The Entrepreneurial Process
by Paul D. Reynolds and Sammis B. White
Paul D. Reynolds and Sammis B. White, The Entrepreneurial Process: Economic Growth, Men, Women, and Minorities (Westport, Connecticut: Quorum Books, 1997).
“Entrepreneurial activity—the creation of new firms, products, or markets—is generally not included in these conceptual schemes” [of a ‘perfect market’]. {Page 2.} Yet:
analysis of data from twelve member countries of the Organization for Economic Cooperation and Development (OECD) indecates that gross and net job gains for the past decade are generally higher among smaller firms and never higher among large firms (Schreyer, 1995). {Page 3}
The percentage of jobs in firms with fewer than 100 employees has increased for all countries (in a survey of 13 OECD countries) except Japan. {Page 3} (Hmm, and Japan's been in recession -- no growth -- for longer than a decade.)
Recent analysis of the European Union (EU) member states indicates that those states where the proportional growth in annual sales among small and medium firms exceeds that among large firms have greater growth in gross national product in the following year (Thurik, 1995). {Page 3.}
In the U.S. and Sweden higher firm birth rates have a statistically significant contribution to measures of regional economic growth in the following periods (Davidsson, Linbmark, and Olofsson, 1994; Reynolds, 1994). {Page 3.}
A number of regional districts have been identified where specialized networks of small firms appear to be responsible for regional economic growth compared to similar regions dominated by a small number of large firms (Arzeni, 1995; Pyke, 1995). {Page 3.}
“Virtually all current research finds that new and small firms have an important role in the creation of technical advances and innovations.” (See Acs and Audretsch, 1995.) {Page 4.} Historical studies of the development of new industries “universally indicate that a large mass of new, small firms is present in the early periods of industry formation.” {Page 5.}
In summary, new and growing small firms have important roles in (1) gross and net job contributions, (2) economic growth, (3) technical advances and innovation, (4) the formation of new industries, and (5) providing work career options for a large proportion of U.S. adults. {Page 6.}
The birth of autonomous firms and their local expansion (either at a single site or a branch within the same county) provide over half, 57%, of all job creation. (Page 15.)
The United States has 1.6 “firm births” annually per 1,000 people. Of three states studied in depth (Wisconsin, Minnesota, and Pennsylvania), Pennsylvania had the lowest, 1.17 firm births per 1,000 human population. {Page 15.} (Is Pennsylvania less equal in wealth than average?)The average number of jobs provided by new firms during their “birth period” of about one year varies very little between the three states studied and the U.S. as a whole: from 6.41 to 7.09. The U.S. average is 6.58 jobs created per firm during its “birth period.” {Pages 15 and 18.}
In the early 1990s new, independent firms accounted for up to 50% of net annual employment growth in Wisconsin (at minimum 41%). Three independent estimates from different data sources – the unemployment registry, U.S. Small Business Administration, and a new firm survey – give this figure of about 40,000 new jobs annually for Wisconsin contributed by new, single-site, independent firms. {Pages 19-20.}
Types of jobs created:
surveys of new firms in Minnesota and Pennsylvania found that three-fourths of jobs created by new firms required post-high school education and training (Reynolds and Freeman, 1987; Reynolds and Miller, 1988). {Page 21.}
In the first year of operation of new firms in Wisconsin the average annual earnings per worker was $15,900; the average earnings for all workers in the state for about the same time, 1992, was $22,100. (Minimum wage would be about $12,000.) That is, jobs provided by new firms in their first year paid 72% of the average statewide. By the fourth year of operation, average earnings in new firms rose to $20,000, a 26% gain. {Page 21.}
Types of firms
In Wisconsin, about
three-fifths of all establishments are in industries oriented toward the local markets (construction; retail; consumer service; health, education and social services). Only in Milwaukee does this ratio drop to about half of all establishments. {Page 26.}
This supports arguments Jane Jacobs makes in Cities and the Wealth of nations.
Judgement of the Entrepreneurial Climate
Nascent entrepreneurs, those trying to start a new business, are more positive than typical adults. Discouraged entrepreneurs, those who tried to start a new business but gave up, are more negative. Those who tried to start a new firm and succeeeded in putting a new business in place are the most negative. {Page 31.}
“Those most heavily involved in the start-up process become more negative over time” {page 32}.
***THESIS tie-in***
“problems with financing are the only ones that provide a significant negative impact on the entrepreneurial climate score.” {Page 34.}
Implications for Economic Theory
Regardless of how one approaches or analyzes the data, it is clear that two of the assumptions underlying the “perfect competition” market model are inconsistent with the data. First, new firm births are clearly not a rare and unique event. Second, new and small firms clearly have a major role in economic growth. {Page 37.}
Moonlighting as entrepreneurs
One behavior very rare early in the start-up is devoting full time to the new firm. This is consistent with the finding that 60-80% of the individuals starting new firms also have another established work role (full- or part-time work or self-employment). {Page 43.}
See far below (note about page 85) for information on more time put into start-up effort giving greater success as a possible link to wealth (as opposed to high income from a salary) aiding entrepreneurship success.
Now I realize I need a management team...
Between 13% and 17% of founders of new firms tried to organize a start-up team in the first month. (The average new firm has 1.73 founders; some 49% of new firms are founded by two or more individuals.) “It appears that the thought of teammates does not always come at the outset. The many benefits of a cooperative approach may become apparent as the complexities of creating a new firm begin to unfold.” {Page 43.}
Characteristics of Entrepreneurs
About 4% of adults are nascent entrepreneurs at any given time. When considering their characteristics, keep in mind that “statements are based on small samples that may not adequately represent the population at large.” {Page 45.} For instance, there are many inexplicable disparities between Wisconsin and the United States as a whole.
Education
In both samples those adults (respondents under 18 were excluded) who had not completed high school were “very unlikely to become involved in starting a new firm. Equally important, there is no dramatic surge in participation among those with graduate experiences.” {Page 49.}
Income
The pattern associated with household income is slightly different for the two samples. There is little effect of household income on prevalence among the U.S. sample, except for a slight increase among those with annual household incomes in excess of $50,000 per year. In the Wisconsin sample, virtually no individuals in households with incomes below $10,000 per year are involved in new firm gestation, and the rate of participation is highest among those with annual incomes in the $30,000-$50,000 range. Larger samples will be needed to confirm the impact of household income. {Page 49.}
Social Network
In data only available from the Wisconsin interviews, “Those who identified sixteen or more family and friends in their social network were three times as likely to be nascent entrepreneurs as those with fewer than six (Reynolds and White, 1993a).” {Page 49.}
U.S. Region
The national survey shows a higher tendency to form new firms in the Northeast and West (which are more urbanized) compared to the South and north-central regions. The measure of type of region on a more local level (metropolitan, mixed, and rural) was very crude and showed no strong differences in level of nascent entrepreneurship. {Page 50.}
Unemployed versus Employed
Both sample showed that “despite the fact that those involeved in the labor force are less likely to start new firms, the vast majority of new firms are started by those actively involved in the worforce.” {Page 50.}
Work-related Values
Nascent and discouraged entrepreneurs were more likely to motivated by autonomy and independence in work than typical adults (with average importance ratings of 3.42, 3.43, and 3.14 respectively); the same pattern held true in being motivated by having specific task interests they could pursue (3.57, 3.33, and 3.21 respectively). Nascent entrepreneurs expressed more interest in building wealth, and discouraged entrepreneurs less, than typical adults (2.99, 2.76, and 2.81 respectively). Nascent and discouraged entrepreneurs attached more value to staying in the community than typical adults (3.01, 2.95, and 2.87), though the difference for discouraged entrepreneurs was not statistically significant. (All other values were statistically significant; ratings were on a scale of 1 to 4; data from the Wisconsin survey: sample sizes were 81 nascent entrepreneurs, 42 discouraged entrepreneurs, and 940 typical adults.) {Page 51.}
Age
The highest proportion of nascent entrepreneurs, almost 10%, ocurred among those twenty-five to thirty-four (25-34) years old. “The rate is one-third this level, about 3%, among those eighteen to twenty-four [18-24 years of age] or thirty-five to fifty-four [35-54] years old. Nascent entrepreneurs are virtually nonexistent among those fifty-five and older.” {Page 54.}
Age with other factors
Seven in ten (69%) of new firm start-ups are provided by one-sixth (17%) of the adult population: 25-34 year olds that are self-employed, unemployed, or students (25.5% of whom are nascent entrepreneurs) or that have employment and a high school degree (1% of whom are nascent entrepreneurs) or more than a high school degree (11.5%). “If those thirty-five to fifty-four reporting self-employment [...] are added, five-sixths (83%) of start-ups are provided by less than one-quarter (23%) of the adult population.” Of self-employed 35-54 year olds, 8.8% are nascent entrepreneurs.
Of those 55 and over with financial reserves, 3.2% are nascent entrepreneurs.
Sex as a factor disappears when you take age into account (more than two-thirds of those fifty-five and over are women).
Reynolds and White, The Entrepreneurial Process (1997) pages 54-55.
Importance of and Satisfaction with community context
access, availability, and quality of various features take precedence over business costs. The only costs that are in the upper half of the list are those associated with taxes (property, business, household and personal), which are not the major cost factors for any business. The upper half of the rankings are dominated by the availability or access (to customers, capital, insurance) or the quality of the context (crime, quality of life). Three items related to government control (state regulations; local [city, county] regulations; zoning and land use) are in the upper third of the rank order. {Page 54; brackets theirs.}
Half of the respondents report they are not satisfied with personal or household and property taxes. One in three is not satisfied with business taxes. This is in contrast to the factors associated with government regulations, generally considered very important but not associated with high levels of “not satisfied.” Only one in six is “not satisfied” with local regulations, state regulations, or zoning and land use. {Page 54.}
***THESIS tie-in***
More than two in five consider access to bank loans and support or capital availability “very important,” [44% and 51% respectively,] and more than two in five are “not satisfied” [39% and 31% respectively] with these features of their immediate context. {Pages 60 and 59.}
In all ratings of importance of and satisfaction with context, there was no difference between nascent and discouraged entrepreneurs. {Page 59.}
Financial needs
Nascent entrepreneurs expected surprisingly little in terms of money necessary: “61% expected to have no external support or even personal equity in the business. Those who did anticipate some form of financial support expected it to be quite modest. The average equity and debt for eighty-nine start-up firms was about $1,500. Twelve percent expected to rqquire up to $10,000; 13%” up to $50,000 and another 13% over $50,000.
(I think this might have something to do with what financial support they have access to: in many cases they’ve chosen to start a firm and they have no capital, so it would hardly make sense for such people to say that they expect to need capital to start their firm.) {Page 60.}
“These small amounts reflect some naiveté on the part [of] the respondents, many of whom are just beginning to develop their financial projections.” For example, and in contrast (although not all nascent plan to have employees): “New firms with employees and in operation for three to seven years require, on average, close to $200,000 of capital from both equity and loan sources.”
When more specific questions are asked, the proportion expecting to need financing went up dramatically: 80% expected some type of ownership or equity funding, and 62% expect to borrow some money. {Page 60.}
49% expect to contribute their own resources in return for equity; 24% expect to lend their own money to their firm. 18% expect other team members to contripute equity, 7% expect loans to the company from team members. 12% expect money in return for ownership shares from banks or other financial institutons; 25% expect loans from same. 9% expect equity from family of selves and start-up team; 7% loans. 7% expect equity from friends or business associates; 6% loans. 6% expect equity from government agencies; 8% government guaranteed loans; 3% expect private investors, venture capitalists, and stockholders to contribute equity; 6% loans. 2% expect ownership from other sources; 1% loans. {Page 61.}
These figures can’t be added together but the total expecting financial support from themselves (including start-up team), family, friends and associates is very significant. THESIS tie-in
Discouraged Entrepreneurs Less Aware of Services
Continuing nascent entrepreneurs were on average aware of 72% of available services, while discouraged entrepreneurs were on average aware of 59%. {Page 62.}
Most considered their most recent “assistance experience” very helpful or extremely helpful (7 in 10 respondents for both groups together), with more nascent entrepreneurs giving high assessments (8 in 10) than discouraged entrepreneurs (6 in 10). None considered the assistance harmful. {Page 62.}
Profile of Nascent Entrepreneurs
At any given time about one in twenty-five adults, in Wisconsin or the United States, are nascent entrepreneurs, involved in a business start-up. Most of these individuals are younger (twenty-five to forty-four years of age), have graduated at least from high school, are likely to have incomes over $30,000 per year, are more likely to live in the more urbanized East or West Coasts, and have a large number of friends and family in their social networks. Further, it is likely that some of their family or friends are active participants in the entrepreneurial process. If they differ from typical adults in their work interest, it is due to a greater desire to be independent and work autonomously, and a somewhat stronger interest in the substance of the work itself. There is a slightly greater interest in financial rewards.
{Page 64. Bold added for THESIS tie-in.}
Length of the Start-up Process
Firms are put in place in slightly less than a year, regardless of the measure of “firm birth.” The average is less than twelve months and as low as ten months for three measures. In every case the median is less than the average, suggesting a large proportion of nascent entrepreneurs put firms in place rather quickly. It takes slightly longer, however, for nascent entrepreneurs to give up and become discouraged entrepreneurs.
{Page 64. I’l say here I don’t like the term “discouraged” for “quitted”; you can be discouraged and still going at something.}
This pattern, then, suggests that most new firms are put into place in about a year and that after two years nascent entrepreneurs [who haven’t founded a firm by any measure] are beginning to lose interest. There is, hovever, a small proportion of people who are quite tenacious about their entrepreneurial ambitions, working on the establishment of a new firm for three or four or five years—some for a decade.
[...] Any random sample of nascent entrepreneurs will include a proportion that has been working on the effort for an extended period. [...] interview will be required to determine which nascent entrepreneurs are reporting on a serious start-up and which are hobby start-ups, pursued in a more casual manner.
{Page 72.}
More-Schooled Entrepreneurs Bring Fewer Firms into Existence
Slightly more than 70% of those who did not go beyond high school, although most had a high school degree, reported starting a new business. In contrast, not a single person out of eight with some graduate training (including a postcollege degree) reported starting a new firm. The pattern is, in fact, clearly linear and negative, with a systematic decrease in the proportion of start-ups reported as educational attainment increases. As a result, less than one in five of the new firm start-ups is reported by those with a college degree.
{Page 75.}
Thirty entrepreneurs with up to a high-school degree are in the sample of people trying to start a new firm, and 70% report the establishment of a firm, providing 66% of all business births. Fourteen people with post-high school education are in the sample of nascent entrepreneurs, with 36% reporting a new business, for 16% of the total. Nineteen people with college degrees are in the sample, 32% brought firms into existence, for 19% of all new firms. Eight people with graduate schooling tried to start a new firm, none succeeded, supplying of course 0% of new businesses. {Page 76.}
Other Characteristics and the transformation of start-ups into new firms
Men are twice as likely as women to report the business as operating. As a result, three-fourths of new start-ups are reported by men. {Page 75.}
Income (THESIS tie-in), employment, residency:
The proportion of business births is highest for those with intermediate levels of income, and three-fourths of the firm births are reported from households with annual incomes between $20,000 and $60,000 a year. The highest proportion of starts is reported by those who are self-employed, followed by those with full-time jobs; together these individuals account for three-fourths of all reported firm births. [...] 53% of the firm births are reported by those who have lived in their county less than ten years, 75% are reported by those who have lived in their state for over ten years. Clearly, many are operating within familiar territory at the same time they are starting their business.
{Page 75.}
Of the eight nascent entrepreneurs in the sample with up to $19K in annual household income, 38% brought new firms into existence, for 9% of all business startups. Ten people came from households making $20K-29K per year, and 60% of them brought their business to idea to reality, for 18% of all firm births. Thirteen people making $30K-49K a year (only thirteen though this is a larger span sort of in the middle) launched 69% of their attempted businesses, for 27% of the total. Twenty nascent entrepreneurs with household incomes of $50-59K started their businesses 45% of the time, for 27% of all new firms. Of eighteen in the sample of people trying to start a business from households with incomes of more than $60,000 brought a business into existence 33% of the time, for 18% of the new firms.
Look at that! Those at somewhat above average income were most successful (or average to above average) and those making more money had the most disproportionate number of attempts.
{Page 75.} (These figures are 1999 dollars at the latest, they are likely in 1992 dollars, which is what other dollar figures were set at elsewhere in the book. The authors may have failed to adjust people’s answers to the income category for inflation and these incomes may reflect the date of the surveys in the 1980s and early 1990s.)
Measures of consumer or business confidence were unrelated to start-up outcome. The four indexes of work interest (autonomy/impact, task or type of work, wealth and prestige, staying in the community), which were present only in the Wisconsin (not U.S.) sample were also unrelated to the outcome of the start-up effort.
{Page 75.}
Thesis Tie-in
Investment of Time and Money Key
The median financial investment from a start-up’s entire team was $85,000 for start-ups that launched a new firm, and $10,000 for groups that gave up, though the median was $100,000 for start-ups put on hold and $200,000 for cases where start-up continues. Average (mean) total team financial investment showed a steadier progression, from $55,000 for start-ups that gave up, $188,000 with a hiatus, $376,000 where start-up continied and $458,000 in cases where a new firm was born.
Total time put in by the team shows a similar pattern, with a median of 1,900 hours put in by the teams of successful start-ups versus 700 hours by teams where the start-up attempt was abandoned and a median of 300 hours both when the start-up attempt continued and when it was put on hold. Average (mean) time put in was a total of 3,110 hours by start-up teams whose effort resulted in firm birth, 810 hours by the teams that gave up, 1,030 hours by those with a start-up hiatus, and 700 hours where start-up continued.
(The sample size was only 74 cases: 33 firm births, 21 start-up continues, 8 start-up hiatus, and 12 give ups.) The maximum time put in, 8,000 hours, and the maximum money invested, two million dollars, were both from team efforts that resulted in new firms. The minimum money invested in all categories was zero.
In brief, there is strong evidence that those able to put a new firm in place put in much more time, complete half again as many behaviours, and invest more of their own funds in the new firm, when compared to those who are not able to get the firm established.
{Page 79.}
Some start-up behaviours associated with success
Nascent entrepreneurs whose efforts resulted in firm births bought facilities and equipment in 88% of cases, versus 45% of cases where the attempt was given up, 43% where it was put on hold, and 53% where start-up efforts continued (statistical significance 0.01, based on one-way analysis of variance F-test). Of cases where new firms were launched, 33% had hired employees, versus 9% of give-up cases, none by cases with a hiatus, and 11% where start-up continues (statistical significance 0.10). Of all start-ups that resulted in firm births, 52% received financial support, as opposed to 18% of nascent start-ups that gave up, 14% of start-up hiatuses, and 26% of continuing startups (statistical significance 0.10). Cases of firm births almost all had entrepreneurs who invested their own money, 94%, while only 64% of start-ups that were abandoned had teams’ money in them, 71% of start-ups put on hold, and 84% of start-ups where efforts continued (statistical significance 0.10).
Other behaviours more associated with firm births but not at the level of statistical significance were asking for funding, devoting full time to the business, applying for a licence or patent, and creating a legal entity for the start-up.
{Page 80.}
Those who don’t abandon start-up attempts may be hobbyists
Those who report a firm birth and those who have given up have similar patterns, particularly in the first year. Compared to those “still trying,” these individuals report more activity from the very first month, an average of 2.5 activities compared to 1.5, with almost twice as many completed in the first year.
This provides a clear answer to [..] why the longer follow-up for the Wisconsin sample was not associated with a substantially higher proportion of successful firm births. It was because the events that determine a successful birth are determined six to twelve months from the first behaviour.
{Pages 81-82.}
[..] those who gave up were more uniform in their early activities and were more often focused on a physical model or prototype. It may be that the commercial viability of the start-up was easier to determine when a new physical product was the focus of the business. [...]
Those who report a business birth are more consistent in the completed activities. While the presence of a business plan may not [be necessary for nor] ensure a successful firm birth, those with succussful firm births and a business plan started working on the plan early in the process, within the first three months.
The low level of effort among the “trying to start” group [...] suggests, once again, that in repeated surveys these “hobby start-ups” will continue to recur as part of a sample of business start-ups.
{Page 83.}
Overview for Nascent Entrepreneurs
those serious about starting a new firm [...] should expect to devote a great deal of time to the effort at the very beginning, as they simultaneously initiate a number of start-up activities. Financial investments will also be required, which may range from thousands to hundreds of thousands of dollars. [Having] A team may also slow the start-up process, but slowness may be a major asset for more complex endeavors or after a new firm is operating, and diverse skills are needed to manage a fledgling firm, particularly one on a high-growth trajectory. A study of the 1% of new firms with the highest growth rates found that such firms were implemented very quickly and had larger start-up teams than typical new firms (Reynolds, 1993).
[...] There seem to be more losses in the start-up process among women, perhaps minorities, and those with more formal education. They may need special attention or may have unrealistic conception of what is involved in starting a new firm.
{Page 85.}
THESIS tie-in
Time more important than money
Each dollar associated with a firm birth [..] represents another two dollars in start-ups that were abandoned. The allocation of sweat equity, however, is more equitable, for it is clear that the majority of sweat equity goes into start-ups that become new firms. If 1.2 billion hours (3 million start-up firms, 400 hours each), or 600,000 person-years, are devoted to firm start-ups each year, three-fourths are probably devoted to those that become new firms.
{Page 85.}
THESIS: If wealth as opposed to income makes one more able to live without working, and if this is important to putting in a lot of time into the business, might the indication that time is more important than money to a start-up becoming a new business imply that wealth, as opposed to high earned income, helps one be a successful entrepreneur?
Impact of Costs on Economy
This small, representative sample of firms in the start-up process makes it quite clear that the appearance of a new firm is neither instantaneous nor without social costs. First, while some firms are put in place in a few months, the average from conception to birth is a year. While a short time in terms of all of human history, it is a significant part of the work life of those involved.
{Page 85.}
Size (of employment, sales, or exports) varies hugely
No matter how it is measured, the size variation among new firms is quite substantial. [New firms in Minnesota, Pennsylvania, and Wisconsin provided 25,417 jobs, $1,864 million in sales, and $183 million in out-of-region exports.] In all states, the largest 10% of the firms provide half of the employment; the largest 10% provide almost 60% of the sales; and the largest 5% provide 90% of the “out-of-region” exports. Conversely, the smallest half are responsible for 10% of the jobs, 8% of the sales, and virtually no out-of-region exports. The same patterns are found across the three states and are widely reported in other studies of new firms (Birch, Haggerty, and Parsons, 1995; Storey, 1994).
{Page 87.}
Differences for different growth trajectories
High start firms were classified as those with first-year sales above $100,000; and low-start firms below. High growth firms were classified as those with compound annual growth rates above 40%; low-growth firms, below (with all firms assumed to have at least $10,000 in first-year sales to avoid extreme compound growth rates and firm birth was uniformly set as the year of first sales {page 125}).
The result is four categories of firms, with 8% in the high-start, high-growth rate group; 39% in the high-start, low-growth rate group; 26% in the low-start, high-growth rate group; and 27% in the low-start, low-growth rate group.
{Page 91.}
The high-start new firms seem to have been in place for a shorter period of time, particularly those in the high-start, high-growth category. This difference, which is statistically significant, suggests that these firms may have been implemented to exploit a “moving target” business opportunity. Similar results have been found in an analysis of the fastest growing 1% of new firms in Minnesota and Pennsylvania (Reynolds, 1993).
In terms of economic contributions, the faster growing firms appear to provide substantially more benefits. For examlpe, the 8% of high-start, high-growth firms are responsible for 15% of all jobs, 27% of all current sales, 40% of all out-of-state exports, and 46% of all out-of-region exports. In contrast, those 27% of the firms in the low-start, low-growth categories provide 9% of all jobs, 3% of all sales, and 2% of all out-of-state or out-of-region exports. The intermediate firms—high-growth, low-start and low-growth, high-start—have an intermediate level of contributions to economic well-being.
{Pages 91-92.}
[...] among the top 10% of the firms, those providing 50% of the jobs, 80% are “high-start” new firms; 21% fast-growth; and 59% slow-growth. Among the top 10% of the firms providing half of the sales, 87% are high-start; 32% fast-growth; and 55% slow-growth. Among the top 10% of the firms providing 90% of the out-of-region exports, 77% are high-start; 22% high-growth; and 44% low-growth. There is little question that the growth trajectories and size are highly related.
{Page 93.}
..and the high-start new firms that provide the plurality of employment etc. presumably require MORE WEALTH to start... [THESIS tie-in].
If a start-up team is defined as persons who have or expect to have a partial ownership in the new firm, [..] slightly more than half [57%] of all new firms are started by teams. One person [as sole proprietor] initiates about two in five [43%] of all new firm start-ups, at least those that end up in the Dun and Bradstreet files or the Wisconsin state employment insurance files. [Two in five (41%) of firms are started by two-person teams.] Approximately one in six [16%] are implemented by teams involving three or more individuals. Firm start-ups that are basically self-employment, which may be half of all new businesses, are not included in this analysis.
Larger teams and fewer sole proprietorships are associated with firms with higher initial sales and higher growth trajectories[..]. One of the more striking findings in an analysis of the largest 1% of Minnesota and Pennsylvania new firms was the substantially larger size of their start-up teams; fewer than 20% were owned by one person (Reynolds, 1993).
The Wisconsin survey included data on family ownership. A large majority of team-owned businesses are family owned: 45% of all new businesses are sole proprietorships, 47% are family owned, and the remaining 8% have non-family team ownership. The family-owned firms category can be broken-down further: 29% of all new firms are family owned and family managed, 18% are family owned and non-family managed.
Sole proprietorships (45% of all new firms) are over-represented (55%) among low first-year sales firms with low growth, are under-represented among low-start high-growth firms (37%), and nearly hold their own with high-start low-growth firms (42%) and high-start high-growth (41%). Family-owned and family-managed firms (29%) made up 30% of low-start low-growth businesses, 33% of low-start high-growth, 25% of high-start low-growth, and 36% of high-start high-growth firms: quite a favorable profile. Family owned and non-family managed firms (18%) were 13% of low-start low-growth, 24% of low-start high-growth, 28% of high-start low-growth, and 17% of high-start high-growth. Non-family team ownership (8%) had only 2% of low-start low-growth firms and 6% of low-start high-growth firms, a whopping 15% of high-start low-growth firms, and only 6% of high-start, high-growth companies.
{Page 94.}
Educational Attainment
Among the start-up teams there are slightly higher levels of educational attainment among the high-start, fast-growth firms, [..]. Almost 57% of the team members, across the three samples, have not completed college.
{Page 97.}
Work Experience
The more substantial new firms are associated with [having] a larger proportion of the start-up teams that left other established organizations or new firms, more years of industry experience, and more experience with new firm start-ups. It is to be noted, however, that two-thirds (65%) of all those involved in these new firms have never been involved in another start-up.
{Page 98.}
Residency
personal social embeddedness [that is, establishment in social and business networks] takes time, which would be reflected in the residential tenure of the start-up team. [.. In the Wisconsin study, one in five respondents] has lived in the country less than five years (fewer than one in ten has lived in the state less than ten years), and 60% report living in the county over ten years (three in four have lived in the state over ten years [Reynolds and White lost some people or some years here..]). There is some relationship to firm growth trajectory, as the principals associated with firms with higher initial sales and higher growth trajectories have lived longer in the host county.
{Page 98.}
Team Profile in a nutshell
In summary, then, start-ups are often a team project, usually involving a family-based effort. Abouc 40% of those involved are women, frequently on teams with men. A broad range of ethnic backgrounds is involved, as is a broad range of educational attainments. Over 85% of those involved are between eighteen and forty-four at the time of the start-up. Over three in four move from one work context to the new firm; only about one in twenty (6%) is unemployed. About half of start-up team mebers have over five years’ experience in the same industry, two-thirds have never started another firm, and most have ample time to become established in the business and social communities.
Higher growth new firms tend to have more experience teams, an absence of very young adults, team members with more industry and start-up experience, and principals well-established in the community.
{Pages 98 to 99.}
Higher Growth Firms Generally Sell to Businesses, Not Consumers
High-start, high-growth new firms are more likely to be associated with manufacturing or distributive services (wholesale, transportation) and producer (business) services; they are less likely to be in retail or consumer services.
{Page 99.}
Legal Form
42% of firms are initiated as sole proprietorships, 42% as corporations, and 16% as partnerships. There is then a shift toward the corporate firm, as half were corporation at the time of the interview (with a decrease in both sole proprietorships and partnerships. Larger new firms are more likely to be started as corporations or to become corporations.
{Pages 99 to 101.}
There is a higher prevalence of high-start, high-growth firms in regional centers (as opposed to “major urban areas”) and a reduced presence in rural areas.
{Page 99.}
Initial Financial Support and Growth Trajectories
The average funding for all new firms in these samples was $54,000, and the median was $3,000 (due to the large number of those with no reports on informal funding). But when restricted to those in the samples for which some informal funding is reported, the average is $98,000, and the median value is $38,000. [...]
There are clear differences associated with the firm growth trajectory, for [among firms reporting financial data] the high-start firms report average initial financial support of $138,000 [for high-growth] and $124,000 [for low growth]; the low-start, high-growth firms an average of $99,000; and the low-start, low-growth firms, an average of $53,000. The median values [follow a similar pattern for firms with financial data: $57,000 (for high-start high-growth), $66,000, $41,000, and $15,000 (for low-start low-growth)]. [Sample size: 2,350 firms.]
{Pages 101 and 102.}
Sources
Only one source of initial funds is almost universal[: ] 85% or more of the new firms in all categories report funds from the start-up team members. This is, generally speaking, about half of all initial funding provided and slightly higher for the high-start, high-growth new firms. Other sources—from a spouse or the immediate family, other kin or relatives, friends and busines associates, or supplier credit— are reported on a regular basis, although seldom by more than one in five or as a source of more than 10% of the initial funding. “Other” is the other major source of initial funding, reported by almost half of the new firms, although least among the high-start, high-growth group and highest among the low-start, high-growth group. This suggests that the low-start, high-growth group is the most creative in locating diverse sources of financial support in the start-up phase.
{Page 102.}
THESIS tie-in
High-start, high-growth firms get 58% of their initial financial support from the savings of the start-up team; high-start low-growth firms get 49%; low-start high-growth firms get 48%, and low-growth low-start firms get 52%. The values for initial funding from team members’ spouses and immediate family is 3%, 5%, 4%, and 7% by type of firm in the same order as above. Other kin and relatives contributed a total of 6%, 7%, 7% and 10% to firms in each category. From friends and business associates came 3%, 4%, 3%, and 3% of initial financial support. Supplier credit provided 9%, 8%, 7% and 7%. The remainder (21%, 26%, 31%, and 20% came from other sources).
Start-up Window
The new firm start-up window can be considered the time between the first and last of four major events—first personal commitment, first financial support, first sales, and first hiring—which may occure in any order (Reynolds and Miller, 1992). [This window averages about a year, with a median value of six months. In relation to growth trajectories:] The start-up window is shorter for firms reporting high-start, high-growth trajectories [10.6 months, median 6 months] and [..] longer for those with a low-start, low-growth trajectory [14.7 months, median 7 months]. [High-start, low-growth firms average 12 months (5 month median) and low-start, high-growth firms average 11.9 months (6.4 month median).]
{Pages 102 and 103.}
Finance Problems Rank High
Eight indices were formed from 44 specific problems. Problems under the rubrics of financial controls (statistically significant at the .01 level) and of financing (significant at the .0001 level) lead the list in perceived severity. On a scale of one to three (major, minor, and none), financing averages 1.98 for all firms but 2.12 for high-start high-growth firms, 2.01 for high-start low-growth firms, 2.03 for low-start high-growth firms, and 1.84 for low-start low-growth firms. Financial controls is 2.00 for all firms, 2.05 for high-start high-growth firms, 2.00 for high-start low-growth firms, 2.04 for low-start high-growth firms, and 1.92 for low-start low-growth firms. (Smaller – presumably less successful – firms have fewer problems). {Page 103.}
Location
“Most businesses are started where the start-up team lives.” {Page 104.}
Region
Overal 57% of new firms are started in metropolitan, 26% in regional center, and 17% in rural regions. The breakdown is 59%, 19%, and 22% for those respective regions in Minnesota; 62%, 28%, and 10% in Pennsylvania; and 32%, 40%, and 28% in Wisconsin. The regions were defined as the Milwaukee, Minneapolis-St.Paul, Pittsburgh, and Philadelphia metropolitan regions; the Duluth, Rochester, and St. Cloud regions of Minnesota, Allentown, Erie, Harrisburg, and Scranton regions of Pennsylvania, and Kenosha-Racine, Madison, and Fox Valley regions of Wisconsin; and the rural the remaining nine regions of Minnesota, five regions of Pennsylvania, and three regions of Wisconsin. (The question, of course, is what’s the population: I think earlier the authors implied that regional centers had a disproportionate number of nascent entrepreneurs.) {Page 105.}
All of this supports Jane Jacobs claims in The Wealth of Cities, that wealth is generated in city regions because of the connections possible there. Even the type of economic sector of new firms by region supports her ideas of where true growth resides:half of the new firms in Minnesota and Pennsylvania emerged in the major urban centers; 70% of Wisconsin new firms emerged in the major urban center or the three adjacent regional centers. There are some systematic differences associated with the context. Rural areas tend to have a smaller proportion of the high-start, high-growth new firms and a larger proportion of low-start, low-growth new firms. The type of economic sector varies less than might be expected, although the proportion of manufacturing and construction new firms is highest in regional centers, producer and business service new firms are a higher proportion of new firms in the metropolitan regions, and retail businesses are most prevalent among new firms in rural areas.
{Page 106.}
External Financial Support
“One-half (49%) of the firms one to eight years old report no external financial support.” This varies from 35% among high-start, high-growth new firms to 62% among low-start, low-growth firms. Of high-growth firms, those that had been in business longest had less external financial support; while among low-growth firms the older ones had more financial support.
Loans are the most common type of financial support: 49% report some type of debt, and 8% some type of equity financing. Only 2% report only equity financing; the other 6% with equity financing report some form of debt. As might be expected, high-start, high-growth firms are about twice as likely to report any type of debt as the low-start, low-growth firms, but the differences are matters of degree. Equity support is quite different, with the high-start, high-growth firms five times more likely to report external ownership than the low-start, low-growth new firms.
The most dominant form of external financial support, reported by 45% of the firms, is a traditional bank loan, usually backed by a physical asset. [...]
The other major source of external equity is private investors, followed by “other” sources of equity. This would include, for example, a bank or financial institution accepting ownership to complement a loan against a physical asset.
[THESIS tie-ins in added bold.]
{Page 113.}
The [median] amount of support appears to be inversely related to the prevalence of support. Many new firms receive small amounts [of outside funding] from traditional sources; a few have very large amounts from distinctive sources. The rare venture capital or government loan is among the contributions most likely to be very large. The median bank loan, reported by almost half of all new firms, is about $59,000 (1992 dollars).
{Page 115.}
The total amounts of funds generated internally from within the start-up team and from external loans and equity arrangements [...] [f]or the total sample, in 1992 dollars, [..] is $667 millions. One-fifth is provided from within the start-up teams, two-thirds from loans, and the remainder (14%) from equity sources. Of this total, over half (54%) is provided from traditional banks or other lending institutions. The two sources with substantial media attention, SBA-backed loans and venture capital equity support, provide, respectively, 1% and 2% of the total funds.
{Page 117.}
[What's needed next is for me to find research supporting the adage that banks only lend to people who don't need money...] [I also believe, but I'm not sure this book quite shows, that self-financing comes first chronologically (and hence in importance) and venture capital last.] [Continuing directly from the last quoted paragraph:]
This suggests that those starting new firms may expect to obtain most of their external funding from traditional sources, and only the exceptional new firm might be suitable for other forms of financial support and other types of loans or equity financing. It is clear that even among equity sources, 86% of the equity funds are not provided through venture capital firms.
These estimates can be translated into aggregate national estimates by computing the average amount per new firm (one year old) and multiplying by annual number of U.S. start-ups. Assuming that half a million new firms are founded each year in the United States—and this is a low estimate, their total informal financing (in 1992 dollars) would require about $25 billion; they would generate a need for $84 billion in loans and about $18 billion in equity financing for a total of $127 billion, with slightly more than $100 billion from external sources. Additional funds are required after the first year for the growing new firms.
[The authors then note that their data looks good in that this extrapolation would expect 1,100 firms to receive a total of $2.4 billion from venture capital and in fact the 1982-1992 period averaged 1,200 firms a year receiving $2.9 billion.]
{Pages 117 to 118.}
Industry experience/contacts is the most popular management emphasis, particularly by high-start high-growth firms.
Among competitive strategies, one strategy dominates: customer service and quality. Next, three receive equal emphasis: lower prices, market responsiveness, and product diversity. {Page 119.}
Fledgling New Firms (Growth After Birth) Overview and Implications
Most regional and national economies are in constant turbulence and change. Existing firms shrink or disappear, and new firms emerge to replace these losses. This is usually in terms of replacements within, or expansions of, existing economic sectors. Occasionally, new firms may create a new sector. The results of these studies have confirmed much of what has been found in other research. First, new firms are one major source of ecoonomic growth: jobs, sales, and out-of-region exports. Second, a small proportion of new firms—those much larger than the typical new firm—accounts for the majority of these contributions.
The third result may be unique. Whereas previous research, even that with the same data sets, has emphasized the importance of the growth of new firms, this analysis—which controlled for the effects of inflation—has found that the initial size of the firm was of greater sigificance in terms of firm size over the first seven years. The most significant contributions came from firms that were large in their first year of operation (sales in excess of $100,000 in 1992 dollars) and had annual compound growth of at least 40%. Only 8% of new firms meet these criterion, but they contributed 15% of all jobs, 27% of all sales, and 40% or more of all out-of-region exports. Firms that started large but had less growth were second in relative importance; those that started large but had high growth were third. The small start-up that stayed small had the smallest share of contributions to economic growth.
These high-starting, faster-growth firms were distinctive in a number of ways. While most new firms in all economic sectors tended to be modest endeavors, more of the larger new firms were in manufacturing, distributive services, and business services; retail and consumer services were underrepresented. Higher-potential new firms were more likely to be in regional centers than in metropolitan areas, least likely in rural areas.
{Page 121.}
“Large” new firms, despite their relative rarity, are so modest I am tempted to call them merely viable. Exceeding $100,000 dollars in sales isn’t much when you consider that at least one person is trying to live off the net revenue. Nevertheless, I’d like to suggest that the evidence of the importance of a large start implies the importance of a wider distribution of wealth.
“All firms are started where the team members live.” {Page 121.}
[THESIS tie-ins abound below]
The start-up teams among higher-potential new firms had distinctive features. They had a higher proportion of men, slightly older team members, and those with more industry experience and more experience with starting new firms (although for two thirds this was their first start-up). They tended to be working in established firms before the start-up and [to] have lived in the region for decades. While about one-third of those inveleved in new firm start-ups were women, they tended to be a larger proportion of those associated with low-start firms.
The firms with more potential tended to get off the ground faster, an average of ten months, compared to over a year for the typical new firm. Firms with more potential reported more start-up problems of every kind and in the following order of decreasing significance: obtaining financing, managing money, dealing with regulations and insurance, planning and implementation, and personnel and site or location issues.
{Page 122.}
About half of all new firms reported no initial financing, from within the start-up team or elsewhere. Among those that do report initial, informal support, the higher-growth firms raised over twice as much as the lower-growth firms ($138,000 compared to $53,000 in 1992 dollars). Regardless of growth trajectory, over 80% get the majority of the funds from within the start-up team. Low-start, high-growth new firms were distinctive in the capacity to raise funds outside the team:friends, family, or business associates.
About half of these new firms reported no external financing of consequence at the time of the interview, although the average for all firms was about $211,000 in 1992 dollars. Among those that received any external financial support, it was $430,000 in 1992 dollars. [...] the average for the high-start,high-growth new firms was $1,049,000, eight times that of the low-start, low-growth firms, where it was $124,000 (both in 1992 dollars).
{Page 122.}
[...] only the higher-growth firms reported any equity financing of consequence. All firms reported that the single largest source of funding was banks and other financial institutions. Indeed, they provided 54% of all funds—internal and external—raised by the new firms.
{Page 123.}
Implications for Starting a Business
There are many ways to start a business, and new firms can be implemented for many reasons. Clearly, modest efforts designed to provide one or two people with an acceptable living are quite common in all states, all types of regions, and—in addition—all economic sectors. Those who aspire to a substantial business seem to follow two courses of action. One is to identify a business opportunity that requires a firm of a partitular size. The start-up effort seems to focus on putting the firm in place at its optimum size and then maintaining it. The alternative appears to emphasize a pattern of growth, either because the potential market is ambiguous or expanding or because resources are scarse at the start-up. In any case, the more significant endeavors clearly require larger, more experienced teams with substantial knowledge of both their region and markets.
{Page 123.}
Chapter 6
Fledgling New Firms: Persistance after Birth
A successful new firm “birth” is reflected in an operational business, one with sales or income, paying expenses and taxes, and, perhaps, with employees. If researchers are active about tracking down new firms, 90% appear to persist from year to year (Cooper, Dunkleberg, and Woo, 1988; Kirchhoff, 1994; Reynolds, 1987a). Current evidence suggests, however, that the tendency to persist increases somewhat after the initial period, the first five to six years.
{Page 129.}
Mary Williams, Paul Reynolds, and Sammis White point out
it is not always clear that the persistence of a business is more desirable than its discontinuance. A business may be marginal, profits may be low, and the owners may subsidize the entire effort with low or unpaid labor. It may be better for all concerned if the firm was shut down, and the resources—employees, facilities, equipment, capital, managerial talent—redeployed to other, perhaps more productive, uses. While some discontinuances may lead to social costs, not all discontinuances are, in the long run, an undesirable outcome. It may be better, then, to describe firms as persistent or discontinued, rather than “successful or failed” or “dead or alive.”
{Page 130.}
Among those firms in late infancy, completing the interview within one year of first sales, 59% persisted; of those in youth, completing the first interview two or three years after first sales, 71% persisted; and of those completing the first interview four to seven years after the first sale, 76% persisted. These differences are statistically highly significant. The later the timing of the first interview, the higher the proportion of the new firms that persist to the second interview.
{Page 133.}
New firms reporting higher first-year sales (adjusted for inflation) were significantly more likely to persist. {Page 134.}
Firms with longer start-up windows were slightly more likely to persist (perhaps): new firms that had a short start-up window of 0-5 months had 73% persistence (in total; breaking it down gives 63% persistence for such firms interviewed in the year after first sales, 74% in the 2-3 years after first sales, and 77% in the 4-7 years after first sales: the short start-up exerts most of its negative influence early; once firms survive the first year they do well); new firms with a 6-11 month start-up window had 72% persistance (72% 0-1 years from first sales to first interview, 73% 2-3, and 71% 4-7); 12-35 months 75% persistant (66%, 69%, 83%); and 36-140 months 77% persistent (90%, 71%, 77%). But none of these figures are statistically significant when comparing different lengths of start-up windows except for “early adolescent” (4-7 year) firms. As for comparing different ages, only the longest start-up window does not provide statistical significance; the first and third sets are statistically significant to the 0.0001 level and the second set to the 0.01 level. {Page 138.}
Competitive strategy and survival: “New firms whose only strategy focus is on low prices have a reduced tendency to persist, especially during the youth [2-3 years after first sales] stage.” “[I]n early adolescence [..] equivocators seem to be less likely to persist, while niche purveyors or those promoting technology in some form are most likely to endure.” {Page 138.}
THESIS tie-in
New firms in their second and third years of existence are far less likely to persist when they report high problems with obtaining financial support. This result stands out among all other measures of reported problems and firm persistence. “Start-up problem index: financial support” for the total sample firms reporting “Low” for financial support problems persisted 73% of the time, for “Medium” the firms persisted 76% of the time, and for “High” they persisted only 70% of the time (these differences are statistically significant to the 0.01 level). For firms interviewed 0-1 years after first sale, 74% of those reporting low problems with financial support persisted, 77% of those with medium, and 74% with high (not statistically significant differences). For firms 2-3 years old, 70% of low, 73% of medium, and only 60% of high problem-reporting firms persisted (statistically significant at .01). And 4-7 year old firms reporting low financial support related start-up problems persisted in 76% of cases, those reporting medium problems persisted 78% of the time, and those reporting high persisted in 75% of cases (not statistically significant). In each case the differences across firm age is statistically significant to the 0.0001 level. {Page 139.}
New firms with a greater emphasis on financial control and formal planning seem to have [] greater persistence. A related emphasis on coordination presents a more mixed effect; it would appear that a moderate level of coordination is optimal for firm persistence. A greater emphasis on marketing strategy seems appropriate for firm persistence during late infancy and youth periods; an emphasis on marketing implementation during late infancy seems particularly related to persistence.
{Page 141.}
“It is clear that firms that raise more funds are more likely to persist,” {Page 141}.
Considered by itself, the growth trajectory of the new firms has a major impact at all stages of the process, with the low-start, low-growth firms least likely to persist beyond each firm life-course stage. High-start, high-growth new firms are more likely to persist beyond the earliest stage, late infancy, but not the later stages.
{Page 143.}
The major factors affecting persistence of new firms that are statistically significant can be summarized by firm life-stage as follows:
persistence of firms in late infancy appears to be enhanced if they are in a regional center, have higher first-year sales, have males on the start-up team, have a team with more educational background, receive financial support toward the end of the stat-up period, emphasize financial controls and marketing implementation, and have a high growth trajectory, particularly if they are in an export potential economic sector. There is no evidence that the number or severity of start-up problems or the presence of financial support has an effect at this stage.
Persistence of firms in youth appears to be facilitated by operating in the consumer services sector, greater levels of start-up financial support, higher first-year sales, older team members recently shifting from established organizations, financial support early in the start-up process, an absence of major start-up problems (particularly related to financial support), with a management emphasis on financial controls, planning marketing strategy, and with a heavy emphasis from the principals, with substantial financial support, with a high-growth trajectory, and operation in an export sector.
The persistence of firms in early adolescence is affected by the same factors affecting young firms, but with more emphasis on the work experience of the start-up team and the fgirm strategy and less with regard to their management emphasis.
{Page 144.}
Procedures used to identify the impact of multiple factors and some of their results: linear additive regression modeling (which I dislike and did rate financing as mattering) and factor interaction identification (which does consider start-up and overall financing to have an impact, and which shows that groups with similar rates of persistence may have those rates for very different reasons).
