Do people start businesses more frequently as a result of recessions? You might think so, but a new study just released by the Ewing Marion Kauffman Foundation suggests otherwise.
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)
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I was laid off in April of 2008 and decided I was tired of depending on people that were unreliable. In July of that year I launched an online kung-fu school, putting my passion and my TV news, radio, PR, marketing and media relations skills to work for myself. I have members around the world paying a monthly fee to study the videos, e-books, audio, and other material that I create myself.
My site was profitable the 2nd month and between it and my instructional DVD sales — all online — I’ve managed to get by (although my wife carries the health insurance in her job).
Ken, awesome! I love to hear successful stories of people who take matters into their own hands and start a business.
I agree that a large part of the disparity is likely due to how the data is collected and reported. These small one-person businesses simply don’t get counted. Conclusions are only as good at the underlying data.
Great food for thought. One reason that there is a disparity is that a lot of one-person businesses, especially the home-based ones, may not report themselves as “business owners” right away. They could be starting out part-time, while still looking for employment.
Maybe a year later, if they cannot find a job, they forgo the job search altogether, and start doing their little business, full time. Then they see their accountant, and register the business.
A 1.5-2 Year delay could account for part of the difference.
The Franchise King
Okay, not to sound cynical, but the SBA does want to justify itself and need for government funds. It’s kind of like the Sugar Marketing Board funding a study that shows that sugar is actually good for you…
Anita: Have you asked Scott Shane about his take on the data?
If I understand the Kauffman study correctly, their finding is the number of incorporated, employer firms formed each year is relatively constant. I don’t think they make that claim for non-employers or include non-employers in their data sets.
The government started collecting non-employer data in the 90s, so it is hard to draw longer term conclusions about this data. But in that relatively short time frame, non-employer formation has shown more variability than employer formation.
So I think the two studies are looking at different things and both are correct.
In Nevada, the recessions have bred many small startups, all from folks losing their jobs. Four very active categories: Auto repair techicians laid off from mainstream dealerships, chefs from restaurants, construction specialties (plumbing, electrician, etc.), and home services (landscaping, cleaning, window-washing, etc.). Many do not pursue business licenses initially, working out of home or vehicle. Unfortunately, many of these small startups either have or are failing, as the market couldn’t support the existing businesses, much less startups.
I am not sure if our experience reflects the nation as a whole, but at our CPA firm we probably see more start ups than other businesses. This is because as soon as they start up they come to a CPA to figure out how to do their taxes. We have seen a significant decline in start-ups since the end of 2007. I personally believe the contrary is true. People do not start up more when the economy is bad, they start up more when the economy is good.When people find out how much can be made on their own, they start up businesses. When the economy is booming, they start up businesses to take advantage of the situation. Here in Florida, every one became a homebuilder overnight. Now they are afraid to start businesses because the future is so uncertain. We have yet to see an uptick of new businesses.
There may be other factors involved here as well, which is also a situation that we have witnessed. In times of increasing unemployment, it is not the strongest workers or the most motivated workers that get laid off first. It tends to be the underperformers. These underperformers are unlikely to go out on their own and start a business. High performers on the other hand are probably not going to jump ship when the economy sours because they know that it may be hard to replace that job if it does not work out. But if the economy is booming, they feel more secure about leaving their job to start a business.
I am a Startup founder and frankly I am not sure whether my “business”, a photo-story magazine called YouTellYou must be counted in one study or in the other.
I have been working on YouTellYou for the past 6 months but YouTellYou is (for now) free to use and the business model is not fully defined. Is it still a business? Even if it’s not making any money (by definition)? BTW, try it, it’s cool!
I beg to differ with SBA statement that unemployment rates affect new start ups. Unemployment discourages “employer business” or anything outside an employer/employee relationship. This is because according to unemployment agencies a person cannot collect unemployment if the same person also has a small business. The assumption is a small business owner is not looking for a job, a requirement to collect unemployment. If a person does have a small business the income must be deducted from unemployment benefits in some states. Now if unemployment benefits dries up motivation might exist to start a new business, but I ask, with what? It may not take venture capital to start all small business but most small business begins with small business owner assets. So where is the connection between unemployment rates and new start ups? Likely new business owners aren’t among the ranks of the unemployed but are employed persons who diversify just to keep competitive in the market. Even if the latter is true, it doesn’t tie to unemployment rates. I take exception to SBA declaration and think it is a marketing slogan.
Joel, I suspect there’s a lot of truth to these 2 sentences of yours:
I think it’s also in part due to the kind of concern that Michele raises. Unemployment benefits rules discourage starting a business right away. A lot of people will be making plans to start a business but won’t “officially” start until after their unemployment benefits run out.
And then there are a handful of states that actually provide assistance to start a business for those that are unemployed. Dawn Rivers Baker wrote about this a year ago: http://bit.ly/13iA65
I agree with you that the unemployment laws are ridiculously outdated and unfairly penalize those who try to start a business. Yes, they certainly do discourage entrepreneurship.
I do believe the data in the SBA study. The study was done by private researchers — university professors if I’m not mistaken.
Unemployment is usually a state-law issue, and the SBA doesn’t have any control over state laws. We should lobby our state lawmakers to change the unemployment laws and rules.
State legislators and unemployment bureaucrats, are you listening?
I think it really boils down to what part of the industry you are in. If you are in an area that people have easy access to capital at any time, you will not see much of a boost when the cash flow is lower.
Another thought about the discrepancy in the outcome of the two studies: Many owner-funded start ups are sole proprietors and may not show up in the same way as new business starts that are incorporated. Some may not even filed a d.b.a. with their county.
Nor would they have filed for an EIN that would identify them as a business.
The unemployment rules encourage cash business start-ups by technicians where the income is underground until the business grows and adds employees.