Why Small Businesses Fail (Growth Part 3 of 8)

In this video we are discussing a common misconception about small businesses… the concept of exponential growth. Watch now!

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Welcome back friends to another weekly video. We have been talking about growth. In this video, we are going to continue defining the key characteristics of growth. We will use these concepts to help answer the question why so many small businesses fail.

The US Small Business Administration (SBA) collects data on small business startups. These are important numbers to understand. We are going to be putting together a lot of information in this video, so bear with me. If you have watched a lot of my videos, I have talked about a lot of these concepts, but here we are combining them to talk about growth.

Growth is the area that I focus on in my own research. If you want to know more about my research, I have written a summary called “On Wolves And Finance” which you can get on Amazon. The link is on my website WolvesAndFinance.com which is in the description box below.

Small businesses are important. They reflect the part of the economy that is new growth. You have a lot of small businesses starting up, some of the them are going to fail, but some of them will grow into the massive companies of the future. If we look at failure rates, the SBA reports that roughly 33% fail within the first two years, and 50% fail within the first five. So 1/3 of small businesses do not survive past two years… that is a lot.

https://www.sba.gov/sites/default/files/Business-Survival.pdf

What is interesting is these statistics are fairly consistent over time. And these statistics reflect how finance people think about markets. Finance people usually will not invest in a business with more than a 30% risk profile. When we talk about interest rates, they usually exist within a range of 5% to 30% and they reflect the risk profile of the investment. So 5% may be fairly risk free government bonds, 15% might be corporate stock in a large company, and 30% would be a high risk startup. Anything that is riskier, you might as well take your money to Vegas, because you are just gambling at that point. Now the reason you would invest in such a high risk investment (30%) is because the higher the risk, the higher the return. For a small business, there is a lot of risk, but if that small business turns into a massive company, you are going to make a ton of money. So you are going to expect a high rate of return to compensate you for all the risk you are taking on.

So if you are in the small business area, how do you make sure you are not in the 30% that fail. That is the key question we are going to look at. One of things I have seen small business owners struggle with, is they do not understand the characteristics of growth. All businesses grow with certain characteristics. If your business plan does not align with how your finances are likely to play out, you are going to run into trouble.

So I am going to talk about what we know about Growth. Let us review what we have discussed so far:

1. Growth exists
2. Growth continues forever

Now I want to add one more characteristic.

• Growth is exponential

This means that growth occurs faster and faster every year. The economy does not just grow every year forever, it is constantly speeding up. When you look at a graph of economic activity, it constantly curves upward. We see this when we look at technology. We see exponential improvements in technology, and we also see this in financial markets. Individual businesses may fail or succeed. The businesses that are successful are the ones that tap into the overall exponential growth of the economy.

You have to realize, these are not just my opinions. These are the assumptions the entire global financial system is based on. Stock prices, bank loans, interest rates all are derived from mathematical equations that are based on these three assumptions. The financial world models growth as exponentially increasing forever. You should realize this because it impacts the decisions you make in your business every day.

Let us use small businesses as an example and talk through some of the problems this creates.

1. It is hard to think in curves. It is much easier to think in terms of straight line growth. As soon as you bring curves into your plan, it becomes much more complicated. A lot of people build their plans based on a straight line. But if the growth actually happens along a curve, you are not going to be prepared. Let us look how this breaks down into numbers. Imagine you have a business that is making $30,000 per year. A straight line projection might be 30,000, 40,000, 50,000, 60,000. You are thinking to yourself, at this rate I could be making 60,000 in four years. But that is now how growth typically happens. Growth is exponential. A more realistic curve would be 30,000, 38,000, 62,000, 102,000. Your growth is speeding up. Now these numbers are not going to be the same for every business. Growth can happen faster or slower than this. The point is that growth tends to happen on a curve, not a straight line. If you do not account for that, you will be unprepared.
2. People get discouraged. Finance helps you look into the future and envision what the payoff might be. This is going to keep you going through the tough start up years. If you do not understand the exponential growth curve, you are going to give up before you hit the payoff in future years. The whole point of starting a small business is to get to the steep part of the curve. That is where you are making money. You are struggling through the initial years to get to the juicy part of the curve. In our example, you are starting out at 30,000. That is not a lot of money, and you are going to struggle. If you are thinking in terms of straight line growth, you are going to think to yourself “I am never going to make any money in this business. I might as well shut the doors.” You might be making the wrong decision, because you cannot see what is available to you.
3. People try to skip the curve. This problem happens because people do not realize how long it takes to grow your business. It takes time to get through the initial startup period before you can get to the second stage of the curve. Some people think they can make an investment and jump to the upper stage of the curve. Business does not work like that. You cannot skip the curve of growth. You have to put in the time and lay the foundation if you want to be able to support long term growth. Even if you are lucky and you catch a market fluctuation that skyrockets your business, what usually happens is that markets correct. If you have not laid the groundwork, you will not be able to sustain long-term growth.
4. People miss the opportunity of the moment. There are two parts to the curve. You have the initial part where you are probably making less money than you need, and you have the upper part, where you have more money than you need. The initial part of the curve is going to be difficult. Many people get frustrated because they do not see the huge opportunity that is right in front of them. Times in your business might be slow, but that is your opportunity to take the time to put systems in place. This is your time to prepare and organize yourself for the rapid growth of the future. This slow period is the most important period of your business. If you do not use it wisely, you will not be prepared when things start speeding up.

In conclusion, we have discussed three characteristics of growth.

1. Growth exists
2. Growth continues forever
3. Growth is exponential

These are ideas that can help you make better decisions in your business. These are not crazy ideas. These are things entrepreneurs have known intuitively for some time. What I am doing, is putting math equations behind them to help you make financial decisions. At its core, finance is inspirational. Finance is showing you what your future can be. You can use this understanding of growth as a map to grow your business and make some money. If you do not have a solid financial plan, you are going to go out of business.

Leave a comment down below letting me know what you think!

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Neither Zach De Gregorio or Wolves and Finance Inc. shall be liable for any damages related to information in this video. It is recommended you contact a CPA in your area for business advice.