Business failure is defined as the closing of a business that results in financial loss for at least one of the business's creditors. An associated term, business dissolution, refers to the formal termination or closure of a business as well, but with dissolution, financial loss (for the business owners or for the business's creditors) is not necessarily a part of the equation.
All entrepreneurs who decide to establish their own business face the possibility of failure, and a good deal of "popular wisdom" holds that failure is not only possible but probable for the small business owner seeking to launch his or her own enterprise (it has long been said that four out of five new businesses fail within five years of their establishment, for instance). But current studies indicate that such gloomy forecasts often present a false picture of entrepreneurial realities. Indeed, many business experts that the majority of small business owners are actually successful with their ventures. "Outright failures of small businesses are in fact remarkably rare," contended Nation's Business, "if failure is defined, reasonably enough, as a business closing that results in losses to creditors because the firm files for bankruptcy or because it simply closes its doors without paying its debts."
Business experts who study the gap between actual rates of business failure and the popular perception of those rates often blame it on a general misunderstanding of the nature of business dissolutions. "The confusion comes in mixing up business failures with business dissolutions," Nation's Business flatly stated. "Lots of small companies go out of business for reasons that probably shouldn't be called 'failure'—the owner may have gotten bored, for instance, may be disappointed with the returns, or may simply want to try a greener pasture. If an entrepreneur closes one business and starts another one that is more successful, that's more reason for celebration than concern." Bruce D. Phillips, a director with the Small Business Administration's office of economic research, even told Nation's Business that studies indicate that there may be four to eight times as many dissolutions as there are outright business failures.
Nonetheless, thousands of small business ventures do fail every year in America. "Companies stumble for many reasons," observed Clyton Christensen in Across the Board, "among them bureaucracy, arrogance, tired executive blood, poor planning, short-term investment horizons, inadequate skills and resources, and just plain bad luck." These factors—as well as myriad others—can have a debilitating impact on an operation, as many small business surveys will attest. Chief reasons for business failure cited within such surveys include the following:
POOR PLANNING Ultimately, many small businesses fail because of fundamental shortcomings in their business planning. Planning begins with finding the right business and is integral to every aspect of business operations, including selecting a site, deciding on financing, anticipating work force needs, budgeting, and managing company growth. Planning that is grounded in realistic expectations and accurate, current information is an invaluable asset. Conversely, planning that is based on hopes and hearsay can cripple or destroy even a good business idea in fairly short order.
POORLY CONCEIVED EXPANSION "Every business owner wants to grow his or her business, but expanding with no infrastructure in place makes a business ripe for failure," wrote Tonia Shakespeare in Black Enterprise. "You can incur tremendous losses when you expand outside your core market. Not only is the physical aspect of expansion costly but there are different buying habits in different geographical locations. If you venture into an area outside your home turf, you had better prepare by doing a lot of research."
CASH FLOW DIFFICULTIES Poor cash flow kills thousands of small businesses every year. "Most business owners don't realize how much money it takes to run a business," wrote Shakespeare. "Understand what it takes to get a revolving line of credit before you start your business. It's always easier to get money when you don't need it, so don't wait until you're desperate. Develop your business plan using conservative projections and don't be overly optimistic." Shakespeare warned that profitable, fast-growing businesses can also run into cash crunches that can ultimately lead to bankruptcy. "That's why ongoing cash-flow analysis—tracking the money coming in and going out of the business—is a must."
INABILITY TO REIN IN FLAWED BUSINESS STRATEGIES Some business owners simply refuse to admit when they are wrong. Many small businesses can recover from ill-conceived business initiatives if they are recognized and halted before too much damage is done. But all too often, business owners and managers stubbornly stick with strategies that are doomed to failure, rationalizing that the initiative will begin paying off next month or next quarter. And before they know it, their business is gone, dragged down by poor planning and inordinate pride. Writing in Management Today, Robert Heller characterized this tendency thusly: "Top management sets its sights on some grand but imperfectly conceived objective, launches an incompetent plan of action, pours in cash rather than control when the action misfires, and ignores all the adverse evidence until the disaster strikes."
DETERIORATION IN CUSTOMER BASE This can happen for any number of reasons, including poor service, high prices, and new competitors. Making improvements in products/services offered, marketing, inventory, customer service, and work force personnel can all do a great deal to halt deterioration in customer relations.
INATTENTION TO WARNING SIGNS Most small business failures do not come out of the blue. Certainly, business failures that result from catastrophic natural disasters or the sudden death of a key business member can not be anticipated, but most businesses expire as a result of more mundane factors. New customer complaints and surges in returns are often early warning signs of operational problems. Basic financial tools such as balance sheets and financial statements, meanwhile, can be very helpful tools in helping business owners diagnose what is ailing their company. The numbers contained in those documents often provide ample warning of poor cash-flow management, inventory problems, excessive debt, undercapitalization, or untrustworthy customers, but the business owner has to take the time to look (or take the time to hire an accountant to look) or the warning signs may go unheeded until it is too late.
Other reasons often given for small business failures include the following:
Inattentive and/or indecisive management
Bankruptcy is a legal proceeding, guided by federal law, designed to address situations wherein a debtor—either an individual or a business—has accumulated debts so great that the individual or business is unable to pay them off. It is designed to distribute those assets held by the debtor as equitably as possible among creditors. Bankruptcy proceedings may be initiated either by the debtor—a voluntary process—or by creditors—an involuntary process.
Chapter 7 Bankruptcy. Individuals are allowed to file for bankruptcy under either Chapter 7 or Chapter 13 law. Under Chapter 7 bankruptcy law, all of the debtor's assets—including any unincorporated businesses that he or she owns—are totally liquidated, and the assets are divided by a bankruptcy court among the individual's creditors.
Chapter 13 Bankruptcy. This is a less severe bankruptcy option for individuals. Under the laws of Chapter 13 bankruptcy, debtors turn over their finances to the court, which distributes funds and payment plans at its discretion.
Chapter 11 Bankruptcy . Chapter 11 bankruptcy law is designed to provide businesses with the opportunity to restructure their finances and debt obligations so that they can continue to operate. Companies usually turn to Chapter 11 protection after they are no longer able to pay their creditors, but in some instances, businesses have been known to act proactively in anticipation of future liabilities.
Business failure is usually a demoralizing event in a person's life because it impacts both professional and personal self-esteem. Indeed, many experts believe that the entrepreneur who experiences a business failure goes through many of the same stages as individuals who suffer from the loss of a friend or loved one—shock, denial, anger, depression, and acceptance. But observers are quick to point out that people who experience business failure can still go on to lead rewarding professional lives, either as part of another company or—down the line—in another entrepreneurial venture.
Many analysts believe that chances of subsequent success in the business world often hinge on the entrepreneur's activities in the first year or two after the failure has occurred. "[After a business failure,] you need a period of decompression to rethink and recharge," one executive told Entrepreneur. "People are too quick to rush into the next thing just to prove they can do it." Instead, victims of business failure are often urged to take the time to honestly examine the reasons for the failure, even as they return to the work world in their old capacity as employee. Was your marketing plan flawed? Did you underestimate the amount of time it would take to become profitable? Did your manufacturing processes compromise product quality? Was your family fully committed to supporting the endeavor? Did you pay enough attention to work force training issues? Small business consultants strongly encourage entrepreneurs to seek out the opinion of others—industry experts, area businesspeople, loan officers, investors, family members, etc.—when taking on this task, for their perspectives can be invaluable in helping you to establish a successful business on your next attempt.
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Christensen, Clayton M. "Why Great Companies Lose Their Way." Across the Board. October 1998.
Delaney, Kevin J. Strategic Bankruptcy: How Corporations and Creditors Use Chapter 11 to Their Advantage . University of California Press, 1992.
Heller, Robert. "Managements That Lost Control." Management Today. October 1995.
"The Most Dangerous Game?" Nation's Business. September 1995.
Schuchman, Matthew L., and Jerry S. White. The Art of the Turnaround: How to Rescue Your Troubled Business from Creditors, Predators, and Competitors. AMACOM, 1995.
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