why small businesses fail

5 Top Reasons Small Businesses Fail and How to Avoid Them

Why does the prospect of starting a small business come burdened with high risk? According to Innovation, Science and Economic Development Canada, the smallest businesses in Canada that only start with fewer than five employees have only a 62.5% chance of remaining open after five years and a 28.6% likelihood of survival after 17 years. However, small businesses with under 100 employees make up 97.9% of all businesses in the country. Therefore, even with high risk, many small companies still survive.

Understanding why small businesses fail will help a company to enact programs that prevent the most common reasons for failure and increase chances of succeeding over the year.

1. Not Understanding the Numbers

A big reason why small businesses fail is a lack of funding or working capital. This can often come as a result of not understanding, or not paying attention to what their financial statements are telling them.

Not accurately tracking your revenue and expenses will leave you flying blind. Are you really profitable? Do you know? In some instances revenue may be great and the balance sheet might look strong, but you may not actually have the cash to keep your business running.

As a business owner, you need to know how much of your revenue is needed for wages, utility bills, or rent so you can set growth and cost-savings goals accordingly.

Taking the time to read and understand your financial statements can prevent you from being surprised and allow you to react and plan in a way that moves your business forward.

Resource: How to Read Financial Statements for Business Owners

2. Not Knowing About Funding Options or Starting with Adequate Capital

Many small business owners don’t understand how difficult getting loans from banks can be. Without adequate funding, some business owners may attempt to dip into personal savings or friends to finance their ventures. Banks recognize the risk of small business failures. Consequently, they are historically less likely to provide loans.

To help business owners get operating funds, the Canadian government took action and passed amendments to both the Canada Small Business Financing Act and the Canada Small Business Financing Regulations to make getting loans easier for small business owners and less risky for financial institutions. The lenders share some of the risks with the business owners and have new products available for the small businesses to use.

Under this program, small businesses can use lines of credit for daily operating expenses or term loans for major business purchases. Each type of funding allows the lender to apply additional interest on top of its prime lending rates or mortgage rates, depending on the product. While businesses pay slightly more in interest, they have a greater chance of getting the funding they need to establish and grow their businesses.

The good news in Canada comes from the 2021 small business Credit Conditions Survey. The majority of small businesses that sought financing had full or partial approval. For instance, 89% of small businesses earned approval for either short or long-term loans. Among the 42% of businesses that requested government financing, 95% got at least some of the funds they asked for. While 85% of businesses reported not requesting financing because they didn’t need it, 3% of businesses did not know where to get funding and 4% didn’t apply because they thought their request would fail. Businesses that don’t seek funding will never get the money they need.

It can help your cause to know what financial ratios and metrics your bank or lender will be most interested in. Speak to your accountant first and make sure those numbers are in good shape and identify other information that may help your application.

3. Not Meeting Market Needs  

The type of business can make a difference in whether it will last. In Canada, small and medium businesses that sell goods had higher survival rates from three to 17 years than those that provided services. However, even for companies that provide goods, the chances of survival depend on meeting the market’s needs for products. If goods sold have no buyers or fail to have profitable pricing, the business still risks failure.

Several famous products failed because they lacked market demand. The Microsoft Zune portable music player could not distinguish itself nor compete with the well-established iPod. The augmented reality tool Google Glass looked unattractive while wearing it, cost far too much for most people to afford, and had poor marketing to promote it. Finally, the Segway could not find an audience of users when alternatives, such as biking or walking, already existed.

Even initial success can be a hindrance sometimes because it can blind business owners to the need to pivot. Business owners and entrepreneurs can become so invested in their product or service, they miss the signs pointing to the need to change or a new opportunity. That dip in sales might not mean it’s time to spend more in advertising, it could mean it’s time for a bigger shift to a new market, product offering, or sales channel.

4. Failing to Create a Business Plan

Failing to plan for the establishment and growth of a business will lead to its failure. Business plans must have clear goals and outlines for how to manage operations. These plans must include information on managing the company, risk management planning, financing needs and sources, marketing plans, and examination of competition.

Clearly outlining the management of the company during its startup phase and as it grows will ensure an efficient organization of employees and managers that meets the needs of the operation. The business owner must have the ability to delegate tasks to management staff, which allows for easier transitions later if the owner chooses to expand the company or retire. Part of the management plan should include information on an exit plan for the owner. The business owner should not assume that they will run the company forever. Having a plan to pass on operations to a new manager or business owner will facilitate future changes in leadership.

Risks for companies will change over time, but all businesses need to evaluate their sources of potential risk and identify ways to mitigate them. Risk management includes creating disaster plans to respond to emergencies, natural disasters, or security breaches. Cyber security should be an important part of the business plan. According to the CIRA Cybersecurity Survey in 2021, 36% of businesses of all sizes reported more cyber-attacks during the pandemic. Data security is vital to all businesses, but especially for small companies that could face devastating losses. The survey also noted that 17% of businesses suffered ransomware attacks with 69% of those victims paying the fees. A small business could fold under such financial strain.

Financing at the startup gets a business going, but companies need clear financial plans to ensure their businesses remain profitable. Pricing products or services, cutting spending, keeping workers paid, and paying operating costs all should fall into consideration when creating short-term budgets and long-term financial plans.

Marketing plans and analysis of competitors both help ensure the growth of businesses. Companies should differentiate their offerings enough to ensure that they meet customer needs. The Microsoft Zune music player was too similar to the iPod to attract customers away from the Apple product, contributing to the Zune’s failure.

5. Bad Management

Perhaps the biggest reason small businesses fail may be staring at you from the mirror.

Small business owners and entrepreneurs can get so focused on doing things a certain way, often because it worked for them in the early days, that they don’t evolve.

What got you to the point you’re at now, may not be what’s needed to move you forward, or get you through a crisis. A business owner may have the skills and knowledge to build and successfully launch a product to the market, but those are very different skills than building, managing and motivating a team over the long term.

It’s critical as a business owner to recognize you’re not an expert in everything and to surround yourself with people who can fill in the gaps. That could mean hiring the right people, working with a business coach, or seeking advice from your accountant. When it comes to starting and growing a business in Canada, failure is a risk. Planning and assistance from trusted advisors like the chartered professional accountants at Avisar can raise the chances of a business succeeding over time. At Avisar, we offer accounting, business consulting, and tax services to help businesses grow and thrive.

Disclaimer: Avisar Chartered Professional Accountant’s blog deals with a number of complex issues in a concise manner; it is recommended that accounting, legal or other appropriate professional advice should be sought before acting upon any of the information contained therein. Although every reasonable effort has been made to ensure the accuracy of the information contained in this post, no individual or organization involved in either the preparation or distribution of this post accepts any contractual, tortious, or any other form of liability for its contents or for any consequences arising from its use.