If you've been part of the vanguard of credit managers who believe that extending credit to small, start-up companies is good business--you now have some ammunition to back up your claim.

In a recent report issued by Dun & Bradstreet, Joseph W. Duncan, D&B's vice president and chief economist, and Douglas P. Handler, manager of economic analysis for D&B, contend that small businesses are misunderstood and are more creditworthy than is generally believed. Among other things, the report contends that the long-held notion that new firms fail early is a myth. Most serious businesses that start up do, in fact, survive for at least several years. The implication of the report is that credit managers who have been automatically ruling out such companies as potential credit customers may be acting against their companies' best interests.

Editor's Note: This article originally appeared in the Credit & Collection Manager's Letter, which Credit Today purchased in 2006.

What's in a Name?
Duncan and Handler contend that a key issue for credit managers is the distinction between a "discontinuance" and an actual business failure. A business failure, say The authors, "is a firm that has gone out of business with losses to creditors, while a discontinuance is a firm that has ceased operations, leaving no outstanding debts." They argue that a firm may discontinue for a variety of reasons; for example, the firm may not be generating sufficient return on capital, or the owners may want to retire.

• Smaller can be better. Surprisingly, the study found (Table 1) that the smaller the firm, the more likely it is to survive. This flies in the face of conventional wisdom.

• Staying small is better yet. The study found that an increase in the number of employees is not the key to long-term survival. Of the survivors who began operation in 1985, about 25% increased their employment, 64.7% have the same employment they began with, and the remainder have lost employees. Duncan and Handler conclude that "a firm's chances of surviving actually decrease as the original firm's size increases."
  They attribute this to the fact that owners of large start-ups are quicker to liquidate or sell their operations to others when they find more lucrative uses of their capital. On the other hand, Duncan and Handler believe that smaller firms are much less flexible and so must develop the staying power necessary to succeed.
• It's not location, location, location. D&B did not find a significant regional trend, although the chances for survival were greater in the West and East/North Central regions.

• A new business is not always what it seems (but you knew that). Duncan and Handler also contend that economic and tax-related statistics are unreliable sources for identifying new businesses or discontinued businesses.

1. Those firms that cease operations are most likely to do so within three years of starting business. However, the failure rate decreases very slowly thereafter.

2. The chance of a new firm surviving decreases as the number of employees increases.

3. The initial size of a firm is an excellent indicator of its long-term growth. Firms that begin operations with fewer than 50 employees have very little chance to add more than 100 jobs. Most large firms have a greater tendency to either close or grow rapidly.

4. New start-ups of small businesses provide a reliable and stable source of jobs. However, only the more risky, larger start-ups will achieve large volumes of employment growth.