And my 2 cents about the high “failure rates” of new businesses, being a small-business owner myself.
By Wolf Richter for WOLF STREET.
New business formations, based on applications for an Employer Identification Number (EIN) with the IRS, exploded in June and July last year, then zigzagged up and down, and then this year exploded again and remained far above the historical range.
In September, 431,381 EIN applications were filed with the IRS, 49% above September 2019, and at the same red-hot level as September last year, according to data released by the Census Bureau today. For the first nine months of the year, EIN applications were up by 58% from the same period in 2019:
The historic high level of new business formations every month is part of the bizarre puzzle that this economy has become: The strange phenomenon of labor shortages, the enormous stimulus payments that went out, the federal unemployment payments that are now ending, the $800 billion in forgivable PPP loans that went to just about everyone last year and earlier this year, the 3.2 million people who still haven’t returned to the labor force….
Last year and earlier this year, there were suspicions that EIN applications were spiking because fraudsters were creating businesses to get their hands on these forgivable PPP loans. But an EIN wasn’t required for PPP loans. Businesses had to have been around for a while to qualify. And the PPP ended in May. Yet business applications have continued to be sky-high every month since then.
The Census Bureau removed from these EIN numbers those applications that were unrelated to typical business formations, such as for tax liens, estates, trusts, etc.
Most new businesses will create a job for the owner and maybe for a few other people and never become large employers. It can be very exciting and rewarding on many levels to own and run a small business. My WOLF STREET media mogul empire is one of them. Those types of small businesses pay other businesses or people on a contract basis, from accounting to IT work. But they don’t add many employees.
The potential job creators.
Using the information in the EIN application, the Census Bureau categorizes businesses with a high likelihood of creating a significant payroll as “High-Propensity of Planned Wages” business applications (HBA).
In September, there were 145,628 EIN applications by businesses that the Census Bureau deemed to be HBAs, up 31% from September 2019. In the first nine months of this year, there were 1.40 million of these business applications, up 41% from the same period in 2019:
The real potential job creators – with planned wages.
Within the HBAs, there are the “Business Applications with Planned Wages” (WBA) by businesses that have a planned date for their first payroll. They have funding, and they’re ready to pay wages. They’re most likely to grow their payroll and become significant employers.
In September, 51,617 WBAs were filed, up 30% from September 2019. In the first nine months of this year, 485,155 WBAs were filed, up 34% from the same period in 2019.
But they remain down by over 35% from before the Financial Crisis:
So how many new businesses with a low propensity to create jobs?
To get the number of applications for businesses with a “low propensity” to become significant job creators, I subtract the number of high-propensity applications from total EIN applications. These are the businesses that might only employ the owner and sometimes a few other people.
These types of business applications have risen for years, roughly doubling from 91,000 per month on average in 2007 to 183,000 per month on average in 2019, or 2.2 million for the whole year 2019! And they did so while the HBAs and WBAs fell over the same period. Then came the spike during the pandemic:
The huge number of these largely one-man shows and one-woman shows delineate a big shift in American society, with ever more people striking out on their own.
Much of that was made possible by the Internet which allowed these entrepreneurs to gain visibility, promote their goods and services, use convenient third-party platforms such as eBay and Amazon, and payment platforms such as PayPal and now many others, and engage in direct relationships with potential customers.
This was already a big trend when the pandemic hit with the flood of cash it unleashed that provided funding to strike out on their own, especially people who got laid off by their employer.
But applications by businesses with planned wages (WBAs) in September were back at levels where they’d been in late 2007 and far below where they’d been before the Financial Crisis.
Here are the three types of business applications: Low propensity to create jobs (red), high propensity to create jobs (purple), and with planned wages (green):
Retail is the biggie, thanks to the Internet and shift to ecommerce. When people think ecommerce, they think Amazon and other giants. But ecommerce has attracted millions of entrepreneurs, working out of their garages, condos, or farms, selling merchandise to customers around the country.
Even as brick-and-mortar retailers and malls have gotten battered, ecommerce entrepreneurs jumped into the game by the millions. And the pandemic accelerated that process.
In September, 73,884 businesses filed applications that listed the NAICS code (North American Industry Classification System) for retail trade businesses, up by 70% from September 2019. For the first nine month, these types of EIN applications nearly doubled from the same period in 2019 (red line below).
It is effectively businesses in the retail trade – think ecommerce out of the garage – that created the lion’s share of the surge in business applications:
The top seven industries, by number of business applications in September, and the % increase from September 2019:
- Retail (red): 73,884, +70%.
- Professionally services (light blue): 82,272, +34%.
- Transportation & warehousing (green): 41,229, +112% related to the delivery needs of the ecommerce boom.
- Construction (black): 39,484, +30%.
- Administration and support (yellow): 30,290, +50%
- Accommodation and food services (gray): 24,014, +50%
- Health Care and Social Assistance (brown): 24,297, +22%
My 2 Cents about Failure rates.
The “failure rates” of small businesses are high. The alternate term used by the Bureau of Labor Statistics is “survival rate.” The commonly cited metrics for failure rates:
20% of the businesses fail within the first year; 50% fail within the first five years.
Sounds discouraging. “Failure” is defined as the business not being around anymore after x number of years. But in many cases, the owner of a business quietly ends the activity and retires, or gets a job with a company, or starts a new business. It doesn’t necessarily involve bankruptcies and upheaval, or even “failure.” Just a change of plans.
The metrics of the number of businesses that aren’t around anymore after x years and call them “failures” don’t sort that out. So these high “failure rates” are misleading about the risks of starting a business, and they can be discouraging even if reality for many of the owners that shut down their businesses looks very different.
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