5 Reasons Small Businesses Fail

Why do businesses fail? There are common reasons why small businesses shut down or why small business owners might decide to sell. Understanding why businesses fail is the best way to avoid the same mistakes.

Common Reasons Why Businesses Fail

  1. Starting With Too Much Debt
  2. No Business Plan
  3. Mismanaged Cash Flow
  4. Ineffective Leadership
  5. Failure to Adapt

Every neighborhood has one: a storefront that changes into a new business every six months. Maybe it started as a breakfast café, then it was a karaoke bar, then a nail salon. These new small businesses set up and shut down almost before anyone can even notice.

These ever-changing storefronts can be a scary reminder that small businesses can come and go in no time at all. Twenty percent of small businesses fail in their first year. That number rises to 50 percent by their fifth year. While those stats might be disheartening, they don’t portray the whole story. Many small businesses fail because of a few finite mistakes. But the great news is that you can avoid these reasons why businesses fail but understanding, recognizing, and solving these top mistakes.

1. Starting With Too Much Debt

Sometimes, it’s necessary to go into debt to finance the launch or purchase of your business. Few aspiring business owners have the cash on hand to pay out-of-pocket, so loans are a reasonable choice to help finance a new venture.
But if you don’t prioritize repaying your debt and making timely payments, it becomes harder and harder to grow operations. Small business owners across all industries report that lack of capital or cash flow is their top challenge. Adding the weight of debt makes it even more difficult to reach profit.

To avoid starting out with so much debt to repay, many aspiring small business owners are looking towards alternative funding methods. 401(k) Business Financing, also known as Rollovers for Business Startups (ROBS), is just one of those alternative methods. ROBS lets you use your retirement funds to start or buy a business without incurring tax penalties or taking a taxable distribution. ROBS can even be used as the down payment on a small business loan – which lets you preserve your savings and decrease monthly payments.

Learn more about your funding options with our Complete Guide to Small Business Financing.

2. No Business Plan

A business plan is a crucial element for a small business. Your business plan will help you with almost all aspects of your business, from financing to operations. If you create your business plan early on, you can use it as a guide and a checklist throughout your small business journey. With a good business plan, you’ll research and understand key areas for success.

Examples of Key Business Plan Sections

Your specific business model. What is your business? How do you plan on making money from it? Are you a SaaS product with a subscription plan? Are you a gym that offers varying membership options? Figuring out your business model early on helps you figure out how and when you’ll become profitable.

The market need for your product or service. Forty two percent of small businesses fail because there’s no need for their product or service. That’s why it’s so crucial to understand the need can help you avoid investing in the wrong idea. Locational analysis is a big part of this understanding if your business will have a physical location. Make sure you’ll actually be serving the community you set yourself up in.

Competition analysis. If you’re a local brick and mortar business, it’s crucial to understand your competition. Are you thinking about opening a pasta spot? You should know that there’s a thriving Italian restaurant already beloved by the community. Then you can pivot and fill a need with a Mexican restaurant instead.

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Even if your business is fully online, you still need to understand your competition. If someone is searching Google for the service your provide, what other businesses come up in the search results? How are their reviews? What do you need to do to get more and better reviews? How do you make sure you show up in the Google search before your competition does?

These are just a few areas a business plan that will help you in the long run. For an in-depth guide on business plans, check out How to Write a Winning Business Plan.

3. Mismanaged Cash Flow

Forty percent of small businesses make money, while 30 percent break even and another 30 percent lose money. You want to be in that 40 percent, but that means keeping a close eye on your cash flow, inventory, and operational practices.

Remember that cash flow and profit are two different things. You can be profitable but still not have cash. Profit looks at the current state of your sales – including sales that may have not been processed with your accounts receivable yet. Ignoring your cash flow means you’re ignoring the money you actually have to work with. That’s cash you need for day to day operational needs like paying invoices, bills, and employees.

As a business is growing and scaling, it’s important that accounts receivable are managed to focus on cash flow. When companies fail to make adjustments to cash flow while they’re growing, it’s more likely they’ll run out of operating capital. And if you’re out of capital, it’s almost impossible to keep ahead of invoices and paying employees.

4. Ineffective Leadership

Fifty seven percent of employees quit their jobs because of a bad boss. Another 14 percent have left multiple jobs because of poor management. What are often called “soft skills” turn out to be key learnings for those in management – especially if you’re new to running a business. Active listening, empathy, encouragement, communication, and compromise are just a few skills you should consider developing as you step into a leadership role.

As a business owner, your employees, vendors and clients will all look to you as a reflection of the business as a whole. From day one, work to set a clear, consistent vision for your team. Communicate often and effectively, give and receive feedback, and know how to execute.

How do you grow leadership skills? Fortunately, there are a lot of resources for you.

5. Failure to Adapt

It’s no secret that small businesses suffered during the 2020 COVID-19 pandemic. There were, and still continue to be, small businesses that failed through little fault of their own. However, many businesses succeeded by smartly pivoting their business model. New or adjusted business models kept many businesses running during times of no or limited in-person occupancy. Restaurants moving to deliveries or gyms adopting digital fitness classes ensured money came in. During the coronavirus pandemic, businesses who couldn’t pivot quickly or refused to adapt to the ‘new normal’ suffered. But many businesses with flexible models and management that opted for innovative thinking managed to make it through.

Change is a constant, so it can be dangerous to grow complacent. Even if things are going well with your business at the moment, being unprepared or unwilling to adjust can be dangerous. Regularly looking to improve your processes, tweak your business model, and innovate your product or services all help you prepare for future success – and protect against future change. Former Intel CEO Andy Grove once said, “Success breeds complacency. Complacency breeds failure. Only the paranoid survive.” It’s a cautionary reminder that success isn’t everlasting – it’s an ongoing effort.

Key Takeaways

Your keys to avoid why small businesses fail:

  • Start smart
  • Have a plan
  • Manage your financials closely
  • Learn from common mistakes
  • Develop as a leader
  • Know what’s happening in your business
  • Never grow complacent
  • Be eager for change

It’s true, some small businesses will fail. But a fear of failure shouldn’t stop you from pursing your dreams of small business ownership. Even in times of challenge, like a worldwide pandemic, there’s opportunity to succeed.

Want to Use ROBS to Start a Business?

Our step-by-step Guide to Rollovers for Business Startups is a complete handbook of everything you need to know about using ROBS to start or buy a small business or franchise.

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