Why do businesses fail?

As valuable lessons can often be learnt from others’ experiences, understanding why businesses fail can help in avoiding failure.

Business failures can be grouped into three categories:

  1. ‘The Start up that never starts’:

    Half a million new businesses are started up every year.  400,000 close every year. Half of new business start ups fail in the first year, 95% fail within 5 years, making this by far the biggest category.  They typically fail because:

    • The business model is wrong, for example the market does not in fact exist;
    • The business is undercapitalised from the start and runs out of cash very early;
    • The business fails to weather a downturn;
    • It was set up in a high growth industry, and fails to survive the ‘shake-out’;
    • The owner does not have the determination or the full skill-set needed to succeed.
  2. ‘The catastrophic failure’
    Contrary to popular belief, these failures are quite rare.  Examples include a major fire, flood or fraud, major litigation, or a major change of legislation.
  3. ‘The incremental failure over time’

    This is the normal type of failure for established businesses. Under-performance leads to poor cash generation / increasing cash burn, which in turn leads to reduced investment, reducing the resources available to the business.  It then becomes a vicious circle, getting ever faster until the business eventually fails. The further advanced the decline, the more likely it is that you will need outside help.

Most Insolvency Practitioners recognise that managing a business that is struggling is immensely challenging.  Nevertheless they often criticise management: why is this?  It is because their view is that ‘poor management’  is the reason for all business failures, whatever the category may be.  They say this for the following reasons:

    • The start up that never starts – each of the 5 reasons set out above involves a failure by management, a faiulure to properly assess the size of the business opportunity, the cash needs of the business, to formulate alternative plans to cover the event of a downturn in the business, or to recognise that being successful in business requires a full tool-set of skills and single-minded determination;

  • The catastrophic failure – IPs see this as a failure by management to properly assess, and then exercise control over, the level of risk faced by the business;
  • The incremental failure – IPs see the failure to take pre-emptive action to avoid the business failing by this route as weak management.

So now you know why IPs are often quite critical of British management!  But then again it’s easy for IPs to hold such views because they have the considerable twin benefits of hindsight and not having personally endured the tough times management did!

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