Small Business Failure Rate: Why Do They Fail?

Written by SmartBiz Team | Jul 8, 2021 4:00:00 AM

It's often reported that more than half of small businesses fail during their first year in operation. However, Small Business Administration (SBA) data on business failure shows that only 20% of new businesses fail during their first year in operation, with this number increasing to 30% during the second year of operation.

From there, the failure rates increase. Businesses in operation five years have a 45% failure rate and 65% during the first 10. The SBA goes on to state that only 25% make it to 15 years or more. About 75% of U.S. venture-backed start-ups fail, according to Harvard Business School research.

The COVID-19 pandemic has exacerbated this situation for small businesses of all ages, and you’re probably familiar with many reasons why the pandemic has proven so devastating. Government-mandated closures and lockdowns, less consumer spending, high unemployment rates, consumers mostly staying home – it doesn’t paint a pretty picture for small business failure rates.

These labor statistics reflect all businesses in the private sector. Looking at the numbers industry by industry gives more information.

Why the COVID-19 Pandemic Is Causing More Business Failures

The COVID-19 pandemic has affected every aspect of what was once ordinary everyday life, so there’s no shortage of reasons why the pandemic has led to more business failures. The most significant of these reasons include:

Additional public health and safety demands. Retail locations and other businesses still open to the public have had to stock up on face masks, plexiglass dividers, and hand sanitizer, all of which were previously unexpected costs. For establishments with large teams or large amounts of space, these costs can prove especially prohibitive.
Hazard pay. Many employees have demanded hazard pay for in-person work during COVID-19, and some local governments have mandated this increased pay for several categories of employees. Many companies unable to pay their employees more than their pre-pandemic salaries have thus closed.
Government-mandated closures. State and local governments have often forced businesses considered non-essential to close their in-person locations. These companies, which include restaurants, bars, venues, and retail stores, thus lack the daily foot traffic vital to their sales. In turn, many such businesses have ceased their operations.
High unemployment rates. According to one study, the number of people not in the American workforce quadrupled from January 2020 to April 2020 (the month after COVID-19 began rapidly spreading in the U.S.). Employers are less productive when their workforces are diminished, which means lower output and thus fewer opportunities for revenue. The result is an increased likelihood of small business failure.
Less consumer spending and activity. The high unemployment and small business failure rates that have accompanied the pandemic have led to a chain effect of additional small business failures. Every business that fails leads to more unemployed people with no discretionary income, leaving fewer consumers who can buy from businesses. This means fewer revenue opportunities and more failure potential for small businesses.
Highly competitive government relief programs. Many applications for government COVID-19 relief programs such as the Paycheck Protection Program (PPP) never hear back. Additionally, the recently launched Shuttered Venue Operators Grant (SVOG) program temporarily went offline after technical difficulties. The resulting delay can be long enough that some applicants fail before learning their application’s fate.

Differences Between Pre-Pandemic and Pandemic-Era Failure

Before the COVID-19 pandemic, most small businesses failed due to poor practices around everyday business considerations such as hiring, marketing, product offerings, and competitor research. Amidst the pandemic, business failure instead stems from the tricky balance that businesses must strike among public safety, government intervention, hazard pay, and decreased consumer spending. These factors were mostly irrelevant before the pandemic.

Although the long-term impacts of these pandemic-era small business failures remain to be seen, short-term statistics have been concerning. A sample of 5,800 small businesses just after the pandemic’s outset found that 43% of respondents were temporarily closed. Between March and July 2020, 80,000 businesses closed. Small business failure rates for the entire pandemic rate are not yet available, though pre-pandemic rates remain helpful to know.

What Is the Business Failure Rate?

The small business failure rate increases as companies grow older. U.S. Bureau of Labor Statistics (BLS) business failure statistics show that small businesses of the below ages have the following average failure rates:

One year or younger: 20%
Two years or younger: 30%
Five years or younger: 45%
Ten years or younger: 65%

Of course, as with all general small business figures, these numbers paint a broad picture. That’s why it can be more meaningful to look at the small business failure rates for several industries.

Breakdown Per Industry

You can break down business failure more by looking at specific industries. The Bureau of Labor Statistics shows that health care and social assistance businesses also have high survival rates and growth projections.

For a breakdown of strong industries, review this slideshow from Entrepreneur: The 15 Most Profitable Small-Business Industries. Interested in what types of business you should avoid? Check out this article from The Balance: 7 Small Businesses You Don't Want to Start.

Why Businesses Fail

Starting a business can be risky but rewarding if done right. There are a multitude of things that can crush a business. A CBInsights analysis interviewed founders of 101 startup businesses that didn’t make it. Here are the top reasons they discovered for business failure.

42% of small businesses fail because there’s no market need for their services or products.
29% failed because they ran out of cash.
23% failed because they didn’t have the right team running the business.
19% were outcompeted.
18% failed because of pricing and cost issues.
17% failed because of a poor product offering.
17% failed because they lacked a business model.
14% failed because of poor marketing.
14% failed because they ignored their customers.

Small businesses may also fail for additional reasons, such as:

Hiring problems

Beyond the reasons outlined in the CBInsights survey, small businesses may fail if they don’t hire qualified employees. At first, you might think you can’t control your hiring abilities, but sometimes, poor employee hiring practices don’t reflect the talent pool or your job description. They can also be consequences of your company’s benefits and culture.

Think about it like this: If you don’t provide much in the way of vacation or other benefits, prospective employees have fewer reasons to take a job with you. As such, they may accept job offers elsewhere.

Let’s say someone to whom you extend a job offer does accept. If this new employee quickly discovers that your workplace is toxic, they may leave before they even truly get started. Whether you struggle with hiring due to a company culture issue such as this one or a poor benefits package, your employee retention – a statistic that correlates positively with better business – decreases.

Poor competitor research

Small businesses can also fail if they neglect to perform meaningful competitor research. Without conducting competitor research, you and your team may miss important insights into the reasons why people prefer other brands to yours. As such, you won’t have the knowledge you need to make product changes that attract these potential new customers.

Without performing competitor research, you might also miss obvious industry trends that you capitalize on with new products and services. Such missed opportunities can prove detrimental to your bottom line – every potential dollar you miss is a small step toward failure.

Startup-specific problems

According to a Failory survey of failed startups, the following are prominent reasons for failure:

34% failed due to a lack of product-market fit
22% failed due to marketing problems
18% failed due to team problems
16% failed due to financial problems
6% failed due to tech problems
2% failed due to operations problems
2% failed due to legal problems

Of course, no two startups are alike. Small business failure and survival rates vary significantly by industry.

Small Business Survival Rates by Industry

According to the aforementioned BLS data, healthcare and social assistance companies are the most likely small business successes. Only 15% of businesses in these fields fail within the first year, giving them a business survival rate of 85%. Within the second year, the business success rate in this industry decreases to 75%. After five years, the percentage of small businesses that survive is 60%.

This BLS data also shows that the most likely industries for failure are construction, warehousing, and transportation. 75% of small business owners in these sectors survive their first year, with this rate dropping to 65% after two years. After five years, only 35% of construction businesses and 40% of warehousing and transportation companies survive.

Of course, small businesses that fail exist in other industries too. Below are some first-year business failure statistics for other sectors:

Restaurants and food service: 15%
Real estate: 12%
Finance and insurance: 16.4%
Arts, entertainment, and recreation: 11.6%
Professional, scientific, and technical services: 19.4%

Regardless of sector, a 2019 Startup Genome report found that 11 in every 12 startups fail. This and the above statistics may seem concerning, but if you take certain steps, you may be more likely to avoid failure.

How to Avoid Business Failure

There’s not one tried and true way to keep a business thriving. But there are solid steps you can take to avoid becoming a sad statistic. These include.

Have a Business Plan: A well thought out business plan is the bedrock for business success. A business plan is a formal statement of goals, reasons they are attainable and plans for reaching them. Often, a business plan is required when applying for a small business loan. (Note: SmartBiz does not require a business plan when seeking an SBA loan).
Even if you’re already running a business, a business plan is a good idea. You don’t need to hire a professional. Check out this post for step-by-step instructions: How to Write a Business Plan for Your Small Business.
Build Your Credit: With less access to business credit, your cash flow can take a hit. And without cash flow, paying for basic expenses – payroll, inventory, equipment – becomes impossible. As such, failure becomes a more realistic prospect.
Keep Your Expenses Low: On the other hand, if your expenses are low, a lack of credit or cash flow may not prove that dangerous to your business. For example, if you’re trying to break into the ecommerce market, dropshipping may lessen your chances of failure as compared to other retail models since you’ll have no on-site inventory costs.
Utilize And Build Your Network: Like all things in life, you can’t go it alone in business.
That doesn’t just mean hiring employees – it means making connections in your industry. The more connections you have, the more likely you are to find trustworthy suppliers and high-paying new clients. You’ll also have access to vital business and industry knowledge you might not find elsewhere.
Train Employees Well: As mentioned earlier, poor employee hires provide a direct path toward business failure. You can avoid this trap by properly training your employees from the jump. The more prepared your employees are to handle the everyday demands of your job, the higher your productivity and thus revenue. And if you’re keeping your costs low as well, higher revenue more quickly leads to more profit.
Know Your Industry: Have you done research? You’ll need to know the ins and outs of your industry to carve out your unique niche. BPlans has a comprehensive article outlining how to do an industry analysis: Know Your Industry Before You Start Your Business.
Get a Loan: Taking on debt might not sound like a solid business strategy. However, low-cost funds can help strengthen your business in a number of ways. A popular use of a loan is to refinance or pay off high cost debt. This can drastically reduce your monthly obligations, putting you in a stronger financial position. Loans can also be used for a number of business building initiatives like hiring, equipment purchases, buying inventory, increasing marketing and more.
If you’ve been in business two or more years and have good credit, consider an SBA loan. With low rates, long terms, very low monthly payments, and no pre-payment penalties, SBA loans are known as the “gold standard”. Visit the SmartBiz Loans website to discover if you’re prequalified with no impact on your credit score. For a list of documents you’ll need to apply, visit the SmartBiz Small Business Blog: Application for a Business Loan: What You Will Need.

In Conclusion

Have you had a business failure? The good news is that you're more likely to succeed if you've failed than if you've never tried. Entrepreneurs who have failed at a prior business have a 20% chance of succeeding versus an 18% chance of success for first time business owners.

As Thomas Edison famously said, “I have not failed. I've just found 10,000 ways that won't work.” Entrepreneurs learn from failure and can come out the other side stronger and ready for their next venture.

That said, failure should never be the end goal – and if you follow the steps listed in this guide, you should be in good shape to avoid failure. If you believe in your products and services and reckon with all the potential pros and cons of your business, survival should be realistic for you and your team. So don’t be afraid to start your dream business – there are ways you can make it last.

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