10 reasons why businesses fail

About 50% of small businesses won't make it to their fifth birthday. Here are some of the problems they run into.


(Photo: Iain Farrell/Flickr)

Take a look at the new businesses in your neighbourhood. Chances are you’ll find plenty. Between 2002 and 2008, an average of about 100,000 new Canadian businesses were launched each year, says Industry Canada. Now, the bad part: after five years, many of them are long gone. Only half of small and medium-sized businesses make it to their fifth birthday, while 15% don’t last a year. And many of them succumb to the same mistakes. Here are 10 key reasons why businesses fail. Try to avoid them at all costs.

Inexperience. “Almost every failed entrepreneur… overestimates their ability to generate revenue, or underestimates what it’ll take” to start making money, says Stewart Thornhill, executive director at the Pierre L. Morrissette Institute for Entrepreneurship at the Richard Ivey School of Business. When a business is started, there’s an early period “where you’re just digging a pit and throwing money into it,” he says, and making money could take longer than expected. Some firms, however, aren’t prepared for revenue delays and simply run out of time and money.

No value proposition. So you’ve built a new product and you think it’s great. Even your cranky in-laws think it’s a winner. What could go wrong, right? “Well, they’re not going to tell you the truth,” says Thornhill. For a number of reasons, entrepreneurs often have an inflated sense of their product’s worth in the marketplace. Thornhill suggests getting your product into the hands of strangers for better feedback. After all, if your business doesn’t offer a solid value proposition—otherwise known as the reason why customers buy what you’re selling—then it’s dead in the water.

No x10. How does your business stack up against the competition? “If what you’re offering is only a little better, it’s not going to be enough to generate the traction that you need,” says Sean Wise, a Ryerson University professor who served for five seasons as the online host for Dragons’ Den. Wise says your product or service needs to be 10 times better than your competitor’s. He uses email as a classic example: consumers made the switch because it’s reliable and infinitely faster than snail mail.

Relying on investors, not customers. During his time on Dragons’ Den, Wise met plenty of hopeful entrepreneurs who were overly focused on finding investors. “People come seeking investment but they haven’t got any customers to prove that there’s a need for what they’re selling,” he says. “Funding doesn’t make you successful—customers do.”

Bad partners. Startups are often group endeavours. And while there are benefits to having multiple personalities behind your brand, you might also be susceptible to group conflict. Thornhill says that business partners need to have a frank conversation about each other’s expectations and how to deal with adversity. “You can have the best business idea in the world, but if the team falls apart and can’t execute on it, then the business is a failure,” he says.

Copycat firms. The good news is that you’ve launched a profitable product that consumers want. The bad news is that “you’re on the radar” for competitors that want to replicate your success, says Becky Reuber, a professor at the Rotman School of Management. Take GroupOn as an example. Once the “daily deals” phenomenon picked up and GroupOn became a household name, a number of similar websites started popping up. Simply put, GroupOn’s business model was easily replicable and the company has suffered for it.

Premature scaling. Some entrepreneurs believe that expansion holds the solution to their problems. But that’s a dangerous line of thinking. According to a study from Startup Genome, an American R&D project that tracks startup activity, premature scaling was the number one predictor of business failure. Under their definition, premature scaling is when one (or more) key elements of the company—the business model, customer, finances, product and team—grew out of sync with other elements. In their data set, Startup Genome found that 70% of startups showed some form of premature scaling.

The economy. During lean economic times, consumers typically rein in their spending. At the height of the recession, the Conference Board of Canada found that consumer confidence dropped to levels unseen since the early 1980s recession. And clearly, Canadian entrepreneurs aren’t optimistic for the future: a recent study from PROFIT magazine said that nearly 40% of small business owners think another recession will hit by the end of next year.

Not getting outside. Some entrepreneurs tinker endlessly with their product before putting it to market.  But perfectionism can be a bad thing, says Wise. “They want to keep it quiet, because they think that the idea—not the execution—is what matters,” he says. “And the truth is, it’s execution—not idea—that matters. So you have to get outside.”

Arpu<cogs. These strange acronyms stand for “average revenue per user” and “cost of goods sold.” In simple terms, a business will fail when it costs too much to land clients who buy too little. “Some people will have a great idea that, in fact, a lot of customers will want, but it’s just not profitable” to make, says Reuber.