Can reformed bankruptcy and insolvency rules lead to more entrepreneurship?

Wednesday 17 June Swedish Entrepreneurship Forum and The Swedish Agency for Growth Analysis organized a seminar that discussed whether Sweden should reform the bankruptcy and insolvency rules in order to improve the conditions for entrepreneurship. Participants included Robert Eberhart, Professor at Santa Clara University and Stanford University.

Pontus BraunerhjelmPontus Braunerhjelm

The moderator of the seminar Pontus Braunerhjelm, Professor at the Royal Institute of Technology, KTH, and Research Director at the Swedish Entrepreneurship Forum, started the seminar by welcoming the participants and introducing the topic. He then gave a short introduction of Robert Eberhart, Professor at the Santa Clara University and Stanford University, and key note speaker. Eberhart started off by presenting an analysis on Japan’s entrepreneurial scene where he had examined how institutional changes related to insolvency and bankruptcy affected what he denoted the failure barrier, the success barrier and the cost of entrepreneurship.

Institutional changes in Japan in focus

Robert Eberhart had chosen Japan as focus for his research since Japan has had a decade of quasi-natural experimental reforms 1995-2005. He described Japan’s climate for entrepreneurs before the regulatory changes as particularly harsh. The idea of bankruptcy was to punish the individual for failing, he said. The Civil Rehabilitation Law (2000) and the Corporate Reorganization Law (2003) were instilled to ease entrepreneurship. These laws were particularly important for well-connected founders because of the higher possibility, due to greater risk taking, of bankruptcy.

Robert EberhartRobert Eberhart 

– Elite founders are more likely to take advantage of their social network. With less harsh bankruptcy effects, new firm performance increased.

Robert Eberhart also showed that when the Tokyo and Osaka Exchanges lowered their listing requirements the results implied that the likelihood of an IPO increased, but also that the initial investments increased in tech-only firms and new firm performance decreased. Eberhart stated that the minimum cost of entry for companies before the reforms was ten million yen. It was changed to one yen to allow young new companies to gain legal and social credibility and thus get opportunity to grow.

Importance of social networks

Robert Eberhart stated that only three percent of the Japanese companies were founded by women, compared to 20 percent in the US. The reason is that women lack the social networks that are often needed.

– It can be hard to analyse how new regulations really affect the market. Too fast growth might be a concern since high growers tend to fall.

Therefore he gives Japan a timeframe of 10 years to see the full effects of the reforms. Eberhart also mentioned that cultural aspects may have imprints on the economy and the view of entrepreneurship:

– The Japanese are usually conservative, but recent development show they are less loyal to their companies and tend to take larger risks.

Risk taking and possibilities to restart important

Björn FalkenhallBjörn Falkenhall 

Björn Falkenhall, Senior Analyst at The Swedish Agency for Growth Analysis, was invited to present the results from work jointly undertaken with Kun Fu and Karl Wennberg on regulatory impact on entrepreneurship (GEM and World Bank data). Falkenhall found the risk taking important and the possibility of a fresh start as something vital to entrepreneurs. He also found it meaningful to reduce costs of failure which presumably would stimulate venture formation and encourage higher risk taking and therefore be more effective. He also emphasized the importance of reconstruction of firms that find themselves in insolvency problems as a way to encourage and make possible successful entrepreneurship.

Björn Falkenhall also stressed the importance of allowing corporate bankruptcy instead of individual bankruptcy. The effect will otherwise demoralize entrepreneurs from starting businesses, especially in Sweden where the fear of failure is high enough to keep potential entrepreneurs from even trying.

Tax law and company law – incoherent systems

Teresa Simon-AlmendalTeresa Simon Almedal 

Teresa Simon Almendal, Associate Professor and Senior Lecturer in financial legislation at Stockholm University, argued that in tax procedure law the personal liability can be huge.

– The rules strikes blindly and are unreasonably high. The only choice for an entrepreneur is to file for bankruptcy and suspend all payments. But most entrepreneurs do not want to kill their baby.

Teresa Simon Almendal thought it was alarming that the rules are so rigid and possibly inconsistent in relation to other paragraphs and laws. They strike outside their original purpose since they are written with the purpose to suspend tax criminals. But smart criminal does not put her/himself in the board of the company or other positions where they have liability, according to Simon Almendal. She also mentioned that there are creditor protection rules as well, where company law will violate the tax law framework. The legal system is not coherent, she concluded.

Restarters are high achievers  

Lenan Bäcker 2Lena Bäcker 

Lena Bäcker, Enforcement Director at The Swedish Enforcement Authority, highlighted that to maintain a high level of growth we need a high level of enterprises.

– Each year 8000 Swedish companies file for bankruptcy, they need to be able to start again.

We need to encourage new entrepreneurs. The Swedish Enforcement Authority focus on the one’s already in practice. Companies that restart their businesses have a higher growth rate. Therefore more entrepreneurship is of societal importance. About 96 percent of the companies are also serious businesses with no criminal intent. Most of the time we talk about the remaining four percent.

Debtor or creditor friendly – or the Swedish way?!

Annina H. PerssonAnnina Persson

Annina Persson, Professor in civil law at Örebro University and also part of the Government’s Entrepreneurship Committee that is headed by Pontus Braunerhjelm, said that we need a more “entrepreneurship friendly” insolvency law. Still, there is always a balance between the debtor and the creditor in insolvency rules. Other pressing issues concerns who is running the insolvency process. In Japan the debtor has less to say. Sweden and Germany are also creditor friendly while the US system is more debtor friendly. It is not self-evident which way to take, according to Annina Persson. Maybe we should find a Swedish way?

Personal liability blocking second chance

Lars BacksellLars Backsell

Lars Backsell, Founder and Chairman of the board of Recipharm AB, thought that the personal liability law is blocking entrepreneurs’ second chance. Major companies are positive towards the insolvency legislation because their ownership is different. For them there is distinct difference between owners and executives. That is not the case for SMEs and entrepreneurs.

– There is no chance that you can start a company without the bank asking you about personal collateral. It shows how integrated these things are. Everything, your house and family, cannot be at stake.

This is always the number one question for a person whose about to start a company. In the US you pay your fines and come back, here you get trapped into financial difficulties forever, Lars Backsell finished.

Create markets, invest in infrastructure and new techniques

PanelThe panel 

In the following panel discussion Robert Eberhardt highlighted that we have to remember that no government created Silicon Valley. But there are some principles that are generally true regarding what a government can do: A first thing is not to punish entrepreneurs for starting a business, Eberhart claimed. 80 percent of start-ups fail but that should not imply that the founders lose their house and all their assets. If a government wants to encourage entrepreneurship it should create markets, invest in infrastructure and new techniques, he continued.

Bankcruptcy is a learning lesson – not a failure

Lena Bäcker stressed that legislation regarding insolvency and bankruptcy is important, but there is also the issue of attitudes. It is a learning lesson to have been through a bankruptcy, it should not be viewed as a failure! Theresa Simon Almendal added that it would be suitable to alter the tax possibilities to deduct losses while keeping a balance regarding incentives. Robert Eberhardt mentioned that Sweden and Europe are amazingly free of tax criminality. If it is easier to go bankrupt, you get more criminals. It is a political choice you need to take, he finished. Lena Bäcker added: Then it is even more important to teach economics and entrepreneurship in schools!

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