Understanding how and why businesses fail can help prepare you for success.
Have you heard that 90 percent of new businesses fail? Or that 50 percent of new businesses fail? Stick around in the entrepreneurial community long enough and you will likely hear a wide spectrum of claims, mostly falling between these two extremes. But what is the true failure rate of small businesses? And should it influence your decisions as an entrepreneur?
What we know about the failure rate of small businesses?
According to data from the Bureau of Labor Statistics, approximately 20 percent of small businesses fail within the first year. By the end of the second year, 30 percent of businesses will have failed. By the end of the fifth year, about half will have failed. And by the end of the decade, only 30 percent of businesses will remain — a 70 percent failure rate. Of course, we must accept several caveats in these data. Here are some common variables.
Definition of failure, if a business no longer exists a year later, it is counted as a “failure.” But there may be entirely valid reasons for the business no longer existing. The owner may be interested in retiring, for example, and chooses to close the business rather than try to sell it or transition ownership; it is hardly fair to count this as the failure of the business.
Annual variance, as you might expect, there is some variance from year to year, based on economic conditions. The data reported above applied to businesses studied from around 2007 to present. It does seem like many of these percentages remain relatively consistent; we might see the failure rate for a single year vary between 15 and 25 percent, but it is not likely to spike or plummet.
Outlier events, major outlier events can significantly change the failure rate for businesses, for better or for worse. For example, the Covid-19 pandemic has created harsh economic conditions for many industries, including bars, restaurants, and other niches dependent on close physical interaction. Failure rates are exceptionally high for 2020.
Industry variance, unsurprisingly, the failure rate varies significantly from industry to industry. Health-care businesses and organizations tend to have a failure rate that’s lower than average since the demand for health-care services is high, consistent, and steadily increasing. On the other hand, failure rates for warehousing and transportation businesses are high due to high cost and maintenance.
Reporting, we also need to be wary of errors in reporting. Some small businesses may not be counted in these metrics due to operating in secret or because of clerical oversights. Other businesses may be counted but may not operate like typical businesses.
Business health, businesses may survive even when performing sub optimally. Many “successful” businesses in this report may be dangling by a thread.
Why people overestimate the failure rate….
I also want to acknowledge that whenever failure statistics are misrepresented, they are usually inflated. In other words, people tend to exaggerate the failure rate of small businesses. Why? It might be a conservative way to taper expectations, or it might play into the desire to discourage would-be entrepreneurs. Either way, we need to be cautious of people who confidently assert a trivial “truth” about business ownership. Small businesses do fail somewhat often, but it is important to take statistics for what they are, to understand their context and to not allow them to unfairly discourage you from pursuing the development of your business.
MOHAMED ROBIN RASHED ELALAMI
BUSINESS CONSULTANT/ENTERPRENEUR
