Of all the new businesses launched in the US, around 20% of them will fail after one year. Worse, about 50% will fail after four years.
Of all the new businesses launched in the US, around 20% of them will fail after one year. Worse, about 50% will fail after four years.
The biggest reasons behind a business shutdown include a lack of a market, bad hires, and one issue we can all relate to — not having enough money. Global pandemics are a lot higher on the list than they were in 2019, too.
You can't guarantee that your own business will stay alive, but knowing the risks goes a long way towards keeping your enterprise safe. Here are all the insights to know about startups going belly up.
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The US Bureau of Labor Statistics has tracked the nation's new business launches year over year since 1994. That quarter-century of data has revealed a lot of insights about just how long a new business tends to last, as well as which industries do better than the rest.
Here are the key stats, from the US Bureau of Labor Statistics as well as other sources:
One interesting takeaway is that the rate of failure begins to slow soon after the first four years, but it doesn't go away. By the time a business is two decades old, only about 20% of the businesses in its initial cohort will still be around. In other words, for every five startups that launch, one of them will be dead within one year and three others will be gone after 20 years.
Certain industries are easier to survive in than others. Healthcare and social assistance fare the best as a category, while the construction industry sees the worst survival rates over time. Of all businesses launched in those two industry categories in 2004, for example, 56.9% of healthcare and social assistance businesses remained five years later compared to just 40.8% of construction businesses.
Similar breakdowns for other industries are hard to come by. One source from 2016 compiled this table of business failure rates by industry, using a retention rate that looked at how many businesses were still standing four years after they first started up:
The main takeaway here is that the first few years are the hardest. Business failures happen fast in the early years, and only begin to level off after the first four years.
Failures still occur steadily and can happen at any point in an operation's existence, but they're particularly concentrated in the first half a decade. If you're launching a startup yourself, you'll want to establish a great five-year plan, and be willing to adapt it when needed.
While it's not an issue that we expect to be recurring, the impact of the coronavirus pandemic on startup success is worth mentioning. 1.6 million US establishments (19% of them) were mandated to close temporarily during the pandemic, according to the U.S. Bureau of Labor Statistics, while 4.7 million (56%) saw a drop in demand for their products or services.
The biggest losers were the airplane industry (76% establishments saw decreased demand), hotels and food services (71%) and “mining, quarrying, and oil and gas extraction,” of which 70% of establishments reported a drop in demand due to the pandemic.
But what about permanent failures? According to one Federal Reserve study looking over the initial year of the pandemic, 200,000 more US establishments permanently closed between March 2020 and February 2021 than is typical, a jump of 25% up from the norm. Barber shops, nail salons, and other in-person services were the hardest hit.
While business exits were between one third and one quarter more than normal during this period, this news is actually better than many were predicting. Still, we might see more closures in the next year, the report warns, as credit bills and rent deferrals come due.
A huge range of factors can contribute to a business's failure, and not all of them can be controlled. But what can a new business owner do to keep themselves out of the half of startups that flop in the first four years, and into the half that succeeds?
Business analytics company CB Insights conducts studies on the most common reasons behind startup failures. They've released two or three updates each year since 2014, so they've stayed on top of the matter.
Here, we'll take a look at their definitive ranking of the top reasons why a business fails, throwing in case studies and additional data when needed. And don't worry — we'll let you know what your business can do to dodge the most likely threats.
Here are the top six most common reasons startups fail:
The biggest reason a startup fails? Poor market fit. This factor was cited as a concern for a huge 42% of business closures, CB Insights found.
A startup might be delivering a cool answer to a problem, but if the problem isn't affecting a large enough group of potential customers, that business won't have a market needed to exist.
The takeaway: Make something that people need and can't get. Your handcrafted reusable grocery bags might look nice, but if your customers already have a burlap sack that does the job, you won't sell yours. If your current product or service isn't solving a genuine problem, your business won't grow and retain customers.
And even if commercial success is in sight, it might be too far away. That's the stated reason for one of the biggest startup flops in recent memory, Alphabet's “Loon,” which aimed to bring global internet access via balloons. Despite a total of $125 million in disclosed funding, Loon shuttered in January 2021.
“Despite the team’s groundbreaking technical achievements over the last nine years, the road to commercial viability has proven much longer and riskier than hoped,” Astro Teller, head of X Lab, told the Financial Times.
This dovetails with the second most common reason why startups bite the bullet: Running out of money.
Getting a business off the ground is a grueling process that inevitably takes years. Even if everything's moving along relatively quickly, a business can run out of the money it needs to reach profitability. Nearly one in three startups- to be specific, 29% of failed businesses- cited a lack of cash as a contributing factor, according to CB Insights.
That number may even be undershooting, as research from U.S. Bank found that 82% of failed small businesses went under due to either “poor cash flow management skills” or “poor understanding of cash flow.” Granted, that's a wide spread between studies, but both of these results agree that a dwindling cashflow is one of the biggest reasons behind a company's failure.
In a separate but related category, CB Insights notes that 18% of failures are tied to pricing problems, in which products or services are priced too high to sell well or too low to make a profit.
In some cases, a business might have ambitions higher than it can deliver at a reasonable pace, like every failed Kickstarter aimed at creating a holographic display or a swarm of autonomous nano drones. In other cases, the market just isn't as hot as expected or the ROI on the marketing campaigns is a few percentage points lower that it needed to be. And maybe that flashy new corner office or company VoIP system wasn't needed in the budget.
The takeaway: Budget carefully and tighten your belt when you can. Categorize everything and benchmark your spending against similar businesses in your industry.
A company is only as good as its employees. Startups can pivot away from their original plan, but they can't pivot away from their team. And hiring the right people is a particularly big deal for a startup, thanks to its small size. If two founders have operated the entire company, than their new hire makes up a full third of their entire employee base.
23% of business flops fail because they can't put together the right team, CB Insights found, making it the third biggest reason for a failure to launch.
Common reasons for poor hiring practices include going with emotional or “gut” instincts rather than a checklist, a bias towards technical competence above community and team compatibility, and failures to catch embellishments or lies from candidates.
The takeaway: Consider working with a great hiring firm, or at the least sink a lot of time into figuring out the hiring process for your business. Above all, don't just hire for a “culture fit,” as this will bias you towards new hires with the exact same blind spots as your existing team. You want a culture add-on, who brings a new experience and skillset.
Your business might be good, but if your competition gets the edge, you'll still lose out. 19% of business failures are due in part to getting out-competed, CB Insights found.
Additional contributing forces are similar, like the 13% whose product was mistimed or the 13% who lost focus. In both cases, competitors gained ground due to missteps from businesses serving the same customer base.
Venture-backed companies are particularly vulnerable to this tripwire. Smart device company Jawbone fell to this issue: The $3 billion startup sucked up $930M in total funding across 17 years, but it still folded, liquidating its assets back in July 2017. The company sold fitness trackers and wireless speakers, but wasn't able to capture a large enough market share in the industry to satisfy shareholders.
The takeaway: Okay, the takeaway here isn't quite as clear as you might want. The truth is, you can't really affect how good your competition is. You can just work as hard as you can at being better, across a variety of areas. Time your products correctly for the market and stay focused rather than trying to do everything for everyone.
Another common pitfall is the lack of a business model, an issue affecting 17% of failed startups by CB Insights' count. Staying flexible about your business plan is good. Never having a plan at all? Very bad.
While it's tough to get people to speak on the record about a poor business plan, one case study to consider may be the downfall of Beepi, a used car marketplace that shuttered in February 2017.
“They were running the business to raise money, and then to get someone else to take it on,” an anonymous source told TechCrunch.
Business plan lapses come in plenty of shapes and sizes aside from the purely monetary ones, however. Common issues include failure to adapt to the market and a failure to set up a generous employee payroll. Interestingly, another potential problem is the inverse of poor hiring practices — some businesses don't come up with an exit plan for getting rid of shiftless cofounders.
The takeaway: Plan out your business model, taking into account any common failure points that may trip you up. And, as you progress, keep updating it to address the most recent data on how your company is doing. Remember, those first few years can be brutal.
One final common reason behind the typical startup failure is a poor marketing plan, cited by CB Insights as impacting 14% of business failures.
Data virtualization startup Primary Data whipped up $100 million in equity and debt before shutting down in 2018 anyway. Its tech was “never quite as compelling as it needed to be,” given that it was selling “mission-critical” software, it was reported at the time. This ties into another common problem, a business with a user unfriendly product. And the company's burn rate wasn't great, either, so they didn't have a lot going for them.
Some founders are great at building a product, but not at selling it. Still, all your expertise in coding or manufacturing can't replace a good focus group. You'll need to know how to convert a target audience into leads, and leads into customers.
The takeaway: Don't skimp on a marketing budget. Every aspect of running a business is important, and the world's best product-market fit won't mean much if you can't get your audience in the door.
Business markets, cashflow, hiring, competition, plans and marketing: They're all common reasons why startups fail. They're hard to do right, and no quick checklist of potential mistakes will save you. But that challenge is just why entrepreneurs love the game.
In the end, we can't singlehandedly save your business with this article. But we can give you a sense of what issues are the biggest ones for you to watch out for. Finding a market fit is key, as is keeping your budget balanced, and hiring the best talent will pay off in dividends.
Most importantly, those first four years are the worst. If you can survive them, you're already ahead of half your competition, and that counts for a lot.
Source: The Statistic Brain Research institute
http://tech.co/startup-failure-rates-industry-2016-01
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