Not All Small Businesses are Created Equal

Stephen DeAngelis

August 19, 2010

I have written a number of posts that have asserted that entrepreneurs are critical to help grow America’s economy and reduce unemployment. The real entrepreneurial heroes are those that create high growth companies that provide employment for people beyond the entrepreneurs, their families, and a handful of others. These are the so-called small business superstars [“Small businesses: Measuring their power and their problems,” by Edmund L. Andrews, The Fiscal Times, 1 August 2010]. Andrews reports that these superstar firms “constitute only 2 or 3 percent of the nation’s companies.” The majority of small businesses, he writes, “are mom-and-pop operations — hair salons, restaurants, bookkeepers, car repair shops — that grow slowly and shed about as many jobs as they create.” Even so, Andrews admits that “small businesses are a crucial source of jobs, employing about half of all workers, according to the Bureau of Labor Statistics.” The point that Andrews is making is that if politicians want entrepreneurs to help America innovate its way out the current economic malaise, they need to find a way to help the 2 to 3 percent of small businesses that hold the potential of creating the most jobs. One would think that this “biggest bang for the buck approach” would appeal to both sides of the political aisle. So who are these superstar companies? Andrews explains that historically they are hard to define:

“The superstars came in all shapes and sizes. They included legions of tiny companies with fewer than 20 workers. Those firms generated about one-third of the new jobs, according to the study. About 43 percent of the jobs came from corporations with more than 500 workers, and another 24 percent came from firms with 20 to 500 workers. Not surprisingly, companies with gangbuster growth defy easy stereotypes. Although some were high-tech start-ups such as Google, most had been around for years before they took off. The average ‘high-impact” company was 25 years old. That doesn’t mean small companies aren’t a big pillar of the job market. Whether or not they grow rapidly, companies with fewer than 250 workers provide almost half of all private-sector jobs, according to the Bureau of Labor Statistics. About 38 percent of all workers are in companies with fewer than 100 employees. When those companies shed jobs, as they have in droves over the past two years, the losses have a big impact on overall employment.”

The fact that pinning down exactly what constitutes a superstar (other than a high growth rate) makes targeting policy decisions that support them extremely challenging. As a result, policymakers resort to more general approaches. For example, Andrews reports that “a bill pending in Congress would create a $30 billion small-business lending fund, add new tax breaks and expand loan guarantees from the Small Business Administration.” Andrews explains why this broad approach for supporting small businesses appears to be required right now:

“Analysts say small businesses suffered disproportionate harm in the downturn, in part because banks couldn’t or wouldn’t make as many loans. Small companies were among the first to resume hiring after the recessions of the early 1990s and 2001. Not this time. Although the economy has added about 600,000 private-sector jobs this year, surveys of small-business owners indicate that, as a group, they have barely begun to hire. In recent monthly surveys by the National Federation of Independent Business, small-business owners have been about as bleak as at any time since the surveys were started in 1986. And in a July survey by the National Small Business Association, 41 percent of companies said they couldn’t raise as much money as they needed — the highest share in 17 years, according to the trade group.”

Despite the apparent problem, neither Congress nor the voting public seems to be in much of mood for funding a new program that risks running up the federal deficit. Both Democrats and Republicans recognize the credit problem, but they differ on what to do about it. Andrews continues:

“Supporters say the $30 billion fund, which would invest in small community banks, would allow the banks to leverage the money and make almost $300 billion in additional loans. The Congressional Budget Office has estimated that the fund would not cost the government in the long term, as the banks repay the Treasury Department with interest. … The new money could make a real difference, but only if the community banks actually use it. Much will depend on the economy itself. Loan volumes actually declined after the Treasury poured money into banks under the Troubled Assets Relief Program, in part because the recession reduced profitable lending opportunities. The bill does try to prod banks into lending. Banks that step up their pace will be allowed to repay the government at much lower interest rates than banks that stay on the sidelines. … But critics say the real problem isn’t a shortage of capital but a shortage of healthy borrowers. In the National Federation of Independent Business’s July survey, although nearly half said they couldn’t get enough credit, only 6 percent of business owners said that was their biggest problem. By contrast, 30 percent said their biggest obstacle was weak sales. Many small-business owners lost creditworthiness as they struggled in the downturn. Plunging property values have made it harder for entrepreneurs to use homes or commercial property as collateral.”

Some small business owners, Andrews reports, are caught in a Catch 22. He explains:

“Bill Owens, founder of Education Solutions in Shelby, N.C., provides a case study in the murkiness of the lending equation. Owens, who developed a cheap way to provide whiteboards to cash-strapped schools, said he has a backlog of orders. But because his credit rating has slipped in the past two years, he can’t get loans to stock up on materials. … Carmen Ortiz Larsen, founder of Bethesda-based Aquas, is reluctant to ask her bank for more credit. Aquas, which provides engineering and information technology services, has 32 employees. Larsen said she would like to expand but worries that asking for a bigger loan could prompt her bank to question her existing credit lines.”

Andrews indicates that even “small-business lobbying groups disagree about what to do.” He reports that “”the National Small Business Association, which says it represents 150,000 small firms,” supports the measure before Congress, while “the National Federation of Independent Business, which says it represents about 300,000 businesses, has been lukewarm.” The real problem, Andrews states, is not lack of credit but “the lack of sales and customers.” The rub, of course, is that customers and sales won’t increase until the unemployment rate goes down and people can start spending again. It is becoming ever more evident, however, that counting on established companies to begin hiring back employees they have laid off is like hoping the Cubs will win the World Series. “According to a survey of 6,200 companies conducted by KPMG International,” even though “U.S. executives are increasingly optimistic about their companies’ revenue growth over the next year,” most of them have “modest expectations for hiring” [“Hopes for a Rebound Show a Modest Increase,” by Joe Light, Wall Street Journal, 2 August 2010]. That’s why finding a way to support high growth rate superstar firms is so important. Helping them to get established or to sustain their high growth rate would have the greatest impact on the economy and on reducing the unemployment rate.