Why do small businesses have a higher chance of failing?

While small businesses are said to be the drivers of economic growth and employment, the sad reality is that many are bound to fail.

According to Small Business Administration, a US government agency that provides support to entrepreneurs and small businesses, about 20% of business start-ups fail in the first year. Another 50% if not more succumb to business failure within five years. And by year 10 only about 33% are still in existence.

The picture in South Africa is similarly gloomy, especially with the National Development Plan aiming for small businesses to be creating 90% of new jobs by 2030.

Allon Raiz, CEO of leading business incubator Raizcorp, says there are several reasons small businesses find it hard to succeed.

Moneyweb asked him to highlight the most common mistakes made by would-be entrepreneurs.

Not being ready

Sometimes aspiring entrepreneurs think they are ready to be an entrepreneur when they are not.

It’s a good idea for would-be business owners to ask themselves if they really are ready to become an entrepreneur or if they are nurturing a fantasy of what entrepreneurship is.

Entrepreneurship requires sacrifice and commitment, and a level of perseverance that most would-be entrepreneurs underestimate.

Lack of a compelling economic right to exist

Often, aspiring entrepreneurs do not have something unique to sell, lacking a competitive advantage. In most cases, they are selling what everyone else is selling.

Sometimes they fail because there isn’t a real market for what they are selling. Before starting a business, the entrepreneur must really understand the market potential for their product or service. They cannot simply assume that there is a big market because their friends and family tell them they would buy from them.

In addition, some entrepreneurs do not have the ability or desire to sell.

“I have often observed entrepreneurs who are afraid to go out and sell because they are afraid of rejection,” says Raiz.

Selling at a loss

Most entrepreneurs cost their products or services incorrectly and end up selling at a loss. They create their selling price at 5% or 10% less than their competitors and never truly understand what it costs to produce their services. The result is that they are always cash-flow starved and cannot understand why they are working so hard and making no money.

Lack of adequate funding

Most start-up entrepreneurs underestimate how long it will take to break even. They overestimate their ability to sell (or for the market to accept them), and they underestimate their competitors. All this results in a much longer period to generate sufficient turnover to break even.

“My view is that if their financial modelling predicts that they will take six months to break even, then they need to make sure they have at least one year’s worth of funding,” says Raiz.

“And if their break-even suggests one year, then they would need two years’ worth of funding and so on.”

Being afraid of finances

Too many entrepreneurs are afraid of the numbers and do not respect their financials enough. Financial discipline is sorely lacking.

Many entrepreneurs make the fatal mistake of trying to save money by doing the books themselves and not outsourcing this function to a bookkeeper.

The result is poor financial records, which means they are less likely to find funding from financial institutions in the future. The longer they take to build financial discipline, the bigger the mess and the bigger the cost to clean up that mess. The problem becomes so big that they simply give up on their financials.

Without understanding your financials, you do not understand your business and therefore you are far more likely to fail.