It’s hard to overestimate the delicacy of the challenge President Obama faces in his speech Thursday night to a joint session of Congress. He’ll have to convince Democrats that his job program won’t give away the farm to Republicans. He’ll have to convince Republicans that he’s not throwing good (borrowed) money after bad. Most of all, though, he has to win over the owners of small growth companies and convince employers that it’s safe to hire. It’s they—not he, not Congress--who have the power to reduce the unemployment rolls.
So, where does the President start? For years, the conventional wisdom has been that startups—companies less than a year old--are the drivers of job growth. Tim Kane, a senior fellow at the Kauffman Foundation, which researches entrepreneurship, put it memorably in a paper last year, “Startups are not everything when it comes to job growth. They are the only thing.” Another Kauffman report expands the job creation elite to enterprises up to five years old, but the message is pretty much the same: To fix unemployment, we should invest political capital and financial capital in new startups. The President seems to buy it: In his letter to Congress about his address, Obama said that his goal is “to continue to rebuild the American economy by strengthening small businesses.”
If only it were that simple. New Kauffman research, analyzed by my Fiscal Times colleague Yuval Rosenberg last week, points out that startups began tailing off as a creator of new jobs even before the Great Recession. And new research funded by the Edward Lowe Foundation suggests that the real sweet spot for job formation lies amid existing growth companies. The Lowe’s data, drawn from Dun and Bradstreet credit reports rather than U.S. government data, allows researchers to track both brand-new startups and expansions by existing businesses—such as new product lines or new geographical locations. Mark Lange, CEO of the foundation, which focuses on helping small-growth companies, says the data show that expanding, existing companies created 71% more new jobs than startups. “If we put all our eggs in the basket that says startups are the key to reviving our economy,” he says, “we miss a huge opportunity.”
According to the paper’s author, economist Don Wall, one problem with startups is that each one tends to account for fewer jobs (three on average, compared with 26 for an expansion by an existing company). So while startups outnumber expansions nine to one in a typical year, they account for only about 65 percent of new jobs created. On top of that, startup jobs tend to disappear faster. In the Dun & Bradstreet data, more than half of the startups founded between 1990 and 2004 had failed by 2009, while only one third of the expansions by existing businesses had gone under.
Young growth companies need different kinds of help from policymakers than startups. Many opportunities for expansion lie abroad, so established growth companies are much more likely to benefit from trade agreements and access to foreign markets than fresh startups. They also desperately need capital. Middle-market, or “stage- two,” growth companies—one-year- to five-years-old with 10 to 100 employees—have outgrown the founders’ ability to finance further expansion out of his or her own personal credit. This has traditionally been a key market for regional banks, but in the wake of the financial crisis, these institutions have little incentive to take the risk, says Douglas Tatum, professor of entrepreneurship at Middle Tennessee State University. “Bank officers have spent the past three years being criticized for everything they’ve done,” he says. “Even though they’re flush with cash, they’re not going to stick their neck out for anyone.”
Ideas for financing aid have been knocking around Washington for at least 10 years. The so-called Bridge Act would give growth companies with revenues below $10 million a tax deferral on profits that would have to be repaid with interest. The Kauffman Organization’s Startup Act includes ideas for a similar tax break on early-stage profits, as well as a tax break for capital investments in startups. Neither proposal appears in early glimpses of the President’s jobs proposal.
Financing or export help aside, the President could still make a lasting impact if he were to convince business owners and managers that they won’t be undercut by a second recession. Lack of confidence currently weighs heavily on hiring plans. When asked for their economic outlook in the most recent survey of the National Federation of Independent Businesses, pessimists outnumbered optimists by 15 percentage points. (Optimists held a 10 percent advantage as recently as January.) It’s no surprise that, seasonally adjusted, only two percent of business owners said they plan to hire.
Which brings us back to the challenge Obama faces Thursday night. His most important audience isn’t the millions watching on television or the 535 curmudgeons attending in person. And it isn’t solely the classic startup jockey who wants to start a consulting business or open a boutique. To have the biggest impact on hiring in this economy, he has to convince the owners of existing, growing businesses that it’s time to take their enterprise to the next stage. The President better bring his best stuff.