Start-Ups Create Jobs, Right? So Let’s Stop Praising Small Businesses — and Fund More

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By pretty much any measure, lending to American small businesses is weak. Most recently, small business borrowing dropped 5% from May to June, according to the research firm PayNet, which tracks such lending. And while May’s borrowing had encouragingly reversed a four-month decline, June’s numbers were actually in sync with a broader trend.According to the recent annual report from U.S. Small Business Administration Office of Advocacy, a year-0ver-year comparison of outstanding loans to the nation’s small business revealed a decrease of almost 7%, for the 12 months that ended in June 2011. At that point,  banks had $606.9 billion in outstanding loans to the U.S. small businesses, compared with $652.2 billion for the same 12-month period ending in June 2010.  That’s not good news for anybody, except maybe the Romney campaign.

But understanding why lending to small firms is down—and how important small firms are to the economy in general and employment in particular—is not simple. Because for as much as politicians glorify entrepreneurs, it’s unclear how crucial they are  when it comes to job creation. For that matter, it’s a little unclear what we’re talking about when we talk about small business. Because one entrepreneur’s small business is another’s gigantic competitor. According to the SBA, for example, a small business is defined in one of the following ways, depending on industry:

  • Annual revenues of $750,000 or less for most agricultural industries
  • $33.5 million or less for heavy construction industries
  • $14 million or less for specialty trade contractors
  • 500 employees of fewer for most manufacturing and mining industries
  • 100 employees or fewer  for wholesale trade industries
  • $7 million or less for most retail and service industries

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That’s a wide range of range of definitions, especially given the way politicians and Chamber of Commerce types like portray entrepreneurs as an urban version of the family farmer. In fact, even the SBA’s small-business loan data is based on a a sort of proxy measure. The agency defines a loan to small business as any business loan of $1 million or less. So a $1.1 million loan to a chain of dry cleaners with $5 million in revenues doesn’t get counted, while a $500,00o loan to a 150-worker auto parts wholesaler does.

Small wonder  there’s no consensus as to why lending is down. Despite speculation that banks are still making it harder for small companies to borrow, PayNet president William Phelan says his firm’s research reveals that banks are actually making it easier. Indeed, while the most recent survey from the National Federation of Independent Business reports that 7% of respondents  in June described loans as “harder to get,” that figure is actually two percentage points lower than it was in May. And 93% of respondents said “that all their credit needs were met or that they were not interested in borrowing.”

Which makes sense. Small businesses often have a relatively thin barrier between success and failure. Facing minimal economic growth—not to mention uncertainty about the effects of healthcare reform and other regulatory and legislative agendas—only the most confident and/or desperate of entrepreneurs will increase their borrowing. And pretty much any rational business owner would be hesitant to expand, as the NFIB survey shows. The question is, How big a deal is that to the nation’s employment picture?

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Depends on who you ask, of course, but in the next few months you can expect to hear a lot about the importance of small businesses to the U.S. economy—and not just because of President Obama’s mischaracterized “You didn’t build that” sentence fragment regarding the role of  government in business creation. As they do with American small farmers, politicians overemphasize the importance of American small-business operators. That is, small farmers aren’t the reason U.S. food prices have plummeted over the decades (adjusted for inflation); most of the credit goes to the efficiencies that came with the rise of corporate farms. Likewise, medium- and large-sized firms likely account for one half to two thirds of U.S. non-farm and non-government employment. Small businesses are important, certainly, employing tens of millions of people and driving innovation. But many if not most small concerns stay that way—or go out of business entirely.

The real Little Engine That Could when it comes to job creation, as shown in a 2010 study from the National Bureau of Economic Research—”Who Creates Jobs? Small vs. Large vs. Young”—is new companies, regardless of their size. As the authors (John Haltiwanger, Ron Jarmin, Javier Miranda) concluded: “Firm startups account for only 3% of employment but almost 20% of gross job creation. The fastest growing continuing firms are young firms under the age of five.”

This distinction might seem nuanced—very few business launches start with 1,000 employees—but it’s important. When politicians criticize government for small-business-strangling regulation, they’re being disingenuous. Most small businesses fail to grow because that’s the nature of the beast. What you want, from a job-creation perspective, is government to foster an environment in which starting a business—period—is easy. It’s a numbers game really; since most small businesses will fail or stall, you want to throw as many ideas on the pavement as possible so that the small percentage of start-ups that thrive is part of an increasing  pool of new companies. The success rate may not change, but the absolute number of successes will.

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Judging by that measure, the state of U.S. entrepreneurship is ripe for meaningful discussion. On the one hand, the Romney campaign might focus on the most recent annual data for U.S. business start-ups, which dropped to a record low in 201o. Conversely, the Obama campaign might highlight the World Bank‘s most recent “Doing Business” annual report, which ranks the ease of organized commerce in 183 countries, based on business-friendly regulations. The U.S.—which finished 4th overall—ranks 13th when it comes to starting a business. That’s the second-highest ranking among the world’s 10 biggest economies.

Rather than arguing over who’s more supportive of existing small-business owners—or harping on regulations, which are not the problem; or worrying about weak borrowing, which is most likely a cyclical phenomenon—both candidates should explain how they’d help wannabe entrepreneurs take the big leap. Because the more of those folks we can guide from fantasy to reality, the more jobs we’ll create down the line.

10 comments
lawrenceanne37
lawrenceanne37

This is such a good idea. I would love it if somebody helped me with my business, anyway! I'm trying to start my own line of surfboards but am having trouble funding them. They're specifically for women, how cool is that?

KRMLLDY
KRMLLDY

All I know is I am a 51 yr old single mom of 4 (ages 30-16), and my concession company (gourmet caramel corn) is growing pretty quickly.  My problem is there is no real assistance out there for me, even though they make it sound like there is for women/minority owned businesses.  If your credit took a hit because of housing or whatever, and you can't really show profit and loss (yet), even though you have contracts with the NHL and a sports arena (43 games and 6 concerts so far, not counting all the normal business and fundraisers I do), You are still on your own relying on family and friends to trust that their belief in what you have is enough to get them their money back and make some profit.  That's a lot of weight on someone like me. 

 I'm still moving forward, but the costs of fronting product for a couple months before you see any returns to the tune of approx $10,000, the cost of the ridiculous amount of insurance required, finding a space you can afford for expansion, paying anyone to help so I don't have to do it ALL,  etc, is enough to make you want to give up on your dream so you don't have to ask them for any more than they've already done.  Instead you stress, and put on a happy face that everything is fine, and hope to the heavens that a door opens that you hadn't seen to help get over the hump.

Being IN IT.... what I am going through... I truly believe is why more small business don't succeed.  You have to have credit to get credit.  You have to have money to get money.  You have to show profits before you have profits.  It's next to impossible to move forward with those odds stacked against us.    Here's hoping I swim instead of sink.!!

Got that off my chest :-)

Barnesdorf
Barnesdorf

One of the largest issues is that entrepreneurs and others simply do not feel confident enough in the direction of the economy to start businesses. When you do not feel as if your investment and effort is going to be worthwhile, you will not start a business.

According to Granted.com, there are millions of jobs in the market at the moment; however, very few of thae jobs appear to be with start ups or new businesses. The economy will only move forward when people have confidence in the market and upward momentum. Entrepreneurs thrive on faith in new ideas and a receptive market.

joe blow
joe blow

Customers create jobs, not investors.  Destroy the middle class and you destroy the customer base for most small businesses.

bcfred
bcfred

Finally some reasonable commentary - loans are down due to lack of demand, not banks hoarding cash.  Banks are currently making negative real interest rates holding Treasuries and maybe a point or two on high-grade bonds.  They would much rather be earning a decent margin on loans.

Don Bartenstein
Don Bartenstein

Um... is it because big business own the lawmakers and corporate welfare is skewed towards them?

Jon Gruett
Jon Gruett

Barnesdorf,

I agree wholeheartedly in your statement about entrepreneurs will start new businesses when they feel confident in the future. Right now they do not. 

A VERY big problem is also that even if they feel confident in their idea and have the passion and drive to make it happen they typically do not have the investment to make it a reality. I know of MANY inventors that have great ideas and have developed their concept well beyond the working prototype level and into the commercialization level but cannot get funding needed to go to that next level. This problem goes way beyond the inventor or entrepreneur and into the investment community. 

One such company that I know of has created some very efficient LED lighting solutions that will knock the socks off the other big brand names. Because they are a start-up that is less than 2 years old they cannot have banks give them even a first look. Not enough history to be considered. They are just now landing some huge orders well over $10 million. It will be easy to find funding once the order is in place. However, what they really need is the 'right' type of investor that understands technology, importance of IP and investment timing in a huge and growing market. If they are willing to jump in now when there is just a little risk I think they will appreciate the returns very quickly. There are many other investors that will jump in once the order is landed but this sort of technology design will not wait. It will eventually be figured out by other lighting companies. 

This is but one example of the problem and it all has to do with finding the right funds from the right investor partner and not the governmental regulations mentioned in political diatribes. Burdensome corporate taxes and excess government regulations will be an issue for these folks once they begin to look at relocating the manufacturing to North America. 

There seems to be a lot of stated desire by the politicians to bring manufacturing back to the USA but I have yet to see any positive movement where they put their money where their mouth is. If I am missing some of those instances where that has happened (other than Solyndra or another solar company) then please have someone send me the examples. I would love to be proved wrong on that point.

If the government got out of the way and let free market capitalism work its magic then we would not have an unemployment problem here in North America. The investment community MUST re-look at their existing model and be creative on how to get people back to work. The future is truly in their hands if the government would just back off the regulations. Those regulations will be a problem once the initial funding is taken care of and the company starts to excel in their respective markets.

I hope that Romney/Ryan will apply their business and financial savvy to this problem and change the way America is moving. We cannot afford to have this many people (23 million) continuously out of work like they have been. 

Jamie Wong
Jamie Wong

Customers create jobs, and that's why companies have to make products which suit the taste of the market. Why do small businesses create jobs? It's because many of them are innovators, introducing unique, "unheard-of" products that wow the customers. It's the innovative and entrepreneutial spirit that keeps the American economy going.

TomDaniel
TomDaniel

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