Across Canada every year, thousands of new small businesses hit the ground running. According to Industry Canada, however, only half will make it to the five-year mark.
If you are running a business, or tempted to start one, check out these common reasons they go belly up.
Not enough revenue
The biggest reason for failure is that the business is simply not viable in the first place, says Eileen Fischer, a professor of marketing at York University’s Schulich School of Business, Torono. “It has too small a number of customers willing to pay for what the business owner can offer at a profitable price."
Businesses seldom fail because no one purchases their products or services, affirms Marvin Ryder, assistant professor of marketing at McMaster University’s DeGroote School of Business, in Hamilton. “They fail because not enough people purchase its products or services.”
High operating costs
This means the business owner was either not charging enough for the product or service, or else spending too much to run the businesses.
“I ask people if they absolutely need to spend everything showing as an expense,” he says. “Could they rent a store in a cheaper part of town, or lease cheaper delivery vehicles? A good businessperson is always looking to see if that last marginal dollar has to be spent.”
Dr. Fischer says that even a great idea that attracts a large enough market might not work. “If you start without sufficient funding or can’t acquire sufficient funding early on,” she says, “you may be destined to go out of business because you don’t have enough fuel to keep it running while you build up your clientele.”
Another wrinkle to this problem stems from things the business owner simply can’t control, such as a major rent increase or a frost in Brazil that suddenly increases the price of the coffee you sell in your cafe.
“This is a catch-all phrase for three main things,” says Prof. Ryder. They are theft by consumers, such as shoplifting or dining and dashing; theft or breakage by employees; or poor inventory management.
In the last, too much of the wrong kind of inventory is ordered and then it has to be moved with very low margins, or else inventory arrives at the wrong time. Think Christmas inventory arriving the week before Christmas, for example.
This issue accounts for about 5 per cent of business failures, he adds.
Excessive fixed assets
In this case, the business owner has gone out and simply bought too much for their new business. They might have purchased state-of-the-art equipment to provide their goods or services, instead of renting it, for example.
“I often see entrepreneurs failing because they have not scaled up at an appropriate rate,” says Dan Kelly, president of the Canadian Federation of Independent Business, an organization that represents 110,000 small businesses. “They make early assumptions. They get a contract quickly and assume that’s always going to be the case. They can end up creating such an overhead that it becomes unsustainable.”
Another aspect of this is what Prof. Ryder calls “the Porsche company car.”
“Let’s say I’m going to start a business as a consultant,” he says. “Now that I am self-employed, I buy a fancy car – like a Porsche – and write it off as a business expense. I would soon learn the hard way that Revenue Canada limits the amount you can claim for a company car, but now I am stuck with the vehicle.”
Lack of business skills
According to Dr. Fischer, the skill set and stamina required to keep a business thriving are no small matters, even with a great idea and financing in place. “It’s such a multifaceted thing to run a business,” she says, “supervising sourcing, supervising employees, supervising the manufacturing or service process, the inputs, the through-puts and the outputs. There’s nobody else to do it but you.”
Underestimating the amount of time they’re going to have to spend on staff-related issues is another frequent mistake made by small business owners, says Mr. Kelly.
Related to the revenue problem is the “cheque’s-in-the-mail” problem, creating a cash flow crunch when clients drag their heels in paying what they owe.
“In many small businesses, consumers pay by cash, credit card or debit card,” says Prof. Ryder, “but in some industries, the norm is to bill the consumer for work completed. Usually that bill has to be paid within some period of time, like 30 days, but that does not always mean your client actually pays the bill then.”
The address of your new business premises might look good on paper, with lots of car traffic passing by, for example. But if there is no on-street parking or a nearby parking lot, says Prof. Ryder, “it’s just too hard for customers to reach you.”
Too many competitors on the same block may be another sign of a bad site, or noise bylaws might mean you can’t open a sidewalk patio. As a result, your dream location can turn into a nightmare.
This problem cuts both ways, says Mr. Kelly. “One of the classic mistakes business owners often make is they want to control everything themselves, and they are too slow to bring in a partner,” he says. “So they end up failing because they don’t have the expertise someone else can bring.”
On the other hand, choosing the wrong partner “can also be a business killer,” he added. “Sometimes you go into business with a family member or best friend, and don’t have the proper dispute-settlement process.”
Partnership failures are like a divorce, says Prof. Ryder. “You start off together, but then one person can no longer put in the energy, and the other partner says, ‘I’m doing all the work.’ Make it three or four partners and it can become very difficult to keep things running in the long term."