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Why companies fail

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The statistics of company failures are deceptive if viewed from the aspect of declared insolvency (liquidation, both voluntary and involuntary); i.e. information that is available from Companies House. For the most recent full year – 2010/11, Companies House database shows an insolvency rate of just less than 1%. So if you’re looking at the probability of your venture ending in failure, 1% per year looks pretty good odds. However, most companies and certainly most micro and small/medium enterprises (MSME’s) don’t reach end of life through insolvency. Insolvency is a stark failure when creditors cannot be paid; in fact most enterprises wind up activities long before that point is reached. Looking at the next best measure of business failure therefore, those enterprises that just stop trading, the statistics are more disturbing. Right now, using this measure, failures are running at 22%, up from the average of the past few years, of 10%. Over 1 in 5 incorporated businesses stopped trading last year.
But what are the main causes of failure and what can be done, or looked out for, to minimise the risks of your business ending in failure. Through my career over the last couple of decades I have been employed by investment houses, banks, parent companies and investors to sort out, turn round, sell or wind up businesses, usually because they have run into trouble. I have observed a relatively small number of common causes of failure that often are so avoidable if they had been identified and corrected early enough. So here is my guide to why businesses fail. I can’t guarantee that being aware of these common causes will prevent you sleepwalking into the same pitfalls, but at least you will have the comfort of knowing I warned you.

1. People fall out.
Here’s a surprise, on a sample of one practitioner in business turn-round (me), I estimate that around 50% of Micro, Small, Medium enterprises MSME businesses fail due to the principals falling out – usually within the first 5 years. MSME are nearly always characterised by having an executive consisting of two or three people who came together to set up and incorporate a closed limited company. This is the most efficient way to run a company and the main reason that our economy is drive by MSME companies is that they are inherently faster to evolve, to respond to market changes and are driven by directors with enthusiastic entrepreneurial spirit. But, there are a lot of pressures during those early years and it becomes easy to get into blame and recriminations when problems occur. Problem is, if a management team  consists of two or three founder directors, there is no way to continue in the event of a fall out. And by gosh, how nasty some of these fall outs become in my experience.

• Choose you partners well and consider how people will work together under pressure.

• Remember that, with co-ownership/shareholding, a small business cannot realistically survive one partner walking away,

• Draw up proper agreements in advance and in particular a Company Handbook that all sign up to and that defines proper procedures for all company discipline issues. Detail things like expenses, leave allocation, sickness, pay differentials, bonuses, dividend policy etc. It may seem daft when your in the first flush of entrepreneurial spirit , but get all partners to agree and buy into a mutual agreement (I call it the Company Handbook) when everyone is getting on, it’s too late if relationships have already broken down.

2. Investors get fed up waiting and pull the plug.
Not so easy these days, but in the ‘good-old-days’ it was relatively easy to get finances from investment houses, banks and individuals. But a business venture would obtain finance based upon a plan – The Plan. Surprisingly in the ‘good old days’, venture capitalists et-al tended towards believing what they were told, what The Plan said. So as a result, failure to achieve pay-back terms etc. resulted in backers losing; first confidence, then heart then their cash (and we ended up with a banking crisis, but thereby hangs another blog!).
This then was the next highest cause of business failure – over optimistic plan coupled with under-achievement and loss of confidence by the backers; in the end resulting in withdrawal of financial support. As everyone is aware, it isn’t that easy to obtain origination finance these days but backers losing confidence in a business and pulling the financial plug, continues to be a very high cause of business failure.

• Don’t rely on external finance – venture funds, banks etc, unless there is no alternative. You may believe that perseverance will carry you through a period of poor returns, but your backers may not. And in the end, you are not in control of the situation.

• If you cannot launch the venture without external finances, set out a realistic, even pessimistic, plan with returns that you are sure will be achieved. When parachuted into a company, I have seen the most ludicrous plans which set out returns that, in hindsight, were completely unachievable – fooling both the backer and the originator.

• If you do proceed with external financial support, DO NOT submit to personal collateral or debt underwrite (your house for example). If you have to risk your house on a venture, be absolutely certain it will succeed. For every one successful business that obtained finance using personal collateral, ten lost the house (I’m guessing, but it is a lot).

3. There really isn’t a realistic market for your product.
Usually, having capacity problems, ie. struggling to service sales, is a great problem to have. You can deal with under-capacity. I loved sorting out companies that had a full order book but were experiencing servicing difficulties; there are things you can do about capacity. But the converse, lack of work, is often deep seated. It can mean that the market isn’t there for your product or you are unable to tap into it. Of course it may be due to failures in marketing skills etc. but very often failure to gain the sales expected is due to product choice; no market, not an attractive product proposition, market already saturated with competitors.

• Realistically assess the market, canvass, test, ask. A hobby or interest product may work well as a business venture and your enthusiasm for it will be a great start, but canvass as much objective assessment as you can. Is it a realistic business opportunity? Will people or businesses pay your required price for it? Eg. If your hobby is riding motorised tricycles, are you sure that there is a significant number of people who share your hobby – enough to build a business?

• Recognise that it is very unlikely (ok – not impossible) that you are the only person in the world to spot a unique market opportunity. If it is a fast growing start-up market – my current favourite, email marketing for example, recognise that you will be fighting plenty of other new entrants and your product needs to be better than theirs’. And in a start-up market, your product needs to evolve rapidly to keep ahead.

• Look for all means of reaching your market. The best way to target B to B sales in my experience is by email marketing.

4. The financial plan is unrealistic.
Achieving a return on investment – remuneration, dividends etc, is based upon the simple principle that sales revenue less cost of sales and indirect costs equals profit, equals cash (usually) and therefore equals remuneration and dividend income. After my three prime causes of failure above, the remaining one is that the costs associated with achieving sales were not properly accounted and that insufficient margin is achievable from the sales expectation.
Of course it is an issue of pricing, but business consultants will often quote the mantra – price is the given, cost of sales is the variable. A market will offer a peak selling point price with diminishing returns for higher prices (unless it a largely hostage market like cigarettes or petrol). If a product cannot be offered at the market price whilst maintaining a financially viable margin, you are a busy fool (marketing speak) and your business will fail due to insufficient return on sales.

• Calculate to the penny all direct costs – ie. costs directly arising from a sale, and all indirect costs – ie. static costs as a result of existing as a business; rent, rates, utilities, phones, insurance, equipment etc. Set out the Plan using as much detail of these costs as possible – it’s never detailed enough in my experience.

• Be realistic on sales volume (note 3 above!).

• Is the income at the bottom line sufficient for your needs to survive and thrive as a business – enough to live on or pay off backers.

The obverse of my crude statistic at the top (twenty percent fail) is that eighty percent succeed. So the odds are still in your favour and being part of a successful start-up is a great experience. It’s hard work, there will be many disasters along the way (nearly always on a Friday in my experience, don’t ask me why) and there will be times when things don’t look great but more often than not it will succeed and your business will join the numbers of MSME’s that are fuelling our economic recovery. (hopefully).

Email Blaster UK

Michael Peters BSc. FOR. is a director of Email Blaster UK and holds directorships with several large corporations. He is a well-known company turn round and start-up expert and has had a long career across manufacturing and IT sectors. His involvement in email marketing through Email Blaster UK is focused on the opportunities presented by this fast growing market and recognition that Email Blaster UK is rapidly establishing a prominent position in the UK and international email marketing sector. Also, having developed market leading software and infrastructure entirely in-house in the UK, Email Blaster UK has no reliance on licensed systems or support services from overseas suppliers.

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