Is capital abandoning the entrepreneur as well?

Where small firms have suffered low rates of business formation, lukewarm employment growth, and near stagnant growth in employee wages, is there public policy that can reignite entrepreneurship?

Politicians on the left and right have been touting the virtues of small businesses as “job creators for the past four election cycles during which time the United States has been trying to dig itself out of the 2007 recession.  According to the Small Business and Enterprise Council, 99.9% of all U.S. businesses had fewer than 500 employees and firms with less than 20 workers made up 98% of all U.S. businesses.  In 2008, small businesses accounted for 46% of America’s gross domestic product, down from 48% in 2002.

And out of the 100 friends you may have, roughly 18% of them are likely employed by a firm that employs less than 20 people.  Out of those same 100 friends, 35 of them probably work for a firm hiring fewer than 100 employees.

But small businesses have been on the decline, not living up to the narrative politicians and policymakers have painted around them.  According to a report by Goldman Sachs, during the period 2007 to 2012, 600,000 small businesses and 6 million jobs associated with them have disappeared.  In addition, job growth, usually attributed to small businesses, has been sourced by big companies, along with increased revenues and wage growth.  While job growth averaged 42,000 a month between 2010 and 2012 for companies with more than 500 employees, small firms saw employee losses of 700 per month during the same time period.  Income growth has been near stagnant for small companies as well.

So what’s to blame for this change in small business fortune?  Goldman Sachs argues that part of the fault lies in new bank regulation.  New bank regulations have made business credit scarce and more expensive.  Banks find it less cost effective to finance smaller businesses and small businesses don’t have ready access to the less expensive public capital markets as their large business competitors do.

This reality check on capital availability for the entrepreneur has me asking if capital is abandoning the entrepreneur?  If banks are tightening lending to small businesses and the decline in small businesses is occuring at he same as the decline in lending, are there then any alternative capital markets that small businesses can turn to?

According to a report from Oliver Wyman, a consulting firm, government can use public policy tools to create an environment that offers alternative capital market mechanisms for flowing capital to small businesses.  For example, with the decline in the number of initial public offerings entered into by small and medium business enterprises, government sponsored clearinghouses can provide investors transparency regarding equity and debt issued by small business enterprises and tax incentives for investors holding publicly-traded shares in small business.  Government can also provide education to small business enterprises on the environment for issuing debt or equity.

Other benefits that government could provide include reducing capital gains taxes for investors who hold debt or equity issued by a small business enterprise and reducing the costs of regulatory compliance faced by small business enterprises that seek the efficiencies provided in capital markets that financial markets don’t provide.

Encouraging greater access to capital markets by small businesses provides benefits to businesses and investors.  The capital markets are more efficient than banks.  Capital markets distribute risks more efficiently and promote economic stability that results from immediate feedback that the markets provide to investors and businesses alike. By encouraging the use of capital markets, especially by reducing the costs to access the markets, government can make it easier for a business to access additional pools of funding.

About Alton Drew

Alton Drew brings a straight forward and insightful brand of political market intelligence. Alton Drew graduated from the Florida State University with a Bachelor of Science in economics and political science (1984); a Master of Public Administration (1993); and a Juris Doctor (1999). You can also follow Alton Drew on Twitter @altondrew.
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One Response to Is capital abandoning the entrepreneur as well?

  1. kenski2013 says:

    After all the risky investment behavior by big banks and Wall Street prior to the great recession, regulations have been tightened, apparently. However, I think some of this is an overreaction by the banks who previously got “stung”, and also a straw man argument from banks and investment houses who want the government to loosen regulations again so they can try some risky investing, which has little to do with small business capitalization.

    There’s no question that starting a business is a risk, since many small businesses fail.
    A small business with a good business plan should be given credit. Perhaps banks and capital markets need a review board like the entrepreneurs on “Shark Tank” to try to figure out which businesses have the best chance of making it. I suspect bankers really know very little about small business, but the “Shark Tank” entrepreneurs seem to have a handle on that.

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