Why Do Small Businesses Fail? Causes, Signs & Statistics

Starting a small business is an exciting venture, but success isn’t guaranteed. Many entrepreneurs set out with big dreams of small business growth only to face unexpected challenges that put their businesses at risk. But why do small businesses fail, and more importantly, how can you prevent your business from becoming another statistic?

The small business failure rate, which we’ll discuss more in-depth below, might be discouraging at first glance. The reasons behind business struggles vary, but common factors include negative cash flow, lack of capital, and poor financial management.

By understanding these common pitfalls, you can give your business the best chance to keep its doors open for the long haul.

In this guide, we’ll break down the most common reasons small businesses fail, explore industry-specific small business failure statistics, and provide actionable strategies to help you prevent small business failure. Whether you’re a new entrepreneur or a seasoned business owner, learning from others’ mistakes can help you navigate challenges and keep your business thriving.

What Is the Rate of Failure for Small Businesses?

According to recent small business failure statistics, just over 20% of small businesses fail in the first year. However, the numbers become even more concerning as time goes on. Over 49% fail in the first 5 years, and 65% ultimately close their doors within 10 years.

However, lots of factors are at play here. For example, your industry has a big impact on average failure rates, especially in the first year. Agricultural businesses tend to survive the best, with just a 12.5% average failure rate in the first year. Retail is the second-best, with a 15.8% first-year failure rate.

Other reports say healthcare and food service are decent options as well, with 15% average first-year failure rates. The information sector (including information technology) has the highest failure rate at 26.4%, while transportation and warehousing are second worst with a 25% failure rate.

Other Small Business Failure Statistics

Where you live also has a big impact on the rate of failure for small businesses. Companies in Washington state had the highest first-year failure rate at 40.8%, while California had the lowest at 18.5%.

Small businesses fail for all sorts of reasons, but the most common are:

• Cash flow problems (reported by 82% of closed businesses)
• Lack of market demand (42%)
• Running out of cash (44%)

While it’s important to be concerned about your business’s future, don’t let these figures scare you. The small business failure rate has actually decreased by 30% since 1977. As long as you approach this new venture with solid financials and a plan, you should be able to avoid small business failure.

Why Do Small Businesses Fail?

Understanding the reasons why small businesses fail is the first step toward preventing failure! Below are the most common reasons businesses are forced to close their doors,

Negative Cash Flow

Employment at small businesses is on the rise, although credit card delinquency rates are up, and applications for small business lending are down. Strategically going into debt can fund your business’s future, but the wrong type of debt can spell disaster for a new business. In fact, negative cash flow is one of the most common reasons why small businesses fail.

Lack of Cash Infusion and Capital

Without access to additional funding, businesses often struggle to recover from unexpected expenses or economic downturns. Many fail because they don’t secure enough initial capital or lack a backup plan for financial difficulties. Exploring small business lending options, seeking investors, or considering alternative funding solutions like invoice factoring can provide a much-needed cash infusion for your business.

Poor Cash Flow Management

Many small businesses fail even though they have adequate funding. In these cases, it comes down to improper resource management. Even profitable businesses can fail if they don’t manage cash flow effectively. Late client payments, high overhead costs, or excessive debt can quickly create financial instability. This is why small business owners must learn how to improve cash flow long before starting a business.

Unexpected Market Changes

COVID-19 was the perfect example of an unexpected shift in the market. Overnight, consumers drastically changed their spending habits. It’s challenging to plan for changes like this, but the more flexible a business is, the better it can weather significant changes. Supply chains, geopolitical tensions, and political policy can all have a tremendous impact on small businesses, so it’s best to stay as flexible as possible—and that includes storing funds for a rainy day.

Signs a Small Business Is Failing

Few small businesses close their doors suddenly. Recognizing the warning signs can help entrepreneurs take corrective action before it’s too late. If you’ve been asking yourself, “Why is my small business failing?” look for these red flags that could indicate financial distress.

Declining Profits

A steady drop in revenue or shrinking profit margins is a major indicator of financial trouble. If sales consistently fall and expenses remain high, your business may be heading toward closure. Declining sales is a common challenge for small businesses, but adjusting your pricing strategy, reducing expenses, and exploring new revenue streams could help you turn things around.

Insufficient Working Capital

Not having enough working capital to cover day-to-day expenses is a serious red flag. Many business owners underestimate how much working capital they need to keep operations running smoothly. Calculate your ideal working capital needs and explore funding solutions to fill any gaps. You don’t need to go into debt to fund your business—alternatives like invoice factoring make it possible to secure funds as quickly as the end of the business day.

Paying Bills Late

Late payments to vendors, employees, or creditors can signal negative cash flow, one of the leading causes of small business failure. Your business may be in trouble if you’re constantly behind on payments. Paying late can also strain professional relationships, putting your business at risk of losing critical vendor support. If possible, work with your creditors for better payment terms or restructure your accounts payables team to get back on track.

Tips for Avoiding Small Business Failure

Starting a small business can feel scary, but don’t let the statistics overwhelm you. Managing a small business requires hands-on effort to provide customers with a great experience and keep the business financially solvent. Follow these tips to avoid small business failure:

• Effectively manage cash flow: Since negative cash flow is one of the top causes of small business failure, keep a close eye on your cash flow management practices. Consider hiring a bookkeeper or accounting firm to help you keep tabs on your inflows and outflows.
• Stick to your business budget: Create a small business budget to prevent overspending. A solid budget ensures you have enough funds to keep the lights on and save for future expenses. However, creating the budget is the easy part. Business owners also need the discipline to commit to their budgets; otherwise, the business could fail.
• Trim unnecessary expenses: It’s tempting to purchase new equipment and hire many employees when you start out. However, new small businesses should keep costs as low as possible. Follow small business money-saving tips to reduce wasteful spending and keep more cash in your growing business.
• Track your metrics: Monitoring essential small business key performance indicators (KPIs) can help you measure progress, identify issues early, and adjust strategies. To better understand your performance, track metrics like net profit margin, cash flow, revenue growth rate, customer acquisition costs (CAC), and accounts receivable turnover.
• Forecast performance: Planning for future financial scenarios helps mitigate risks and avoid cash shortages. Run a pro forma analysis to project future performance based on your balance sheet, cash flow statement, income statement, and budget.

In-Summary: Why Do Small Businesses Fail?

The small business failure rate is challenging for many entrepreneurs, with 20% of small businesses failing in the first year and nearly 50% closing within five years. The most common reasons why small businesses fail include negative cash flow, lack of capital, poor financial management, and declining revenue.

Fortunately, proper planning can help you avoid small business failure. Recognizing the early warning signs—like declining revenue, insufficient working capital, and trouble paying bills—is key to preventing failure. Business owners can avoid small business failure by improving cash flow management, creating a solid budget, cutting unnecessary expenses, and tracking the right KPIs.

While the percentage of small business failures may seem daunting, the good news is that small business failure statistics show an overall decline in failure rates over the years. With careful planning, financial discipline, and strategic decision-making, business owners can prevent small business failure and build a thriving, sustainable company.

Small Business Failure FAQs

What percentage of small businesses close within their first year?

About 20% of small businesses fail within the first year. However, some industries, like agriculture and retail, tend to have lower failure rates. Failure rates also differ by location, with Washington state having the highest rates while California has the lowest.

What percentage of small businesses fail in the first five years?

Nearly half of all small businesses fail within the first five years. Most fail because of cash flow problems, a lack of capital, or declining revenue. By year ten, 65% of small businesses close their doors.

What happens when a small business fails?

When a small business fails, its owners may need to liquidate assets, pay off outstanding debts, and close operations. Some may file for bankruptcy, while others try to sell or restructure the business. Closing a small business can be devastating, so it’s best for entrepreneurs to carefully manage cash flow and keep their doors open.