Most entrepreneurs charge into the marketplace with high hopes of success, but many face crushing disappointment when their businesses fail. In fact, the number of small-business exits exceeded the number of start-ups for the first time this year. While 400,000 new businesses are being created annually, 470,000 are closing, leaving a deficit of 70,000, according to the U.S. Census Bureau.
Not all business exits are failures—sometimes an owner gets a job or retires—but some of them undoubtedly are. And often it's because the owners got blindsided by factors they did not anticipate.
"A lot of companies fail unexpectedly," said attorney Andrew Sherman, a partner at Jones Day in Washington, D.C., who advises businesses on issues affecting growth and strategy. "They fail by surprise; they don't have any safety belt."
The good news? "A lot of risks can be averted, but only if you plan for them," Sherman said.
The first step in learning to avoid business failure is understanding what is likely to cause it. Here are 11 common reasons businesses go under.
—By Elaine Pofeldt
Posted 30 July 2014
"The No. 1 reason people fail is, they run out of money," said David Goldin, CEO and president of AmeriMerchant, a provider of merchant cash advances.
Research bears him out. The 2013 Global Entrepreneurship Monitor report, produced by Babson College and other universities, found that the top reasons for discontinuing a business in the U.S. were problems obtaining financing and lack of profitability—problems that plagued more than half of businesses that shut their doors. Only a few economies had more exits triggered by these problems: Japan, Korea, Greece, Portugal, Ireland and Spain.
Of course, it's not just failure to raise money that can lead a business to fizzle. Many high-revenue businesses suffer from poor cash flow. They can't make payroll or keep the lights on because there's a big gap between when they finish their projects and when they get paid—sometimes due to simple problems, like failing to invoice promptly.
It's not a rookie mistake: About 37 percent of experienced business owners sometimes fall short of the cash they need to cover business expenses, according to an annual report by the Corporation for Enterprise Development, a nonprofit based in Washington, D.C., that is focused on helping low- and moderate-income households grow and hold on to their assets. The businesses surveyed had revenues from $49,000 to more than $1 million annually.
Sometimes the critics of a new business concept are right: Founders are wasting their time on an idea that's a dud or is ill-timed—and haven't done enough testing or market research to find that out. "If you're not keeping up with the trends, there's a good chance customers won't purchase your services," AmeriMerchant's David Goldin said.
Ask Jordan Malik. The entrepreneur from Levittown, New York, co-founded LookTrade in 1999, a tech start-up that helped companies run their own online auctions. It imploded in 2001, during the dot-com bust. "The reality is, everyone was doing the eBay thing," he said, looking back with 20-20 hindsight.
Malik learned from his mistake. He left the start-up world behind and eventually got a job at a major advertising agency, selling products on eBay and Amazon on the side. In 2009, after losing his job, he dove back into entrepreneurship and started what became a group of five small businesses to help e-commerce merchants improve sales and profits, offering systems he developed to do so. The sites include FindSpotter.com, which tells merchants what to sell on Amazon and where to find it. Today they collectively generate more than $500,000 a year in revenue for the solo entrepreneur.
"I advise entrepreneurs not to be bullheaded about an idea when everyone is saying the idea doesn't work," said Malik, now 43.
What consumers tell market researchers they are willing to spend doesn't always sync up with reality. Until you test your pricing in the marketplace, it's hard to tell if potential customers will actually pay what you plan to charge.
One reason entrepreneur Jordan Malik believes LookTrade failed was that there were cheaper solutions for setting up an online auction than what it offered. "If people wanted a customized solution, there were options that cost about $19.95 a month; our solution was in the thousands," Malik said. While he and his partner debated whether to revamp the business model, the start-up petered out. "We were so determined, we burned through our cash," he said.
Another common hazard is failing to price a company's offerings in a way that allows a profit. With many services becoming commoditized in a more global, digital marketplace, it can be tough to raise prices, but doing so can be essential to staying profitable and surviving. In an April survey of small-business owners by PNC Bank, 74 percent of respondents predicted consumer prices would rise in the next six months—and 37 percent of small businesses said they planned to increase their own prices, too. The average projected hike was 1 percent to 2 percent.
There's nothing wrong with spirited debate among founders—some level of it is healthy for governance—but when there's constant conflict or one partner checks out emotionally, it can destroy the team's morale.
"A lack of collaboration and communication by and among the co-founders looks like parents fighting in anticipation of a divorce," Jones Day attorney Andrew Sherman said.
Most start-up teams fail to plan for the possibility that a partner may want to leave at some point, which can lead to conflict and hurt the business in the future. More than 60 percent of owners lack an exit plan, according to research by Securian Financial Services.
To keep the business stable, create a written shareholder agreement. "Usually that requires a lawyer charging you good sums of money," said Shane Leonard, CEO of Stockflare, a London-based start-up that offers investing ideas and is rolling out in the U.S. next week
Leonard's two co-founders at the business, launched in 2013, decided to leave day-to-day operations after finding life at the start-up was not for them. They didn't have a written shareholder agreement, but Leonard remains on good terms with both, and they still hold equity as he continues on with new partners. However, he realizes in retrospect what could have gone wrong.
"My partners' leaving went smoothly because they are seasoned professionals, friends and fully behind the business as investors, even if they aren't partners anymore," he said. "However, if they weren't, it would have been a real mess and killed the business."
Most businesses feed off the owner's energy and excitement—and there's plenty of it to go around right now. A recent survey by Manta, the online social network for small businesses, found that 83 percent of owners were optimistic about the second half of the year.
When that eagerness to succeed is missing—which can happen for many reasons—the business can quickly die on the vine.
"The owner may not be hands-on anymore and has been replaced by someone who may not be as good as that person is," AmeriMerchant's David Goldin said. "It could be the owners are getting tired as they get older, losing their drive, are sick of the business or have been there too long. Priorities change. It could be a family event, such as the birth of a child."
Big companies know that it's vital to refresh their brand. Even car-rental giant Avis, which stuck with its classic "We try harder" tagline for 50 years, updated it in 2012 with a new one—"It's your space"—which touts the comfortable interiors of its cars.
Small companies that lack the marketing budgets of corporate giants often neglect this side of the business—to their peril. The National Small Business Association's year-end report for 2013 found that only 46 percent of respondents planned to try new advertising and marketing strategies in 2014.
If you haven't given any thought to your branding recently or are using the same piece of direct mail you used four years ago, that's a warning sign you could soon be running the business that time forgot.
Americans may spend much of their lives staring at the screens of their laptops, tablets and smartphones, but many businesses still aren't making the most of opportunities to reach customers online.
The 2013 Small Business Technology Survey by the NSBA, conducted last August, found that while 82 percent of businesses have a website, a whopping 72 percent of firms did not sell their products or services online. That represented only a slight increase over 2010, when 74 percent said they weren't selling online. And few small firms are making the most of opportunities to dive into the mobile market—a good opportunity to reach younger consumers. Only 18 percent have a mobile website, the survey found.
It's not just big companies like Target that criminals target in data breaches. Many small firms get victimized—and it can be deadly to them, research shows. Sam Graves, R.-Mo., chairman of the House Subcommittee on Small Business, said in a 2013 speech that 60 percent of small businesses fail after a cyberattack.
The NSBA's 2013 technology survey found that while 94 percent of small-business owners report being very or somewhat concerned about cybersecurity, nearly half have been victimized by a cyberattack. Often, this results in time wasted, service interruptions and thousands of dollars lost. For those whose bank accounts got hacked, the average loss was $6,927.50.
Despite the risks, many do-it-yourselfers have not turned to professional help. Among the business leaders surveyed by NSBA, 40 percent said they handle tech support themselves, while only 32 percent assign a staffer to tackle this. Just 24 percent rely on an outside service provider.
Even if you're a David in a world of Goliaths, it doesn't mean the Goliaths are the only threat to your existence. Entrepreneurs need to be just as wary of new disruptors in their industry. Unfortunately, business owners often underestimate the new kid on the block. One reason is that they are blinded by what AmeriMerchant's David Goldin calls the "owner syndrome"—they think their product or service is the best.
Sometimes it may not be a competitor's superior product that puts you out of business. They may beat you on a factor like convenience or TLC.
Consider this: 66 percent of consumers in 1 of 10 industries Accenture studied last year switched to a new company because of the service. Even worse, 82 percent felt their provider could have done something to prevent them from switching. If you're not sure how happy your customers are, consider using a tool like SurveyMonkey to take their pulse—before they defect.
It can be exciting to win a big account, but owners who devote all of their time and attention to one or two clients put themselves in a very vulnerable position. If that business dries up, the loss of income they suffer is as catastrophic as a job loss is to an employee. And failing to replace the lost customers quickly can lead the businesses to close—even in the case of larger companies.
In its 2014 survey of its members, the Turnaround Management Society, an association of turnaround professionals in Alhabra, California, found that 12.2 percent of corporate businesses failed because they did not have enough new customers.
If the people who serve your customers aren't psyched about coming to work, it's probably going to show in their performance and hurt your overall profitability. Employees who aren't happy about their situation at work aren't likely to put in extra effort or stay up late working on a new innovation to help your company, which are "the things small and growing companies rely on," Jones Day attorney Andrew Sherman said.
Gallup found in 2013 research that 70 percent of American workers are either not engaged at work, or are actively disengaged to the point of trying to subvert the work of colleagues.
The good news for entrepreneurs: Small companies do better than big companies at keeping workers enthused. Forty-two percent of employees at small firms are happy, compared to just 27 percent to 30 percent of those at bigger companies.
What can you do to avoid disengagement? Often, a "cultural disconnect"–where leaders' words don't sync with the realities of the line worker—causes the problem, so make sure it's not afflicting your business, Sherman said. "It's when the CEO stands up and says, 'This year we're cutting costs' but doesn't explain how oh, by the way, he just leased a new Mercedes-Benz 500 and made some improvements to his office."