Everybody wants to be an entrepreneur. The myth of footloose 25-year-olds changing the world while incidentally becoming deliriously rich has intoxicated a generation. And governments are eagerly handing out tax breaks to help them get started. After all, those new companies are engines of economic growth and job creation, right?
Well, maybe, says Stanford Graduate School of Business professor George Foster. He suggests that policymakers and would-be tycoons alike could do with a sobering belt of reality. In a new multi-country study, he finds that most startups never take off — and among those that do, setbacks destroy a sizable share of the employment and revenue gains in the sector.
“Most of the stories you hear about startups have a very glossy ring,” Foster says. “They talk about all the new jobs created and all these great experiences. It’s always this hockey-stick graph of continuous growth and happily-ever-after. My experience with early-stage companies — and what I’ve heard from all the many entrepreneurs that visit Stanford — is that there’s a lot of carnage, and even the most successful CEOs have a roller-coaster existence. So I wanted to do a systematic study and see what’s really going on.”
Foster and his collaborators gathered data on more than 158,000 startups worldwide, tracking each company for five years. What they found is that while some young firms enjoy significant revenue and job growth, those gains are substantially offset by losses in other firms. Among companies in their fifth year, for example, total job destruction — declines in headcount among retrenching companies — amounted to 65% of all the new jobs created in that year.
And that estimate on the debit side of the ledger probably understates the bloodshed. It doesn’t count jobs lost in startups that went belly-up or jobs cannibalized when startups take market share from incumbent firms, what economist Joseph Schumpeter called “creative destruction.”
The upshot, Foster says, is that the economic contribution of the early-stage sector, particularly in terms of employment, is much smaller than commonly assumed. “Politicians keep talking about gross job creation. When I say that net job creation is a better measure, they either look at me with a blank stare or they don’t want to hear it.”
They need to hear it though, because these findings point to a different policy approach, focused not on increasing the number of startups (which may result in companies being founded that never should have been) but on improving their success rate. “To me, one of the big messages is that public policy needs to be more oriented to sustain the scaling of ventures,” Foster says.
That hockey-stick world is a fantasy. The reality for most startups is a lot of jarring ups and downs, more like a high-speed game of snakes and ladders. – George Foster
Indeed, the numbers show that revenue and job destruction rise as companies age from three to five years, suggesting that promising businesses often have trouble making the transition out of startup mode. “If you’ve gone to 200 or 300 employees in a few years, you’re probably stretching the limits of management systems and executive mindshare,” Foster says. “If you don’t get a scalable infrastructure in place, you can get derailed and plummet very, very fast.”
But then, most entrepreneurs would love to have the problem of managing growth. Among five-year-old firms, the top-performing 10% provide roughly 80% of gross revenue and job creation, the study shows. An even smaller percentage account for most of the declines — because, as Foster points out, you can only lose ground if you’ve previously gained ground. “The majority of startups start small and stay small, so there’s nothing to destroy.”