Managerial inadequacy is generally perceived as the major cause of small business failure.
Unfortunately, this term encompasses a very broad set of issues. It has been estimated that two
thirds of small business failures are due to the incompetence of the owner-manager. [16] The
identified problems cover behavioral issues, a lack of business skills, a lack of specific technical
skills, and marketing myopia. Specifying every limitation of these owners would be prohibitive.
However, some limitations are mentioned with remarkable consistency. Having poor
communication skills, with employees and/or customers, appears to be a marker for
failure. [17] The inability to listen to criticism or divergent views is a marker for failure, as is the
inability to be flexible in one’s thinking. [18]
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Ask many small business owners where their strategic plans exist, and they may point to their
foreheads. The failure to conduct formal planning may be the most frequently mentioned item
with respect to small business failure. Given the relative lack of resources, it is not surprising
that small firms tend to opt for intuitive approaches to planning. [19], [20] Formal approaches to
planning are seen as a waste of time, [21] or they are seen as too theoretical.[22] The end result is
that many small business owners fail to conduct formal strategic planning in a meaningful
way. [23], [24] In fact, many fail to conduct any planning; [25], [26] others may fail to conduct
operational planning, such as marketing strategies. [27] The evidence appears to clearly indicate
that a small firm that wishes to be successful needs to not only develop an initial strategic plan
but also conduct an ongoing process of strategic renewal through planning.
Many managers do not have the ability to correctly select staff or manage them. [28] Other
managerial failings appear to be in limitations in the functional area of marketing. Failing firms
tend to ignore the changing demands of their customers, something that can have devastating
effects.[29] The failure to understand what customers value and being able to adapt to changing
customer needs often leads to business failure. [30]
The second major cause of small business failure is finance. Financial problems fall into three
categories: start-up, cash flow, and financial management. When a firm begins operation (start-
up), it will require capital. Unfortunately, many small business owners initially underestimate
the amount of capital that should be available for operations. [31] This may explain why most
small firms that fail do so within the first few years of their creation. The failure to start with
sufficient capital can be attributed to the inability of the owner to acquire the needed capital. It
can also be due to the owner’s failure to sufficiently plan for his or her capital needs. Here we see
the possible interactions among the major causes of firm failure. Cash-flow management has
been identified as a prime cause for failure. [32],[33] Good cash-flow management is essential for
the survival of any firm, but small firms in particular must pay close attention to this process.
Small businesses must develop and maintain effective financial controls, such as credit
controls. [34] For very small businesses, this translates into having an owner who has at least a
fundamental familiarity with accounting and finance. [35] In addition, the small firm will need
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either an in-house or an outsourced accountant. [36] Unfortunately, many owners fail to fully use
their accountants’ advice to manage their businesses. [37]
The last major factor identified with the failure of small businesses is the external environment.
There is a potentially infinite list of causes, but the economic environment tends to be most
prominent. Here again, however,confusing appears to describe the list. Some argue that
economic conditions contribute to between 30 percent and 50 percent of small business failures,
in direct contradiction to the belief that managerial incompetence is the major cause. [38] Two
economic measures appear to affect failure rates: interest rates, which appear to be tied to
bankruptcies, and the unemployment rate, which appears to be tied to discontinuance. [39] The
potential impact of these external economic variables might be that small business owners need
to be either planners to cover potential contingencies or lucky.
Even given the confusing and sometimes conflicting results with respect to failure in small
businesses, some common themes can be identified. The reasons for failure fall into three broad
categories: managerial inadequacy, finance, and environmental. They, in turn, have some
consistently mentioned factors (see Table 1.5 “Reasons for Small Business Failure“). These
factors should be viewed as warning signs—danger areas that need to be avoided if you wish to
survive. Although small business owners cannot directly affect environmental conditions, they
can recognize the potential problems that they might bring. This text will provide guidance on
how the small business owner can minimize these threats through proactive leadership.
Table 1.5 Reasons for Small Business Failure
Managerial Inadequacy Financial Inadequacy External Factors
Failure in planning (initial start-up
plan and subsequent plans)
Inexperience with managing
business operation
Ineffective staffing
Poor communication skills
Failure to seek or respond to
Cash-flow problems
Insufficient initial capitalization
Inadequate financial records
Not using accountants’ insights
Inadequate capital acquisition
strategies
Failure to deal with financial
Downturn in economy
Rising unemployment
Rising interest rates
Product or service no longer
desired by customers
Unmatchable foreign
competition
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Managerial Inadequacy Financial Inadequacy External Factors
criticism
Failure to learn from past failures
Ignoring customers’ needs
Ignoring competition
Failure to diversify customer base
Failure to innovate
Ineffective marketing strategies
issues brought about by growth Fraud
Disaster
Ultimately, business failure will be a company-specific combination of factors. Monitor101, a
company that developed an Internet information monitoring product for institutional investors
in 2005, failed badly. One of the cofounders identified the following seven mistakes that were
made, most of which can be linked to managerial inadequa
