Have you heard that 90 percent of new businesses fail? Or that 50 percent of new businesses fail? Stick around in the entrepreneurial community long enough and you’ll likely hear a wide spectrum of claims, mostly falling between these two extremes.
But what is the true failure rate of small businesses? And should it influence your decisions as an entrepreneur?
According to data from the Bureau of Labor Statistics, as reported by Fundera, approximately 20 percent of small businesses fail within the first year. By the end of the second year, 30 percent of businesses will have failed. By the end of the fifth year, about half will have failed. And by the end of the decade, only 30 percent of businesses will remain — a 70 percent failure rate.
Of course, we have to accept several caveats in these data. Here are some common variables.
Some people wield small-business failure statistics as a tool for discouragement; they want to warn would-be entrepreneurs about the dangers of starting a business. But there’s a more useful way to study and learn from statistics like these.
For starters, the failure rate gives you an idea of how and when businesses tend to fail. Only 20 percent fail within the first year but 50 percent fail within the first five years. In other words, an additional 30 percent of businesses will fail between years 2 and 5, or about 7.5 percent of the initial amount per year. If we assume a kind of “death by natural causes” and take that 7.5 percent figure as a predictable rate of failure, we can assume about 12.5 percent of businesses in the first year fail due to lack of preparation in one way or another. If you’re better prepared than the bottom eighth of business owners, you’re in good shape.
This is also useful for calculating risk, especially if you apply this risk to your personal life. We tend to be optimistic when evaluating our own endeavors due to the overconfidence effect, but statistics can keep us realistic and pragmatic. If we assume a 20 percent failure possibility for our business in year 1, we should be distributing our investments and our time accordingly; we need to balance our risk profile to protect us in the event of failure.
I also want to acknowledge that whenever failure statistics are misrepresented, they’re usually inflated. In other words, people have a tendency to exaggerate the failure rate of small businesses. Why? It might be a conservative way to taper expectations, or it might play into the desire to discourage would-be entrepreneurs. Either way, we need to be cautious of people who confidently assert a trivial “truth” about business ownership.
Small businesses do fail somewhat often, to the point where you basically have a 50/50 shot of surviving past year 5. But it’s important to take statistics for what they are, to understand their context and to not allow them to unfairly discourage you from pursuing the development of your business.
Originally appeared in Entrepreneur