Why Small Businesses Fail

Hundreds of thousands of small businesses are founded each year. Unfortunately, many of those businesses will fail. Research suggests many common reasons. This article lists and describes those risks.

We group the risks under three headings: strategic, operational, and financial. In future posts, we will discuss practical steps businesses can take to address these risks through effective risk management.

Strategic

1. Lack of experience. The founder or founders may not have the skill set to perform the tasks necessary to have the business survive or thrive.

2. Started for the wrong reasons. Too many founders do not consider why they started their business. Was it to make money? Was it to gain independence? Was it some combination of both factors? Was it something else? If the founders are unclear about the “why,” they may fail to execute the “what.”

3. Poor location. For businesses that require foot traffic, a poor location can undermine even the best strategic planning, operational excellence, and financial resources.

4. Poor planning. We are not talking here about a “business plan” used for attracting investors were securing financing. Rather, businesses fail for lack of effective strategic planning and ongoing operational planning.

5. Poor business model with insufficient revenue streams. A business may address a viable market, but with a cost structure or potential revenue streams that simply do not mesh sufficiently with that market.

6. Not enough demand. A business may have an excellent idea for a product or service, but there simply may not be enough demand, no matter how much enthusiasm the founders display.

7. Declining market. A business may be addressing a failing industry segment. However viable it was to make carriage wheels in the late 1800s, by the 1920s carriage wheel manufacturers and vendors faced tough times.

8. Competition. New entrants into a market may pressure existing businesses in ways that fundamentally undermined their viability.

9. Out-of-control growth. Although businesses generally favor growth, many businesses fail because they cannot keep up with demand. In seeking to do so, they introduce operational inefficiencies, fail to plan, and/or place fatal financial strains on the business.

10. Overexpansion. Relatedly, a business may fail because it expands to rapidly in expectation of potential market growth that does not manifest.

11. Poor reputation management. No matter how solid a business’s products or services may be, public perception of the company may fatally undermine the business. This might happen if customers are turned off by boorish employees, if rumors in the marketplace are left unaddressed, if business promises exceed business results, if under performance with respect to one product or service undermines customer confidence in other offerings, or if poor employee morale or poor talent management leads to dissatisfied and disgruntled current and former employees.

12. Lack of succession planning. If the founders do not have solid, executable plans for how they will be replaced, even a superior business may fail. Likewise, if the business does not have effective talent management (identification of staffing needs, hiring, training, motivation, workplace safety, personal and professional growth, and compensation), the business will not be able to perform its duties and meet its potential over time.

13. Failure to innovate. A business that does not continuously consider innovation risks death by obsolescence. A business that does not keep abreast of changes in customer/client preferences is blind to potential opportunities and potential threats. A business that does not regularly assess how changes in technology, social trends, and economic forces may modify its competitive environment is likewise courting disaster.

Operational

1. Founders can’t get out of their own way. Quite often, businesses fail because the founder or founders will not (or believes they cannot) get out of the way. This risk can manifest itself in many different ways. The founder may be unwilling to let go of operational tasks. She may be blind to areas that are not within her core expertise. She may be unwilling or unable to take advice from experts, professionals, peers, and staff. She may be so interested in maintaining or enhancing her power that she undermines the otherwise healthy growth of the organization.

2. Poor financial record-keeping. Solid accounting fundamentals are critical to the effective functioning of an organization. If a company cannot determine how it makes money and how much money it makes, it will not survive.

3. Operational mediocrity or inefficiencies. In the face of any competition, a business that does not have effective processes, systems, and controls places itself at a profound disadvantage in the marketplace.

4. Dysfunctional management. Management is a distinct function in the business. Even if a small business has only a limited number of employees, numerous business functions must be effectively executed, including customer service, operational execution (e.g., production and distribution of products, provision of services), marketing, financial record keeping, risk management, regulatory compliance, training, hiring, and research and development. Failures in any of these areas pose risks to the entire organization.

5. No online and mobile presence. It is a fact of modern business that almost any organization needs to have an online presence and a mobile presence in order to thrive. If you don’t, one of your competitors will.

6. Poor marketing. This risk may manifest in many ways: poor understanding of customers, insufficient product differentiation, or insufficient articulation of the product or service’s value proposition.

7. Poor inventory management. In any business that handles inventory, inefficient or inadequate inventory management can be fatal. Carrying excess inventory ties up financial resources and space. Carrying insufficient inventory risks production delays and customer dissatisfaction.

8. Unreliable suppliers. Supply chain problems can pose substantial risks. Service providers sometimes do not emphasize these issues, but almost any business uses the vendor of some sort, and failing to take account of potential vendor problems can result in profound operational challenges.

9. Bad talent management. Solid employment practices are critical to business success. These include planning for the proper hiring, providing meaningful job descriptions, providing employee handbooks and operational manuals, interviewing fairly and effectively, providing workplace safety, providing a constructive work environment (e.g., free of harassment and discrimination), effective supervision, fair and adequate discipline, constructive feedback and review, appropriate compensation and benefits, professional development, and effective termination and exit procedures.

10. Insufficient product diversity. Although over-diversification may dilute any company’s focus, marketing, and value proposition, businesses face risks if they fail to consider how to grow their product or service lines in order to meet current and emerging customer/client needs and preferences.

Financial

1. Lack of a cash cushion. Even if a business has a viable business model and is making money that covers costs, that business will nevertheless face risks if it does not have sufficient cash resources to handle lumpiness in payments, temporary downturns, and other expected or unexpected challenges.

2. Lack of capital. A cash cushion, however, is insufficient. The business must also have sufficient resources to grow in order to serve its market and stave off competition.

3. Over-investment in fixed assets. Small businesses may fail because they invest too many scarce resources in fixed assets, and thus limit their flexibility to respond to ongoing market forces.

4. Poor credit arrangements. Growing businesses may face risks because they have insufficient access to favorable credit terms, are over dependent on credit, or conversely are unnecessarily hesitant to access credit markets.

5. Personal use of business funds. In businesses of any size, there is always a risk of financial fraud or embezzlement. In a small business, however, there is an enhanced risk of informality in commingling business and personal assets. Such practices can create regulatory difficulties, undermine reputation in the community, and impede business planning and execution.

Conclusion

All of these risks may be addressed by proper risk management. None of them is necessarily fatal. But together, they can present many challenges to business growth and prosperity.

Your Turn

What have we missed? And what resources have you identified to overcome these challenges? Please let us know.

Also, please share this post if you found it useful. We are out to change how organizations think about risk management, and we need your help.

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