Firm Closure, Financial Losses and the Consequences for an Entrepreneurial Restart

Individuals who want to become entrepreneurs need to spend time on an important aspect: risk. They risk not only their financial well-being, their career, their family relations, but also their physical well-being. Indeed, asking nascent entrepreneurs about anxieties preventing them from becoming entrepreneurs at the end, they prominently refer to financial risks. However, is their fear justified? How likely is it that entrepreneurs suffer private losses from business closure? And what does it mean for their entrepreneurial career if private losses occur? May it even be more likely that losses at other stakeholders are more important for an entrepreneurs’ further entrepreneurial career? Financial losses arising from business closure can befall various stakeholders: shareholders, banks and public institutions, or suppliers and other stakeholders. It is reasonable to expect that financial losses impact the likelihood of a restart as a function of the stakeholders who have been forced to bear losses. Because most start-ups rely on entrepreneurs’ own capital there is a high probability that entrepreneurs themselves are financially affected by loss-making business closures. This would, as a consequence, reduce their personal wealth, the fundament of future actions. However, it is of twofold importance if banks suffer losses. First, losses at banks are likely to be strong correlated with personal losses of the entrepreneurs reducing entrepreneurs’ personal wealth. Second, losses at banks are "public" debts impeding the chance of credit from other banks. Both are bad for restart feasibility. Multivariate analyses reveal that the occurrence of private losses of the entrepreneurs does not affect the restart likelihood. Losses are merely important if they arise at banks or public institutions. Then, restart is less likely. This effect may be the result of the role that banks play with respect to start-up financing, where they are often the first address to turn on. Furthermore, the type of closure matters. Restart probability is higher if the closure was result of management disagreements. Surprisingly, restart probability is independent from closure types that can be considered a business failure. This means, that if closures took place because the business development does not meet the entrepreneurs’ target thresholds of performance or because of liquidity problems or excessive debts arose, restart likelihood is not affected significantly. This was not expected since other studies show that restart is less likely in the case of business failure. However, it might be that there the closure type measures capture effects that actually come from incurred losses for which it was not controlled. The major finding of this analysis is that financial losses due to business closure are important for the occurrence of an entrepreneurial restart – if the losses incur at banks. This has an important implication for entrepreneurs. Entrepreneurs who want to continue their entrepreneurial career after a business closure should avoid losses at banks or public institutions.

Metzger, Georg (2008), Firm Closure, Financial Losses and the Consequences for an Entrepreneurial Restart, ZEW Discussion Paper No. 08-094, Mannheim.