If you own a small business or are thinking of 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. Lots of 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 risk. 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.
Any entrepreneur who is 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 that you should get out before you even try. However, knowing the numbers can help you decide how to distribute your funds effectively so that you 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.
There are so many factors in play when you start a new business that it’s nearly impossible to calculate your exact odds of success. If everyone could do that, then almost every startup would be failsafe. But knowing the numbers can help you 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 have a better chance of succeeding than if you’re an entrepreneur in a low-survival field.
Health care is one of the top industries for small business growth. According to the Bureau of Labor and Statistics, the health care 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. If you can make it over that hump, this is a lucrative industry with high success rates.
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 failed. 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 that startups fail, you can detect specific patterns among small businesses that don’t make it.
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’re going to have a hard time getting customers if nobody wants what you’re offering. No market need accounts for 42 percent of small business failures.
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 need to invest to be able to support the business.
Operational costs include day-to-day expenses, such as payroll, utilities, and other overhead outlays. But you also have to take into account the startup costs, including financing fees, permitting, construction, design, and web development.
If you don’t bring in the sales that you expect, you might run short. Almost 30 percent of small business owners say that they couldn’t access the funds that were 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.
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 so that you can 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 people believe that if they undercut their competitors, they’ll secure the majority of their target audience. But pricing isn’t a cut-and-dry equation. The right pricing structure holds a great deal of psychological pull.
If you price your products too low, potential customers might miss the value. If your prices are too high, your target market might shop elsewhere.
How to Avoid Failing as 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.
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 make up for a lack of market relevance.
Doing market research before developing your business plan will help you know whether your idea is viable. Once you’ve conducted the analysis, you’ll be able to use it to secure financing. Lenders are aware of the business ideas that are successful in the marketplace. They’ll be more likely to offer you financing options if your concept is lucrative.
Determine How Much Cash You Need
Experts say that 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 counseling for 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 your application for financing is rejected by a traditional bank, 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.
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 take up a great deal of your time. Even if you hire other people to do the dirty work, though, 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.
Know Your Competitors
Many entrepreneurs skip a crucial step when they’re planning they’re 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 truly have no competitors, then people may not be itching to buy what you have to offer. More than likely, you do 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 still devote most of your attention to your own products, pricing, branding, and messaging.
Price Your Products and Services Correctly
There are many factors that 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 that 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 price your products and services accurately 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.