Entrepreneurship Not for the Faint of Heart

Stephen DeAngelis

September 7, 2011

Although I’m a big advocate of entrepreneurship, I’m also a realist. Although many entrepreneurs dream of making their fortune by starting their own business, the truth is “the average new venture will fail within five years.” [“The Entrepreneurship Myth,” by John Tozzi, Bloomberg BusinessWeek, 23 January 2008] If you find that depressing news, you really won’t like to hear that “even successful founders usually earn 35% less over 10 years than they would working for others.” The focus of Tozzi’s article was a book written by Scott Shane, professor of entrepreneurial studies at Case Western University, entitled The Illusions of Entrepreneurship. According to Tozzi, “Shane argues that increasing the rate at which new companies are formed does little for the economy or job growth; instead, expanding existing businesses would be a more efficient way to spend time and money.”

 

Shane admits that the sector in which one starts a new business makes a huge difference. The best case for the economy and job creation is starting a business that creates a new industrial sector. The next best scenario would be to start a business in a sector that is still growing. As an example, Shane notes, “The odds that you make the Inc. 500 are 840 times higher if you start a computer company than if you start a hotel or motel.” Money aside, Shane admits, “People who run their own businesses have greater job satisfaction than people who don’t.” There is nothing wrong with trading job satisfaction for greater financial rewards — just do it with your eyes wide open. Desperation is not a reason to start a business.

 

Desperation may be behind a surge in entrepreneurism among older Americans. Anne Tergersen reports, “Faced with bruised nest eggs and high unemployment rates, older Americans—ever resourceful—are becoming entrepreneurs.” [“Older Americans Fuel Entrepreneurial Boom,” Wall Street Journal, 29 June 2011] Citing statistics from the nonprofit Ewing Marion Kauffman Foundation, Tergersen reports, “Individuals between the ages of 54 and 64 represented 22.9% of the entrepreneurs who launched businesses in 2010 – up from 14.5% in 1996.” Tergersen also depressingly reports, “Failure rates for new businesses are high—as high as 90% by some measures.”

 

Although entrepreneurship may have been up for seniors last year, the continuing economic malaise appears to have dampened the entrepreneurial spirit overall. John Bussey asks, “Will the damage done by the weak economy have a long-lasting effect, discouraging the next generation of entrepreneurs?” [“Shrinking in a Bad Economy: America’s Entrepreneur Class,” Wall Street Journal, 12 August 2011] Bussey disagrees with Shane’s conclusion that “the rate at which new companies are formed does little for the economy or job growth.” He reports:

“U.S. job growth depends on small businesses, which generate about two thirds of net new jobs, according to the U.S. Small Business Administration. Start-ups fuel job growth disproportionately since by definition they are starting and growing, adding employees, says the Kauffman Foundation, which researches and advocates for entrepreneurship.”

Unfortunately, Bussey goes on to report, “Bureau of Labor Statistics data show the total number of ‘births’ of new businesses [has] declined sharply from previous years. What’s more, the number of people employed by new businesses that are less than a year old—a common definition of a start-up—also declined. That trend started a decade ago.” Bussey interviewed Shane for his article and Shane, discussing last year’s statistics, said, “More people who were self-employed failed and left self-employment than people who entered. The net effect is negative, not positive, largely because downturns hurt those in business and those thinking of entering business.”

 

Like Shane, Bussey notes that the sector in which a business is started makes a significant difference. He explains:

“Then there’s the Web-based, fast-growth, stratosphere of the start-up firmament, where entrepreneurship is red hot. Silicon Valley and tech hubs throughout the U.S. are filled with these enterprises. ‘You have a real dichotomy between the technology and Web-based economy versus the meat and potatoes economy,’ says Steven Kaplan, who teaches entrepreneurship at the University of Chicago Booth School of Business. Students at the school have lately gotten record funding from venture-capital and angel-financing groups for their tech projects. ‘I had two students this year, they had offers from private equity firms, and they turned down those jobs to go to work for start ups,’ he says. ‘I haven’t seen that since the end of the 1990s.’ But it is in the realm of meat and potatoes that the vast bulk of the economy resides. And it isn’t well.”

The biggest problem for America is that entrepreneurism is trending in the wrong direction. Bussey continues:

“Dane Stangler, director of research at Kauffman, says the annual number of new ’employer firms’ — start-ups that employ more than just the founder — was steady for years and has drifted down since the mid 1990s. ‘So all of the energy that we’ve poured into entrepreneurship over the last 30 years’ — incubators, education, special funding — ‘hasn’t moved the needle,’ he says.”

That is not good news. Can anything be done to reverse this trend? Bussey is cautiously optimistic. He concludes:

“[Stangler] believes several developments could boost entrepreneurial spirits in coming years: the economy’s push for lower-cost products and services, which start-ups could provide; a growing number of older adults, some retired, who will seek employment by starting their own firms; and the spread of Internet- and tech-based innovations into the broader economy, something he calls ‘a completely new infusion of energy.’ Other researchers say cultural characteristics such as individualism and a society’s acceptance of business failure and recovery are the chief fuel for entrepreneurship, and that most other factors — consumer demand, financing, the cost of entry — are just cyclical. The U.S., which has plenty of individualism, is clearly testing that theory: Will an innate entrepreneurial spirit power up a bad economy? Or will our changing economy continue to produce fewer jobs from start-up entrepreneurship? For the moment, the trend lines aren’t encouraging.”

Since the technology sector is “stratosphere of the start-up firmament,” politicians in Washington, DC, have finally decided to try and tap the expertise of entrepreneurial, tech savvy immigrants. [“U.S. to Assist Immigrant Job Creators,” by Miriam Jordan, Wall Street Journal, 2 August 2011] Jordan reports:

“In its quest to spur job growth and jump-start the economy, Washington is reaching out to foreign entrepreneurs. Alejandro Mayorkas, chief of U.S. Citizenship and Immigration Services, a unit of the Department of Homeland Security, … [unveiled] several initiatives designed to attract and retain foreign entrepreneurs, particularly in the high-tech sector, who wish to launch start-up companies in the U.S. Among the initiatives is a plan to make it easier for some foreigners to qualify for legal permanent residence, or green cards, if they can demonstrate their work will be in the U.S. national interest. The changes will also include a way for entrepreneurs to obtain work visas without a job offer from an established company.”

For workers with a technical background, this is good news. For the unemployed without such a background it should be a clarion call to get some training. Although America desperately needs “employer firms,” as the Kaufman Foundation calls them, what it really needs are “high growth” employer firms. Entrepreneur Luke Johnson writes, “All the really successful investments I’ve ever made have achieved great returns because the underlying companies enjoyed high growth.” [“There is only one way to be a success,” Financial Times, 9 August 2011] In a post entitled Not All Small Businesses are Created Equal, I wrote: “The real entrepreneurial heroes are those who 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.” Doug Richard, a US-born British entrepreneur, agrees with this assessment. He told Jonathan Moules and Elizabeth Rigby, “It is not small business that supports economic growth, but young businesses that grow fast.” [“Tax breaks aim to lure seed investors,” Financial Times, 28 March 2011] Johnson laments, “Right now underlying growth in the west is very scarce indeed.” Johnson concludes:

“Growth matters not just because it leads to rising prosperity. Growing countries tend to be more optimistic and happier. Material improvement leads to general satisfaction; decline leads to misery. Growth is also the only realistic way to generate the necessary tax revenues to pay back public debts and fund the obligations of ageing societies. … But growth is never easy. For a start, it consumes resources, which are likely to be finite. It is cyclical and can have environmental impacts. Growth is spurred by innovation, most of which is based on technological advances. While overall these developments are welcome – better products, more efficient processes – rises in productivity usually rely on automation, thus leading to fewer jobs. So while growth engenders new jobs, it also kills old ones. It is about reinvention, which itself triggers ‘creative destruction’, and the requirement for retraining. Thus companies must constantly adapt, or die. Citizens must re-skill, or risk becoming redundant. This turmoil has accelerated in the digital age across our global economy. … My conclusion is that growth is a necessity both for business and a fulfilled society. To drive it we need more patient capital, better technical education, deregulation of commerce and lower tax on private enterprise. This is a shortlist of requirements: but a fantastically difficult series of actions to implement.”

The intent of this post is not to dissuade potential entrepreneurs from testing the water. I just want them to know that water could be cold. A dose of reality never hurts. Those writing about entrepreneurism can sometimes be too optimistic. That optimism is understandable. As a whole, entrepreneurs are a very optimistic group. They believe in themselves, in their ideas, and in the future. We need more of them not fewer. But we need them to get out of the garage and start high growth employer firms.