Why is the number of U.S. start-ups falling?

By Fareed Zakaria Washington Post Opinion writer May 19

PALO ALTO, Calif.

Silicon Valley has more than 23,000 start-ups, at least according to the networking site AngelList. It certainly feels that way when you’re in Palo Alto. But it turns out that this place is the exception to a worrying trend. It is by now well documented that start-up activity has been slowing down in the United States for about three decades, dropping sharply over the past 10 years. Even as American culture has turned entrepreneurs into rock stars, the U.S. economy is producing fewer and fewer of them.

Start-ups have been central to America’s economic health. A study published in December by the National Bureau of Economic Research points out that during the 1980s and 1990s, when entrepreneurial activity was high, new companies played an outsize role in boosting innovation, productivity and job creation.

There are many different ways to measure the growth and success of start-ups, but they all point to a similar conclusion. The Kauffman Foundation reports that the percentage of adults owning a business has been declining since the 1990s, when the foundation first began to track that number. At the Brookings Institution, Ian Hathaway and Robert Litan found that the start-up rate (the number of new companies as a percentage of all firms) has fallen by nearly half since 1978.

Why is this happening? No one is quite sure. Some are quick to blame big government. There is something to this critique, but the story is complicated. If high taxes discourage would-be entrepreneurs, then how to explain the burst of start-ups in the 1970s and early 1980s, when tax rates were sky-high? The United States in that period had a host of highly regulated industries, economic stagflation, social and political turmoil, and geopolitical anxieties. And yet it produced Silicon Valley. Even today, California ranks toward the top of the country in terms of taxes and regulation, yet it is also home to some of the most vibrant entrepreneurial activity in the world, in sectors as diverse as high tech, entertainment and energy.

But ever-multiplying regulation does hamper business activity. The Economist magazine argues that the U.S. economy has grown less competitive in the past 20 years. After a wave of deregulation in the 1980s, red tape has proliferated, licensing requirements have expanded and legal costs have risen dramatically. Large, entrenched firms — armed with lawyers and lobbyists — are able to navigate this regulatory landscape better than new ones. “The game may indeed be rigged,” it concludes. Brookings’ research shows that established firms, age 16 years or more, have gained large shares of the market and workers. The authors note that “it has become increasingly advantageous to be an incumbent, particularly an entrenched one, and less advantageous to be a new entrant.”

But a less-noted factor that might be crucial is generational. Baby boomers have proved to be great entrepreneurs, launching companies when they were young and keeping at it as they aged. Succeeding generations have been much less likely to found their own firms. Leigh Buchanan, citing Kauffman data, has explained that the percentage of start-ups launched by people in their 20s and 30s fell from 35 percent in 1996 to 18 percent in 2014. Meanwhile, the share founded by people in their 50s and 60s has actually increased over the past decade.

Young people today dress like Silicon Valley entrepreneurs, consume technology voraciously and talk about disruptive innovation. But they want to work at Goldman Sachs, McKinsey and Google. They are earnest, intelligent, accomplished — and risk-averse.

Is this caution born out of years of stagnant incomes, the financial crisis and a sluggish economy? Maybe, but I think there is something broader at work. Baby boomers were shaped by the 1960s and its counterculture. They were told to “tune in” to their passions and “drop out” of the old establishment. They were rebellious about everything — politics, parental authority, old-fashioned morality and big institutions. Their willingness to strike out on their own was not a pose to get venture capital funding. It was an expression of their passion.

Out of that bohemian world came the informal start-up culture that has now gone mainstream. Steve Jobs once explained that using LSD was “one of the two or three most important things” he ever did. When describing his intellectual influences, he pointed to the beatnik bible, “The Whole Earth Catalog.” Its founder, Stewart Brand, argued in an essay that we owe to the hippies the leaderless, individualistic and decentralizing revolution of personal computers and the Internet.

Of course, the counterculture’s assault on the establishment and traditional values caused enormous political and social upheavals. There was an erosion of law and order, trust in government, family structure and deference to authority. So, the question is, can we get disruption, but of a kind that is not, well, too disruptive?

________________

Dear Fareed,

Very interesting article. From my experience dealing with venture capital and as a small business aficionado I see the following factors as key to fostering a healthy start up environment in the United States:

(1) America has a healthy small business culture that we should continue to embrace. There is and has been an enterprising entrepreneurial culture in the United States in recent times. The United States, from its highest levels of government, its many geographically diverse branches, state governments and commercial enterprises embraces small businesses.  It was and is still entirely possible for fledgling start-ups to engage in meaningful contracts with federal, state and commercial enterprises. In this regard, the United States is markedly different from many other countries in Europe and Asia, which do not promote small businesses anywhere close to this scale.

(2) Deadlocked Government is a distraction. Over the past decade or so, political bickering has risen to a level where budgets are continually awash with uncertainty and programs live under the constant threat of cutbacks and sequestration. This environment diverts the attention of government from doing its intended job and increasingly and unfairly impacts those smaller more discretionary programs that would often foster innovation by small businesses.

(3) Conventional financing options are markedly more difficult to attain. Twenty years ago I could take my fledgling business to a main street bank and walk out with a loan and a line of credit facility. That had to be substantiated, managed and deserved, of course, but it was eminently viable. Today that has become far more difficult with banks raising the qualification bar substantially to mitigate risk and, as a result, many new start-ups will not qualify for this source of liquidity. Other conventional financing routes are friends and family, angel, and venture capital. Each of these is also under pressure with the current economic environment. For example, challenged by their anemic-return-weary investors to maintain and make target earnings on investment, venture capitalists have also raised the qualification bar for target businesses. To qualify for venture capital these days, small businesses must show an increasingly higher level of performance and success—essentially it has become more of a “buyer’s market” for the investor.

In summary, I believe that key reasons contributing to a decline in the number of start ups is the tight economic environment, coupled with a deadlocked, distracted government, and the risk averse attitude of financial institutions. Other than that, we still cling to our pro-small business culture.

 

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