This post was inspired by Chris Baskerville’s Quora answer to What are the top 5 reasons why startups fail?.
Follow Chris on twitter @ChrisBaskervil.
Having handled 700+ corporate and personal insolvencies, I would make the following observations as the top 5 reasons why startups fail:
1. Lack of capital:
“Cash is King”
Most business owners that I have dealt with, start a business not pre-planning the funding requirements necessary to:
- Obtain key infrastructure (such as: plant and equipment) by inception; and
- Have sufficient cash flow to fund the day-to-day operations.
I have used the ‘aeroplane analogy’ many times to demonstrate this point.
Imagine saying to Tim Hibbetts: “We have a new fighter jet for you to test, it is only missing two (2) ailerons, apart from that, it is good to go“.
The lack of foresight to see and obtain the capital requirements of the business, goes hand in hand with the fact that the most unsuccessful business owners simply have no business plan at all (this is elaborated further below as it is considered one of the key reasons for startup failure).
Having only 95% of the necessary capital to start your business is not enough. You need 100%. Just as an aeroplane needs 100% of its infrastructure to fly.
Small home-based businesses, obviously need less capital than a restaurant or airfreight transport company.
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2. Expanding too soon:
It is very easy for a business owner to think that because of a few ‘early day successes’ that they have nailed their product mix sufficient to expand to a new office, factory, warehouse, geographical location or some other superfluous area.
Expansion needs to be fully costed and properly funded.
Imagine saying to a Chief Financial Officer, like Garrick Saito: “Hey Garrick, our new software, that will revolutionize social media, requires 100 users to reach the Break-Even Point. We currently have 20. I think we need to move to an upmarket city location so we look good to our customers”.
Not that accounting is a blood sport, but I would think you would be shot on the spot.
Expansion also requires infrastructure, not only from a plant and equipment perspective, but also from a personnel perspective too.
Do you have the right team to manage the expansion? Are your team trained to handle the rapid growth as you achieve scale?
Some of the most tragic expansions I have seen, is where a business that has yet to get their business model right in the location they originally founded, all of a sudden expands their business into another geographic location that stretches logistic capabilities and dramatically increases overhead expenditure.
What is your response time if things go bad? How soon can you or your business react to the good and/or the bad? Can your business afford to pay for multiple locations?
3. Heavy reliance on debt funding:
“A man in debt is so far a slave”. [Ralph Waldo Emerson]
As soon as a loan is drawn down to start a business (a loan which is most likely secured against the family home), you are on the ‘debt clock’.
Debt payments are now cemented in time and you need your business to get to the Break-Even Point (BEP) as fast as possible. Not achieving your BEP or, not achieving your ‘critical mass’ (some people prefer to use the term ‘scale’) in time, may mean further borrowings to keep your statup afloat.
The most obvious places to obtain further funding, are from personal credit cards followed secondly by refinancing the mortgage on the family home.
Then there are the family members, your best friend in the whole world (at least when they are getting their money back) and so on and so forth, until you have no further capacity to borrow and interest repayments kill your precious cash-flow.
Too many times a failed business leads to the loss of the family home and potentially, the loss of the family (i.e., separation/divorce).
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4. Poor strategic management:
“A fish rots at the head.”
I have seen time and time again, a person who was great at their trade craft (say, plumbers, builders, accountants, chefs etc.) make a move to their own business. While they are great (if not fantastic) at their particular trade, they are not groomed nor educated for business. Business is its own wild animal. One wrong move and it can eat you alive.
I have often wondered why the governments of the day do not instil a ‘business owner test’ to those wishing to start their own business. Pass the test and you can be in business.
Then again, I think about all the money us Insolvency Practitioners (and our lawyer friends) make from failed businesses … that thought quickly goes away.
“Knowing how to operate within a business is mutually exclusive to know how to operate a business”.
5. No business plan.
“If you fail to plan, you plan to fail”. [Benjamin Franklin]
“Hope is not a strategy”. [Rudy Giuliani]
Imagine saying to Robert Frost: “Hey Robert, lets chuck a couple of guys in a scuba suit, put them in a fast plane and see if we can touch the moon?”
A mission to the moon requires a properly thought out plan. So too does your business.
Think about the family holiday. There are a few key stages that the holiday goes through before coming to fruition:
- First stage – Concept: “Lets go on holidays to Disney World”.
- Second stage – Basic planning: “I think October is the best month based on lower crowd numbers, lets fly to Orlando and rent a car”.
- Third stage – Detail: “We fly American Airlines from gate 52, on 29 January 2015 at 8:35am, staying 9 nights at the Caribbean Resort. A Honda Civic is available on arrival in bay 28.”
Most failed business owners stop planning at the Concept Stage. Yet, when it comes to our holidays, meticulous details are planned for.
Why not use the same mantra for your business? I mean, at the rate at which small to medium business fail, its only going to make you or break you.
The other key element to the business plan is to get you explicitly stating your ‘Why’.
- Why are you in business?
- What need are you satisfying?
- Why has it not been done before?
- Why can you deliver a better result than your competition?
- How will you obtain your ‘first mover advantage’?
Planning your business forces you to seriously think about all areas of your business and not just the fluffy parts of your business like “sales” or “profit”.
Meticulous details like: operations, employee ramp-up, funding and forecast financials and logistics are needed to be considered.
But you only need to do this if you want to give yourself a fighting chance. If not, leave your business concept on the napkin you used at the local bar.
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For further information as to some of the most common mistakes I have seen business owners make, see also: What are the most common mistakes made by small to medium business owners?