Small Business Failure Rates

I've seen plenty of small business and entrepreneurial-related websites People often cite the high failure rate of new small businesses, with upwards of 90% of them supposedly failing in the first five years. However, there are no credible studies to back up these statistics. I spoke with the Office Advocacy, U.S. Small Business Administration to uncover the truth about small business survival rates. warn potential entrepreneurs about the failure statistics of new small businesses. Many say that between 50-65% of them will fail during the first two years and 90-95% will fail within five years. I've conducted quite a bit of research and have never found a credible study indicating that 90-95% of all new businesses will fail within five years. What's more, I see these "statistics" tossed around a lot in small business and entrepreneurial forums, striking unnecessary fear into the hearts and minds of people who may be considering starting their own venture. Being the curious sort of guy that I am, I decided to uncover the facts by doing some digging. I began my investigation at the Office of Advocacy, U.S. Small Business Administration where by the way, they use the terms firm "birth" and "death" rather than failure.

In my conversation, the first thing I discovered is that it is important to distinguish between the two types of firms: employer and nonemployer. Employer firms have employees and nonemployer firms do not[1]. Most nonemployers are self-employed persons operating very small unincorporated businesses, which may or may not be the owner's principal source of income. Nonemployer businesses can be full- or part-time enterprises and can include ventures such an actor, a housewife doing bookkeeping a few hours a week, an engineer with a full-time position doing technical drawings on the side or someone who owns and operates his or her own retail shop, among many others. As an example, when things have been slow in my other lines of business, I've taken on consulting jobs here and there over the years. Like a lot of people who do projects such as these, I report the income on my tax return using my own social security number, which statistically makes me a nonemployer firm.

Employer firms are generally more complex than nonemployer firms. Since by definition an employer firm has at least one employee (which may or may not be the business' owner), they are more likely than a nonemployer firm to have a formal organizational structure and incorporated. As employees become involved and revenues rise it becomes increasingly necessary for the organization to adopt a formalized corporate structure. Interestingly, while employer firms account for the majority of receipts and payroll in the United States (97%), nonemployer firms are far more numerous (20.6 million versus 6 million)[2].

The second discovery was that failure is not always what it seems-particularly when discussing nonemployer firms. These enterprises tend to come and go at a much higher rate than employer firms but not necessarily because they are failing. Nonemployer ventures are more fluid than employer firms because many times they are project-oriented side jobs or something that is done while a person is between full time jobs. Hence, when a nonemployer firm ceases to operate it very well may not be because the person did not achieve the desired end but rather because the person did achieve the desired end and no longer has a need to operate the venture.

Say for example that I don't have time to take on any consulting jobs in 2008 because I'm too busy making money in my other businesses. Although my consulting business didn't fail, statistically it would still show up as a "death" because it ceased to exist in 2008 by virtue of the fact that I didn't accept any work. These types of closures-which aren't failures at all-are very common among nonemployer firms.

Even among employer firms, closure does not necessarily mean failure. Businesses often close for reasons other than economic failure. Our lives change-we get married and divorced, have kids, decided to move, we (or a loved one) develop health problems and all sorts of other things that may cause one to decide to close a business. Also, sometimes people don't realize the amount of time they have to devote to their business and decide to close for this reason.

A neighbor of mine had always wanted to own an ice cream store so one day she took the plunge and set up shop, becoming an instant success. In fact, her business became so successful that it required her attention 12-13 hours a day. After about a year she realized that this was not what she had envisioned so she decided to close. For whatever reason she didn't sell the business, she merely closed it. Shortly thereafter someone else opened an ice cream shop in the same location, where it continues to operate today. The point here is that the business closed, but it did not fail.

Now I'll get back to my discussion with the Office of Advocacy, U.S. Small Business Administration. According to their latest figures, approximately one-half of all new businesses will survive for at least five years, which is of course not anywhere near the dismal statistics that some people would have you believe. After five years, the survival rate jumps considerably. The moral of this story is that if you're considering starting your own business, a 50/50 chance of survival isn't that bad-those odds certainly don't seem to deter people from getting married. They key thing to remember is to do your homework, learn from others and do everything you can to make sure that the business you decide to start is part of the 50% that do survive.

[1] Self-employed owners of incorporated businessestypically pay themselves wages or salary, so that business is an "employer." As a result, nonemployer data do not include self-employed business owners with any paid employees (U.S. Census Bureau).

[2] Office of Advocacy, U.S. Small Business Administration