If you own a small business or are considering launching one, you’ve probably heard some less-than-promising statistics about small business failure rates. According to the Small Business Administration, only 20 percent of small businesses fail in the first year.
However, after that, the numbers take a dramatic turn for the worse. Only about half of small businesses stay alive for five years. Approximately 33 percent make it ten years.
Don’t let these numbers discourage you. Many companies do succeed.
Small businesses comprise 99.9 percent of all firms in the U.S. Many people are doing it right and staying in business. We’ve put together some guidelines to help you minimize risk and join the ranks of the successful small businesses that are the crux of the American economy.
The Importance of Success Rates
Starting a small business comes with some risks. You’re probably well aware of that. People love spouting out the numbers about how many small businesses don’t make it. You might want to wave that advice away. After all, your idea is different, and you’re determined to make it work.
Entrepreneurs hoping to be in it for the long haul must crunch some numbers to analyze their chances of succeeding before investing in startup costs.
Understanding small business failure rates doesn’t necessarily mean you should get out before trying. However, knowing the numbers can help you decide how to distribute your funds effectively to have the best chance of success.
According to Fundera, the small business failure rates are as follows:
- 20% fail in the first year
- 30% fail in the second year
- 50% fail within five years
- 70% fail within ten years
These rates have remained relatively consistent over the decades. Although an economic slump could impact your business, many small businesses thrive through recessions. The implication is that any time is a good time to start a business, and you can count on the survival rates staying steady no matter what happens to the economy.
So many factors are in play when you start a new business that it’s nearly impossible to calculate your exact odds of success. Almost every startup would be a failsafe if everyone could do that. But knowing the numbers can help determine whether your idea or industry is potentially lucrative.
Small Business Survival Rates by Industry
Every industry is different when it comes to small business survival rates. If you start a business in a flourishing sector, you can succeed better than an entrepreneur in a low-survival field.
Healthcare is one of the top industries for small business growth. According to the Bureau of Labor and Statistics, the healthcare and social assistance category is slated to grow by 21 percent between 2014 and 2024.
Statistics from 2015 show that more than 40 percent of businesses in this category were still operational after 11 years. About 19 percent shut down after one year. This lucrative industry has high success rates if you can make it over that hump.
Although the construction industry is growing, success rates for small businesses in this field are not as encouraging. Only about 75 percent of construction businesses make it through the first year. Approximately 35 percent are still active in year five. What about starting a restaurant? Many people believe that this is one of the most volatile industries. But Forbes reports that most restaurants don’t fail in the first year.
A 2014 study showed that about 17 percent of food-service businesses close within the first year. That’s lower than the average small business failure rate. In comparison, other service-based industries have a failure rate of about 19 percent in the first year.
About 70 percent of restaurants succeed through the second year in business. Approximately half survive five years.
In sum, the sectors with the highest five-year survival rates are:
- Agriculture and wholesaling
Those with the lowest include:
- Finance, real estate, and insurance
- Communications, utilities, and transportation
Why Do Some Small Businesses Fail?
In addition to understanding how many small businesses fail, you need to know why they fail. If you can pinpoint the reasons for the collapse, you can take preventative measures to avoid having those situations happen to you.
Although there is seldom one reason startups fail, you can detect specific patterns among small businesses that don’t make it.
1. No Market Need
While many resources cite a lack of startup capital as the number one reason that small businesses fail, the market’s need for a product or service is more influential. Even if you sell the highest quality product at the lowest price, you’ll have difficulty getting customers if nobody wants your offer. No market need accounts for 42 percent of small business failures.
2. Lack of Funds
About 29 percent of small businesses fail because they run out of cash. Most small business owners know exactly how much they must invest in supporting their businesses.
Operational costs include day-to-day expenses, such as payroll, utilities, and other overhead outlays. But you must also consider the startup costs, including financing fees, permitting, construction, design, and web development.
You might run short if you don’t bring in the sales you expect. Almost 30 percent of small business owners say they couldn’t access the funds necessary to operate their companies. Lack of capital can affect your business in the following ways:
- It can make it difficult for you to expand.
- It may force you to get rid of employees.
- It might leave you unable to pay for expenses associated with increased sales.
- It could compel you to cut employee benefits.
- It can impact your ability to buy new inventory.
Although 40 percent of small businesses may use a bank loan to finance their startup, about 77 percent of small business owners are rejected when they apply for loans at large banks. The rejection rate for small businesses that apply for loans through small banks is about 52 percent.
3. Your Team Isn’t Up to Par
It’s tough to start a small business alone. Having a supportive and capable team is vital to the growth and success of your business. About 23 percent of small businesses fail because they don’t have an adequate lineup of partners, managers, and employees.
Competition isn’t necessarily a bad thing. If you have competitors, you know that there is a need for your product or service in the marketplace. However, you must be aware of the landscape to stay above your competition. We offer some solutions for doing that below.
Pricing plays a significant role in the success or failure of a small business. Many believe that if they undercut their competitors, they’ll secure most of their target audience. But pricing isn’t a cut-and-dry equation. The right pricing structure holds a great deal of psychological pull.
Potential customers might miss the value if you price your products too low. If your prices are too high, your target market might shop elsewhere.
How to Avoid Failing a Small Business
Now that you know what contributes to small business failure, you can do something about it. Here are some tips for success.
1. Research Market Relevance and Need
Identifying whether the market needs what you offer is a critical part of business plan development. Even the best marketing and the highest budget can’t compensate for a lack of market relevance.
Market research before developing your business plan will help you determine whether your idea is viable. Once you’ve conducted the analysis, you can use it to secure financing. Lenders are aware of the business ideas that are successful in the marketplace. They’ll likely offer you financing options if your concept is lucrative.
2. Determine How Much Cash You Need
Experts say small business owners should have at least three to six months of working capital. Those funds will cover your operating expenses if you fall short on revenue. To play it safe, however, you should have a sufficient cushion in your working bank account to cover cash flow issues. Stock a contingency fund with three to six months of liquid cash, and don’t touch it if you don’t need to.
Determining how much liquid capital you need to launch a business requires some planning, research, and strategy. When you’re just starting a business, you may not have concrete numbers to work with. Therefore, you’ll have to do a lot of estimation.
Conduct cash-flow estimations for various scenarios. Calculate worst-case, best-case, and middle-of-the-road forecasts.
You can get realistic numbers by using the following resources to help you with your research:
- Entrepreneurs with established businesses in your industry – Network connections and mentoring can help you launch with knowledge.
- Suppliers – Shop around for the best prices.
- SCORE – This SBA-sponsored organization offers to counsel small business owners.
- Business startup guides – Look for those that offer tips for your industry.
- Franchise organizations – Ask existing franchises how well their numbers corresponded with the franchisor’s projections.
- Business consultants – If you can afford the cost, consultants can help you get organized and even do some research for you.
If a traditional bank rejects your application for financing, you’ll need to look into alternative lending sources. You might open a credit card, tap into your savings, work out an agreement with a family member, or raise funds through investors or crowdfunding.
3. Gather a Strong Team
The CEO or founder of a small business often gets their hands dirty with every task related to running the company at first. Operating in this manner can get exhausting.
Don’t be afraid to outsource the tasks that you don’t excel at or that take up much of your time. Even if you hire other people to do the dirty work, you’ll need to establish a strong management culture.
You have a better chance of succeeding if you hire the right people to take care of aspects of the business in which you fall short. You might need individuals to manage your accounting, human resources, or marketing. Be realistic about what you need, and allow for compensation in your startup budget.
4. Know Your Competitors
Many entrepreneurs skip a crucial step when they’re planning their business. They don’t research the competition. If you don’t believe that you have competitors, then you need to ask yourself two questions:
- Are you being realistic?
- Is there a market need for your product or service?
If you have no competitors, then people may not be itching to buy what you offer. More than likely, you have competitors, and you need to spend at least one-month performing competitive analysis.
You might recognize that you have competitors, but they’re not offering what your company offers. That doesn’t matter. You still need to know what your competition is doing. That way, you can craft your marketing and value proposition to set yourself apart.
Some tips for performing competitive analysis include:
- Identifying your competitors
- Examining their website, customer experience, strengths, and weaknesses
- Exploring what makes their product unique
- Subscribing to their newsletter and following their blogs and social media accounts
- Being aware of their pricing, including shipping costs
- Reading customer reviews
The bottom line when conducting competitive analysis is that you should be aware of what other businesses are doing but don’t get obsessed. You should devote most of your attention to your products, pricing, branding, and messaging.
5. Price Your Products and Services Correctly
Many factors go into setting the proper prices for your business. Many entrepreneurs get caught up in short-term cash flow issues and pricing plans. However, you have to look at the bigger picture.
Two essential equations you must understand are the cost of acquisition and the lifetime value of a customer. Once you work these numbers into your business plan, you can accurately price your products and services and create a marketing budget that fits your needs.
The Bottom Line
Even though opening a small business can be scary, you should know that more small businesses are opening than closing. Running a business is hard work, but you can succeed with the right preparation and mindset.