Why Small Businesses Fail and How to Prevent It

We hear the statistics all the time: “Thousands of new businesses open every day; half of all businesses tank after 5 years,” and so on. So why is the outlook for new business owners so dismal?

You could have an extensive, very semantic conversation about why businesses just can’t seem to make it over the hump and stay open for the long haul. There have to be some basic, overarching deficiencies that cause them to fail so quickly, right?

Businesses go under for a variety of reasons, but in this post, we will attempt to pin down the thought processes of new business owners and the decisions they make to sabotage their own success.

Failure to anticipate unexpected losses.

It’s important to be very mindful of the position you are in during the crucial first couple of years of a new business. Like a nascent organism waking up in the wild for the first time, a new business needs time to gain its footing before it can begin to make forward progress.

At the start, a business is sure to take some missteps and encounter unforeseen problems that can turn out to be very costly, and early in the game, at that.

The Gambler’s Fallacy

There is a cognitive bias called positive expectation bias, otherwise known as the Gambler’s Fallacy, which is a hard-wired optimism that causes us to believe that the best possible outcome will occur, regardless of the circumstances.

Optimism isn’t a bad thing, but a business owner has to combine this with the reality they are facing by recognizing that they might run into problems, such as a longer than expected period before significant revenue comes in, or issues with the actual product or service that will need to be resolved. Due to this and other circumstances, it may be a long time before you reach your break-even point.

Undervaluing your product leads to insufficient gains.

The first instinct of a new business owner is usually to make the product cheap because they are afraid of alienating customers by overcharging them. You have to temper this instinct.

That doesn’t mean you should charge an arbitrarily higher cost; once you determine the true value of your product, the point is, to not charge less than what you know you should because you’re afraid people won’t pay it. This very common practice can potentially cause you to fall short of the revenue your business needs to operate.

Check out this bonus post to help you see if you’re charging too little for your product or service:

How to Tell if Your Prices Are Too Low

Waiting too long to go to market.

Business owners all know that they have a finite runway to get the business rolling. If you use up the majority of your runway before you even open, then you’re pretty much operating on a wing and a prayer.

A business owner of course wants the product to be perfect before they start selling it. It may just be that they’re waiting for the right time to open, to achieve greater sales potential. In any case, it’s important not to wait to long. More often than not, it’s better to open while you still have a good amount of runway left, so that you’ll at least have a cushion if money doesn’t start coming in right away.

Rely on data & research, not intuition.

Most entrepreneurs do their homework. They do demographic & market research, gather data for mean income, product demand, and the like. But there are those who are sure there is a market for what they’re selling, simply based on limited feedback they’ve received from a small group of people and a “gut feeling” that their idea will work.

If that sounds like you, then there’s a good chance that you will become a statistic. There’s no substitute for doing your due diligence to be reasonably sure that your product will sell.

If you’re not sure where to start with market research, here’s an article with some useful tips:

The Market Research Process a Fresh Perspective

In summation, here are a few points to remember: Be as sure as you can be, that there is a market that will buy what you’re selling; do not undervalue your product; secure at least 50% more capital than you expect that you will need; and don’t forget to promote your business, early and often.

There are no guarantees, of course, that your small business will be able to survive and thrive for years to come, but if you prepare well and do your homework beforehand, you can get pretty close to a guarantee of success.