Lately, Republican candidates are taking shots at Mitt Romney because in his private equity life he had some failures. Democrats have made no secret that they are going to go after Romney because in his private equity life, he had to shut down some unprofitable plants to save businesses. Heaven forbid, other businesses he invested in went belly up. I am not here to defend or advocate for any particular candidate, but I do think that Americans need a much better perspective on failure.
Why are we so hard on failure?
One of the things the start up community does is embrace failure. When a company goes under, you learn from it. I have invested after tax dollars that were hard to earn into many companies, and not all of them have worked out. One went belly up. One is marginal, one is on fumes, and the rest are operating, but like any company they have challenges. I have had some exits too. But, even those had many twists and turns along the way and the company could have gone under.
Being in business isn’t easy. It’s risky. If it were easy, we’d all leave our cushy government and corporate jobs and go on our own and start entrepreneurial companies. But, statistics show that fewer than 30% of all start up businesses make it ten years. Starting a business isn’t rocket science, but it’s a heckuva lot tougher. But, encouraging people to take that risk leads to gigantic gains for our entire society.
To give you a little perspective, you need to know what Romney engaged in. He was in what is called Private Equity (PE). Most people confuse Private Equity with Venture Capital (VC). Venture invests in newer companies that have a new technology. Private Equity invests in an existing company that has been operating and reinvents that company. Usually, PE firms use a lot of leverage (debt), to generate returns. Extra leverage on the balance sheet magnifies the rate of return if the company can afford the debt load. If the company can’t afford it, it either restructures again or goes bankrupt. The reason it’s called Private Equity is that the money for the fund comes from private sources, not government sources. The companies that the PE firm buy and run are not listed on public markets, but closely held. The big payoff for PE comes when they spin the companies back out into the open market through an IPO or acquisition. Private Equity firms take risk.
With the assumption of risk comes the chance that occasionally things won’t turn out for the best. Sometimes, companies the PE firm buys fail. There can be a huge cadre of reasons for that, and if you listen to a PE guy talk about their failures it generally centers around some of the business decisions the firm made to engage with the marketplace. Sometimes, it’s even a bad market.
Today, Eric Lekofsky($GRPN) wrote an interesting piece on one of his firms, Innerworkings($INWK). Innerworkings has been a very good business, but for awhile the stock cratered. The decline didn’t have a lot to do with the company operations, but demand for the line of business that the company was in. Printing decreased significantly in 2008. Not a lot Innerworkings could do to avoid the tsunami of the banking crisis. Other firms ($CME) were directly affected too, and we know how that turned out.
How firms responded to the crisis and how they were managed after says a lot about them. It’s also reflected in their stock price. Look at the following chart and you would have to conclude management did a helluva job, even with the failure in 2008-09. They were down 88%!
What do you think INWK’s management team did in December of 2009? My guess is they embraced their failure and learned from it. Failure was accepted and put behind them. They adapted and then ran with a new business plan. No doubt, Mr. Private Equity Romney was faced with similar circumstances with companies he had poured money into. Sometimes he failed, but the scorecard says he made the right decisions more often than not.
In the case of the candidates that are lining up to take shots at him, Gingrich, Santorum, Paul, Huntsman and Obama, only one, Jon Huntsman, has run a real live on the ground business. The rest are political operatives and we know that politicians don’t know very much when it comes to analyzing profit/loss businesses. (think Solyndra, Fannie Mae $FNM, Freddie Mac)
In America, we need to learn to learn how to appropriately deal with failure. That doesn’t mean we celebrate it. It does mean we encourage people to go out into the world and take calculated risks to try and create businesses that make society more productive. In the process, some will hit, and their founder will get rich. Most will fail, but we learn from those failures, pick up the pieces and start again. Lashing out at people that have had failures make us more risk averse and less willing to take a chance. That sort of attitude doesn’t lead to a better American society.