Business failures are more common than people think. An average of 1-in-5 businesses fail within the first year, and this figure rises greatly each year for the first five years.
Why do small businesses fail?
Businesses face a lot of challenges that are often overlooked during their founding. Learning these issues early on and doing everything to protect against them is a good first step in remaining in operation for years to come.
Key Takeaways:
- 23.2% of new U.S. businesses fail within the first year, 48% by year five, and 65.3% by year ten.
- Up to 82% of small businesses fail due to poor financial management and cash flow issues.
- Inflation rates, like 8.5% last year, are a key factor in why most small businesses fail, as they increase costs and reduce consumer spending.
- Cash flow software for small businesses can help manage finances and prevent cash flow problems.
Percentage of small business that fail in the USA
Recent data indicates that 23.2% of businesses launched in March 2022 folded within their first year. So, what causes small businesses to fail?
A big culprit is inflation. March saw inflation tick up to 5.0% and last year, it hit a jaw-dropping 8.5%, putting serious pressure on businesses.
| Percentage of businesses that fail | When the businesses fail |
|---|---|
| 23.2% | Within 1 year |
| 32.8% | After 2 years |
| 36.2% | After 3 years |
| 43.2% | After 4 years |
| 48.0% | After 5 years |
| 52.9% | After 6 years |
| 56.6% | After 7 years |
| 59.6% | After 8 years |
| 62.2% | After 9 years |
| 65.3% | After 10 years |
Source: LendingTree
Getting through the first year is just the start of the journey. By the time you hit the five-year mark, about 48% of new ventures will have already shut down. And if you’re still around after a decade, there’s a 65.3% chance you might face the end.
It’s a tough road, but understanding the reasons small businesses close is the first step for long-term success.
Industries with the highest failure rates
Some industries have a tougher time staying in business than others. The transportation and warehousing sector leads with a 24.8% failure rate for first-year businesses. This high-risk sector includes trucking, taxis, air, rail, pipeline transport, postal services, and warehousing.
The information sector, encompassing film, publishing, telecom, and data processing, has the highest five-year failure rate at 55.7%.
| Industry | Failure rate within 1 year | Failure rate after 5 years | Failure rate after 10 years |
|---|---|---|---|
| Wholesale trade | 18.7% | 49.3% | 69.9% |
| Utilities | 19.6% | 42.5% | 54.3% |
| Transportation and warehousing | 24.8% | 48.4% | 66.0% |
| Retail trade | 12.9% | 40.2% | 58.3% |
| Real estate and rental and leasing | 17.8% | 40.8% | 57.8% |
| Professional, scientific and technical services | 22.2% | 49.8% | 69.1% |
| Other services (except public administration) | 15.6% | 41.3% | 60.4% |
| Mining, quarrying, and oil and gas extraction | 24.4% | 55.4% | 75.5% |
| Manufacturing | 17.6% | 42.4% | 56.4% |
| Management of companies and enterprises | 20.0% | 49.3% | 67.0% |
Source: LendingTree
Retail, on the other hand, boasts the lowest one-year failure rate at 12.9%, possibly due to a rebound in consumer activity post-pandemic.
For long-term survival, agriculture, forestry, fishing, and hunting show the lowest failure rates after five (34.8%) and ten years (49.5%), likely due to their essential role in providing food and resources.
The Challenge of Small Business Failures
To stop potential failure, you have to start asking yourself: Why do small businesses fail within the first 5 years?
Every entrepreneur needs to be cognizant of the challenges ahead or have a management team that is.
Knowing the reasons for the failure of small businesses can guide you in implementing effective strategies and avoiding potential pitfalls.
Let’s look into the 10 reasons why small businesses fail:
1. Lack of Proper Planning
Comprehensive business plans are more important than owners assume. These plans are often used to obtain funding, yet they allow you to have the in-depth planning in place to succeed in the industry.
How?
Business plans lower the risk of business failures by allowing you to plan for the following:
- Market analysis
- Market strategy
- Marketing plans
- Sales plans
- Description of products and services
- Operating plans
- Financial projections
- Much more
Projections are one of the components that enlighten owners about the potential of their business and allow them to develop a roadmap of success for the business. If you don’t have one already, begin creating your business plan to reveal insights that you may have otherwise overlooked. Remember, lack of proper planning is the most common reason why small businesses fail.
2. Inadequate Financial Management
One major reason why small businesses fail to grow is poor financial management. Small businesses are on a limited budget and do not have the massive amount of funding that Fortune 500 companies can offer to their subsidies.
Common issues in financial management include:
- Poor budgeting, leading to overspending
- Inadequate cash flow management, leading to struggling cash reserves
- High amounts of debt
Cash flow remains the single largest factor in business failure. SCORE reports that 82% of companies fail due to cash flow problems. If you lack adequate cash flow, you’ll:
- Accumulate higher debt
- Struggle to pay debts
If you cut back on expenses or find other forms of funding at low interest rates, you’ll have an easier time maintaining healthy cash reserves. Even better, leverage financial consolidation software to get a comprehensive overview of your finances so that you can track and manage cash flow more effectively.
Otherwise, if cash flow is low, you won’t have the liquidity to pay for supplies, make payroll and satisfy debts. The end result? A failed business that has insurmountable debt.
3. Insufficient Market Demand
You love your product or service idea, but does everyone else? Is there demand in the market for what you want to offer? Some of the most cutting-edge solutions never made it past the prototype and initial supply phase because the market just wasn’t ready to embrace them.
You can avoid this fate by:
- Assessing customer needs on a local and much wider scale
- Analyze the competition and your potential to take market share
- Validate the business idea
Unfortunately, it’s not enough to assume your 1-in-a-million idea is going to be successful. To understand why do some small businesses fail, in-depth market research and surveys must be performed.
Additionally, using sales forecasting software can help you predict future demand and make more informed decisions about your product’s market potential.
4. Weak Marketing and Branding Strategies
Even with high demand and interest in a market, you need to focus on marketing and branding if you don’t want to experience small business failure. The concept of “build it and they will come” is one that only happens in movies.
You need to:
- Create a clear value proposition
- Focus on consistent messaging and branding
- Promote your business on the right marketing channels
Targeted marketing strategies with a high return on investment are ideal, and a lot of resources must go into the process to reach your target audience.
If a marketing strategy doesn’t work adequately and meet your KPIs, you need to know when to abandon it. Analyzing the causes of small business failure can provide crucial insights into why your strategy fell short and how to prevent similar issues in the future.
5. Ineffective Leadership and Management
Leadership and management are crucial skills to have as an entrepreneur. Steve Jobs was an amazing leader with the pizazz to convey ideas to the world that were exciting and innovative.
However, he was just one part of the team.
Strong leaders like Jobs knew how to:
- Make impactful decisions to grow the business
- Change with the market conditions
- Delegate
The mistakes leaders make, such as micromanaging and ineffective communication, contribute to why do most small businesses fail.
6. Competitive Landscape and Industry Changes
One of the big reasons why small businesses fail is that they don’t adapt to industry changes to stay ahead of the competition. To understand why do so many small businesses fail, it’s crucial to recognize the need for continuous innovation and flexibility in response to market trends.
Some small business owners also make the mistake of getting into markets that are highly competitive and have more established, larger competitors. Entering and succeeding in saturated markets can be very challenging, particularly if you don’t have a strong unique selling point.
Entering into an industry that’s constantly evolving can also be challenging and lead to failure if you don’t adapt to it. It’s crucial to ensure your business is agile and able to adapt to changes and the landscape shifts.
7. Lack of Persistence and Resilience
Just like in life, things rarely go smoothly or as planned in business. Every business owner faces setbacks and challenges.
But one of the most overlooked reasons for failure of small business is that owners don’t have perseverance or resilience.
It’s okay to have setbacks. In fact, these are opportunities for learning and growth. Don’t let them deter you and keep you from pushing forward to your goal.
Steve Jobs faced failure, but he didn’t let that stop him from achieving his goals. He pushed for the development of the Apple Lisa and Apple I, two products that failed miserably. Apple was unable to recoup the millions of dollars they invested in these products, so Jobs was ousted from the company he helped found.
In 1997, he found his way back to Apple, took the helm and helped drive the company to what it is today: a household name.
If Steve Jobs faced failure, then you undoubtedly will at some point. Learn from these mistakes, adapt your strategy and keep a positive mindset.
8. Failure to Understand Legal and Regulatory Requirements
Navigating the legal landscape can be tricky, but ignoring it altogether can be a recipe for disaster. Many small businesses fail to recognize the importance of being compliant with regulations—whether it’s local zoning laws, proper licensing, or health and safety standards. Non-compliance can result in fines, legal battles, or worse, shutting down.
9. Poor Customer Service and Experience
In a world where every customer interaction counts, falling short on service can spell disaster for small businesses. Too often, businesses overlook the importance of relationship-building, which can lead to a vicious cycle of bad reviews and lost customers.
Make sure every employee knows how to go the extra mile. Regular training can help turn good service into exceptional service, creating memorable experiences that keep customers coming back.
10. Overdependence on a Single Revenue Stream or Client
When a small business gets too cozy with one big client or one main revenue stream, it’s setting itself up for a potential disaster. What happens if that client cuts the cord or your core product goes out of style?
The smart move– diversify. Consider adding new products or services to your lineup that cater to different customer needs or market segments.
Conclusion
Businesses can fail for a number of reasons, from lack of planning to poor financial management, lack of market demand, weak branding, ineffective leadership, shifting markets and lack of resilience.
Businesses must engage in proper planning and brand building to achieve their objectives and attract new customers. Addressing the challenges above can help businesses improve their chances of success. To avoid these common pitfalls, seek out the help and support of professionals and use the tools at your disposal to keep your plans and finances in check.
Tools like Cash Flow Frog, a top-rated cash flow software for small businesses, offer invaluable assistance in managing your financial operations.
FAQ
What is the failure rate for new businesses within the first year and subsequent years?
About 23.2% of new businesses fail within their first year. This rate rises to 48.0% by the five-year mark. After ten years, the failure rate is 65.3%.
What are the most common reasons why small businesses fail?
The top reasons why small businesses fail include inadequate planning, poor financial management (especially cash flow issues), insufficient market demand, weak marketing strategies, ineffective leadership, and failure to adapt to industry changes.
Which industries have the highest failure rates for new businesses?
Industries with high failure rates include Transportation and Warehousing (24.8% in the first year), Mining and Oil Extraction (24.4% in the first year), and Information Sector (24.1% in the first year).
How to address common factors that lead to the failure of a small business and increase chances of success?
To succeed, businesses should create a detailed business plan, manage finances carefully, diversify revenue streams, invest in effective marketing and branding, and adapt to market changes.
Guard Your Business Against Failure
Take control of your cash flow now! Use our projection tool to anticipate financial challenges and keep your business thriving.
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