Entrepreneurs are often visionaries who identify an under-served area and turn it into a business. Just think of some of the tools you use in your daily life—smart phones, portable GPS systems, cloud-based storage, Facebook, LinkedIn and more—someone invented each one of these devices or services and they became indispensable to many of us in our daily lives. However, entrepreneurs face many challenges and can fail if they don't start with a solid business plan.
Why Small Businesses Fail
There is a lot of misinformation about how many businesses fail in their first year. The fact is only about 20% fail in year one. That level of failure has remained largely static for the past few decades according to the Bureau of Labor Statistics. However, 50% of businesses fail between years 4 and 6.1,2
The majority of the time, failure can be attributed to lack of profits and insufficient funding. Many entrepreneurs are so confident they leap before they look. They don't like to sit down and draw up a business plan, or assign numbers and projections to their “great idea.” Sometimes, they are simply enamored with their concept and fail to really consider demand, competitors, distribution channels, etc. Or the business owner runs a successful enterprise and comes up with an idea for a new product, service or offshoot venture but doesn't determine if the market truly values this product or service, how to get demand going and what costs or lead time are involved.
Failure Is Not Fatal
Winston Churchill famously stated “Success is not final, failure is not fatal, it is the courage to continue that counts.” Sir James Dyson, the creator of the now ubiquitous bright-yellow Dyson vacuum cleaner made 5,126 prototypes before coming up with the one he sells now. He went on to create other products, including a washing machine with two tubs, which also took years of mistakes before a version worked as Dyson wished.
Would you have had the fortitude to continue after failing over 5,000 times? Failure is painful, no doubt. If the failure is a public event, it is even more agonizing. We can berate ourselves endlessly. Failure of a new venture, if executed judiciously, does not have to financially devastate the entrepreneur. However, if you staked your personal fortune on the venture, you may be jeopardizing your family’s security, feel judged, depressed, angry and more. (For related reading, see: What risks does an entrepreneur face?)
In the stock market, one guiding principle is to limit losses. If you lose 10%, you need 12% to recover. If you lose 25%, you need 37% to get back to even. However, once you allow losses to draw down 50%, you need 100% in gains to get back to even. It is much easier to earn 12% than 100% so minimizing loss by being unemotional and pragmatic can help us stay on track.
Risk in Business
When you are in a business, risk can arise in many forms. Undercapitalization is a huge reason for failure. I have seen businesses with pending orders from major potential vendors but not enough capital to produce the inventory to meet the demand. Financing for production can be challenging as the company's track record and ability to execute may not be proven. Any seasoned potential investor or capital source recognizes there are many areas to navigate in executing and running a successful enterprise besides production in delivering units to a distribution center. Without a track record, a financial backer may not be confident the entrepreneur is capable of pricing, sourcing, shipping, quality control, customer service and the many other variables that go into running a profitable enterprise.
Access to Capital
Getting capital for a startup is hard. Banks typically lend to businesses with a minimum of three years of profitable operating experience. Very often sales need to be seven figures and a personal guarantee is also required. If an owner is starting out and doesn’t want to risk his or her own capital, others may question how vested they are in the enterprise. Friends and family are more trusting and supportive, therefore that circle is the most-often suggested first step.
Angels do exist, however these groups see many deals and getting in front of them and actually acquiring enough funding from an angel group can be challenging if not impossible. Angel groups are often comprised of other entrepreneurs who built successful enterprises and in some cases, had a liquidity event and love investing in other entrepreneurial ventures. However, they often wish to give advice to the business owner, which may fall on deaf ears. Another issue is angels often invest as a group and must agree on an enterprise to support. (For related reading, see: Protect Your Idea From Angel Investors.)
Have a Business Plan
Creating a business plan and doing research in advance is really the best way to be prepared. Hiring a market research firm or running tests on targeted customers provides hard data. You can even execute a “pop-up shop” online or in a brick-and-mortar location to test out demand, cost of acquisition, average size of orders and more. Running a beta test is critical, and many investors won’t consider a deal until they see results. This is known as “proof of concept.”
A well-written business plan can serve as a guide to realistic projections. Running your business plan by seasoned entrepreneurs or business advisors is another way of finding the flaws and working to button up the plan before going live. We all have blind spots, so having an outsider who is knowledgeable about your sector or some subset of your distribution channel is a great idea. Building your network in advance, speaking with many different types of experts and hiring a profitability consultant, business coach or business advisor can be worth the financial outlay. (For more from this author, see: The Importance of Small Business Forecasting.)
Failure is painful but we can learn from our mistakes. If you are judicious in your launch and open-minded to critiques, you can tweak a plan before going full-scale. Nothing ever works exactly as we plan, but it's still important to have a plan we can adjust. It's like going on a road trip with young kids. If you are driving from New York to Florida, you would map out the planned route, assume how many hours you might drive each day and have an idea of where you may stay each night. You’ll have an ultimate destination, itinerary and approximate costs assigned. Once you start out, weather, your children’s temperament and health during the drive, and detours can impact the overall trip, but you can adjust since you have an overall plan.
Having a macro plan for your new venture provides a baseline but can allow for shifts as opportunities or challenges present themselves. The key is to plan and keep failures small so you can recover and try again if necessary until you succeed.
(For more from this author, see: Emergency Planning for Small Business Owners.)
1. Headd, B. Redefining Business Success: Distinguishing Between Closure and Failure, 2002
2. Shane, S. Startup Failure Rates – The Real Numbers, 2008