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The real reason why startups fail

· June 2, 2011

Could there be just one single reason behind most startup business failures? I happen to think so.

Could there be just one single reason behind most startup business failures? I happen to think so.

Almost everybody is familiar with the statistics: 50% of startups will be out of business before they are 5 years old. A little bit less known fact is that the rate at which companies fail decreases substantially as the companies age.

First two years are critical

Below is a graph showing how that 50% failure rate is spread over the years, depending on the age of the company. The data comes from the official business statistics provided by the U.S. Census Bureau and is an average for the years 2000-2009. The vertical axis shows the percentage of companies going out of business. The horizontal axis represents the companies’ age.

Distribution of business failures based on age

U.S. Business Failure Rates

Source: U.S. business statistics

As you can see, almost 1 out of every 4 establishments failed during its first year of operation. However, the chances of survival increased significantly as the establishments grew older. This is an indication that the most critical period of any company’s life is its first year (or two) of operation.

Why do they fail?

But, why do so many startup businesses fail during those first couple of years? And, how many reasons could there be for those failures? If the articles on this oh-so-popular topic are to be your guide, you will inadvertedly end up with the impression that there are a pletora of factors.

Here’s a typical sample:

As the list of articles grew, so was the number of reasons in them. However, while reading the articles, I couldn’t shake off the feeling that most of the failures can be attributed to just one single cause.

The real reason: not enough of sales

So, here’s my hypothesis: the real reason behind most startup failures is their inability to sell enough of their product or service and/or sell it at a sufficiently high markup to sustain and grow their operation.

By the way, this hypothesis is not based on any hard-core research. Rather, it’s a pure observation made over the course of years of “being out there”. Since I don’t have any research data to (dis)prove this hypothesis, the next best I can do is to present my arguments.

So, below I’m listing some of the most frequently listed reasons for business failure along with my own comments.

Lack of experience

To suggest that lack of experience causes businesses to fail is almost the same as suggesting that driving cars causes them to crash. A complete nonsense.

First of all, there is no guarantee that having prior business experience will save companies from going bust. Additionally, business education is no guarantee of business success, either (see my post on why MBA graduates are ill-prepared to start a business).

Second of all, even if experience increased your chances of success, the likelihood that somebody starting a business knows absolutely everything about that business and market is practically zero. In conclusion, everybody lacks (at least some) experience related to the business they are starting.

Finally, experience by definition is a something that can be obtained only by actually living through it. So, you cannot have experience without having experienced it, first. In other words, experience is not a function of success or failure.

Insufficient capital

Running out of money is a very commonly cited reason for business failure. And yes, nobody can dispute that a business cannot operate without cash or credit. On the other hand, it’s the sales that funnels cash into your business.

Therefore, going out of business because you ran out of money, essentially means that you weren’t able to bring in enough cash by selling your product or service. So, instead of blaming your business failure on “insufficient capital” blame yourself for not focusing enough of selling.

No business plan

If by business plan we mean the written document that VC firms are asking for, to blame a failure on nonexistence of such a document is laughable. I mean, how many people who are starting a business do actually write a formal business plan? 1 out of 100? Less?

You do need a clear idea about what you want to do, how much it will cost you, where the money will come from, etc. But, you don’t need to write it down following some artificial template and give it a title “the business plan”. In fact, most startup companies I know, haven’t written down anything at all and many are doing very well.

Poor location

True, if you choose to locate your business in an area that nobody visits, is too expensive to maintain, or is not frequented by your target customers, you will have difficulties to sell your products and services effectively.

However, there are many ways how you can increase your sales even if your location isn’t optimal. Furthermore, in the age of the Internet and online commerce, a successful business can operate even without any location, whatsoever. And, of course, there always remains the possibility to move to a new and better location.

Insufficient demand

Maybe you fell in love with your own product and disregarded the market trends. Maybe you priced your product right out of the market. Or, you didn’t price it high enough and your customers thought it must be of substandard quality. Or, you were targeting the wrong group of people. Or… it could be any of the other 100’s of explanations of “insufficient demand”. However, the bottom line remains: no matter What explanation you choose, blaming your business failure on insufficient demand is just another way of saying “we didn’t make enough of sales”.

Poor accounting

The more complex your business model and money flows, the harder it is to do the accounting in a way that is not only correct from legal standpoint, but also in a way that provides useful information for business decision making. The unfortunate reality of today, however, is that many businesses—starting or established—have zero or only very vague idea about their real expenses. In such circumstances, it’s no wonder that they run out of money without actually noticing.

“Keeping close tabs on expenses” is actually the other side of the same coin that also carries “selling enough product or service”. You cannot have one without the other. You can never sell enough if you don’t have a clear idea of your outlays because it’s only a matter of time before your out-of-control costs catch up with you.

So, there you have it. Am I right or am I wrong? I want you to be the judge and also tell me what you think. So, please make sure to leave a comment below.