Failure in small business comes in many forms, but the surprising bit can be when it comes more than the actual mechanics. Frequently the most serious money mistakes happen either right out of the gate or, perhaps more surprisingly, just after a period of initial success. Mistakes that happen during the startup phase tend to kill off the weak rather quickly, and aren’t really much of a surprise to anyone but the unfortunate business owner.
The really tragic mistakes are those that kill a small businesses that made it over the startup hump; those are just sad. These are entrepreneurs who got through the hard parts of research, planning, and drawing up a business plan. They put in the long days, and managed to cobble together enough business to get off the ground — only to stumble at the very time their workload should have been getting easier.
While survival statistics can vary widely by the type of business, according to the Small Business Administration seven out of ten new firms will make it two years, and between 36% and 51% will make it five years. Here are four of the major stumbling blocks.
Shifting Focus to the Top Line
When entrepreneurs first start out in a new business, the bottom line gets all the attention — things like making sure there’s enough cash to pay the bills next month and make payroll. The needs are immediate and the focus is short term. The danger comes in when next month, or even the next quarter, is no longer a problem. What tends to happen is the focus shifts from paying the bills to top line sales. Sometimes that means aiming for bigger jobs, or regular work at bigger companies. At a software company I co-owned, we nearly died because we accepted a prestigious contract with a Fortune 100 company. The pay scale was fantastic — but no one told me that the bigger companies are, the slower they pay their bills. That customer sometimes took nine months to pay an invoice. We added interest to the amounts due, but they would simply line through it and not pay it. We could then either sue our biggest customer or lump it.
Expanding Prematurely
Bigger is not always better. Just because a company is profitable at one size does not mean it will remain profitable if it scales. Expansion that depends upon a single anchor customer can be particularly problematic. What happens if that customer leaves? Every expansion plan should not only have the funds to cover the expansion, but enough to cover one-time charges to curtail the operation if the bottom falls out.
Owner Equity
It’s tempting for owners of profitable companies to start stuffing cash in a 401(k) or siphoning off cash for the owners. Resist the temptation. Other than cash reserves, that money should be going back into the company. I saw one family business, a small local grocery store, go out of business because the owner’s family treated the business like a personal ATM. The store was profitable, but not enough to support his wife and kids pulling personal cash out of the till on a daily basis. The owner actually tried to replace the family with hired help — but it was too late to save the business.
Inappropriate Austerity
This advice usually comes from a well meaning business adviser, and might be appropriate for a more mature businesses — but most startups haven’t been in business long enough to build up that much in the way of unnecessary expenses and overhead. Slashing expenses willy-nilly can have disastrous consequences. These days it’s become almost counter-intuitive to suggest that if you want growth, you have to make investments to facilitate that growth. Companies cut expenses when they want to expand revenue without regard for the future. Mature companies can get away with it; small companies are less able to absorb cutbacks in personnel or resources. Cuts at a small company will make impacts on customer service and product quality that will almost immediately translate to the bottom line.
Basically the danger zone in small business is at that clumsy nexus between being a small company and being a big one. Company owners lose that successful small business perspective, and start acting like they’re a company with fat cash reserves. It’s easy to slack off on the research and planning that made them successful, and start shooting from the hip. Since most business plans don’t cover more than the first three years of operation, it’s not a surprise that’s when small companies start running into trouble.