Who Will Bridge The Jobs Gap? The Case For Startups And Young Firms JUNE 2013 by Nikhil Joshi & Zak Newman
EXECUTIVE SUMMARY The U.S. faces a jobs gap of almost 10 million jobs1, a shortfall so large that even if the economy adds 200,000 jobs a month, we won t return to pre-recession employment levels until the next decade. But where will these jobs come from? Action is needed on many fronts, but policymakers and business leaders would do well to focus on the most dynamic part of the economy: start-ups and young firms. STARTUPS AND YOUNG FIRMS CAN ACCELERATE OUR RECOVERY: Virtually all net new jobs2 come from young businesses. Startups play an especially important role: they contribute almost 20 percent of net job creation while they account for only 3 percent of total employment. Many jobs created by start-ups are destroyed when those firms fail but young firms that do survive add jobs much faster than their mature counterparts. UNIQUE CHALLENGES FOR YOUNG BUSINESSES: New and young businesses have always faced unique challenges, such as difficulties managing cash flow, that have a smaller impact on older, larger firms. Recent economic conditions have imposed new barriers that disproportionately affect young firms. As a result, business starts fell during the recession and have not yet recovered. GOVERNMENT AND BUSINESS CAN HELP: Policymakers must focus their attention and resources on the businesses most likely to drive job creation: start-ups and young firms. But government can t solve the problem alone big business can aid the recovery by encouraging the growth of younger firms. (1) The Brookings Institution Hamilton Project calculates the jobs gap each month. They define the gap as the number of jobs that the U.S. economy needs to create in order to return to pre-recession employment levels while also absorbing the people who enter the labor force each month. (2) The difference between jobs created and jobs destroyed is net new jobs. 2
U.S. ECONOMY MUST FILL JOBS GAP OF ALMOST 10 MILLION The U.S. economy still has more than 2 million fewer jobs than it did in January 2008, the high point for employment. But the jobs gap we face after accounting for population growth since 2008 is even higher: economists at the Brookings Institution Hamilton Project estimate that we need 9.9 million additional jobs to return to pre-recession employment levels. EMPLOYMENT IS STILL BELOW PRE-RECESSION LEVELS 138000 Total non-farm employment, 2003 today (thousands) 136000 134000 132000 130000 128000 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Source: Bureau of Labor Statistics, accessed June 2013. Closing the Jobs Gap, The Hamilton Project, June 2013. 3
STARTUPS AND YOUNG FIRMS CAN ACCELERATE OUR RECOVERY
FIRM SIZE ALONE IS NOT A GOOD PREDICTOR OF JOB CREATION Policymakers interested in economic development have long paid special attention to the size of businesses. But when it comes to job creation, firm size by itself is not the most important factor. In the previous economic expansion, new jobs were added by small, medium and large firms in proportions almost identical to the share of the workforce they employed at the start of the expansion. Researchers have found that after controlling for firm age, firm size has no relationship with growth. Most U.S. companies are small. More than half of firms with any employees at all have fewer than five workers, and 99 percent of businesses earn less than $10 million each year. But only a small sub-set of these businesses mostly start-ups and young firms - truly make outsized contributions to job growth. IN PREVIOUS ECONOMIC EXPANSION, JOB CREATION APPROXIMATELY PROPORTIONAL TO SHARE OF EMPLOYMENT FOR SMALL, MEDIUM AND LARGE FIRMS 100% Share of private sector job gains and average share of employment by firm size, November 2001 December 2007 80% 60% 40% 20% 0% Share of Employment Share of Job Gains Small Firms (1-49 Employees) Medium Firms (50-499) Large Firms (500+) Source: Bureau of Labor Statistics, experimental Current Employment Statistics series with employment by firm size class. 5
STARTUPS ARE MOST IMPORTANT JOB CREATORS Small start-ups employ just three percent of private sector workers in the U.S. but they are responsible for almost 20 percent of net job creation. Of course, many start-ups fail, leading to high rates of job destruction among young firms. In fact, after five years about 40 percent of jobs created by startups have been eliminated because of firm failure. Young firms that do survive, however, grow faster than mature firms. The data offer a clear lesson for job creation: encouraging more business start-up activity, and helping more of these businesses survive, is the path to creating the most net new jobs. START-UPS WHICH ARE MOSTLY SMALL MAKE A DISPROPORTIONATE CONTRIBUTION TO JOB CREATION Share of employment, job creation and job destruction by firm size and age, 1992-2005 50% Small firms (1-500 employees) Large firms (500+ employees) 40% 30% 20% 10% 0% Start-ups Young (1-10 yrs) Mature (10+yrs) Employment Job Creation Job Desctruction Start-ups Young (1-10 yrs) Mature (10+yrs) Employment Job Creation Job Desctruction Source: Haltiwanger, Jarmin and Miranda, Who creates jobs? Small vs. large vs. young, NBER Working Paper, November 2012. Census Business Dynamics Statistics. 6
HIGH-GROWTH FIRMS COME FROM A VARIETY OF SECTORS AND GEOGRAPHIES A focus on high-growth companies should not be confined to Silicon Valley startups or even to a few high-growth industries. A 2011 study by the Small Business Administration found that High Impact Companies companies with the highest national sales and employment growth that together account for virtually all net job growth in the economy can be found in a wide span of business sectors and commercial activities. No industry had more than 5 percent of its firms fall into the high growth bucket, and few industries had less than 1 percent of firms growing quickly. Portion of Companies that are High Impact High growth firms as portion of total firms by industry (2006)1 5 4 3 2 1 0 Heavy Construction Social Services Instruments, Related Chemical Products Oil, Gas Extraction Petroleum, Coal Utility Services Health Services Metal Minings Primary Metal Industries Transportation Equipment Electronics Air Transportation Insurance Agents Agricultural Services Food, Kindred Products Rubber, Plastics Fabricated Metals Water Transportation Insurance Carriers Paper Products Banking Non-Bank Credit Machinery non Electric (1) Latest data available. Source: Acs, Parsons and Tracy, High-Impact Firms: Gazelles Revisited, U.S. Small Business Administration Office of Advocacy, June 2008. 7
UNIQUE CHALLENGES FOR YOUNG BUSINESSES
NEW FIRMS HAVE ALWAYS FACED STRUCTURAL BARRIERS, BUT THE RECESSION ADDED NEW ROADBLOCKS Business startups and young firms are crucial for job creation. To the extent that these firms face structural disadvantages compared to larger, older businesses, these disadvantages are best viewed as market failures that should be addressed through public policy. Our experience through the Great Recession and subsequent recovery suggests that in difficult times, barriers disproportionately impacting startups and young firms increase. Economic activity by these high-growth firms fell steeply in the recession, and remains depressed. STARTUPS AND YOUNG FIRMS ALWAYS FACE STRUCTURAL DISADVANTAGES BUT A WEAK ECONOMY RAISES EVEN MORE BARRIERS FINDING TALENTED WORKERS Startups lack a robust recruiting infrastructure makes it difficult for new firms to find workers, and less cash on hand means new firms can t match pay packages offered by mature firms. SEED MONEY IS DRYING UP Entrepreneurs are finding it more difficult to find investors and are getting less startup funding when they do. Venture capitalists in 2012 invested 52% less in first time deals than in 2007, according to Price Waterhouse Coopers and the National Venture Capital Association. The average size of each investment has also dropped by 59% in the same period. MANAGING CASH FLOW & CAPITAL Startups typically do not have the assets or cash flow necessary to borrow in traditional credit markets, forcing entrepreneurs to be more reliant on venture capital and angel investors. FEWER INVESTORS ARE INTERESTED IN IPO s The recession took an enormous toll on the market for initial public offerings. Where an average of 550 firms went public globally each quarter of 2007, only 306 deals were made in each quarter of 2011. This has had a disproportionate impact on small, young firms that investors see as less stable investments during the recovery. PROTECTING INTELLECTUAL PROPERTY Entrepreneurs applying to patent their innovations discover the patent process to be too cumbersome without government affairs or legal staff. Additionally, the high cost of defending patents in court means that small businesses struggle to afford the necessary legal services. CONSUMER DEMAND STILL RECOVERING Real retail and food service sales dropped more than 13% between 2007 and 2009 due to the recession. Only in the last several months have sales returned to their pre-recession levels. Small, young firms which often have tight margins and less cash on hand find it harder to weather these storms than more established companies. 9
ECONOMIC ACTIVITY BY YOUNG FIRMS DOWN SINCE START OF RECESSION During the previous economic expansion, from 2001 to 2007, the share of firms that are young stayed approximately level. But since the recession began in late 2007, young firms are not only making up a smaller portion of all firms, but they are contributing a declining share of overall employment and job creation. 50% Young firms as a share of total firms, job creation and employment 2000-2011 30% 45% 25% 40% 20% 35% 15% 30% 10% 25% 5% 20% 0% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Share of firms that are young Share of Job Creation, young firms Share of employment, young firms (right axis) Source: Haltiwanger, Jarmi and Miranda, Business Dynamics Statistics Briefing: Where Have All The Young Firms Gone?, Kauffman Foundation, May 2012. 10
BUSINESS STARTS HAVE NOT RECOVERED After falling significantly during the recession, when credit markets froze and consumer demand cratered, the level of business starts has still not rebounded to pre-recession levels. The depressed level of business starts is hurting job creation. Before the recession, startups added an average of 940,000 new jobs each quarter. Now, that number has fallen by 200,000 jobs per quarter. 230 Quarterly private sector establishment births, 2005-2012 220 Business start-ups have not yet recovered to pre-recession levels, costing the economy 200,000 new jobs per quarter. 210 200 190 180 170 160 Average new business employment pre-recession: 940,000/qtr The Recession Average new business employment post-recession: 740,000/qtr 150 2005 2006 2007 2008 2009 2010 2011 2012 Source: Bureau of Labor Statistics Business Employment Dynamics 11
YOUNG FIRMS ARE PRODUCING FEWER JOBS During the recession and its immediate aftermath, start-up hiring fell by 15 percent. We don t yet have complete data on whether per-startup hiring rebounded later in the recovery, but the steep drop in jobs per startup during the recession points to cash flow management issues and slow growth for even the most dynamic companies: new firms. Jobs created per start-up firm, 2000-20111 6.6 6.4 6.2 6.0 5.8 5.6 5.4 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 (1) Latest data available. Job creation measured from March to March for each year. Source: Census Bureau Business Dynamic Statistics 12
GOVERNMENT AND BUSINESS CAN HELP
GOVERNMENT-LED ECONOMIC DEVELOPMENT EFFORTS SHOULD FOCUS ON STARTUPS AND YOUNG FIRMS Currently, government efforts to increase private sector job creation focus on factors like firm size and sector. Shifting attention to firm age, and the problems faced by startups and young firms, could result in dramatically better results. AREAS OF FOCUS FOR GOVERNMENT JOB CREATION EFFORTS: 1. Encourage more start-up creation: The number of business starts fell during the recession, and is yet to recover. Government efforts to increase access to seed funding, reduce barriers to occupational mobility (such as costly non-employer-sponsored health insurance), and allow more immigrant entrepreneurs to set up shop could reverse this decline. 2. Improve business conditions for start-ups: The steep drop in jobs per startup that occurred during the recession suggests that cyclical business conditions, such as frozen credit markets, are holding back start-ups. Solving this market failure could increase economic activity generated by startups and young firms. 3. Help more young businesses survive: A full 40 percent of jobs created by startups are destroyed when those firms fail but the firms that do survive grow faster than mature firms. Policies targeted at increasing the survival rate, such as providing more capital access between seed funding and IPO s could significantly boost job creation. 14
LARGER BUSINESSES CAN PLAY AN IMPORTANT ROLE IN BOOSTING STARTUPS AND YOUNG FIRMS Government is not the only actor that can help startups and young firms increase job creation. Large mature businesses can play an important role, from investing in young firms to providing mentorship and other support. These activities are mutually beneficial if big businesses can help restart the U.S. jobs engine by helping startups and young firms, all businesses will realize the gains. GROWING CONSENSUS THAT BIG BUSINESS CAN AND SHOULD HELP YOUNG FIRMS McKinsey & Co. White Paper On Restarting the U.S. small-business growth engine : Public-sector leaders should examine the policies that limit the growth of entrepreneurial small companies, as well as those that could spur it. But the private sector and larger businesses, in particular have a bigger role to play than is generally acknowledged. In fact, we believe that larger businesses should think more broadly and creatively about supporting and mentoring entrepreneurs, spurring demand for the products and services their businesses supply, and providing creative financing to tap mutually beneficial growth opportunities. U.S. Treasury Secretary Jack Lew, at the Capital Access Innovation Summit: The President has created several initiatives, like Start Up America, to get big companies involved, and we will continue to look at new ways to help bring large companies and small businesses together. But we need corporate America to continue leading by example as well. Their support is really crucial. So today I want to call on leaders of large businesses to do more to invest in new startups, mentor entrepreneurs, promote creative solutions for working capital, and become good customers to small businesses. 15
by Nikhil Josh and Zak Newman NJOSHI@BUSINESSFWD.ORG 202-861-1270 1717 RHODE ISLAND AVENUE NW SUITE 660 WASHINGTON, D.C. 20036