2015-05-29 08:31:51
Karen Mills
May 27, 2015
Americans have long believed in the importance of entrepreneurs to the health
of our economy. We see ourselves as risk-takers and innovators. Today more than
ever, the entrepreneur is celebrated, failure is accepted as a cost of doing
business, and starting your own company is seen as a path to achieving the
American Dream. Although it s difficult to measure directly, entrepreneurship
is understood to be a way to a middle class life. In an economy where
traditional manufacturing jobs have gone offshore, and globalization and
technology have put pressure on U.S. wages, small businesses may be an even
more critical pathway than ever to mobility and opportunity not just for the
business owner, but also for those who fill the jobs that business creates.
Americans understand this, but do their economic policymakers?
Even in this era of political gridlock there is agreement in Congress that
entrepreneurs need support. And mayors and governors are experimenting widely
at the state level and in cities and towns. But the economic toolbox that works
for big companies isn t the same one that works for small ones. If policymakers
hope to be successful in their efforts to promote entrepreneurs and small
businesses, they need to know what works in short, they need a Playbook for
small business job creation.
Shift the focus to include small companies
In the past, economic development has prioritized big businesses. That s why
states continue to compete to lure companies to build new offices and plants
like the Tesla gigafactory in Nevada by offering tax breaks and multi-billion
dollar incentive packages. But these economic development strategies focused on
big businesses, sometimes known as elephant hunting, may overstate the
importance of large firms.
Half the people who work in this country either own or are employed by
businesses with fewer than 500 employees. And these smaller firms create two
out of every three net new jobs. It is sometimes more effective for a region to
grow its small businesses than to get caught up in a bidding war for elephants
a process that too often helps only the elephant.
Like big companies, small businesses do love tax breaks, and reductions in red
tape. But these things are not enough. An effective policy strategy for small
businesses needs to focus on the unique needs these companies have.
Three things small businesses need
Despite the lack of comprehensive national strategy toward entrepreneurs, new
programs are gaining traction at the federal, state, and local levels across
the country. A Massachusetts economic growth bill passed last fall with over
two dozen investments targeted at entrepreneurs and small business owners. Over
the last six years the federal government funded more than 50 new regional
innovation clusters, and across America new accelerators and entrepreneurship
boot camps are proliferating.
In fact, we know a lot about what works from observing this recent
experimentation. Two important themes have emerged: First, the programs that
work well to help entrepreneurs and small business owners tend to involve
partnerships between many players. Business, government, research universities
and community colleges all need to be involved, as well as the entrepreneurs
themselves. There is no one large anchor company with whom to make the deal, so
new institutions for collaboration such as NorTech in Northern Ohio or Ben
Franklin Institute in Pennsylvania have become important intermediaries. And it
is interesting to note that how effectively these new partnerships function
seems to be critical to the success of the region.
Second, there is no one-size-fits-all package to help small businesses,
precisely because each of the different types of small businesses has different
needs. The Main Street business owner needs a different kind of capital from
the high-tech entrepreneur. For each city or region the right mix of programs
depends on what outcomes the leadership of that area is trying to achieve.
Hence the development of the Playbook, an array of new approaches that can be
tailored to meet the specific situation.
The Playbook is a policy menu, based around three core needs of small
businesses: access to capital; people and skills; and innovation ecosystems. By
picking appropriate policies from each major area, some mayors, governors, and
even the federal government, are creating successful models for shaping policy
agendas to drive entrepreneurship and small business growth.
How policymakers can create small business jobs
Access to capital
SBA loans
Angel funds and tax credits
Seed investment funds
Communinty reinvestment
Business plan competitions
People and skills
Entrepreneurship education (mentoring, classes, online education)
STEM education
Address 'middle skills' with partnerships between business and community
colleges
Ecosystems
Manufacturing institutes
Research / commercialization grants
Cluster initiatives
Incubators and accelerators
Innovation districts
Main street associations
Access to capital
Entrepreneurs and small business owners need to access capital to start and to
grow. The type of capital required and its source depends on the type of
business, its stage of life, and its strategy for the future. A Main Street
small business might require a term loan from a bank to buy a piece of
equipment. A supplier might need a working capital loan to finance a big order.
A start-up might need an angel investor who believes in the project to provide
initial equity.
The types of capital generally split into two areas: Debt and Equity.
Sources of small business capital
Marker driven
banks, finance companies
online lenders (Ondeck, Lending club)
credit cards
venture capital funds
angel networks
friends and family
Philanthropy and goverment subsidies
community reinvestment act
community development financial institutions
loan guarantees
small business investment companies (SBIC)
state seed and equity funds
business plan competitions
For debt, the traditional source is bank debt, though recently there had been a
rapid influx of new online lenders (such as the recently public Lending Club
and OnDeck Capital) that provide new, though sometimes costly alternative
products. There also have been innovative new entrants in accounts receivable
lending such as Fundbox and C2FO.
In some areas and sectors, the market provides all the capital needed. But even
with the economic momentum we ve seen recently, gaps in certain areas still
persist. That is where government can often play a critical role. For example,
the market for bank credit for small businesses has been tight, particularly
for loans under $150,000. For the government to help make more debt available,
the most powerful policy tool is loan guarantees. Providing a guarantee verses
a direct loan has a number of advantages. First, there is someone else in the
picture, most often a bank, which also has a stake in having a positive
outcome. This second voice, often from the private sector, can be a critical to
reduce losses. Second, the actual cost of a guarantee is only the cost of the
losses, giving these kinds of programs the ability to deploy large volumes of
capital. In the case of the more than $30 billion in loans the Small Business
Administration (SBA) guaranteed in years following the recession, the loss
rates and cost were projected to be under 5% of the actual capital deployed,
and those projections are currently holding true.
The gap in equity capital is even more extensive and exists in most regions of
the U.S. In fact over 70% of venture capital funding currently goes to
companies in only three states: California, Massachusetts, and New York. To
offset this, policymakers can offer tax credits to angel investors, create
state-funded venture capital funds, or employ hybrid structures such as the
federal Small Business Investment Company (SBIC), where private investors use
their funds augmented by government guaranteed funding to increase the level of
growth capital invested in promising companies in the region. Accelerators and
business plan competitions with funding for the winners have also helped fill
the significant gap in early stage funds.
People and skills
Having the right people with the right skills is just as important to small
businesses as having access to capital. But here again, the market does not
always work perfectly on its own. Recent work by Joe Fuller at Harvard Business
School shows a significant gap in middle skills, those that require more
training than a high school diploma but less than a college degree. This
research shows that the market for middle skills operates very poorly. There is
little planning and almost no communication between the relevant parties.
Businesses expect a just-in-time solution to their work force needs they
post a job and expect a worker to show up immediately with exactly the right
skills.
In reality, no part of the labor market can work well without accurate
information about the current and future need for skills. Businesses have to
plan their workforce needs ahead of time; community colleges need to know what
training to offer; and young people need to know what career paths will be open
to them if they enter different academic programs.
Better incentives are needed to get businesses, community colleges, local
workforce boards, and others to collaborate and share information. In
Cleveland, the NorTech initiative has had success working with Lorain County
Community College to increase skills training needed in the workforce to match
up with jobs in the flexible electronics businesses growing in their area.
Vermont has done the same with farmers to support their Farm to Plate growth
plans.
Policymakers should also work to foster entrepreneurial skills. Research has
shown that small business owners have more success if they have some counseling
or mentorship. Many business owners have no formal business training and are
hungry for the basics so they don t have to reinvent the wheel themselves.
Programs from the Kauffman Foundation s FastTrac to Goldman Sachs 10,000 Small
Businesses are working to address this issue while the SBA already counsels
over 1 million small businesses a year through its large network of Small
Business Development Centers, Women s and Veterans Business Centers and SCORE
volunteers.
Ecosystems for innovation and entrepreneurship support
Finally, governments can help create innovation ecosystems that build on a
given region s entrepreneurial strengths. This idea may sound vague, but it is
rooted in a long line of research on the economic benefits of geographic
clusters. Silicon Valley has shown the benefit of clustering entrepreneurs
around innovative companies and research universities. These ecosystems start
organically but often benefit from additional support to grow. (It is always
better to build on assets that exist, rather than to try to create an
innovation center from scratch.)
Clusters have gained credibility as a policy tool in the last decade since work
by Mercedes Delgado, Michael Porter, and Scott Stern showed that strong
clusters drove better economic performance. In the last six years the federal
government funded 56 cluster initiatives in areas from green energy to defense
contracting. The best cluster initiatives are well-led organizations with a
strategy to help small businesses get the things they need to grow. This might
be a national marketing campaign, as in the efforts of the Oregon Wine Cluster,
or innovation in composite technology for Maine s boat builders.
Federally-funded Manufacturing Institutes are also a new model of building
ecosystems, where universities and businesses collaborate to develop promising
innovations in advanced manufacturing. The first such institute, split between
Youngstown, Ohio, and Pittsburgh, focuses on additive manufacturing. The
recently passed provisions of the Revitalizing America s Manufacturing and
Innovation Act (RAMI) funded up to 15 more.
A third promising policy area is the emergence of accelerators. These new
institutions take entrepreneurs with budding business ideas and give them the
time, space, and mentorship to build their businesses. The multi-week programs
usually end in Demo Days or other opportunities for entrepreneurs to present
to potential funders. Shared work spaces and other entrepreneurship communities
and incubators, such as 1776 in Washington, D.C., the Capital Factory in
Austin, and 1871 in Chicago (named for the year of the Great Chicago Fire),
provide another way to create a vibrant locus of startup activity in a region.
In June 2014, almost 800 accelerators from across the country competed for $2.5
million of federal grants, which were eventually awarded to 50 winners from 31
states, indicating that very small funding can motivate intense interest in
this sector.
Finding a way forward
Not everyone believes in an active policy agenda for entrepreneurs and small
business owners. Many think that the right formula is just to leave small
business owners alone, and that cutting taxes and reducing regulation will be
enough to create a favorable environment. Others are concerned that if
government gets involved it will pick winners and losers, or put a thumb on
the scale, giving some small businesses an unfair advantage over others,
rather than allowing the market to work.
There are two problems with these arguments. First, the use of competitive
processes reduces the likelihood that government funding might be subject to
favoritism. Second, market failures are all too common, and so certain segments
of the small business community are chronically underserved. For example,
women- and minority-owned firms have greater challenges in accessing growth
capital, but tend to over-perform when capital is available. Government s role
is to step in when these failures occur and provide access and opportunity so
that all of America s entrepreneurs have a chance to succeed and contribute to
economic growth.
Today, the American middle class is being squeezed. The benefits of economic
growth are going to a small group at the top. New business creation is down.
Globalization will continue to exert pressure on workers. In such an
environment, good policies to further entrepreneurs and small businesses are
more needed than ever. The interest in such an agenda is there; what s most
often missing is a clear recipe that both works and that can be adapted to
local conditions. This Playbook is an attempt to fill that gap.
Entrepreneurship is America s secret sauce. With the right tools, we have the
chance mayors, governors, national leaders and even the business community
to set the playing field for entrepreneurs so they can do what they do best:
grow their companies and create jobs.
Karen Mills is a senior fellow with Harvard Business School and Harvard Kennedy
School focused on competitiveness, entrepreneurship and innovation. She was a
member of President Obama s Cabinet, serving as Administrator of the U.S. Small
Business Administration from 2009 to 2013.