A new report on the state of entrepreneurship out of the Brookings Institute, and dissected by data-fiend blog FiveThirtyEight, seems to depart from the observable reality on the ground in places like Silicon Valley, New York, and Los Angeles. The primary conclusion of this report, that entrepreneurial activity has declined significantly over the last several decades, simply doesn’t jibe with reality. The other takeaway, that rising failure rates for early stage businesses are a red flag, simply misunderstands the fundamental changes in the way companies are being built today.
By a wide range of measures, the advantages of incumbency in corporate America have never been greater. “The business sector of the United States,” economists Ian Hathaway and Robert Litan wrote in a recent Brookings Institution paper, “appears to be getting ‘old and fat’” …
But recent research suggests that established businesses have less and less to fear from would-be disruptors. This is partly because, as I noted this spring, fewer Americans are launching businesses. In the late 1970s, according to data from the Census Bureau, 15 percent of all U.S. businesses were startups, meaning they had been founded in the past year. In 2011, the latest data available, the so-called startup rate had fallen to 8 percent. In the late 1970s, according to data from the Census Bureau, 15 percent of all U.S. businesses were startups, meaning they had been founded in the past year. In 2011, the latest data available, the so-called startup rate had fallen to 8 percent.
Lost in this broad-reaching statement is the fact that not all new businesses are created equal. Without a doubt, the vast majority of businesses started in the 70s, 80s, and even 90s were the furthest thing from tech startups – the kind of high-growth, venture capital-worthy companies that have the greatest potential to disrupt major industries. Rather, they were the kind of local, mom-and-pop businesses – restaurants, corner stores, and service businesses – that grow slowly and only rarely challenge the established giants in their industry. To lump these businesses in with technology-driven startups is the worst kind of apples and oranges comparison.
Ask any venture capitalist or active angel investor whether the rate of startup formation has slowed recently and you’re likely to get a quizzical response. If anything, that rate of viable young companies has expanded significantly in the last several years thanks to concepts like the lean startup methodology, accelerator programs, and infrastructure changes that reduce the barriers to building a startup – but maybe viable is the key word.
When it comes to the increased rates of failure, that may be more a reflection of the different way that entrepreneurs and investors are approaching company-building in the current era. No longer must companies raise millions in capital off the bat and build infrastructure before testing a product idea in the market. With this lower cost basis and lower barrier to entry, many more marginal or unproven ideas get to see the light of day, albeit in a nascent form.The basic idea in these cases seems to be, “Throw something out there and see how the market responds, then adjust or pivot as necessary until achieving product market fit.”
Sure it means a higher rate of failure, on an absolute basis, but the majority of these failures raise only nominal amounts of capital and never grow beyond a handful of employees. In a sense, these business are more like R&D experiments than companies. The Silicon Valley mentality, which has now permeated other geographic markets like LA, New York, and Boston, teaches investors and entrepreneurs to view these failures in a neutral or even positive light, as learning experiences that often lead to subsequent successful ventures.
Brookings and FiveThirtyEight also focus on the declining number of businesses that make it beyond ten years as a sign of an unhealthy entrepreneurial market. A big reason for this phenomenon is consolidation at the top of the food chain. But this doesn’t make the early sellers failures. Technology-powered businesses today can reach scale and obtain enormous valuations in far less than ten year’s time. So when Yammer sells to Microsoft for $1.2 billion after just four years, or Instagram sells to Facebook for $1 billion after just two years, these are hardly failures.
These exits do mean that the giants of the technology industry, with their massive balance sheets, have been able to stay relevant and dominant through acquiring up and coming challengers. But for incumbents outside of tech – brick and mortar retailers, print publishers, and the music industry come to mind – disruption at the hands of upstart businesses remains a very sobering reality. If anything, success in technology-centric industries has grown more binary as global connectivity continues to shrink the world and make regional success stories more and more rare. But again, this doesn’t mean that entrepreneurs aren’t starting and growing many “successful” companies or disrupting legacy market leaders.
FiveThirtyEight rules out the impacts of an aging population on what Brookings describes as a decline in entrepreneurship. On the other hand, the report raises questions about the stifling effects of changing regulations and the ability for non-tech companies to bring innovation in-house. Sure both phenomena are real, but neither has choked off startup innovation in the way that that FiveThirtyEight seems to suggest.
I don’t mean to question the accuracy or reliability of Brookings data – the think tank has certainly proved itself trustworthy and capable in the past. But there is more to understanding changes in a market than looking at raw numbers and, in this case, Brookings seems to miss many of these nuances. As anyone who spends their days deeply embedded in the startup ecosystem can attest, entrepreneurship is very much alive and well in this country.