November 22, 2014

Start-ups Have Been Shrinking

In an earlier post, I wrote about the large share of net job creation that comes from new firm formation.

The importance of firm formation to net job creation raises the question: Over time, are newly formed businesses employing more or fewer people? Given the number of net new jobs created from firm formation, a decline in startups’ average employment could pose problems for our economy’s ability to generate the jobs we need to reduce current levels of unemployment.

To figure out what has been happening to the initial employment of new businesses, I took a look at data from the Longitudinal Business Database of the U.S. Census (see figure below). The vertical axis measures the average number of employees per new business in its founding year. The blue bars show the average number of employees in new firms by year. The black line shows the five year moving average of that figure.

The figure shows that the average new establishment founded in 2005 employed about one less person than did the average new establishment founded in the early 1980s (although the numbers are marginally better in 2005 than in the mid-1990s.)

Rate of job creation by new businesses

Unfortunately, the Census data is only available through 2005, making it difficult to know if the trend toward lower average firm size it shows is continuing. To see what has been happening more recently, I took a look at Bureau of Labor Statistics (BLS) data. Below is a figure that shows the average number of employees at new businesses established in each quarter from the first quarter of 1999 through the second quarter of 2009. The pattern is a decline in the average size of start-ups, from 6.6 to 4.2 employees.

average number of employees per new business

The number of employees hired by the average new business may be falling over time for any of a number of reasons. But my focus today is not on why the number has declined, but the implications of the decrease. New business formation is an important source of net job creation. Because the average number of employees hired by each new business is declining, we need to create more new businesses every year to generate the same number of net new jobs.

That leads me to a final question:  If those additional businesses don’t get formed, will we remain stuck with current high levels of unemployment?

12 Comments ▼

Scott Shane


Scott Shane Scott Shane is A. Malachi Mixon III, Professor of Entrepreneurial Studies at Case Western Reserve University. He is the author of nine books, including Fool's Gold: The Truth Behind Angel Investing in America ; Illusions of Entrepreneurship: and The Costly Myths that Entrepreneurs, Investors, and Policy Makers Live By.

12 Reactions

  1. That’s been over too long a time to be due to a recession. Very interesting trend though – keep us up to date!

  2. Scott,

    Thank you for your informative article. Even though you’re saying it’s not about the “why,” I’m going to offer my opinion on it.

    The internet has changed so many things, and I’m thinking it has also contributed to the lower employee numbers with new business start-ups.

    Some firms just don’t need as many employees, because lots of things can be automated, or done vitually.

    Most of us (small business owners) are looking for ways to reduce costs, and having more tools at our disposal helps us do just that.
    I feel that it’s important to look into the “why,” in this case.

    The Franchise King

  3. Its simply because starting a business in this economy is not the way to go. There are plenty of profitable winner businesses out there selling as we speak for far less then their really worth. Now is the time for people who want the most out of life to grasp on and take the plunge.

    I think a key idea to remember when buying a business is to try and buy a winner. I know its tempting to buy a loser business and turn it around, but I don’t think it’s the financially sound way to operate. Purchase a mature profitable small business and you’ll have cash flow right from day one.

    I’d also recommend not straying out of your field of expertise. A person that has been an executive of a produce company for 15 years has no business buying a water park. Stick to what you know.

    Anyone interested in the buying of a business should check out The Business Buyer Advocate blog at http://www.businessbuyeradvocate.com/ . It is a great blog full of must have knowledge for anyone thinking about taking the plunge. It’s frequented by quite a few experts in various aspects of the field that can help you with any questions you might have or perspective you might need.

    Buying a business very well could be the most important decision you ever make in your life. You have to make sure you buy the right business the right way.

    If you are on the other side of the fence and looking to sell a business or just want to get the other perspective check out their sister blog The Business Seller Advocate at http://www.businessselleradvocate.com/

  4. >> That leads me to a final question: If those additional businesses don’t get formed, will we remain stuck with current high levels of unemployment? <<

    Yes. Unless you agree with the current administration that simply extending unemployment benefits is the answer.

  5. I agree with Joel; automation has reduced the need for as many employees. However, I think it should also be noted that the increasingly complex regulatory environment involved in additional employees discourages businesses from bringing on more people (since it just adds more regulation and tax burden).

  6. I dont believe thats its bad to start a business now. In fact I bought a business – actually three of them and while tough its rewarding. Nonetheless I have made many many mistakes and you can read about it on my blog. Learn from me – I just hope it helps.

    http://insightersguidetobusinessacquisitions.wordpress.com/

  7. What about the rise of the microbusiness? I think more people are going into consulting, doing a 1-man show, in response to getting laid off in the bad economy. What’s missing here is the number of new businesses – there might be something there. These new businesses would only employ 1 person, and weren’t started with the intention of employing more.

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