What leads to business failure?

 

There is no step-by-step formula that will guarantee success in the fast changing and dynamic environment in which businesses operate. There is no blueprint that can be followed to achieve lasting business success.

New and old businesses make mistakes and some of which can be fatal. The following are some of the most common reasons for business failure.

Not making something customers need

The main killer of businesses is not making something customers need. It is vital to have a product or service that customers truly value and for which they will pay a premium.

The key is to understand exactly what customers want and to give it to them.

“A product is not a product unless it sells. Otherwise it is merely a museum piece.” Ted Levitt

The target market is too small

Your target market must be large enough to build a sustainable business.

Is the total market for the product or service large, rapidly growing, or both?

Is the industry now, or can it become structurally attractive?

The “build it and they will come” approach is dangerous!

Poor pricing strategy

The traditional methods such as cost-based and competition-based pricing will not work. Neither of these methods takes account of value to the customer.

You need to use target costing and value-based pricing to succeed in today’s highly competitive market place. You need to focus on profit instead of volume or market share.

Pricing power is probably the most valuable asset for business success. According to Warren Buffet, the leading investor, it is the most important factor that he looks at when evaluating a business.

Poor cash flow management

Cash flow is the life blood of all businesses and is the key indicator of business health. In the current credit crunch environment, where access to liquidity is restricted, cash management becomes critical to survival. It is estimated that cash flow problems cause half of all small business failures in the UK.

You need to ensure that the working capital cycle is as short as possible by managing your debtors, creditors and inventory period and avoiding over-trading, over-financing and over-investment.

Too much money is as dangerous as too little

The key is to get just enough money to get started and test the business model, but not so much that the business is insulated from market tests. It is important to learn early whether the product or service has the potential to be profitable.

It is important to keep a tight grip on cash - not just because conserving cash will help businesses to survive longer, but also because it is a sign of the correct attitude - that the company is serious about succeeding in the longer term.

For example, Autonomy was founded in 1996 with less than $5,000. The company was bought by HP for $11 billion this year.

http://www.bbc.co.uk/news/business-14584871   

Cost control is not enough

Controlling costs is not enough. You need to use a cost reduction programme to eliminate waste and drive costs down continuously. For example, Kaizen costing is based on the belief that nothing is ever perfect, so improvements and reductions in the variable costs can always be made.

Failure to innovate

To be really successful, continuous innovation and generation of new ideas are needed. Simply relying on customers to ask for a solution will not be enough. The key is to understand how customers work, what they need today, and where they are headed in the future. As Henry Ford said:

“If I had asked my customers what they wanted, they would have told me a faster horse.”

The best and most successful innovations are the ones where a company delivers something that the customers did not even know they needed but cannot live without. 

In the end, the real test is not just whether you can come up with new ideas and solutions, but if the ideas and solutions can be turned into cash.

Why is it difficult to raise finance for start-up and early-stage companies?

Due to the riskiness of businesses – especially start-ups and early-stage businesses – only a small number of businesses get funding from investors.

Entrepreneurs need to first understand whether their business fits into what external investors want before pursuing them. Otherwise, it is simply a waste of time, money and energy on an elusive goal.

What are the main reasons for such a low success rate?

Lack of experience

Smart investors will check whether the management team has the relevant experience to run the business before they read the rest of the business plan.

A team without the right experience is highly unlikely to get the attention of investors. Potential investors will look closely at the management team.

Flawed business model

Entrepreneurship is not just about market share; it is about a strong and sound business model. You need to have a product or service that customers truly value and for which they will pay a premium. The product or service needs to be some combination of better, cheaper and faster. Cheaper does not mean it has to be cheap or priced lower than the competition. It means that you must have a cost advantage that adds value for your customers.

Requested investment is too high

The key is to get just enough money to get started and test your business model, but not so much that your business is insulated from market tests. It is important to learn early whether your product or service has the potential to be profitable. In order to test your product or service, it is not necessary to spend a large amount of money.

During the Dot-Com bubble many start-ups received vast sums of money that insulated them from market tests. Boo.com spent more than $130 million trying to launch its business in 18 countries and failed. Webvan spent about $1 billion trying to set up an online grocery business and failed.

Illusion of first mover’s advantage

Basing the business only on first mover’s advantage is just an illusion. The first mover’s advantage rarely works in isolation from other competitive advantages.

Many examples illustrate that the first to market is rarely the industry leader in the long run.

For example, Google was not the first search engine, but it now dominates the search market. Apple was not the first to market portable music players, but it leads the market.

  

No exit route

Investors will not put money into a start-up unless there is a way for them to get their money back within about five years.

But most start-ups are not suitable for an IPO, thus preventing investors' ability to sell their shares.

Low sales growth

Investors look for rapidly growing markets mainly because it is easier to obtain a share of a growing market than a mature or stagnant market. Smart

entrepreneurs will try to identify high-growth potential markets early.

Start-ups need to generate at least $30 million in sales within five years for most investors to consider investing. Only a small number of companies can achieve such sales growth.

Low return

The business opportunity must have a realistic chance of achieving a high return on capital – Internal Rate of Return of 40% per year is a good starting point. It may seem high, but it is commensurate with the risk – investors lose money on more than 45% of the deals and need to do very well on the ones which are successful to show an overall positive return. Very few new businesses have the potential for generating a 40 percent a year return.

Rather than searching for investment they are unlikely to get, entrepreneurs would be better off redesigning their business models so they can pursue their opportunities without outside investment. Once they have a proven business model that meet investors’ requirements, they can approach them for funding.

How to Raise Finance for Business from Private Investors

One of the biggest challenges that entrepreneurs face in starting, running and growing their businesses is finding suitable funds. Raising finance for a business venture requires determination, courage, preparation and focus. It is not for the faint-hearted!

There is no shortage of businesses wanting investment – just a shortage of good businesses. Most proposals are rejected by investors after the initial review. Only a small number – fewer than 3% of the proposals get funding.

You must clearly demonstrate to investors that investing in your business will give them a higher return than leaving their money in a bank account or investing in another business or shares.

You can increase the odds by knowing what investors are looking for and avoiding some of the pitfalls.

What do investors look for?

Investment criteria vary, but most investors will be looking for businesses which meet the following criteria:

A. The Team

Honesty

Plans and ideas do not get funding, people do. Therefore, honesty and integrity are vital factors in persuading investors to let you manage their money.

Personal qualities

The business world is full of people who are clever and conversant in current management concepts and fads. In short supply are people who are wise – people who are discerning, reflective and are less vulnerable to quick-fix remedies. Investors will back people who are focussed, pragmatic and wise.

Financial commitment

To attract investment, you need to invest your own money in your business. If you are not prepared to risk your own money, investors are unlikely to want to risk theirs. This should be new cash going in; the fact you have already invested thousands of dollars and hundreds of hours does not cut much ice with many investors.

Market knowledge

As the rate of change continues to accelerate, yesterday’s winning strategy may become today’s losing strategy. You need to know every intimate detail about your market, customers and competitors. You will need to be market focused, rather than product focused.

Business acumen

Investors want to make sure that you can actually run the business successfully, rather than just write a business plan about it or talk about it.

Investors look for entrepreneurs who are aware of the challenges they are facing and who do not seek to conceal them. On the contrary, they know what they are good at and they are looking for partners who can make up for their shortcomings and help them to overcome these challenges. This type of self-awareness and realism comes from years of experience and lessons learnt.

Economy

High salaries and perks for the directors and managers before the venture is profitable will send negative signals. Money should only be spent on the must-have things, not on the nice-to-have items. If the business is going to survive, the salaries should be paid by its customers, not by its investors.

B. The Business

High return

The business opportunity must have a realistic chance of achieving a high return on capital – Internal Rate of Return of 40% per year is a good starting point. It may seem high, but it is commensurate with the risk – investors lose money on more than 45% of the deals and need to do very well on the ones which are successful to show an overall positive return.

Realistic financial forecasts

You need to ensure that the financial forecasts are realistic and credible. Plucking numbers out of thin air will ensure that your proposal will be discarded by investors. For example, if your forecast shows sales increasing 100% per year, you had better have a convincing marketing strategy to back it up.

You must have detailed financial forecasts showing what could happen in the best possible case and a worst-case, if things do not go according to your plan (as they often do not).

High growth potential

Investors look for rapidly growing markets mainly because it is easier to obtain a share of a growing market than a mature or stagnant market. Smart entrepreneurs will try to identify high-growth potential markets early. 

Static, ‘lifestyle’ businesses (such as single restaurants or retail outlets) are of little interest to investors.

Intellectual property

Having a trademark, copyright or patent can be attractive to the investor, as long as it acts genuinely as a clear barrier to entry or secures a competitive advantage, rather than just being there for the sake of it.

Investment ready

The business must be investment-ready with a fully developed product or service.

Examine risks

You must address the critical risks and problems that the business may face. Investors will generally be aware of some of these risks, so failure to address them will undermine your credibility. Investors would rather back cautious optimists than reckless gamblers.

Exit route

After putting their money in, most investors want to get it back within five years, either through trade sale, sale to other shareholders, refinancing, or, rarely, flotation. You need to demonstrate a genuine intention and ability to provide such an exit.

What are the most common reasons investors reject proposals?

When investors read business plans, they are looking for reasons to love the business, but they are also looking for reasons to discard it. As soon as they spot a red flag – regardless of how good the rest of your plan is – your chance of getting them to invest will evaporate fast.

The following are the most common reasons for rejection:

• The management team lacks relevant experience.

• The management team lacks market awareness.

• The product/service has not gone through market validation.

• The financial forecasts are unrealistic and are based on too many 
   assumptions.

• The financial returns are inadequate.

• The amount of investment requested is too high and the equity offered 
   is too low.

• The business is too complex.

• The business is not scalable.

• The business has no clear exit strategy.

Most professional investors are capable of sorting “sheep” from “goats” – so presenting your business as one thing when it is another is a waste of everyone’s time. Do NOT try to separate unsuspecting investors from their money by hiding fatal flaws! In the end, the only one being fooled is you!

Investors need to believe and trust the people behind the business. Belief can be conveyed through the information provided in the business plan. Trust can only be established via meeting with investors. Thus the quality and credibility of the information in the business plan will help to open the door; the meeting will help to convince the investors that you can deliver the results.