Startup Myth Busters
By: Ken Kousky, BlueWater Angels and Krista Tuomi, American University
Federal and state governments are beginning to recognize the important role that startups play in job creation. (A recent article by Neumark, Wall, and Zhang notes that they account for almost 20 percent of gross job creation.) For these startups, early stage financing is increasingly necessary given the shortened product life cycle – businesses can only succeed by moving rapidly from ideas to product distribution. Banks do not provide this type of funding; family and friends rarely have enough; and the public stock market is only an option for established firms. The 2014 Joint Small Business Credit Survey Report emphasizes this. In particular, it finds that the majority of small firms (under $1 million in annual revenues) and startups (under 5 years in business) are unable to secure any credit. (The average approval rate from all sources was only 38%). Not surprisingly, lack of credit availability was the top listed challenge for startups in 2014.
The remaining lifeline for many of these firms is angel investment, which offers appropriate quantities, requisite mentorship, and is the best match for the high risk/return profile of start-ups. To be effective however, angel investors need a supportive legislative environment. This in turn requires that reports and articles in the media reflect the true state of play in the angel and venture capital worlds. Unfortunately, sometimes they do the exact opposite.
One of the problems is the confusion as to the definition of venture capital (VC). What many call VC falls more in the realm of private equity, especially where a company has a market cap over $1B or is over five years old. This is where the recently reported “surge” in venture has gone. The growing IPO market has created a gap where large institutional investors provide late stage financing for companies queued for public listing. For small startups, however, actual venture funds remain at disappointing levels. According to the PwC-NVCA MoneyTree report, only $1B of the total $48B VCs invested in 2014 was in the startup/seed round.
Creating a false sense of abundance in “venture” capital can jeopardize attempts to ease the regulatory environment for Angels. The confusion over startup growth adds to this. A number of news sources have reported on the US Census Business Dynamics Data, which shows that the growth of businesses with 1-4 people “small business” has “correlated with population growth”, leading Nasdaq’s Small Business Redux to note that, “there is no indication that small business needs special attention of politicians”. Many read this to mean that start-ups are doing fine. Unfortunately they are not. Start-ups are not equivalent to small businesses, as small businesses include many long time “mom and pop” firms.
The health of actual startups is actually quite dire. In a recent Brookings Institution report Litan and Hathaway found a long term decline over the last few decades, with a steep drop since 2006. Part of this can be attributed to the recession of 2007-2009, but there is little evidence of an improvement since then, with business deaths exceeding births in 2011 for the first time in the “thirty-plus-year history of our data.” (Litan and Hathaway, 2014) This obviously has effects on employment. Startup employment grew significantly less post 2009, especially compared with the recovery from the deep downturn of 1981–82. For example, Laderman and Laduc from the Federal Reserve of San Francisco show that between March 2010 and March 2011, lower employment growth at start-ups may have subtracted as much as 0.7% from total job growth, or roughly 760,000 fewer jobs (Laderman and Laduc, 2014).
Keeping perceptions aligned with reality is crucial to fostering a healthy start-up environment.
originally printed on ACA Angel Insights Blog