Small Business

The Bottom Line on Startup Failures


By Karen E. Klein Q: Why do so many startups go bust within three years? What reasons are behind these failures? What makes a successful startup? -- H.W., London

A: The odds are stacked against startups: They suffer a disproportionate failure rate in both boom times and bad. That's the bad news.

The good news: Because few meaningful statistics exist about small, privately held companies, the astronomical business-failure rates that we hear quoted so often tend to be misleading. For instance, a survey done by the U.S. Commerce Dept. says that of every 10 small businesses, 7 will survive their first year, 3 will still be going after 3 years, and only 2 will remain after 5 years.

What those figures don't tell us is why young businesses fall by the wayside. The methods for counting business "failures" overinflate the failure rate because they count lapses in renewals of business licenses -- as well as bulk transfers or sales -- as "failures." More detailed research has shown that many of those outfits close their doors for positive reasons: they are acquired by larger outfits, get sold at a profit, or merge with another entity. So don't let the numbers deter you. (For more insights, see "Small-Business Failures: A Framework for Analysis" by Troy A. Festervand and Jack E. Forrest, both of Middle Tennessee State University.)

Most of us know through experience, however, that a lot of independent businesses do indeed close their doors quickly -- with certain industries more prone to see startups fold than others. Figures compiled by the National Restaurant Assn., for example, show that 80% of independently owned eateries fail within their first two years, for instance.

So why is it that so many new businesses don't succeed? Or, more to the point, what can an entrepreneur do to ensure a better-than-average shot at success? First, let's look first at the "big picture," then move into specifics.

SEDUCED BY DREAMS. "Most startups start with an entrepreneur's dream, a passionate evocation of a solution dying to be born," says Rohit Shukla, president of the Los Angeles Regional Technology Alliance. "But in a business environment where information flies around unencumbered by previous bounds of convention or technology, it is very likely that many people have approached a specific problem with solutions that, while they are not identical, are similar enough and plausible enough to complicate even the most vivid dream.

"Yet many start-up entrepreneurs, jealous of their dream, refuse to part with it, and risk being the big fish in a shrinking pond instead of sharing their dream with a team who can shape and guide it into open water," Shukla adds.

So, the founder's attitude, ability to be objective, willingness to bring in needed help, and share power are all crucial to success. "Most startups make the mistake of falling in love with their product or service," says Shukla. "Ultimately, it is this lack of self-criticism that causes many companies, startups and their more mature counterparts, to fail. Startups suffer this fate more often because there are more dreamers than doers."

AVOID TUNNEL VISION. He recommends that would-be entrepreneurs take a very hard and realistic look at their idea, product, or service long before they think about making a business out of it. (Get some objective, outside input if your own view is colored by being too close to the situation.) Is there an unmet need or problem that will be solved by the business? How difficult will it be to communicate the solution? In other words: Why should anyone want to buy from you? "Most startups seem to regard their product as an end in itself, a solution looking for a market, instead of one that focuses sharply on a problem which they are uniquely qualified to solve," Shukla says.

Which brings up the second challenge: getting a good handle on the competitive environment that the business will face. Many startups make the major mistake of dismissing the competition, Shukla says.

A third problem: How to bring the product to market? Is it going to require a change of behavior on the part of intended customers? Most startups underestimate the difficulty, not to mention the time and money required, to get a product launched and established in the marketplace.

Pulling together a team of people to sustain the enterprise is the entrepreneur's next challenge. The skills required to run a company differ from those needed in a startup's earliest days, and few entrepreneurs can satisfy all those needs by themselves.

PLANNING PAYS. Once a new company is up and running, the most obvious cause of failure is simply running out of money. Experts call undercapitalization a symptom of poor planning, however, rather than a true cause of failure. Other reasons why businesses fail in their early years include: poor business location, poor customer service, unqualified/untrained employees, fraud, lack of a proper business plan, and failure to seek outside professional advice.

Clearly, planning plays an integral part in success. "We studied firms that had developed a business plan at the outset, and found that 85% were still in business after three years. I think that fact speaks for itself," says Jonathan Goldhill, a small-business consultant and former director of an economic development center in California's San Fernando Valley. "I would say that the primary reason for failure of startups within three years is usually...management's failure to act, or management's failure to react, or management's failure to plan." Have a question about running your business? Ask our small-business experts. Send us an e-mail at smartanswers@businessweek.com, or write to Smart Answers, BW Online, 46th Floor, 1221 Avenue of the Americas, New York, NY 10020. Please include your real name and phone number in case we need more information; only your initials and city will be printed. Because of the volume of mail, we won't be able to respond to all questions personally.


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