Why Do Small Businesses Fail?

Date: March 20, 2017

If it was easy to start and run a successful small business, just about everyone would do it. But what leads to business failures? The answers are as diverse as the businesses themselves, but there are some common challenges.

More importantly, if you’re thinking of starting a business, what can you do to increase your odds of success? Read on for an overview of some common challenges new businesses face, and learn what can be done to minimize them.

 

By the Numbers

Cynical sayings like “most small businesses fail” exist for a reason, but the odds are better than most people realize (and trending in the right direction). Small business “births,” or start-ups, are actually increasing, while “deaths,” or failures, are declining. American employers are failing 30 percent less often than they were in the late 70s, with the failure rate in long-term decline.

One of the biggest reasons for this is an increased focus by new entrepreneurs on planning and evaluation before committing to opening up shop. And today’s small businesses have technology, data, and resources that weren’t available decades ago.

On average, about two thirds of small businesses survive the first two years, half survive five years, and one in three 10 years. After the most difficult (and most volatile) first few years, survival rates flatten out. Keep in mind that not surviving doesn’t necessarily mean failure, either, because a business could be sold or merged with another.

So, the odds are actually pretty good provided you do the essential work of planning, researching, and being prepared to adapt to change.

Related: 5 Keys to Failing the Right Way

 

Lack of Planning

Common reasons for failure include anything from poor location, low cash flow, failure to seek advice, growing too fast, poor customer service, poor industry selection, or even bad employees.

But one common reason for success? Having a plan in place that addresses each of these challenges, in addition to anything and everything relevant to your enterprise.

Opening a small business is a big endeavor, and the old adage is true: if you fail to plan, you plan to fail. While a plan for your business is key, planning for how your business will fit into your life, and planning to approach every challenge (and failure) as a learning opportunity are both equally as important as a general business plan.

Related: 5 Rookie Mistakes that Kill Small Businesses & How to Start a Business in the New Year

 

Lack of Research

It’s common for new entrepreneurs to start a business related to their expertise and previous employment, or a favorite passion, pastime, or hobby. But detailed market research and a thorough evaluation of your competitors must be done during the planning process, and businesses must be prepared to adapt to market changes on the fly.

Good plans are backed up by great research and intuition. Knowing (and proving) that a good or service your business will provide is in demand, and that this demand is expected to remain (or increase), are crucial for sustaining growth.

Having a thorough, well-researched plan will be your business’ foundation. It will merge your vision with a clear strategy, and it’s absolutely essential for securing funding. But where do you begin, and what should be included?

Like most big projects, a business plan will be more manageable step by step. They vary in size and complexity, but here are seven essential sections that shouldn’t be overlooked.

 

Insufficient Funds

The final section of a business plan usually focuses on the financial side of operations, like forecasted income, balance sheets, and cash flow projections or statements.

When in doubt, overestimate costs, because it’s easy to have unrealistic expectations when it comes to the cost of starting and sustaining your business. And that doesn’t account for the unexpected curveballs that could cost you dearly.

Lacking startup funds and being unable to come up with adequate financing are common reasons for failure, but this speaks to the importance of research, realistic projections, and thorough planning up front.

If you lack the cash or assets to start on your own, like most businesses, you will need to borrow.

Related: 8 Things to Consider Before Taking Out a Small Business Loan

 

Loan Mistakes

It’s tough to get financing without investing a substantial portion of your own funds, having good credit, or having the means to pay back loans. Most businesses require some type of loan, and loan mistakes can seriously damage or cripple your business.

Common mistakes include borrowing to cover operational costs that don’t increase revenue, misunderstanding a loan’s true cost, taking the wrong type of loan, relying on short-term (high interest) loans or credit lines, or simply believing that more money will solve the problem. Sometimes financial obstacles can be overcome by spending less instead of borrowing (and spending) more.

Financial, loan-related challenges are complex and too numerous to count, but in the planning period and early, turbulent startup stages of a small business, it makes sense to budget and plan for far more than you anticipate might be needed.

And don’t forget to explore every possible avenue for free (or nearly free) funding, like these top small business grants.

Related: 5 Biggest Small Business Loan Mistakes

 

Losing Focus on Cash Flow

According to a U.S. Bank study, 82 percent of business failures are due to poor cash flow management, or poor understanding of how cash flow contributes to business. Cash flow is critical, because it’s the lifeblood of your business. Without it you can’t buy inventory, pay or hire employees, or secure financing or a line of credit.

If your bills exceed cash on hand, you’ve got a cash flow problem. It’s a common challenge because many new entrepreneurs lack training in finance, and banks aren’t flexible with payment schedules. Cash flow can also shift dramatically depending on the time of year, or even by day of the week.

What makes it even more challenging is that cash is most needed when your business is growing. Even with consistently high sales, if customers (especially other businesses) haven’t paid their invoices, your cash can be stretched dangerously thin at the wrong time.

A strict handle on cash flow helps insulate your business during struggles, downturns, or unpredictability, and also allows more flexibility during growth periods.

You will have more control over the timing of what goes out than what comes in, so tight expense controls are critical. This requires clearly and closely tracking receivables against payables (especially payroll). Try this four-step approach to cash flow management.

Related: Starting a Business? How to Control Cash Flow During Infancy & Checklist for Managing a Small Business’ Finances

 

Going Solo

Small business owners are experts about the goods and services they offer, but few are equally skilled at accounting, human resources, the law, taxes, or any of the other complex and technical areas that intersect with running a business.

Trying to do everything yourself and not knowing when it’s time to seek help can be critical mistakes. Whether it’s hiring new employees or seeking professional help from a lawyer, accountant, or business coach, it’s important to know when you’re stretched and need help.

While paying for help will cost you, the time saved and knowledge gained will be well worth the investment. You will have peace of mind and be able to focus more on growing your business.

Related: 5 Time Management Tips for Small Business Owners

 

It’s also worthwhile to network and build business connections through a membership in a small business association like NFIB. Other association members will be like-minded business owners looking to network, collaborate, share their experiences, and learn. And you will gain access to great business products and services that save you time and money.

Click here for more Small Business tips and resources from experts and NFIB members like yourself. Become an NFIB member today to enjoy member-exclusive benefits on business products!

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