beautifully designed iPad and its App Store. Many factors including timing, markets, technology, and the right team need to come together in order for a new product or business model to be successful, and if someone cracks the code, value is created.

Small-business and innovation entrepreneurship differ

Not all entrepreneurship is about bringing innovation to market, of course. Many start-ups essentially offer products and services that already exist, and not all entrepreneurs are trying to create the next unicorn company that will change the world. Many small-business entrepreneurs are trying to provide for their families, be their own bosses, and have flexibility in their schedules—in fact, the vast majority of people starting companies are trying to build small businesses. In 2017, only about 40 percent of founders in North America said their product was new or innovative, according to data from the Global Entrepreneurship Monitor (GEM), a research organization focused on entrepreneurial activity. In China, the number was 25 percent. In Indonesia, it was less than 12 percent. At the same time, while 60 percent of North American founders expected to create some jobs and hire employees, fewer than 15 percent foresaw needing 20 or more employees in the next five years, and worldwide, those expectations fell to less than 8 percent. These founders clearly aren’t aiming for unicorns, which create thousands of jobs.

What causes “failure” is different for these two kinds of entrepreneurs, growth entrepreneurs and small-business founders. When US Bank conducted a survey of small-business owners whose companies had failed, the top two reasons cited involved capital: 82 percent said they’d failed due to poor cash-flow management, and 79 percent blamed starting out with too little money. But compare that to a survey by CB Insights, a data company looking at VC–backed companies, which, by definition, are trying to innovate and scale in order to get venture funding. In this survey of founders who shut their companies, the No. 1 reason listed, by 42 percent of respondents, was an inability to find product market fit—“no market need,” as CB Insights puts it. Only 29 percent of founders said they ran out of money.

Nevertheless, for both growth entrepreneurs and small-business founders, research suggests that the learning process of opening and closing a business increases the chances of success the second time around. University of Michigan’s Francine Lafontaine and Stanford’s Kathryn Shaw looked at serial retail business founders—typical small-business entrepreneurs—in Texas, from 1990 to 2012. Only about 25 percent of these retailers opened more than one establishment over those years, but these serial entrepreneurs were, in Lafontaine and Shaw’s words, “considerably more successful,” with 7 percent lower likelihood of shutting down overall than for inexperienced founders. And the effects were cumulative. Each previous business lowered the hazard risk by nearly 4 percent.

Lafontaine and Shaw were not able to determine with the data set they used whether the businesses shut for positive and neutral reasons such as a sale, a better opportunity for the owner, or retirement, or for negative reasons such as bankruptcy, lack of profitability, or legal problems. As a result, it is impossible to determine how much of a future boost toward success came from a small-business failure versus a positive exit. But in research on innovation entrepreneurs, Harvard’s Paul Gompers, Josh Lerner, and David S. Scharfstein and the Federal Reserve Bank of New York’s Anna Kovner were able to isolate the impact of a failure versus a success on a serial entrepreneur’s next venture. They used data, captured by Dow Jones’s VentureSource database, on nearly 10,000 VC-backed companies founded between 1986 and 2000. Over 1,100 of the companies were founded by serial entrepreneurs. What the researchers discovered, unsurprisingly, is that having a successful enterprise increased the chance that the next venture would be successful by more than 30 percent. But surprisingly, having a failed venture increased second-round success by 5 percent.

To increase innovation, support serial entrepreneurs—even if they have failed

I have heard many US-based investors say, “I would rather back someone who has tried to start a business, even if it didn’t work. At least they learned on someone else’s dime.” The research indicates that this approach is right. To some extent, entrepreneurship is a numbers game, and those who try, and try again, create jobs and drive innovation. A predisposition to give entrepreneurs a second chance may help explain some of the variation in entrepreneurial activity across cultures. 

Pay attention to cultural perceptions

Society’s impressions of entrepreneurship predict how much of it actually happens in a country. The “GEM 2017/2018 Global Report” reveals which countries value entrepreneurship more than others.

•••US and Canada
•••Countries favoring entrepreneurship more: China, India, Indonesia, Israel, South Korea, Saudi Arabia, United Arab Emirates
•••Countries favoring entrepreneurship less: France, Germany, Poland, Spain, UK, Japan

Deutsch, 2019; Global Entrepreneurship Research Association, 2018

Intuitively, you might think more-risk-averse cultures would produce people with a higher fear of failure, and that this would inhibit the desire to start a company, but it’s not that simple. The “GEM 2017/2018 Global Report” looks in detail at how self-perception and societal values affect entrepreneurial activity worldwide. In its population studies of 55 countries, the report finds that expressed fear of failure was not a good predictor of how many people pursued or avoided entrepreneurial careers. In Bulgaria, for example, only 21 percent of the population indicated a fear of failure, but a paltry 4 percent was involved in entrepreneurship. In Thailand, where 53 percent of people reported fear of failure, the entrepreneurship rate of 22 percent was more than five times that of Bulgaria.

When it came to individual self-perception, where people reported high levels of an ability to see opportunities and confidence in their own capabilities, GEM tracked higher rates of entrepreneurship. 

How society views entrepreneurship also predicts the amount of entrepreneurship in a country. In places such as North America, Asia (excluding Japan), and the Middle East—where a lot of people consider entrepreneurship to be a good career choice, society awards high status to successful entrepreneurs, and the media pay a lot of attention to entrepreneurship—the percentage of the population engaging in entrepreneurial endeavors is substantially higher than in more conservative areas, including Europe and Japan. Japan is a particular example of a place where culture holds entrepreneurial activity back. Only 24 percent of the population see entrepreneurship as a good career choice, and only 7 percent see opportunities for innovation. It is no wonder that only 5 percent of the population is engaged in starting new companies.

Policy makers need to pay attention to these cultural issues as they think about economic growth and entrepreneurship’s impact on it. Entrepreneurs, especially innovation-driven ones, have long been seen as the primary job-creation engine. Important analysis of the US Bureau of Labor’s Business Dynamics Statistics data set by Tim Kane for the Ewing Marion Kauffman Foundation suggests that companies in their first year of existence have created an average of 3 million new jobs annually in the United States since 1992, and that, in all but seven of those years, they have created 100 percent of the net new jobs. Kane’s study demonstrates that after the first year of business, as a group, new firms actually lost more jobs than they created, but the net number of jobs lost over the next 14 years was a fraction of the 3 million initially created. 

Entrepreneurs: The primary job-creation engine

An analysis of US Census Bureau data finds that companies in their first year of existence have created an average of 3 million new jobs annually in the United States since 1992.

Kane’s conclusions are mirrored in worldwide research from GEM. The “2011 High-Impact Entrepreneurship Global Report” analyzed surveys conducted from 2006 to 2010 with over 70,000 active entrepreneurs and discovered that high-growth entrepreneurs (defined as experiencing 20 percent or greater year-over-year job growth) made up 4 percent of the respondents but created 40 percent of the more than 800,000 jobs their companies supported. These are the entrepreneurs most likely to be building firms trying to bring innovative products and services to market. They are the angel- and VC-backed entrepreneurs. And they are the group that, once identified, need to be nurtured and supported through early failed ventures.

I believe Mrin is one of those future high-impact entrepreneurs. She has clearly been bitten by the entrepreneurship bug. She definitely plans to try again when she finds an idea she is as passionate about as the one that didn’t work. As for takeaways from her experience, she recognized that she had failed in a market she had little experience in; that, since nothing went according to plan, she needed to keep moving on multiple paths—not rely on just one; and that she should have been sure the business concept had a defined revenue model on which to execute. Her biggest lesson, she says, was “how not devastating it actually was to fail. I wish people would be more comfortable talking about the failures. There is so much to be learned.” This is an entrepreneur I would invest in any time.

Waverly Deutsch is clinical professor and academic director of university-wide entrepreneurship content at Chicago Booth.