Entrepreneurship May Work Like A Clock, But It Still Needs Winding: Exploring the Kauffman Study on New Firm Formation

1/15/10Follow @wroush

Like others in the tech-journalism business, we here at Xconomy tend to pore over the latest statistics about the entrepreneurial economy pretty obsessively: how much money venture firms are raising and investing from quarter to quarter; how much they dole out to each new startup in their portfolios; how much these portfolio companies eventually return to their investors through mergers, acquisitions, or public offerings.

But what if none of this really matters? What if it turned out that the number of new companies created by entrepreneurs is pretty much the same every year—and that things like how much money venture firms are handing out, or how many companies are achieving lucrative exits, or how many students are graduating from business school, or how many startup incubator programs are springing up, make no difference whatsoever to the nation’s overall levels of entrepreneurial activity? Would this mean that all the conferences and white papers and blog posts about the best ways to boost innovation and entrepreneurship are, in the end, pointless?

Well, that’s a serious question now—because the last three decades of data, according to a new study from the Ewing Marion Kauffman Foundation in Kansas City, MO, show that the number of new businesses incorporated in the United States holds steady at about 700,000 per year, give or take 50,000. It’s as regular as clockwork. In fact, it’s as if American entrepreneurs were programmed to start 700,000 new ventures every year—in the same way that, say, American parents pass on the genes for red-headedness to roughly 170,000 newborns every year.

You can read all about it in Exploring Firm Formation: Why Is the Number of New Firms Constant?, by Kauffman Foundation senior analyst Dane Stangler and senior fellow Paul Kedrosky. (Kedrosky, a San Diego-based investor, entrepreneur, and essayist, is also an Xconomist, and to complete the disclosures, the Kauffman Foundation is an underwriter of Xconomy’s Startups Channel.) When I first met Stangler at a Kauffman Foundation function last October, he and Kedrosky were still puzzling over the numbers they’d been digging up from places like the Census Bureau, the Small Business Administration, and the Bureau of Labor Statistics, which all seemed to show the same thing: Americans start the same number of businesses every year, come hell or high water.

That is a remarkable and, at least on the surface, counterintuitive finding. As Stangler and Kedrosky point out in their final report, which was published Wednesday, a casual observer might guess that the number of new firms would fluctuate from year to year in response to such major forces as economic recessions or expansions, technological change, and the availability of capital and credit. (We certainly hear the howls of local technology innovators every time venture firms scale back the number or size of Series A rounds.) But these things don’t seem to make any difference in the big picture.

“It’s a real puzzle, and it didn’t appear as if anyone else had noticed it or written about it,” Stangler told me by phone yesterday.

He and Kedrosky might not have noticed the phenomenon themselves if they hadn’t already been examining, for a different study, the question of survival rates for new companies. The percentage of the companies founded in 1990 that were still in business in 1995, they’d found, is almost exactly the same as the percentage of companies founded in 2002 that were still around in 2007. (It’s about 50 percent.) “That was interesting,” Stangler says, “and one of the possible inputs to that is that the number of new companies founded each year is remarkably similar”—which turned out to be the case.

Nobody had noticed this fact before, Stangler speculates, because it’s about constancy, not change: “You don’t stop to think, ‘Why is there not a trend here? You have to recognize the absence of something.”

Being good scientists, Kedrosky and Stangler first checked to see whether there might be something wrong with their instruments—that is, that the data might be wrong or incomplete. But all the datasets they checked showed … Next Page »

Wade Roush is Chief Correspondent and Editor At Large at Xconomy. You can subscribe to his Google Group or e-mail him at wroush@xconomy.com. Follow @wroush

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  • http://www.cictr.com Tim Rowe

    You can’t draw conclusions about lions by counting cats.

    What is clear is that this country’s lions are not fairly distributed. They like to cluster in the places that feed them best. Think about where the Googles, Akamais, Microsofts, and Genzymes spring up. So lets not let up on our efforts to feed the lions!

    The Kauffman Foundation has done research recently looking at the differences between US states’ ability to support startups. They analyzed many factors, and found huge variation. And these differences indeed seem to play out in the flow of venture capital. For instance, they found that Massachusetts was the best state for entrepreneurship in US, looking at factors like the presence of leading tech institutes, like MIT, social acceptance of entrepreneurship, etc. And MA also has the highest venture capital investment per capita of any region in the world. The conclusion: supporting entrepreneurship does make a difference.

    Restaurants, laundromats, landscape services companies and their like provide the majority of employment in the US, and we are blessed to be an entrepreneurial nation that keeps these sectors vibrant. We need those businesses. And we ALSO need the new lions who help us remain globally competitive, by becoming the next generation of global corporations. And by and large, it is our lions who make inroads into improving the quality of human life around the globe, be that through energy efficiency, better healthcare, or better productivity.

    So, I’ll say it again: lets keep feeding the lions!

  • Wade Roush

    @Tim: Well said. I don’t think the Kauffman researchers are suggesting that we should stop feeding the lions (although Paul Kedrosky has argued, in other writings, that the venture industry needs to shrink drastically). I think the work they’re doing is important because it makes us question our long held assumptions — such as the belief, so widely held that it’s almost unspoken, that more venture investment automatically equals more innovation.

    What strikes me when I read Kauffman studies is how little we really know about how entrepreneurship works. If anybody is going to make “entrepreneurship studies” into more of a science, it’s them.

  • http://www.venturemechanics.com Ron Wiener

    Agree with you both. Perhaps stated a little differently, what matters the most is not quantity but qualities of these startups. The very nature of today’s startups, so many of them built on low-cost platforms (VoIP, smartphones, etc.) not generally available five years ago, is dramatically different from the average profile of prior generations of startups. CapEx requirements, time to market, “virtuality” if you will, all different; as are market potential, jobs creation potential, shareholder returns potential, fundability. Any study that is looking strictly at the number of new startups is not gathering the relevant underlying trends.

    Let’s assume all things remaining equal (e.g. population) there is a set % of society that is entrepreneurially minded. Unemployment may encourage a few more people to think about taking a hiatus from the corporate world but without an entrepreneurial mindset and skill set, and a good business idea, how many will actually launch a startup? Not that many. What matters most are the characteristics of the companies being started now versus in years past, not the number. And as Tim pointed out, national statistics are not as revealing as regional comparisons; they are simply too blended to show what’s really going on.

  • http://www.forleapsake.com/blog Dino Herbert

    Those who conducted the Global Entrepreneurship Monitor 2009 Global report stated that the number of new U.S. businesses declined by 24% in 2009. It will be interesting to see what the researchers at Kauffman find for the period from 2006-2009.
    It’s also understandable that the “big boys” will always account for the “lion share” of job creation. This is to be expected. However we cannot discount the effect that the 95% of “normal” firms are having on the economy. Having 33% fewer new jobs annually would definitely be newsworthy.

  • qed

    To Dino Herbet: the 2009 publicity of GEM is not necessarily reliable. PR reports decline, although, on average, there was actually an increase across countries. There is good evidence to suggest that during recessions, the number of attempted start-ups actually increases, when displaced employees attempt self-employment. GEM measures start-up attempts, not actual start-ups.

  • http://www.forexbase.com Pavel Rorecek

    The big question is what percentage of these companies are incorporated in the US just for tax reasons (domestic or abroad) and are actually not founded by real entrepreneurs.

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