The topic of this post is close to my heart as I have seen my close family members struggle with their businesses, be it my dad who ran an electrical equipment manufacturing company, or my uncle in Dubai who runs a power electronics company or my first cousin who runs an exotic boutique clothing store in New Jersey.

A lot of family members and close friends have struggled to take their business off the ground. Some of them have been unsuccessful initially and have tried multiple times before reaching success.

This is a deep dive into nuances across business sectors on why those businesses fail

I want to go beyond the cliche reasons like not having a business plan or not having the right team etc. to dissect this so that folks who aspire to start a business successfully in any sector or industry will find useful and actionable information here.

A small video illustrates these nuances before you go further

Not being able to fund the day to day operations of the business with cash that the business generates is the single biggest cause of failure for small businesses with more than 63% of small business owners attributing their failure to this.

Navin Krishnan, after having worked with more than 800 small businesses

In order to get deeper into this and really understand why this is such a big issue, I connected with 7 small business owners, some family and some friends along with a couple of business owners I had a professional relationship with during my corporate career.

All of these business owners have experienced failure at multiple points in their entrepreneurship journey and have shared the following insights with me that will be relevant for aspiring business owners and current business owners.

These business owners have started up at least two businesses and a couple of them are currently running more than 4 businesses each

So what did I learn from them?

Top 3 reasons why most small businesses fail are related to the business owner’s lack of understanding of their own business nuances

To explain further, they are 

Not successfully managing cash generation from the business to pay operational expenses is the number one cause why business owners had to close down

This was the biggest factor that all the business owners unanimously agreed on as the cause for small business failure. 4 out of 7 of all business owners said that this was the number one cause and 2 out of 7 of business owners said that this was the number two cause. 

If you want to read about how a small business can keep growing, you can refer my article here on 11 things that small business owners need to do to continue to grow their business.

In effect all business owners placed this either as the number one or number two cause of business failure.

A business that cannot generate sufficient cash to take care of recurring expenses will inevitably fail even if it received a huge funding boost to start off with. To achieve this, a business owner will need to do the following

• Have a minimum viable market of paying customers
• Be frugal till the business can build a safety net of emergency cash
• Build an engine to acquire customers organically at a low cost

Business owners not knowing the levers available to them to make key decisions

Of the business owners I spoke to, 5 out of 7 agreed that this was the number two cause why they failed in the past attempts to build a business.

When a business owner does not know what metrics he should be tracking regularly he also does not know what should be tweaked to course correct. Many business owners also don’t have an idea of how fast their business should grow to ensure that it succeeds.

You can look at this article that recommends sector specific growth rates for small businesses.

A friend who found success the third time he began a retailing business said that “Inventory turns” was his key metric for success. He could tweak his inventory mix to speed up or slow down sales based on the season to maintain it at a level that provided him free cash to manage expenses.

Business owners should do the following

• Identify the one key metric that drives the ability to manage recurring expenses
• Look at levers that can help maintain that metric at the desired level
• Track that metric day-in and day-out to make sure the business is on track

Spending too much money before the business model proves itself

This was something that all business owners agreed upon, but they ranked it third overall among the top reasons we discussed.

All business owners, in the multiple attempts, discovered that a successful business is something that shows early signs of success even in a scrappy state.

All businesses that they built and have been running successfully had something in common, which was that the business owners were extremely frugal till they could build a reliable revenue stream before they even hired a second person.

In my uncle’s business, he started small as a power electronics installation engineer, he was a technical expert so in the initial days, when he migrated from India to Dubai, he took up smaller contracts where he could net a 50% or more margin on the value of the contract.

He would do the installation himself, usually working out in the Dubai hot sun and getting his own hands dirty.

He did this for a period of 2 years till he saved up around $800,000. It was at this time he hired his first employee and then started to work on larger contracts.

Almost all successes that I have seen started and scaled this way. Start small. Prove the model. Scale by reinvesting the profits.

This section takes a look at small business failure across industry sectors

What are the failure rates of small businesses across sectors?

After I learned about the top three reasons why small businesses fail, I did a little bit of research and spoke to some more business owners from those specific industries to understand the failure rates of small businesses across sectors.

I also read a couple of research reports on small business failure and dug into the data on business closures over the last five years.

Here is what I found, the following table captures the various sectors where small businesses make up a significant portion of the economy. The Average failure rate refers to how many small businesses fail within 3 years and 5 years of starting up.

For the share of small businesses in each sector, I have considered businesses with less than 20 employees, and where each business sector contributes to more than 0.2% of the overall pie. I have grouped similar sectors to give an overall view.

In the table below, retail trade for example, combines shops, gas stations, retail stores, boutique stores and similar mom & pop establishments under the same umbrella for ease of analysis.

Business Sector for small businesses	Share of small businesses (how big is each sector as a percentage of the total pie?)	Average Failure rate within 3 years	Average Failure rate within 5 years
Retail Trade (combines multiple sectors)	5.7%	27%	51%
Rental real-estate (housing and commercial)	5.0%	7%	17%
Transportation and warehousing Services	3.8%	44%	93%
Construction and allied services	4.3%	26%	47%
Restaurants, Cafes, Bars and Pubs	4.1%	67%	89%
Financial services	4.5%	23%	37%
Medical and healthcare services	5.50%	35%	78%
Software products & SaaS related businesses	4.30%	83%	96%
Manufacturing	3.20%	27%	61%
All other technical, professional and personal services related businesses	22.50%	29%	45%

Why do all these sectors have such a high failure rate?

After compiling the data points for the failure rates of each of these businesses, I spoke to individual small business owners from each of these sectors to further understand the key insights for each sector.

What is the key reason for failure of retail businesses?

The number one reason why a retail business fails is because of too much money gets blocked in inventory, that does not get sold in time to pay for expenses. 

On average, small retail businesses should earn at least $85 per sqft per month to be in business. They would need to sell their total inventory at least 1.5 times to 2 times per month to ensure enough cashflows.

What are the key reasons for the failure of transportation and warehousing businesses?

The number one reason for failure of logistics and warehousing business is due to poor utilization of assets. Trucks and warehouses should have an asset utilization greater than 70% to be profitable

In a transportation business, if trucks travel empty or are down due to repairs, they drag the profitability down.

What is the key reason for the failure of a construction business?

The single biggest reason for failure of construction business is taking on too many projects at the same time, leading to delays in project completion and subsequently delays in getting paid which turns the business cash flow negative.

What are the key reasons for the failure of restaurant businesses?

Most restaurant businesses fail primarily because of two reasons

• Not having a sound understanding of the Cost per dish versus the revenue earned from serving the dish. Restaurants need to make at least 2X to 2.5X the cost per dish while selling it.
• Not having enough occupancy on average during the day to cover for the running expenses. The average Revenue Per Seat Hour should be at least $8.5 for restaurants in casual dining space to remain viable.

The cost per dish usually covers the cost of ingredients, the time value of money spent in preparing the dish, the time value of the table occupied by the customer and the average cost of utilities spent on making one dish. In some cases, it will also have a cost of pilferage added.

Why do financial services businesses fail?

The highest failure is seen in financial service businesses that handle other people’s money. The biggest reason for such failure is the failure of the fund manager to deliver an above average return and keep the churn rate of clients less than 25% per year.

As more clients churn, the business earns less per client over their lifetime, but still incur costs to acquire new clients.

Why do professional services businesses to fail?

According to practicing professionals, the main reason for failure of professional services businesses is the lack of an inner circle of clients, where the relationship with the business owner runs deep and precedes the start of the business.

It is extremely unlikely that a professional can succeed in the initial days without having clients who know and trust the work of the professional. Getting your foot in the door and showing a track record with the help of old friends go a long way in acquiring new clients.

What are the reasons for failure of Software and SaaS businesses?

There are three key reasons why most of the SaaS and Software businesses fail prematurely. Having worked at a SaaS product company and having taking a region to success, from my experience, the top 3 reasons are:

• Failure to build a minimum viable market that can provide sufficient cashflow to take care of running expenses
• Getting carried away and spending too much on marketing through paid channels without building a sustainable organic marketing engine
• Missing out on identifying the ‘needle in the eye’ pain point of the target customer and having only general features in the product

A typical SaaS business must generate a lifetime value from each customer that is at least 2X to 3X the total cost of acquiring the customer

Why do manufacturing businesses fail?

There are two primary reasons why manufacturing businesses fail. Both of these are interlinked to how efficiently a manufacturing operation is done. The two reasons are

• Not growing sales sufficiently to ensure an asset turnover ratio greater than 0.5, this means the manufacturing capacity is not even 50% utilized in a given year
• Not being able to produce products at a unit cost that is less than 75% of the perceived value that the manufactured product provides the customer

Many manufacturing business owners who get into business are often engineers or specialists in the industry. They often lack expertise in setting up a good sales and marketing engine to keep the business growing.