The 4 Most Common Reasons a Small Business Fails

Many small businesses in a broad range of industries perform well and are profitable but a study by the U.S. Small Business Administration (SBA) that covered the years 1994 through 2020 revealed that only 67.7% of new small businesses survived their first two years. The five-year survival rate was 48.9% and the 10-year rate was just 33.7%. Only 25.6% of new small businesses made it to 15 years.

The most common reasons that small businesses fail include a lack of capital or funding, retaining an inadequate management team, a faulty infrastructure or business model, and unsuccessful marketing initiatives.

Running a business is not for the faint of heart. Successful business owners must possess the ability to mitigate company-specific risks while simultaneously bringing a product or service to market at a price point that meets consumer demand levels.

#1 Financing Hurdles

A primary reason why small businesses fail is a lack of funding or working capital. A business owner is usually painfully aware of how much money is necessary to keep operations running on a day-to-day basis from funding payroll, paying fixed and overhead expenses such as rent and utilities, and ensuring that outside vendors are paid on time. Owners of failing companies are less in tune with how much revenue is generated by sales of products or services, however.

This disconnect can lead to funding shortfalls that can quickly put a small business out of operation.

Another reason that small businesses fail is that owners miss the mark on pricing products and services. Companies may price a product or service far lower than similar offerings with the intent to entice new customers and beat out the competition in highly saturated industries.

This strategy can be successful in some cases but businesses that end up closing their doors are often those that keep the price of a product or service too low for too long. Small businesses have little choice but to close down when the costs of production, marketing, and delivery outweigh the revenue generated from new sales,

Small companies in the startup phase can also face challenges in obtaining financing to bring a new product to market, fund an expansion, or pay for ongoing marketing costs. Angel investors, venture capitalists, and conventional bank loans are among the funding sources available to small businesses but not every company has the revenue stream or growth trajectory necessary to secure major financing from them.

Small businesses can be forced to close their doors without an influx of funding for large projects or ongoing working capital needs. Business owners should first establish a realistic budget for company operations and be willing to provide some capital from their own coffers during the startup or expansion phase.

It's imperative to research and secure financing options from multiple outlets before funding becomes necessary. Business owners should already have a variety of sources they can tap for capital when the time comes to obtain funding.

#2 Inadequate Management

Another common reason small businesses fail is a lack of business acumen on the part of the management team or owner. A business owner is the only senior-level person within a company in some cases, especially when a business is in its first year or two of operation.

The owner may have the skills necessary to create and sell a viable product or service but they often lack the attributes of a strong manager and don't have the time to successfully oversee other employees. A business owner has greater potential to mismanage certain aspects of the business without a dedicated management team whether it be finances, hiring, or marketing.

Smart business owners outsource the activities they don't perform well or have little time to successfully carry through. A strong management team is one of the first additions a small business needs to continue operations well into the future. It's important for business owners to feel comfortable with the level of understanding each manager has regarding the business’ operations, current and future employees, and products or services.

#3 Ineffective Business Planning

Small businesses often overlook the importance of effective business planning before opening their doors. A sound business plan should include:

• A clear description of the business
• Current and future employee and management needs
• Opportunities and threats within the broader market
• Capital needs, including projected cash flow and various budgets
• Marketing initiatives
• Competitor analysis

Business owners who fail to address the needs of the business with a well-laid-out plan before operations begin are setting their companies up for serious challenges. A business that doesn't regularly review an initial business plan or one that's not prepared to adapt to changes in the market or industry meets potentially insurmountable obstacles.

Entrepreneurs should have a solid understanding of their industry and competition before starting a company. A company’s specific business model and infrastructure should be established long before products or services are offered to customers and potential revenue streams should be realistically projected well in advance. Creating and maintaining a business plan is key to running a successful company for the long term.

#4 Marketing Mishaps

Business owners often fail to prepare for the marketing needs of a company in terms of capital required, prospect reach, and accurate conversion-ratio projections. It can be difficult to secure financing or redirect capital from other business departments to make up for the shortfall when companies underestimate the total cost of early marketing campaigns.

Getting your company's name in front of your customers is a crucial aspect of any early-stage business. Companies must ensure that they've established realistic budgets for current and future marketing needs.

Having realistic projections in terms of target audience reach and sales conversion ratios is critical to marketing campaign success as well. Businesses that don't understand these aspects of sound marketing strategies are more likely to fail than companies that take the time to create and implement cost-effective, successful campaigns.

The Bottom Line

New businesses face several challenges when they first open their doors. Statistics gathered by the U.S. Small Business Association reveal a daunting failure rate. Running out of money and lack of experience are the greatest risks but new business owners have options to increase their odds of success. The Small Business Association offers and supports several loan programs. Seeking advice and education from experienced professionals can help, too.