No small company wants to go out of business, yet many do. And the younger the company, the greater the likelihood that it will.
According to the SBA Office of Advocacy (PDF), about two-thirds of businesses with employees survive at least two years, but only 50 percent make it to the five-year mark and just one-third celebrate their 10-year anniversary.
The rates of companies that go out of business have changed little over the past 20 years, the SBA says, and are consistent across a range of industries, including manufacturing, retail trade, food services, hotels and construction.
Why do small companies fail and go out of business?
Unfortunately, the reasons are many and all too common. Here are ten to consider, along with advice on what the business can do to avert disaster before it strikes.
Why Small Companies Fail
1. Starting for the Wrong Reason
According to Forbes, more than 500,000 businesses are started each month — many for the wrong reason. Case in point, an electrician who worked for a building contractor decided that he no longer needed to answer to an employer and could do better financially by stepping out on his own.
What he failed to realize, however, was that although he had the skills to do the electrical work, he lacked the acumen to manage a business successfully. Over time, his enthusiasm waned. He shut down his fledgling company and, happily, went back to work for his previous employer.
Unlike the unfortunate electrician, you stand a much better chance of success if you start your business for the right reasons. These include having a passion for what you’ll be doing, a positive mindset that keeps you going when others give up and a willingness to learn the skills needed to run a business.
2. Insufficient Capital
Starting a business without sufficient operating capital is almost certainly a death-knell. Not only that but many new business owners underestimate the perils of riding the cash flow roller coaster. In fact, according to Hiscox’s 2015 DNA of an Entrepreneur Report, 21 percent of US entrepreneurs have resorted to using their credit cards to fund their businesses.
Failure to manage cash flow is what caused one marketing consultant to lose his business. Used to a regular paycheck, he failed to realize that clients can take weeks or even months to pay. Being forced to take on expensive loans just to survive left him with no choice but to shutter his business and find a job with another firm. Protecting your capital before you start your business gives you a good buffer for the ebbs and flow in your business. In fact as per Hiscox Business Insurance, one third of small business owners don’t have insurance and one in three small business owners get sued even if they haven’t made a mistake and have to spend a chunk of their capital combating lawsuits. Getting the right liability insurance for your business is the first step to helping you manage your cash flow better.
Before starting a company, it is vital to ascertain how much money you will need to cover startup costs and to keep the business running for the first year or two. Use a startup calculator like this one from the Wall Street Journal. Also, sit down with a financial advisor or SCORE mentor to discuss your plans.
3. Improper Planning
Lack of proper planning is another common reason small companies fail and go out of business. All too often, entrepreneurs focused on achieving their dream of financial independence fail to take the painstaking but necessary step of creating a strategic business plan that factors in components such as workforce needs, analysis of competitors, sales and expense forecasts and marketing budgets.
One burgeoning entrepreneur, enthralled with the idea of becoming a salon owner, started her business without first conducting market research to see if the area could support such an endeavor. Try as she might, she was never able to build a customer base strong enough to keep her doors open.
To better ensure success, take whatever time you need to create an effective business plan. Many companies have software to make the job easier and faster. It doesn’t have to be reams of pages long — some companies even offer one-page plans. Regardless of length, planning is critical.
4. Poor Management and Leadership
Effective management and leadership skills are essential to business-building success, and a lack of either can lead to confusion and conflict within the ranks, poor morale and reduced productivity.
Make it a priority to acquire the skills needed to strengthen areas where you know you are weak. Read books on leadership from authors such as John Maxwell, Stephen Covey, Peter Drucker and Sheryl Sandberg; join peer advisory groups like Vistage or take an online course in leadership from Dale Carnegie.
The bottom line: Your employees look to you for leadership — so lead!
5. Expanding Too Quickly
More than one company has experienced bankruptcy as a result of the business owner’s reach exceeding his grasp concerning expansion.
Decide about expansion only after carefully reviewing, researching and analyzing what you will need regarding new employees, facilities and systems. While it may be feasible to do much of the work yourself early in the life of your business, that won’t be the case after your expand. Just keep in mind, slow and steady wins the race.
6. Failure to Advertise and Market
An adage says, “When business is good, it pays to advertise; when business is bad, you have to advertise.”
Many companies go out of business purely because the owner failed to promote and market. The “if you build it, they will come” mentality doesn’t work in an age when consumers can choose from among a multiplicity of options. You have to get your message seen and heard.
While traditional methods of advertising are still useful, one of the best ways to market your business is with a website. Even in 2016, nearly half (46 percent) of all small businesses do not have one, according to a report from the research firm Clutch. So just by creating a site, which you can do using any number of self-service platforms, you put yourself ahead of many of your competitors.
While you’re at it, set up profiles on social networks where your customers gather. Also, start an email newsletter and advertise on Google and Facebook — both of which are inexpensive ways to build a presence online.
7. Lack of Differentiation
You’ve heard of the term, “Unique Value Proposition” (UVP, for short). That describes the qualities, characteristics, products or services that differentiate a business from its competitors. The problem is, too few businesses actually have a UVP, or they fail to make it clear what theirs is — probably because they don’t know themselves.
To determine your value proposition, use a tool like the Value Proposition Canvas, which makes it explicit how you create value for your customers and even helps you to design products and services your customers want. Once you know the UVP, communicate it clearly, to customers and staff.
8. Unwillingness to Delegate
Entrepreneurs can often be their own worst enemies in that they seek to do everything themselves. One extreme example comes from a CEO of a small but growing engineering firm who, after 10 years was still emptying the dishwasher in the employee break room.
As an entrepreneur, you may think, “No one can do it better than me.” Or, “If you want something done right, you have to do it yourself.” Or, “I can’t trust anyone else with this responsibility.” That attitude can lead to a sense of overwhelm and burnout.
The remedy: Learn to delegate busywork (emptying a dishwasher certainly qualifies) to others while concentrating on the tasks that contribute to the growth of the company, like casting vision and grooming others for positions of leadership.
9. Unprofitable Business Model
Just because you have a business idea about which you’re excited doesn’t mean it’s a good one. That’s where creating a business plan, conducting marketing research and seeking the advice of others can be a lifesaver.
Also, it pays to ask yourself questions like: Is there a customer base for this product or service? Is there a proven revenue model? How long would it take to bring the business to market and at what cost?
10. Underestimating the Competition
A final reason worth mentioning for why companies go out of business is underestimating the competition.
Even if you have a sound business model, plenty of funds to operate and the necessary management skills to be successful, you still face one daunting challenge: the competition.
You may be a David surrounded by several Goliaths; that’s particularly true if you’re in the retail trade, located where there is an abundance of big box stores.
Also, you have to consider disruptive startups who may be building a better, cheaper, faster, more convenient, higher-quality mousetrap.
To increase your chance of success, conduct a competitive analysis as part of your overall market analysis. Assess your competitor’s strengths and weaknesses and implement strategies to improve your competitive advantage.
Window Image via Shutterstock