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Growing pains

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The risk of small businesses failing has long been exaggerated, and a leading debt agency has debunked the myth that start-up operators are doomed to go under in the first year of trading.

Evidence suggests that trying to grow a business – taking it from infancy to adolescence – is a bigger threat to survival than inexperience.

Credit reference checking agency Veda Advantage, formerly Baycorp, studied businesses entering financial administration in 2006-07, and says relatively few closed in their first year.

“Our analysis shows that only 1.5 per cent of businesses close within this period,” Veda information services general manager Erica Hughes says. “It appears that most SMEs face financial trouble in their median growth period, a stage we have defined as ‘corporate adolescence’.”

According to the study, most of those proprietors/managers who take the drastic step to wind up their businesses enter external administration between their second and fifth year.

This involves about 32 per cent of business exits. Some 21 per cent wind up between the sixth and ninth year, meaning more than 50 per cent conclude trading after the second year.

The learning curve for a growing business looks extraordinarily steep, but after the fourth or fifth year, the business challenges diminish.

“The transition from SME operation to a larger business is like a period of corporate adolescence,” Hughes says.

“It may seem like an effort at the time, but once a business reaches a certain point in its development, it’s time to take a more mature style of financial operation – or risk all of the upside of the establishment period.”

The study suggests that better cash flow management and properly managed credit systems are essential to fail-proof a business during the growth phase.

Despite popular references to the poor success rate of new operations, a paper released six years ago – Business Failure and Change from the Productivity Commission – agrees with Veda’s findings.

“Contrary to common perceptions, most Australian businesses survive for a considerable time,” the paper says. “For example, around two-thirds of businesses are still operating after five years and almost half are still operating after 10 years.”

The paper found about 7.5 per cent of businesses ended each year, with cessations accounting for about 80 per cent, and changes in ownership the remainder.

The point that needs to be emphasised is that most exits are not firm failures.

“Less than 0.5 per cent of businesses exit each year due to catastrophic failure – bankruptcy or liquidation,” the paper reveals.

The closer you look at the exits, the more it becomes likely that some business owners find the challenges of growing a business, employing staff, paying taxes, getting entangled in government red tape and managing money all too hard. And a job with four weeks holiday and sick leave eventually looks too attractive to ignore.

US magazine Business Week explored small business failure in the US and concluded flawed statistics may make entrepreneurs’ prospects look worse than they are.

One problem is data. It’s hard to get stats on why a privately held business that has not gone broke has rolled down the shutters for the last time. Most of the 1.8 million small businesses in Australia are home-based and don’t operate as companies.

A Wells Fargo/National Federation of Independent Business study for US businesses showed that annual failure rates were more than nine per cent when failure was defined simply as “discontinuance of ownership”. But when failure was defined as bankruptcy, the number dropped to less than one per cent a year.

An Australian Bureau of Statistics analysis of business exits pinpointed the main reason for the discontinuance of the operation.

“The most common reason for businesses to fail is that they’ve undercapitalised, or don’t have enough money on hand to keep going,” it reports. “That often is the result of insufficient planning or the lack of a business plan.”

The report lists the common reasons for business failure:
•    Lack of financial planning and review
•    Over-dependence on specific individuals in the business
•    Owners concentrating on the technical, rather than the strategic work at hand
•    Inadequate capitalisation
•    Lack of management systems
•    Lack of vision, purpose, or principles
•    Poor market segmentation and/or strategy
•    Failure to establish and/or communicate company goals
•    Competition or lack of market knowledge
•    Absence of standard quality program.

Erica Hughes says the challenge of growing a business and getting everything right can shock a successful SME.

“Many businesses expand quickly without a deliberate decision to outgrow their SME status,” she says.

“This can mean owners and directors can often feel overwhelmed by the growing pains associated with middle business and can become distracted from core cash management issues.”

Last word

•    Trying to grow a business is a bigger threat than inexperience
•    Business fail in their adolescence phase more than the start up phase
•    Less than 0.5 per cent of businesses exit each year due to catastrophic failure – bankruptcy or liquidation
•    The transition from micro to medium business requires the business leader to understand the risks of faster growth.
•    Planning and accessing expert help for crucial areas such as marketing and financial management are vital to avoid failure.

Work on your business, not in it. To learn how, book a complimentary business assessment today with a Switzer Business Coach.

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

Published on: Wednesday, September 16, 2009

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