Why Do Small Businesses Fail?

We’ve all heard that a high percentage of small businesses fail in their first five years. Only around one in ten are still around for their sixth year! This is an incredible statistic, and highlights just how hard it is for entrepreneurs to get their ideas off of the ground.

So what is it that causes these failures? We’ve complied a list of common reasons from ASIC reports, bank reports and from our own experience with the customers that we work with.

Poorly designed business model

Without a doubt one of the major reasons people fail is that their business model is simply not viable. People regularly start a business in a field that they love, not an industry that is likely to have many successful businesses.

I was at a conference recently where Mark Bouris gave a speech about starting a business in an industry that is growing rather than one that is in decline. He said that the “rising tide” will help push the business forward even if everything else is holding it back. He believed that his former business Wizard Home Loans was well placed in the late 90’s to capitalise on the switch many Australians made away from the major banks.

If you spend the time to work out your business model and invest in an industry that is growing, then you are already ahead of the vast majority of business owners.

Poor management decisions

The truth is that many people are not cut out to be business owners or managers. I’ve always believed that you should play to your strengths. If you are a “salesman” type personality then you’re business will do well in sales however you are unlikely to be able to manage your team effectively.

If you don’t have the skills to manage a business then consider doing a course so you can learn how to manage your staff and make effective strategic decisions. Talk to your friends and co-workers before you start a business and ask them for feedback about whether or not you would be an effective manager.

Economic uncertainty

There is always going to be another boom and another bust coming, the real questions are ‘when will they happen’ and ‘will you be prepared’. If you have ample cash reserves on standby then you will be in a strong position to survive the bad times and possibly even capitalise on the opportunities that present themselves when the storm clears.

Business owners often blame the economy for the failure of their business however they should take the responsibility on themselves to effectively prepare for and handle the crisis.

Burnout

When a new employee joins us at the Home Loan Experts we ask them to read a book called The E-Myth. This is a book about how small businesses work, how they grow and the importance of systems and procedures.

Unfortunately most small business owners never grow beyond being a one man band or having just a couple of employees because they are unable to delegate effectively and build systems & procedures.

If you can’t delegate effectively then you will almost certainly burnout after a few years. Running a business becomes “all too hard” and you become trapped by your business rather than freed from working by your business.

What this means for applying for a loan

The banks have long known that many small businesses fail in their first few years. For this reason they typically require you to have been in your business for at least two years prior to applying for a home loan.

By providing financial statements and tax returns for two full financial years the banks can clearly assesses how profitable your business is and if you can afford to take out a mortgage. For businesses that are over five years old the banks will be more favourable in their assessment as you have a strong, proven track record.

With low doc loans the majority of lenders also require you to have been in your business for two years, however some can consider businesses just one year old as an exception to normal lending criteria.