Had Few Turning
Points in 2012
Young, fast-growing small businesses were in the spotlight in 2012 for their role in job creation. The Atlanta Fed honed in on the high-growth element, recognizing that both young and mature firms play important roles in job creation.
Small businesses have long been a symbol of America's independent spirit, innovation, and economic dynamism. Because they are regarded as such, people often hold them up as a solution to the nation's growth and employment challenges.
This focus on small business, though perhaps overstated, is understandable. Small businesses account for a large share of all U.S. firms and employ millions of workers. Because of this important role, the Atlanta Fed has taken a natural interest in how small businesses contribute to economic growth and job creation. Over time, the Atlanta Fed's understanding of this critical role has evolved in response to a complex and nuanced reality: when it comes to boosting American entrepreneurship, there is no silver bullet.
Determining which business segments contribute the most to job creation can be difficult. Small businesses, young businesses, and high-growth firms have all been on the Atlanta Fed's radar as important sources of job growth. In 2012, the intersection of these three—young, fast-growing small firms, often called "gazelles"—was in the spotlight. The Atlanta Fed's study of the small business landscape suggests that the high-growth aspect is what matters most. Most high-growth firms are young and small, but the larger, older ones tend to play an outsized role in job creation. Simply put, young, fast-growing firms matter, and so do the mature ones. Indeed, in 2011, only 1.5 percent of all firms grew fast enough over the previous three years to be considered high growth, but together they were responsible for nearly 33.7 percent of all gross jobs gains by expanding firms. Those 10 years or older had a greater-than-average contribution to employment growth, representing 30 percent of high-growth firms but contributing 43 percent to the job gains of all high-growth firms, according to research by U.S. Bureau of Labor Statistics economists Akban Sadeghi, James Spletzer, and David Talan. Because high-growth firms occur in nearly every industry, concentrating policy efforts on one business segment—or even one industry—would be a misdirected strategy.
All firms, whether large or small, high-growth or family business, have to start somewhere. Indeed, start-ups and entrepreneurship more generally are part of the solution to the growth and employment challenges facing the nation.
In this regard, a broad range of policies could help foster growth, innovation, and job creation. On one side of the coin are policies aimed at removing obstacles to growth, such as the fiscal policy uncertainty that clouded the outlook in 2012. On the flip side are growth-promoting policies, including those intended to encourage investments in human capital and infrastructure. Monetary policy also plays a role in supporting entrepreneurship by fostering price stability and moderate longer-term interest rates. When these conditions prevail, the other policies can better do their jobs.
Factors other than policy also help encourage the emergence of high-growth firms. The Atlanta Fed has identified a handful of critical factors through its conversations with entrepreneurs, business incubators, financiers, and others. One of these influences is the presence of an entrepreneurial culture. This aspect, which varies by location, is reflected in attitudes toward such concepts as innovation, experimentation, failure, and success. Areas with lots of entrepreneurs tend to spur even more entrepreneurship. Other factors include access to external capital, the availability of skilled workers, and the ability of entrepreneurs to form networks or strategic alliances. (See the sidebar for further discussion about the unique challenges facing high-growth firms.)
Anecdotal information about the U.S. economy played an integral role in the monetary policy process. This grassroots economic intelligence helps Fed policymakers form a comprehensive, current view of how the economy is faring.
So, when Federal Reserve Chairman Ben Bernanke met with members of the Atlanta Fed's research staff and entrepreneurs, professional advisers, and financiers in the fall of 2012, they were able to gather insight into the unique challenges facing high-potential start-ups and growth-oriented new businesses.
Atlanta Fed vice president and senior economist John Robertson explained that this segment of the small business landscape, often called gazelles for their high-growth status, contributes disproportionately to U.S. job creation and economic growth. At the same time, gazelles also face a different set of challenges than other small businesses. "They don't yet have an established track record, and may not have all the talent they need or strong relationships with key customers, advisers, and financiers," Robertson noted.
Financing was a key theme around the table. In particular, leaders of these firms noted that access to financing was a persistent challenge in 2012. Many of them relied on personal savings, credit cards, funds from family and friends, and home equity lines of credit to fund their start-up costs. This process was made even tougher due to the housing crisis and tighter credit standards, they said. Additionally, many growth-oriented young businesses have technology or intellectual property as their source of collateral, noted Robertson. These hard-to-value assets make it difficult to qualify for a traditional bank loan, leading such firms to seek other funding sources such as equity-based financing.
Angel investors and venture capitalists, who have traditionally served as alternative sources of funding for entrepreneurial businesses, also did not make it easy for these businesses to obtain financing. Angel investors, many of whom are themselves former entrepreneurs, tend to fund smaller deals on a more local basis. At the other end of the spectrum is venture capital, an industry that has become more concentrated. Venture capitalists have tended to go after larger deals and thus are focused on more mature investments. This dichotomy creates a so-called "middle space," where financing can be hard to find, roundtable participants said.
Chart 1 shows where businesses, young and mature, report having gotten the money to start up (see the chart).
As 2012 progressed, the optimism of small businesses declined. The National Federation of Independent Business (NFIB) small business optimism index fell from 93.9 in January to end the year at 88, the second-lowest reading since March 2010. Similarly, the Atlanta Fed Small Business Survey highlighted declining expectations among southeastern small businesses. According to the third-quarter 2012 survey, most small businesses lowered their expectations for improvements in the coming year. The outlook worsened from the first-quarter readings; optimism levels for sales fell to third-quarter 2011 levels. Interestingly, however, the survey revealed the bifurcation between young and mature firms. In comparison to the first-quarter survey, firms less than five years old reported more positive outlooks, while mature firms downgraded theirs.
The Great Recession affected large and small businesses alike. In 2012, more than three years into the recovery, small businesses continued to face significant headwinds to growth. Perhaps as a result, the rate of new start-ups declined during the recession and has remained low. At the same time, new start-ups have made a smaller contribution to job creation than before the downturn. According to data from the Bureau of Labor Statistics, there were roughly one-third fewer fast-growing firms in the U.S. economy than there were in the mid-2000s, and they added about half as many jobs as they did then.
Some of the headwinds to growth in 2012 included weak sales and widespread uncertainty on a host of issues, including the new health care laws, fiscal policy, and the European sovereign debt crisis. According to a November survey by the NFIB, nearly 20 percent of small-business owners listed weak sales as a top concern. Regulation and taxes also ranked high on the list of challenges.
Additionally, small businesses faced tight lending conditions throughout 2012, although demand for credit was also weak. According to the Atlanta Fed's Small Business Survey (Atlanta Fed), southeastern small businesses—particularly younger firms—had a difficult time securing financing. Of the one-third of small businesses that sought loans in the third quarter, 39 percent of mature firms reported securing the full amount of requested financing. In comparison, just 25 percent of young firms received the entire amount.