Cambridge AS A Level Business Studies/ ZIMSEC Advanced Level Business Studies/ Business Enterprise Skills Notes: Enterprising/ Entrepreneurship : Reasons Why Businesses/Startups Might Fail

  • As has been hinted on time and time again not all businesses/startups are successful
  • There is a lot of statistics out there about just how many businesses fail int heir first year
  • Some claim as many as 90% of businesses fail in the first year
  • According to one study by the United States based Small Business Association:
  • Only 25% of businesses make it into their 15th year of existence
  • There are so many reasons why business ultimately fail it would be impossible to enumerate them all
  • Just like we haveĀ  innumerable things that can kill a human being
  • There are however popular reasons that stick out when it comes to reasons why businesses fail
  • These are the most common causes
  • They include:
  • Lack of experience by owners
  • Insufficient capital (funds)
  • Fraud/Misappropriation of funds
  • Over-investment in fixed assets (non-current assets)
  • Poor market research
  • Poor location of the business
  • Poor management of credit
  • Lack of differentiation
  • Overexpansion
  • Lack of a succession plan
  • Lack of contingency planning
  • No diversification

Lack of experience

  • There are certain characteristics that an entrepreneur needs for their business to be successful
  • If an owner lacks one of these it might eventually lead to the downfall of their business/startup
  • In addition to these characteristics, the business owner also needs to have at least basic business skills
  • They need to be able to adequately managed working capital for example
  • If the owner has not had a management position ( i.e. they lack experience) it might result in them making critical mistakes that will spell doom for their business
  • A lot of new business owners lack experience inĀ  areas such as finance, purchasing, selling, production, and hiring and managing employees
  • Such new owners would be well advised to hire people with the relevant skills even if it is on a consultation basis instead of permanent positions

Insufficient capital

  • A lot of new owners underestimate ( are not realistic about) the amount of capital they require
  • Often a lot of new businesses take time to reach the profitable stage
  • During their early years/months they can be making losses due to any number of reasons
  • This can be exacerbated by lack of experience on the owner’s part which might result in a business taking longer to make profits than would otherwise be the case if an experienced person was in charge of the business
  • Often the most successful business have a series of funding cycles where they raise funds once they have reached a certain stage
  • If a startup fails to get additional capital at a critical stage it will burn out all its existing capital and ultimately fail
  • Businesses like Facebook and Amazon took more than a decade to become profitable!

Fraud/ Misappropriation of funds

  • This can happen in two ways:
  • Plain simple fraud where owners or someone in the business takes business funds makes personal use of them
  • This can be actually planned as in the case of pyramid schemes were the owners have a deliberate exit strategy to defraud whoever invests in their business
  • It could also be unplanned where one of the managers/owners simply steals money
  • Sometimes the owner can legitimately take money from their own business, in a way that still cripples the business
  • There is however another form of fraud
  • Some new innovative business might be formed around a new revolutionary and science-based idea
  • For example, there was once a company called Theranos which claimed it could do a host of scientific tests using just a drop of blood
  • When it turned out that its touted scientific method was a fraud the whole company crumpled into nothing
  • The company was based on a fraudulent idea/claim
  • At its peak the company had an estimated value of $9 billion
  • Overnight this was wiped to zero

Over-investment in fixed assets (non-current assets)

  • Over-investing in fixed assets can be fatal to a business
  • Usually, it means less working capital to the business
  • Working capital is the lifeblood of the business and its shortage can lead to problems

Poor market research

  • Market research allows the business to identify new opportunities in the market
  • A business can then be formed to satisfy these new opportunities
  • Faulty market research data might lead to a business making missteps and ultimately failing
  • Some business are formed without any market research
  • Here the owners simply rely on their own instincts/ gut feeling
  • This can have catastrophic results if those instincts are wrong

Poor location of the business

  • Location can hurt or boost a business’s prospects
  • For example, a luxury brand that is located in a poor neighbourhood is likely to fail
  • This is because people in that neighbourhood might not have the disposable income to spend on luxuries
  • The location also affects taxes and other expenses that a business has to pay
  • It also impacts on the distance to the potential market, availability of labour to the business, distance from raw materials etc

Poor management of credit

  • In order to fund the purchase of assets a business has two major options
  • Use capital that is brought in by the owner(s) of the business
  • Or borrow money in the form of credit e.g. debentures, loans etc
  • The balance between debt capital and equity capital is delicate and has to be managed carefully
  • Otherwise, if a business fails to pay its creditors it might face liquidation or lose some of its critical assets leading to it shutting down
  • For example, the creditors to a farm business might auction its irrigation equipment effectively killing the business

Lack of differentiation

  • If a business fails to make its product stand out from those in the market this might spell its doom
  • This is especially true if the market for that particular product is saturated
  • For example, the mobile networks in Zimbabwe are have managed to achieve a penetration rate of more than 100%
  • This means that anyone who wants and can have a phone now probably has one
  • If a new play were to enter that market they would have to give their customers a compelling reason to switch over
  • Offering more of the same will mean the new business will most likely fail

Lack of planning

  • The planning stage is often ignored by a lot of new business owners
  • If planning is not properly carried out it might mean the business being dead on arrival
  • Planning allows the owners to define the objective clause
  • That means expressly stating why the business has to exist/ the reason for the business’s existence

Lack of a succession plan

  • Lots of business usually die with their owners or shortly after
  • This is usually due to lack of proper succession planning
  • The business would depend heavily on the owner
  • For this reason, a lot of family businesses hardly ever succeed when they are held by the second generation of owners

To access more topics go to the Advanced Level Business Studies/ Business Enterprise Skills page

To access more topics go to the Cambridge AS A Level Business Studies page