Not named after founders.

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What the Best Startups Have in Common

Justin Fox is a Bloomberg View columnist. He was the editorial director of Harvard Business Review and wrote for Time, Fortune and American Banker. He is the author of “The Myth of the Rational Market.”
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Can you tell when a company is founded whether it has a real chance of hitting it big?

Actually, yes, you sort of can. These are among the results of a study of new business registrants in 12 states from 1988 through 2014:

After I saw that I was all ready to drop everything and start work on what would surely be a huge bestseller, "Don't Name Your Company After Yourself and Register It in Delaware: The New Rules of Startup Success." Until I read this:

We strongly caution against a causal interpretation of the regressors we employ for our predictive analytics -- while factors such as eponymy and business registration form are a “digital signature” that allows us to differentiate among firms in the aggregate, these are not meant to be interpreted as causal factors that lead to growth per se (i.e., simply registering your firm in Delaware is not going to directly enhance an individual firm’s underlying growth potential).

That's Jorge Guzman and Scott Stern of the Massachusetts Institute of Technology's Sloan School of Management, ruining my party. They are out not to derive sure-fire money-making tips but to assemble a better metric of startup activity. Existing startup measures such as the Kauffman Foundation's index of startup activity and the Census Bureau's business dynamics statistics have been showing a long-running decline in entrepreneurship that is at odds with both popular perception and evidence from venture-capital surveys. Guzman and Stern's measure of "entrepreneurial quality" is intended to differentiate startups with big growth potential from run-of-the-mill small businesses, and allow them to be counted separately.

It turns out that the high-potential startups Guzman and Stern identified, as FiveThirtyEight's Ben Casselman has already reported, do not appear to be in decline. True, the startup boom/bubble of 1999 and 2000 hasn't been matched since, but the overall trend line slopes upward. Casselman made such a nice chart that I'll just use that:

source: fivethirtyeight

So that's heartening. Less so is Guzman and Stern's finding that, since 2000, startups that pass the entrepreneurial-quality screen have been less likely to make it to an initial public offering or positive-value acquisition than they were in the 1990s. Something is making it harder for startups to strike it rich, although it's not entirely clear what. I do wonder whether it's that the dot-com enthusiasm of the late 1990s and 2000 made it too easy for startups to strike it rich, thus making otherwise perfectly respectable subsequent success rates look poor in comparison.

Guzman and Stern's research also allows us to compare entrepreneurship across regions in a new way. According to the Kauffman index of startup activity, the Miami area topped even the San Francisco and San Jose areas in startup activity in 2015. But according to Guzman and Stern's entrepreneurial-quality measure, there's really no comparison. Here are San Francisco, San Jose and environs (darker colors = higher entrepreneurial quality):

Source: Guzman and Stern


And here's the Miami area:

Source: Guzman and Stern

In and around Silicon Valley, people are apparently starting businesses with short names, patents and Delaware corporate charters. In and around Miami, people are starting business with long names -- often their own names -- that are structured as partnerships or limited liability companies. Some of those eponymous companies might still hit it big (think Ben & Jerry's ), but they are less likely to than their Silicon Valley peers. Not all entrepreneurship is created equal.

  1. The study is "The State of American Entrepreneurship: New Estimates of the Quantity and Quality of Entrepreneurship for 15 US States, 1988-2014," by Jorge Guzman and Scott Stern, and it'll cost you $5 if you don't have free access to National Bureau of Economic Research papers. But there's also free policy paper by Guzman, Stern, Catherine Fazio and Fiona Murray, "A New View of the Skew: A Quantitative Assessment of the Quality of American Entrepreneurship," that discusses the results.   

    Also, if you're wondering why it's 12 states in the text of my column and 15 in the title of the research paper, it's because Guzman and Stern derived their index of entrepreneurship quality using data from 12 states and then used it to measure entrepreneurship in 15: Alaska, California, Florida, Georgia, Idaho, Massachusetts, Michigan, Missouri, New York, Oklahoma, Oregon, Texas, Vermont, Washington and Wyoming.

  2. The Kauffman index did experience a bit of a rebound in 2015.

  3. From the policy paper by Fazio, Guzman, Murray and Stern: "Whether this is primarily a challenge for capital markets or reflects systematic reductions in various aspects of ecosystem efficiency remains an important challenge for both future research and policy intervention."

  4. Austin, Texas was No. 1, Miami 2, San Jose 3 and San Francisco 6 (of 40 metropolitan areas).

  5. "Ben & Jerry’s, for example, was founded with the intention to be a one-store, homemade ice-cream shop," Fazio et. al. write in their policy paper.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Justin Fox at justinfox@bloomberg.net

To contact the editor responsible for this story:
Zara Kessler at zkessler@bloomberg.net