5 Reasons for Small Business Failure (and How to Avoid Them)

How to avoid small business failure

Small business failure is a fact of life every budding business owner must face. As exciting as a new entrepreneurial venture can be, it’s foolhardy to rush into the experience while neglecting certain key elements, such as cash flow management, hiring and retention, marketing and operations. It’s a tall order under any circumstances, but even more so when the life of a fledgling business falls on one person’s shoulders.

There are many reasons for why a small business doesn’t make it. One primary cause, according to Investopedia, is that successful business owners “must possess the ability to mitigate company-specific risks while simultaneously bringing a product or service to market at a price point that meets consumer demand levels.”

This gargantuan challenge may be why approximately only 20 percent of new businesses make it through a full first year of operation, and why almost 50 percent of small businesses can’t endure to five years or longer. Citing these statistics, USA Today notes, “The good news is that survival rates begin to flatten out after several years of operation.”

Confronting and overcoming these challenges means the difference between survival and failure in today’s marketplace. The most effective strategy involves understanding the primary causes for failure and planning beforehand how you will address them.

Here’s a look at five major reasons why some small businesses don’t achieve profit and success:

I. Insufficient capital and poor financial management

For every business owner, there’s a constant tension between understanding how much money is required to maintain daily operations and the amount of revenue that comes from the sale of products or services. When this discrepancy becomes acute, a business can simply run out of money and then be forced to shut its doors.

In fact, keeping pace with cash flow is essential to small business survival. More than 80 percent of companies close because of cash-flow-related problems, making this the number one reason for small business failure. Even “profitable companies fail all the time for the simple reason that they run out of cash.”

To offset this dire outcome, it’s critically important to create (and stick to) a realistic operational budget for your business. A budget plan must include the following:

  • Assessment of the amount of money needed for day-to-day operations
  • Costs for fixed and variable overhead expenses
  • Funds to pay third-party suppliers and vendors
  • A plan for borrowing money when needed, either through asset-based financing, investment capital, conventional loans or business grants

Experts strongly advocate researching and compiling information on these budget plan elements before you actually need the working capital. It’s better to have this data on hand when money is needed, rather than waiting until a cash-related crisis occurs.

2. Lack of business planning and a viable business model

As noted, a viable cash-flow strategy should be an essential component of a business plan. Other factors include:

  • What the business is about (its products or services, mission, vision for the future)
  • A strong financial forecasting model (based on estimated operating costs and generated revenue)
  • Current and projected labor needs (the number of employees needed now, and in the future)
  • An in-depth competitor analysis (understanding what the marketplace looks like)
  • Marketing and sales strategies (how to reach prospective customers and close deals)

Adoption of the right business model is another element to include in your plans. Study similar businesses in your industry, both locally and in other regions, and establish a model that includes some or all of these elements:

  • Planned company infrastructure
  • A milestone chart with key tasks and objectives to be addressed and completed by assigned dates
  • Hiring policies and guidelines for personnel
  • Preliminary or more sophisticated branding strategies

Addressing some or all of the above once the business is underway risks playing catch-up during a critically important early growth stage, and could quickly lead to small business failure.

3. Leadership and management shortcomings

An inability to transition from being a solo entrepreneur to a CEO or business owner with employees is another “mine-field” for many businesses.

Not every entrepreneur comes equipped with the types of leadership or management skills needed to supervise, inspire and manage a group of individuals. Someone ill-equipped for this task can make a wide range of management mistakes, such as hiring too quickly and having the wrong team on board, or failing to create a human resources policy that covers most labor-related contingencies.

Such shortcomings can result in a workplace exhibiting poor morale and low productivity, key ingredients for small business failure.

It’s incumbent upon small business owners to find the time and resources to hone their leadership skills. Take online human capital management classes. Participate in leadership webinars. Drill down deep into your professional network and locate a person who’s willing to help out as a leadership mentor. Do everything possible to prepare for recruiting and managing employees before management problems arise.

4. Absence of an effective marketing strategy

Coping with funding, putting together a business plan and starting the hiring process are big challenges in and of themselves. Assuming you have a great new product or service idea, and the means to make it available to customers when they want it, the next question is–how will you get the word out?

Some small businesses fail because they’re unprepared for the demands of marketing their company’s offerings. They lack an understanding of who their target customers are, what problems or challenges those customers face, and how their product or service will serve as a solution. These small businesses don’t pay sufficient attention to the value of branding, public relations, and related marketing efforts.

It’s never a case of “Build it, and they will come.” You have to find them!

Be certain you understand what sets your business apart–its unique value proposition. Then make every conceivable effort to get the word out there.

“Use social media, word of mouth, cold calling, direct mails, and other tried-and true marketing techniques,” advises Bplans. Find ways to encapsulate your value proposition in language customers can understand “so you can capture a market share and begin building your conversion rates.”

Marketing consumes an unpredictable amount of time, money, and resources. It’s essential to incorporate a full-fledged marketing plan within the business plan, so you have a realistic sense of what’s needed to reach and attract your target audience. Without such a plan, you risk going through all of your available cash and having little to show for it.

5. Neglecting to anticipate growth and expansion challenges

Finally, there’s the challenge associated with more successful business ventures. In a period of accelerated consumer demand and record-high sales, there comes a point when the existing infrastructure, current business model, employee workforce, and other key elements are no longer sufficient to handle issues related to growth and expansion.

A failure to anticipate this nearly inevitable event has caused many small businesses to shut down.  This is, simply, because they lacked the vision and resources to expand when necessary.

To counter this threat, even at the earliest stages of your business, look into the following options to handle the risks (and benefits) of rapid growth:

Preparing for success is just as important as guarding against failure. With plans and strategies in place, you’re better equipped to cope with ever-changing marketplace conditions.

Yes, small business failure happens, sometimes at an alarming rate. But research, knowledge, and drawing on past experiences and learning from others can pave the way towards a more fruitful outcome for you and your exciting small business.

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