Start-ups are a significant source of job creation in the U.S. Separately, mature small firms account for a large portion of employment levels. Bank lending and initial public offerings (IPOs) are important forms of financing for start-ups and mature small firms. However, both types of financing have yet to fully recover from the financial crisis of 2008-09. This is cause for concern because available financing is key to start-up formation and business sustainability which, in turn, fuel job growth.

Start-Ups: A Significant Source of Job Creation

While older firms are important with regard to employment levels, it is new and young businesses (i.e., less than one year old) that are a key source of job growth. The U.S. economy is comprised of more than 6 million establishments with paid employees. The status of these businesses is constantly churning — some grow, others decline, and yet others close. New businesses replenish the pool of establishments with paid employees; since 1977, newly born companies created 3 million jobs per year on average. As we discuss below, these 3 million new jobs exceed total average annual job growth overall, reflecting job destruction by mature firms.

In recent years, however, the rate of start-up formation has slowed sharply. After declining from 667,000 in 2006 to 507,000 in 2010, the number of startups rose in 2013 for the third consecutive year, albeit only to 628,000 — well below their 2006 peak. As for employment growth, the rate of job creation at start-up companies was steady in the 1980s and 1990s at 11 start-up jobs per 1,000 people (i.e., among every 1,000 Americans, 11 were newly hired at a company begun that year). Not surprisingly, the start-up jobs rate declined along with the rate of start-up formation (to just 8 start-up jobs per 1,000 people in 2009), and improved modestly to 9 per 1,000 in 2013.

As for where start-ups have been predominant in the economy, Figure 1 shows the sectors that accounted for the largest number of jobs created by start-ups in the period from 1994–2013. Note that the Information Technology sector appears relatively unimportant in terms of start-up job formation during this period, accounting for just 3% of jobs created by new young firms (included in “Other”) This is somewhat misleading, however, as it doesn’t take into account the critical issues of (1) survival rates and (ii) net employment growth rates.

Figure 1: Jobs Created in U.S. Establishments <1 Year Old by Sector, 1994-2013

Figure 1

So, for example, a lot of pizza restaurants that fall under the “Accommodation & Food Services” category may open each year after hiring cooks and serving/delivery personnel, but their survival rates are often low. By contrast, far fewer tech firms may set up shop each year with just a handful of employees but, if they successfully develop a product, they survive and often go on to add many more employees. This suggests that some sectors are better than others in creating sustainable jobs.

Small Firms: Big Employers

The World Economic Forum has noted that “most young firms start small, but most small firms are not start-ups.[1] ” Almost half of U.S. private sector employment is in firms with fewer than 250 employees; the proportion has been relatively stable over the past two decades, suggesting that small firms consistently account for a large portion of employment levels.

Existing firms create significantly more new jobs than start-ups. Given the very large share of activity accounted for by mature firms, it is not surprising that, in terms of sheer numbers, older firms create and eliminate the largest number of jobs. On average since 1977:

• 10 million new jobs have been created each year at existing firms (e.g., a Starbucks corporate headquarters);

• 3 million new jobs have been created each year at new establishments of existing firms (e.g., a new Starbucks somewhere in the U.S.)

• 14 million jobs have been eliminated each year by existing firms (e.g., “mom and pop” coffee shops closing locations when Starbucks enters a new market).

In aggregate, existing employers averaged net job losses of 1 million workers per year, at the same time that newly born companies created 3 million jobs per year on average. So, what matters most, in aggregate, is creating new jobs and holding on to existing jobs.

Less Bank Lending to Small Businesses

As per the aforementioned World Economic Forum study, most lending to small and medium-sized enterprises (SMEs) in the U.S. is by the largest banks. Around 85% of all commercial and industrial loans of $100,000 or less were made by banks with more than $1 billion in assets (the largest size bucket reported by the FDIC). Although small banks might lend more to SMEs as a fraction of their asset size, the asset base of large banks is so much larger that their lending to SMEs dwarfs that of smaller banks.

Policies that were enacted in the aftermath of the financial crisis of 2008-09 may have had unintended negative consequences for lending to SMEs. Among the most notable of these policies is the Dodd-Frank Wall Street Reform and Consumer Protection Act intended, in part, to govern the behavior of large banks by making them “less risky.” Risk aversion may have adversely impacted SME lending— the dollar value of commercial and industrial loans to small businesses in 2013 was 15% below 2008 levels (i.e., five years later and with nominal GDP in 2013 14% above 2008 levels.)

Fewer IPOs

Stock market IPOs are another important source of funds for young and/or small firms, often functioning as a key rite of passage for many entrepreneurial firms, and allows founders and financial backers to begin cashing out. Furthermore, venture capital and private equity firms are typically contractually mandated by their limited partners to exit their portfolio companies within a certain number of years after the initial investment, and thus are motivated to either sell out or take a company public.

From 1980–2000, an average of 311 firms went public in the United States each year, but in 2001–2011, this number fell to an average of only 99 per year. The drop in IPO activity was most severe among small firms – one study[2] documented that the average number of small-company IPOs per year in the period between 2001 and 2009 fell by more than 80% relative to the annual average number of small-company IPOs in the period between 1980 and 2000.

A number of explanations for the prolonged drought in IPOs have been advanced. For example, it has been argued that the Sarbanes Oxley Act of 2002 (SOX) imposed additional compliance costs on publicly traded firms. As a percentage of revenue, these costs have been especially onerous for small firms. Consistent with the SOX explanation for the decline in IPO activity and, as noted above, the decline in IPOs has been most pronounced among small firms. Other observers have attributed the drop in small company IPO volume in the U.S. to a decline in the “ecosystem” of underwriters that focus on smaller firms and provide analyst coverage only after a company has gone public.

Policy Implications

The drop in IPO activity generated concern among policymakers given that, as outlined above, a big source of job creation is by young, fast-growing firms. Consequently, the Jumpstart Our Business Startups (JOBS) Act was signed into law by President Barack Obama in April 2012 with an explicit goal of encouraging start-ups. Whether attributable to the stimulus provided by the Act or not, the number of IPOs in 2013 rose to over 200, but still well below the 1980-2000 average of 311.

It’s undoubtedly a negative for job creation by start-ups and mature small firms that IPOs — and bank lending too — have yet to fully recover from the financial crisis of 2008-09. In addition, there is anecdotal evidence that the U.S. policy environment has made entrepreneurial employment growth more difficult to achieve. At the federal level, the dominant factor here may be new regulations on labor. So for example, the passage of the Affordable Care Act is creating a sweeping alteration of the regulatory environment that directly changes how employers engage their workforces.

So in summary, this brief analysis gives a bit more granularity to the extent to which start-ups are a significant source of job creation in the U.S. and mature small firms account for a large portion of employment levels. Further, given that bank lending and IPOs are important forms of financing for start-ups and mature small firms, it seems clear that a greater degree of confidence in the power of capitalism is needed to further stimulate economic growth. In a number of the articles in this month’s edition of the Cornerstone JSFB, we argue that greater transparency and improved corporate governance, can indeed begin to rebuild this confidence…and thus help stimulate the financing that is needed to restart the entrepreneurial jobs engine.

Michael Geraghty is the Global Markets Strategist at Cornerstone Capital and formerly the founder of Informed Investor, LLC a consultancy specializing in thought leadership that produces bespoke research reports for institutional investors. Michael has over three decades of experience in the financial services industry including working as an investment strategist at UBS and Citi.


[1] Not All SMEs Are Created Equal, World Economic Forum Global Agenda Council on Financing & Capital, 2014
[2] Where Have All the IPOs Gone?, Gao, Ritter & Zhu, 2012