Studies suggest that 95% of companies in the U.S are small businesses with less than 50 employees. But when it comes to economic impact, it’s not simply the size of the business that makes a difference. Our research shows that firms which are both small, young create the bulk of growth and innovation in the U.S. We might call these small young companies startups. Over the past three decades, companies less than a year old created an average of 1.5 million jobs per year. So, it’s true that small businesses matter, but diving deeper will show that it’s the young startups less than 10 years old which really punch above their weight class.
WHY DOES THAT MATTER?
If we consider the 2006-2009 period, large established firms shed more jobs than they created, while young and small firms remained a positive source of job creation. Put more simply, startups have been responsible for nearly all of the NET job creation since the recession. Research by the Kauffman Foundation found that startups often lead to greater economic productivity, increasing wages and very often improved quality of life for employees. These companies not only act as the primary source of job creation but also play a significant role in intensifying competition and driving innovation, building a more dynamic economy.
But here’s the problem: small business creation took a major hit during the recession and hasn’t fully recovered. Since the recession, and until 2014, there was a steady decline in the rate of new businesses opened. We're now seeing a small recovery here, but have not returned to pre-recession rates of startup creation. Although the number of Americans who were self-employed grew during the recession period, this amount was offset by the entrepreneurs whose businesses failed and left self-employment. More businesses closed than opened, leading to a “startup deficit." Nearly 500,000 firms were generated during the 1983-1987 recovery period compared to just over 100,000 during 2010-2014 recovery. The Kauffman Foundation cited in their research that the number of companies less than a year old fell by nearly 50% between 1978 and 2011.
Startups have an outsized impact on our economy, and we don't have enough. If we desire economic growth on a national, state, and local level we need to pour rocket fuel on the creation of new small businesses across all industries. More startups means a more dynamic economy, as well as more jobs, wage growth, and opportunity. If entrepreneurship is the American dream, then the American dream is on life support. It’s time to rally and kick new business creation back into high gear.
WHAT HAPPENED EXACTLY?
The decline in the risk-taking appetite of millennials
When we consider the age of new entrepreneurs, we notice that the segment of baby boomers (55-64) has risen from 14.82% of new entrepreneurs in 1996 to 25.46% in 2016. During this same period, younger entrepreneurs (20-34) declined from 34.27% to 24.37%. We all tend think of Mark Zuckerberg creating Facebook in his dorm room when we think of entrepreneurs. The reality is the those in their 40’s and 50’s are more likely to start a new business. Today, only a quarter of entrepreneurs are young people, who are often seen as the "future."
Why aren’t young people starting businesses like they once were? In 2014, about one third of the 25 to 34-year-old group reported fear of failure kept them from starting a company. Another significant hurdle for this group is growing student debt. We've seen an 89% increase in the number of student borrowers between 2004 and 2014. Research shows that most millennials entered the labor market during the Great Recession, and this has had a lasting impact on their financial stability and preference to take risks. More simply put, increased debt and economic uncertainty has discouraged many young people from starting a company.
Young people are uniquely positioned to be successful as entrepreneurs, maybe more than any other age group. For the most part they have lower opportunity costs than those with more established careers and families. Young people also have the advantage of fresh perspective, working without years of indoctrination to a “way of doing things”.
The geography of economic inequality
According to a recent report, concentration on communities that are flourishing has left behind many areas that haven’t seen comparable growth. “The U.S. economy contains a diverse and fragmented landscape of economic well-being - one in which many communities are flourishing, while far too many are left behind,” stated this years Economic Innovation Group report. Fifty-two million Americans live in distressed communities. That’s about 17% of the U.S. population. Each state has about 15% of their average population in these communities. Other key findings include:
- During national recovery, distressed zip codes were the only groups that declined both in jobs and business establishments.
- Dominating the recovery, prosperous zip codes generated 52% of the country’s new jobs and 57% of net new business establishments between 2011 and 2015.
- Compared to 2000, distressed zip codes now provide fewer jobs and business.
- 58% of adults with no education beyond high school live in distressed zip codes.
In 2016, 75% of venture capitalists visited just four places — San Francisco, New York, Boston, and Los Angeles. With most of the capital still constrained to the coasts, opportunity is limited for much of the country, further hurting distressed communities. VC's such as Steve Case and Paul Singh are driving change here with investments across the Midwest, but more is needed. The decreasing appetite for risk, as mentioned above, combined with a lack of capital, creates a difficult cycle for distressed communities to break. If young, small businesses create well-paying jobs better than any other business vehicle, then we must find a way to bring startups to these communities.
Highly-skilled immigrants are critical for the U.S. to remain competitive and expand the national economy. Though some may be fearful that immigrants could take U.S. jobs, research generally shows immigration is NET positive for job creation. Twenty-four out of 50 top venture-funded companies had at least one immigrant founder. “Immigrants play a key role in creating new, fast-growing companies, as evidenced by the prevalence of foreign-born founders and key personnel in the nation’s leading privately-held companies," states a study by the National Foundation for American Policy. Legal restrictions related to startup visas, student visas (CPT/OPT), EB-2 visas, H-1B, etc., restrict the growth of entrepreneurial immigrants.
Immigrants are twice as likely to start businesses in the United States as native-born Americans. According to surveys conducted by Kauffman Foundation, among the top venture-backed companies, immigrant founders created an estimated average of 150 jobs per company.
POSSIBILITY OF A TURNAROUND?
A dynamic startup community is critical to the overall health of the economy. Without these young and small businesses, it will be impossible to tackle economic problems such as sluggish productivity, wage growth, and a lack of dynamism. Millennials grew up in the digital age and have more exposure to entrepreneurship than previous generations. The explosion of the internet and advancement of mobile devices created significant opportunity with low barriers of entry. These opportunities are fragile, though, and require intentional effort. The internet is saturated today by large business and many opportunities of tomorrow appear too capital intensive and logistically challenging. Smart cars, clean energy, artificial intelligence, augmented realty, and the internet of things all carry higher barriers of entry than what Google or even Uber faced in the past. Further reform and adjustment in public policies at local, state, and national levels would support entrepreneurial expansion helping to level the playing field and support early stage companies when they are the most fragile. We would like to suggest the following to shape a new model of economic development that brings more dynamic innovation and job growth to our economy:
- Younger entrepreneurs are more open to trying new ideas and are more likely to take the risks that older generations potentially shy away from. Since most startups have trouble raising funds, initiatives like Revolution’s Rise of the Rest could help with venture funding. Further reform of the rules on crowdfunding would also encourage millennials and startup entrepreneurs of other generations to be more optimistic and consider startups. Public and private partnerships in capital raise are critical. Programs like Nebraska's prototype grant are essential for young small businesses. Opportunities should not be as focused on the growth potential or size of a firm as much as the age. The focus should be on new companies (less than 10 years) of all sizes and types.
- More initiatives such as Welcoming America and the Mosaic Project could be formed to engage and train immigrant entrepreneurs by providing them with mentors and networks. We should welcome immigration of both highly skilled and highly driven individuals from around the world. Immigrants are significantly more likely to start companies than native-born Americans.
- To the largest extent possible, policies should encourage investment in distressed areas. Specifically, those not on the coast, in order to drive capital investment and spur economic growth in these areas. Startups, which have been disproportionally concentrated in already successful areas of the country, should be fostered in the areas that need jobs and growth.
- Restructuring state and national licenses can help improve worker mobility and provides startup entrepreneurs the flexibility to explore new markets and expand internationally.
KANSAS CITY: A CASE STUDY
Recent studies have found that young, small businesses in Kansas City, Missouri, are a job-creating powerhouse, averaging 16,376 new jobs each year. Researchers have found that Kansas City’s first-time employers created 84,011 new jobs from 2012 to 2016. That accounts for 65% of all new employment in the area. Although the wages paid are less compared to the city average, after three years, they tend to exceed the average, and the gap is anticipated to expand further in succeeding years.
It's not all bad news for young firms. The Kauffman Foundation seems to think momentum is building, citing that growth in firms less than 5 years old has finally just returned to pre-recession levels. By implementing policy and initiatives that encourage more startup creation, we can build on the momentum of this growth. Small business is the backbone of the U.S. economy. But we must look deeper to realize it is small and young firms that have a disproportionately large economic impact. Startups play a profound role in creating new employment opportunities. If policymakers develop reformed strategies, it will help fuel entrepreneurial growth. The intention of this piece is not to layout all the solutions. That is beyond the scope here. Policymakers of all levels must bring a vigilant focus on young, small businesses to their work. Ross Baird, founder of the VC firm, Village Capital, writes, “Simply put, the blind spots in the way we innovate — the way we nurture, support, and invest in new ideas — make all our other problems harder to solve.” Nurturing this fragile innovation environment for young firms will fuel growth, reviving local economies across the nation with new jobs and dynamic innovation. Ultimately, it may help us solve our greatest problems more effectively.
Additional Reading and Sources