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Why Your Startup Can Fail After Year Five – And How To Prevent That From Happening

There’s a mantra that’s all too commonly repeated in the small business sector – the notion that upwards of 80% of businesses fail, usually within the first year. It’s an intimidating figure; one that drives home the difficulty of success as an entrepreneur.

It’s also woefully inaccurate.

“As far as we can tell,” writes Glenn Kessler of The Washington Post, “there is no statistical basis for the assertion that 9 out of 10 businesses fail.

It appears to be one of those nonsense facts that people repeat without thinking too clearly about it.”

The problem is that everyone seems to have a different idea of what constitutes failure.

If a business doesn’t return on the initial investment made by venture capitalists, but otherwise manages to stay afloat, has it failed? If a company ends up being acquired or absorbed by another organization, is that failure? If a startup doesn’t meet one of its projected goals, is it dead in the water?

“About three-quarters of venture-backed firms in the US don’t return investor’s capital, according to recent research by Shikhar Ghosh, a senior lecturer at Harvard Business School,” writes Deborah Gage of The Wall Street Journal. “His findings are based on data from more than 2,000 companies that received venture funding from 2004 through 2010.”

“There are also different definitions of failure,” Gage acknowledges. “If failure means liquidating all assets, with investors losing all their money, an estimated 30% to 40% of high potential U.S. startups fail, he says. If failure is defined as failing to see the projected return on investment—say, a specific revenue growth rate or date to break even on cash flow—then more than 95% of start-ups fail, based on Mr. Ghosh’s research.”

Not only that, notes Kessler, different industries have different failure rates. A startup in the home computing sector, for example is going to be dealing with different challenges than one involved with manufacturing; one is going to be either more or less likely to fail than the other. Lumping all industries together under one umbrella only skews the data further.

So, What Are The REAL Numbers?

We’ve established that most of the frequently-cited values are inaccurate. That leaves us with one question: what is the actual startup failure rate? How many businesses actually fail to make it past their fifth year?

At first glance, that question seems to have a fairly simple answer. As you can see from the chart above (courtesy of smallbusinessplanned), Most studies on failure rates have determined that somewhere between 40-50% of businesses remain open after year 6. Not surprisingly, a business’s chance of failure grows smaller over time, as well – a company that’s been around for six years is far less likely to fail than one that’s just getting on its feet.

As it turns out, even this statistic is somewhat inaccurate. A 2002 study by economist Brian Headd found that the majority of studies on small business failure rate don’t actually distinguish between failures and closures. What that means, according to Headd, is that around a third of ‘failed’ businesses were actually successful enterprises which, for one reason or another, closed down.

If we’re to believe any of the established studies, this would put the actual failure rate somewhere between 30%-50%. That’s a bit more heartening a figure than the one everyone’s so keen on repeating, no? At any rate, we’ve discussed statistics enough – let’s move on.

How Can You Be One Of The Successes?

It’s time for the really important bit of this piece. How can you ensure that your business is one of the successes, and not one of the failures? In other words, precisely what is it that causes startups to fail, and how can you avoid falling victim to it with yours?

In short? Don’t be arrogant. Plan your actions carefully, and understand your market before you dive in.

“Start-ups often fail because founders and investors neglect to look before they leap, surging forward with plans without taking the time to realize that the base assumption of the business plan is wrong,” explains Carmen Nobel, in a Harvard Business School article. “They believe they can predict the future, rather than try to create a future with their customers.”

“Entrepreneurs,” she continues, “tend to be single-minded with their strategies – wanting the venture to be all about the technology or all about the sales, without taking time to form a balanced plan.”

There are other factors that play into it aside from planning, of course. Maybe the founders were inexperienced, and had no idea what they were doing. Maybe they failed to connect properly with their customers, or didn’t market themselves effectively. Maybe they were unable to adapt to a changing market, or simply got one-upped by a competitor who did a better job than they did.

The raw truth is that there’s really no surefire, foolproof way to secure one’s success when founding a startup – and that may not always be a bad thing.

In Closing: The Merits Of Failure

Believe it or not, being the founder of a failed startup isn’t always a bad thing – and not just because we learn more from failure than from success. As noted by Nobel, even a failed business can yield networking opportunities with venture capitalists, business partners, and fellow entrepreneurs. Failure as an entrepreneur could even land you a job with a larger enterprise.

“Boards of successful companies often seek out the founders and CEOS of failed companies because they value experience over a clean slate,” says Nobel, quoting Professor Ghosh. “After all, Henry Ford, Steve Jobs, and Desh Desphande experienced multiple failures before achieving success.”

So…what should you take from all of this, then?

Simple – as an entrepreneur or small business owner, don’t bother fretting over your chances of success. Instead, simply focus on growing and developing your business as best you can. Should you fail, be sure you’ve done enough homework to understand why.

Kevin Blanchard

Kevin Blanchard

Kevin Blanchard is the CEO of ServerMania.