288 ENTREPRENEURSHIP
giveness of a portion of debts, a person or a corporation can declare bankruptcy only
once every six years.
The specter of bankruptcy is always with the entrepreneur and the firm’s financiers.
It accounts in part for the high rates of return required by equity investors. Equity
investors understand that in a bankruptcy they will likely gain nothing and may even lose
all their capital investment, so they need high returns from the winners. Our discussions
of the resources that provide sustainable competitive advantage for the venture have
implicitly included the prospect of bankruptcy. Ventures created with resources that are
rare, valuable, imperfectly imitable, and nonsubstitutable are more resistant to environ-
mental threats, competitive attacks, and internal implementation errors than firms with-
out these resources, and thus more resistant to bankruptcy.Warning Signs/Predictive Models. Bankruptcy seldom sneaks up on a firm. There are
usually warning signs that appear as early as 12 to 18 months before the crisis actually
occurs. Financial problems, specifically inability to make interest and principal pay-
ments, are the usual precipitating events. However, any time the business’s liabilities
exceed its assets, it may file a bankruptcy petition. Because of the accounting rule that
requires acknowledging liabilities as soon as they are known, firms with cash to pay their
debts may find themselves with negative net worth. This can happen when a firm must
recognize future liabilities for employee health costs or pensions, but the signals are usu-
ally evident earlier and the longer-term cause is poor management. The early signs
include unhappy customers, a faulty production or service delivery process, bad relations
with investors or banks, employee unrest and work stoppages, and, ultimately, poor
financial management.
There are telltale signs of impending crisis. For example, when a firm changes man-
agement, advisers, and especially accountants and auditors, it suggests that problems are
mounting. These changes often result in late filing of financial statements. Other indica-
tors are:- Qualified and uncertified accountants’ opinions
- Refusal to provide access to key executives
- Sudden search for an alliance partner
- New interest in a merger or acquisition without strategic reasons
- Writing off assets
- Restrictions on credit terms and availability
Because creditors can either save their investments or attempt to save the firm if they
are aware of the crisis early enough, research has been conducted to provide an early
warning system for bankruptcy. The most famous of these predictive models uses infor-
mation commonly available in financial documents.^38 There are two models, one for pri-
vate companies and the other for public firms. The models, equations that calculate Z-
scores from a discriminate analysis of the data, are shown in Table 7.4.
By plugging in the venture’s actual financial ratios, multiplying these ratios by their
weights (coefficients), and calculating the total, an analyst can determine whether the