It’s no myth: Starting a business — and keeping it alive — is a herculean task.
Two years after launch, nearly 32% of private-sector businesses have failed, according to recent data from the U.S. Bureau of Labor Statistics. This seems to be a pattern for new businesses that have opened up in the past few years.
According to the most current 5-year data, slightly more than 45% of businesses that opened in 2016 closed their doors by 2020 – nearly 1 in 2.
Why do so many small businesses fail — and how can your company be a survival-rate story?
Top 17 Reasons Why Small Businesses Fail
Small businesses can shut down for all sorts of reasons. Here are some of the top reasons why small business survival rates drop to about 68% after 2 years and continue on the decline.
1. No Market Need
One of the top reasons small businesses fail is because there’s no need in the market for the business’s product or service.
Think about it: Who hasn’t had a great idea only to discover that it’s already been done? Also, just because you’ve developed a product you think is brilliant doesn’t mean other people will think so, regardless of how much you spend on marketing.
2. Insufficient Capital
Many startup businesses fail because they run out of funds. Lack of revenue and cash flow to manage everyday operations can make it extremely difficult to survive.
After all, most entrepreneurs don’t have a truckload of money lying around, and obtaining funding can be a job in and of itself if you don’t know where to turn.
3. Poor Management
Lack of proper team management also accounts for startup failures. Poor leadership can lead to poor employee morale, lackluster productivity, mismanagement of funds and more. Ineffective managers negatively impact company culture, and their adverse effects can be seen on company revenue too.
4. Inability to Read the Market
Another top reason for business failure is a general disregard for a business’s customers and their shopping habits. Success in entrepreneurship requires a little bit of consumer psychology. You need to be able to put yourself in your customers’ shoes and understand what’s driving them to purchase your product or service.
Look critically at who is shopping at your store: Are they repeat customers or one-time shoppers? If they’re the former, introducing a loyalty rewards program could encourage them to keep coming back — and thank them for doing so — or come up with even more creative ways to drive retention.
To compete in a market, your business can’t be everything to everyone. You need to specialize. If you primarily sell one category of product or service, focus on it and devote extra resources to cutting the costs of producing it while maintaining quality. The key is to not spread yourself or your business too thin.
6. Lack of Management Expertise
New entrepreneurs shouldn’t be discouraged from throwing their hat in the ring. However, a lack of expertise — or any level of experience — when it comes to managerial skills for small business owners can lead to a world of problems for starry-eyed newcomers. Small business owners must embody the character traits and leadership skills necessary for success in a competitive market.
Keeping a business afloat demands more than just focusing on the bottom line. Business owners also must learn how to retain top talent, responsibly delegate authority and plan inventory, among countless other day-to-day tasks.
7. Shoddy Accounting
Business failure can happen before it even gets off the ground because proper accounting practices are neglected. If you start a business and don’t yet have the capacity to hire a dedicated professional accountant, then use accredited accounting software, such as Intuit QuickBooks, to help streamline these tasks.
8. No Checks and Balances
Businesses are organized in hierarchies to maximize efficiency and keep operations running smoothly with multiple team members. However, things can get out of hand if the roles and responsibilities of each member aren’t clearly expressed.
To prevent confusion, conflict and the potential for business failure, ensure that all team members have their responsibilities in writing when they’re hired or promoted. Without a clear vertical delegation of labor across the hierarchy, conflict is bound to arise.
9. Unreliable Customer Service
As an entrepreneur, you understand that the customer is king. However, if a customer registers a complaint or requests a refund and you deliver subpar customer service, it’s disrespectful to them and you risk losing future business.
Whether you run a physical storefront or ecommerce store, invest time in training your staff and preparing written protocols for instructing them on how to deal with customer complaints. Although difficult customers are inevitable from time to time, appropriate communication skills should be leveraged to diffuse the situation — not aggravate it.
10. Inadequate Team
Another answer to “Why do small businesses fail?” is that the wrong people are hired. As a business owner, your staff and partners are the lifeblood of your company. Without them, the whole organization can collapse. Therefore, hiring is important to ensure you lay the correct foundation for your business.
To keep your business from getting burned by an unreliable or problematic employee, make sure every candidate you hire shares your vision for the business and its long-term plan.
11. Bad Location
Brick-and-mortar storefronts need to be strategic about their locations. If your business isn’t in a location that’s accessible to your clients, is sparsely populated, isolated or potentially dangerous, consider relocating before you bleed cash and customers.
Here are some of the top questions to ask yourself when choosing a location for your business:
- Is there ample parking for your clients?
- Are you visible from street-level?
- Is there through traffic?
- Are you surrounded by competition?
- Are you located near public transit?
- Is your target demographic living in the area?
12. Legal Mistakes
The reasons why businesses fail are as much a legal matter as they are a business matter. More often than you might think, it is due to mishaps with the law.
Some of the following are the most prevalent legal issues that cause small business failure:
- Not paying state and federal taxes
- Failure to organize as a business entity (limited liability company, limited liability partnership, etc.)
- Failure to draw binding contracts
- Failure to protect intellectual property
- Failure to consult the services of an attorney
To keep your business operating as it should, keep yourself out of legal trouble by regularly consulting a licensed attorney specializing in commercial law. Not only can they help you remain compliant with government regulations, they can also help draft and notarize your contracts and agreements.
Many business startups also fail because of competition. Between marketing and promoting your brand, it can be costly to compete with more established businesses, particularly those who already have a foothold with similar clientele.
14. Pricing Issues
Pricing issues tend to be another factor behind why small businesses fail. After all, pricing too high or low can help make or break your bottom line.
15. Undefined Business Model
Another contributing factor is having an unclear business model. Lack of strategy, not knowing exactly who your target market is or what value you can provide can all contribute to small business failure.
16. Poor Marketing
Whether you’re not getting your name out there enough or to the right people, or lack clever advertising tactics, poor marketing can make the difference between revenue highs and lows.
Poor marketing data doesn’t help things, either. In a 2019 Forrester Consulting thought leadership paper, 37% of marketers surveyed attributed wasted ad spend to poor data quality.
17. Motivation Changes
There may come a moment where you begin to lose your focus or your passion for what you do. When this happens, your business can suffer. Alternatively, you could one day decide this isn’t the right opportunity for you and pursue a different venture altogether.
Obtaining Capital for Your Small Business
There are several ways small business owners can get funds.
- Self-financing is one way, either with money you’ve saved, personal equity, credit-card debt or from investments from friends and family.
- Many entrepreneurs seek funding through investors and by petitioning sponsors for venture capital. (While this is a popular method for gaining funding in the technology sector, it isn’t a viable option for most small businesses.)
- Some entrepreneurs can look to national or global small business grant programs with monetary awards.
- The fourth and most common way small businesses obtain funding is through a loan.
Avoid Becoming a Small Business Failure Rate Statistic
If you want to avoid small business failure, you would do well to first address some of the most common reasons: a lack of need in the market, poor management and a lack of funds.
Make Your Mark in the Marketplace
Regarding need in the market for your product or service, it helps to do research before making any serious investments. Analyze your marketplace and identify any competitors.
Check revenue figures in your category, both in your region and nationally. Is the market growing? If not, it may not support the introduction of a new product or service.
You also should try to find a niche. This can be challenging for new small businesses since it may feel like anyone with cash in their wallet is a potential customer.
The reality is, most people you think could be potential customers won’t be. Only those who have a genuine want or need for your idea will stick.
Start with ideas that are proven, then narrow your focus as you learn more about your customers. Don’t hesitate to test your ideas and run surveys, either.
Assemble Your Team Smartly
Now that you know what percentage of businesses fail, avoid common pitfalls.
Here are tips to follow regarding your team and management abilities.
- Put friends or family in leadership positions unless they have the skills to be there.
- Just hire for skill level (hire for soft skills as well). Your project manager may be a maverick in the coding language you need, but that doesn’t mean they have the soft skills necessary to manage a project from start to finish.
- Establish leadership positions from the beginning.
- Build your teams around professional relationships, and make sure you set some ground rules. Even if your business is small, even if it is family-operated, it’s important that everyone involved understands your core objectives and works toward them.
Fund Your Small Business the Smart Way
Be selective about how you finance and how you spend. Just because you have a new business doesn’t mean you need a flashy new office with high rent.
Many small businesses start in people’s living rooms and scale as they grow. Often, entrepreneurs access funding strategically once they’re ready to make investments that will pay off in the future.
If you’re ready to fund your business, consider a small business loan.