Business Failures - Five Reasons Why Small Businesses Fail

Most small businesses are born when one talented individual with a gift and a passion suddenly realizes that their gift is making someone else wealthy.

What these individuals don't realize is that the established business owner also brings a set of skills to the table which are as much responsible for the success of the business as the talented souls who actually produce the product or perform the service.

The successful business owner knows that it actually takes two skill-sets to run a successful business operation: he or she has learned, perhaps through the school of hard knocks, that such mundane things as marketing, management continuity and the ability to control growth are equally as relevant to the bottom line and health of the company as the actual ability to provide a good or service.

Does that mean our talented individual shouldn't give it a go?

Statistically speaking, they probably should not.

According to the U.S. Small Business Administration, more than half of all business failures occur within the first five years of operation. Obviously these statistics fluctuate depending on the nature of the business; restaurants and contractors tend to suffer more than CPA's for example. More than 70% of all closely held businesses will fail when passed from one generation of ownership to another.

And make no mistake, a business failure can leave a family emotionally and financially devastated, so opening a small business should not be undertaken without first taking a long, hard look at the other side of operating a business.

If you are willing to risk your personal assets, and quite possibly your professional reputation, then you should ask yourself this question: "Am I sure I'm ready to handle the business side of this?" If you answer "No" or "I don't know," to this question, then perhaps it is time to take a business course or two at the local community college. Take the time to lay a foundation for your success before you hang out your shingle. If you are ready to answer "yes" to that question, then you will want to read the following discussion on why small businesses fail.

One of the biggest reasons why small businesses fail is because the owner becomes complacent.

After a business operates profitably for a few years, it is easy for the owner to believe they are invincible. They tell themselves that they are better than the competition and that they have a lock on the market. If they are too complacent, they take their clients and their market for granted. This is deadly for a business because, let's face it, there are always hungrier sharks circling in the waters just waiting for an opportunity to show off their innovation and enthusiasm.

The other area where complacency is dangerous is the "It can't happen to me syndrome". This kind of thinking allows a business to be become too arrogant to watch for danger signs or take advice, and they are blindsided when an adverse event occurs.

It is statistically probable that most businesses will suffer at least one catastrophic setback during the course of its operation. It might be an event like a serious employee related accident or an economic crisis of some kind. If the owner understands that the business isn't invincible, then these events present an opportunity for the owner to step back and re-evaluate employees and procedures---looking for ways to prevent future instability. On the other hand, the complacent owner is more likely to respond with a decision that worsens the situation.

The single common thread that runs through every successful business is the owner's dedicated focus to the tested operations of the business. One sure way to cause a small business failure is for the business owner to become too interested in the golf course or an area of business operation outside of their specialty.

When a business owner attempts to expand their area of operation into other less familiar areas, they are, in essence, opening a brand new business that they know almost nothing about on the back of a functioning business. Even if the new leg of the business is in a somewhat related field, the operation will look drastically different from almost every perspective. Client management to paperwork, it's all different. The electrician, for example, who thinks that the grass is greener on the general contractor's side is making a dangerous assumption when he believes that he knows how to run an entire job because he has been on many of them. This is even more risky if this is tried with a business that is already in danger of failing.

Running a small business is exhausting and time consuming. Many small businesses fail when the owner gives into the temptation to turn its operation over to a trusted high level employee. They believe that after years of training trusted employees, building longstanding client relationships, and putting procedures in place that it will run without their input and they head for the links. It isn't long before supervisors become resentful at the long hours and stress that comes with running the business. They become angry at having decisions that are beyond the scope of their abilities foisted upon them. Soon the product or service begins to suffer.

A business that has more work than it can handle might sound like a good thing, but that isn't necessarily so.

Overselling a business' capacity almost always foretells a chain of events that ends up hurting the business' reputation, angering over-tired employees, and pressuring vendors.

Overselling capacity is surest way to make clients angry because someone is not going to get their goods or service on time. And depending on the nature of the client's business, late orders not only make the offending businesses look bad, they jeopardize the client's relationship with their customer as well. Who forgives a vendor that puts you in that position?

We don't have to look far for a simple example of this. Most of us have eaten in a restaurant at one time or another that was shorthanded on the shift. We end up waiting too long for our food. The result is that we are mad, and the food is cold and horrible. How often do you return to a place like that?

Overselling capacity is usually indicative of deeper problems in an organization. It can mean that business is suffering from liquidity issues or they have an inability to plan.

Liquidity, for our purposes, is the ease and speed that an asset can be converted into cash without taking a price discount. The most liquid assets are things like certificates of deposit. Remember, the operative words here are 'without taking a price discount.'

Why is this important? Because it is a statistical probability that every small business will likely find itself in a period of unprofitable operations at some point in time, and a business that doesn't have enough cash to purchase inventory, meet its payroll obligations or pay its other expenses like rent and utilities during those times will not survive for long.

Often, the owner of the business makes the mistake of believing that they can use credit to carry them through these periods; We don't have to look past the recession of 2008 to see how inaccurate this thinking is. Even with quality, unencumbered collateral, lenders still won't lend without proof of a sufficient income stream, so access to credit should not be counted on.

A new business that establishes itself as the cheapest is absolutely setting itself up for failure.

Unless a new business starts out with an established client base (ie: by purchasing contracts) or the good or service they provide is in an niche market where there isn't much competition, they will most likely find themselves bidding or competing in a heavily impacted playing field. The temptation for any new business is to underbid the competition in order to get their foot in the door, hoping to build on their reputation in the meantime.

The new business owner needs to remember that they are not (usually) competing against novices. In a tight market, an established business will have a pricing structure that marches the line right at what the market will bear; they have streamlined their procedures so that they are operating within an expected profit margin. In other words, it is going to be hard to provide a good or service below the operating cost of a successfully functioning business. Businesses who try this strategy most often find themselves operating in the red or at best break-even.

Another unfortunate side-effect of the 'being the cheapest' strategy is that the referrals that are generated through this strategy carry the cheap price tag with them everywhere they go. The business or individual who helpfully refers such a business will always be sure to add what a great price they got, and the new referral is going to want the same deal.