Why Bankruptcy Reform Is Bad For Entrepreneurs


In 2005, after years of debate, Congress significantly toughened federal bankruptcy law. Many opponents charged that the law would unfairly burden the poor, the elderly, military personnel, and their families. Five years later, a different and surprising group of Americans have found themselves suffering from the new law: entrepreneurs.

Growing evidence exists that bankruptcy reform is promoting fear amongst entrepreneurs, retarding the growth of new ventures, delaying economic recovery, and preventing new and small businesses from doing what they’ve always done best: creating jobs.

Most entrepreneurs are not huge risk takers. To succeed, they strive to mitigate risk as much as possible. When an opportunity’s potential risks become too large, they forego or backburner it. And, as a recent Babson Global Entrepreneurship Monitor report noted, fear of failure is surged amongst entrepreneurs.

Passionate entrepreneurs have never focused on bankruptcy as they seek to start and grow new ventures. But it’s always been there as a crucial safety net. Today, however, if your startup fails, the risks are greater for you, your family, and your extended network of informal investors. When entrepreneurs are worrying about losing their family’s home, they become more cautious and tentative.

Last summer, the Journal of Business Venturing published a global view of the effects of bankruptcy laws on entrepreneurship. Its authors found that reducing the time and cost associated with bankruptcy directly encourages more new firm entries.

The authors concluded by quoting The Economist: “Making it easier to close a business may not sound as inviting as announcing yet another ‘enterprise fund’ or ‘innovation initiative,’ but it is more vital… In the short run, enlightened bankruptcy laws reduce unemployment by keeping viable companies alive. In the long run, they boost rates of entrepreneurship. The best way to get more people to start businesses is to make it easier to wind them up.”

A 2010 USC study established a direct link between changes in US bankruptcy law and reduced entrepreneurial activity. Its authors concluded, “Many entrepreneurs go through several business models before they are successful… The harsh provisions of the new law appear to discourage some potential entrepreneurs from starting new businesses, and to keep entrepreneurs who have a business failure from starting anew.”

Seasoned entrepreneurs often say: “fail fast, fail often… and learn from it.”  This bounce-back mentality is the basis for America’s unique entrepreneurial strength. America’s culture has attached less stigma to startup failure: that’s been one of our key competitive advantages. This culture is diminished by arduous bankruptcy laws.  

As the new Congress reconsiders financial reform, it should also make the 2005 bankruptcy law more entrepreneur-friendly. Yes, there will be marginal costs to the financial industry: likely a few billion dollars in the short term. But those costs pale in comparison to the benefits: a more robust entrepreneurial sector, more capable of generating the new jobs we desperately need.

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