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17 September 2004
Young Company Finance September 2004
Shades of Gray - Young Company Failures Revisited


“I believe” says Nelson Gray “there is actually an understandable, but in some ways unfortunate reluctance to admit the truth about why so many (young Scottish) companies have gone down.  “Because people don’t want to belittle other people, they don’t want to be seen to criticise. Because we are meant to be encouraging entrepreneurship, the people who are in the in the entrepreneurship promotion game find it very difficult to say publicly, ‘Well that company crashed because, frankly, the management was not good enough’. You can’t say that publicly, but probably that is what happens.”

Gray, one of Scotland’s most prominent and successful business angels and fund managers, has agreed to add his insight to a question now troubling Scottish Enterprise, as revealed in the August issue of Young Company Finance. “Sometimes it is dressed up for public consumption, or even for the  investors’ own kind of self esteem or ego: ‘We didn’t quite manage to get the product to market or we failed because we ran out of cash’”, says Gray. “It’s rather like saying the patient died because his heart stopped!”

This reality pill may prove difficult for many people to swallow, but Nelson Gray insists that it is vital that while we encourage entrepreneurship, we do not
downplay the “natural risks”. He reaches for and quotes from an analysis
of business statistics, admittedly from an American source but nevertheless
relevant. “After three or four years the chances of still being in business are 25
percent, a failure rate of 75 percent, and then this goes on to list the probability
of winning on slot machines (32 percent), horseracing (41 percent), and
blackjack (45 percent). Ergo, business owners might have a better chance of
success if they went to Las Vegas and gambled their investments”.
“That’s not because people are stupid. It’s because business is really
tough and not all the factors are under the entrepreneur’s control”, says Gray.
He illustrates the point with the story of a company he is currently investing
in. They are owed £60k by a customer which recently went bust: not enough
to bring them down, but enough to wipe out this year’s profits and put
them back in overdraft. “It could be argued that the management should
have seen that coming, that they shouldn’t have extended that level of
credit, but sometimes small businesses have no alternative but to take that risk
if they want the sale. You’ve got all sorts of other risks, from key people
leaving, to large companies simply taking too long to make up their minds to
take up your product.”

Gray agrees with Peter Shakeshaft who last month told YCF that out of every 10 start-ups, he would expect that two would “take off”, four will be unspectacular survivors, while the rest would fail. “What you’re really saying is that
over time you’ve got two winners out of ten, but picking the winners is really
tough, and as a fund manager you have to say you believe in all your companies and work with them for a very long time”.  That, says Gray, is what is happening
now in a lot of angel networks here, and is also what he has seen in America
where “syndicates are being formed in order that they have both the capital
and intellectual base to support a company for four or five years or more”.

He also praises the Prince’s Scottish Youth Business Trust, which is not only
making loans of £5,000 to £25,000, but is prepared to put in a huge amount of
aftercare. He believes that new companies need “mentoring, coaching, bullying,
the occasional kick and the pat on the head” in what is often an emotional
roller coaster. He is less than confident that the public sector can
provide that sort of help and assistance. “Apart from the skills and experience
issues, it’s questionable whether the public sector could, or even should, take on the potential personal liabilities that working that close to a company can bring.”

He wonders if Scottish Enterprise is perhaps funding too many small businesses
with not enough money and very little ongoing management support; he is concerned about the lack of financial training at the local enterprise
company level, “the hard stuff, like what does your balance sheet look like
and what does your cash flow look like”.  It does not stop there. Gray also
wonders if in the drive to promote entrepreneurship, support organisations
inflate the expectations of start-ups. “Anyone who wants to start a business,
almost regardless of how good or bad their idea is, seems now to be an instant
‘entrepreneur’. It’s a hard judgement call to make, but sometimes the
best advice should be ’don’t do it’. We all know that not everyone can be a jet
pilot or an olympic sprinter. We should admit the same with entrepreneurship.
A bit of early honesty could save a lot more pain at a later date. In the USA
they often seem more willing to make it a condition of investment that the person
with the idea takes on a true entrepreneur to drive the company forward.”
But he complains that Scotland – crucially - does not have a sufficiently large pool of talented and experienced managers to parachute in to early stage companies. “It’s a catch 22. You need high quality managers to improve the chances of success, but given the risk, and the limited cash start-ups have, it’s hard to get such people to
put their reputations on the line. And frankly we don’t yet have enough cashed-out entrepreneurs to go around. Much of this input therefore needs to be given by investors. Perhaps some of the funding now going to consultants to make companies ‘investor ready’ should instead go to help with post investment support?”

Gray is also brutally frank about company founders who think, because they are brilliant academics and research scientists, they will also be brilliant CEOs. “A lot of academics just don’t understand what a start-up managing director’s job is. Suddenly they don’t have the support mechanisms of a university anymore and they are responsible for every small operational detail, from negotiating with suppliers
and dealing with the bank, to coping with employment law. It can be quite obvious what needs doing when you’ve done it 27 times before, but I think in a lot of cases companies do need real hands-on, detailed help. Too many would-be  entrepreneurs don’t realise they need help until it’s too late. That’s why we have to be a bit more honest with people when we are promoting entrepreneurship. If they understand the real difficulties and stresses, perhaps they will be more willing to improve their chances of success by taking help, training and support. That’s
why I am such a keen supporter of the Entrepreneurial Exchange. Members get the opportunity to learn from others who have gone before.”

Scotland, says Gray, has come to accept that being an entrepreneur is a good thing. “The problem is in promoting this and saying, ‘this is really good, you should have a go’, but it’s quite hard to add, ‘but by the way, there’s a 75 percent chance you’re going to fail,even if you’re good’. Getting people started in business is not enough. We need to continue to nurture and support them for many years afterwards. I
see this in the Entrepreneurial Exchange. Members with turnovers of less than £1 million are learning from those with £5 million, while they in turn are learning from the £20 to £50 million people. We have ‘life long learning’ for individuals and we now need it for entrepreneurs, with the help of entrepreneurs.”



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