What keeps you up at night?
For business owners, the list can be long, simply because operating a business brings with it so many uncertainties. One of every 5 establishments started in 2014 (the most recent year for which statistics are available) didn’t make it a year. Almost half of those started in 2011 haven’t survived, according to the U.S. Small Business Administration.
The good news is that the survival rate of startups has increased in recent years, according to the SBA and the Kauffman Foundation. Both on a one-year and five-year basis, businesses have a greater chance of living longer than they did earlier in the decade.
And once you know some of the most common reasons startups fail, you can work to ensure your business doesn’t fall prey to the same traps.
The most common reason startups fail is that they don’t meet a market need, according to data analytics firm CB Insights, which combed through hundreds of startup founders’ stories of how their businesses failed. These businesses may develop a solution to a problem that isn’t big enough or can’t be solved in a scalable way.
Sageworks co-founder Brian Hamilton says business founders have to identify what is different about the product or service from offerings already in the marketplace. “Many MBA students wrongly assume you need disruptive technology or something radically different,” he says. “That’s not necessarily true. But you do have to take a deep look at your customers and what their needs are, then offer something that’s different enough that your offering is compelling, and that difference had better not be a lower price.”
Meeting a market need also means selling to someone who will actually pay for the product or service. High-flying technology companies today will crash tomorrow if they can’t find a way to generate revenue, Hamilton says.
The second most common reason startups fail is that they run out of cash, according to CB Insights. Nearly 1 in 3 of the failed startups named this as the cause. Sometimes this can occur while a company is trying to find the right fit between a product or service and a market. Other times, it can happen because of poor cash flow management. Common issues related to cash flow management include extending credit to customers when it’s not critical and ramping up expenses before revenue is there. “The experienced entrepreneurs keep their overhead low, and they grow their business organically,” says Hamilton. “They are strategic about granting credit and don’t offer it automatically, and they don’t go on a hiring binge just because they have secured some financing.”
Failing to have the right team in place was the third most common reason cited by failed startups for their demise. Firms studied by CB Insights indicated that they had lacked “a diverse team with different skill sets.” A founder might be great at selling but lacking when it comes to financial literacy. This is why it’s so important for owners to turn to accountants or other trusted advisors for help, according to Hamilton. “Often, business owners are so busy making ends meet that they don’t have time to sit down and look at and analyze financial data that can help them run their business better,” he says. “Financial statement information is massively underused by businesses.”
The fourth most common reason for startup failures identified by CB Insights is getting outcompeted. “While obsessing over the competition is not healthy, ignoring them was also a recipe for failure in 19% of the startup failures,” the firm says. According to Hamilton, one of the traps of obtaining outside financing to start a business is that a company can become comfortable enough in its position to lose perspective of what’s going on in the marketplace. That can be dangerous. “When economic conditions are pretty good, businesses that really never should have received capital get money, creating more supply than demand warrants and even worse, creating noise in the market that can add confusion over the true value points of a product or service.”
Finally, failed startups often cited pricing or cost issues as a reason for the company’s demise. This can cover many problem areas, but Hamilton says one common mistake of businesses is pricing too low. “People tend to price low when they first start a business, thinking it is how they will differentiate their offering,” he says. “It’s better to spend time and develop a real product or service differentiator so you can command higher prices. Operating costs always grow as a business grows, and if you price low at the start and then have to raise prices to cover those costs, you could lose many of your early customers who think the increase is unfair.” The better approach is to price for decent margins and build and protect a real brand so that you can maintain customers and build the franchise, he says.
Mary Ellen Biery is a research specialist at Sageworks, a financial information company that provides financial analysis solutions to accounting firms and privately held companies.
