The study Exploring Firm Formation: Why Is the Number of New Firms Constant? shows that the level of new firm formation has remained virtually consistent from year to year for more than 30 years.
Authors Dane Stangler and Paul Kedrosky of the Kauffman Foundation researched several types of data on company formation, beginning in 1977. These included employer firms as tracked by the U.S. Census Bureau and the Small Business Administration, firm startups tabulated by the Census Bureau, and new establishments (including existing firms adding locations) as tracked by the Census Bureau and the Bureau of Labor Statistics. No matter which type of data the authors studied, they found that the number of new companies launched each year varied by just 3 to 6 percent. In fact, the number of startups stayed fairly consistent even from quarter to quarter within a given year.
Stangler and Kedrosky wondered if there had been more fluctuation before 1977, so they looked into Census data from the 1940s and 1950s and found a similar pattern: Annual change in the number of new business starts varied by only about 7 percent.
What factors help people take their business idea from dream to reality? The authors looked at factors including economic recessions, expansions, taxes, population growth and the availability of capital, and found that these did not affect the rate of new business startups either.
SBA Study with a Different Conclusion
However, their study is somewhat at odds with an SBA study called “Nonemployer Startup Puzzle” that came out last month in December 2009. The SBA study found a correlation between job losses and startups of single-person businesses (called “nonemployer businesses”), noting on page 24 of that study: “Nonemployer start-ups follow and are heavily affected by a state’s unemployment rate.” In other words, there are more startups when unemployment is high.
How to Reconcile the Apparently Different Conclusions?
I don’t know why the Kauffman study and the SBA report reach what appear to be different conclusions, at least when it comes to single-person businesses.
Here’s one explanation: maybe it’s a question of understanding how people start businesses and how those businesses grow. In other words, if you isolate those startups without employees, and could measure them better, perhaps we would see more startups. Here’s why:
The SBA report seems to have a clearer grasp on the fact that people typically start businesses with no employees. That’s especially true for someone out of a job who feels he or she has no choice but to start a business. If you can’t find a job for yourself, it’s unlikely you’re going to be able to convince VCs or angels or bankers to give you money so you can hire employees for a new business out of the gate. So, chances are, if you can’t find a job, you start a business that has no employees. And since there is no legal requirement to register a startup, that business may stay under the official radar screen for a few years until it grows.
Plus, some people start a business and then a year or two later when economic conditions improve, go back to working as an employee for someone else. They’re in and out of business ownership quickly — perhaps before their business shows up on official radar screens. Now, some might say those short-term business owners never really started a business — calling them “underemployed.” However, I say that’s a matter of interpretation. If you sell website designs, the entrepreneur who starts a sole proprietorship and engages your firm for a new website is still a customer, regardless of whether he closes down his business 2 years later. So in the stream of commerce, that startup still matters. Number of employees is not the only way to measure economic impact.
In the end, though, I really can’t explain why these two reports seem to reach different conclusions. If anybody can, please leave a comment and share your thoughts. Meanwhile, you can read the studies for yourself:
- Exploring Firm Formation: Why Is the Number of New Firms Constant? (Kauffman Foundation Report – PDF)
- Nonemployer Startup Puzzle (SBA report – PDF)