The Case for Startups

Posted on February 9, 2011

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Where do jobs come from? In these times of high unemployment, this question is of particular relevance.  A recent study by the Kauffman Foundation, titled “The Importance of Startups in Job Creation and Destruction“, answers this question clearly: jobs come from startups, defined as firms less than 1 year old. As the graph below so convincingly demonstrates, without startups, there would be no job growth. As the author of this study, Tim Kane, says, “This fact is true on average, but also is true for all but seven years for which the United States has data going back to 1977.”  Wow!

Although it’s difficult to infer causality from statistics, we can guess some of the reasons for this disproportionate share of job growth in startups. First, there are so many of them: data from the U.S. Census BDS study (the same data that forms the basis for the chart above) indicate that young firms, those under 5 years old, constitute the largest group of firms, between 30-40% of all firms. A second factor is the large amount of churn in the U.S. job market.  Every year, about 16% of the jobs in the U.S. economy are destroyed, and 18% of jobs are created.

This data comes from a report from the Center for Economic Studies here. Of course, this is average over the time period; some years, job creation outpaces job destruction, other years it doesn’t. On the whole, however, we need the workforce to grow about 2% a year just to keep pace with new entrants to the workforce.

On the job creation side of the ledger, entry jobs are by definition from new firms. Expansion could come from firms of any age or size, but the data suggests that much of this also comes from newer and smaller firms.

This chart also comes from one of the Kauffman Foundation studies. Note that there is a small error in the chart: the 53% refers to the first 4 columns, firms up to 49 employees, not to the first three columns. This is an amazing statistic! More than half of the net new jobs in the economy come from firms of 49 employees or fewer. Think about what this means for public policy. Rather than bailing out banks “too big to fail”, the data suggest that if our objective is to create jobs, we would be better off supporting small firms.

A few more thoughts about startups. I believe that startups are disproportionately responsible for much of the innovation in this country. This is difficult to prove by data. I could take a look at patents as a proxy for innovation, but I think it’s a poor proxy. Filing a patent is an expensive proposition, more likely to be paid for by large and established companies. And not every patent is equally innovative; some are much more important than others. So I’ll offer anecdotal evidence. Over the years, I’ve met with the heads of business development for many large firms. Nearly all of them have told me the same thing: that large firms are not particularly good at taking ideas from inception to the first $10-20M in revenue; that they are much better at taking an idea that has been proven, and growing it from tens of millions to hundreds of millions and even billions.

The history of a number of iconic large firms bears this out. Google, after it’s initial innovation on their search engine by ranking pages based on links, makes most of its money from a technology that they acquired from a much smaller company (ad sense). Oracle has acquired almost 70 companies over the last 5 years, accounting for a large portion of its growth. Apple Computer seems to be the most prominent exception to this rule, but even Apple acquires smaller companies for their innovations. For example, Apple acquired NeXT for their operating system, which forms much of the underpinnings for the current MacOS. And recently, as Apple has tried to enter into the market for mobile advertising, they acquired Quattro Wireless.

Recently, the White House has started to recognize the value of startups. I was pleased to see the announcement of the Startup America initiative last week. Although this initiative is far from perfect, and the jury is still out as to whether it will deliver on its promises, I’m hopeful that it signals a change in public policy, and a recognition of the importance of startups in our economy.

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