Why Most New Businesses Fail – And How Not to Become One of Them

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Are you thinking about starting your own business? If so, you have a lot of company. According to the Department of Labor, more than one million new businesses are formed each year. But most new businesses fail. Depending on the source quoted, somewhere between 50% and 90% will fail, usually in the first year.

Why do so many businesses fail? And if you’re planning to start a new business, how can you avoid becoming one of them?

Some business ventures fail for bad luck, but probably far more fail for causes that were not only known up front, but could have been prepared for in advance.

Lack of capital

Why Most New Businesses Fail – And How Not to Become One of Them
Why Most New Businesses Fail – And How Not to Become One of Them
Many new businesses require money up front just to open the doors. Would-be business owners often borrow against their homes, their retirement plans or from their relatives to make it happen.

This presents two problems: 1) debt obligations are created, causing an instant increase in monthly expenses, and 2) no money is available to cover living expenses before the business is generating any serious revenue. The chances that a business will succeed under these circumstances are…questionable!

SOLUTION: Avoid entering any business that will require a large investment up front. Avoid borrowing to make that investment (save that resource for later—you may need it!). Most of what you’re bringing to a new business should be your skills and abilities, not your capital. You don’t want to buy a business, you want to be a business!

Lack of cash flow

Most businesses that fail do so for a lack of cash flow. Maybe some never had it from the beginning, while others had it for a time and lost it. Either way, cash flow IS a business.

SOLUTION: Know where your revenue will come from before you even start a business. Line up clients before you open the doors. If that isn’t possible, develop a large network of reasonable prospects—you should know that a revenue base is there otherwise don’t even start.

Work your business part time to develop revenue while you still have your job for income. Alternatively, work part time (or contract) for as long as it takes to build your business to where it can sustain you financially. This is the one aspect of having a business that you can’t fail at. No cash flow=no business!

Lack of knowledge

People often start businesses they know nothing about. They may start a business because they know someone who’s in it, or they may get into one that’s part of a trending fad. That starts a process of learning in the preverbal “School of Hard Knocks”, and it usually doesn’t end happily.

SOLUTION: Being self-employed is not a time for earn-and-learn; you need to have as much knowledge as possible beforehand. In fact you’re whole basis for becoming self-employed are your abilities as an expert. Consider the following:

  • Start a business related to your current occupation
  • Learn what you can from published sources
  • Work for businesses already in the field
  • Start the business as a part time venture so you can make your mistakes while you’re still on someone else’s payroll

Lack of time

Get-rich-quick schemes on TV are so convincing, aren’t they? In six months you’ll be making $50,000 per month(!), sitting all day by a pool or a beach in a warm place with palm trees, surrounded by beautiful people, and a fleet of luxury cars parked nearby–all yours, we’re to presume. Apparently that kind of money will not only buy you all those perks, but it will also leave you with plenty of free time to enjoy them.

But forget all of it! It’s pure fantasy. Most entrepreneurs never get that rich, and few ever have that much free time if they do. Running a business, especially a new one, will require more time than a full time job. Not everyone is willing to work 60, 80 or 100 hours a week to make a business work. Often there are other obligations and interests that make working that many hours undesirable or impossible, and the business withers and dies.

SOLUTION: Be realistic about how much time you’ll need to put into a new business, keeping in mind that you probably won’t be able to afford to pay someone else to do those important-but-not-necessarily-profitable jobs. Clear the decks of as many outside distractions as possible; hobbies may have to be put on hold, and needy friends and family members may have to be held at bay.

You’ll also need to identify the most profitable activities in your business. The ones that generate the most customers, cash flow and profits will be where your first best hours need to be spent. The sooner you can get that going smoothly, the sooner you can hire others for the stuff that doesn’t put money in your pocket. Then you’ll have time for pools and palm trees.

Poor timing

Timing is everything–and nowhere is this more true than starting a business. Many new businesses never get out of the starting gate for no reason more complicated than bad timing.

Sometimes this can be bad timing on your part. Starting a business when you’re unemployed can be really bad timing, and that’s the time many choose to make the move. But cash flow is usually the goal of the unemployed and new business ventures seldom provide this in any abundance, and never quickly.

Sometimes timing issues will be completely beyond your control. Starting a home building business or a mortgage company in 2006 would be stellar examples of bad timing for factors beyond your control. Sometimes you can see that sort of thing coming, sometimes not.

SOLUTION: Starting a business requires a strategic plan. You should do it at a time that’s favorable to you, not at a point of desperation or for a lack of alternatives. Make sure you have your contacts lined up, a tested marketing plan, and your financial house in order before taking the plunge.

Big picture, pay close attention to the economy and to the industry you’re going into. These are the forces that can carry a business one way or another. Better to start a business late in a recession (or early in a recovery) when much of the competition has folded, than when the economy is booming and competitors are on every street corner. Look at developing trends that affect an industry. As an example, consider the affect that direct video rental companies, like Netflix, have had on brick-and-mortar video businesses. New technologies are creating new businesses and destroying others, and the trends can never be ignored.

Choosing the wrong business

Every year thousands of people plunge into businesses they know close to nothing about, and the results are completely predictable. Often this happens through franchising operations or multi-level marketing schemes. Ease of entry is the only reason anyone might consider them, but they can be especially enticing because they carry the notions that…

  • other people are doing it (implied: “and so can you”), and
  • there’s a company or network to back you up and help you succeed.

Now, both these points may be legitimate, but here’s the thing…as an entrepreneur you’re the point person in any business you’re operating. No matter how many resources you have on the back end, your business will never be any stronger than it is on it’s front line, and that’s you.

SOLUTION: Never pick a business because it seems to be working for others or because of a convincing marketing presentation. Never pick a business that’s completely outside your area of expertise. Pick a business because

  1. it’s one where you have demonstrated skills and abilities
  2. it’s something you’re genuinely interested in
  3. it’s where you have natural connections (networks, affiliate relationships, product sources, etc)
  4. you have more than just a casual idea of what it takes to succeed in it
  5. it’s one you’re likely to stay with even when the cash drawer isn’t full
  6. it’s a business in which you can claim some status as an expert

Starting a new business should never be a blind shot in the dark. It should be about calculated risks in which you’re aware of the likely challenges you’ll face, and more importantly, how to overcome them.

Are you in business for yourself? What obstacles did you run into when you started, and how did you work them out?

( Photo courtesy of f33 )

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10 Responses to Why Most New Businesses Fail – And How Not to Become One of Them

  1. This is great list. One more item to mention is Lack of Business Sense or Know-How. In my 15+ years as a Business Coach and Financial Planner to business owners the most prevalent problem I’ve seen (after lack of capital and not allowing enough time for the business to take hold) is just poor business management – everything from systems and processes & marketing messages to bookkeeping and employee management.

    You can have the right product/service. You can have substantial financial backing. But if you don’t know how to run a business as a business and get good employees to buy in and help you, you’re doomed to make plenty of really expensive mistakes – which means you’ll need even MORE capital to get going and the process will take even longer.

  2. John – I was thinking of that as being part of Lack of Knowledge, but I think you’re right, lack of management skills is an entirely separate category.

    No matter what else you bring to a business, lack of management skills could undo it all.

  3. Great list – one that every potential business owner should look at prior to taking the plunge. I would add lack of patience is important. Most business owners have to realize that it takes time for a business to become successful. I imagine some people just throw in the towel too early.

  4. Ronika – Brilliant point! In the high tech world of today, we like everything instantly, including success.

    Most businesses will take time to develop, and patience–and a realistic attitude–will go a long way.

  5. Hi Kevin, I’ve been involved with many small businesses as both an owner and an employee, and this post is spot on. I think lack of capital is one of the most common mistakes, as hardly anyone talks about it. If you don’t have enough capital, you miss opportunities or are forced to do things like max out your credit cards. You probably won’t be able to get a business loan, as you point out, and now you are putting your personal assets at risk.

    To avoid this situation, you can phase in your business and do the low capital things first, and then move into more expensive areas. (For example, start selling things at flea markets before you rent commercial space for a store). This works well with your idea of doing the new business part time.

    It also allows you to test your business concept cheaply. If no one buys your stuff at the flea market, it’s likely a store would fail miserably.

    Another point I would make about time is it takes time to become profitable. Many people give up at six or nine months when they are just starting to turn the corner. It takes time to build up a customer base and get the word out.

  6. Jennifer – you brought up another point that relates to capital but the post was already getting too long! The part you mentioned about trying your business at a flea market (or equivalent venue) before renting space, is part of the capital issue. Many new business owners invest in office or retail space, often high end to create a winning image, and also in furniture, equipments and other typical trappings of a business, doing it before earning their first dollar.

    That’s another way of either burning precious capital, or creating new debt, and it really puts the cart before the horse. It’s so critical to test an idea, then retest for consistency, to make sure the business will be viable before investing any major money.

    Amadeo Giannini started what would eventually be known as the Bank of America from a makeshift desk on a street corner in San Francisco. Talk about a shoestring opertation! All things are possibe when there’s a viable market for what you’re selling.

  7. Great run-down, Kevin! As you know I have never “been employed”; I’ve always owned small businesses. I believe that a big problem for new as well as seasoned small biz owners is that they fail to understand the difference between profit and cash flow and that the answers to issues with both of these are usually buried in the balance sheet.

    Also I have to agree with Jennifer for self-serving reasons, as I started selling stuff from my own mall kiosks straight out of college. 🙂

  8. Hi Chaz – I agree. Some business owners think that as long as there’s money in the cash drawer or the bank that they’re doing well. That will only work for a while. If you don’t turn actual profits and turn them consistently, you’ll be out of business in short order.

    I think that what you and Jennifer are referring to could loosely be considered market research. Testing small scale before ramping up. Ramping up before knowing there’s a market for what you’re selling is usually a recipe for failure. The problem is that so many people base their business ideas on the corporate model that they can’t see the wisdom of peddling from a push cart, so to speak. They think they need to first acquire the trappings of business success so they won’t look like the upstart that they really are. But that method creates built-in costs that you can’t afford.

  9. Very well written article, thank you for the information!

    I’d say that ‘nailing a profitable business model’ would also include cash flow management, which leads back to “founder dysfunction”. They may have great sales, but if cash keeps flowing out of the expense column they have no hope.

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