What People Don’t Get About That “50% of Small Businesses Fail in 5 Years” Statistic
We live in a data-driven society now: how data gets interpreted is a HUGE deal, and small business data is no exception. An oft-cited SBA figure was cherry-picked to make people think a 9–5 job is your only option.
People think the United States is a country that supposedly loves entrepreneurship. Well…only incredibly rich ones who grace the cover of Forbes, Fast Company, and so on whose parents paid their Stanford tuition or have been some type of oligarch for generations. For the rest of us peons? In my day to day life, I constantly encounter people who say some variation of “How come you don’t want a regular job? Being an independent consultant and managing video game sales sounds SO hard!”
Because I’d rather get a pap smear from Edward Scissorhands than be someone’s employee ever again, thanks. And the emotional labor of having to follow someone else’s schedule and do their thing, all while I can’t deduct my operating expenses, is a hell whole lot harder than having my own business. At least to me. But just like how not everyone wants to be or can be a solopreneur, not everyone can or wants to be an employee and it’s time that people learned to accept that.
So people who’ve never worked for themselves in any capacity absolutely LOVE pointing out this one particular statistic that over half of small businesses “fail”. It comes from this case study put out by the Small Business Administration (SBA) claiming that “at least 2/3 of businesses with employees survive at least 2 years and about 50% survive at least 5 years”.
People love taking that 50% statistic and completely running away with it. They have no idea what this number actually means.
The SBA tracks formally registered businesses with IRS-issued employer identification numbers (EINs) with fewer than 500 employees. They claim that 99% of American businesses fall into this category. So they track openings and closures regardless of the events around them, it’s part of the agency’s function.
But first things first: a major issue in parsing that oft-cited 50% figure is that the smallest businesses and what both the Department of Labor and Census Bureau calls non-employers (has at least $1,000 in gross receipts and no employees) are not demarcated from more established and well-funded companies that can afford to sustain 50–100 employees, let alone up to 500. That “only 50% survive” figure only applies to businesses that have employees, and the SBA only broke those figures down by a few key industries like retail and manufacturing but claimed that there didn’t seem to be a major difference across industries as far as firm age went.
The Census Bureau actually has more comprehensive data on non-employer businesses — freelancers and solopreneurs — than the SBA does. Per their 2017 statistics released in 2020, there’s about 25.3 million non-employer businesses in the United States, bringing about $1.2 trillion in revenue. 8.2 million of them are minority-owned, 10.6 million owned by women.
The 2012 case study linked above gave the tiniest businesses a closer look:
61.3% of 1–4 employee businesses still alive and kicking after five years sounds more promising for a solo owner-employee, or a few people operating as a co-op, than “only half of new small businesses make it five years BEFORE DYING A HORRIBLE DEATH” does, but there’s a great many people who will look at those dots getting gradually smaller with both age and firm size and think “why bother”.
The presentation of these numbers is scary. But it’s not telling the full story. Of the 38.7% who aren’t around after five years, are there some who gave up and took a job or moved onto other things? Probably. Having your own ship isn’t for everyone and that’s okay! But if you’re going to cite these figures, at least think about the reasoning behind them and how they’re presented.
It’s because those “didn’t survive” numbers only constitute AN ENTITY CEASING TO EXIST over time.
Yes, there’s businesses that shut down due to being unable to operate anymore. Especially in recessions and uncertain times like the pandemic, and would constitute a “business failure”. Speaking for New York, commercial rents have gotten out of control and it’s definitely caused thousands of small businesses to shutter and sadly making our streets look like abandoned strip malls.
But not all business closures represent a complete discontinuation of operations, let alone abject failure!
Why? You have people who wind down their current companies, and they start a new business because their old entity didn’t work for their growth plans, or life plans for that matter. Winding down a business entity can actually mean good or neutral events took place.
For instance, a lot of my game studio clients start out as a single-member LLC, or perhaps two or three owners with no employees, then they get an offer from an investor after their build is completed or have a successful release. Their business consultant and accountant look at the situation, their goals, and advise them to form a C corporation in order to grow and be able to flexibly take on additional equity investment. Let’s say the new corporation raises $250,000 from the investor and now projects are getting done, employees and freelancers are hired. Eventually, that wildly popular game turns into a franchise and they sell the company to a larger studio for a few million — which means their company now ceases to exist thanks to the buyout or merger.
So this scenario would go under those closure stats, but would you actually call that a failure?
I’m about to go under those “failure” statistics by closing down my New York-based LLC and replacing it with a California one. I’m still in business (hey hey hey) and it’s doing pretty swell. But because I’m permanently relocating for the foreseeable future, it doesn’t make sense for me to file as a foreign corporation doing business in California. Why keep paying business taxes to a state I don’t live in anymore? So Sonic Toad Media will go under “survived more than 5 years but still closed”, even though the entity has existed for six solid years and all of its assets and liabilities were simply transferred to a new entity out west.
The business itself isn’t actually dying. Semantically, the company is still generating service, commission, and royalty income. There’s just going to be a few days between the birth of the California LLC and the death of the New York one, all in my attorney’s capable hands. The only difference is I’ll have a new EIN and address, and the company’s age gets reset to 0 as far as statistical records go. In real world terms, the brand has survived, I’m thriving and it keeps getting better!
Going from running on empty to making more money often prompts people to want to change business entities — and it applies in reverse. Getting through a contraction phase can mean holding on for dear life, but still surviving in the end even if doesn’t look that way statistically.
Ditto for changes in ownership! You could start with an S corporation and it’s perfect for your needs at the time, but you meet like, your business SOULMATE whose vision really aligns with yours and you want to own the company together. Non-residents of the United States can’t own S corp shares. You’d need to go with a C corp or a multi-member LLC taxed as a partnership, and carefully consider which one would result in state-level taxes for a foreign owner.
Other life changes that affect your taxes and business plans like marriage, having children, and moving can have an effect on your business decisions.
As both your personal and business priorities and goals change, what was working for you five years ago may not work for you now. Windup and startup papers are incoming as a result.
Relocation is a big one and I wager we’re going to see a lot of misinterpretation of SBA and Census statistics in the coming years as we examine the small business bloodbath the pandemic has wrought. Those “failure” statistics lump in digital businesses with brick-and-mortar shops and restaurants that have an incredibly different dynamic and set of risks and benefits. It’s obvious that the latter unfortunately had millions of real closures as convoluted aid packages came too late, if at all.
It’s reported that about 9 million US small businesses are at risk for permanent closure for these reasons. But you also have several million people who were already freelancing or doing some from of digital entrepreneurship, where depending on what you do and your personal situation (e.g. needing childcare or not), you either suffered a massive incalculable loss or your home-suitable operations fared great in this age of Zoom towns.
If you’re fortunate to be in the latter category and decided to move to a low-tax state, you might think just buying a house in Nevada or Florida is enough to prove you’re no longer a resident in New York, New Jersey, or California. Nope! You’ll be doing what I’m doing and shutting down your original company and opening a new one to avoid dual taxation. You’re going to have a harder time proving your move is permanent if your current company is still in operation and you didn’t want to bite the bullet on those legal fees, startup and dissolution fees, and brief disruption in operations.
For many of us, no amount of money will convince us to be someone’s employee ever again. Some of us also have physical and mental health issues that make a normal job untenable. All I’m asking is that you take a look at statistics and their presentation more closely. There’s always a story behind the numbers, a story you might not even be aware of.