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The Conventional Wisdom: The kind of growth that lands a company on the Inc. 500 list is extremely difficult to manage. As a result, fast-growing small companies fail at an exceptionally high rate.
The Truth: It just ain't so. If anything, astronomical growth may increase a small business's chance of survival.
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You'd think most of those Inc. 500 companies would be gone by now. The typical business on our 1985 list grew 900% in revenues from 1980 to 1984. That kind of hair-raising growth severely strains cash flow, staff, and management capacity. In small, young, private companies, that strain can be fatal. So we'd expect former Inc. 500 companies to have an extremely high failure rate.
Makes sense -- except it's not what the research shows. If anything, the 1985 Inc. 500 alums, which all experienced hypergrowth, may have lower failure rates than other small companies. When we tracked down the 1985 list 10 years later, we could confirm only 57 failures out of 500. And that's using a very broad definition of failure. We counted as a failure any company that closed while under its original ownership -- even if there were no losses to creditors and the owner simply went on to other things. We also counted as a failure any company that was acquired by new owners after a Chapter 11 filing, even if the company is still in existence today. To be on the safe side, we also lumped in with the failures the 38 other businesses we couldn't locate -- though our company-tracking experience suggests we were being too cautious. A few of the companies missing in action probably quietly changed names or were sold. So using excessively inclusive guidelines, we came up with 95 presumed failures, a 10-year failure rate of 19%.
That begs an obvious question: How often do ordinary small companies fail? Well, that depends on whom you ask. The truth is that research on business-failure rates should be taken with a grain of salt because no one has yet found an ideal source of comprehensive data. Still, some of the data that are available suggest that the Inc. 500 failure rate is low. One way to show that is to look at survival rates -- sometimes defined by researchers as the number of companies that stay in business without changing owners or reorganizing. Of the 1985 Inc. 500, 238 companies, or 48%, survived 10 postlist years under the same ownership, without being acquired or going public.
The Office of Advocacy of the U.S. Small Business Administration publishes national statistics on business-formation and -termination rates. That series, which is based on data from unemployment insurance rolls, suggests a highly turbulent economy. The data suggest that every five years, half of all firms with employees disappear or reorganize. Meanwhile, the 1985 Inc. 500 is about half as volatile, with approximately half the companies changing ownership or failing in a 10-year period. (In case you're wondering why there are any businesses left in the United States, it's because new ones keep starting up.)
Of course, the SBA numbers include very young companies -- and we might expect them to expire at a higher rate than older ones. By the time the Inc. 500 alums made our list, they had already reached a median age of seven years, so they were likely to be more durable than brand-new start-ups. But even when compared with small businesses of a similar age, the 1985 Inc. 500 companies may be hardier.
In their landmark study of small-business survival rates, Bruce D. Phillips and Bruce A. Kirchhoff tracked 814,000 small companies started between 1977 and 1978 for a period of eight years. Those businesses are basically the peers of the 1985 Inc. 500, whose median launch year was 1978. Although Kirchhoff and Phillips were unable to follow their sample through to 1995, they had enough years of data to use economic models to estimate long-term survival rates. According to Kirchhoff's estimates, one would expect that about 120 of every 500 companies in his sample that had made it to 1985 would survive under the same ownership in 1995. By comparison, 238 of the 1985 Inc. 500 did so. In other words, Inc. 500 companies survived at about twice the rate Kirchhoff projected for ordinary small businesses -- while attaining remarkable average growth rates.
Kirchhoff now says, however, that he believes his original long-term survival estimates were too low. John E. Jackson, of the University of Michigan, has found somewhat higher survival rates by studying Michigan companies over a six-year period. Meanwhile, researchers like Paul D. Reynolds, Babson College's Paul T. Babson Professor in Entrepreneurial Studies, have found that four years after start-up, from 75% to 80% of entrepreneurs report that their companies are still in business. Other researchers report still different numbers, based on different samples and time periods. Kirchhoff and Phillips, however, studied a group particularly similar to the 1985 Inc. 500 in age and year of start-up; their sample also represented, like the Inc. 500, a wide variety of industries and regions.
So much for the companies that survived. Are there lessons to learn from the failures of the Inc. 500 class of 1985? Two trends are immediately identifiable from the failures. The first is hardly surprising: companies that were just breaking even or losing money in 1984 were more likely to fail than others. The second is downright heartening: the group of ex-businesses includes a small number of companies that got into trouble with regulators for questionable business practices. Our Inc. 500 list screens only for growth, not for ethics, and as a result it always includes a few companies we'd rather not be associated with. The good news is that those companies may have a higher-than-average failure rate.
