5 Reasons why many new businesses failFor years there has been a widely quoted, but apparently made-up, reference to a Bloomberg Publication study that said eight out of ten new businesses will fail within their first two years. The real figure may be closer to 50%, but the fact remains that most people who begin the process of starting a business will not see that proposed business thrive.

There are many things that can happen to thwart the best of intentions, and many of these are beyond the control of the entrepreneur. Previous MBA blogs have discussed the additional challenges that women entrepreneurs face, and certainly age, location, and the economy play huge roles. But in my nearly 30 years of working in the field of entrepreneurship, I have noticed five factors that seem to doom a significant portion of the ultimate failures.

  • Lack of management and business experience
  • Failure to conduct a basic “break-even” analysis
  • Lack of customer validation
  • Under-capitalization
  • Inadequate marketing effort

Each of these five challenges will be the subject for a blog of its own in the future, but let’s start by reviewing each at this time.

FOUNDER DYSFUNCTION

What could be better than turning your passion or hobby into a career? This is the dream of many entrepreneurs who relish the idea of expanding something they love, and are good at, into a venture that can earn a living. These creative and skilled people are often referred to as “artisan entrepreneurs,” or “technical founders.” Unfortunately few such people have managed to couple their creative abilities and innovative thinking with business acumen. So they may be wizards at writing code, copywriting, artistry, attention to detail, and adhering to quality standards of work. But they may be virtual strangers to pricing, hiring, legal compliance, accounting practices, sales, and negotiating deals.

GET OUT THE CALCULATOR

Closely related to this lack of business skills, is the failure to understand the complex relationship between cost of production, opportunity cost, pricing strategies, and the effect of competitor pricing. I have met with startups that have not taken the simple step of computing how much it would cost them to make the product or offer the service they are proposing. But a simple calculation could point out to them that their business idea may be mathematically impossible to profit from. A product that costs $10 to produce and is readily available on the market for $9 doesn’t allow for any profit margin, and in this case, even precludes the possibility of breaking even. This is why the process is called “break-even” analysis. Even if they could break even, it may still be impossible to actually make a profit.

BUILD IT AND THEY WILL COME…OR NOT

Just like some entrepreneurs don’t bother to do the math to see if they can break even, many don’t bother to do the research to see if a significant number of people are interested in buying the product or service. “Build it and they will come” was popularized by the 1989 film Field of Dreams, but as a business strategy it is more likely to result in “Field of Nightmares.”

SHOW ME THE MONEY

A common mistake in cash projections is to mistake “sales” with “cash-in-hand.” Many startups imagine that the flow of customers will begin within minutes of opening the business, and that those customers will be immediately throwing cash at the business owners. I have seen many entrepreneurs devote sufficient money to open the business but fail to budget for the period of time during which expenses continue to pile up faster than revenue. Some businesses send an invoice with delivery of the product and then allow thirty days for payment. That alone should indicate that there will be a considerable lag before cash receipts start matching ongoing expenses. And cash flow is a leading killer of new businesses.

ONCE PEOPLE HEAR ABOUT ME…

One of the reasons customers don’t show up on the first day of business is because they don’t know the business exists. Those same entrepreneurs that forgot to budget for ongoing expenses also often forget to budget for the type of extensive (and expensive) marketing campaign that can introduce a wide customer base to a business that didn’t even exist a few weeks ago. Do social media posts ever go viral and result in thousands of people hearing about a new venture? Yes. Does word of mouth ever get crazy and result in standing lines of people trying to spend money? Yes. But both are rare and neither can be relied on as a marketing strategy when the survival of the business depends on it.

IN CONCLUSION

Just one of these five weaknesses could seriously harm a business’s chance of success. Make it two or three and the odds are against survival. Unfortunately a surprising number of entrepreneurs manage to incorporate the “five-prong approach” to throwing in the towel. In future blogs we will revisit each of these, and more importantly, discuss how they can be overcome.

Since 2004, Bob Cohen has served as CEO of the Braintree Business Development Center, a non-profit regional entrepreneurship and business incubation program serving Mansfield and much of Northeast Ohio. Most of Bob’s work has been with high-tech, high-growth start-up businesses but he has an extensive background working with a variety of entrepreneurs. He earned a Ph.D. from Ohio University and an M.A. from The Ohio State University. He is a frequent presenter on topics related to business communication, planning, capital, and marketing.