Key Reasons Why Small Businesses Fail

Key Reasons Why Small Businesses Fail

Commissioned by liB-Business Support Americas

Submitted By Silas Titus

Accredited Associate of The Institute for Independent Business

Introduction

The significant role of small business in the U.S. economy suggests that an understanding

of why small businesses fail (or are successful) is crucial to the stability and health of the

U.S. economy. For this discussion we will define Small Business1to be an enterprise that

is independently owned and operated for profie that is not dominant in its industry.

It is widely agreed that the growth of small businesses contributes greatly to the nation's

economic expansion. Entrepreneurship is linked to creation of jobs, increases in

productivity, and improvements of living standards, and to economic growth in the

United States in general3. Small businesses help create new jobs, introduce new products

and provide specialized expertise to large corporations. Small firms represent about 99

percent of employers, employ about half of the private sector workforce and are

responsible for about two-thirds to three-quarters of the net new jobs4.

Unfortunately, according to the U.S. Small Business Administration, over 50% of small

businesses fail in the first year and 95% fail within the first five years5• "Businesses with

fewer than 20 employees have only a 37% chance of surviving four years (of business)

and only a 9% chance of surviving 10 years", reports Dun & Bradstreet and of these

failed businesses, only 10% of them close involuntarily due to bankruptcy and the

remaining 90% close because the business was not successful, did not provide the level

of income desired, or was too weak to continue6.

The purpose of this paper is to better understand why small businesses fail and how those

causes can be avoided. At the end, a framework is presented to evaluate the existing

resources and understand their influence on the factors of failure from a firm level. The

intent is that this is one way that will promote adoption of necessary preventive measures

and a plan of action to avoid such failures.

1 The Office of Advocacy often defines a small firm as one with fewer than 500 employees. Industry

definitions are available from SBA's Office of Size Standards (www.sba.gov/size).

2 U.S. Small Business Administration, "Frequently Asked Questions," 2003.

http://www .sba.gov/ advo/ stats/ sbfaq .html

3 Baumol, W.J, 1993, Entrepreneurship, management and the structure of payoffs, Cambridge. MA:MIT

Press

4 Small Business Economic indicators, Office of Small Business Advocacy, US Small Business

Administration, Washington D.C, June 2003( Available from www.sba.gov)

5 Small Business Economic indicators, Office of Small Business Advocacy, US Small Business

Administration, Washington D.C, June 2003( Available from www.sba.gov)

6 "Some of the Reasons Why Business Fail and How to Avoid Them," Entrepreneur Weekly, Issue 36,

3-10-96.

What is business failure?

Some conclude that a business failure occurs only when a firm files for some form of

bankruptcy protection while others contend that there are numerous forms of

"organizational death," including merger or acquisition7. Still others argue that failure

occurs if the firm fails to meet its responsibilities to the stakeholders of the organization,

including employees, suppliers, customers and owners.

From a theoretical standpoint, entrepreneurial process is defined as the set of activities

through which innovations change existing combinations of factors of production. The

most widely recognized sources of inspiration for an entrepreneur are market efficiencies

and technological process8. From this viewpoint, a business failure is the termination of

an entrepreneurial initiative that has fallen short of its goals.

Every business has a life span that is depicted by its business life cycle. A business life

cycle is normally defined by four stages; Introduction, Growth, Maturity and Decline.

Most business life cycles will experience a slow introduction and growth stage, a short

maturity stage and a rather quick decline stage. Some studies discuss business failures as

being the last stage of an organization's life cycle9.

Losses that entail one's own capital or someone else's, or any forn1 of capital reduces the

rate of business continuancelO• A business that is not earning an adequate return (or is not

meeting owner's objectives) may discontinue existence. Personal reasons such as

retirement, illness, death of the owner or selling the business to make a profit accounted

for 30% of discontinuance ofbusinessesll 12. In the context of this paper, business

failure

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