Why Businesses Fail

Why Businesses Fail

It helps to improve your chance of success if you know what not to do. The most frequently cited reasons for start-up business failure are:

Lack of money:

This is the equivalent of saying the patient died because he or she stopped breathing. Or, as Henry Ford said on his deathbed, “The only thing wrong with the Model T was that people stopped buying it.”

Companies fail because they run out of money. Most start-ups suffer from under capitalization. The entrepreneur underestimates the amount of money and time it will take to make the enterprise profitable. Scott Clark writes, “It takes a long time for a start-up company to break even because unforeseen contingencies always develop.” He and others estimate that it takes two to three times the amount of capital estimated by entrepreneurs to reach profitability.

Entrepreneurs, and their financial backers as well, try to run the start-up business on a shoestring. In doing this, they run the risk of running short of cash and then having to raise more capital. Raising capital the second or third time for a company that hasn’t met its projections is more difficult than raising the full amount needed at the beginning, as difficult as that is. As James Schermerhorn, Edward Lowe Foundation, has written, “Overcapitalization can’t kill a small business, a capital shortfall can.”

Another reason why start-up businesses are often undercapitalized is that the entrepreneur doesn’t know how to raise the capital or doesn’t have access to capital. As a result, these entrepreneurs try to make a go of it through self-funding or money from family or friends. When the business fails, so do many friendships and family relationships.

Poor management:

Entrepreneurs are often specialists in one, but important, aspect of the start-up business. They often lack management, leadership, business, financial, marketing or human resource skills and knowledge. “Poor management is the greatest single cause of business failure” asserts Steve Muhlhauser, SBA.

Management of a business encompasses a number of activities. Excellent management is key because a failure early can have devastating affects on the company. Also, good management is essential because a start-up business has no slack. In an ongoing business, a bad month can be absorbed. But a bad week can be fatal to a start-up.

Management of information and good decision making is critical. Fred Nerone, International College, writes, “Small businesses are run by entrepreneurs who usually have specialized experience in their product offering, but may lack a business or managerial background. They are well-intentioned and bright individuals, but frequently fail to admit that they are untrained and inexperienced in business basics such as marketing, finance, human resources and planning. As such, they venture out into the business arena, unprepared for the competitive and strategic environment that is apt to defeat their good intentions.”

One of the early fatal mistakes entrepreneurs make is to hire the wrong people. “The first people you hire form the DNA of the company, and that team will drive your valuation in the future”, is the way Angus Davis, Tellme.com, puts it. The majority of aspiring entrepreneurs fill their management ranks with friends. Not only is the surest way to breakup a friendship, it is the most predictable way to enhance failure. Scott Clark, Puget Sound Business Journal, gives this advice, “Never hire acquaintances to join the management team unless they have management experience appropriate to your field of business, and they are willing to openly disagree with you.”

Lack of planning:

“Fail to plan and you plan to fail” is the way Robert Sullivan has stated this in his book The Small Business Start-Up Guide. Planning is not about what you will do in the future. Planning is about the future implications of present decisions and actions.

Marketing misjudgments:

Many of the failures in marketing result from the failure to obtain objective knowledge of the market (customer needs, competitive responses and technological capability). High tech start-ups are especially prone to this failure because they are often technologically driven. Just because something is novel or “cool” doesn’t mean that customers will buy it, or that competitors won’t find a way to provide solutions superior that may or may not involve the technology.

Often high tech start-ups focus too much on push and not enough on pull. Attempting to push a product into a market or create a new market may be part of the technology mythology, but the reality is that letting the market pull you is a much better approach with a higher probability of success. Many of the dot-com failures result from a push approach that ends up with the company being too far ahead of the market (if it will ever catch up) and not enough money to develop the market.

But objective knowledge of the market is not enough. Many start-ups fail because they do not believe and act on the knowledge they have obtained.

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