Why do small businesses fail? That’s the #1 question people have been asking, even before the pandemic put so many companies out of the market. The reasons for small business failure are many, and we’ll dive into the most common ones today. Along with the problems, we’ll also give you the solutions to small business failure, so you can avoid making those mistakes for your own company.
Why Do Small Businesses Fail: The Numbers
Most of us support or are somehow involved in a small business. Whether it’s owned by someone we know or our family, or it’s our local grocery store, small businesses are all around us. And while the idea of supporting a small business is a charming gesture to invest in our society, it’s mostly up to the business owners to keep their business afloat. There are things they tend to overlook or neglect in their work that can lead to their failure.
And numbers serve to support that statement.
- There are about 543K new businesses that are established each month in the U.S.
- Around 99% of all employers in the U.S. are small business owners. They employ more than 57 million people
- Around 20% of new small businesses never make it past their first year of operation
- Around 50% of new small businesses fail within the first five years of being established
- Startups only have a 37% chance of succeeding after their first four years in business
- The #1 reason why small businesses fail is their inability to generate new business
- More than 80% of businesses fail due to cash flow problems
- 14% of small businesses close down because they ignore their customers’ needs
- Close to 46% of small businesses fail due to managerial or service/product incompetence
When there is a record-breaking number of small businesses that pop up all around the U.S., statistics like these put a whole new perspective on the world of business. It’s not all about cash flow or all about customer service. Small businesses fail for a number of reasons and often a combination of them.
Prevent Small Business Failure From the Get-Go
One of the most important things, when you’re diving into a new business venture, is to be absolutely frank with yourself. Don’t be afraid to ask the questions you don’t have the answers to. Finding them before you have launched your company can save you from a quick fall afterward.
- Why am I entering this niche? What is the source of my motivation to do it?
- Am I good at making decisions?
- Do I have the physical and emotional resilience to run a business?
- How will this new business affect my family and my personal relationships with others?
- How good am I with planning and organizing processes? How good am I at managing people?
- How well do I get along with a range of different personalities?
For more tips on starting a small business in 2020, check our guide.
The 13 Reasons Why Small Businesses Fail
#1 Poor Planning or No Business Plan At All
Many small business owners wrongly assume having a great, original idea is enough to skyrocket their business even if they decide to just “wing it” with their business plan. While that may work for 1% of cases, it won’t be as successful for the other 99%.
What does a sound business plan cover?
At a minimum, it should include:
- A clear business description (including goals, services, and/or products offered)
- Current and future management and employee needs
- Capital needs (including various budgets and projected cash flow)
- Opportunities and threats within the market
- Competitor analysis
- Marketing strategies/initiatives (and budgeting for them)
Before you start laying out your business plan, you need to have a good understanding of the industry and where your business fits within it. The main goal of a business plan is that it urges you to define your Unique Value Proposition (UVP).
UVP is the thing that differentiates your business from your competitors. If you’re running a Spanish restaurant, for example, your UVP can be the food itself, the live music in the evenings, the decor of the place, ‘3 for 2’ Gazpacho lunches, the sky’s the limit!
The other main goal of your initial business plan is to define the business model and infrastructure (distribution channels and logistics, e.g., physical locations, online stores, etc.) that your business will follow. It will help you plan your financials and project future cash flow.
Even if you have a business plan, you shouldn’t stop there. One of the most common pitfalls with business plans is that once they have been laid out, business owners never go back to review and update them. If you fail to check your business plan regularly and update it as the market and industry change, you risk meeting unsurpassable obstacles down the road.
#2 Failure to Understand Your Target Clients
Regardless if we run a business or not, at the end of the day, we’re all someone’s customers. We all expect to be treated well, with respect, and fairly. In a vastly connected world, “the customer is always right” rings ever more true. If someone is unhappy with your service, they’ll go on social media and complain about it to their friends and connections in a split second. That’s how long it takes for your business to get a bad reputation. It’s also how little it requires for a small business to fail.
The good news? Social media and the Internet, in general, are not all bad and negative. The reasons why it’s so easy for clients to express their opinions in an instant are the same ones that enable you to monitor customer feedback, engage with existing and new clients, and communicate with your community.
Small businesses fail because they don’t use social media well enough. What can you do to avoid that mistake? Here are 5 simple solutions:
1. Social Media
Think Facebook, Instagram, Pinterest, Twitter, LinkedIn, YouTube, even Snapchat, and the likes of it. These are all great social listening tools that make it easier than ever before for you to “listen” to your target audience and customers. In today’s world, more and more people prefer to contact a business through social media than to pick up the phone and call them. It is faster and more convenient, and thanks to push notifications that alert you each time your business has been liked, mentioned, re-tweeted, pinged, or poked, you know exactly when and how to engage with customers.
The trick is not to spread yourself too thin across different social media channels. Pick the top ones your customers use and don’t bother keeping profiles in the rest.
2. Google Reviews
Based on a ReviewTrackers study in 2018, 6 in 10 consumers (63.6%) look into Google for reviews before visiting a business. That’s higher than any other review site. What is more, over 50% of consumers expect that companies will respond to their reviews within the first 7 days. This goes to show that consumers are increasingly more engaged with businesses and expect them to be just as active online as they are.
For people to be able to leave reviews of your business online, they need to be able to find it, which is why you need to set up your Google My Business listing (aside from having a website). You can read more about it here.
3. Yelp Reviews
Based on the same study we mentioned above, Yelp is the second most trusted and visited platform for business reviews. 4 in 10 consumers (45.18%) turn to this online business directory before they choose a business. Listing your business there and tracking the feedback it receives can have a great impact on your company image and credibility.
4. Review Websites
There are websites that serve only the purpose of letting consumers review businesses. These are powerful tools both for people who leave reviews and for businesses that respond to them. Trustpilot is one of the popular review websites that get nearly 45,000 new reviewers each day. That’s a massive number of people joining the platform each day!
5. Customer Surveys
Surveys are one of the oldest forms of asking customers for their feedback. While they may have been paper-based in the past, the majority of them have transferred online. The easiest way to use surveys to ask clients direct and specific questions about their experience with your business is to collect their emails at the point of sale. That way, you can quickly identify your repeat customers, the top clients, and those who are less engaged or 1-timers.
The value of surveys is in the fact that they allow the customer to be more open and honest as opposed to you asking them to suggest areas for improvement straight to your face. Online surveys are the perfect format for that. They aren’t instant, they give the client time to think, and it lets them comment on things they wouldn’t be comfortable saying face-to-face. Surveys also serve as a continuous reminder of your company. It’s a win-win!
#3 Poor Inventory Management
Before you skip to the next point, service-based businesses also have inventories!
The Small Business Administration (SBA) has listed poor inventory management as one of the major reasons why new businesses fail. Inventory mismanagement can lead to inventory overages and shortages, which can be the silent cash flow killers of your company.
If you don’t have a clear understanding of your sales patterns, you can easily fall into the trap of keeping too much or too little in stock. It can be the cereal boxes in your grocery store, the L-sized dresses on your online retail shop, the fertilizer your landscaping team uses on clients’ properties.
The problem with the majority of items you can stock in your inventory is that they can lose value or become obsolete as time passes. If investing in a point of sale (POS) system isn’t a solution that applies to your type of business, you can look at your past inventory shortages and overages, and make future projections based on these. The key is to find the most optimal channel of supply, so you can re-stock quickly in case you’re short on something.
#4 Unsustainable Business Growth
When you start a business, you’re often eager to grow, to develop, to expand, basically to start getting ROI and monetizing the business. That’s understandable, but it’s not sustainable.
In business, it’s those who play the slow and steady growth game that are usually the ones who win the race. If you expand too quickly, it often means you’ve taken on a significant amount of debt, and that can easily backfire if there’s unexpected economic turmoil and the market shrinks. There are so many scenarios in which abnormal growth can bite you.
If you decide to work double, even triple shifts, just so you don’t turn down clients, this can result in product/service quality decline, drained workforce, and a destroyed work-life balance. Instead, “pick your battles,” choose which customers to court and which ones to court later.
Being a ‘Yes man’ can be a good thing, but saying No is an essential part of running a business successfully.
#5 Financial Hurdles & Lack of Sales
Cash flow problems can arise for a number of reasons. On one side, you may not be reaching your sales goals, and on the other, you may have miscalculated the pricing of your products and services.
Insufficient Working Capital
Still, the primary reason why small businesses fail is the lack of working capital. That capital is necessary to cover fixed and varied overhead expenses (e.g., rent and utilities), payroll, vendors, and operational supplies. If you don’t have a clear understanding of how much your business is making in sales, as well as how much you’re spending each month (revenue vs. costs), you can easily be on the losing side of things. Make sure your costs are optimized, and that there are no loose ends. Tap into your personal savings if you haven’t already and be wary of accumulating too much business debt.
All In One Basket
If you rely on a single large customer or they are bringing in more than 80% of your business, you’re in serious trouble. What if they suddenly drop you, go out of business, or find another business like yours? Odds are, you won’t make it with just 20% of sales from other customers. Let’s say you run a cafe that depends on students during the school year. What will you do in summer when students are off? You’ll have to think of ways to attract a different type of audience to keep your business sustainable.
When it comes to pricing, many small and new companies set their prices far lower than those of their established competitors with the hope of enticing new customers. This is where many fall into the trap of poor maths. If the costs of production, delivery, and marketing are greater than the revenue from sales, the downfall is imminent.
#6 Trying to Be a Jack of All Trades
Starting a small business is rarely a well-planned and funded, much less an organized endeavor. It’s “all hands on deck,” and that sometimes translates into “all hands on all decks” (even if those hands aren’t exactly fitted to touch those decks).
A business can really pick up when every task and process is delegated to the person (or software) best suited to perform it. Every business owner has their strengths and weaknesses, not to mention just having 24 hours in the day, so it’s not always the better choice to try and do everything. It is all about delegation and strategic investments, be it in hiring new employees, buying software, or doing a course to acquire a specific skill.
Some small businesses fail because their owners try to be everywhere at once, thus missing to be in one place long enough to get the crucial tasks done. This can create a domino effect and establishes a company culture where each employee is expected to demonstrate the same “Jack of all trades” behavior.
#7 Neglecting to Handle Administrative Tasks
As surprising as it may sound, there are actually companies that go out of business due to lack of bookkeeping and proper documentation of the tasks and processes within the business. It’s true that administrative tasks are probably the least exciting bit of running a business, but they are just as important.
From tracking inventory shortages to accounting and bookkeeping, administrative tasks can easily eat up an entire day. Many small business owners dread the idea of burying themselves in piles and piles of sheets and paperwork (even if it’s in a digital format), but that’s an essential part of running a business. The solution is to delegate some of these tasks to better-prepared employees or to technology. There are many apps and software that automate certain processes and remove the administrative headaches off your shoulders.
#8 Refusal to Adapt to Market Changes
The so-called old-fashioned stubbornness is still quite strong with small business owners, especially if it’s a family-run company that has existed for generations. Technology has massively changed the way consumers interact with businesses, and it has decreased their tolerance and attention spans. This means that your customers won’t wait around forever for you to adapt to their changing needs.
It’s easy for entrepreneurs to get tunnel vision and think their ideas or products are the best, and people will fall for them in a heartbeat, even when all evidence points against it. The ability to pivot in business is the reason companies like Coca Cola and McDonald’s, are still around after decades.
Think About Coca Cola
Coca Cola has actually been around since 1886, and even if their original recipe hasn’t allegedly changed, the company has gone through so many product additions, changes in advertising, changes in the shapes of their bottles even. All of that because they understand it is consumers’ changing needs that ultimately determine how, what, when, and how much of your product or service you will sell.
Think About McDonald’s
Whether you like fast food or not, you can’t deny the massive global success McDonald’s has and is likely to continue to have.
What started as a drive-in burger joint run by brothers Richard and Maurice McDonald, grew to become the largest fast food franchise in the world. Much has changed since Ray Kroc, a milkshake machine salesman, helped the brothers develop the franchise (1955) and later bought it.
The store design, the logo design, the menu, and its packaging have all been through drastic changes throughout its 60+ years long history. Consumer demand has forced the franchise to introduce vegetarian and fish options, as well as more sustainable practices for all McDonald’s stores worldwide.
This is the power of consumer demand and how it drives constant change.
#9 No or Poorly Managed Marketing Budget
It’s true that investing in marketing at the very beginning of a small business sounds like a risky idea that can only cost you. In our experience, most business owners turn to marketing when they feel they’ve already made the most of word-of-mouth first and need extra clients to keep things running.
While that seems like a valid decision, there are many companies that never make it to that stage. More often than not, these days, early marketing campaigns precede word-of-mouth. For people to recommend you, they need to know you first. To do that, they need to be able to find you, and unless your location is right in front of them, they may never discover your business if you don’t market yourself to them. It’s how things are in today’s highly competitive markets.
But, let’s say you did see the value of digital marketing for your small business from the get-go. This doesn’t guarantee instant success. Marketing mishaps and mismanaged marketing campaigns are one of the top reasons why small businesses fail regardless of their industry.
The good news for business owners is that there is actually a lot they can do before turning to an advertising agency. Like we mentioned earlier, you can start by going on social media and setting up company profiles in the most beneficial channels (a.k.a. the social media platforms your customers are using the most). You can also create a business listing on Google My Business and join business directories like Yelp. These are fantastic and crucially important starting points for any online marketing strategy.
Once you’re ready to start investing in Facebook ads, Google ads, and more wholesome marketing solutions, you can either hire people to do it internally or outsource it to an external service provider. Either way, analyzing your options, securing a budget, and setting realistic expectations for the results (both in terms of reach and timeline) are things that need to happen before you make any marketing commitments. If you try to adapt as you go, you may end up losing money with no ROI.
#10 Inadequate Management
By far, this is the number one reason why small businesses fail. It all boils down to management at the end of the day. A huge part of it is the owner’s mindset and attitude toward the business, the employees, and the product or service they’re offering.
One of the most common pitfalls with small businesses is that their owners can easily get too set in their ways, which is bad both for running a business and for managing a team of people. Neglecting to respond to the needs of clients and staff members can lead to a drop in sales and people leaving your company.
As a business owner, you may be a great salesperson, but that doesn’t necessarily mean you’re good at managing people and processes. Even the top-selling business is doomed if it doesn’t have a strong manager or a team of managers who understand the processes within the company, the employees, the costs and benefits associated with the products/services the business offers, and the current state of the market.
#11 There’s No Market or It Is Too Small
The heartbeat of any successful business is sales. As long as you’re selling and meeting your financial goals, you can resolve most other issues you encounter along the way. But if there’s no market for your ideas, products, or services, there’s only so much you can do. Before you start your business, you need to clearly determine the potential of the market, the chances of it shrinking or disappearing, as well as the opportunities for it to grow.
- How sensitive is your market to economic fluctuations?
- What is the buying power of your potential clients?
- How often and how much of your product/service will people want/need?
You can’t start a profitable venture if you don’t have the answers to these and other related questions. The “market” isn’t “everyone.” It must be a clearly identifiable group of people who share the same need for whatever it is you’re offering. The “market” also isn’t a static notion, a constant. Much like a living organism, it changes over time.
People have a tendency to always crave something new and something better, even if it is just a matter of new packaging and fresh ads.
The solution to a possible business failure caused by poor market choice is simple: do your homework before you start selling.
#12 The Wrong Location
With small, location-based businesses, it’s all about the exact area where they are situated. It’s the neighborhood; the street number; the proximity to certain other businesses; it’s all of these combined, and then some. If your small business relies heavily on walk-in traffic like beauty salons and cafes, or if it’s a consultancy company or an auto shop, it has to be at a convenient location.
When it comes to choosing the location of your business, you need to consider the following:
- Where your customers are
- Where your competitors are
- What’s the traffic, parking, accessibility, and lighting in the area
- What’s the safety of the building/premise
- What’s the local community like, is it open to supporting new businesses, etc.
- Are there local programs for new businesses opening in specific areas
- Does it meet your storage needs (if applicable)
- Is there room for possible expansion
If you run a service-based business where you go to your clients and not them to you, your location isn’t as important. However, it should, ideally, make it easy for you to reach customers speedily.
#13 Started the Business for All the Wrong Reasons
Quite often, the reason why a small business fails is that the owner started it for the wrong reasons. If your primary reason is to become a millionaire overnight, or because you fancy the idea of being your own boss, then you should probably dig deeper into your reasons for starting a business. While these are certainly benefits that successful entrepreneurs reap after years of hard work, they aren’t enough to start a business.
If you don’t have a passion for the job, a positive attitude, patience, and fierce determination, you’ll probably surrender, come the first hitch on the road. Building a successful business means you’re not defeated by failures and you’re not afraid of making big decisions. In business, the good comes together with the bad, you can’t expect it to all be smooth sailing all the time.
The Bottom Line
“Risk comes from not knowing what you are doing.” — Warren Buffett
So find people that do. Running a small business can often feel like it’s you against the world, but finding the right people with the right skills can make or break your success. Be willing to ask for advice or help with the aspects of management and operations that are unclear to you. All 13 reasons we listed for why small businesses fail to start were because there was a lack of knowledge, understanding, or experience in a certain area.
Dealing with business failure is possibly the last thing you want to experience with your company, so the sooner you start working on mending the pain points, the sooner you’ll see progress. We hope our 13 reasons and solutions to small business failure manage to help you improve and develop your business. Don’t forget to check back with this article as we will be updating it as time passes.
Stay tuned for our next topic!