Why Startups Fail (So You Know How Not To)

Henry Cooper

By Henry Cooper

Why Startups Fail

I have spent the last 16 years advising small and micro-business startups through my accountancy practice, BirchCooper Accounting Services.

I really enjoy working with this sort of business because I find the diversity and energy inspirational. It’s always exciting watching them grow and thrive. However, it's not always plain sailing. I want to share with you some of the common warning signs I've come across so you know how to avoid failure.

 

Cash flow problems

You may have heard a saying “profit is vanity, cash is sanity”. This is very true. Even if a business is making lots of profit, it will be worthless if the cash isn’t there to keep the company trading.

Don’t forget - a balance sheet may infer that the business is solvent, for instance, it might have assets in the form of equipment and debtors. However, if the cash isn’t there to pay your suppliers, the VAT-man or the taxman, then it will all be meaningless and the business will soon fail.

The lesson? 
Cash is king. Remember, balance sheet solvent means nothing if you can't pay your debts as and when they are due.

 

Debtor payments terms too long

Here we're talking about how long it takes for your customers to pay you. You should make your payment terms as short as possible, but as long as practical to ensure that you remain competitive. Bear in mind that many customers will not adhere to these terms. Make sure you make these terms clear and chase your customers for payment, regularly. Failing to do this may mean that some of your customers might start to see you as a bit of a “soft touch” and pay others, ahead of you.

The lesson?
Don't be seen as a soft touch. It's your livelihood, so don't worry about chasing customers for payment.  

 

Not having enough capital to start out with 

It's vital that you're completely clear from the outset as to how much you will need to get the business up and running, both for initial requirements and for initial trading, this might include:

  • Premises
  • Deposits (rent etc.)
  • Advertising
  • Insurances
  • Equipment
  • Initial stocks
  • Borrowing costs
  • Advice
  • Software

And don’t forget to budget for your personal income as well.

The lesson?
Understand your requirements from the outset by writing a detailed business plan.

 

Not having funds in place for a contingency

In addition to not having enough initial capital, you should also be prepared for the unexpected.  
 
There will be a temptation to take money out of a business to fund your income needs, without enough forward planning.
 
However, you need to ensure that you leave funds in the business to cover for:

  • Tax/VAT/PAYE bills
  • Unexpected costs, such as repairs
  • Higher than expected borrowing costs
  • Liquidity

By not allowing for these contingencies, you run the risk of the business becoming insolvent, which means the business can't pay everyone that it owes money to. In the case of a limited company, the company has an obligation to close down.

The lesson? 
Prepare for the unexpected. Don't take everything out in Directors Loan Accounts or dividends straight away.

 

Making naive business decisions

Many business owners I've worked with, will spend lots of time on the “exciting” aspects of their business, such as getting those new clients/customers and making those first sales. However, whilst getting caught up, in this excitement, they will often make business decisions based on advice from “the man down the pub”

  • You should incorporate to save tax
  • Register for VAT on the Flat-Rate Scheme – you’ll make some money here
  • Put the cost of your car, through your limited company

You need to bear in mind here, that just because some of these ideas have worked for others, it doesn’t mean they are appropriate for you.

I've seen many businesses who are working through an inappropriate structure. For instance, a window cleaner, who has become a limited company to make some tax savings, whilst not considering the additional compliance costs.

Make sure you take appropriate advice from: 

  • An accountant
  • A Lawyer
  • An HR specialist, if you are thinking of employing people

Whilst you might be reluctant to pay for this advice, it will usually save you money and compliance issues in the future.  And make sure you ACT on ALL of the advice, not just the advice that you WANT to hear!

The lesson?
What works for one, may not work for another. Seek independent advice and speak to an accountant or bookkeeper

Having the right team in place (or not)

When we are starting our businesses, there is always the temptation to try to do everything yourself, things like:

  • IT support
  • Bookkeeping
  • Secretarial support
  • Advertising/PR

Whilst this might, initially, be a necessity, due to cash-flow, you should at least try to outsource, as soon as is practicable

In my experience, it is often the case when you calculate how much time these tasks take out of your working day, it will often be more cost-effective to pay somebody else, either by outsourcing or employment. It will free up more of your time, to gain even more business and therefore more profits

And don’t forget, if you are employing people, make sure you take HR advice to make you fully aware of the consequences.

The lesson?
Don't overstretch yourself as this will only harm your business in the long run. Look into automating certain processes, such as marketing, and recruiting staff or hiring an intern

 

The consequences of non-compliance

I spoke earlier about compliance issues – some examples are

This is just a selection.  

I have seen potential clients, where I am the first adviser they have spoken to and some of these compliance problems are why they have decided to (belatedly) take some action. Unfortunately, it is often too late at this stage and the penalties can’t be overturned or cancelled, which will sometimes mean that the business can’t continue as it can’t afford to pay them.  In some extreme situations, the business owner could even lose their house.

I had a client that had an old dormant company, with about £7k in the bank account. He ignored numerous reminders from Companies House. In the end Companies House dissolved the company, which meant the company bank account was frozen and he lost all of the money in it.

The lesson?
Ignore nothing. Make sure you're up to speed on your legal and financial obligations – and take advice where necessary. 

 

Overtrading

This might seem a strange one but overtrading can be dangerous. I've seen businesses getting excited and agreeing to provide large orders prior to working out their true costing and whether they can deliver the same quality product.

This can be the same whether you ae selling products or services. Whilst it is great to see a quick increase in sales, remember that you will still have to pay for the cost of these sales, sometimes before you have received the money from the customer

An example I can share with you here is a recruitment agency that provided high-value contractors to their clients. The contractors were paid on 7-day terms, but the clients had 30 days payment terms. The agency had severe cash-flow problems due to the lag between paying the contractor and receiving the fee from the client, during a period of significant growth.

The lesson?
Don't bite off more than you can chew. 
 

Not spotting the early warning signs of danger

Finally, the thing to remember is that all of the issues that have been discussed, whilst causing potential problems, can be avoided or at least mitigated by being aware of them. So how can you do this?

  • Have a robust business plan, but be prepared for it to evolve as the business evolves
  • Monitor and try to forecast your cash flow on a regular basis – make sure you reconcile your bank account, with your accounts regularly to ensure nothing is missed.
  • Chase your debtors regularly – enforce your credit terms
  • Always be aware of your liabilities and when they are due
  • DON’T ignore official letters, reminders etc.
  • Work closely with your advisers – keep in touch with them – act on their advice and if you are not sure, ASK!

And finally...

Running any business, but especially a startup can be a scary process. It can be devastating when things go wrong, sometimes due to matters outside of your control. But, with a little care and by following these steps, you can make it a success. 

 

Henry is an AAT Licensed Accountant and established BirchCooper Accounting Services in 2001. From small beginnings, working at home, it is now a high street practice specialising in providing small businesses and start-ups with a full range of accountancy services. Follow Henry on Twitter @BirchCooperH 

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Henry Cooper

Published 17 May, 2017 by Henry Cooper

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