The 10 best and worst states for starting a small business

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There are many important things to consider when starting your own business or a side hustle, and location is at the top of the list. Local and state laws can entail different taxes, zoning regulations, and licensing requirements, so it pays to be strategic when choosing your state, city, and even neighborhood, according to the U.S. Small Business Administration.

Related: 5 Things Not to Do When Running a Small Business

Finally, according to the U.S. Bureau of Labor Statistics (BLS), around 20% of all new businesses fail within the first two years of opening. The BLS also found that 45% of businesses fail within the first five years. After 10 years, that number rises to 65%.

Capital on Tap, a company that offers a credit card and expense management platform for small business owners, analyzed BLS data to determine the percentage of startups that are still active after three years – and analyzed the U.S. states with the highest and lowest odds of survival over three- and five-year periods.

“There are over 30 million small businesses in the U.S., which make up a huge portion of the economy. And as that number continues to grow, so will innovation and commercial drive,” said Damian Brychcy, CEO of Capital on Tap. “This study should be a positive sign for entrepreneurs in the top 10 states who are thinking about starting a business.”

Photo credit: John Coletti | Getty Images. Boston, Massachusetts.

Characteristics of business-friendly states

Before we dig into the data, it's important to consider what factors make a state attractive to new business owners. And it's about more than just starting a business. The following factors can help keep small businesses afloat and lead to continued success:

Steer

Perhaps most importantly of all, a business-friendly tax environment can keep costs down and put more money in your pocket. You'll have to worry about payroll, employment, income and corporate taxes, all of which can affect hiring and expansion decisions. Some states also offer tax incentives for small businesses that can remove expensive hurdles. Looking at the self-employed tax table in your area can be helpful.

Workforce

If you want to run a healthy, growing business, you'll almost certainly be hiring. The best states for small businesses have an abundance of available talent and a high college-educated workforce. Starting a business near a college or university can also attract interest from recent graduates. This is especially the case in the technology industry.

Regulations

Government policies for small businesses include more than just taxes and deductions. Government programs can provide grants and loans to business owners and encourage investment from larger donors. Compliance is another factor. States can reduce the cost of doing business by reducing red tape, such as required government permits or clearances.

Growth potential

You want to start your business in a place where it can be successful both in the short term and long term. A number of factors can help with this – financing, investment in infrastructure and quality of life, for example. Close proximity to sources of financing can help your business grow, as long as the area can support your employees and their families. States and cities with a low cost of living, good schools and solid infrastructure not only attract talent, but also retain it.

Massachusetts

With elite universities, a thriving tech center, a strong economy, and a highly skilled workforce, Massachusetts tops the list. Nearly 82% of small businesses survive their first year. Boston is also a growing hub for STEM jobs and home to many investors and potential employees. The state also has a strong Economic Development Incentive Program (EDIP) that offers tax and real estate incentives for job creators.

Wisconsin

In addition to a relatively low cost of living, Wisconsin also has one of the best public university systems in the country (read: highly skilled workforce) and a business-friendly government that provides tax breaks, low-interest loans, and grants to small businesses. Wisconsin also runs a public-private capital initiative through the Wisconsin Economic Development Corporation (WEDC), which recently announced a $100 million investment in the state's startups.

South Dakota

Taxes are the big selling point of starting a business in South Dakota. Since the state does not impose corporate, income, property, or business inventory taxes, it is affordable for owners to run a small business. The state is very affordable and has very few regulations, which lowers the overall cost of running a business.

Minnesota

Nearly 81% of small businesses survive their first year in Minnesota, a feat that is thanks to the state's supportive business environment, educated workforce and relatively affordable quality of life. Minnesota also has nine small business development centers across the state that provide advice, mentoring, networking opportunities and access to capital.

Iowa

With its high quality of life and low cost of living, Iowa is an attractive place to start and grow a small business. One of the most important factors is the extremely low energy and utility costs, which is especially important for manufacturing. Iowa's cities also offer property tax incentives for small businesses and some of the lowest workers' compensation costs in the country.

Washington

Fewer than 43 percent of new businesses in Washington remain in business after five years. This is due to expensive real estate, complicated regulations and the highest minimum wage in the country ($16.28/hour). The state's business tax is also calculated based on gross revenue, not total profit, so companies with low margins will have a particularly tough time.

District of Columbia

Washington, DC, is one of the most expensive metropolitan areas in the country, both in terms of real estate and the general cost of living. This means high salaries and high rents for offices or retail space. The city's business taxes and regulatory requirements are also relatively high, which can reduce profit margins.

New Mexico

High unemployment rates and limited access to capital make New Mexico a difficult state to start a small business in. Compared to surrounding states, there is a shortage of skilled workers and complex regulations can be a burden for business owners. More than 23% of small businesses fail within the first year.

Florida

Although Florida claims to be a thriving location for entrepreneurs and small businesses, the data tells a different story: more than 55% of small businesses go bankrupt within five years. One of the biggest factors is the increasing frequency and severity of hurricanes, which has led to rising insurance costs. This impacts both the available workforce and a company's bottom line as premiums skyrocket.

Nevada

Nearly 23% of new businesses fail within their first year in Nevada, despite the fact that there are no corporate or income taxes. Part of the challenge is local governments: regulations vary widely depending on the city you choose, and there are different requirements for certain licenses and fees. A heavy reliance on tourism can also backfire when travel to the state declines, such as during the pandemic.

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