The Small Business Association (SBA) claims the failure rate of small businesses within two years is about 30%. While that’s a relatively high percentage, it’s more encouraging than some of the more alarming numbers you might hear regarding the rate of small business failures.
Why do so many small businesses fail — and how can your company avoid that?
There’s been a great deal of research on the failure rate of small businesses. Here’s what we know.
Top 3 Reasons Why Small Businesses Fail
Small businesses can tank for all sorts of reasons, most of which you’d expect. According to CB Insights, the top three reasons small businesses fail are:
- There’s no need in the market for the business’s product or service (42%)
- The business ran out of funds (29%)
- There’s a lack of proper team management (23%)
Other reasons for small business failures include:
- A lot of competition (19%)
- Pricing issues (18%)
- An undefined business model (17%)
- Poor marketing (14%)
- A loss of focus (13%)
In some cases, founders just lost their passion for the project and moved on to other, more lucrative pursuits (9%).
Who Needs Your Business Services or Products?
The fact that the No. 1 reason small businesses fail is due to a lack of need in the market shouldn’t be surprising. Who hasn’t had a great idea only to discover that it’s already been done?
At the other end of the spectrum is the concept of the “solution with no problem.” Just because you’ve developed a product you think is brilliant doesn’t mean other people will think so, too — no matter how much you spend on marketing.
Many Small Businesses Run Out of Funds
Running out of funds, the No. 2 reason small businesses fail, is perhaps one of the most challenging matters. Most entrepreneurs don’t have a truckload of cash lying around and obtaining funding can be a job in and of itself if you don’t know where to turn.
Obtaining Capital for Your Small Business
There are three main ways small business owners can get funds.
- Self-financing, either with money you’ve saved, personal equity, credit-card debt or from investments from friends and family.
- Many entrepreneurs seek funding through investors and by petitioning sponsors for venture capital. (While this is a popular method for gaining funding in the technology sector, it isn’t a viable option for most small businesses.)
- The third and most common way small businesses obtain funding is through a loan. Historically, most companies have obtained loans through banks. Unfortunately, the biggest banks approve 26.9% of small business loans. Small banks tend to approve more loans for small businesses (50.2%), but alternative lenders approve even more, at 56.7%.
How to Avoid Your Own Business Failure
According to one Forbes article (which cites a Bloomberg article), about 80% of entrepreneurs starting a small business fail within the first 18 months. Another report from Small Business Trends claims more than 50% of all small businesses fail after five years based on the Census Bureau’s Business Dynamics Statistics. Perhaps the most startling statistic, from USA Today, claims 1 in 5 new businesses (20%) survive past their first year of operation.
While there is some inherent risk in starting a small business and success is never guaranteed, some of these statistics aren’t backed by scientific studies. And those that are have issues, too.
The Small Business Association (SBA) claims the real failure rate of small businesses within two years is more like 30%. While that’s still a relatively high rate of failure, it’s more encouraging than some of the more alarming numbers you might hear as you start to launch your small business idea.
Avoiding Failure in Your First Year of Business
If you want to avoid business failure, you would do well to first address the three most common reasons: a lack of need in the market, poor management and a lack of funds.
Make Your Mark in Your Marketplace
Regarding need in the market for your product or service, it helps to do research before making any serious investments. Analyze your marketplace and identify any competitors. Check revenue figures in your category, both in your region and nationally. Is the market growing? If not, it may not support the introduction of a new product or service.
You also should try to find a niche. This can be challenging for new small businesses since it may feel like anyone with cash in their wallet is a potential customer.
The reality is, most people you think could be potential customers won’t be. Only those who have a genuine want or need for your idea will stick. Start with ideas that are proven, then narrow your focus as you learn more about your customers. Don’t hesitate to test your ideas and run surveys, either.
Assemble Your Team Smartly
Regarding your team and your management abilities, try to avoid common pitfalls.
- Put friends or family in leadership positions unless they have the skills to be there.
- Just hire for skill level; hire for soft skills as well. Your project manager may be a maverick in the coding language you need, but that doesn’t mean they have the skills necessary to manage a project from start to finish.
- Establish leadership positions from the beginning.
- Build your teams around professional relationships, and make sure you set some ground rules. Even if your business is small, even if it is family-operated, it’s important that everyone involved understands your core objectives and works toward them.
Fund Your Small Business the Smart Way
Be selective about how you finance and how you spend.
Just because you have a new business doesn’t mean you need a flashy new office with high rent. Many small businesses start in people’s living rooms and scale up as they grow, only accessing funding when they’re ready to make investments that will pay off in the future.
If you don’t have cash on hand to fund your business, you might consider a small business loan.