No, this is not a semantics test. “Small business loans” and “small loans to business” measure different things.

The more popular “small loans to businesses,” reported recently by the Small Business Administration, uses data from the Federal Deposit Insurance Corporation Call Reports to track loans of less than $1 million, regardless of the size of the borrowers. The less popular “small business loans,” produced by the Federal Financial Institutions Examination Council (FFIEC), uses information gathered from the banks under the Community Reinvestment Act to measure loans of any size to companies with $1 million or less in revenue.

The statistics on “small business loans” may provide a more accurate picture of the small business credit market than the “small loans to business” figures because big businesses can obtain loans of less than $1 million.

The number of bank loans to small businesses dropped a whopping 68 percent between 2007 and 2010, and the dollar value of the loans declined 55 percent in inflation-adjusted terms. These drops are much larger than the 9 percent decline in the number of small loans to business and the 10 percent slide in the the real value of those loans observed over the same period.

Like the small loans to business numbers, however, the small business loan numbers show that the fall in lending to small companies didn’t just occur during the downturn but continued into the recovery that followed. From 2009 to 2010, bank loans to small businesses fell by 32 percent, and the dollar value of the loans declined 11 percent in inflation-adjusted terms.

The recent decline in small business lending more than offsets the expansion that occurred in the years prior to the downturn. As the figure below shows, the number of loans made to businesses with less than $1 million in sales increased 70 percent between 2005 and 2007. (That is much faster than the rise in the number of companies with sales of less than $1 million, which IRS data show only increased 7.4 percent between 2005 and 2007.)

But even after accounting for a correction for this period of easy lending, bank loans to small businesses have contracted severely. In 2010, the number of loans was at 54 percent, and the real dollar value of the loans was at 48 percent, of 2005 levels.

Source: Created from data from the Federal Financial Institutions Examination Council

From Small Business Trends

Small Business Loans and Small Loans to Business

In fact, by the time that companies enter their teenage years, the odds that they will go under have flattened out. A twelve year old business and a seventeen year old business face roughly the same odds of being shuttered in the following year.

In the figure below, I use Bureau of Labor Statistics (BLS) data on the survival of the 1994 cohort of new businesses to illustrate this point. The figure shows the percentage of businesses alive in a given year that failed during the subsequent year. For example, 20.2 percent of the businesses founded in 1994 died between 1994 and 1995. However, only 4.3 of the businesses founded in 1994 and still in operation in 2010 died between 2010 and 2011.

The figure indicates that the new business failure rate for companies started in 1994 steadily declines until 2006 and then flattens out. While the odds of going under never disappear, they pretty much hold steady at 5 percent once the businesses reach age 12.

Source: Created from Bureau of Labor Statistics data

From Small Business Trends

Businesses Face High Rates of Infant Mortality

Loans from finance companies are an important source of credit for many small businesses. Next to banks, they provide more credit to small businesses than any other source, the SBA Office of Advocacy explains.

Recently released data tables from the Small Business Administration’s annual publication, Small Business Economy, shows the severity of the recent decline in small business loans from finance companies. In the figure below, I present the SBA estimates of the amount of outstanding receivables on business loans from finance companies adjusted for inflation from 1980 to 2010.

Source: Created from data from Small Business Economy 2011

The figure indicates the clear drop off (and lack of recovery) in finance company loans. Between the end of 2007 and the end of 2010, the real dollar amount of outstanding business loans from finance companies fell 28 percent, back to levels not seen since 1998.

This decline has contributed to the difficulty that many small business owners have in obtaining access to credit today. As the SBA’s Office of Advocacy said last fall in “Frequently Asked Questions About Small Business Finance:”

“The recent decline in finance company lending … is a major contributor to the tight condition of today’s small business lending market.”

From Small Business Trends

The Drop in Lending by Finance Companies

The nationally representative survey of approximately 500 business owners and managers of companies with sales of between $100,000 and $250 million per year shows that the net percentage of respondents who were pessimistic (percentage pessimistic minus percentage optimistic) about the local economy was 22 percent in the spring of 2012.

This was the lowest level since the fall of 2007, when the net percentage pessimistic was 1 percent. But back in the fall of 2004, 9 percent of small and medium sized business owners were more optimistic about their local economy than pessimistic about it.

A similar pattern can be seen in the business owners’ optimism about their own companies. A net 11 percent were optimistic this spring, the most positive level since the fall of 2007. But again, these numbers are low in comparison to before the recession. In the spring of 2007, for instance, a net 30 percent of respondents were optimistic.

Moreover, decision makers at small and medium-sized businesses remain profoundly pessimistic about the national economy. A net 38 percent were pessimistic about that in the spring of 2012. In comparison to the net 15 percent who were optimistic in the fall of 2004, that’s not very positive at all.

Then again it’s not the horrific net 69 percent pessimistic about the national economy recorded in the spring of 2009.

Optimistic Photo via Shutterstock

From Small Business Trends

Small Business No Longer Plagued By Recession Pessimism

The dollar value of small loans is down substantially since the start of the financial crisis and Great Recession. SBA data reveals that the inflation-adjusted value of business loans of less than $1 million shrank by 19 percent between 2007 and 2011. As the figure below shows, we have yet to see any recovery in the real value of small loans to business.

Source: Created from data from Small Business Economy 2011

The amount lent has declined in large part because banks are making fewer loans. While the average value of loans shrank 6.7 percent since 2007, the number of loans fell 13 percent, from 24.5 million to 21.3 million. The SBA data doesn’t tell us whether all small businesses now have fewer loans or fewer small companies are borrowing, but other data suggests that the latter is true.

Much of the drop in loan volume comes from a decline in real estate lending. As probably would surprise few people, the number of commercial real estate loans dropped 39 percent between 2007 and 2011, a much larger decline than the 10 percent reduction in the number of commercial and industrial small business loans.

However, the large decline in the number of commercial real estate loans was not reflected in a decline in the value of the loans. The real dollar value of small commercial real estate loans fell only 17 percent between 2007 and 2011, less than the 20 percent drop in the value of real value of commercial and industrial small business loans.

From Small Business Trends

The Great Recession’s Effect on Small Loans to Business

According to the Organization of Economic Development and Cooperation (OECD) publication, Entrepreneurship at a Glance 2011, less than one percent of companies with ten or more employees are gazelles – employers that have been in operation for no more than five years with ten or more employees that increase employment by 20 percent per year or more for three years.

The United States has an even smaller share of gazelle companies than other developed nations. In 2007, the last year that the OECD measured employment growth in U.S. businesses, less than one quarter of one percent of companies were gazelles. While I have no hard data on the share of gazelles during the recession and weak recovery that followed, I doubt that the share of gazelles increased substantially, if at all. The share of gazelles means that of the roughly half a million new businesses with employees created in the United States every year, a little over 1,000 will be gazelles.

Moreover, most gazelles, while growing faster than other companies, are not adding jobs at a rocket-like pace. After three years, a company with ten employees needs only have a little over 17 workers to have generated the 20 percent per year compound employment growth necessary to be a gazelle.

Companies that grow much faster than gazelle pace (super gazelles) are much rarer still – so rare that they are hard to measure statistically.

Our elected officials need to recognize that the gazelles and super gazelles they love for their job creation capabilities are extremely rare. They should take that information into consideration when formulating policies toward high growth young companies.

Gazelle Photo via Shutterstock

From Small Business Trends

Rarity of High Growth Young Companies

The change in the number of jobs created per investment is similar. The CVR’s data show that the average number of jobs at angel-backed companies fell 58 percent (from 6 to 2.5) between 2010 and 2011.

But instead of mentioning this huge job in angel job creation, the report simply says “Angel investments continue to be a significant contributor to job growth with the creation of 165,600 new jobs in the United States in 2011, or 2.5 jobs per angel investment.”

To me that’s a big omission. We can debate whether the creation of 165,000 plus jobs is really “significant” in an economy that the Bureau of Labor Statistics (BLS) reports created just shy of 27 million private-sector jobs in the 12 months ending in June 2011. But, if you think that the creation of 165,000 new jobs is “significant,” then you should think that a 204,400 job drop is “significant” too.

If we believe the CVR’s numbers, then we need to figure out what happened. A drop of this magnitude in angel job creation shouldn’t be ignored.

Are the numbers correct? The authors of the report — who know the data better than anyone else — expressed no reservations about the 2010 job creation figures. In last year’s report, they wrote, “Angel investments continue to be a significant contributor to job growth with the creation of 370,000 new jobs in the United States in 2010, or 6 jobs per angel investment.” If last year’s figures were erroneous, surely they would have noticed and said something (or at least included a disclaimer in their report.)

Second, both government agencies and academics have (implicitly) expressed confidence in the CVR’s figures. For instance, the National Science Foundation reproduced some of the CVR’s numbers in its 2010 Science and Engineering Indicators, a widely used government report.

Moreover, in a recent blog post on Forbes.com, Professor Patti Greene of Babson College discussed the 2011 CVR report without out expressing any concern about the accuracy of the figures. (Please note that I am not criticizing Dr. Greene here; I, too, have used the CVR’s numbers uncritically.)

On the other hand, something seems wrong with the CVR’s numbers. The 2010 job creation figure was 48 percent higher than the 2009 figure. And the 2010 estimate of the number of jobs created at the average angel-backed company was 37 percent larger than the previous year’s figure. Unfortunately, the CVR doesn’t provide enough information about its methodology for others to figure out if their analyses contain any errors or biases. All we can do is to rely on the folks at CVR to tell us if there’s a problem, and they didn’t.

This poses a dilemma. The 2011 report says that the dollar value of angel investment increased 12.1 percent between 2010 and 2011; the number of ventures receiving angel funding went up 7.3 percent; and the number of angels investing increased 20 percent. Therefore, if we believe the CVR’s analysis, we need to conclude that the angel market is improving, but job creation at angel backed companies is plummeting. However, if we think something is wrong with the CVR’s numbers, then we have to conclude that the report tells us nothing about what’s going with the angel capital market.

Which alternative do you think is correct?

From Small Business Trends

Job Creation by Angel Backed Companies Collapsed in 2011

As bad as this might sound, the situation was worse for several demographic groups:

• Self-employment declined more among men than women. The number of self-employed men declined 8 percent from 2007 to 2010, while the number of self-employed women dropped only 6.3 percent.

• Minority self-employment dropped more than White self-employment. Between 2007 and 2010, the number of Whites (Caucasians) in business for themselves declined 6.5 percent. Among Hispanics, the drop was 11.3 percent, and among Asians it was 12.3 percent. For Blacks (African Americans), the decrease in self-employment was a whopping 17.1 percent.

• Self-employment among the young fell, while among older people it increased. The number of self-employed people under the age of 25 fell 11.8 percent between 2007 and 2010. For people aged 25 to 24, the decline was 11.2 percent; for those aged 35 to 44, 18.2 percent; and those 45-54, 8.3 percent. By contrast, the number of self-employed Americans aged 55-64 rose a slight 0.4 percent, while the number of Americans over 65 in business for themselves increased a solid 8.5 percent.

• Self-employment declined more among the less educated. Between 2007 and 2010, the number of self-employed Americans without any college education dropped 10.5 percent, while the number with some college declined 11.6 percent. The number of people in business for themselves with a bachelor’s degree fell a more modest 4.7 percent. But those with a master’s degree or higher increased 4.6 percent over the three year period.

• Rural self-employment dropped more than self-employment in urban or suburban areas. The number of self-employed Americans living in central cities declined 5.6 percent between 2007 and 2010, while in suburban areas, it fell 8.4 percent. In rural areas, it decreased 11.8 percent.

Ethnic Diversity Photo via Shutterstock

From Small Business Trends

Which Demographic Groups Have Suffered the Greatest Decline in Self Employment?

That’s why recent data from the Kauffman Firm Survey (KFS) is disappointing: It demonstrates how rare employment growth among new companies really is.

The KFS is an ambitious effort to track 4,928 companies founded in 2004 over time to identify which businesses survive, die, stagnate and grow, and identify why some businesses do better than others. Not too long ago, the Kauffman Foundation released the sixth year results for the survey and the findings aren’t very pretty.

The data show that relatively few new companies survive over time, let alone grow. By 2009, only 56 percent of the companies started in 2004 were still in business, according to the Kauffman Foundation’s analysis of the data.

Moreover, hiring people isn’t very common for young businesses. Only about half of the companies that survived to year six had any employees at all. This means that at age six, only 29 percent of the companies started in 2004 were providing a job for anyone.

The number of jobs provided by most of these companies is very modest. According to the Foundation’s analysis, the typical (median) six year old company had only a single employee, while the average (mean) business had 3.7 workers.

Even the biggest company in the sample is a small business. At 265 workers, this company was a little more than half the minimum size of a large business, according to the Small Business Administration’s definition (500 or fewer workers). That is, none of the new businesses tracked in the study experienced the kind of break out growth that investors, entrepreneurs, and policy makers hope new companies will have.

While a complete understanding of the causes of new business job growth awaits systematic analysis, one factor jumps out: whether the business began as an employer. The KFS reveals that only 11 percent of businesses without employees in their start-up year had any employees six years later.

Doomed Growth Photo via Shutterstock

From Small Business Trends

Startup Company Growth

Nobel Prize-winning economist Kenneth Arrow explained why entrepreneurs rarely sell their new product ideas to established companies better able to exploit them.

His answer has become known as “Arrow’s Information Paradox” and goes like this: If you try to sell someone a piece of knowledge, like an idea for a new product, they won’t buy it unless you also provide evidence that the idea will work. Otherwise, the buyer risks wasting money on ideas that go nowhere. Therefore, to sell an idea to someone else, an entrepreneur needs to disclose information about it.

That’s the problem. Ideas cannot be taken back once they are revealed. However, once someone has been told an idea, any incentive to pay for the idea evaporates since the information the information just provided for free cannot be rescinded.

This is the paradox: Ideas cannot be sold if they aren’t disclosed, but once they are disclosed no one will pay for them.

Professor Arrow explained that the patent system helps to solve this paradox. If you have a patented technology, you can disclose it to see if a buyer is interested. If the disclosure peaks the buyer’s interest then he or she will have to pay to use it. As long as the patent cannot easily be worked around, this legal protection precludes others from pursuing your idea without paying for it.

Companies are getting much better at avoiding Arrow’s Paradox than they use to be. While markets for technology remain a very tiny share of all economic activity – the World International Patent Organization (WIPO) reports that they totaled approximately 1/3 of 1 percent of world GDP in 2009 – they are growing very rapidly. The WIPO found that when measured in constant (2009) dollars, the total spent on royalties on licensing was $15.5 billion in 1970, $44.3 billion in 1990 and $180 billion in 2009.

Alongside the rise in the magnitude of markets for technology, a variety of organizations that help match buyers and sellers have emerged, including IP clearing houses, technology licensing offices at universities and government agencies, IP brokerages, and auction houses, WIPO reports. Moreover, big, established companies have become more active at soliciting technologies developed by independent entrepreneurs and academic institutions. And more companies are forming to make money solely from the development and sale of intellectual property, letting others use their IP to make and sell products.

In short, in high tech, more businesses are selling ideas as companies are using the patent system to get around Arrow’s paradox.

High Tech Concept Photo via Shutterstock

From Small Business Trends

Emerging Markets for High Tech Ideas