Small
Business Failures and Financing – The Real Story
How often do businesses fail? For years, the quick answer to that question
was that four out of five new businesses fail within the first five years of
opening.
But now, U. S. Small Business Administration Office of Advocacy economist
Brian Headd, takes a new look at business failure and challenges that commonly
accepted failure rate – and the notion that business closure and business
failure are one and the same.
In an article called "Redefining Small business Success," Headd says that the
practice of using business closings as an indication of business failure can
distort the rate of business failure.
The reason is that not all businesses that close are failures. Sometimes
businesses close because the owners lose interest, or because they realize they
would prefer to work for someone else. And, more businesses now include an exit
strategy as part of their initial business plan. In fact, US Census Bureau data
shows half of new employer businesses survive more than four years, and about
one-third of closed businesses were successful at closure.
The key predictors of success haven't changed, though. Businesses that have
employees and that have good financing tend to survive longer.
Headd's article, which was originally written for Small Business Economics,
can be read in full on the Office of Advocacy web site:
http://www.sba.gov/advo/stats/bh_sbe03.pdf.
Where Do Businesses Find Funding?
Cash is king, but when businesses go looking for lenders to provide that
cash, they quickly find that funding sources are finicky princesses that are
mighty difficult to please. So, where do small businesses get financing?
Financing Patterns of Small Firms, a report published this fall by the Office
of Advocacy, takes a detailed look at that question. The report features over
400 statistical tables drawn from the Federal Reserve’s Survey of Small Business
Finance comparing the borrowing patterns of various small business subgroups.
Among the key findings:
Over 80 percent of the small businesses surveyed used some kind of credit and
had outstanding debt on their books at the end of 1998. Fifty-five percent of
small firms had some kind of traditional loan, while 71 percent obtained credit
from non-traditional sources, mainly owners’ loans and credit cards.
The most frequently used kinds of credit were personal and business credit
cards, lines of credit, and vehicle loans. Forty-six percent of small firms
used personal credit cards, 34 percent used business credit cards, and 28
percent used lines of credit.
The most frequent suppliers of credit to small firms were banks; 38
percent of small firms had credit outstanding from commercial banks in 1998.
Owners’ loans were next in popularity (14.2 percent of small firms used them),
followed by finance companies (13.3 percent).
Loans from owners are an important source of small business finance. The
survey did not collect data on their use by sole proprietors, so the extent of
their use is understated. For small corporations, borrowing from themselves
and banks were the two most common sources of financing, far exceeding
borrowing from any other source. Some 30 percent of small corporations
borrowed from owners as compared with 14 percent for all small businesses.
While the majority of small firms used some financing, most small firms’
reliance on credit in business operations is limited in scope: 47 percent of
firms had no outstanding debt, and another 25 percent had just one loan
outstanding.
The percentage of small firms using credit normally increases with firm
size. The percentage of firms using any credit increased from 70 percent to
99.6 percent as the employment size of the firms increased from 0 to over 100.
This rising trend is most evident in small firms’ uses of credit from loans
supplied by depository institutions (banks, thrifts, etc.). For example, only
22 percent of firms with no employees used credit from depository
institutions, while 78 percent of firms with over 100 employees used
depository institutions.
The use of owners’ loans and personal credit cards leveled off or
diminished as firm size increased.
To conclude, two distinct patterns between firm size and the type of credit
used were observed. The positive relationship between firm size and the
percentage of credit from depository institutions seems to reflect the
availability of credit to larger small firms—credit becomes more available as
firm size increases. A flat or inverse relationship between firm size and the
use of owners’ loans and personal credit cards reflects a different phenomenon.
Very small firms tend to use these alternative sources because other sources of
financing, which are usually cheaper, may be unavailable.
The information compiled on this site is
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Small
Business Failures and Financing – The Real Story
