Why more Small Businesses are Going Bankrupt

Written by jessica Alba

According to the economic recovery plan, small businesses are supposed to be our future. After all, they are the major employers today. But, it is anything but easy to stay open, with a recession. Even in good times, at least 50% of small businesses close within the first five years. However, maybe understanding why more small businesses are going bankrupt will help new entrepreneurs be prepared for the challenges that lie ahead.

According to an article in USA Today, “Fewer people are starting small businesses, and firms already open are struggling under changing consumer habits, a lack of funding options and tougher bankruptcy laws…On average thus far in 2009, some 350 commercial enterprises file for bankruptcy daily — an increase of 240% from 2006, the first year after the bankruptcy law was changed.”
With these grim statistics, it is no wonder that fewer worthy entrepreneurs are not willing to put their finances on the line to help bring their dreams to reality. Some are waiting until the economy improves. Others are simply changing their dreams altogether. But, a growing number of small businesspersons are seeing their dreams turn to nightmares.

Passing it On

With the unemployment rate almost in the double digits and the rising cost of groceries and other consumer goods, customers are simply not making purchases that are not necessary. For many, the fear of potentially not having a job next week and the uncertain economy has led them to buy only the basic necessities. Even then, individuals are learning to shop with more frugality.

Unfortunately for entrepreneurs, frugal customers do not bode well for business, even if they provide the basic necessities. The overhead is basically still the same. Employees still have to be paid. The shelves still have to be stocked with a variety of products, and the basic expenses of day to day operation still have to be met. In essence, it is simply the effects of passing on the economic concerns of the shopper to the business.

No Money

A lot of small businesses function on loans. They borrow the money today on the basis of their outstanding purchase orders. Then, when the clients pay, the loan is paid in full. In some cases, the money is borrowed to purchase products and the payments are made as the products are sold.

However, with the lagging economy and so many banks struggling as well, the money simply is not there to loan. Even if the bank has the money to give, the state of the economy has them very leery. Foreclosures and bankruptcies are at an all time high. So, banks are less likely to risk lending money on the chance that the customers will come.

Without the money to properly function, small businesses simply cannot afford to keep the doors open. Most entrepreneurs have already sunk their life’s savings, a second mortgage, and personal loans from friends and family into the business. So, if the bank will not provide the necessary money for day to day operations, it is not long before the business goes belly up.

Oftentimes, when a small business goes bankrupt, personal bankruptcy follows, because every penny possible has been used to keep the doors open. Exceptional entrepreneurs may lose their business and home all in one fell swoop. In some cases, even family is a casualty, because they have also lost the money, time and patience in the venture.

Size Matters

If you listen to the news today, then you already know that small businesses are responsible for the majority of jobs. More people work for the hometown business than the big corporations that employ thousands. But, small businesses also have a lot less leeway for mistakes or miscalculations.

If the business plan does not take into account particular situations, it can mean financial disaster in no time at all. On the contrary, larger businesses can scale back on one area to promote another, shuffle employees around, and more easily add or change products and services. Plus, they often have resources unavailable to small business. Thus, they can pretty much drown out the smaller competition with promotions, sales, discounts and other consumer incentives that can put the small business entrepreneur out of business in no time flat.

In short, trying to start and maintain a small business during hard economic times is very difficult. Even if you do all of the necessary homework and determine costs and customer interest and need, the larger businesses provide unequalled competition, because they have more business resources. Also, banks are not as willing to provide small business loans in this tight economy. Finally, it is simply the trickledown effect. As consumers lose their jobs, or live in fear of tougher times, purchasing power is being limited to necessities only. Even then, many household have chosen to do without a lot of products and services. So, now you know why more small businesses are going bankrupt.