Why Do So Many New Businesses Fail?
New research by the U.S.
1. Poor Execution
When you're the boss, the only place you should point fingers is at the mirror.
As business ideas and opportunities, crisp execution—rather than a clever idea— is vital to the success of new businesses. It stands to reason, therefore, that poor execution is the downfall of most startups that go bust. There are several ways you can avoid execution failure. First, you should conduct an honest evaluation of your skills and only pursue opportunities that are aligned with your strengths. Entrepreneurs who are blinded by greed or arrogance are more prone to getting in over their heads. It's also wise to surround yourself with talented people who aren't afraid to speak up when you're headed off a cliff.
Companies with inept leadership usually fail in the first year or two, but even established companies can stumble badly when they outgrow the capabilities of the founding team. Bill Gates led Microsoft from inception to its current position as one of the largest and most successful companies in history, but this is seldom the case. As a founder, you need the discipline to know when to hand over the reigns to a professional manager who can take your business to the next level.
Companies with inept leadership usually fail in the first year or two, but even established companies can stumble badly when they outgrow the capabilities of the founding team. Bill Gates led Microsoft from inception to its current position as one of the largest and most successful companies in history, but this is seldom the case. As a founder, you need the discipline to know when to hand over the reigns to a professional manager who can take your business to the next level.
2. No Viable Market
What if we launched a business and nobody showed up?
Each day, entrepreneurs from the "build it and they will come" school of business invest their money in a cool idea with the hopes that customers will magically appear once they open the doors. All too frequently, these hopes turn out to be in vain. History is replete with ventures that crashed and burned because the founders spent all of their time and money developing a product without bothering to consider how to attract customers. Even worse, many did not really understand what customers valued and were willing to pay for. (Remember the "dot bomb" era of the not-so-distant past?)
It's imperative to research and validate the market before you launch your business. Talk to prospective customers and find out what they really need. Chances are, you will end up with a much more compelling offering than what you initially dreamed up on your own. Remember, find the customers first, then look for a solution.
It's imperative to research and validate the market before you launch your business. Talk to prospective customers and find out what they really need. Chances are, you will end up with a much more compelling offering than what you initially dreamed up on your own. Remember, find the customers first, then look for a solution.
3. Too Much Leverage
Give me a lever long enough and I will bankrupt my company.
Mature companies can predict revenues over the next few quarters with some degree of certainty. These businesses can make prudent use of leverage, both financial (debt) and operating (fixed overhead costs) to improve equity returns.
Revenues projections for early-stage companies, on the other hand, can be all over the map. In this environment, it can be dangerous to take on more than a modest amount of debt or other fixed obligations (rent, salaries, etc.). With little margin for error, if revenues take longer to ramp up than expected—as they nearly always do—you may find yourself handing the keys of your business over to your creditors.
It's best to keep most costs variable at first and use equity capital to finance your startup until your company has been around a while and you develop some confidence in your ability to forecast sales. Delay making investments or taking on fixed obligations until you have a critical mass of customers. You'll know when it's time to rent a larger office space or hire that second shift when you've got a backlog of orders on the books.
Revenues projections for early-stage companies, on the other hand, can be all over the map. In this environment, it can be dangerous to take on more than a modest amount of debt or other fixed obligations (rent, salaries, etc.). With little margin for error, if revenues take longer to ramp up than expected—as they nearly always do—you may find yourself handing the keys of your business over to your creditors.
It's best to keep most costs variable at first and use equity capital to finance your startup until your company has been around a while and you develop some confidence in your ability to forecast sales. Delay making investments or taking on fixed obligations until you have a critical mass of customers. You'll know when it's time to rent a larger office space or hire that second shift when you've got a backlog of orders on the books.
4. Undercapitalizing the Business
Maybe you should've waited to order that red Ferrari after all...
It's all too common for entrepreneurs to grossly underestimate the amount of time and capital necessary to reach cash flow breakeven, causing many promising ventures to shut down prematurely. Be conservative with your financial projections and plan on having adquate funds when you launch to cover all sunk costs (including startup losses) until your company becomes cash flow positive.
If you don't have enough savings to cover the required investment, it may be tempting to launch your startup under the assumption that you will be able to obtain funding at a later date. Whle staging investment has its advantages (preserving the option to abandon, higher valuation and—therefore—less dilution, etc.), this strategy can backfire and leave you unable to get the money when you need it most or force you to negotiate with banks and investors from a position of weakness. It's often better to change the business model to bring required investment in line with available resources.
If you don't have enough savings to cover the required investment, it may be tempting to launch your startup under the assumption that you will be able to obtain funding at a later date. Whle staging investment has its advantages (preserving the option to abandon, higher valuation and—therefore—less dilution, etc.), this strategy can backfire and leave you unable to get the money when you need it most or force you to negotiate with banks and investors from a position of weakness. It's often better to change the business model to bring required investment in line with available resources.
5. Lack of Competitive Advantages
Never bring a knife to a gunfight!
Does your town really need another dry cleaner, pizzeria, or lawn care service? Entrepreneurs frequently start these me-too kind of businesses because of their simplicity and modest capital requirements. However, the lack of competitive barriers render them extremely vulnerable to new entrants, who will gladly cut prices to the bone to steal customers.
If you want your startup to thrive, you need something that insulates it from competition. It could be a great location, a cool brand, proprietary technology, or a cost structure that cannot be easily replicated. None of these advantages is likely to be permanent, but they only need to shield you long enough for your company to take root. This will give you time to make investments that create additional barriers.
If you want your startup to thrive, you need something that insulates it from competition. It could be a great location, a cool brand, proprietary technology, or a cost structure that cannot be easily replicated. None of these advantages is likely to be permanent, but they only need to shield you long enough for your company to take root. This will give you time to make investments that create additional barriers.
6. Competing Head-to-Head with Industry Leaders
Better sharpen those elbows...
A sure sign of impending failure is an entrepreneur who plans to bootstrap his new business while competing directly against entrenched market leaders. Large businesses have enormous resources to deter competitors from entering their markets. Big companies can undercut your prices, outspend you on advertising, and choke off access to suppliers and distributors. I strongly advise against making a frontal assault unless you have a world-class team and very deep pockets. Even then, your chances of success are likely to be disappointing.
7. Picking a Niche That is too Small
Don't be a market of one!
Most small businesses compete successfully against larger rivals by specializing in a niche market. However, you still need to do your homework to be sure that the niche is large enough to support your business and that customers are not too expensive to find and serve. You may discover that niche markets can be just as fiercely competitive as the mass market. You need to figure out how fast your niche is growing and how much market share you will need to capture.
If your financial projections require you to hold more than a few percent of market share to remain profitable, be careful. Don't press ahead unless you can convincingly demonstrate to yourself how your competitive advantages will enable you to become the market leader.
If your financial projections require you to hold more than a few percent of market share to remain profitable, be careful. Don't press ahead unless you can convincingly demonstrate to yourself how your competitive advantages will enable you to become the market leader.
8. Breakup of the Founding Team
Breaking up is hard on you -- and your company.
A startup can be a high-stress environment, especially when you are struggling to turn the corner before the lights go out. At moments like this, disagreements about the direction of the company or the division of profits among the owners can lead to a rift within the founding team. Because people wear lots of hats in startups, the sudden departure of a key executive can doom a fledgling organization. This makes it imperative to structure agreements so that the founders and key hires are treated fairly and that everyone's interests are closely aligned with the success of the new venture.
9. Poor Pricing Strategy
The price is right?
The most common method for setting prices is to start at the unit cost and then mark up the price to achieve a profit, so-called "cost-plus" pricing. Unfortunately, cost has little to do with how a product or service is valued by customers, which can lead to systematic underpricing. For example, if a widget costs $20 to manufacture, and you sell it to a customer for $25 when that customer would gladly have paid $35, you have left $10 worth of value on the table.
Even worse, cost-based pricing can lead to prices that are greater than what the market will bear. Because unit cost is related to sales volume (see CVP Analysis for more info), high prices lead to fewer sales, which in turn increases unit cost, leading to a further round of price increases.
As Thomas Nagle and John Hogan point out in The Strategy and Tactics of Pricing, failing to account for the effect of price on sales volume—and hence costs—has led to numerous business failures over the years once they enter a "death spiral" of price increases to allocate fixed costs across a smaller volume of sales. You should instead let anticipated prices, based on the product's perceived value to customers, determine the cost structure, not the other way around. Consequently, pricing strategy and customer value should be addressed in the earliest stages of planning a new business.
Even worse, cost-based pricing can lead to prices that are greater than what the market will bear. Because unit cost is related to sales volume (see CVP Analysis for more info), high prices lead to fewer sales, which in turn increases unit cost, leading to a further round of price increases.
As Thomas Nagle and John Hogan point out in The Strategy and Tactics of Pricing, failing to account for the effect of price on sales volume—and hence costs—has led to numerous business failures over the years once they enter a "death spiral" of price increases to allocate fixed costs across a smaller volume of sales. You should instead let anticipated prices, based on the product's perceived value to customers, determine the cost structure, not the other way around. Consequently, pricing strategy and customer value should be addressed in the earliest stages of planning a new business.
10. Growing too Fast
What goes up...comes down...
Growth is considered as an indication of business success, but uncontrolled growth can—and does—kill entrepreneurial companies for two primary reasons. The first is that businesses need systems and infrastructure to scale properly, but few invest the time and effort to lay the foundations for growth in those first hectic years. That's too bad, because things tend to spin out of control when you put the pedal down. This can be especially problematic for companies that receive a large infusion of outside capital. It's the equivalent of trying to break the land speed record by strapping a jet engine onto a soap box racer. Don't be surprised when the wheels come off...
The second reason is that top-line growth requires additional investments in fixed assets (warehouses, machinery, trucks, etc.) and working capital (inventory, accounts receivable, etc.). At controlled rates of growth, companies are able to finance incremental sales through internal cash flow. Hypergrowth, on the other hand, can suck up large amounts of cash, forcing businesses deep into debt or bringing the whole enterprise to a screeching halt. Many times, owners are not even aware of the impending collapse, because they focus on profitability (as depicted on the income statement) rather than cash flow. Never forget that cash is the lifeblood of your business!
The second reason is that top-line growth requires additional investments in fixed assets (warehouses, machinery, trucks, etc.) and working capital (inventory, accounts receivable, etc.). At controlled rates of growth, companies are able to finance incremental sales through internal cash flow. Hypergrowth, on the other hand, can suck up large amounts of cash, forcing businesses deep into debt or bringing the whole enterprise to a screeching halt. Many times, owners are not even aware of the impending collapse, because they focus on profitability (as depicted on the income statement) rather than cash flow. Never forget that cash is the lifeblood of your business!
