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From Start-up to Stop: The Recession and Entrepreneurship

Friday, October 30, 2009

I’ve taken a look at the data, and, I’m sad to report, the Great Recession has badly damaged the entrepreneurial sector of the U.S. economy.

Everyone knows that the United States is in the midst of the most severe recession since the Great Depression. But, while the media is full of reports about how the recession has affected large businesses and consumers, little has been said about its effect on new and small businesses. I’ve taken a look at the data, and, I’m sad to report, the Great Recession has damaged the entrepreneurial sector of the U.S. economy.  

Business failure rates have jumped. According to the Office of Advocacy of the U.S. Small Business Administration (SBA), business bankruptcies increased 79 percent from the fourth quarter of 2007 to the first quarter of 2009, and employer firm terminations rose from 2007 to 2008.

Perhaps because of the rise in the small business failure rate, the number of entrepreneurs in the economy has fallen. The self-employment rate is now below pre-recession levels. Moreover, those self-employed who have managed to remain in business have had to reduce their work hours.

In fact, an increasing number of small business owners would shift back to working for someone else if they could. The Discover Card Small Business Watch, a survey of small business owners, indicates an increase from 2007 to 2009 in the number of business owners who would discontinue their business operations if offered a high-paying job.

In 2008, small business lending fell for the first time since 1993.

Both sales and earnings at small businesses have taken a hit during the recession. In July, a third more of the business owners responding to a National Federation of Independent Business (NFIB) survey reported that they had lower sales than higher sales over the previous three months, a significant increase in the number of entrepreneurs reporting a sales decline over the pre-recession period. In fact, the Discover Card Small Business Watch survey showed that the percentage of small business owners who said that finding new business was the most challenging aspect of business more than doubled from June 2007 to June 2009.

The SBA reports that sole proprietors’ income has fallen. And more small business owners responding to the NFIB survey in July reported an earnings drop over the previous three months than reported an earnings increase, a reversal from the situation at the end of 2007.

Not surprisingly, given the poor condition of the small business sector, the number of people starting businesses has declined, with U.S. census data showing a dip in the per-capita rate of new employer firm formation in 2008.

The recession has also left an increasing number of small businesses challenged financially. The American Express Open survey of small business owners indicates an increase in the number of businesses reporting concerns about cash flow and their ability to pay bills on time.

The percentage of small business owners who said that finding new business was the most challenging aspect of business more than doubled from June 2007 to June 2009, a survey found.

Particularly troubling is the fact that entrepreneurs do not expect the poor financial conditions to improve any time soon. The Small Business Syndicated Banking Study, conducted by Barlow Research Associates, showed a decline in the number of businesses expecting financial conditions to improve in the next year, and the July 2009 NFIB survey indicated a decline in the both the Small Business Optimism index and small business owners’ expectations of future sales, as compared to late 2007.

The adverse economic conditions have led many small business owners to de-emphasize growth. The American Express Open survey reveals a drop from September 2007 to August 2009 in the percentage of small business owners who said that business growth was their company’s single most important priority, while the July 2009 NFIB survey shows that fewer small business owners are making or planning to make new business investments in mid-summer 2009 than in late 2007.

Employees of small businesses have also been hurt, as the small business sector has experienced severe job loss. According to the SBA, more than half of the jobs lost in the first half of 2008 were lost in small firms, with these losses concentrated in the smallest of the small firms. And the July 2009 NFIB survey shows that more small business owners are shedding jobs than are adding them, a reversal from the pre-recession situation.

Small businesses do not have plans to add back jobs any time soon. In July 2009, more respondents to the NFIB survey reported plans to decrease hiring than to increase it, and in September 2009 the American Express Open survey showed few small business owners planning to hire over the next six months.

Financing a new or small business has become difficult. Data from AngelSoft, a provider of angel investment tracking software, shows that the share of companies seeking financing that received capital from angel U.S.-based angel groups dropped by half from 2007 to 2008. The Angel Capital Association’s survey of the angel investment groups showed that the number of angel investments fell by 16 percent and total funding declined 9 percent.

Venture capital activity has also declined. According to Dow Jones Venture Source, capital under management and the number of companies receiving venture capital have both fallen. Paralleling this reduction has been a decrease in exit activity, with declines in both the number of IPOs and acquisitions and the value of those exits.

The adverse economic conditions have led many small business owners to de-emphasize growth.

Small business lending has also dropped. In a Wall Street Journal op-ed, analyst Meredith Whitney said that small business credit card lines are down 25 percent since September 2008, and account terminations have risen by 10 percent during the recession.

In 2008, small business lending fell for the first time since 1993. The SBA reported that its loans securitized for sales declined by 30 percent in 2008 and 7(a) loans by 40 percent from the end of 2007 through the end of 2008.

According to the Federal Reserve Board’s Survey of Senior Loan Officers, lending standards to small businesses had tightened dramatically since the recession began. Moreover, respondents to the July 2009 NFIB survey explain that loans have become less available, with an increasing number saying that their borrowing needs have not been satisfied.

Perhaps because capital has become difficult to access, owners have changed how they finance their small businesses. The American Express Open survey reports a decline from September 2007 to August 2009 in the percentage of businesses with plans to get short-term loans or to obtain and use lines of credit, and an increase in the plan to use personal or private funds to address cash flow challenges.

In short, the entrepreneurial sector of the economy has been hit hard by the recession, and it remains unclear when recovery will return.

Scott Shane is the A. Malachi Mixon III Professor of Entrepreneurial Studies at Case Western Reserve University and the author of The Illusions of Entrepreneurship: The Costly Myths that Entrepreneurs, Investors and Policy Makers Live By.

Image by Darren Wamboldt/Bergman Group.

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