By Paul Morin
Small businesses, even those that appear promising at the start, have an unnerving failure rate. Here I’ll discuss three common small business killers, and what to do about them. In my extensive time in entrepreneurship, I’ve experienced and seen them all, in my own businesses and those of my clients. The good news is that if you are aware of these issues and keep vigilant watch, you can spot them early and often prevent them from killing your business.
Common Small Business Killer #1: Insufficient Funding
I guess this one should come as no surprise. Most businesses are started on a “shoestring budget” and tend to stay that way through most of their lives. While this may be unavoidable for some who are starting a business, for others, it is simply an issue of not understanding the likely capital requirements of the business and planning accordingly.
Solution: Perform a break-even analysis before you start your business, so you can get a basic understanding of the sales volume you will need to break even. This will, of course, involve making many assumptions and it will never be perfect; however, it will at least give you a target and a basis for understanding where you need to take the business. It will also help guide you as you put together your pro-forma financials, including a cash flow projection, which will help you understand when the business is expected to start generating, rather than burning cash.
Realize that if you make your projections too “rosy,” you are likely to miss them and run into cash flow problems. Project conservatively and leave yourself a buffer for projection error. Finally, make sure you understand the potential sources of capital available and stay ahead of your capital requirements, so you’re not in a compromised position, trying to raise cash in an emergency.
Common Small Business Killer #2: Weak Profit Margins
Some businesses have inherently weak profit margins, due to a variety of factors, but usually because of intense competition and the pricing power of key suppliers. If you know from the get-go that you are entering a business with weak margins and little hope of improvement in that area, you’re either crazy, don’t realize this issue, or have some other ulterior motive.
Solution: Before you enter any business, make sure you have a very good understanding of the profit margins of the business. In particular, you should look for gross margins of sixty percent or better. I will agree with you that such businesses are not easy to find, but as one of my first mentors told me, when you have gross margins of sixty percent or better, you can make a lot of mistakes in the remainder of your business and still survive to fight another day.
Make sure that, as you are putting together the pro-forma financials for your venture, you are very realistic regarding the direct costs you will have in producing your products and/or delivering your services. Any unrealistic assumptions regarding these costs will give you an inaccurate picture of the likely gross margins you will enjoy in your business and make your pro-forma financial projections misleading and dangerous. Likewise, be very realistic about how you will be able to price your offering, as this will be the other determinant of the gross margins you will be looking at. Finally, be realistic about how these direct costs and pricing power are likely to change over time, given the competitive forces and other market trends you see at work in your industry.
Common Small Business Killer #3: Unskilled Management
The unskilled (or under-skilled) management issue occurs quite a bit. Two scenarios where this issue is particularly common are:
1. a person comes out of a larger corporate environment with a very specific skillset and decides to become an entrepreneur; and
2. a family business employs its family members in key management and leadership positions, regardless of the fact that they don’t have the experience or the skills to do the job well.
There are many other situations where entrepreneurs do not have the proper skills to run the business they have chosen, but these are two of the most common.
Solution: When you are starting a business, or even if you already have it up and running, take a close look at the types of skills that will be necessary to run and grow the business effectively. If you are not sure what it takes to be great at your endeavor, take a look around at those who are already succeeding in the same or similar businesses. Take a close look at the core skills and knowledge they employ to allow them to do well in that business. In some businesses, the most important competency is financial acumen, in others it’s operational knowledge, in most all, it’s marketing and sales capabilities.
Make an honest assessment. Where you see gaps in your knowledge and capabilities, partner with or hire others to fill those gaps. Remember when you’re doing this assessment that, regardless of how talented you may be, it will be very hard for you to have the time, energy and capabilities to do all tasks well. Be sure you have the most critical ones covered and seek assistance everywhere else.
It’s important to understand that these are just three of many potential “small business killers,” but start with making sure you have these three under control and we’ll cover some others in the future.
I look forward to your thoughts, comments and questions. Leave a comment below!
Paul Morin is the founder of CompanyFounder.com. Morin has worked with various entrepreneurial companies in senior management roles and has led the development, review and selective implementation of several hundred start-up and corporate venture business plans, financial models, and feasibility analyses. You can e-mail Morin at firstname.lastname@example.org.
Originally published: Sep 9, 2011