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Why do Companies Collapse?

Jul 13 2012, 20:44   |   By SME Mentor

Its only when we know the reasons can we prevent the pitfalls

Entrepreneurs are an optimistic lot.  They are positive, energetic and believe that their product, service or innovation will be successful, change the world and make them rich!! So the last thing an entrepreneur wants to focus on is failure! 

One of the least understood aspects of entrepreneurship is why businesses fail, and there's a simple reason for the confusion: Most of the evidence comes from the entrepreneurs themselves.  In spite of success stories that you hear and read, only a small number of businesses become truly successful.  For every Airtel or Infosys, there are several that failed or just survived and did okay.

Businesses often fail because founders and investors neglect to look before they leap, surging forward with plans without taking the time to realize that the base assumption of the business plan is wrong. They believe they can predict the future, rather than try to create a future with their customers. Entrepreneurs tend to be single-minded with their strategies - wanting the venture to be all about the product or service or all about the sales, without taking time to form a balanced plan.

I have had a close-up view of a few business failures-including my own, and several ventures in which I have invested. And from my observation, the reasons for failure cited by the owners are frequently off point, which kind of makes sense when you think about it. If the owners really knew what they were doing wrong, they might have been able to fix the problem. What follows, based on my own experiences and observations, are the top reasons businesses fail.  Some are obvious, and some may surprise you.

Poor Management: Many a report on business failures cites poor management as the number one reason for failure. Entrepreneurs frequently lack relevant business and management expertise in areas such as finance, marketing & sales and hiring and managing employees. Unless they recognize what they don't do well, and seek help, business owners will soon face disaster. A good entrepreneur knows the gaps in his team and moves quickly to fill those gaps.   

No Planning: Planning forces an entrepreneur to think through, analyze and look before leaping, and making sure that market conditions, customer data and base assumptions are reviewed and finetuned.  Proper planning ensures that businesses can adapt to changing customer demands and the environment.  Unless the entrepreneur reviews and updates his plan on regular basis, he is setting himself to fail.  At the same time, it is important to realize that just planning will not yield success too.  And all too often, they do not give themselves wiggle room to pivot midstream if the initial idea doesn't jibe with customer demand.  Execution & flexibility is absolutely important!

Undefined Target Market & Demand: Many entrepreneurs seem to fall in love with their product/creation. The feeling of having created something overwhelms their sensibilities. They forget that for commercial success, every product or service, no matter how great, needs a target market. Similarly, some entrepreneurs launch businesses without defining what constitutes their core/target market.  The math just doesn't work. There is not enough demand for the product or service at a price that will make it viable and sustainable.  This, for example, would include a start-up trying to compete against Infosys and its economies of scale.  Timing is also important - it determines demand, funding and the ability to scale up and grow. 

Not being persistent: I have seen several businesses fail because the entrepreneur and team are not persistent and do not keep trying.  They give up easily.  The biggest of brands and the successful entrepreneurs faced failure during their initial days. So, what makes you different? Why do you need a guarantee that losses will never come knocking on your door? The learning curve is essentially the same for everybody. Entrepreneurs who aren't ready for the drill shouldn't consider themselves as long-term players. "No Pain, No Gain" isn't just a gymming quote fad; it is a truth about life, including running a business.

Failure to Sell/Market: Another key factor for failure is the failure to understand the importance of marketing and selling.  Do not be focused on trying to build the best mousetrap alone; focus on selling and getting customer feedback that will help you build an effective mousetrap faster and in line with customer expectations.  Entrepreneurs need to understand that selling is an absolutely key factor that separates the successful from the mediocre.  If you are not good at salesman, make sure that one of your first hires is a good salesperson.  Having created a great product doesn't guarantee success to anybody. You need to market it and make investors and consumers realize its uniqueness. Many entrepreneurs tend to sit back, smugly confident that the "greatness" of their idea will magnetize investors and sales.

People Issues: One of the most common reasons for business failure is team and people issues.  What kind of team; do my employees share my vision and understand the company, its products and its business plan.  Do members of the management team have complementary skills and can work in a team environment?  I have seen companies where the founders/promoters to have similar backgrounds and experience, and this leaves holes in important places.   

Unplanned /Aggressive growth. This one might be the saddest of all reasons for failure - a successful business that is ruined by too aggressive or unplanned expansion. This would include moving into markets that are not as profitable, experiencing growing pains that damage the business, or borrowing too much money in an attempt to keep growth at a particular rate. Sustainable growth should be the mantra.  This is hard, considering the fact that growing a profitable organization and dreaming of becoming the next Ambani or Birla is the dream of every entrepreneur.

Poor Financial Management:  You cannot be in control of a business if you don't know what is going on. With bad numbers, or no numbers, a company is flying blind, and it happens all of the time. Why? For one thing, it is a common - and disastrous - misconception that an outside accounting firm hired primarily to do the taxes will keep watch over the business. In reality, that is the job of the chief financial officer, one of the many hats an entrepreneur has to wear until a real one is hired.  Good entrepreneurs understand the importance of numbers and are disciplined to manage and run their organizations by paying very close attention to financials. 

Lack of a cash cushion. Entrepreneurs need to understand and remember that business is cyclical and that bad things can and will happen over time - the loss of an important customer, changes in regulation, competition, or aggressive expansion. These things can all stress the finances of a company.  A common fatal mistake for many failed businesses is having insufficient operating capital.  It is imperative to ascertain how much money your business will require.  Your CA/Advisor can help ascertain total capital requirement, at least till the business gets going and can support costs.  Remember, Cash is King! 

Operational Mediocrity & Inefficiencies: Every start-up needs to go through a phase of financial crunches, breaking-even and entering profitability. Unless an entrepreneur is backed by daddy's unending money resources, it doesn't make sense to operate in a lavish manner. Recruiting staff beyond the immediate requirement and allowing overheads exceed the initial estimate starts eating into financial stability.

When it comes to the success of any new business, you - the business owner - are ultimately the "secret" to your success. For many successful business owners, failure was never an option. Armed with drive, determination, and a positive mindset, these individuals view any setback as only an opportunity to learn and grow. Most self-made millionaires possess average intelligence. What sets them apart is their openness to new knowledge and their willingness to learn from their mistakes and move ahead.

If your business does fail, and you realize that you were early to market, or customer preferences have changed, and it is time to move one, do so with grace and humility.  Savvy entrepreneurs know that running a company that eventually fails can actually help a career. Even failed businesses yield future networking opportunities and can throw open opportunities to start something new or get into a job that leverages your experience and expertise.  There are several venture funds and companies that often seek out the founders and CEOs of failed companies to be on their Board because they value experience over a clean slate. After all, Henry Ford, Steve Jobs, Soichiro Honda and Bill Gates experienced multiple failures before achieving success.

 

Vinod Keni is the CFO of Aavishkaar Venture Management, an early stage venture fund.  He is also the founder/Chairman of Aquarian Group & Peachtree Capital Partners.  He is a mentor to several early and growth stage companies, an active angel investor and member of the Indian Angel Network.  As an entrepreneur, he has started and exited from companies in technology, services, retail and manufacturing.  As finance professional, he has worked with companies, including E&Y, Intel, Harvard Pilgrim, VerticalOne, HeadHunter and TDW.    


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