Innovation Blog

Birth and Death Among  Startups, and the Rise of Necessity Entrepreneurs

By Shlomo Maital

  There is controversy over whether the tendency of Israeli startup companies to ‘exit’, by being acquired by foreign companies, is good or bad for Israel.  in the past three years, there has been  a constant crop of such exits, about 85 a year, though their peak value  ($10 b. in 2006) has declined sharply by some 75 per cent.   Clearly, it would be better for Israel if those acquired companies could be scaled up to global size, creating jobs, income, wealth and exports for Israelis.  But even entrepreneurs who want to achieve such scale, rather than take home a very large check, face formidable obstacles, in manpower and finance. 

  I believe that a bigger problem than ‘exit’ is ‘death’.  There are many unobserved funerals.  Of Israel’s some 3,000 startups, many are quietly closed each year.  Perhaps the spotlight should be focused more on “what can be done to increase survival rates and reduce morbidity?” than on “what can be done to reduce exits?”.        

       What can be learned from American data?  According to a study by Moya K. Mason, “Research on Small Businesses”  [http://www.moyak.com/papers/small-business-statistics.html ],  U.S.  Census data show there were 5.7 m. US firms with employees, and 17.0 m. without employees (i.e. sole proprietor) in 2001.   Small firms with less than 500 employees account for 99.7 per cent of the 23.7 m. American businesses in total.  Hence, the small business sector in the U.S. is hugely important. 

    For businesses with employees (as noted, about 5.7 m.),  there were 572,900 new firms born in 2003, and 554,800 firms that closed that year.  The vast majority of those were ‘small’. So, each year, roughly 10 percent of small businesses die, and the same number are born.   This process is healthy and important.  It is part of what Joseph Schumpeter called ‘creative destruction’ and what Peter Drucker called “innovation and abandonment”. 

     Mason reports, “2/3 of new employer firms (i.e. firms with employees) survive at least two years, and half survive at least four”.  About a third of firms that closed said their firm was successful at closure.  That implies that the firm was likely acquired and merged into a larger firm.  [1]   

   In America, such ‘exits’ leave their IP, assets and added value in the U.S., since the vast majority of them are acquisitions by other US firms.  So an ‘exit’ in the US has different economic implications than an exit in Israel.    

    Worldwide, a massive study known as GEM Global Entrpreneurship Monitor finds “there are about 300 m. persons trying to start about 150 m. businesses” in the GEM countries, whose population totals 4 billion, roughly two thirds the total world population.  A third of the businesses people try to launch are actually launched, or 50 m., each year,  about 137,000 every single day.  About an equal number of active firms terminate (die)– 50 m. a year.  

    Massive medical research is underway to find cures for disease.  I wonder why similar research is not undertaken to discover why 50 m. businesses ‘die’ yearly, and to discover remedies.  Some may deserve to fold — but many may not. 

    The GEM study shows that one of the most basic motives for starting a business is “necessity entrepreneurs” — those who cannot find suitable work and start a business to survive.  Necessity entrepreneurship seems to be growing worldwide in the wake of the global economic crisis.  It is one of the few positive effects of the crisis.

[1]  Mason cites a study by Brian Headd, U.S. Bureau of the Census, Business Success: Factors Leading to Surviving and Closing Successfully,  working Paper #CES-WP-01-01, Jan. 2001).