×

Alive at five: The key year for companies' survival

We may be hearing more about how corporations are people in the upcoming election, but we don't hear much about how short a company's life really is.

If companies were people, most wouldn't even make it to high school. Economists know that companies die off in droves, but the causes of death and even the probability of dying in a given year are less clear.

Firms tend to survive their first few years, but see a mass die-off in the fourth year. This is according to a recent study of the involuntary "deaths"—liquidation, delisting and permanent trading halts—of publicly traded companies between 1985 and 2006. Strong venture capital support can protect the company in its early years, according to the study. And if a firm survives those critical initial years, mortality rates become relatively low and constant.

Who are all these companies that die off so soon after their "public births" in the market? Probably not any you've heard of.

They are companies like Ultimate Escapes, a luxury travel club that held its IPO in 2007, but filed for bankruptcy protection in late 2010. Or Southern USA Resources, a natural resources exploration company that first traded in 2009, reaching prices near $3,000 per share before falling to 3 cents a share and dropping off the market in 2013.

Many more companies barely learned to walk before being gobbled up by larger corporations, although the authors did not include such "deaths" by a merger or acquisition in their analysis.

"Even though the acquired company might cease operations as an independent entity, its business might remain largely intact," said Alexander Borisov, one of the authors of the paper from the Journal of Financial and Quantitative Analysis. "Many of the relevant parties, such as shareholders and creditors, for instance, might also fare well in such events."

A similar pattern of company mortality showed up in a CNBC analysis of data from the Bureau of Labor Statistics, which tracks private sector establishments. In that data set, a company opening up a new branch would count as a new establishment, even if it is part of a larger firm.

Unlike public companies, which are presumably already fairly successful by the time they file for an IPO and probably have a cushion of backing to get them through the early years, the privately owned companies that make up most of the private sector are more likely to fail in their first few years.

Only about 1 in 5 establishments survive for 20 years or more—that's even worse than the probability of surviving an infection with the Ebola virus.

But not all analyses paint such a simple picture. Researchers at the Sante Fe Institute used ecological survival analysis techniques to analyze the life spans of companies traded in North America between 1950 and 2009.

Unlike Borisov's study, which only counted "bad" deaths, the Sante Fe researchers included the vast majority of companies that disappear through mergers and acquisitions. They found similarly dire death rates—50 percent of all companies expired in the first decade—but they found no jumps in the mortality rate for young companies or at any age, regardless of cause of death or industry.

"The mortality risk was effectively constant across a firm's lifespan." said Marcus J. Hamilton, corresponding author of the paper. "On average, it doesn't matter if you sell bananas or airplanes, if you're big or small, you're facing a constant mortality risk."

Hamilton said that the next step is to develop a theory about why half of companies tend to die after 10 years—it could be two years, or 300 years. That explanation could have serious implications for how companies are founded and managed.

"We were struck by how little quantitative understanding there is about company mortality," said Hamilton. "Companies are an enormous part of the U.S. and world economy, but there is so little understanding of the qualitative side of what makes companies successful."