Before we talk about small business failure rates, let’s try to understand the small business profile. This information has been gathered from a host of sources, most notably the U.S. Department of Commerce, Bureau of Census.
Small Business Failure Statistics
Here are the statistics that are of importance when analyzing the reasons for small business failure.
- Family owned: 28.2%
- Owned by founder: 77%
- Purchased from others: 20%
- Inherited: 2.4%
Small business failure rate:
- Year 1: 85%
- Year 2: 70%
- Year 3: 62%
- Year 4: 55%
- Slowly reducing to 35% failure rate after 10 years.
From these very simple statistics we can begin to appreciate some of the causes of small business failure. Firstly, a full 57% generate revenue of less than $25,000 per annum. This is revenue, not profit. A traditional small business will generate approximately a 33% margin, once fixed a variable overheads are taken into account. This results in a profit of perhaps $8 to 9,000; hardly enough to get by on, let alone call a business. With returns such as this, it may be suggested that the business owner is working way below minimum wage, however, there are many small home based businesses that are kept alive, simply to give the owner an activity.
The greatest majority of small businesses are in the hands of the founder, or the founder and his family. They often do not have employees so the impacts they have on employment statistics are negligent.
Effects of a high small business failure rate
The most damming number is the small business failure rate statistics. With 85% failing in the first year and even after 10 years the failure rate is still close to 33%. Why is this? We know that small business plays an important role in serving the needs of our society, why do they fail?
The most prevalent reasons are lack of business experience, poor planning and under capitalization. These core reasons are all interdependent on one another and if one fails, the whole thing fails.
Of the business failures, very few close their doors as a result of bankruptcy. Of the 85% that fail in the first year, only a bit over 6% of them file for bankruptcy protection, the balance, which is by far the majority, simply closes their doors.
The small business failure rate 2012 is not yet available, but if the 2011 trend continues, the prognosis is not good. There is a marked difference in small business failure rates in different parts of the country. The westernmost states, California, Hawaii, Oregon, Washington and New Mexico saw an overall INCREASE in small business failure of as much as 149% between 2007 and 2011. This drastic increase in failure rates has been driven by the continued instability in the housing market and the decline in tourism.
Conversely, the eastern states and the upper Midwest have the greatest DECLINE in failure rates, with Mississippi chalking up an impressive 37% decline in failure rates. Whether this improvement will continue is anybody’s guess at the moment. With the number of natural disasters in the state, there could be negative movement.
Reasons for small business failure
Let’s go back and continue with our analysis of the reasons for small business failure. We have already mentioned lack of business experience, poor planning and under capitalization. What else can lead to a small business failure?
If your small business is selling to the general public, a poor location can be a death warrant. Many small businesses rely on walk by traffic. They establish themselves by creating impressive store fronts and signage. This investment is of no value if there is no traffic. Traffic is found in malls and on main thoroughfares, but the cost of rental and rates can be excessive.
Poor inventory management can be a fault. If the inventory level does not meet demand the small business owner can find himself stock rich and cash poor. An investment in fixed assets that is too great for the enterprises purpose can be a contributor, as can poor credit arrangements, personal use of the business funds, unexpected growth, competition and lower than anticipated sales.
Small business failure statistics will point out that a well thought out business plan will result in a business that is twice as likely to grow and prosper as a business with no plan. A business plan forces the entrepreneur to take a good hard look at his ideas. You must not build a business plan that complements your idealistic vision of success. A business plan must be brutally hard, it must come as close to the truth as humanly possible. If your plan, after serious critique still looks doable, then off you go. A great business plan that has built under these rules will also aid immeasurably in the event you wish to secure capital.
small business failure stories
Knowing what we now know about small business failure percentage, let’s turn our attention to a selection of small business failure stories.
Alison Kero opened a personal assistance and concierge business in downtown Manhattan in 2004. Four years later it was at its peak during the summer of 2008. Ms. Kero was running flat out handling tasks for anybody from busy housewives to Wall Street hedge fund managers. We all know what happened next, the bottom fell out of home prices and the market collapsed. By this time Ms. Kero had invested heavily in advertising that was singing its song to an empty choir loft. Her declining business began to frustrate her and eventually she had enough and packed the business in. When asked why she closed up shop she stated, “I know now that I did not love what I was doing.”
You must love your business, you must be dedicated to your business and you must be ready to ride out the rough times.
Richard Barbis founded an architectural firm in Oregon. It opened its doors in 1996 and closed in Feb of 2009. In 2008 the company was doing well, six employees and a backlog exceeding two years. The bulk of the company’s work was in the private sector as opposed to government work which was financed with bail-out money. As his private sector target market was now the target for competitors, his work load shrank and eventually dried up all together. His analysis of the failure was, “we were hit from all sides.”
Do not put all your eggs in one basket. It is important to take on work from different sectors. In the event one sector recedes, there will still be work on the books.
There are as many horror stories as there are minutes in the day. Even with the best of planning, some failures could never have been avoided. With a well written plan, and a keen eye on detail and an ever watchful eye on cash, many disasters can be avoided. Yes, business is risky, but one can mitigate the risk by learning from the mistakes of others and by having a full grasp of all the pertinent business fundamentals.
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