Why Small Businesses Fail – A Liquidator’s Perspective

We have all read the staggering statistics about small businesses failure rates. I’m not sure how accurate they are but it got me thinking. Just as we can learn from other people’s success, we can surely also learn from their failure. And who better to learn from than the men and women who are called in to clean up the mess – the liquidators!

So, why do small businesses fail?

To find out, we surveyed 3 Sydney-based insolvency professionals with decades of experience between them. We asked them why small businesses fail. The results were very pointed.

Who did we talk to?

Dabid

Bradd Morelli Louisa Sijabat David Hill

Jirsch Sutherland Vincents Mackay Goodwin

What they said

“In my view, under-capitalisation is probably the most common reason for SME business failure, there may be other problems present but they often stem from this”, Bradd Morelli said.

What he is saying is that these businesses never really stood a chance. Unless the business has the right amount of funding – whether it be debt or equity – they are forever robbing ‘Peter to pay Paul’. A few will make it because they quickly become cash flow positive, but they are the exception to the rule.

Louisa Sijabat has seen plenty of under-funded businesses go to the wall too. She warns, “I think there are stories out there of now-famous companies started on a shoestring budget, and while this is sometimes possible, I think it hides important information from people who want to have their own business that they do need to financially plan for the start of their new business and ensure they have enough funds to see their business through.”

Perhaps under-funding is actually a symptom of another issue identified by the panel – poor decisions by management. This point was not lost on Sijabat who actually ranked this as the number 1 reason for small business failure. “Ultimately, I have seen this to be the key factor as to why small businesses fail. These management decisions encompass a wide range of things, including the extent of cash withdrawn from the business (as the owners’ wages or salaries or drawings or benefits, car lease payments and the like, as well as the extent to which they seek out and listen to professional advice especially when things are not within their main expertise – for example, legal disputes, business acquisitions etc, and of course, operational and staffing decisions”.

David Hill also linked these two key causes of small business failure. “Obviously the result of under-funding and poor decisions is too much debt!! And by the time you realise you are in too deep, it’s often a fait accompli that you will go under.”

So, whilst having the right amount of funding is critical, so too having the right funding mix. Hill continues, “Debt behaves very differently to equity, particularly from a cash flow point of view. Obviously, debt needs to be serviced and repayments need to be made. That’s money that is going out of the business on a regular basis and if it’s not being replaced by after-tax profits you’ve got a problem.”

According to the panel, failure to recognise and act on changing conditions was also a big concern. “A classic example is a business owner experiencing a downturn in work and not being able to reduce staff numbers, this may be because they see the staff as family”, said Morelli.

Ironically, by trying to protect jobs, the business owner is actually putting the whole business at risk, imperilling even more jobs in the process. Whilst no-one is suggesting you should be heartless in your decision-making, there is a need for clear thinking and decisive action when conditions are changing.

Whilst the focus is often on new businesses, a shifting landscape is an area that can also affect mature businesses. According to Sijabat, especially ones where technology has changed the way things get done. “It really is so easy to be busy ‘in’ our businesses that we may not spend time addressing how the whole landscape itself is changing”, she warned. Businesses of all sizes need to keep an eye on the market, to avoid becoming too internally focused.

Though they were less common, the panel cited internal conflict, poor succession management and fraud as other causes of failure. Says Morelli, “I have not seen a great deal of business failure due to fraud, but the ones I have seen where fraud is involved tend to be larger.”

The Rankings

The business is under-funded
Management make poor decisions
Management fail to act on changed conditions
Fraud/conflict/other

The Key Take-Outs

The key take-outs for small business owners appear to be these:

1. Get help

It seems clear that poor decision-making is right up there as one of the key reasons for small business failure. Unlike big business, you don’t have an expert in every role. You are entirely likely to be dealing with matters that are well outside your area of expertise. So, we recommend that you:

Surround yourself with people that can help you to make good decisions
Develop processes for evaluating decisions
Don’t get paralysed – not making decisions for fear of making a bad one is effectively deciding to do nothing
Not all advice is good advice – whether well-intentioned or otherwise – engage a professional

2. Address your funding

If you are under-funded, you are at serious risk of failure. If you have too much debt in your funding mix, the same applies. So, we recommend that you:

Carefully identify the right amount of funding for your business
Think carefully before you decide to ‘bootstrap’ it – are you creating certain failure?
Don’t forget to allocate money to things like marketing (to boost leads and sales) and professional fees (to get good advice)
Don’t be overly optimistic in your profit forecasting – both amount and timing
Don’t forget to factor tax into your calculations
Consider sources of equity funding – you might be better to give up a bit more equity but give yourself a real shot at success

3. Act early

There is little doubt that the earlier you act, the greater your chances of success.

No investor or lender likes to get involved in a business that is a) burning cash and b) has no clear plan for how they will turn things around. If you are in that situation, things are going to get worse before they start to get better. Now is your best chance to attract an investor or a lender.

So, don’t lose time wondering if you should do something, do it now. And if you’re not sure what to do, refer back to number 1 above.

How we can help

BridgePoint Group provides advice to small and medium businesses in Australia on a range of issues, including strategy, planning and business funding.

Our solutions are always specific to your needs but in situations such as these, may include providing access to experts, advisory board roles, general advice, consulting on specific issues and/or assisting you to raise debt and/or equity capital if appropriate in your situation.

For more information regarding any aspect of this article, or for help with your business, please phone Neil Parker on 1300 656 141.