Dollinger index

Foundations of New Venture Finance 255

to get started—even those that are primarily bootstrapped or start without business

plans. (To obtain optimal benefit from the material in the rest of this chapter and in

Chapter 8, students should be familiar with basic accounting and financial statements.

In addition to the many excellent textbooks on the subject, online sites can help jump-

start an understanding or refresh rusty skills. See the endnote for references).^3

The table below shows the top reasons that most businesses fail, based on a sample

compiled by consultants who help troubled companies.

The primary reason for failure is too much debt. A firm with debt must make regu-

lar interest payments and must be prepared to repay principle either bundled with the

interest payments or all at the end. Failure to make the payments is one cause of busi-

ness bankruptcy. This flaw can be embedded in the business at the outset if a poor finan-

cial structure leaves the founder with too much debt relative to equity; it can also arise

later when the business has to borrow to cover expenses; or it can occur as a function of

inexperienced management or poor planning. Whatever the origin of this problem, the

lesson is that poor financial management, poor planning, and inexperienced manage-

ment all contribute to business failure.

How much money does the entrepreneur need? One of the most important and diffi-

cult tasks for start-up entrepreneurs is determining how much money they need. If they

raise too little money by underestimating the business’s needs, the firm will be under-

capitalized. Undercapitalized businesses may run out of cash, borrowing capacity, and

the ability to raise additional equity just when a new infusion of funds could get it over

some hurdle. If that happens, the firm goes out of business. It is often said that for new

firms “cash is king,” because when an entrepreneur runs out of cash, the king is dead—

and the business is often lost.

It may seem impossible to many entrepreneurs, but being overcapitalized is a sig-

nificant danger as well. An overcapitalized firm raises too much money and sends the

wrong signals to the stakeholders. For example, thinking that business is better than it

actually is, employees may press for wage and benefit increases. Customers may take

longer to pay knowing that the new venture has plenty of cash on hand, and suppliers

could demand more immediate payment. If the cash is spent on frivolous perquisites or

office decor, investors will lose confidence. Also, excess cash earns no or very low

returns, which diminishes total return to investors.

Too much debt

Inadequate leadership

Poor planning

Failure to change

Inexperienced management

Not enough revenue

Other

28

17

14

11

9

8

13

Reasons for Failure Percentage of Businesses

TABLE 7.1 Causes of Business Failure

SOURCE: BusinessWeek, August 25, 2003: 14. Data from Buccino & Associates, Seton Hall University.

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