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Why the Small Business Failure Rate Is 90 Percent Smoke and Mirrors

In Uncategorized on September 16, 2010 at 12:23 pm

By Mark Henricks | September 2, 2010

You can’t read or talk about small business long before you run across it. If you haven’t heard it before, it could well rattle whatever resolve you have to go into business for yourself. Ninety percent of small businesses, you’ll learn, fail within one year of startup. Are you now thinking twice about refinancing the house and draining your retirement account to finance your startup? Oh, yeah.

However, without passing judgment on the specific prospects for whatever startup you are considering, if you listen to the 90 percent failure rate stat, you are probably making a mistake. It’s a myth, and far — very far — from the truth. No one seems to know where that factoid came from. We can say that, whatever it’s source, it’s flat wrong.

According to well-supported studies by reputable researchers, 70 percent of new firms that have at least one employee survive for at least two years. Roughly half go on for five years. That comes from the SBA, but other studies reached similar conclusions.

And even the 30 percent failure rate after one year may overstate the real risk of starting a small business. That’s because other studies have shown that most firms that close their doors were profitable at the time. They may have closed because the owner had health concerns or decided to do something else more personally interesting. They didn’t, most of the time, go broke.

Of course, risk is best considered relative to the alternatives. One alternative to starting a business is getting a job. And it turns out that going to work for someone else is roughly as likely to be short-lived as going to work for yourself. The Bureau of Labor Statistics looked at American workers’ average tenure on the job and found that, even when considering only more stable, older workers, 31 percent of the jobs they took ended in less than a year.  Not only that, but 65 percent of the jobs ended in fewer than 5 years. Whether you’re punching a clock or signing paychecks, it seems, the future is about equally uncertain.

Caution: Although the chances of a job ending may resemble those of a business closing, the impact of losing a job is likely to be less. You typically don’t liquidate your savings and personally guarantee a loan to start a job. If the job ends, you find a new one. You aren’t as likely to have to sell your house to pay off lenders, or file for bankruptcy, as if you started a business that didn’t work out.

Another qualifier: The SBA stats are for firms with at least one employee in addition to the owner. The agency’s researchers found that non-employer firms — people self-employed in one-person enterprises — tend to go in and out of business at much higher rates. That’s mostly because they are easier to start and stop, not necessarily because they are doomed to fail.

So next time you’re talking about business and hear the 90 percent-failure rate myth, feel free to nod and go along. As long as you know the truth, you have a competitive advantage against more gullible, more fearful and less well-informed would-be rivals.

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