ENTREPRENEURIAL FAILURE IN THE SPOTLIGHT OF THE COMPETENCE-BASED THEORY OF THE FIRM

Prof. Dr. Jörg Freiling* Full Professor University of Bremen Chair in Small Business & Entrepreneurship Wilhelm-Herbst-Str. 5 D-28359 Bremen E-Mail: [email protected] Phone: +49 421 218 66870 Fax: +49 421 218 66902

Dipl.-Kfm. Jan Hendrik Wessels Research Assistant University of Bremen Chair in Small Business & Entrepreneurship Wilhelm-Herbst-Str. 5 D-28359 Bremen E-Mail: [email protected] Phone: +49 421 218 66878 Fax: +49 421 218 66902

* Corresponding Author

Abstract: The market process selects out a huge number of new ventures. Five years after foundation only about half of a source population remains in the market. Compared to research on entrepreneurial success factors, new venture failure is supposed to take the back seat. Many findings on business failure address more the symptoms (e.g. financial distress) than the final causes. Against this background, this article outlines an explanation of entrepreneurial failure in spotlight of the Competence-based Theory of the Firm (henceforth: CbTF) to explain the oftentimes long causal chains of entrepreneurial failure.

Keywords: Entrepreneurial Failure; Business Failure; New Venture Failure; Competencebased Theory of the Firm; Case-study Research.

INTRODUCTION From a macroeconomic point of view the core element of the market process is to intermit new ideas and new ventures to a selection process. From evolutionary theory we know the basic pattern of variation, selection, and retention (Aldrich and Martinez 2001) that mirrors the logic of the market process as well. As for new ideas and start-ups, this logic implies that only a part of the initial population is able to survive over a longer period of time. Statistics on insolvencies (e.g. Creditreform 2009; Schrör 2009) as well as numerous empirical work (Mata and Portugal 1994; Wagner 1994; Mahmood 2000; Fritsch and Weyh 2006; Brüderl et al. 2007) reveal that almost 50% of new ventures fail within five years after foundation. Ten years after founding, however, ‘age’ as a variable loses its influence on the survival of the firm (Wagner 1994; Mahmood 2000). After this time, only ten percent of the initial population remains in the market wherefore Timmons and Spinelli (2007: 84) state: “[…] for new businesses, […] failure is the rule, not the exception“.

However, in the face of the manifold liabilities of new ventures these results are not surprising. Start-ups are confronted with liabilities of newness and adolescence (e.g. reputation disadvantages of new ventures) (Stinchcombe 1965; Brüderl and Schüssler 1990), liabilities of smallness (Aldrich and Auster 1986), and in case of international entrepreneurship liabilities of foreignness (Hymer 1976; Zaheer 1995). A higher longevity of the ventures could be desirable from a macroeconomic and microeconomic view as well. It would strengthen the positive new venture effects of economic renewal and employment creation (Fritsch et al. 2004; Hagen et al. 2011). Therefore, this phenomenon of entrepreneurial failure is the centerpiece of this paper.

There is a striking evidence as for the asymmetry between research on critical success factors on the one hand and research on factors causing business failure on the other. Besides the vast literature on key success factors (e.g. Stuart and Abetti 1987; Roure and Keely 1990; Cooper et al. 1994; Baptista et al. 2007), little has been said about the final reasons of failure (for further comments on this issue see also Bruno and Leidecker 1988; McGrath 1999; Zacharakis et al. 1999; Shepherd 2003; Cope et al. 2004). Notably, success and failure are not two sides of the same coin considering that research seldom conceptualizes successful ventures as non-failed (Castrogiovanni 1996). Despite that, research on success factors is 2

somewhat questioned in terms of rigor and relevance (Kieser and Nicolai 2005). There are numerous ways to be successful and every day the number of promising options grows. For example, Timmons and Spinelli (2007) identifiy more than one hundred success factors. Oppositely, however, we can expect that for the very nature of entrepreneurial failure only a limited set of factors applies and that failure paths seem to be rather similar if we compare insolvent firms.

The run of events is a critical dimension since failure is the negative outcome of the last stage of a corporate crisis. Business research presumes that corporate crises are complex phenomena of oftentimes long-term evolved trajectories of manifold and interrelated causes (Seeger et al. 2003). It is not easy to separate causes, effects, and symptoms of a firm’s crisis. Therefore we presume that the aim to figure out stand-alone factors of success and failure is quite questionable. But especially in context of failure it seems that processes of business failure evolve and form a pattern. Moreover, we assume that there might be some typical factors that trigger processes of failure. E.g. shrinking turnover causes financial trouble which often ends in a bad reputation and so forth. Thus, a more or less self-energizing process is triggered and runs along an often precarious path. To date, we know little about these patterns. Related to the status quo of research on business failure Thornhill and Amit (2003, p. 479) state: "[T]he mechanics of firm failure remains an understudied phenomenon". In this context Sitkin (1992) emphasises the comparatively high benefits stemming from analyzing entrepreneurial failure – an up to now widely unnoticed remark.

Against this background, we scrutinize causes and effects of entrepreneurial failure. Thereby we address a research gap by raising the research question: What are reasons and patterns of entrepreneurial failure? To answer our question, we proceed as follows: First, we provide a basic understanding of the subject matter of entrepreneurial failure and highlight the status quo of research on entrepreneurial failure. Related to that, we employ competence-based theory of the firm (henceforth: CbTF) as a branch of research on dynamic capabilities (Freiling et al. 2008) which belongs to the interpretive paradigm (Burrell and Morgan 1979). On this basis we deduce main causes for and patterns of entrepreneurial failure and draft a priori propositions which is in line with the abductive research process of our study. Finally, we give insight in our case-study designed empirical work, discuss our findings and give a brief outlook on further research possibilities. 3

CONCEPTUAL FOUNDATIONS AND STATE OF THE ART OF ENTREPRENEURIAL FAILURE Before we address research on causes of entrepreneurial failure, we outline a measure for entrepreneurial failure. Thereby we refer to Watson and Everett (1993) who present four measures of entrepreneurial failure: (1) insufficient revenues, (2) discontinuity (change of ownership, closure) for any reason, (3) liquidation or sale to prevent further losses, and (4) bankruptcy.

It is somewhat difficult to establish an overall understanding of entrepreneurial failure as these measures comprise different elements and range on different levels. The most undoubted indicator of business failure is bankruptcy but only a minor part of failed ventures really go bankrupt while the most are liquidated (Egeln et al 2010; Hagen et al. 2011). Liquidation or sale of a company to avoid further losses imply actions due to business distress as key deciders see no more opportunities for success. Inadequate revenues, however, not necessarily require situations of acute distress and characterize so-called ’living dead‘ ventures (Ruhnka et al. 1992; DeTienne et al. 2008) that still exist on the market but generate marginal revenue compared to the original expectations of founders and investors. For this reason we argue that bankruptcy, liquidation, and sale to avoid further losses as well as ‘living deads’ are adequate measures of new venture failure while discontinuations for any reason, however, can also be attributed to acquisitions of rather successful firms or personal reasons such as illness or age and are therefore not regarded as entrepreneurial failures within the scope of this paper. In this sense, entrepreneurial failure is the final step of a more or less long-lasting negative development.

The phenomenon of entrepreneurial failure is far from being well explored in business research although many studies focus on the analysis of insolvency and crisis (Hall 1992; Stokes and Blackburn 2001; Bates 2005; Saridakis et al. 2008). Based on a literature review about the failure of businesses in general, Crutzen and van Caillie (2008) point out that most contributions either employ an organizational or a financial approach to research on business failure. This goes along with a preference to focus on specific stages of the failure process. While organizational approaches tend to focus on the early stages and therefore on the causes of the failure process, financial approaches (cf. Balcaen and Ooghe 2006) pinpoint 4

the last stages and their respective financial indicators of failure (Crutzen and Van Caillie 2008). In sum, the outcome of existing research is quite heterogeneous and addresses different parts of the causal chain of entrepreneurial failure. Financial approaches mostly examine operational factors (e.g. measuring indebtedness, cash flow to net sales ratio, or cash flow to total debt ratio) and, thus, address more the symptoms associated with the economic situation of the venture rather than focusing relevant strategic aspects (Laitinen 1992; Sullivan et al. 1995). While ‘failure prediction models’ allow estimating the probability of venture failure and therefore provide monitoring information for investors, they do not contain meaningful information on the root causes allowing a deeper understanding of failure reasons as well as sound implications for entrepreneurial decisionmaking. To derive managerial implications, identification of causal relationships of new venture failure is needed (Abdelsamed and Kindling 1978). As mentioned above, earlier steps of entrepreneurial failure are addressed by organizational research approaches on critical factors of entrepreneurial failure that we will outline next.

The hazard rate of new ventures is addressed by manifold studies based on population ecology theory (Hannan and Freeman 1977) that address obstacles of new ventures by liabilities (e.g. ’liability of smallness‘ (Welsh and White 1981; Aldrich and Auster 1986) and ’liability of newness and adolescence‘ (Stinchcombe 1965; Hannan and Freeman 1984; Brüderl and Schüssler 1990; Fichman and Levinthal 1991)). Related to that, Audretsch and Mahmood (1995) state that a low initial firm size, the market entry in times of high unemployment and macroeconomic downturns, founding in a capital-intense industry and the ownership structure of subsidiaries are hazardous to new venture survival. The findings of Mata et al. (1995) suggest that founding in periods of high rates of entry activity in the new ventures’ industry and founding in a shrinking industry have a negative impact on survival. Thornhill and Amit (2003) acknowledge age-varying determinants of firm failure. By applying resource-based theory they find that failure of young firms is caused by a lack of valuable resources and capabilities (in particular deficiencies in general management and financial management abilities), while failure of older firms is related to insufficiently coping with the challenges of a changing competitive environment. With respect to the aim of deriving managerial implications, the deterministic approach of population ecology studies points to external causes of failure that can hardly be influenced by entrepreneurs. However, just in case of entrepreneurial failure, internal factors seem to matter and 5

entrepreneurs have considerable discretion as for the run of events of their venture. Therefore, a more voluntaristic perspective is necessary to better understand the entire set of factors related to start-up failure. We will address this later in more detail below.

In particular in the context of entrepreneurship research we know comparatively little about the root causes of failure (Bruno and Leidecker 1988; Cope et al. 2004). Table 1 portrays manifold findings whereby lacks of capitalization and management skills as well as doubtful strategic decisions are pointed out as main problematic areas of new venture failure (Duchesneau and Gartner 1990; Venkataraman et al. 1990; Bruno et al. 1992; Lussier 1995; Zacherakis et al. 1999; Egeln et al. 2010).

- insert table 1 about here -

Most research highlights that managerial shortfalls of founders predominantly have a considerable impact on new venture failure. These deficiencies are particularly relevant in early phases of the start-up process as main reasons for bankruptcy (Pennings et al. 1998; Stam et al. 2010). The finding is rather unspecific for no generalizable deficiencies can be specified. Moreover, the causality is not really surprising facing the oftentimes small number of people involved in managing the venture in early stages of development. Independent from insolvency surveys, there is some empirical evidence that the availability of entrepreneurial skills positively correlates with entrepreneurial performance (e.g. Bates 1985 and 1990; Stuart and Abetti 1990; Brüderl et al. 1992; Herron and Robinson 1993; Chandler and Hanks 1994; Storey 1994; Brüderl and Preisendörfer 2000; Lee et al. 2001). Colombo and Grilli (2007) analyze the relation between entrepreneurs’ human capital and growth of new technology-based firms based on econometric models. Their findings indirectly reveal that entrepreneurs of technology-based firms possess a very different set of skills and, therefore, prefer working in teams for the purpose of closing managerial gaps and triggering synergies. Freiling (2009) analyzes statistical surveys on managerial problems of founders. The commonalities are rather obvious: Insufficient knowledge and skills in the realm of finance, accounting, and taxes on the one hand and marketing issues on the other are the most critical shortfalls of founders. As for human capital, Cooper et al. (1994) and Dahlqvist et al. (2000) note that general human capital is related to entrepreneurial failure. Rauch and

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Rijsdijk (2012) added to this debate that special human capital has direct negative effects on business failure.

Besides economic reasons of new venture failure there seem to be quite meaningful findings from behavioural theory dealing with entrepreneurial failure. Entrepreneurship research has pointed out that entrepreneurs are more prone to heuristics and certain cognitive biases than other people (Busenitz and Barney 1997). They argue that established firms are more likely to have developed routines in decision-making that reduce the complexity in decisionmaking for managers in a reasonable manner (Nelson and Winter 1982), while start-ups typically lack such routines due to their short history, causing entrepreneurs to (over)simplify decision-making by relying on biases and heuristics. Despite the effect of complexity reduction, this may lead to serious and often path-related errors. E.g., Ucbasaran et al. (2010) note that entrepreneurs, compared to non-entrepreneurs, have a greater tendency to be over-optimistic. Hmieleski and Baron (2009) state a negative relationship between entrepreneurs’ optimism and the performance (in terms of revenue and employment growth) of their new ventures. In this context, Cassar (2010) finds empirical evidence for considerable over-optimism in nascent entrepreneurs’ expectations that end up in overestimation of the business’ future performance. Surprisingly, (nascent) entrepreneurs who do business planning reveal even stronger effects of the over-optimism bias than those who do not. This is consistent with the findings of Forbes (2005). Entrepreneurs exhibit more overconfidence the higher their firm’s managerial scope in terms of scanning, analysing and planning is. In the context of failure, over-optimistic business planning, e.g. in terms of turnover forecast, may (mis-)lead the entrepreneur to expenses based on turnovers only expected by the entrepreneur. Besides this potential threat of liquidity problems it seems rather obvious that overconfident entrepreneurs get frustrated when facing unexpected outcomes. This may finally lead to business closures.

Understanding entrepreneurial failure as a process involves a closer look at the run of events. Organizational crises usually develop over a longer period of time. With respect to the mentioned managerial shortcomings and to the finding of poor strategic decisions of failed entrepreneurs as main causes of new venture failure we need to take a closer look at the mechanisms that prevent start-ups from turning back to a sound organizational path of development. Insofar, we need to better understand phenomena like lacking responsiveness 7

and persistence of poor strategic decisions in the context of organizational trajectories of the new venture. These phenomena may be closely related to the already mentioned cognitive biases.

The reason for this is that ventures typically show up in competition with rather scarce resources so that initial decisions go along with considerable organizational commitment. As path dependence research (Sydow et al. 2009) and research on organizational decline suggest, ventures may be locked-in on unfavourable organizational paths - often without considerable chances to break them. Against this background, research on organizational decline and path dependence stresses the importance of prior successful and well-established routines. Routines and heuristics enable entrepreneurs to efficiently resolve recurring problems. While routines provide the venture with stability and predictability in their activities, they often simultaneously reduce the firm’s responsiveness - be it caused by irreversible investments or by cognitive inertia. Thus, many scholars point to the ‘success breeds failure’ phenomenon (Miller 1990, 1994; Whyte et al. 1997; Audia et al. 2000; DeNicolis-Bragger et al. 2003; Barnett and Pontikes 2008) that rests on a non-reflection and non-questioning of successful routines and heuristics. In this sense, entrepreneurs could make use of dysfunctional routines and/or heuristics when new or adjusted solutions are necessary. The reasoning is similar to the Leonard-Barton (1992) debate on core rigidities. Dysfunctional persistence of established and formerly successful routines is core of the threat rigidity phenomenon as well. But while ‘success breeds failure’ addresses causes for crisis development, threat rigidity refers to the reaction to threatening situations in the realm of avoidance strategies and an increasing non-recognition of the organizational environment (Kiesler and Sproull 1982; D'Aveni and MacMillan 1990), e.g. because of uncertainty about the effectiveness of new patterns of action (Staw et al. 1981; Hambrick and D’Aveni 1988).

Besides dysfunctionality of successful routines, escalating commitment points to the effects of unsuccessful actions and decisions in terms of mental lock-ins. While resource commitment involves investment decisions in connection with sunk costs (Staw 1997), cognitive commitment refers to the motive of self-justification. That is, decisions and their respective consequences are to be justified to oneself and to others which triggers suppression or misinterpretation of negative feedback. Cognitive commitment occurs when decision makers feel personally responsible and is caused by fears of failure (of possible 8

consequences, such as loss of face) or too high levels of self-efficacy as to one’s own problem solution capability (which is closely related the concept of internal locus of control, cf. Staw and Ross 1987; McCarthy et al. 1993; Staw, 1997; Whyte et al. 1997). Closely related to that, Kiesler and Sproull (1982: 560-561) highlight the role of mental models that reflect in cognitive and emotional dependence to planning efforts: „When managers have a personal stake in the plans, they will be likely to underinterpret stimuli indicating planning failures or overinterpret stimuli indicating planning success.“ We can assume that underinterpreting stimuli that indicated planning failures is also closely related to selfjustification.

With respect to the state of research on new venture failure we conclude the following interim result: Considering the findings on organizational decline and behavioural research we need to be aware of root causes that may stimulate or contribute to escalation of processes of new venture failure that are usually looked at from an economic perspective by entrepreneurship researchers. In spite of organizational approaches of research on entrepreneurial failure, there is striking evidence of the heterogeneity of research designs applied and the heterogeneity of their findings. Thus, the picture of strategic aspects relevant to entrepreneurial failure is still vague and rather diffuse. Moreover, empirical surveys on the causes of entrepreneurial failure do not tell us meaningful details on the causal chains and the run of events in case of failure. Causes, effects and symptoms are neither explicitly pointed out nor aligned in a causal relationship. Moreover, empirical research relies predominantly on quantitative methods (as for some exceptions see Bruno et al. 1992; Zacherakis et al. 1999; Pleschak et al. 2002) and lacks theoretical background. The lack of longitudinal studies is rather evident and marks a cornerstone for further research on this issue (Rindfleisch 2011). This situation relies to a large extent on the problem of identifying failed entrepreneurs willing to tell their story. Besides that, empirical research in this realm is problematic since cognitive biases of failed entrepreneurs oftentimes play an important role. Attribution theory (Weiner 1986) stresses the self-serving bias and actor-observer bias that entrepreneurs tend to attribute failure to external factors whereas they trace back causes of success to their own personal behalf (Zacharakis et al. 1999; Silvia and Duval 2001). E.g. in the survey of Egeln et al. (2010), 37% of asked entrepreneurs claimed a negative market development as a cause of the failure of their ventures – despite the fact of overall positive rates of market growth in their respective branches during the period of their existence. Yet, the methodological 9

problem of a single informant bias (Kumar et al. 1993; Ernst 2003) is not adequately considered in research on new venture failure. We will address this in more detail in our research methodology section. THEORETICAL EXPLANATIONS AND A PRIORI CAUSALITIES Theoretical Approaches and the Nature of Entrepreneurial Action Business and management studies deal with different paradigms and theoretical traditions. E.g. in market equilibrium, there is no room for entrepreneurial action. Aspects of incomplete and asymmetrically distributed information, undiscovered opportunities, different levels of motivation, lacking skills and capabilities, however, are - as cornerstones of entrepreneurial action - dynamic real-world phenomena and should be addressed by theoretical frameworks. What are adequate theories? The search starts with considering antecedents that reflect the reality of new venture processes. In order to address this issue in more detail below we need to recall for the essence of entrepreneurial action.

With respect to the very nature of venturing we can summarize that founding new firms by entrepreneurs - be it stand alone or in teams - happens in a typical context: Every entrepreneur is equipped with an individual (and incomplete) set of information, knowledge, skills, and ambition. Entrepreneurs strive for satisfying their needs (Campbell 1992) - be they of the economic (e.g. income, profit), social, or psychological kind. Besides the findings from goal setting theory (e.g. Locke and Latham 2002), entrepreneurship research tells us that creative freedom, autonomy, and self-realization besides economic issues rank among the top motives that drive entrepreneurial action and start-up processes (Kuratko et al. 1997). Different from persons scrutinized in typical areas of business research, entrepreneurs are people equipped with a willingness to shape the outer environment to position their firms and themselves in a favourable fashion. An internal locus of control is the according feature that entrepreneurship research often uses to address the nature of entrepreneurs (e.g. Kroeck et al. 2010). It reflects the rather voluntaristic viewpoint as for the relationship between entrepreneurs and their firms on the one hand and business environments on the other. Finally, understanding the nature of venturing takes an explicit consideration of time. Entrepreneurs start with certain competitive moves. These moves force themselves and maybe even other parties to make related decisions. This causes competitive dynamics and

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often creates moderate states of path dependence. It suggests that time and, therefore, the chronological order of the run of events play a pivotal role.

In terms of the paradigmatic grid developed by Burrell and Morgan (1979), the cluster of the ‘interpretive paradigm’ represents a sound starting point for understanding entrepreneurial failure in terms of the core assumptions. Referring to Freiling et al. (2008), theories of this tradition primarily assume: subjectivism of the people, radical uncertainty, moderate voluntarism and relevance of time. As for human behaviour, there are different concepts how to model it. However, all the concepts employed have a common denominator. Different from the homo oeconomicus concept, they regard people as striving for making rational decisions, equipped with free will and trying to modify the set of targets, means, and alternatives in a manner that is favourable from their personal point of view (Mises 1949). Mostly, people are not able to make perfectly rational decisions. Due to a lack of information, knowledge, skills, and experience, they decide according to the ‘trial and error’ notion that is mirrored in von Mises’ (1949) concept of the acting man (homo agens). More than that, perception and evaluation schemes among people differ and cognitive biases occur that might lead to misinterpretations and misbelieves. In this respect, people often make promises they are unable to keep. The last aspect holds particularly true in case of overoptimistic entrepreneurs. Insofar, the rather new envelope concept of ‘bounded reliability’ (Verbeke and Greidanus 2009) is a sound candidate to consider this and to replace the oversimplistic concept of ‘bounded rationality’.

Comparing the reality of start-up endeavours in the context of entrepreneurial failure as outlined above with these antecedents, we conclude that this set of assumptions is to a large extent able to reflect entrepreneurship reality. Insofar, we adopt this set of antecedents henceforth and employ the competence-based theory of the firm (CbTF) to develop causeand-effect structures that shed light on entrepreneurial failure as the dependent variable by addressing firm’s resources and capabilities as crucial drivers of failure processes.

A Competence-based View on Entrepreneurial Failure Since the explanandum of CbTF is competitiveness or survivability, respectively, this theory is directly related to the research question of our paper. Building on market process theory of the Austrian School (e.g. Mises 1949), CbTF deals with the notion of trial and error. Due to 11

incomplete and asymmetrically dispersed knowledge in the market people develop expectations based on prior knowledge as a frame of reference for decision-making. Due to uncertainty, the real outcome of decisions is in most cases different from the expected. This causes adapted expectations and new actions - and so forth. However, based on the availability and use of knowledge and skills there are sometimes monumental differences among entrepreneurs. The differences cause a specific handling of the entrepreneurial actions that help explaining performance measures such as survivability or competitiveness.

When looking for reasons for unbalanced entrepreneurial skills and poor decision making, we come back to the antecedent of subjectivism. Since organizations as well as people differ in what they know, can, and want and idiosyncrasies are a pervasive fact of (economic) life, it is not astonishing at all, that successful and non-successful entrepreneurs differ in this respect. The results of empirical surveys (cf. section 2) on this research topic clearly support this reasoning. In addition to that, these studies specify the deficiencies related to the start-up process. We consider CbTF useful to explain entrepreneurial problems in connection with assets, resources, skills, and capabilities and employ the terminology in terms of Freiling et al. (2008).

Entrepreneurial action requires the availability of a certain resource endowment and, in particular, knowledge and skills. CbTF considers firms as open systems (Sanchez and Heene 1996) that are permanently in touch with external parties (customers, suppliers, collaboration partners, consultancies etc.). Figure 1 portrays the interfaces of the firm to the business environment and at the same time illuminates issues of internal coordination. In fact, the exchange processes with external partners and the internal coordination are close to the exploitative actions addressed above while renewal allows for addressing the explorative side of entrepreneurship. In this context, some potential bottlenecks appear that may cause an insufficient handling of entrepreneurial activities. These bottlenecks can be located within the value-added system of the firm as portrayed in the middle of figure 1. The problems can be fixed by integrating external assets of the different kind or by fostering internal development processes of the firm. - insert figure 1 about here –

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Commencing with the elements of the value-added system, there might be absolute bottlenecks when the resource endowment is simply too scarce to be competitive. In this context, the firm might be equipped with an insufficient amount of financial capital, human resources, market assets and so forth. The bottleneck can be located in one category of assets, as empirical surveys quite often reveal. Empirically relevant is to a large extent the case when bottlenecks are an inter-related problem of the entire resource endowment, so that many problems need to be fixed almost simultaneously.

Market process theory and, in particular, CbTF tell us that the resource endowment of firms is constantly in a state of flux. Accordingly, entrepreneurs are often in a position to overcome critical bottlenecks. This, however, requires entrepreneurial foresight and action as well as the activation of certain mechanisms that reinforce the young firm’s resource system. One important cornerstone in this regard is the acquisition of what Sanchez and Heene (1996) call ‘firm-addressable assets. As for these assets we can distinguish among knowledge and other kinds of external assets. In the open system view according to Sanchez and Heene (1996) the firm-addressable assets are not specified as for the resource owner. Cohen and Levinthal (1990) highlighted the vital role of the so-called ‘absorptive capacity’. The absorptive capacity consists of three interconnected elements: the recognition, the integration, and the application of external knowledge to commercial ends (Cohen and Levinthal 1990). Although (external) knowledge might belong to the most important drivers of resource and capability development, we should not under-estimated the need to acquire other kinds of external assets as well.

Different from that, figure 1 highlights the interface between the firm and the product market. In this context, firms constantly learn by participating in the market process. Simply speaking, the more they are involved in transactions, the more they are able to learn and to reconfigure their resource endowment. Once again, due to subjectivism there is no automatism that fuels organizational renewal by learning in the market place. Instead, the firm’s personnel (with contact to the customer) might manage transactions individually. The same holds true for internal reconfiguration processes at the different layers of the valueadded system of the firm. Some firms perform better, i.e. they absorb more information in the market and are more capable in drawing the right conclusions (and implementing the consequences), while other firms perform low. In our context and based on CbTF, we need 13

to consider obstacles to learning and the downside of learning outcomes. First, a low pace of learning as for reconfiguring the value-added system leads to ‘vicious circles’ with unfavourable results. Second, entrepreneurs normally make decisions based on mental models and dominant logics (Prahalad and Bettis 1986) as outlined above. These patterns are useful to reduce the contextual complexity and, therefore, to ease decision-making. However, they could lead to increasing inflexibility and cause unawareness of contextual developments. Via learning pathologies entrepreneurial failure becomes more likely. In terms of the learning model developed by Argyris and Schön (1978) this could imply that, at best, single-loop learning occurs while at the same time useful processes of un-learning do not take place at all. However, in these events, processes of double-loop learning and deutero learning might be useful but do not take place. Such ‘cognitive limitations‘ prevent entrepreneurs from reflecting their own decisions and reinforce the ‘pathological’ trajectory that finally ends up in entrepreneurial failure.

Closely related to that, we look at those system elements that control the entire management and value-added system of the firm. According to figure 1, we refer to the strategic logic, sometimes also called ‘dominant logic’ (Prahalad and Bettis 1986), and the management processes. Both system elements are closely inter-related. The strategic logic consists of previously learned mental models that help decision-makers (here predominantly entrepreneurs) selecting information, getting orientation in a complex and dynamic world, and making sound decisions by activating available knowledge. Since the business environment often and sometimes radically changes, the strategic logic must be responsive to consider novel constellations and ways to success. As figure 1 tells us, e.g. environmental scanning, benchmarking, and advice from consultants (Sanchez and Heene 1996) support renewing mental patterns and, thus, to ensure necessary adaptations of the dominant logic. These adaptations, however, do not happen automatically but depend on the openmindedness of decision-makers, in particular entrepreneurs.

With respect to this, we need to know more about the behavioural and, in particular, cognitive dimension of making decisions by entrepreneurs. The antecedents about human nature tell us that, due to subjectivism, entrepreneurs are equipped with individual interpretation schemes. Despite the considerable variety of the mental structures, prospect theory (Kahneman and Tversky 1979) suggests that certain commonalities exist. People face 14

problems when judging situations in the face of uncertainty. Notably, entrepreneurial tasks are difficult to perform in states of information overload, high novelty, complexity, time pressure, and uncertainty. This makes them prone to cognitive biases (Baron 1998). In fact, some systematic biases are well researched (Kahneman and Lovallo 1993; Busenitz and Barney 1997; Baron 1998; Camerer and Lovallo 1999; Zacharakis and Sheperd 2001; Cassar 2010). They rest on situational contexts faced by entrepreneurs and on individual differences among the decision-makers (Baron 1998; Forbes 2005). However, findings of Burmeister and Schade (2007) remind us to be careful by assuming that entrepreneurs are more biased than other people. In fact, there seem to be differences depending on the investigated bias. Baron (2004) suggests that successful entrepreneurs are less susceptible to certain cognitive biases, e.g. sunk costs, than less successful ones, so even failed entrepreneurs may be especially prone to certain cognitive biases. Keeping this in mind, we find that entrepreneurs judge their individual situation and their skills often in a too positive manner (Forbes 2005). Koellinger et al. (2007) find that this holds particularly true for nascent de-novo entrepreneurs. This over-confidence is problematic for entrepreneurs who make initial decisions and investments that create - often considerable - organizational commitment. Consequently, they believe that difficult situations will come to a good end although information on markets or business environments contradicts this believe (Baron 2004). In these situations they stick to initial mistakes and, thus, create ‘escalating commitment’ (McCarthy et al. 1993; Baron 1998). In the face of the usually scarce resources in case of start-up processes these commitments make entrepreneurs and their firms stick to the wrong track too long so that finally there is no (easy) way out. In terms of research on organizational paths (Sydow et al. 2009) this might create a lock-in the firm can no more escape from. Entrepreneurial over-optimism may lead to planning fallacy (Baron 1998; Forbes 2005). This may be an explanation for the findings that over-optimism is negatively related to, first, performance indicators of revenue and employment growth (Hmieleski and Baron 2009) and, second, nascent entrepreneurs’ survival chances (Koellinger et al. 2007). In addition to the overconfidence bias, attribution biases may hinder entrepreneurs who are on a problematic path to assign causes of problems correctly (Zacharakis et al. 1999; Silvia and Duval 2001). As Baron (1998) points out, entrepreneurs underlie the self-serving bias and, thus, show a strong tendency to attribute positive outcomes to internal circumstances (e.g. own skills) while attributing negative outcomes to external factors. This leads to the problem of commitment described above. 15

CbTF provides us with arguments that help to explain the empirical findings on new venture failure. For the purpose of our abductive research process and explorative empirical fieldwork that we discuss in the next section, we need to be a priori aware of the bottlenecks of the firm’s resource endowment, an insufficient capacity of absorbing external knowledge and other kinds of firm-addressable assets that weaken internal processes of resource and capability deployment, lacking open-mindedness and inflexibility of decision-makers, the downside of learning processes (low pace of learning, inert mental models) and underlying cognitive biases (over-optimism bias, self-serving bias) that can trigger self-reinforcing rigidities and prevent start-ups from necessary adaptations in competition.

RESEARCH METHODOLOGY Research Design The research design should carefully consider the subjective, idiosyncratic, dynamic and complex nature of the failure phenomenon. Moreover, there is a huge research gap as for the final reasons of failure and the typical run of events in those cases. The early state of research reminds us to carefully analyze the often complex web of factors that play a role in case of start-up failure. In the face of these facts, we apply a qualitative and exploratory research design (Eisenhardt and Graebner 2007). Thus, we address context-sensitive process research questions of ’how‘ and ’why‘ due to cross-case research (Yin 2009; Barratt et al. 2011) and refer to the epistemological principle of pattern prediction according to von Hayek (1964) to better understand the basic principles of entrepreneurial failure. To prepare empirical research we condense explanatory variables from previous research and employ a theory that is able to consider them. As for the relevant factors, research on organizational capabilities and competences is in a promising position to consider these constructs. Whereas most streams of competence research seek to explain competitive advantages of firms, the CbTF focuses on organizational survival. It is therefore chosen.

CbTF belongs to the interpretive paradigm that predominantly aims at theory building, striving to generate descriptions, insights and explanations about social phenomena in order to derive a system of interpretations and causalities as for the constitution of processes (Gioia and Pitre 1990). This corresponds with a qualitative and explorative methodological backing 16

of grounded theory (Glaser and Strauss 1967) and case-study design (Yin 2009; Eisenhardt 1989). Thus, we apply CbTF (Freiling et al. 2008) to develop research propositions based on a priori constructs (Eisenhardt 1989, Barratt et al. 2011). By confronting previous findings and theoretical considerations on the one hand with the results of empirical fieldwork on the other, we employ the iterative logic of inquiry based on grounded theory (Strauss and Corbin 1990). This process of research follows neither a purely inductive logic as proposed by early works on grounded theory (Glaser and Strauss 1967) nor a purely deductive logic as proposed by critical rationalists (Popper 1959) but rather an ‘abductive’ logic (Reichertz 2007), as mentioned above.

Literature provides no clear recommendation on the amount of cases needed for cross-caseresearch. Even more, Yin (2009) rejects such a recommendation. In line with von Hayek’s (1964) concept of pattern matching, he argues that case study research should not follow the ‘sampling logic’ of quantitative methods in the sense of ‘statistical generalization’, e.g. surveys, since their purpose is not to scrutinize the scope or frequency of specific phenomena. Instead, he pledges for a ‘replication logic’ approach in the sense of an ‘analytical generalization’. For example, the amount of twelve cases is adequate when the last three cases do not provide an increase of knowledge. On the other hand, Eisenhardt (1989) suggests a minimum of at least four cases for the purpose of pattern prediction due to crosscase research. She argues that more than ten cases are difficult to handle due to the growing complexity of data.

Qualitative case-study based research is confronted with concerns regarding arbitrary, invalid conclusions and problems of generalization (Miles 1979; Gephart 2004; Gibbert et al. 2008). Nevertheless case-study based research has found a growing body of acceptance even in top journals (Eisenhardt and Graebner 2007; Barratt et al. 2011; Welch et al. 2011). To conduct rigorous case study research (Eisenhardt 1989; Eisenhardt and Graebner 2007; Gibbert et al. 2008; Yin 2009) suggests applying four criteria that we address in table 2 in line with the core elements of our research design (for an overview for general means to address quality requirements see Gibbert et al. 2008): First, construct validity refers to the data collection phase and to the extent to which a study scrutinizes what it wants to investigate. Second, internal validity refers to the causal relationships between variables and results and to the data analysis phase by demanding for logical reasoning to defend research conclusions. 17

Third, external validity in case study research refers to ’analytical generalization‘ from empirical observations to theory. Fourth, reliability refers to enabling subsequent researchers to derive same insights if they reproduce the study’s research design.

We conducted our empirical research in Germany. In Germany entrepreneurial failure is stigmatized and tabooed by society. It is quite hard to get a second chance (Kay et al. 2007; European Commission 2007; Federal Ministry of Economics and Technology 2009). Therefore, failure goes along with negative emotions that minder the willingness of failed entrepreneurs to talk about their failure (Bruno et al. 1992). Due to this, it is quite hard to acquire interview partners that are willing to tell their story. Moreover, the already mentioned problem of single informant bias requires employing modes of triangulation (Kumar et al. 1993). In the face of these difficulties, we applied a convenient sampling approach due to our aim of detecting patterns of new venture failure that are not specific to contextual factors. According to Park and Bay (2004), cases from different competitive environments can be a useful approach to multiple case study design.

- insert table 2 about here -

We developed four case studies from failed German new ventures by conducting eight semistructured with each case consisting of one interview of the failed entrepreneur and one with an investor (venture capitalist or business angel). For the purpose of data triangulation, we used business plans as a third source. All ventures were growth oriented, backed with venture capital, located in the business-to-business sector, and remained not longer than ten years in the market (excluded one that was categorized as ’living dead‘).

Field work was carried out from 2010 to 2011. The interviews lasted between 1:38 hours and 2:35 hours and were semi-structured with questions derived from literature and CbTF. For avoiding biases, in every interview two interviewers took part. One interviewer was in charge of moderation whereas the other interviewer remained passive for the sake of observing the interview situation from a more neutral point of view. At the beginning of the interview the respondents were asked to tell the run of events the narrative way - commencing with the very early steps of the seed phase till the final failure. After the narrative part a vital and open discussion followed up based on a semi-structured interview guide. Whereas the moderating 18

interviewer had to concentrate on his active role, the other member of the interview team observed the interview and paid particular attention to contradictions and aspects that were still open or ambiguous. Thus, this person could easily raise additional question and to summarize findings by conclusions and an interim result that should animate the interviewee to confirm the statements or to correct them whenever necessary. By this function, we intend to ensure high levels of accordance of interviewees and the perception of interviewers. Moreover, this role was useful to clarify certain causalities. With one exception (Delta case) the typical interviews constellation comprised one interviewee and, as mentioned, two interviewers. Notably, as for the interviewed entrepreneurs all of them became restart entrepreneurs.

Despite high acquisition efforts by the researchers, non-restarters could not be motivated for participating in the case study research. It is assumed that restarters were able to cope emotionally with the failure. They passed through learning loops and, therefore, are capable of reflecting the causes accordingly. Notwithstanding, the danger of a fundamental attribution bias and problems of the ex-post survey (e.g. memory gaps and sense-making) remain. The interviews of the case studies were conducted separately with the entrepreneur and the investor side. Both sides were informed about this and expressed their consent in advance. Therefore – except for one case - there were no open conflicts between the interviewees. In cases where open conflicts with all investors prevailed, it was not possible to obtain an interview approval of both interview partners. As a result, these case constellations remain a blind-spot of research and should be considered in future research.

There was no general rule with whom to conduct the interviews at first (either the entrepreneur or the investor side). However, this is not relevant since the researchers conducted the interviews as if case-specific knowledge would be non-existent in order to avoid biases. Likewise, this helped the assurance of anonymity claimed by the interview partner. Although discrepancies between the investor and the entrepreneur perspective in the perception and interpretation of events with lower relevance for the explanation of failure occurred, the central strand and causal attributions of investors and entrepreneurs have been surprisingly - very congruent. In addition to the presumably increased reflection of restarters and the non-existence of open conflicts between the interviewees, the mutual knowledge of the interview partners, i.e. interviews have been conducted with both sides, may yield an 19

increased objectivity or rather decreased biases. Details of the four cases are provided in table 3.

- insert table 3 about here -

All interviews were digitally recorded and afterwards transcribed. We began data analysis by constructing single case histories. Therefore, we applied coding techniques (Miles and Huberman 1994) by using MAXQDA software to identify main causes and cause/effect structures within single case chronologies that we derived from business plans and from semi-structured interviews of entrepreneurs and investors. Afterwards, we did cross-case analysis to check for consistent patterns by comparing insights of each case with those of the other cases (Eisenhardt and Gartner 2007). We first present details of the single cases and then conclude main findings of cross-case analysis in the next section.

Company Alpha Company Alpha was founded in 2005 by four already experienced (serial) entrepreneurs. The team had across-the-board business planning competences, particularly in the realm of marketing, legal and technology. In the pre-seed-stage Alpha won business-planning contests and received many positive feedbacks on their business idea. The entrepreneurial team expected financing and technological development as main challenges due to technological novelty of their business solution and high initial investments to be made. They were confident that their solutions provide considerable customer value and they expected “(…) quick market acceptance.” Between 2006 and 2009, a business angel, a group of business angels, a regional venture capitalist, a strategic investor and an early stage venture capitalist invested 1.5 Mill. EUR. Despite the initial expectations, technological development was only a minor issue. In the beginning of the start-up stage, Alpha realized revenues almost as expected. However, in later steps unexpected long decision cycles of potential customers turned the sales challenge into Alpha’s dominant problem. Potential customers were bound to established competitors by long-term contracts so they faced considerable switching costs. Moreover, due to the novelty of the business model, there were no competitive role models in the market. Thus, pricing became a particular issue. In the light of these developments, sales costs were higher than expected. In sum, the costs developed as expected but revenue growth was more than sluggish. While the founders and other shareholders claimed for cost 20

reductions but agreed on an adaptation of their performance expectations facing the long-term perspective of the business, the early stage venture capitalist insisted on staying on targets and pledged to raise sales efforts. From the early stage venture capitalist’s point of view, the entrepreneurial team was responsible for the situation. Conflicts escalated and the entrepreneurs resigned from business. By now, the status of Alpha is ‘living dead’.

Company Beta The business idea for Beta arose in August 2008. Founder A met founder B, who searched areas of application for his process technology to produce innovative marketing media. Founder A, a marketing and sales manager, came up with the idea of producing and marketing novel merchandising items using this method. With the aid of a business consultant, the founders developed a business plan. A cardinal error can be found in the creation of the business plan: “The business planning was prepared carelessly. We had a consultant, who came from the banking sector. We have done the preliminary work for him and he managed to adapt everything to banking standards. The business plan was developed based on perceived assumptions, which were supported by arguments and validated externally. The line of argument has been designed to represent Beta as a successful model. Thus, with regards to the creation of the business plan, I picked those lines of arguments that were in compliance with my requests. However, I failed to do a solid market research, to consider the market itself and the different market segments. I did not have a clue about the average margins or how large the volumes were. If all this would have been done before, I would have been able to realize that Germany was a completely saturated market. The causes of failure lie in the lack of acceptance of the product. There is no market for this.” Beta was founded in November 2008. A was the business leader, B the co-partner. Very soon conflicts between A and B arose due to the fact that B tampered into the operations while A claimed for making sole decisions. In January 2009, the conflict escalated and Beta was restructured until 31/03/2009. A and B agreed to a license payment scheme in order to make use of property rights. In addition, A's sister, a lawyer, took over the shares of B - primarily to support her brother.

The first financing of Beta was carried out by a loan in the amount of 250,000 EUR from a regional bank. Nevertheless, Beta could not realize any revenues. In November 2009, took out a loan in the amount of 220,000 EUR from a second financial institution. Although Beta was still unable to realize first revenues, the creditors did not question the efforts made. 21

Already in the middle of a severe crisis in 2010, Beta was still capable of raising more money from another bank. However, the managerial issues in this crisis changed dramatically: "We have no longer acted in respect of the product and the market, but focused on raising money and protecting our liquidity." In October 2010, Beta got its first and only job. Nevertheless, that job had nothing to do with the original product. In December 2010, A applied for insolvency. In addition to the lossmaking business planning, Beta committed operational errors that led to the erosion of financial resources. Besides wrong choices when hiring personnel, Beta misallocated the financial means. Founder B has received 450,000 EUR for property rights and licenses, even though the actual value only amounted 250,000 EUR. However, neither did A examine the property rights, nor did he employ a patent attorney.

A justifies his behavior and adherence to wrong decisions as follows: “Of course you end up having too little money, but why is it missing? In our case, this problem emerged due to the high level of unprofessionalism, naivety and misjudgment of myself. (...) Certainly, I have perceived the problems at some point, but suppressed them effectively. More and more critics and legitimate concerns came up, but I always dismissed these and did not allow criticism. ... And with regards to customers, I immediately found the decision makers to be too risk-averse and stupid. It was a mixture of arrogance, presumption and existential fear. … Due to high emotional and (selfmade) time pressure, I was not capable of reflecting this subconscious perception. You are not really concerned about the failure. ... The last six months from June to December were crucial. Starting in June, when liquidity broke down, we changed course by expanding the product portfolio in order to convince new investors. Although this implicates that even the entrepreneur himself lost faith with the concept, I was not able to face the reality anymore. In December 2009, I drew hope from an interested investor, generating euphoria again. However, after the Due Diligence in March 2010, he rejected his plans when realizing that there was no substance. Up to that point, I have always believed in the product and in the feasibility of the concept. That was euphoria paired with stupidity." The behavior of A is based on a high perceived self-efficacy, which he has built up during former professional successes: "I am an idea machine. I am good at representing and selling things. In my previous jobs, I've had great success with these capabilities; I've created so many new things and sold them. I can turn someone like Inge Meisel into Claudia Schiffer. That is my strength. ... I did behave like a marketing and sales manager, but not like an entrepreneur. I ignored that I would not be able to lead a company with my shortfalls. You have to get much more help and expertise. But in my arrogance, I did not allow criticism or different opinions - that was for sure.” 22

Obviously, there are strong mental patterns that prevent the entrepreneur from questioning the own beliefs by the feedback received. Metaphorically speaking, A is highly committed to a mental track he does not want to leave. In the middle of the crisis and after lots of negative feedback his only conclusion is trying harder the same. In times where ways out of the crisis are still available he over-confidently ignores any kind of external and internal advice. Later on, there no way out any more.

Company Gamma The founders A and B know each other for a very long time and accumulated considerable IT expertise. In 1986, they already developed the business idea when they collaborated as employees. Later on, in 1996, they founded a consultant engineering company and sold this still existing company in 2008. In 1998, they started the pre-seed phase of the firm Gamma. Gamma was founded in September 1999 by five entrepreneurs.

A and B were principal shareholder and three employees from the pre-seed phase became minority shareholder. The business idea of Gamma was based on the following concept: Gamma’s customers were provided with software created by established software companies for industrial development processes via the internet. This license-based revenue model only charged the customers for the actual time they used the software so that they were able to reduce their overall costs. The entrepreneurs identified the refusal of the software firms to rent their software to any third party as the main risk for Gamma’s success. Notwithstanding, the well-established software companies were interested in the idea since they saw the possibility that young or small firms, that cannot afford the software, were introduced to their products and might purchase these when gaining more market share.

To develop the data center and to make it available to customer were some of the technological and financial challenges, i.e. to establish a use-based accounting system and to create a security system ensuring that the software is only available to contract customers and that the data is protected from competitors. Furthermore, hundreds of software licenses needed to be gained in order to cover capacity peaks on the one hand. On the other hand, these licenses were necessary due to the fact that the workflow of industrial development processes requires different software solutions and thus, a full range of software offers. The

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founders expected highly dynamic market growth. Target customers were OEMs as well as sub-contractors of engineering services. The aim was to serve 500 customers.

In order to meet this portfolio of costumers, a broad distribution network needed to be established. Simultaneously, a VC-financing was required to penetrate the market as a pioneer and to occupy it as well as to manage the high initial investments in software licenses and computer infrastructure. The first financing in the amount of approximately 1 million EUR took place in February 2000 after an extensive Due Diligence by a strategic investor, a VC-company of a large IT group, enabling the establishment of Gamma. The VC-firm took intense care of Gamma since Gamma’s success was supposed to come along with increasing revenues for the IT-group.

The VC-company replaced the third managing executive by a leading sales manager and a commercial manager so that A and B could focus their efforts solely on technical development and pre-marketing. Soon Gamma was able to demonstrate the proof of concept, increased its workforce to the amount of ten, had its first customers and annual sales of 100,000 EUR. "The first launch for smaller companies was very good. We got access to the managers and customers of large software companies that were enormously sensibilized. The interest in the market was great, media reports increased and there was a real spirit of optimism there." The growth phase was financed by a contribution of a VC-firm in the amount of approximately 2 million EUR during March 2001. The entry into international markets was initiated to follow within six months. "That was a pretty adventurous hockey-stick planning. It was a good time for this; around 2000 when the internet hype prevailed at the stock market. In retrospect, it was very easy to get venture capital, since investors were likely to support every start-up. The examination of our business case was very superficial. They recognized the customer value, the IT-group, the competition and the market which already took notice of us. For them it was immediately plausible that one could make money with that idea. Not really established in the market, the venture capitalists pushed us going public.” Gamma rapidly grew in terms of employees (from 10 to 40 in six months) by stagnating sales. The end of 2001 marked the beginning of a significant corporate crisis. "The second VC-investor exerted an enormous pressure on us due to the issue that we had high costs, but sales were too little. Every two weeks, we were supposed to report to the shareholders and to explain ourselves. We passed on this pressure to our sales staff. 24

...we blamed our employees and found them to be incompetent. In addition, we sought that their stories about positive customer signals were only based on wishful thinking. Today, I think that the marketing department tried its best to place our solution on the market. It has failed because of larger customers... Credibility was a problem there, i.e. customer concerns regarding the feasibility of the concept (because otherwise they could not offer services to their clients properly). Or their concern with respect to our licenses, i.e. they worried about us having too few licenses so that they would not have access on demand. Or doubts about the data integrity and the security in terms of data transmission. The time for our solution did not yet come. ... And sometimes even the customer IT competed with us, since they had their own computer capacities and licenses. .... This has not always been successful, but slowed down the entire process." In 2001, Gamma achieved a turnover of 300.000 EUR. Nevertheless, at the beginning of 2002, Gamma got under pressure exerted by the software companies: "At the beginning, the software firms were enlightened to make their software available for us. However, they only experimented with us and allowed the rental – which was valid until revoked only. In 2002, they closed down the license access, for different reasons. Some wanted to perform Gamma’s business model themselves, while others felt strongly about the cannibalization. Some were concerned that consumers could interpret any supply issues as a software error. At some point we could no longer provide all the software modules along the development chain, which, however, was particularly important for larger customers." In the run of the crisis the governance conflicts escalated. Besides the pressure of the venture capitalists the founders found themselves in situations of dissent and - over time with increasing frequency - quarrel. A and B managed the business based on different mental logics. These logics and beliefs rest to a large extent on the different background of the two entrepreneurs. "B was in charge of technical and commercial duties, whereas I was responsible for sales and the market. Therefore, I recognized first that the market was not likely to start up quickly and that we needed to reduce costs. In addition, B was the initiator and driver of the business idea. I originally wanted to take care of our first company and only joined this one due to friendship reasons. B was so much more committed to Gamma. .... The opinions diverged more and more and at some point, no harmony was left between us. The conflict was rather incidental, and not the central cause of failure. But I refused to deal with this situation any longer. " As in other cases as well, governance problems occur and often escalate. Between entrepreneurs and investors a certain tension developed. In the run of events, monitoring became an issue. The investors were unsatisfied as for lacking professionalism of the management of the entrepreneurs. Thus, they intervened to ensure a regular reporting that conforms to industry standards. A recalled: 25

“Sometimes it is hard to meet obligations, such as managing the own administration and organization. Therefore, we did not realize that the efforts we put it paid off. ... The second investors were only interested in commercial numbers and in the ROI. They introduced new reporting guidelines that we were not well schooled in. Therefore, we had to submit hundreds of pages of reporting at the end of a month. ... To cope with this, a few days after the meeting, we needed to hire a commercial director and an accountant and also employed two employees in the accounting department in order to get the reporting done. Additionally, the costs for their employment were not considered in the planning of the financing budget in the amount of 2 million EUR – even though recruiting, hiring and training of sales staff took place simultaneously. However, they came gradually, and the sales cycle generally requires six months to a year until a salesperson can generate cash. Naively enough, all this was not even considered in the planning design. The whole thing was an absolute economic disparity; of course, four people were employed in the accounting department, but to have only one sales person first, then the second, then the third, and so forth.... Although you do take notice that deviating from the plan, however, you do not really care. Then, later on you do take care, however, often it is too late to change course.” Founder A and the investors agreed upon a dissolution contract. In February 2002, A resigned from office and resume office of the first start-up of the founders of A and B again. B conducted Gamma’s business on his own. As the milestones were not reached, in August 2002, the two investors announced their withdrawal from contracts. In September 2002, Gamma applied for insolvency. Gamma’s birth defect is seen in the business planning and in an euphoric mood, preventing a critical reflection: "The Business Case met our realistic expectations, in which we believed in. We were in high spiritis. .... Within our area of expertise, we were the pioneers. So, obviously we found the whole concept to be great and sought of entering the stock market after two years. You know, you have to have an exciting story in order to persuade an investor. Investors request you to be optimistic, to broaden your horizons and to think big. That is when the principle of hope flows in ... to the planning. And if they react euphoric and enjoy a great reputation (as in the case of the IT-group in the IT market), then ... then you do not question anything and start to feel euphoric as well." As in other case studies as well, Gamma had serious problems of thinking in terms of the market. First, Gamma was not sufficiently aware of the necessity of carefully analyzing the target market. Second, Gamma only insufficiently understood the buying behavior of the target customers and the real sales cycles. Insofar, Gamma was unable to understand what was going on in the market. The same holds true as for understanding competition and competitive dynamics in the market. "The revenue forecast was determined by extrapolation. In a complex vein, market size and potential were researched within various sectors. The objective was to achieve 2 or 26

3% market share in the respective sectors. The study of marketability probably was something like the birth defect of Gamma. What are the differences between laboratory tests and real application scenarios in the market? What circumstances are likely to occur which may shipwreck the whole concept? At the beginning we did not take enough care of these issues and believed that our concept will make its way due to the enormous cost savings of the customers. And also the danger posed by the software companies has not been considered sufficiently: 'That's no competition, on the contrary. This is an additional business for them'.“ A justifies the escalation of the crisis and adherence to wrong decisions as follows: "First, with regards to the principle of hope, you would not admit that the whole situation can be identified as desperate. But then they continue asking you by salami slicing. This is a vicious circle. The more we fail to meet the performance expectations, the more intense and extensive reporting is expected by the investors expected. Up to 40% of your time is devoted to justify your situation in front of the investors. This is mainly due to the fact that you need to ask managers, technicians and sales people in order to prepare your reports. Everything/everyone is working to generate the shareholder reporting and lacks the capacity to then deal with any other problems. The issue arising here is that you are only concerned with the reporting and yourself, but fail to take care of the customer and the market. There is no time to reflect the situation."

Company Delta Delta was founded by three entrepreneurs, two engineers and one businessman (financial accountant), who were familiar with each other for a longer time. The founders intended to implement their know-how as special machine constructors, since the technology market was booming. Founded in February 2000, the first customer placed a 200,000 EUR order on Delta in May 2000. In August 2000, Delta received a contract award of 100,000 EUR. Impressed by this development, in August 2000, a US company placed an 8 Million US-$ offering for a takeover, but dropped it a bit later on due to the 9/11 disaster and the dawn of the internet hype.

In 2002, the first financial support in the amount of 400,000 EUR took place. The investor was a former customer of Delta, who had sold his company on the stock market and founded a venture capital firm with the money he had made. In 2004, a second financing was done by a regional VC-institute in the amount of 600,000 EUR. Between 2003 and 2007, Delta recorded annual sales growth between 50% and 70%. In 2007, Delta reached an annual turnover of 4 million EUR, employed a workforce of 33 people with steadily growing orders. To cope with the anticipated growth in 2008, the company hired 12 additional engineers,

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since experience shows that these need a training period of half a year in order to be productive. "At the end of 2007, we, the founders, sought to get Delta organized and to include a second hierarchical level. We had many new employees that needed to be integrated professionally. The office building was not enough anymore.... We had too many large meetings being inefficient. All these problems needed to be resolved urgently. [...] However, the first investor had gone public with his VC-company and incurred huge losses. Since we were the hottest prospect in his portfolio, he had to sell us, seeking to turn us into a stock corporation. [...] With the fantastic end of 2007 and the fantastic start in 2008, the desire to go public or rather to sell us even became bigger. .... We could no longer take care of the business operations. " In February 2008, the founder advised the investors of a financing gap. This gap came into existence due to the pre-financing of projects, the project volumes and the newly recruited engineers in July 2008. In the middle of 2008, the global economic crisis became an issue and suddenly, Delta failed to acquire new orders. At that time, Delta had 19 orders in its pipeline. The highest priority was designated to two orders of large well-respected clients. Nevertheless, the management of these orders caused problems for the company. The machines did not pass the verification tests of the customers and later amendments took too much time. As a result, in addition to the lack of revenue from new contracts, Delta also failed to generate cash from already existing orders. "You receive an order with 40% of the price as advance payment and then you start developing. If the machine is finished, you have to deal with 100% of the costs of purchased parts. Therefore, the machine needs to be accepted as quickly as possible.... In addition, delays in the processing of other jobs may emerge. As far as the two wellrespected clients were concerned, we could not postpone these orders to be able to complete simpler, smaller orders first. These two machines tied up too many resources." Although the turn of the business was highly visible, the activities did not really change. The same held true as for the mental models of the entrepreneurs. Things had to be changed but nothing really happened for a rather long time. Furthermore, governance issues got out of control in times of the crisis and caused confusion as well as conflict. Entrepreneur A admitted: "We had some highly motivated employees, but the 12 new ones could not be instructed because we had to deal with the high pressure of whether the clients would accept our machines. There were always the same people that had to work overtime. Founder B (commercial director) and I (CEO) were supposed to spend 80% of our time on finding investors, although we were needed urgently in the technical field as well. The third team founder was a thoroughbred engineer who sought to increase the pressure on the employees but often failed to deal with them. At some point, we became incapable of 28

paying punctually. We tried to change things in the organizational field; however, efforts needed their time to show results. And because we were under such pressure, we almost refused to see any positive changes and were thus, not really able to cope with this spiral." The investors shared the conclusion that the entrepreneurs made considerable mistakes and were not sufficiently qualified: "The personal relationship of the founders was very good; however, there have been massive failures in terms of commercial issues in the past. For example, this kind of financing would have demand the situation to be anticipated. Nevertheless, corresponding sensitivity analyzes have never been performed. Neither the commercial plan nor the derived liquidity planning were appropriate for this undertaking. The rapid growth of the working capital may lead to an increasing demand for capital which cannot be covered. If this would have been argued in a feasible vein before, the funds certainly would have been available - even based on external capital. In my opinion, this was one of the main reasons. In addition, certain inexpediences may lead to the establishment of bad specifications. Finally, we and the bank also called for the head of the merchant. Of course, in some way he rightly suggested that the acceptance of the machine by the customer cannot be influenced or forced. Obviously, such a project business is difficult to plan. In addition, they had relatively high share of sales in the US. Following the insolvency of Lehman Brothers on 15th September, 2008, no orders were placed anymore. Before that day, the system still worked because new orders involved advance payments that could be used for pre-financing the current orders. But then this concept did not work anymore. " In the opinion of the founders, Delta’s birth defect was located in the first financial support: "The capital error was located within the dealings with capital investors. The first financial support provided 400,000 EUR; unfortunately, the investor lacked the necessary experience to calculate the firm’s requirements. We were always forced to delay supplier payments instead of running the business properly. .... At some point, we extended our current-account-credit to 1.6 million EUR. It should be noted, that our desire still was to lead a solid, owner-managed medium-sized enterprise. .... The first investor more or less ‘starved’ us, and refinancing took place in quite small amounts, although we would have needed the money much earlier. .... Due to the poor profitability and high debts, despite all efforts in 2008, we did not find an investor. " The problematic constellation as for the first investor caused follow-up problems that got out of control. Likewise, the regional VCG identified the selection of the first investor to be the source of the problems: "The first investor joined the company with a small share of 25% percent. He really had a low book value. We then raised a minority share of 25%, so that the first one had about 45% of the shares. The refinancing became extremely difficult because the shareholder group was not willing to give away shares with significant levels of value. Particularly the first investor did not agree to give up shares and thus, we were not able to stabilize 29

the company. This one couldn’t really be taken seriously because he could not produce high levels of liquidity.... In such situations, of course, the value of the company decreases accordingly. That was difficult." Both founders had believed in Delta’s success, at least until the company went bankrupt. Despite serious doubts, their basic beliefs and their mental models seem to be unchanged over time: "We had absolute confidence in the market. Machines were available for 5.5 million EUR and worked to full capacity. Unfortunately, we failed to acquire new orders. The investors did not make additional payments. We successfully tried to receive payments from other sources, i.e. from suppliers and customers; however, that was not enough. As a merchant, my task would have been to recognize that this does not work anymore. But as an entrepreneur, I tried to ‘save the day’. Nevertheless, it was not possible to save anything. Furthermore, we were deeply indebted so that only one possibility is left. … Finally, the current-account-credit matured, Delta was heavily indebted and applied for insolvency."

DISCUSSION We deduced from CbTF that we need to be a priori aware of the bottlenecks of the firm’s resource endowment, an insufficient capacity of absorbing external knowledge and other kinds of firm-addressable assets that weakens internal processes of resource and capability deployment, lacking open-mindedness and inflexibility of decision-makers, the downside of learning processes (low pace of learning, inert mental models) and underlying cognitive biases (over-optimism bias, self-serving bias) that can trigger self-reinforcing rigidities and prevent start-ups from necessary adaptations in competition. In accordance with our abductive research design we now formulate propositions that are developed in CbTF terms and derived from our empirical work. The case studies reveal three major factors that play a key role in the failure process. We address these issues one by one and, thereby, develop research propositions. The first set of propositions deals with firm’s embeddedness in markets. In this realm, we can observe that entrepreneurs are equipped with a lot of energy and self-confidence. They are convinced that their concepts and products will be a success in markets. The case studies reveal that the mindsets of the entrepreneurs are significantly influenced by internal issues. However, as for market peculiarities, the founders are often rather unaware. One issue is market intelligence. In the cases of Alpha, Beta and Gamma, the founders based their plans on completely false assumptions about the behavior and purchasing decision process of 30

potential customers. In the case of Beta, if nothing else the acceptance of the product was overestimated due to a superficial research. In the case of Alpha, the entrepreneurs were persuaded to offer a superior value to potential customers and that the market could be entered without any problems. Besides often insufficient market analyses, they do not take enough care of the wishes of the customers and their mindsets. The cases Alpha, Beta und Gamma reveal completely unrealistic calculations and expectations of the founders and a high level of unawareness of the customer’s buying process including low evidence of customer’s needs and wants. Industrial buying processes are often very complex. At a personal level, the contact person of the customer does not always clearly state what he or she really thinks about the product and/or the start-up.

Initially, it is quite common that entrepreneurs conduct a preliminary conversation with potential customers in order to test the market acceptance. Nevertheless, these conversations take place under conditions which founders are rarely aware of. The atmosphere here can be described as follows: There are two sides and each side knows that a business is not yet conducted. The founders are still new to the business; the opponent is aware of this. Often principles of courtesy and interest are applied. Notwithstanding, this interest should not be equalized with the factual intent to purchase. Moreover, those buying decisions are typically not made by single persons but buying teams. Insofar, if the contact person should be highly committed to buy products from the start-up, it does not mean much since other members of the buying center can hold completely different positions. Finally, every transaction is embedded in a set of organizational procedures, decision-making rules and practices, and organizational policies that are in most cases rather intransparent from the perspective of the start-ups. Without a sound understanding of these peculiarities and without awareness of the real decision-makers, it is often impossible for the start-up to move into a favourable position in terms of bargaining. Insofar, an insufficient understanding of the customer’s buying context is a first reason for a low turnover. Entrepreneurs misunderstand buying behaviour, signals of the customer, and, thus, the sales cycle. Against this background, we propose: P1a. A misunderstanding of the buying process and the buying behaviour of potential customers by entrepreneurs is positively related to new venture failure. It would be possible that misinterpretations or rather disregards of the demand side could be explained by competence deficits of the founders. In the light of our findings, however, this 31

seems to be only a half-truth. The precarious run of events is also fueled by the behavior and attitudes of investors. The investors in many cases did not notice the planning fallacies of the entrepreneurs. This is rather surprising facing the fact that many of the investors are experts. Moreover, they had the chance to screen important information on the venture within the scope of due diligence procedures. However, the investors often believed what the entrepreneurs promised and animated the entrepreneurs to develop optimistic ‘hockey stick’ plans. This seems particularly surprising, since in the cases of Alpha and Gamma entrepreneurs had experiences in the area of start-ups; and simultaneously, in the case of Beta, entrepreneurs showed sales experiences. The three cases identified arrogance and euphoria as reasons for the poor performance and non-consideration. P1b. Investors who do not correct entrepreneurs’ misinterpretations of the demand fuel the process of new venture failure. The second set of propositions deals with the principles and mental structures of decisionmaking. The common sense of the entrepreneurship research suggests a certain degree of risk tolerance and optimism in order to overcome challenges and to cope with the uncertainty about the outcome of the start-up project. When considering failed start-ups, it becomes obvious that the line to a dysfunctional euphoria is really fine, particularly when eliminating risks and overestimating opportunities.

The question arises of why these failed plans are diagnosed at a very late stage. The cases suggest that positive feedback offers the breeding ground of euphoria. Thus, the entrepreneurs of the cases Alpha, Beta and Gamma take financing commitments as confirmation of their plans and are likely to misinterpret signals of their target customers. While positive customer feedback has been recognized to a great extent, negative criticism has been dismissed as a starting difficulty. The entrepreneurs considered above tended to attribute successes to their own strategy, but did not do the same with regards to large problems. This false attribution and the exaggerated self-confidence left no room for selfcritical reflections.

Furthermore, the case studies Alpha, Gamma and Delta imply that conflicts between investors and entrepreneurs are likely to accelerate the process of failure. Although conflict can be principally useful or destructive, in case of governance of young firms in crises 32

conflict seems to be predominantly detrimental. If revenues are not proceeding as planned, investors tend to become nervous and to exert high pressure. Thus, they set up another front within the crisis. Instead of actually doing business, the founders try to reassure their investors. Thus, they spend most of their rather precious time on mitigating conflicts. In the case of Alpha, this resulted in power struggles between founders and investors, which accelerated the downturn. In the case of Gamma, the entrepreneurs were not aware of the extent of reporting requested by institutional venture capitals. The case of Delta pointed out that the entrepreneurs made several mistakes: neither did they check the professionalism and reliability of the first investor, nor did they conduct a neutral assessment of the company value. Additionally, they achieved too little funding for their shares.

During the business planning the entrepreneurs develop an idea on how to get into the business and how to make it profitable. With regard to this strategic logic, they select information and reach general decisions. Positive feedbacks, e.g. in terms of successful venture capital acquisition or (misunderstood) signals from potential customers trigger overconfidence. This strengthening of the strategic logic seems to hinder the perception of trajectory deviations. Thus, positive developments are attributed to their own actions, whereas negative ones are mostly associated with unfavorable developments. Likewise, entrepreneurs identify deviations from the target path as temporary. In their view, these deviations can be corrected when acting consistently. Nevertheless, over time this becomes more and more illusionary. The mental models which were useful initially, may lead to a dangerous isolation from the outside world. Therefore, we propose: P2a. Over-optimism based on misinterpretations of feedback (customer feedback, investor feedback) and attribution biases is positively related to new venture failure. P2b. Inert strategic logics prevent corrections of over-optimism and, thus, positively related to new venture failure. The last explanatory area builds on this. When most of the targets according to business planning remain unachieved, growing scepticism of investors causes first liquidity problems. More, the divide between (lower than expected) revenues and real costs reinforces existing problems. At the same time former trust and/or confidence in the relationship between entrepreneurs and investors turns into growing scepticism of the investors and raises serious doubts whether the entrepreneurs are capable of managing the business. Later on, mistrust replaces former trust. At this point in time, many problems already escalated and caused 33

counter-productive modes of conflict. However, the escalating conflicts between entrepreneurs and investors oftentimes do not cause revisions of the entrepreneurs’ plans and actions but, inversely, keep them on the misleading track. This causes considerable conflicts between entrepreneurs and investors that oftentimes completely get out of control. Once mitigation fails, liquidity problems arise and can no longer be fixed due to fundamental mistrust among the decision-makers involved. P3. Escalating conflict between entrepreneurs and investors in connection to an ill-defined entrepreneurial governance system is positively related to new venture failure.

CONCLUSIONS By dealing with entrepreneurial failure and trying to show mechanisms that are of distinct relevance to analyzing entrepreneurial failure we faced a considerable research gap of the conceptual and empirical kind. Our paper took previous empirical findings into account to the end of developing a new conceptual starting point of understanding entrepreneurial failure. Therefore, we found CbTF relevant to explain empirical findings. From the competence-based perspective we learned that entrepreneurial action rests on decisions made by people, in particular entrepreneurs, who act on the basis of the assets and knowledge available to them. This, however, does not shed enough light on the cognitive processes in the background. Therefore, our second core point was to consider behavioural aspects as well as the time dimension within the interpretive paradigm CbTF belongs to. Prospect theory enables us to better understand misinterpretations and cognitive biases of decisionmakers that cause misleading decisions while research on path dependence is useful to better understand the destructive paths of organizational failure. While we pointed out the inherent hazard of path dependent evolutions, we need to limit our conclusions insofar as path dependent downward spirals may dissolute when unforeseen exogenous forces (e.g. shocks, catastrophes, crises) occur.

So far, we did primarily explorative fieldwork and identified first causalities. Future empirical research is needed to specify the propositions for at this time we identified causal areas but not clear-cutting constructs, yet. Insofar, more explorative research is useful as well as first steps of exploitative research. One main challenge of exploitative research will be to access a huge number of people that are able and willing to report on entrepreneurial 34

failure. Identification of respondents and finding sound ways of motivating them to take part in this kind of research will be a challenge due to the very nature of the problem. Almost everyone involved on entrepreneurial failure has a rather low willingness to participate. Another issue is that, according to the iterative research design of this paper, the different steps of empirical research should correspond with theory application and development. Our results reveal that in terms of the open system view of the firm obviously not all system elements matter in the same way. Moreover, the findings could be reinterpreted within the scope of an adopted open system view that takes particular notice of start-ups.

Another issue of future research could be a comparison of failed and successful entrepreneurs and/or ventures. Actually, we suppose that the failure reasons differ from critical factors of success. However, there is still a lack of proof. A comparison, however, would be possible and rather easy, as long as a sufficient number of failure cases is available for access to successful start-ups has never been a problem.

So far, we developed propositions based on a first reality check. These causalities play a role in patterns of entrepreneurial failure. We already shed some light on self-reinforcing mechanisms of failure that cause, finally, a lock-in the start-up firm can no more escape from so that failure can no longer be avoided. In terms of research on organizational paths it would be interesting to know more about the factors that cause these lock-in effects. This deserves more attention in future research, the more so as entrepreneurial failure seems to be an ideal research object of organizational path dependence in terms of Sydow et al. (2009).

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Table 1. Empirical findings on failure causes in context of new ventures Source: own illustration, based on the systematization of Egeln et al. (2010); specified percentages correspond to the scope of answers, multiple answers were permitted

Findings

Sources poor strategic decisions

too strong dependence on one/few customers

limited planning horizon/-efforts rigid focus on target customers malinvestments growth strategy is too risky no cost-covering prices too high prices inappropriate advertising strategy low product diversity regional focus is too narrow too strong dependence on one/few suppliers deferred investments too high product diversity regional focus is too broad

business concept/planning errors

excessive costs vague/doomed business model

inappropriate timing of market entry no/hardly any market research incorrect business definition underestimation of capital requirements for market

Bruno and Leidecker 1988 Venkataraman 1990 Bruno et al. 1992 Egeln et al. 2010 (44%) Hunsdiek and May-Strobl 1986 Duchesneau and Gartner 1990 Gaskill et al. 1993 Egeln et al. 2010 (38%) Egeln et al. 2010 (34%) Egeln et al. 2010 (32%) Hill and Hlavacek 1977 Cressy 2006 Egeln et al. 2010 (31%) Gaskill et al. 1993 Egeln et al. 2010 (30%) Gaskill et al. 1993 Egeln et al. 2010 (28%) Gaskill et al. 1993 Zacharakis et al. 1999 Egeln et al. 2010 (26%) Pleschak et al. 2002 Egeln et al. 2010 (24%) Egeln et al. 2010 (21%) Egeln et al. 2010 (20%) Egeln et al. 2010 (18%) Egeln et al. 2010 (17%) Egeln et al. 2010 (10%) Hill and Hlavacek 1977 Maisberger 1997 Zacharakis et al. 1999 Lussier and Halabi 2010 Cardon et al. 2011 Maisberger 1997 Pleschak et al. 2002 Duchesneau and Gartner 1990 Maisberger 1997 Cardon et al. 2011 Bruno and Leidecker 1988 Bruno et al. 1992 Zacharakis et al. 1999 Cardon et al. 2011 Duchesneau and Gartner 1990 Bruno and Leidecker 1988 Bruno et al. 1992 Pleschak et al. 2002

44

launch and production development faulty financing concept flawed marketing/sales concept too late or insufficient marketing activities excessive R&D costs underestimation of customer-related modification efforts

Pleschak et al. 2002 Pleschak et al. 2002 Pleschak et al. 2002 Pleschak et al. 2002 Pleschak et al. 2002

Skill and qualification shortfalls

controlling

marketing

market knowledge

organizational skills/ operational management

insufficient knowledge in human resources management/ deficiencies in the staffing policy technical skills

no/hardly any (start-up) consultancy

imbalanced qualifications contract design overestimation of one’s own capabilities lack of commitment lack of perceverance incompetent key personnel

lack of entrepreneurial vision unfavorable personality traits/ impulsive behavior of the lead entrepreneur very high internal locus of control of the lead entrepreneur sales and distribution

Hunsdiek and May-Strobl 1986 Pleschak et al. 2002 Egeln et al. 2010 (32%) Cardon et al. 2011 Maisberger 1997 Egeln et al. 2010 (23%) Lussier and Halabi 2010 Hunsdiek and May-Strobl 1986 Pleschak et al. 2002 Egeln et al. 2010 (22%) Bruno and Leidecker 1988 Duchesneau and Gartner 1990 Meyer 1999 Pleschak et al. 2002 Egeln et al. 2010 (22%) Lussier and Halabi 2010 Cardon et al. 2011 Hill and Hlavacek 1977 Pleschak et al. 2002 Egeln et al. 2010 (13%) Zacharakis et al. 1999 Egeln et al. 2010 (8%) Duchesneau and Gartner 1990 Gaskill et al. 1993 Maisberger 1997 Kay and May-Strobl 2001 Schulte 1999 Cressy 2006 Hunsdiek and May-Strobl 1986 Hill and Hlavacek 1977 Maisberger 1997 Cardon et al. 2011 Maisberger 1997 Maisberger 1997 Duchesneau and Gartner 1990 Zacharakis et al. 1999 Cressy 2006 Cardon et al. 2011 Duchesneau and Gartner 1990 Zacharakis et al. 1999 Franco and Haase 2010 Duchesneau and Gartner 1990 Pleschak et al. 2002 Duchesneau and Gartner 1990 Bruno and Leidecker 1988 Bruno et al. 1992

45

lack of experience weak communication skills lack of business knowledge insufficient strategic management

Gaskill et al. 1993 Michael and Combs 2008 Franco and Haase 2010 Franco and Haase 2010 Pleschak et al. 2002 Pleschak et al. 2002

Intra-corporate causes insufficient process innovations insufficient product innovations insufficient personnel reduction insufficient product quality technical planning targets are not achieved high decision-making power of the lead entrepreneur non-participative decision-making

Egeln et al. 2010 (28%) Egeln et al. 2010 (22%) Franco and Haase 2010 Egeln et al. 2010 (17%) Bruno and Leidecker 1988 Bruno et al. 1992 Zacharakis et al. 1999 Egeln et al. 2010 (13%) Pleschak et al. 2002 Duchesneau and Gartner 1990 Duchesneau and Gartner 1990

Problems on sales and factor markets decline in sales/ collapse of the target market bad dept losses increasing prices on factor markets poor industry development generally poor economic situation strong competition personnel acquisition issues lack of customer loyalty problems related to tapping new markets problems related to customer acquisition poor supplier relations/ problems with suppliers or cooperation partners lack of service quality of infrastructural network partners/bureaucracy cautious customer behavior uncompetitive product image/reputation problems

Pleschak et al. 2002 Egeln et al. 2010 (57%) Cardon et al. 2011 Egeln et al. 2010 (52%) Egeln et al. 2010 (49%) Zacharakis et al. 1999 Egeln et al. 2010 (42%) Franco and Haase 2010 Cardon et al. 2011 Egeln et al. 2010 (39%) Gaskill et al. 1993 Egeln et al. 2010 (35%) Franco and Haase 2010 Egeln et al. 2010 (35%) Franco and Haase 2010 Egeln et al. 2010 (27%) Bruno et al. 1992 Egeln et al. 2010 (26%) Egeln et al. 2010 (25%) Zacharakis et al. 1999 Pleschak et al. 2002 Heimerl and Reiß 1998 Franco and Haase 2010 Pleschak et al. 2002 Pleschak et al. 2002 Pleschak et al. 2002

Financial problems

undercapitalization/ lack of financial reserves/ insufficient equity capital

Hill and Hlavacek 1977 Bruno and Leidecker 1988 Duchesneau and Gartner 1990 Bruno et al. 1992 Zacharakis et al. 1999 Pleschak et al. 2002

46

increasing/early debt

credit refusal lack of investment capital loan terminations problems with banks/ restrictive behavior of the principal bank low funding availability

poor VC/shareholder cooperation

lower sales than planned

Thornhill and Amit 2003 Egeln et al. 2010 (65%) Hill and Hlavacek 1977 Bruno and Leidecker 1988 Bruno et al. 1992 Thornhill and Amit 2003 Egeln et al. 2010 (56%) Egeln et al. 2010 (45%) Cardon et al. 2011 Egeln et al. 2010 (34%) Egeln et al. 2010 (22%) Cardon et al. 2011 Maisberger 1997 Pleschak et al. 2002 Zacharakis et al. 1999 Franco and Haase 2010 Bruno and Leidecker 1988 Bruno et al. 1992 Gaskill et al. 1993 Zacharakis et al. 1999 Cardon et al. 2010 Pleschak et al. 2002

Personal issues stress/excessive workloads disappointment related to income expectations to high personal liability health reasons family reasons too strong risk aversion dissonance regarding corporate strategy problems related to succession

Egeln et al. 2010 (18%) Egeln et al. 2010 (20%) Cardon et al. 2011 Egeln et al. 2010 (13%) Egeln et al. 2010 (13%) Maisberger 1997 Egeln et al. 2010 (12%) Egeln et al. 2010 (8%) Hill and Hlavacek 1977 Egeln et al. 2010 (6%) Egeln et al. 2010 (4%)

Internal management issues

conflict/disagreements in management team

compensation of shareholders management changes

Hill and Hlavacek 1977 Bruno and Leidecker 1988 Meyer 1999 Pleschak et al. 2002 Egeln et al. 2010 (8%) Egeln et al. 2010 (4%) Egeln et al. 2010 (3%)

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Table 2. Key Elements of the Research Design Justification of research approach

there is a gap in existing theory that does not adequately explain the phenomenon under investigation the research is exploratory and therefore calls for case research to build theories the research is explanatory (i.e., asking “how” and “why” types of questions) the context and experiences of actors are critical

Research question

What are causes and patterns of new venture failure?

Unit of analysis

Failed new ventures

Research purpose and role of existing theory

CbTF aims to explain competitiveness; modification is needed to explain new venture failure.

Case selection and number of cases

Convenient approach

Data collection and analysis

Data triangulation: business plans and guideline-based semi-structured interviews with entrepreneurs and investors.

Research approach is therefore neither purely inductive (deriving new theory strictly from data) nor deductive (testing or confirmation/falsification of existing theory); an abductive approach is applied: CbTF and formerly research findings provide a priori propositions for exploratory fieldwork.

Number of cases: 4

Data analysis occurs simultaneously and iterative to data collection which allows to adjust constructs and relationships as well as questions for follow-up guideline-based semi-structured interviews. First, within-case-analysis is conducted. Second, cross-case analysis is performed by comparing the first two cases at a time and then successively adding further cases to analysis while applying replication logic. Quality measurements

Construct validity: Research framework is explicitly derived from literature and theory (CbTF). Theoretically derived a priori knowledge (in particular internal causes of failure, precarious paths of organizational development, biases in perception and expectation) is matter of the guideline for semi-structured interviews. Reduction of single informant bias (Kumar et al. 1993; Ernst 2003) through means of triangulation (business plans and semi-structured interviews with entrepreneurs and investors), Reduction of subjective researcher interpretation biases through reflecting conclusions with the interviewees. Internal validity: Is achieved through replication logic related means of cross-case pattern matching. External validity: Is addressed through cross-case analysis and through outlining details on the case-study contexts to allow the reader to follow cross-case conclusions. Reliability: All elements of the applied research design are clearly outlined and documented.

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Table 3. Profile of Case Study Companies Alpha Sector

Beta

Internet/Software Creative

Gamma

Delta

IT Logistics

Mechanical

Industry

Engineering

2005 to date

2008-2010

1999-2002

2000-2009

Status

‘living dead’

insolvent

insolvent

insolvent

Members of

4

2

5

3

1.5 Mill. EUR

0.6 Mill. €

6 Mill. DEM

4 Mill. EUR

0.7 Mill. EUR

20,000 €

0.3 Mio DEM

4 Mill. EUR

14

2

40

45

B-to-B

B-to-B

B-to-B

B-to-B

Period of Existence

Initial Team Investments (cumulated) Max. of Annual Revenue Max. of Employees Business Sector

49

Figure 1. The Open System View of the Firm (Source: Sanchez and Heene 1996: 41)

50