Mike O'Donnell | Aug. 23, 2018

The Life Cycle of a Small Business

One of the least imponderable imponderables to me is the fact that ever since the Bureau of Labor Statistics (BLS) began collecting information on year-over-year small business survival rates, the life cycle of most new small businesses in Colorado and elsewhere in the United States is fairly predictable and hasn’t really changed much over these last two-plus decades, despite all the economic turmoil we’ve been through this century.

The BLS study tracks new small firms with employees, which represents about a quarter of all new small business startups in Colorado each year, and aside from those businesses who started during the dot-com bubble burst or the Great Recession, you can almost set your watch by the fact that out of 100 new firms with employees that will launch in Colorado this year, some 78 or 79 will still be around twelve months from now.

And if someone started their new business in either of the two worst possible years ever in Colorado, which were 2001 and 2008, there would have been 74 of them left after twelve months, so not really a huge difference from the best years to the worst years.

By the end of the second year in business, somewhere between 66 and 68 of those original 100 businesses will still be here, with that number dropping to 59 by the end of year three.  By the end of year four, there are usually around 51 left, although if the small business was established in 2012 or 2013, the survival rate through the end of year four is more positive, at around 54 or 55. This trend indicates that new businesses, post-Great Recession, are doing better than their pre-Great Recession peers.

Things are more predictable by the end of year five, with around 47 or 48 firms remaining. The survival rate begins to flatten out beyond that with only a few businesses dropping off the chart each year thereafter.

If you plot the survival rates for each cohort of annual startups in Colorado, one on top of the other, from 1994 onwards, you can see that most of the lines overlap. Survival rates are reasonably predictable!

The one thing that this chart doesn’t tell you, however, is that back in 1994, the average Colorado startup was creating about seven new jobs that first year. These days, that number is closer to three, but the survival rates are still pretty much the same. This chart also doesn’t tell you that we are seeing relatively fewer startups, per capita, in Colorado each year but if one of my two readers has been paying attention to previous postings, she would know that already.

And I should pause, parenthetically, to state that I am writing about “survival” rates here and not failure rates, as many of my pessimistic colleagues are wont to do. Only a relatively small percentage of small businesses will close each year because of financial issues, like running out of cash or losing the farm. There are lots and lots of non-financial reasons why a business may choose to discontinue operations and many times it is the realization that “if you build it, they may not necessarily come” which is the hallmark of those many aspiring entrepreneurs who watch late night television and/or leap before they look.

But why are small business life cycles important?

Well the obvious reason is that bank regulators and almost everyone else involved with funding small businesses can see these statistics just like you and I can. And because a relatively large number of startups fall away before their first or second birthday, it is a lot easier to NOT lend to any startup small business just in case the one you lend to is one of the ones that drop off quickly. And this is really because a personal credit score isn’t necessarily a good predictor of whether a business that someone starts today will still be here tomorrow.

I call this the “it’s a lot safer to say no” syndrome that the regulators encourage, purely on the basis that the banks aren’t capable of working out which businesses will still be around in about five years’ time. It is better to wait until the business is two or three years old because a much smaller percentage will drop away after then.

The reluctance of banks and indeed any non-traditional nonprofit lender to lend to a startup is why Colorado Lending Source created the Colorado Main Street loan program, a micro-loan program (ranging from $5,000 to $50,000 loans) for underserved small businesses in Colorado looking for affordable, early-stage financing. About 80% of our Colorado Main Street loans are made to startup businesses and all of the Colorado Main Street loans are made to businesses unable to access funds from the banking system.

We refer to this program as a character-based lending program because once you understand the character of the applicant, you can do a reasonably good job predicting which small businesses are likely to be around in five years.

In the olden days (and yes, I am from that era – I remember Gilligan’s Island, Lassie, and Hop-a-long Cassidy from my black and white TV, and, yes, I do have a tennis-ball frame walker on lay-a-way), you would make a loan to someone based on who they were, not what “someone” (read a credit agency with sieve-like firewalls, or a regulator with an Ouija board) told you they are. Character-based lending!!

The next time you meet someone who is working on starting their own small business, encourage them, don’t discourage them. It is possible to survive! And it is possible to thrive!! We need more new small business startups in Colorado and with the right preparation, they can always be one of the fifty-percenters.

Entrepreneurship is how Colorado was built and if we continue to let it slip, this will become half the state it once was. So, if you are unable to assist an early stage small business owner looking for a little bit of debt funding because some hawk-eyed individual wearing a green translucent visor and carrying a clipboard tells you that it is easier to say “no”, send them our way. (The small business person not the visor person!) We will do our best to help!