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What are the main causes of business failure?

Oct 11, 2016 AT 12:41 PM

What are the main causes of business failure?

 

The following list summarizes causes from the literature and interviews of business experts conducted by the work group. The main causes for small business failure are identified as limited experience and limited knowledge of how to run a business.

• Failure to plan appropriately

• Overly optimistic business owners

• Inadequate marketing

• Primary focus on product or service, not on acquiring capital, accounting, and hiring

• Employee theft and other problems of new hires

• Pricing not sufficient to cover overhead costs

• Undercapitalization

• High cost of health care for business owners and employees

 

The deficiencies in planning and the abundance of optimism often work together to cause most of the problems that lead to small business failure. Many new business owners go into business thinking that a great product or service is enough to have a successful business. They envision sufficient sales and therefore do not consider the need to market. They envision early profitability so that they do not plan for sufficient capital and hence run out of money. Many new business owners are successful only after some starts and failures.

Knowledge on how to run a business improves chances for survival. A Dun and Bradstreet study found that 90 percent of business failures were due to the owners’ lack of skills and/or knowledge. On the other hand, the study found that 90 percent of small businesses getting assistance from an SBDC or other source of expert assistance were still in business after five years. Another study determined that businesses that received venture capital were more successful than those that did not. This appears to be because firms that receive venture capital also receive business advice and oversight. The important role of experience is also evidenced by the fact that many new business owners are eventually successful after a number of failures.

Personnel practices, especially hiring, are another area in which many new business owners lack skills. Hiring the wrong people can be especially disastrous in some industries where employees have access to the company’s funds. Theft by employees can be a significant problem of new hires, particularly in the restaurant industry.

Many new business owners think that they can price their goods as low as their large business competitors. But because they do not have the economies of scale that the large businesses do and because they often do not recognize or underestimate overhead costs, their pricing often does not cover their costs.

Undercapitalization is cited in the literature, in interviews, and in the surveys as a contributing factor in business failure. The SBA suggests that businesses should have at least nine to ten months of working capital when they start. Many businesses do not have this amount of capital. In some cases this could be because of over-optimistic planning, in other cases this could be from insufficient access to capital.

The high cost of medical insurance for both the business owner and employees is cited in the literature and interviews as a possible contributor to business failure. The literature also states that lack of access to affordable health insurance keeps many potential entrepreneurs from starting a business. This may have changed.

The same attributes that are considered entrepreneurial – single-mindedness, optimism, and willingness to take risks – can lead to business failure if not tempered by experience or broadened by training.


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