Examining What Percentage of Small Businesses Fail

Fair warning: This analysis of the percentage of small businesses that fail may shrivel your entrepreneurial spirit. Startups burn optimism as fuel, and cold, hard facts can render optimism inert.

Yes, the odds are stacked against your small business. But the playing field isn’t always level. This article is packed with facts to help you avoid the hazards and hurdles that drive half of all small companies out of business before they are five years old.

We’ll tour the obstacles and identify safeguards.

For example: a lack of operational cash flow is one of the most common factors behind small-business failures. And it can be remedied with an investment, cost-cutting measures, or a specialized refinancing loan.

According to the latest information on small business failure rate published by the U.S. Bureau of Labor Statistics:

• Roughly 20% of small businesses fail within the first year. 21.6% of small businesses founded in March 2017 were closed by March 2018.
• Roughly 33% of small businesses fail within two years. 31% of small businesses founded in March 2016 were closed by March 2018. 
• Roughly 50%of small businesses fail within five years. 49.3% of small businesses founded in March 2013 were closed by March 2018.
• Roughly 66% of small businesses fail within 10 years. 66.3% of small businesses founded in March 2008 were closed by March 2018.

Sobering, isn’t it?

But it doesn’t have to be you.

Small Business by the Numbers

The overwhelming majority - 99.9% or 30.2 million - of businesses in the United States fall into the small business category, defined as “an independent business with less than 500 employees” by the U.S. Small Business Administration. 

Entrepreneurs launch thousands of new businesses every year. But small businesses are vulnerable to competition and economic downturns and changes in fashion. Small businesses are fragile. Without large customer bases and substantial cash reserves, entrepreneurs can find themselves with no alternative to pulling the plug.

Contrary to popular opinion, the survival rate curve across industries is pretty similar - there is no industry with a distinctly higher percentage of startups that fail. This holds true even for the falsely notorious restaurant business. 

A rare exception could be the construction industry, with only 25% of companies founded in 2004 making it to 2015. Healthcare services, on the other hand seem to have a higher success rate than most other companies, according to the Bureau of Labor Statistics. 

Is the Percentage of Restaurants that Fail Higher than Average?

Beliefs about the restaurant business and its supposedly higher failure rate are not based in fact, according to data gathered from the BLS. On the contrary, the business failure rate in this industry has been dropping steadily for the past five years.

• Roughly 20% of restaurants fail within the first year, just like businesses in other industries. In fact, the restaurant fail rate from 2014 until now has been dropping to 10-12%.
• Roughly 30% of businesses in the accommodation and food services sector fail after two years, about 3-4% less than in other industries.
• Roughly 50% of businesses in the accommodation and food services sector fail after five years, just like businesses in other industries.
• Roughly 62% of businesses in the accommodation and food services sector fail after 10 years, 3-4% less than in other industries.

The food biz’s bad rep is likely due to the high rates of startup failures. Restaurants tend to have small staffs, and businesses with fewer than 21 employees fail more often than other service-based operations. When the employee count goes up, statistics show that the median life span of restaurants is 9 months longer than average.

Why do Small Businesses Fail?

You may be surprised to learn that lucky rabbit’s feet have little to do with small-business success. Nor do witches’ curses account for most failures. There are things that need to be done right and, more importantly, things that should not be done wrong.

Let’s take a look at some statistics to get a better feel for how things stand.

• One in five small businesses end their operations before their first year runs out, according to U.S. Small Business Administration. About one half make it to the five-year mark, and a third survive to be a decade old.
• Cash-flow issues are the cause 82% small businesses closures, according to a study by U.S. Bank. Another 42% don’t find customers for their product, 29% simply run out of cash, 23% don’t invest enough into human resources and end up with a mismatched team, and just 19% actually get pushed out by competitors.
• Small businesses run by people under 30 years old fail twice as often, say researchers at MIT’s Sloan School of Management. Experience does go a long way - the right set of business skills trumps youthful optimism and a go-getter attitude.
• Healthcare and social assistance businesses have the best success rate, according to figures compiled by Visual Capitalist. 85% of these kinds of enterprises make it past their first year, while 60% survive to celebrate their fifth birthdays.

Cash-Flow Issues

Even the most profitable company with the most effective marketing strategy can fall prey to the deadliest of small business assassins - the lack of positive cash flow. Cash flow difficulties are the main culprit for 82% of small business failures.

Companies with a positive cash flow have enough operating funds - money for settling debts, reinvesting in the business, credit cards for covering expenses, and the like. 

Cash-flow issues can arise when too much of the company’s revenues get tied up in accounts receivable. Commercial clients pay with 30- to 60-day invoices. Invoices for future payments don’t go toward building up inventory or paying workers’ salaries. A company can have a positive book value because of big receivables, but until those funds arrive it may not be able to cover expenses.

Another way cash flow gets disrupted (and the business failure rate gets hiked up) is by stocking up too much inventory. The bills don’t wait for your products to get sold.

Your small business can go belly-up extremely quickly with an untimely and aggressive growth strategy. The bigger the business, the bigger the expenses. If cash flow is clogged while you’re simultaneously pursuing expansion, you can find your company in a world of hurt.

Building up a cash reserve before beginning a growth campaign is an intelligent move. External financing, like small business loans, can be a successful growth catalyst if used intelligently.

Managing growth, building up a cash reserve, and keeping an eye on the credit rating of invoiced clients are some of the best ways to secure a healthy cash flow.

The Product Can’t Find Its Place on the Market

Making sure people want the products you sell seems like a no-brainer. However, statistics show it isn’t obvious to everyone: 42% of small businesses fail simply because no one wants to buy what they are selling.

A product needs to solve a problem or fulfill an existing need. You can have the most ingenious idea, a foolproof business plan, and plenty of capital to get everything off the ground, but if there’s no one who wants your product, you are marked for death.

Market research is crucial for assuring that the product does not miss the mark. That’s more important in some industries than others. Again, the healthcare and social assistance industry has a more generous small business survival rate, maybe because everyone wants to be healthy.

A good way to avoid investing into something there is no need for is constructing a minimum viable product.

An MVP is a bare-bones version of your product with enough basic features to test its viability in the market and receive crucial feedback before fully committing. 

MVPs are usually marketed to so-called lighthouse consumers - loyal early adopters who can give honest and truthful feedback after using a prototype version of your product. They are likely to be more forgiving and to incorporate a vision of the future of the product - and thus serve as a litmus test for the fully developed version.

Bad Team Chemistry

Creating a team of individuals with complementary traits and characteristics is of utmost importance. This is a chore easier said than done - not having the correct team composition is the reason behind 23% of startup failures.

Finding the right talent for the job can be a daunting task, but it’s become much easier with resources like LinkedIn and Facebook. Once you find the best team, don’t do everything by yourself - delegate and play to everyone’s strong suit.

Retaining good employees can be even more difficult than finding them. Providing ample benefits is the most effective tool in boosting employee retention. Team-building activities can also help you bring cohesion and shared vision to the team.

Lackluster Market Research

It’s not the 20th century anymore - advertising has come a long way since the days of buying TV air time and hoping you’ll somehow reach the right demographic group for your product. Today, you can narrowcast your message to your best target audience.

Knowing the customers’ age, gender, and income level is paramount for proper marketing strategies. CB Insights research suggests that ignoring customer demographics is responsible for 14% of the small business failure rate.

Good ideas: Run focus groups. Conduct online surveys via social media. Collect data from the Bureau of Labor Statistics and other government sources.

Don’t neglect social media. Your profile page can help you get to know your customers and their needs, preferences, and inclinations. Interacting with consumers and engaging them through posts is a surefire way of creating a loyal and satisfied customer base.

A Badly Thought Through Plan

“By failing to prepare, you are preparing to fail,” the old adage says. You can put an immense amount of blood, sweat, and tears into your enterprise, but if you didn’t have a realistic plan to begin with, it's all for naught.

Without a realistic, complete, detailed, honest plan based on current information and market research, your business idea will just be another data point boosting the startup failure rate.

A good business plan should have the following points:

• A clear illustration of the business model, vision of the future, and important milestones.
• Thorough market analysis with up-to-date information.
• The sketch of an ideal team.
• Financial projections - required capital, income statements, cash-flow analysis, and expense forecasts.
• The state of the competition.
• Plans for managing the company’s growth and budget.

Poor Management

There’s a reason people go to business school. Managing a company takes distinct skills in many areas - finance, marketing, purchasing, selling, hiring employees, creating a cohesive team...

A business owner lacking the necessary skills in a certain area and failing to recognize it is a recipe for disaster. Don’t fall into the overconfidence trap - if you see that you are struggling with a certain aspect of running a business, hire a professional or educate yourself. 

Neglecting a business once it is established is another common management mistake. Continuous research, data analysis, and market planning are crucial. Don’t get lulled into a false sense of security once your business gets off the ground.

Getting Shoved Out by Competition

“Don’t focus on others - focus on yourself” is good advice. The first thing on your list of priorities should be developing your own product. Still, 19% of the startup failure rate is due to simply losing out to competitors.

When a new product’s place in the market has been validated, it doesn’t take long for new companies to start popping up, vying for a place in the sun. Keeping an eye on what the competition is up to is a crucial step to keeping your own product or service differentiated and fitted snugly into its niche.

Insufficient Cash Reserves

Around 29% of new businesses fail because of insufficient starting capital. Small hidden costs, like buying a URL for your site or designing business cards, can add up to a huge bill at the end of the month. That’s why good planning is essential.

When starting a new company, you should have a cash reserve to carry you through the first six months. Otherwise you are setting yourself up for failure.

In Conclusion

Ultimately, most small business fail for the same reason: entrepreneurs don’t educate themselves sufficiently on the market, on running a business, on building a team, on the basics of finance - all the tasks required of small-business managers.

There’s no excuse. A solid business-school education is a fine thing to have, but you can learn all you need to know online if you’re really committed. You can learn from the mistakes others have made, the lessons they’ve learned, and the advice they share. Educate yourself, be smart and, most of all, good luck - because that’s a big part of the picture as well.