10 reasons small businesses fail (and how to avoid them)

For many, the idea of starting a new business brings thoughts of freedom, financial independence and being your own boss. While all of these are achievable through owning a small business, getting there may be harder than you anticipate.

In fact, a large percentage of small businesses fail to survive even a few years. While occasionally these collapses are outside of the owner’s control, small businesses often fail for reasons that could have been avoided with the right knowledge and resources.

Let’s look at 10 reasons small businesses fail and share some helpful tips to avoid falling into these traps.

1. Misunderstanding what your customers actually want

It’s easy to design a product or a service to be what you like. However, your preferences may not align with those of your potential customers. Sometimes this can be a large-scale misalignment where there is no demand for what you’re offering. Other times, it could be a small difference in the way you deliver part of your product or service.

Regardless, the result is the same — people not buying what you’re selling.

The best way to avoid this misalignment is through market research. Set up or pay for focus groups. Get your brutally honest friends together and ask for their feedback. Assess online reviews and encourage both your customer base and your staff to offer feedback.

The more you understand what your customers really want and not just what you think they want, the higher your chances of succeeding.

2. Incorrectly assessing (and planning for) future costs

Starting a small business can be expensive. Most people know that before they launch, they need to fully understand how much things are going to cost. However, they often underestimate costs or aren’t aware of certain expenses.

For example, if you’re starting a restaurant, you’ve probably thought about things like food costs, rent, labor and maybe some marketing. But you might not think about things like the costs of health permits, inventory waste, restaurant software, seasonal changes in the price of food, insurance and more.

Yes, there will be things that catch you off guard no matter how much planning you do. But the more of these typical surprises you can turn into expected expenses, the more of a chance your small business has to thrive.

3. Not planning for surprise expenses

For a new small business, money is usually tight. Unexpected expenses – such as needing to repair equipment, replace damaged stock or hire additional staff on a short notice – can quickly throw your cashflow off balance. An unusually slow month or a shortage of sales can also quickly doom a business tight on cash.

This is why having a backup plan is essential. Having cash reserves in place can act as an emergency fund for your business, either to cover unexpected expenses or to help bolster your cashflow when sales slow down.

This can also include researching fast business loan providers and identifying expenses that could be cut in a worst-case scenario.

4. Poorly managing your staffing situation

While some businesses can operate as a one-person show, chances are you need support in order to get your business to run properly.

However, it can be difficult to find help to fill your roster at the wages you’re offering while maintaining your profit margins. High staff turnover is even worse, as you’re left scrambling to find and re-train employees to pick up the slack.

Before staffing becomes an issue, be proactive in how you hire and retain your employees.

5. Going into a business you don’t enjoy

You may have heard the advice that you should go into business doing something you love. While good advice, many people misinterpret it and only look at the enjoyment of the service instead of the work that goes into it.

For example, you might like going to restaurants to eat, but do you like cooking? Do you like managing staff in a high-pressure environment? If you go into owning a restaurant solely because you’re a foodie, you may find that you don’t enjoy the rigors of the job.

Starting a small business is a grind that often requires long hours and a fervent desire to succeed. If you’re not passionate about what you’re doing or, even worse, don’t enjoy it, finding the motivation and discipline to push through the hard days may be a challenge.

6. Going into a business you know nothing about

Incorrectly assessing costs, getting caught off guard by surprise expenses, and miscalculating customer demand are all symptoms of a larger problem: You don’t understand the industry in which you’re trying to do business. While you can mitigate some of these factors through research, the best way to get in front of these challenges is by getting real-world experience in the field.

Additionally, it’s important to realize that proximity to an industry does not automatically spell knowledge and experience. For example, just because you go to a lot of bars does not mean you have a lot of knowledge about the bar industry.

Make sure that the type of business you choose is in a field you understand — at least to some degree.

7. Tracking the wrong metrics

A common reason many small businesses fail is that they don’t have an accurate understanding of the health and direction of their business. When you don’t have a crystal clear picture of things like sales, finances, inventory, growth, workforce health and industry trends, you stand to make poor strategic decisions.

Before you start your business, set up reliable processes to accurately track your data. Additionally, ensure you are tracking the metrics that actually matter. It can be tempting to measure things that make you feel good and ignore the less exciting, but equally (or more) important indicators.

For example, tracking sales as a bar owner feels good when you see great numbers. Monitoring details like employee theft through heavy pours and free drinks isn’t as fun, but it’s just as important to the longevity of your business.

8. Not understanding the legal aspects of running a business

Each industry has a unique legal landscape that a small business owner must understand. Ignoring these critical details could make your business vulnerable. For example, if your business involves managing staff, you need to understand the legalities of hiring and firing. According to Shouse California Law Group, a law firm that specializes in employment law, businesses may owe between $5,000 and $100,000 in a wrongful termination suit, not including legal fees.

While some businesses get by with cutting corners, rolling the dice with legal issues is a recipe for small business failure.

9. Cash flow problems

You can have a product or service that everyone wants but still fail as a small business if you don’t manage your cash flow effectively. This becomes especially important in businesses where payment is made on delivery or on net terms.

For example, let’s say your business has $100 and you sell a widget for $500, but you don’t collect payment until you’ve built and delivered the widget. Let’s also say the widget costs you $300 to make, meaning you’ll earn a profit of $200. While this sounds like a recipe for success, you have a major cash flow problem. You don’t have the $300 needed to build the widget so you can collect on the $500 payment.

Solving cash flow issues starts with planning. If you still find yourself in a bind, you can always look into invoice financing as a way to generate more cash up front.

10. Falling behind your competition

There’s a popular military cliche that applies to running a successful small business: Complacency kills. In a military setting, the idea is that when you begin to get complacent, accidents happen and people get hurt. Similarly, if you become complacent with your competition, your business stands to get hurt. If a competitor offers a new service that you don’t or finds a way to offer equal or better service at a lower price, you may lose business.

Never assume what your competitors are doing. Consistently monitor, test and assess their products, marketing efforts and new ideas. Additionally, ensure you’re always looking for ways to innovate so you can turn your competitor’s complacency into an asset.

The bottom line

Considering the many ways your small business could fail is never an enjoyable task. However, attention to the many risks of starting a business can help you see these threats coming before they can sink your operation. By understanding the potential pitfalls and having a plan in place, your small business stands a greater chance of succeeding and delivering those feelings of freedom you dreamed of.