Entrepreneurs Turn Business Failure into Success
Eva Sun's wake-up call came in 1997, and it came from the bank. For 10 years, she had entrusted Libra Trading, a rice distributor that did business with Asian and mainstream grocers across Canada, to her husband while she raised their children. Now she learned that the $3 million, 11-person company was $4.5 million in debt and behind on its payments. Sun owed an additional $2 million to friends and family who had invested in the business. Libra had plenty of customers, but many were unprofitable. The company was operating without any outside financial or legal counsel. The books were a mess. "When I got that phone call," says Sun, "I had no idea what was going on with the company."
Kenneth Lin, then Sun's husband, says managing the company was not his forte. He says he focused on sales and marketing, signing on large grocers such as Loblaws and IGA. "Growing sales was what I saw as my job when I took over the company," he says. "I didn't have a share of the business, so all of the accounting was left to her."
That phone call changed Sun's life, and quickly. After years on the periphery of Libra, Sun, who at 42 had just given birth to her third child, hired a team of accountants and lawyers—one of the few things she did right at the time, she says. Over the next few years, they shepherded her and the business through a painful overhaul. Sun laid off four employees and slashed benefits to others. She dropped several grocery products to focus on rice and stopped distributing brands that were barely profitable. Revenues fell to $2 million; her marriage was another casualty. In 2004, nearly seven years after that first phone call, Sun's attorneys convinced her that her debt load was unmanageable. She declared bankruptcy.
The collapse of a business can be devastating, both psychologically and financially. But even successful entrepreneurs have to reach a comfort level with the risk of failure. Only about half of all startups survive for more than four years, says Brian Headd, economist for the Small Business Administration's Office of Advocacy. That number remains steady in both good and bad economic times.
Failure doesn't need to be as bad as it sounds. There is, of course, total, abject failure, in which entrepreneurs permanently damage their reputations, go broke, and alienate everyone they ever worked with. But even Sun didn't experience that. Instead, she did what's often referred to as "failing up." She reached out to her business partners, financiers, and family. She explained what happened, took responsibility, and now, four years after Sun declared bankruptcy, Libra is again strong and profitable. And though she was broke, Sun discovered she was rich in resolve. "I never lost a night of sleep. I never lost my appetite. It was kind of shocking, even to me," she says, laughing. "But that's where being a mother is an advantage. There was no option for me to just feel sorry for myself and not move on. People would say things like, `You're so strong, you had to do so much,' but my three children aren't my burden, they are my support. They kept me going." Her ex-husband says that while the divorce was incredibly difficult, in some ways, it was good for both of them. "The separation gave her a better chance to survive because she could be fully in charge of her company," he says. "And she's very capable." For his part, Lin learned that managing doesn't interest him. Says Lin: "Maybe failure is a good starting point for the next stage in our lives."
Entrepreneurs who manage to fail up may be surprised by how much support they receive for future ventures, positioning themselves as stronger, savvier operators with far less probability of failure the next time around. "Failure is a great tuition payment," says Sanford Ehrlich, director of entrepreneurship at the Entrepreneurial Management Center of San Diego State University. "Failure is not something one has to be ashamed of.
And if you can recover from it, it is a badge of honor."
On the other hand, rack up too many failures and those badges start to look like warning signs. "At some point, the cat runs out of lives," says Edward Zimmerman, co-founder of two angel investing groups and chairman of the technology group at New York law firm Lowenstein Sandler. While drive and discipline can push entrepreneurs to success, they can also push them to keep working when it should be obvious that a business won't succeed. "The sense of omnipotence, purpose, the ambition—it can create blind spots for entrepreneurs," says Kenneth Siegel, business psychologist and president of Los Angeles consultants Impact Group. When your credibility is shot among colleagues and friends, it may indicate you're not on the right path.
If, however, you haven't lost your appetite for entrepreneurship, it's important to ensure that your investors, partners, and customers don't lose theirs, either. That means taking care of them as best you can while the business winds down. Then you'll want to conduct a thorough analysis of why your business failed, and communicate that to everyone who had a stake in it. And before you jump headlong into your next venture, you'll want to consider your mental health. "You need to ask yourself, `Am I ready to approach an undertaking that I understand to be extremely high-risk and prone to failure?' " says Gregg Fairbrothers, adjunct professor of business administration at the Tuck School of Business at Dartmouth. Try to take a break to ensure that you're not carrying any baggage into your next company. Then you can launch your new venture, applying whatever unique lessons you've learned from your mistakes.
Failing successfully begins while your company is still operating. Protecting your colleagues and employees financially is paramount in maintaining good relationships and eventually repairing your reputation.
Jordan Ho's Chicago-based Web development company, Raydium, fell apart at the end of the dot-com boom. It had been financed with $375,000 from angels, friends, and family. Ho had hired those closest to him, including college pals, fellow church members, and even his future brother-in-law—not relationships he took lightly. "I got these people to leave their jobs, jump ship with me, and I was responsible for them," he says. "That was the biggest weight I felt in the whole process of shutting down the company." Before the company officially ran out of money, Ho warned employees that the business would soon close. Raydium paid out a month of salary so that its 10 full-time contractors could look for work while tying up loose ends.
After Raydium closed, Ho essentially became his contractors' agent. "I still had a lot of relationships with businesses that wanted work, so I became the point person for farming out my guys as developers to help transition them to other software jobs," he says. He sourced and managed the work. "Sometimes I'd make $30 an hour, sometimes I'd make $10," he says. "But the developers always got their full rate."
The arrangement also allowed the group to continue to work together, without dwelling on Raydium's failure. "It kept us from having this big void of [no] contact, but we were still able to take time to regroup," he says.
Understanding the complexities of why your business failed can help insulate you next time. Try to methodically walk through each aspect of the business, and see what you could have done to change things. "Try not to beat yourself up," says Fairbrothers. "Nobody gets things right the first time. The only tragedy is when you do it wrong the second time, too."
Don't blame the world before blaming yourself, suggests Siegel. Instead, address the elements that were in your control. Was the failure primarily one of development, marketing, management, or sales? Then look at external forces. Months, or even a year later, ask these same questions again. That provides a more global view of what happened and, ideally, more perspective.
Most business failures result from several factors.
Josh Golden left Northwestern University before his junior year to start UpZing, which provided wireless broadband service to large apartment buildings that were not networked. He got off to a good start, raising $100,000, landing a contract for a pilot installation and negotiating to build a network in a 550-unit condominium tower in downtown Chicago.
But the initial installation was trickier than expected, and Golden and his partners realized they didn't have the expertise necessary to build bigger systems. "After we finished the pilot system, which is still running today, we realized we would have needed to significantly retool the company in order to make it work," says Golden. Landing new business became more difficult after September 11, when landlords became much less willing to allow young entrepreneurs to roam around their buildings looking for networking potential. And by 2002, wireless broadband, which had been a luxury when the company launched in 2000, was no longer a rarity. "We didn't have the energy to recast ourselves again," says Golden. "We realized it was a good idea but not a great idea, and we'd be better off pursuing other things."
This sort of blunt clarity is priceless in the eyes of those who have lost their money on you. "You have to be proactive about keeping people appraised, even if it's embarrassing," says Golden. "You're saying, `Hey, I screwed up and lost a bunch of your money, Mr. Investor. But someday, I hope to give you another opportunity that can more than recoup your investment.' "
The major investor in UpZing, Tom Fitzpatrick, remains Golden's mentor and friend, even after Golden lost $100,000 of his money. "I've crashed and burned with entrepreneurs who gave in to the very human impulse not to talk about bad news, and I've elected not to move forward with those people," says Fitzpatrick, now managing director of early-stage investor Harper Laboratories. "But Josh was extremely effective in responding to what he was learning every day and communicating those challenges to me. So by the time he got to the point where he had played out this particular thread, I was comfortable with that conclusion." They talk weekly, and Fitzpatrick says he would eagerly invest in one of Golden's future projects.
No one goes down in flames alone. That's why you need to explain what happened to absolutely everyone: your vendors, your suppliers, your employees, and your family. There's no need for spin: Honesty and the presentation of a lesson learned can be sufficient. "I've seen people be real jerks when they've lost your money, and I've also seen people demonstrate sterling character and learn terrific lessons," says angel investor Zimmerman. "I don't expect people to be successful in every idea, but I do expect that they are reasonable in their self-assessment."
In Sun's case, because the reputation of Libra Trading remained intact, and because it was still the dominant rice distributor in parts of Canada, her newly hired team of accountants and attorneys thought the business was salvageable. That meant Sun needed to speak to all of her suppliers and customers directly. "I took full responsibility for the failure," says Sun. "I was very open about the fact that I did not attend to warning signs. I should not have mingled family relationships with business decisions. But I also told them product quality had never been compromised and we were going to improve our controls, and they were content to give me a second chance." Her two major suppliers negotiated new terms, extending her payment window from 30 days to 120, allowing Sun to keep Libra afloat as she reorganized the company.
Her business partners weren't the only ones due an explanation. Sun opted to tell her three kids everything about the business and the divorce. "I couldn't shelter them, and at that point, I needed them for their emotional support and to be my partners," Sun says. She gave her two older children, who were in a private school, a choice: Either get weekend jobs and work vacations or go to public school. They opted to work.
Without any assets or savings, Sun sold the house she and her husband had owned, which had two mortgages on it. Sun's relatives made the down payment on a house next door to her mother. Working full-time, Sun needed her mother's assistance with the three children. And with a budget of $35 a week for groceries, the family picked vegetables from her mother's garden six months out of the year. "We ate a lot of ground pork. It was only $1.99 a pound!" Sun laughs. "After a year the kids very politely asked, `Mom, can we have something else?' "
It was a brutal stretch, but they learned a lot. Sun became an involved manager, cutting unprofitable customers and aggressively negotiating with suppliers. With better inventory management, she was able to move into a smaller warehouse and cut her real estate costs. Her family "learned we didn't really need much," Sun says. "It's helped teach them that they never need to compromise in their life. Whatever comes their way, they can handle it, whether it's financial or emotional."
For Roy Warren, who suffered a public humiliation after being ousted as CEO of Bravo! Foods International in 2007 after a decade with the company, repairing his reputation meant reaching out to business colleagues who weren't involved with Bravo. Warren turned the exercise into a road trip, driving from Florida to Massachusetts and meeting with former colleagues. He shared his side of the story about what had happened and asked their advice about his credibility. Eight months later, he had raised $1.5 million for his next venture from institutional investors who had backed him in the past. One of the executives he visited on his road trip sits on the board of directors for his new company, Attitude Drink, which makes energy drinks and beverages with nutritional supplements.
Before launching another company, take a breather. "Some type of prolonged, 30- to 60-day debriefing will certainly help ensure that you don't repeat the mistakes of the past," says psychologist Siegel. "For some people the collapse of their company can be as traumatic as a death." Get some outside perspective, either by joining a peer support group or visiting a career counselor.
This is also a good time to revisit some of the questions you asked yourself in your initial analysis and broaden their scope, says Dartmouth's Fairbrothers. What worked? What should I do more of in the future? What should I do less of? What am I proud of? What do I regret?
Serial entrepreneur Andy Payne can testify to the value of taking some time off. After Revenio, his online marketing company, went under in 2002, "I was depressed for quite a while," he says. "I unplugged for close to a year, and just spent time with my family."
Part of the trauma of Revenio's failure was that it came on the heels of spectacular success. Payne had founded Open Market, an e-commerce software company, in 1994. He took it public in 1996 and cashed out two years later. Based on the success of Open Market, it took Payne all of a week to raise $4 million to start Revenio. Within months of its launch, Revenio had 100 employees. Over the next three years, Payne raised an additional $35 million. By the end of 2000, Revenio had its first round of layoffs. "It was an incredibly emotional roller coaster," says Payne. "We went from, `Omigod, this thing is going to Mars,' to `Omigod, we're going out of business tomorrow.' " In 2002, the company laid off all but five people and conducted a fire sale of its assets and technology.
A year of solitude helped bring closure to the Revenio experience, Payne says, and provided a psychological boost as he started thinking about his next steps. "It was a valuable lesson learning that you can take on a project and it can fail, but that doesn't mean that everybody you worked with is going to deem you a personal failure and never want to see you or work with you again," he says. "You're going to be judged by how you carry yourself through the experience. Not necessarily the outcome." Today, Payne is a one-man incubator, concentrating on seeing a company through its first few years of existence. And he's laying the groundwork for another startup, focusing on Internet ticket sales.
His investors, not surprisingly, include of some his former Revenio partners.
When you're ready to get back into the fray, part of the trick will lie in keeping the past failure from haunting the new company. That means translating your "lessons learned" into guidelines for the new venture.
Ho and Golden, both burned by the dot-com bust, have launched Table XI, a consulting firm specializing in e-commerce, data management, and strategy. The eight-person outfit is tightly managed and run entirely on revenues, which now come to about $1 million a year. Table XI strives to grow by forming partnerships with its clients. Some remnants of the dot-com era remain—there's a ping-pong table in the loft office, and a chef comes in weekly to cook the staff's meals—but the company hardly flies by the seat of its pants, hoping for the next round of funding. "Failure definitely makes you neurotic about certain things," says Golden. "We manage the heck out of our cash flow. At some point, you realize that the best use of your time isn't in saving $37, but in the beginning, it's important to address those concerns."
Eva Sun is back to running her own company. Libra National, which retained the business of Libra Trading after the restructuring, more than a decade after that first phone call, is profit-driven, with a full-time accountant, and carries no debt. Sun no longer leaves departments to run themselves. Rather than letting the production department make ordering projections, she reviews accounts weekly to figure out what they might need. She closely manages her receivables and inventory, maintaining positive cash flow and eliminating the need for outside financing, even though several of her former investors had said they were willing to invest again. Today, the 20-employee company brings in almost $4 million in revenue annually—a million more than it made at its peak, and double what it earned during the restructuring.
In hindsight, Sun says the failure of the company was not so different than the breakup of her marriage. "You can't place blame on others. There is some right and wrong, but no black and white. Let's face it, not all relationships are happily ever after," she says. "And that's not so different from running a business. I can't say I have any regrets. That period of time was an incredibly important chapter in my life."
For a video interview on failure, go to businessweek.com/go/sb/videos
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