The Wall Street Journal
By: Justin Lahart & Mark Whitehouse
November 19, 2010
Fewer new businesses are getting off the ground in the U.S., available data suggest, a development that could cloud the prospects for job growth and innovation.
In the early months of the economic recovery, start-ups of job-creating companies have failed to keep pace with closings, and even those concerns that do get launched are hiring less than in the past. The number of companies with at least one employee fell by 100,000, or 2%, in the year that ended March 31, the Labor Department reported Thursday.
That was the second worst performance in 18 years, the worst being the 3.4% drop in the previous year.
Newly opened companies created a seasonally adjusted total of 2.6 million jobs in the three quarters ended in March, 15% less than in the first three quarters of the last recovery, when investors and entrepreneurs were still digging their way out of the Internet bust.
Research shows that new businesses are the most important source of jobs and a key driver of the innovation and productivity gains that raise long-term living standards. Without them there would be no net job growth at all, say economists John Haltiwanger of the University of Maryland and Ron Jarmin and Javier Miranda of the Census Bureau.
"Historically, it's the young, small businesses that take off that add lots of jobs," says Mr. Haltiwanger. "That process isn't working very well now."
Ensconced in a strip mall behind a Carpeteria outlet, Derek Smith has been tinkering for two years with a wireless electrical system that he says can help schools and office buildings slash lighting bills. With his financing limited to what he earns as a wireless-technology consultant, he has yet to hire his first employee.
This is a far cry from his last start-up, which he cofounded in 2002. At the two-year mark, that company, which makes radio-tracking gear for hospital equipment, had five employees, about $1 million in funding from angel investors and offices with views of downtown San Diego.
"When I started this the plan was to go out and raise a bunch of money," says Mr. Smith, who is 36 years old. That was in late 2008, just as financial markets around the world collapsed. "I quickly discovered I can't do what I did before."
Tough economic times have pushed more Americans into business for themselves, working as consultants or selling wares online. But many are not taking the additional step of forming a company and hiring employees.
For people like Mr. Smith, lack of funding seems to be the biggest problem. Two traditional sources of start-up cash--home-equity loans and credit cards--have largely dried up as banks wrangle with massive defaults and a moribund housing market. Venture-capital firms that typically invest in young companies, as well as angel investors that focus on early-stage start-ups, are pulling back as they struggle to sell the companies they already own.
Venture-capital firms invested $25.1 billion in the year that ended in September, up 10% from the same period a year earlier but still down 27% from two years earlier, according to Dow Jones VentureSource. Angel investment amounted to $8.5 billion in the 2010 first half--30% below the average level in the five years leading up to the financial crisis, estimates Jeffrey Sohl, director of the Center for Venture Research at the University of New Hampshire.
"I've never seen seed capital so low," says Mr. Sohl. "This is alarming."
Some entrepreneurs say it's not all about financing, though. They express concern about taxes, health-care costs and the impact that wrangling in Washington over the federal budget deficit will have on them. "I can't determine what the cost of providing health care for employees would be," says Kevin Berman, 47, who is starting a local-produce company in Orion Township, Mich., called Harvest Michigan. Starting a company "is harder than it was at any time I can remember."
San Diego has long been one of the nation's entrepreneurial hotbeds, a culture that dates back to the 1960s with the founding of Linkabit Corp., a communications company whose alumni have launched scores of technology companies. A 1970s biotechnology start-up, Hybritech Inc., gave rise to a thriving biotechnology industry.
Lately, though, the pace of start-ups securing funding in San Diego has been slowed at the University of California at San Diego center that helps researchers move their work into the commercial sphere. "Investors are moving away from early-stage companies," says Rosibel Ochoa, director of the William J. von Liebig Center. "Nobody wants to touch them."
Scarce funding is putting researchers like Deli Wang in a bind. The 42-year-old engineering professor is an expert on nanowires, thread-like structures with widths less than a thousandth the diameter of an average human hair. He has a plan to make light-emitting diodes using nanowires that, he says, would be far more efficient than existing alternatives. Investors, he says, are interested--if they can see a prototype. Building one would cost Mr. Wang $200,000 that he doesn't have. "We're kind of stuck," he says.
To be sure, some companies are still getting started, particularly in biotechnology, where cash-rich pharmaceutical concerns are eager buyers and investors. In the first half of 2010, health care and biotech accounted for 44% of all angel investments, Mr. Sohl says.
And in many cases, entrepreneurs today don't need as much money, or as many people, to start new businesses. Software, communications technology and high-tech equipment are far cheaper and far more powerful than they were a decade ago.
At Mr. Smith's one-man San Diego start-up, Tesla Controls Corp., circuit boards, semiconductor chips and other components litter a plastic folding table he uses as a workbench. "The hardware stuff is all cheaper," he says. "Any of these chips are $5 or less."
Much of Mr. Smith's economizing is the result of necessity. With a family to support, he doesn't want to borrow against his house. Angel investors, if interested, would demand a larger stake at a lower price than he can stomach. And the small stake he still has in his earlier start-up, Awarepoint Corp., is only paper wealth.
The lack of funding is slowing him down. And the day a week he spends on consulting takes away from the time that he can devote to his new company. "I would love to be able to hire other people," he says. "But right now I can't."
Write to Justin Lahart at firstname.lastname@example.org and Mark Whitehouse at email@example.com