Why Do Businesses Fail and How to Prevent It

It’s a sobering truth for every budding entrepreneur: the majority of businesses don’t make it past the first five years. Statistics from the Small Business Administration (SBA) indicate that approximately one-third of small businesses fail within their initial two years. Additionally, around half of them cease operations within five years, while roughly another third of businesses survive for a decade. Merely a quarter of newly established businesses make it to 15 years. In fact, I’ve seen some studies that cite the success rate is even lower.

These statistics may seem daunting, but they aren’t meant to discourage you. Instead, they’re a reminder that success in business doesn’t come easy—it requires grit, innovation, and, perhaps most importantly, an understanding of why many businesses fall short.

Let’s dive into some common pitfalls and major reasons new businesses fail and explore how you can avoid them to ensure your new venture is among those that flourish.

12 Key Factors Why Businesses Fail

There can be many contributors to the demise of a business. However, I believe that all of the factors I’ll address below ultimately lead to one common denominator.

Ultimately, the primary reason for business failure is: BURNOUT.

That is, it’s not that the factors below are insurmountable. In fact, most intelligent entrepreneurs are capable of working past any one of these challenges. The real culprit is the combination of these factors, combined with myriad other operational headaches compound.

So let’s break down these growth constraints, then address how you can overcome or prevent them, while keeping your sanity in tact.

1. Financing Hurdles

Securing sufficient funding is a critical hurdle for many businesses that are either early stage, or in seasons of rapid expansion. Entrepreneurs often underestimate the amount of capital needed to start or grow a business, which can lead to financial distress and, in worst-case scenarios, failure. A study by US Bank found that 82% of businesses that fail do so because of cash flow problems.

Also down the road, the precarious balance of cash flow can be disrupted by various factors such as unexpected expenses, poor sales, late invoice payments, or overinvestment in inventory, quickly leading a thriving business into a whirlpool of financial crisis.

Keep in mind that growth sucks cash, so while your top line might suggest that business is booming, it’s possible to grow yourself out of business.

2. Ineffective Business Planning

A well-structured business plan is like a compass that guides your business decisions, enabling you to navigate the challenging landscape of entrepreneurship. Despite its crucial role, many businesses overlook the importance of effective planning which often leads to missteps and failure. Worse, they waste time and money on creating (or buying) a useless plan full of unsubstantiated theory and fluff.

A study by CB Insights revealed that 42% of small businesses fail due to a lack of market need for their products and services, a pitfall that could have been avoided with thorough market research during the planning stages. Ineffective planning also leads to poor resource management, unrealistic goal setting, and missed opportunities.

3. Ignoring Customer Needs

Ignoring customer needs is a fatal mistake that can derail even the most promising business. No matter how innovative your product or service may be, if it doesn’t address the needs or desires of your target audience, it is unlikely to gain traction in the market.

While most businesses will tell you they take pride in offering top notch customer service, the reality that is often a delusion, because they are out of touch with the customer’s true wants, needs and experiences. In fact, a survey conducted by ‘Right Now Technologies’ showed that around 89% of customers stopped doing business with a company after experiencing poor customer service.

Moreover, in an era where online reviews and social media feedback are instantly visible and widely influential, ignoring or misinterpreting customer needs can lead to devastating public criticism, denting your reputation, and discouraging potential customer base growth.

4. Inadequate Management

Studies suggest that 30% of failures in business can be attributed to poor management, and personally, I would propose that the number is actually much higher, as poor management is to blame for many of these other factors. This includes ineffective delegation, a lack of clear direction, weak communication, poor financial management, and an inability to adapt to change.

Without skilled leadership steering the ship, companies may lose focus, make ill-advised decisions, and struggle to respond effectively to market changes or operational challenges.

5. Ineffective Marketing

Regardless of the quality of your product or service, without strategic and effective marketing, it’s unlikely that your business will be able to gain the visibility and traction it needs to succeed. The digital age has made marketing more complex, yet also more crucial than ever.

Companies need to stand out in an overcrowded market, and this requires a clear understanding of your target audience, a unique selling proposition, and a well-executed marketing strategy. A poorly planned marketing approach doesn’t just lead to wasted resources; it can also fail to connect with potential customers, leading to wasted investment, lost sales opportunities and reduced growth potential.

strategic and effective marketing

6. Unsustainable Growth

Business growth is undeniably a marker of success. However, when this growth is uncontrolled or too rapid, it can quickly become a liability leading to business failure. This phenomenon, often referred to as “growing broke,” can stretch a company’s resources to breaking point, resulting in severe operational and financial challenges.

A study by Startup Genome found that 70% of startups ramp up their operations too quickly, contributing to a significant number of failed business ventures. Overly rapid expansion can lead to cash flow issues as businesses struggle to finance their increased operational costs. It can also result in a drop in the quality of products or services as businesses scramble to meet increased demand. Also, a rapid increase in workload can put excessive pressure on staff, potentially leading to burnout and high turnover rates. Couple this with overly optimistic sales projections, and it’s quick path to growing right out of business.

7. Lack of Innovation

As a PwC survey revealed, 54% of executives believe that their company struggles to align innovation strategy with business strategy, leading to disjointed efforts and missed opportunities. This is reminiscent of Blockbuster’s failure to adapt to the digital age, which paved the way for innovative companies like Netflix to dominate the market.

Innovation is not just about developing new products, but also about innovating your processes, improving efficiency, and finding new ways to engage with customers. Businesses that foster a culture of innovation are more likely to stay competitive, meet changing customer needs, and ensure their long-term survival in the market.

8. Lack of Passion

Lack of passion is another critical factor that contributes to business failure. Running a business is not just about figuring out how to turn a profit; it’s about having a burning passion for what you do. Passion is the fuel that drives entrepreneurs to overcome obstacles, work long hours, and persist in the face of adversity. Without passion, the motivation to keep going can quickly dwindle, especially during tough times – leading to burnout, as mentioned above.

9. Wrong Mindset

A mindset is the set of beliefs or attitudes that shape how we perceive the world and our place within it. A friend once defined mindst as “mind is set” or “mind is stuck.”  Unfortunately, many entrepreneurs harbor negative or limiting beliefs that can stifle their potential for success, and their mind is stuck in this mode of thinking.

One common example is the fear of failure, which can prevent business owners from taking necessary risks or pursuing innovative ideas. This fear can be paralyzing, leading to stagnation and a lack of progress, or even self sabotage. Other detrimental mindsets include an inability to adapt to change, a reluctance to delegate or trust others, and a resistance to feedback and continuous learning.

10. Not Understanding your X Factor

Understanding your ‘X factor’ – that unique selling proposition (USP) that sets your business apart – is crucial for entrepreneurial success. Sadly, a majority of businesses do not know what makes their business unique… or what they think makes them unique (i.e.. “we offer great service!”)… isn’t actually unique at all.

Without a clear understanding of their X factor, businesses struggle to differentiate themselves in a saturated market, often finding it challenging to attract and retain customers.

11. Competitor Success

Competitor success can contribute to the failure of a business, especially if that business fails to keep pace with changes and advancements in the industry. Every successful stride that a competitor makes in terms of innovation, market expansion, or customer satisfaction is a potential threat to businesses that are unable to match or exceed those strides.

According to a study by CB Insights, 19% of businesses fail because of fierce competition. In the face of a competitive market, businesses that fail to differentiate themselves, innovate, or adapt to changes often find themselves losing customers to competitors who offer better products, services, or prices. Companies like Kodak and Nokia, for instance, were ousted from their market-leading positions due to their inability to compete with more innovative rivals.

12. Unwillingness to Learn, Adapt or Diversify

Businesses need to be in a constant state of learning, adapting, and diversifying to stay relevant and competitive. However, some entrepreneurs resist change, sticking to what they know and disregarding market trends and customer needs. They may also forego opportunities to diversify their products or services, fearing the risk associated with stepping into the unknown. But this resistance can limit growth and pave the way for failure.

According to a report by McKinsey, companies that are unable to adapt to changes are twice as likely to fail as their more agile counterparts. Similarly, businesses that fail to diversify their offerings risk losing customers to competitors that offer a broader range of products or services. Examples abound in the corporate world, with companies like Blockbuster and BlackBerry failing because they were too slow to adapt and diversify.

learning, adapting, and diversifying

What Are the Signs That Your Business Is Failing?

Recognizing these signs early on can give you a chance to make necessary changes and potentially turn the tide before it’s too late. Remember, it’s essential to keep an open mind, acknowledge mistakes, and be willing to adapt.

Declining Sales

One of the most apparent signs that a business might be failing is a consistent decline in sales. If your revenue has been decreasing over a period of time, or stagnant despite market growth, this is a clear indicator that something is wrong. It could be a result of diminishing demand, poor customer satisfaction, or increased competition.

Frequent Customer Complaints

A surge in customer complaints is also a red flag for your business. If your customers are continuously expressing dissatisfaction with your products, services, or customer experience, it’s a sign that your business may be in trouble.

These complaints can range from quality issues, poor service, lack of responsiveness, or even pricing concerns. As per a report by American Express, one unhappy customer can potentially deter up to 16 potential customers, so take customer grievances seriously, or risk them using their virtual megaphone to deter other would-be buyers.

High Employee Turnover

High employee turnover is another telltale sign of a failing business. If your employees are leaving frequently, it could indicate a toxic work environment, lack of growth opportunities, or dissatisfaction with management.

High turnover can significantly impact service quality, customer satisfaction, and overall productivity. Topgrading reports that replacing an employee costs between 5 and 25 times their annual salary.

Difficulty Paying Bills

If you’re having trouble meeting financial obligations, such as paying bills or salaries on time, your business is on rocky ground. This can be a result of cash flow issues, high debts, or poor financial management.

Don’t bury your head in the sand. Dig in and understand your financial statements so you can see where the money is going, and put a plan in place to make sure the business’s most important resources are taken care of.

Loss of Key Customers

Losing key customers can be a devastating sign for your business. These are the customers who bring in a significant portion of your revenue. According to a study by Bain & Company, a 5% increase in customer retention can lead to a 25% to 95% increase in profits. Contrarily, if they start to leave, it can seriously impact your financial stability.

There’s a general rule of thumb that says that the top 20% of your customers produce 80% of your profits. However, be careful not to allow any single customer to represent too large of a percentage of your revenue, as overreliance on one or two key accounts will put your company at risk.

successful business requires proactive planning

How to Prevent Business Failure

Building a successful business requires proactive planning, efficient execution, and continuous learning. Here are some strategies that you can implement to avoid common mistakes and keep your business healthy:

Build a Robust Business Plan

Creating a robust business plan lays a strong foundation for business success. It should outline your business goals, target market, marketing strategies, financial projections, and growth plans. It has been proven over and over again that businesses with a plan are more likely to grow than those without one. But remember that planning is ongoing.

While you might have goals and strategies that extend months or years out, the most efficient way to do execution planning is in 90 day sprints. This ensures you’re always moving forward on your long-term goals, and gives you the opportunity to regularly reevaluate and course correct if necessary.

Regularly Review and Analyze Financial Statements

Frequent reviews of your financial statements allow you to track your cash flow, profits, and expenses. It helps you identify financial issues early on and respond effectively. Statistics have shown that 79% of small businesses with successful fiscal management practices consistently review their financial statements.

If you need help, find a CPA and/or business coach that can help you interpret that data and learn to use it to make sound business decisions.

Embrace Innovation

Keeping up with industry trends and embracing innovative solutions can help businesses stay competitive. This could involve investing in new technologies, exploring new markets, developing new products or services, or staying on top of the latest trends in software or digital marketing.

Focus on Customer Satisfaction

The fact that 61% of consumers have switched brands due to poor service highlights the importance of prioritizing customer satisfaction. In today’s competitive landscape, providing high-quality products or services isn’t enough.

A thriving business pays close attention to every step of the customer journey – from the first interaction all the way through to billing and collections, or responding to complaints. Assess every customer interaction point and brainstorm with your team on how you can improve the customer experience at every step.

Invest in Employee Development

Great employees stay at companies that are willing to invest in their learning and development, and where they can see a path to career growth.

The only thing worse than training your employees and having them leave is not training them and having them stay.  — Henry Ford

Investing in employee development not only ensures you have a skilled and motivated workforce, but it increases the likelihood of long-term retention – both of which provide a huge competitive advantage.


Why do new businesses fail in the first couple of years?

One of the most common reasons why businesses fail is a lack of planning. Without a well-structured business plan, businesses can struggle to maintain a strategic focus, resulting in wasteful spending, weak financial strategies, and poorly guided decisions. Additionally, many new businesses underestimate the financial requirements and end up undercapitalized. This lack of funding can force them to close down when they face unexpected expenses or when revenue generation is slower than expected.

Market research is another aspect that many new small business owners neglect. Insufficient understanding of their target market, competition, and customer needs can lead to ineffective marketing and sales strategies. According to CB Insights, 42% of startups fail because they do not address a market need.

Lastly, issues such as poor customer service, low-quality products or services, and inadequate management skills are also common reasons small businesses fail. These factors can result in unsatisfied customers, high employee turnover, and ultimately, business failure. Hence, proper planning, sufficient capital, solid market research, and excellent customer service are critical for the survival and success of new businesses.

Why do 80% of businesses fail?

The failure of 80% of businesses can be attributed to a variety of factors, and is most likely a combination of factors. Inadequate business model and solid financial management are the primary contributors. Businesses often struggle to maintain cash flow and manage debt, because they overestimate revenue projections and underestimate expenses.

Poor market understanding and ineffective (or absent) marketing also play a role. A lack of a robust business plan, poor customer service, and high employee turnover further contribute to business failure. Investing in employee development and creating a positive work environment is crucial for success.

How do financial problems lead to the failure of businesses?

Growth takes cash – whether it’s a new business, or an existing business on the rise. Inadequate cash flow can severely hamper a business’s ability to cover day-to-day operating costs, even if the business has access to credit. This can result in operational issues, the business might be forced to make deep cuts to payroll and other critical resources, and ultimately, when the business runs out of cash, it will cease to survive.

Second, high levels of debt can cripple a business. The interest payments on the debt can consume a significant portion of the business’s income, leaving little for growth or investment. Furthermore, businesses with high debt levels are also more vulnerable to changes in market conditions, such as interest rate hikes, changes to credit terms, or economic downturns.

Lastly, without a clear understanding of their financial position, business leaders are basically flying blind. Making strategic or financial decisions based on estimates or gut feel leads to poor decisions, such as overspending or underinvesting, which can jeopardize long-term sustainability.

Why do businesses fail to retain customers or clients?

Businesses can struggle to retain customers due to subpar service, failure to understand evolving needs, low product/service quality, and weak communication. To ensure successful customer retention, it is crucial to focus on designing a positive customer experience at every interaction, understand their true wants and needs, deliver high-quality products, and be clear and proactive with communication.