Lauren Williams

Risky Business: How financial vulnerability exacerbates traditional business risk

Editor’s note: This post is part of our Domestic Financial Innovation series – click here to read other posts in the series.

Business ownership is a risky endeavor regardless of an entrepreneur’s financial well-being. By most accounts, about half of all businesses in the U.S. will fail within their first five years, and only one-third will survive for 10 years or more. Imagine, then, how the risk increases and the stakes rise when a business owner’s venture is founded on shaky footing.

The fewer resources and options you have, the more you stand to lose if your business goes under. But at the same time, many entrepreneurs go into business either precisely because they lack other options or in spite of having few resources to start with or fall back on. Those who fall into these categories are predominantly microbusiness, businesses with five or fewer employees including the owners. Even though the United States’ 26 million microbusinesses contribute significantly to nationwide economic activity and their owners’ household balance sheets, many still struggle to make ends meet or build long-term wealth through business ownership. Until recently, little was known about how the typical microbusiness manages its finances, the major financial challenges they face or which components of financial capability lead them to business success.

To begin to bridge this gap in understanding, my organization, CFED, a nonprofit that empowers low- and moderate-income households to build and preserve assets, published In Search of Solid Ground: Understanding the Financial Vulnerabilities of Microbusiness Owners with support from MasterCard’s Center for Inclusive Growth. Using online and phone surveys of microbusiness owners from across the country, we began to construct a better picture of their financial lives. Here’s what we found:

  • Cash flow problems—lacking sufficient liquidity to cover business expenses at the time they arise—are key drivers of financial insecurity for both microbusiness owners and their households. Forty percent of respondents to our online survey reported that they sometimes do not have enough cash on hand to meet their business expenses.

  • Remarkably low short- and long-term savings levels compound these challenges even further, with 30 percent of respondents to our online survey reporting no business savings at all, and an additional 38 percent saying that they could cover only two months or less of business expenses with their current savings. This is preventing microbusiness owners from mitigating income-expense mismatches, weathering emergencies or meeting long-term goals that contribute to greater financial stability.

  • Difficulty accessing appropriate financial products and services, especially credit, also compounds microbusiness owners’ financial insecurity. Thirty-six percent of online survey respondents reported that their inability to borrow was a challenge, with the majority of these attributing this barrier to bad or non-existent credit history. Those that are vulnerable for other reasons—like young startups, less formal businesses, those generating lower household incomes for their owners, those with fewer employees, and minority-owned businesses—are more likely to experience difficulty accessing financial products that suit their needs.

These findings all lead us to a much more refined understanding of the deficits in access to information and financial products facing these business owners, and the types of behaviors that might support greater financial well-being among them. Many of these vulnerabilities are mutually reinforcing: lack of access to credit can make bridging cash flow gaps difficult, and cash flow deficits could make it hard to save for emergencies and leave business owners in a risky position in case of some financial shock. In the long run, failure to address these problems will prevent business owners from achieving financial security, growing their businesses, or amassing wealth.

At the end of the day, while entrepreneurship will always be a risky endeavor, we can mitigate some of those potential pitfalls—and the spillover effects they might have on households—by improving the financial capability of microbusiness owners. CFED’s next steps involve taking the insights we gathered about microbusiness owners’ financial challenges and pairing them with the expertise of private, nonprofit and government partners to build and refine solutions that give microbusiness owners a more solid financial footing. Stay tuned in the coming months.

Lauren Williams is a program manager for the Entrepreneurship and Affordable Homeownership teams at CFED.

business development