A Well-Prepared Entrepreneur Is Worth His Weight in Gold

Lessons from a business failure

12/02/2014 Barcelona

Alberto Fernández Terricabras

“One afternoon we decided to close the business. I think it was a good decision.” Sandro Bortesi started a business and failed. His Racing Masters, an entertainment center for professional pilots, despite its expensive and delicate cars, its engineers and corresponding team of mechanics, barely lasted 18 months.

Sandro not only had the courage to recognize his failure in time – which meant the investors were able to recover 80% of their capital and Sandro could continue working for them as a private equity consultant – he also was generous enough to share his experiences with those attending the Continuous Education session “Learning About Entrepreneurial Failure from the Entrepreneur’s Perspective”, organized by IESE Alumni Association in collaboration with Finaves.

An excessively optimistic business plan

One of the most frequent errors that entrepreneurs make is to have excessively high and unrealistic expectations. In general, they tend to underestimate the outgoings and overstate their income. Sometimes this is because there isn’t a market or it hasn’t been well quantified. (A piece of advice: if you spot a business opportunity that no one else has taken advantage of, ask yourself 1,001 times why.) On other occasions it’s because there’s too much competition or competition that has resources that you can’t match, or because you are unable to differentiate yourself from them.

Sandro explained that he was the one who designed the business plan. He went over it and over it, producing 25 different versions in Excel, he did the numbers over and over again, but the day came when he had to face the reality: “It was impossible to carry out,” he said. Clients didn’t appear, the costs continued and there were soon liquidity problems. “The championships boycotted us and the pilots didn’t want to come. We didn’t have any political cover,” he said.

IESE Prof. Albert Fernández, who moderated the session, shared his experience as director of Finaves. “In 90% of cases that I see, the predictions are very optimistic although the entrepreneur is always convinced that they’re very conservative.” For this reason he recommended playing devil’s advocate with the project and to carry out an exhaustive and rigorous analysis of both the market and the competition and factor in “every variable:” costs, salaries, and remember that the cost of the management team has to match and be linked to the speed at which income is arriving, and not, as Sandro admits it they had done, the other way round. They designed their business plan from a bottom-up perspective, that is, based on what they wanted to get from the project rather than what it was really capable of delivering.

Problems with partners

Cash flow tensions tend to arrive sooner than later, as well as tensions between partners (as Sandro says, the typical reaction being “I’m not taking a salary cut”). One of the three partners and co-founders left at the start as he couldn’t provide the capital agreed. As his contribution to managing the project was considered critical for its development, he remained involved. However, the other two partners had to make up for the shortfall. The withdrawal of a partner or lack of understanding is a common problem and can create serious consequences as traumatic departures can leave significant gaps in capital and know-how.

Sandro and Fernández were in complete agreement on this. You need to know the founding partners really well, you have to understand their real motivations, their personal circumstances and what really matters to them. Some may decide to enter into a business, as Sandro did, because it’s the “project of a lifetime,” and be prepared to fully dedicate themselves to it. Others, on the other hand, may do it just for money and with a short-term outlook. The important thing, whatever the case, is to talk, and above all talk about the trickiest and most problematic questions, which are the ones we tend to overlook.

On the subject of finding good partners, Fernández made four simple recommendations: avoid flashy partners, know about their relationships and lifestyle, share responsibilities with them and make the best possible agreement. Furthermore, he added, it’s vital to have a demanding and hands-on management committee that doesn’t just play a consultant role.

Lack of finance and cash flow problems

Sandro said that the financing for the idea wasn’t a problem for them. On the contrary, it was surprisingly easy. In barely a couple of months and in two rounds they obtained €870,000. “We didn’t expect to get the money so quickly.” However, there was something before the fundraising phase that should have alerted him: Although everyone loved his idea (not only friends and family but also pilots, teams and people from the motorsport world) nobody was prepared to put up any money.

On the other hand, and although they had no problem raising the necessary funds to start the project, there was a lack of liquidity that derived from the impossibility of carrying out business plan. This is a problem that didn’t only affect the business but also the relationships between the investing partners. As Fernández puts it: “The pre-money valuations are exaggerated because the business plan hasn’t been achieved. I say this to many entrepreneurs: ‘Do you want to get finance? Make a low pre-money valuation and gamble on the variable.’” The same thing that applies to the business – not putting in a lot of fixed costs and focusing on variable costs – is also good for the relationship with the investor. “An entrepreneur who is not prepared to gamble on the variable is one who doesn’t believe in their business plan,” he said.