Running a business is not for the faint of heart; entrepreneurship is inherently risky. Successful business owners must possess the ability to mitigate company-specific risks while simultaneously bringing a product or service to market at a price point that meets consumer demand levels.
While there are a number of small businesses in a broad range of industries that perform well and are continuously profitable, 20% of small businesses fail in the first year, 50% go belly up after five years, and only 33% make it to 10 years or longer, according to the Small Business Administration (SBA).
To safeguard a new or established business, it is necessary to understand what can lead to business failure and how each obstacle can be managed or avoided altogether. The most common reasons small businesses fail include a lack of capital or funding, retaining an inadequate management team, a faulty infrastructure or business model, and unsuccessful marketing initiatives.
- Running out of money is a small business’s biggest risk. Owners often know what funds are needed day to day but are unclear as to how much revenue is being generated, and the disconnect can be disastrous.
- Inexperience managing a business—or an unwillingness to delegate—can negatively impact small businesses, as can a poorly visualized business plan, which can lead to ongoing problems once the firm is operational.
- Poorly planned or executed marketing campaigns, or a lack of adequate marketing and publicity, are among the other issues that drag down small businesses.
Top 6 Reasons New Businesses Fail
1. Financing Hurdles
A primary reason why small businesses fail is a lack of funding or working capital. In most instances a business owner is intimately aware of how much money is needed to keep operations running on a day-to-day basis, including funding payroll; paying fixed and varied overhead expenses, such as rent and utilities; and ensuring that outside vendors are paid on time. However, owners of failing companies are less in tune with how much revenue is generated by sales of products or services. This disconnect leads to funding shortfalls that can quickly put a small business out of operation.
A second reason is business owners who miss the mark on pricing products and services. To beat out the competition in highly saturated industries, companies may price a product or service far lower than similar offerings, with the intent to entice new customers. While the strategy is successful in some cases, businesses that end up closing their doors are those that keep the price of a product or service too low for too long. When the costs of production, marketing, and delivery outweigh the revenue generated from new sales, small businesses have little choice but to close down.
In response to the COVID-19 pandemic, the government gave help to small businesses through its Paycheck Protection Program, which in its first two rounds gave 5.2 million forgivable loans to small businesses of up to $10 million each. The third round of PPP funding went into effect on January 11, 2021, with $284 billion in available funds. First-time recipients of PPP can receive up to $10 million each, and companies that have already received an earlier round can receive a second round of up to $2 million. The American Rescue Plan Act, signed into law on March 11, 2021, authorized an additional 7.25 billion for the program. On March 30, 2021, President Joe Biden signed the PPP Extension Act of 2021 into law which extends the PPP to May 31, 2021. The You can find the PPP application on the Small Business Administration's website.
Small companies in the startup phase can face challenges in terms of obtaining financing in order to bring a new product to market, fund an expansion, or pay for ongoing marketing costs. While angel investors, venture capitalists, and conventional bank loans are among the funding sources available to small businesses, not every company has the revenue stream or growth trajectory needed to secure major financing from them. Without an influx of funding for large projects or ongoing working capital needs, small businesses are forced to close their doors.
To help a small business manage common financing hurdles, business owners should first establish a realistic budget for company operations and be willing to provide some capital from their own coffers during the startup or expansion phase. It is imperative to research and secure financing options from multiple outlets before the funding is actually necessary. When the time comes to obtain funding, business owners should already have a variety of sources they can tap for capital.
The percentage of small businesses that fail within the first 10 years, according to the Small Business Administration.
2. Inadequate Management
Another common reason small businesses fail is a lack of business acumen on the part of the management team or business owner. In some instances, a business owner is the only senior-level person within a company, especially when a business is in its first year or two of operation.
While the owner may have the skills necessary to create and sell a viable product or service, they often lack the attributes of a strong manager and don't have the time to successfully oversee other employees. Without a dedicated management team, a business owner has greater potential to mismanage certain aspects of the business, whether it be finances, hiring, or marketing.
Smart business owners outsource the activities they do not perform well or have little time to successfully carry through. A strong management team is one of the first additions a small business needs to continue operations well into the future. It is important for business owners to feel comfortable with the level of understanding each manager has regarding the business’ operations, current and future employees, and products or services.
Lack of a business plan and an unwillingness to adapt the plan as challenges arise can create structural problems for a small company that are ultimately insurmountable.
3. Ineffective Business Planning
Small businesses often overlook the importance of effective business planning prior to opening their doors. A sound business plan should include, at a minimum:
- A clear description of the business
- Current and future employee and management needs
- Opportunities and threats within the broader market
- Capital needs, including projected cash flow and various budgets
- Marketing initiatives
- Competitor analysis
Business owners who fail to address the needs of the business through a well-laid-out plan before operations begin are setting up their companies for serious challenges. Similarly, a business that does not regularly review an initial business plan—or one that is not prepared to adapt to changes in the market or industry—meets potentially insurmountable obstacles throughout the course of its lifetime.
To avoid pitfalls associated with business plans, entrepreneurs should have a solid understanding of their industry and competition before starting a company. A company’s specific business model and infrastructure should be established long before products or services are offered to customers, and potential revenue streams should be realistically projected well in advance. Creating and maintaining a business plan is key to running a successful company for the long term.
4. Marketing Mishaps
Business owners often fail to prepare for the marketing needs of a company in terms of capital required, prospect reach, and accurate conversion-ratio projections. When companies underestimate the total cost of early marketing campaigns, it can be difficult to secure financing or redirect capital from other business departments to make up for the shortfall. Because marketing is a crucial aspect of any early-stage business, it is necessary for companies to ensure that they have established realistic budgets for current and future marketing needs.
Similarly, having realistic projections in terms of target audience reach and sales conversion ratios is critical to marketing campaign success. Businesses that do not understand these aspects of sound marketing strategies are more likely to fail than companies that take the time to create and implement cost-effective, successful campaigns.