Entrepreneurs Don't Love the Great RecessionScott Shane
Over the past decade, I've seen a bunch of articles arguing that recessions are good for people who run their own businesses. With headlines such as "Entrepreneurs Should Love a Recession," these authors claim that the down economy isn't "bad news for entrepreneurs." Instead, they argue that recessions are "one of the best times to start, nurture, and incubate a small company". Because entrepreneurs have "less to lose" in recessions and because recessions "enliven" entrepreneurship, are "a motivational boost" to would-be entrepreneurs, offer "excellent employee choices," and "spur booms in innovation," these authors seem to believe that the Great Recession is no problem for America's entrepreneurs.
While their optimism is uplifting, their arguments are flawed. The Great Recession has been bad news for small business owners on almost every dimension one can measure.
What the Numbers Show
The data paint a stark picture of entrepreneurship during the recession. For instance:
Fewer people are starting businesses. Numbers from the Bureau of Labor Statistics show that on a per-person basis, the rate at which people started new establishments fell 13.3 percent from 2007 to 2009. Similar declines can be seen in the rate at which new businesses with employees have been formed. From 2007 to 2008 (the latest year for which data are available), Census Bureau numbers show a 6.1 percent decline in the per-person rate at which new employer businesses were started. The search firm Challenger, Gray & Christmas reports that from the first three months of 2007 to the first three months of 2010, the share of those in its outplacement services who started businesses declined from 10.6 percent to 3.4 percent.
New and small businesses are dying at a rapid pace. In the first three months of this year, the number of business bankruptcies was more than double the level in the initial quarter of 2007, according to the American Bankruptcy Institute. In addition, from 2007 to 2008, the Census Bureau reports that the number of non-employer businesses in the U.S. declined 357,000. The BLS reports that from 2007 to 2009, the number of self-employed people fell by 562,000, with 270,000 of the lost self-employed having previously run incorporated businesses.
Small business employment has shrunk dramatically. According to the monthly ADP Small Business Report, 6.4 million small business jobs were lost from December 2007 to June 2010. This decline occurred amid evidence from several sources that hours worked and compensation at small businesses had also fallen. Even at newly formed businesses, employment declined. The BLS numbers show that the number of employees hired by the average startup fell from 4.32 to 4.18 in the 2007-09 period, a 3.2 percent decline.
The financial situation at small businesses has deteriorated significantly. Both the monthly Discover Card Small Business Watch and the semiannual survey by American Express Open report an 11 percentage-point increase in the number of small business owners facing cash flow problems.The National Federation of Independent Business' monthly survey of its members found that their sales have declined over the past few years, while Sageworks reports that the small businesses it tracks are experiencing lower profit margins.
Small business owners are worried about the prospects for their businesses. Confidence among small business owners is way down, with both the NFIB and Discover Card Small Business Watch optimism indices below their 2007 levels. The proportion of small business owners who said in June 2010 that it's a good time to expand is less than half the share that made the same statement back in June of 2007, according to the NFIB. From April 2007 to February 2010, American Express Open shows an 11 percentage-point increase in the share of owners who believe their business is at risk of going out of business and a 9 point decline in the percentage who believe their business will grow. So pessimistic are small business owners that Discover Card Small Business Watch found that nearly 24 percent more business owners would take a higher-paying job rather than continue to run their own businesses in 2009 than in 2007.
Equity capital has become hard to get. From 2007 to 2009, venture capital commitments dropped 42 percent, the number of VC deals fell 29 percent, and the number of VC-backed companies declined 28 percent (with companies getting initial financing falling 44 percent), according to numbers from the National Venture Capital Assn. and PricewaterhouseCoopers Money Tree. Valuations of early-stage companies and the percentage of venture capital-backed businesses experiencing an "up investment round"—an investment in which the company is valued at more than in the previous investment round—are both down, according to analysis by law firm Cooley Godward Kronish. The numbers on investing by business angels are little better. The figures from Angelsoft, the leading purveyor of investment management software to angel groups, show that these organizations cut the share of the submissions they fund by 44 percent from 2007 to 2009.
Access to credit has tightened. The bank senior loan officer survey conducted by the Federal Reserve indicates a persistent tightening of small business loan standards since late 2007. Trade credit is also down, with the index of trade credit provided by the National Association of Credit Managers at 88 percent of its June 2007 level in June of this year. NFIB data show that, in June, the share of small businesses that are borrowing was down 17 percent from its level in June 2007 and the share of businesses whose borrowing needs were met was down 31 percent.
Exits from investments in high-potential startups have dried up. From 2007 to 2009, initial public offerings by venture capital-backed companies were down an enormous 90 percent, and acquisitions of these companies were down 30 percent, according to numbers from Dow Jones Venture Source. The Dow Jones data also show that the value raised in IPOs was down 36 percent in real terms from 2007 to 2009, and the value raised in merger-and-acquisition deals was down 68 percent.
What the Government Has Done
The optimistic chirping about how well small business owners have been doing has a cost. It takes attention off of what needs to be done to help those running their own businesses. We need to keep Washington's attention on the recession's harm. Instead of helping small business owners, many of the federal government's recent actions have heaped new burdens on them.
The health-care reform bill has increased costs at the largest small businesses. Beginning in 2014, small businesses with more than 50 employees that do not offer employee health insurance will be penalized $2,000 per worker for all employees beyond the initial 30. And all businesses, from the tiniest small businesses to the largest, will have to spend more time and money to adhere to the law, because, as one observer put it, "small businesses will need help filing the correct forms for tax credits, fines, and opting out of insurance."
A host of new regulations has increased the burden of compliance. According to the Heritage Foundation, the cost of new regulations increased last year by the largest amount since 1992, coming in at $13 billion. The Code of Federal Regulations, which lists all regulations currently on the books, increased by almost 5,400 pages, to 163,333 pages, the highest level ever.
Taxes on successful small business owners are going up. In 2013, individuals who make more than $200,000 per year face a 0.9 percent tax increase on salaries and 3.8 percent on unearned income to pay for the cost of the heath-care legislation. If the Bush tax cuts are allowed to expire, small business owners who earn a lot will face an additional 4.6 percent increase in income taxes and a 5 percent increase in capital gains taxes.
Efforts to get more capital to small businesses have done little. Lending programs at the Small Business Administration have been beefed up, but less than 1 percent of small businesses make use of these loans.And the infamous Troubled Asset Relief Program did little to get credit to small businesses.Paul Atkins, a member of Congress's TARP oversight panel, wrote in a statement to a House committee: "After a thorough review, we found little evidence that these programs have had a noticeable effect on business credit availability."
Instead of blaming Wall Street for the problems of Main Street, those on Pennsylvania Avenue might consider working to counteract the adverse effects of the Great Recession on Main Street's entrepreneurs. And those writing about those entrepreneurs might consider toning down the all-is-fine rhetoric. It takes the pressure to help struggling business owners off policymakers.