Rise in start-ups draws doubters

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The Wall Street Journal
By: Sarah E. Needleman
February 2, 2012

Rise in start-ups draws doubters

Did U.S. entrepreneurship grow last year?

A report released last month suggests there's been a major resurgence in the number of start-ups operating nationwide. But some skeptics say that the study fails to take into account the potentially significant numbers of small businesses that shuttered last year.

According to the Global Entrepreneurship Monitor, 12.3% of the U.S. population was actively engaged in starting or running a new business in 2011, a staggering 60% increase from 2010.

The annual report defines new businesses as ventures less than three-and-a-half years old.

An increase in start-up activity is a good sign for the overall national economy because it will lead to more employment opportunities in the near future, says Donna Kelley, the report's lead author and an associate professor of entrepreneurship at Babson College in Wellesley, Mass. "It's indicating that we're seeing a recovery," she says.

The report, based on a combination of survey results and population data, shows that more than half of U.S. early-stage entrepreneurs--59%--expect to create up to four jobs within the next five years. Another 27% plan to create between five and 19 jobs and 14% plan to create 20 or more jobs during that period.

Some critics argue, however, that the GEM report doesn't paint a complete picture of the nation's entrepreneurial landscape. Though it does note that 4.4% of U.S. survey respondents closed businesses within the past year, data from the Bureau of Labor Statistics tell another story.

The government agency reports that the total number of self-employed Americans with incorporated and nonincorporated businesses declined 2% last year. As a result, the number of small businesses shuttered also must have risen last year, says Scott Shane, a professor of entrepreneurial studies and economics at Case Western Reserve University's Weatherhead School of Management.

Using a bathtub as an analogy, he says: "If the level of water is going down, the amount flowing out has to be greater than the amount flowing in."

To be sure, just because a business closes doesn't necessarily mean it failed and that another person is collecting unemployment. The former owner could've decided to retire or even go work for someone else. "But every business closure eliminates the jobs of the people who worked there," says Mr. Shane.

John Haltiwanger, an economist at the University of Maryland, says he's skeptical of the GEM report given that it claims such a dramatic boost in start-up activity. "Last year would've been a much more robust year in employment growth and we didn't see that," he says. "It was a pretty anemic year."

But Ms. Kelley offers a possible explanation for the surge in U.S. entrepreneurship identified by the study. She says start-up rates declined in 2010 and 2009, so last year entrepreneurs were essentially making up for lost ground. "It's very likely people were delaying starting businesses during the recession due to the fact that conditions weren't favorable for entrepreneurs," she says. "People that did start businesses during the recession were more likely to start out of necessity because they had no other sources of income."

Another factor: many newly launched businesses won't survive for very long. On average, 20% of start-ups fail within their first year, according to the Ewing Marion Kauffman Foundation, which also conducts an annual study on entrepreneurial activity in the U.S. Its newest report, due out next month, is expected to show that start-up volume in the U.S. increased by just a few percentage points in 2011, just as it did in 2010, 2009 and 2008, says E.J. Reedy, a research fellow for Kauffman, a nonprofit in Kansas City, Mo.

Still, he notes that last year's report indicated that U.S. entrepreneurship in 2010 reached its highest level in more than a decade. He reasons that this happened because many people saw new businesses opportunities resulting from the recession. For example, he says reduced commercial property rates may have prompted the launch of new retail shops and restaurants. Many people also likely started businesses in 2010 because they got laid off or their work hours or pay got scaled back. However, the latter types of businesses typically lack full-time employees, he adds.

Kauffman bases its entrepreneurial activity index on a monthly population survey jointly sponsored by the Census Bureau and Bureau of Labor Statistics. It focuses on the rate of business creation at the individual owner level.

The GEM is a nonprofit consortium that was initiated in 1999 as a partnership between Babson College and London Business School. Today it consists of more than 85 research teams from around the globe. The 2011 GEM report is based on a survey of 140,000 adults in 54 economies, including 6,000 just in the U.S. Researchers looked at responses from a random sampling of participants, as well as population data for each of the countries represented, to draw conclusions about entrepreneurial activity in those nations. The 2010 GEM report was based on a survey of 175,000 adults in 59 economies, including 4,000 in the U.S.

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