AMES, Iowa -- Howard Van Auken knows the drill. Entrepreneurs are often so enthused about their chances of success when starting a new business that failure literally is not an option.
"When you start a business, the last thing you think about is going bankrupt," said Van Auken, the Bob and Kay Smith Fellow in Entrepreneurship at Iowa State University. "You're so pumped up, so hyped and so positive about this opportunity that you can't even imagine it failing."
But maybe entrepreneurs should, since the most recent U.S. Census Bureau data estimates that approximately 50 percent of small businesses (less than 500 employees) close within four years of launch.
And according to a new study of 90 Iowa small business owners by Van Auken and his ISU management faculty colleagues Jeffrey Kaufmann and Pol Herrmann, there is very little awareness of bankruptcy protection among those small business owners. Most respondents didn't know about the state exemptions available to them to protect personal property if their business went bankrupt -- not even how they can protect themselves from losing their homes.
Based on these results, the researchers propose that new business owners learn more about bankruptcy protection available to them and make a failure plan part of the start-up process.
Paper being published in professional journal
Kaufmann, Herrmann and Van Auken authored a paper on their study titled "The Impact of Bankruptcy Laws on the Entrepreneurial Decision: Are Entrepreneurs Even Aware?," which will be published in the October issue of the Journal of Applied Management and Entrepreneurship. It is the first to study an entrepreneur's awareness of bankruptcy law and their decision to start a business.
Data for the study was collected through a questionnaire that was mailed to 400 small business owners who had sought start-up counseling at the Iowa Small Business Development Center (ISBDC) within the past two years. The questionnaire asked owners to rate their awareness of the types of bankruptcy, how to file for bankruptcy, state exemptions, changes in bankruptcy law, and the possibility of losing their homes. Ninety usable questionnaires were returned.
Since the study found that almost all the owners were unaware of government financial protection available to them, the researchers conclude that no direct relationship exists between bankruptcy and entrepreneurship in terms of the number of business start-ups. But Kaufmann says that states like Iowa should try to create one as a way to encourage new business, since states set the amount of personal property that start-up entrepreneurs can protect.
"It seems to me that the state has to get them (start-up owners) to look at bankruptcy law," said Kaufmann, who is also a lawyer and serves as vice chair of the International Law Committee for the Administrative and Regulatory Law Section of the American Bar Association.
"If you look at Iowa, we're losing Maytag, we're losing manufacturing, we're losing farming to the big factory farms, so for the state to survive, we're going to need to focus on encouraging new businesses," he said. "Now there's not a lot states can do to encourage it, but one thing that they can do is control this one aspect of bankruptcy law (the amount of protected personal property). This is the main thing that they can do as a state to protect people from complete ruin. Entrepreneurship's risky, so you need to encourage that risk -- and you do it by that sort of soft landing."
Kaufmann reports that some states and the European Union -- specifically the United Kingdom -- are already using bankruptcy protection as a form of economic development.
"They're saying in effect, 'To encourage this activity (entrepreneurial start-ups), we'll protect you a little bit more,'" he said. "All the data has shown that states with more debtor-friendly bankruptcy laws have more entrepreneurship, and there's always been this assumption that it's a direct cause and effect."
Making a failure plan part of the start-up process
But regardless of a state's protection, the authors encourage new business owners to learn more about bankruptcy law and begin making plans for the worst.
"The owners should seek legal advice at start-up and lawyers -- or someone with some background in the legal area -- should advise new business owners about legal exposure and consequences and how to protect themselves in case they do experience financial difficulties," said Van Auken. "I think they skip that process because they just don't know."
"And if you go to a lawyer about a new business, he or she may talk to you about incorporating or forming a partnership -- some of the basic things," said Kaufmann. "If you don't ask specifically, my guess is that a lot of lawyers don't say, 'And we should also plan for bankruptcy.'"
At the very least, Van Auken says that government could create a better mechanism to get the word out about their state's bankruptcy protection to new entrepreneurs -- possibly through small business development centers like the Iowa SBDC.
The authors plan to continue this research project, possibly extending it to additional states.
