Six Traps That Wreck Established Businesses

Longevity in business can leave owners complacent, unprepared, and misaligned with their personal goals. Here's how to avoid the key dangers success can bring

By Karen E. Klein

There is a plethora of advice available for new business owners. But it’s wrong to assume that the hard work diminishes once entrepreneurs have established their ventures. It’s just that over time, creativity and innovation can subside: When mature companies fail, it is often because they haven’t adapted, particularly during an economic downturn. In this Smart Answers column, three longtime business consultants lay out six major pitfalls that lie in wait for established businesses—and they illustrate how owners can overcome them.

1. Complacency. Once a company grows to the point where it owns its product or service niche, it’s all-too-easy to stagnate by following conventional wisdom and obsolete business practices. For instance, a 69-year-old professional service provider recently asked when social media would "just go away," says Mark Stevens, chief executive officer of MSCO, a Rye Brook, N.Y., management-consulting firm and author of Your Company Sucks: It’s Time to Declare War on Yourself (BenBella Books, August 2011). "Worst of all, a company may have a certain way of doing things that it clings to, even when all the evidence says it isn’t working the way it used to," he says. Even a mature company must maintain a startup mentality, invest in innovation, and raise the bar for its products and services. If that doesn’t happen, Stevens says, it can face a long and painful slide into obscurity.

2. Labor Costs. As a business grows and loyal employees get yearly salary increases, their compensation may grow out of proportion to their market value. "We go into companies and find salaries that boggle the mind," says Corey Massella, a CPA and partner at Citrin Cooperman, a business advisory firm based in New York. "You can have a long-time secretary who earns as much as the officers of the company." Evaluate staff salaries annually, making sure they remain competitive, but do not get far out-of-line with the duties and responsibilities required. "It’s a tough thing because you don’t want to hurt loyal people, but small companies cannot maintain these huge salaries, especially during a tough economic time," Massella says.

3. Lack of Contingency Planning. Even in the best of times, companies should have contingency plans for emergencies, disasters, recessions, and industry upheavals. It’s crucial to establish cash reserves, adequate insurance, and credit relationships when things are going well—not when unexpected reversals happen, as they will in the life of every business, Massella says. "I have seen some companies fall in this recession and some come under tremendous pressure, especially in industries related to real estate," he says. Have at least a good idea how your company can react and recover if a competitor brings out a transformative new product, or a key employee is incapacitated, or your business is hit by major theft. Such events will be difficult, but they won’t be impossible to overcome if you’ve considered your response ahead of time.

4. Losing Sight of Enterprise Value. Entrepreneurs who build their business income but ignore their company’s long-term value may wind up without the nest egg they are counting on from an eventual sale, says Jim Muehlhausen, founder of the Business Model Institute in Indianapolis and author of The 51 Fatal Business Errors (Mulekick Publishing, 2008). The most successful business owners build their income at the same time they are building their company’s enterprise value, he says. "I use the drop-dead rule. What’s your business worth if you’re walking out to your car and you get hit by a bus?" he says. Nearly one-third of small businesses close their doors when the founder retires or expires, Muehlhausen says, because they have not developed a going concern that can live on without them.

5. Ignoring Personal Goals. As your company matures, evaluate how it fits into your personal and financial vision. "As life evolves, ask yourself whether running this company still meets your goals," Massella says. A high-risk, high-reward business may be a terrific challenge for a young person or someone whose children are grown, but inappropriate for an owner with a young family or children about to enter college. "A business owner whose risk tolerance and personal wealth have dwindled may miss out on opportunities like acquisitions or new equipment purchases that will keep the company growing," Massella says. If you still believe in your business and you have the energy and resources to run it, stick with it. If not, be honest and get moving on an exit strategy.

6. Insisting on Family Succession. It is almost universally a mistake to assume that your kids will want to take over your company and are equipped to do it successfully, Stevens says. "I have two sons and it would have thrilled me to bring them into my business, so I understand the joy that would bring. However, you can give your kid a car or a trust fund, but if you’re going to give them a business, they have to have the DNA to run it," he says, "and most people don’t." His consulting practice has worked frequently with family businesses that are failing under second-generation leadership. "What happens is the founder stands on the sidelines and manipulates because secretly, they don’t think anybody’s as competent as they are," he says. "Every decision the kid tries to make is countermanded with the employees, the other parent gets involved because the kid is miserable and ineffective, and it turns out to be hell for everyone." Make a realistic exit strategy that doesn’t involve your children unless they are eager, entrepreneurial, and educated enough to revitalize your company for the long-term.

Karen E. Klein is a Los Angeles-based writer who covers entrepreneurship and small-business issues.