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Why We Should Invest More in Existing Businesses (Opinion) Small businesses employ a lot of people, so policy makers invest in resources that help start new companies. But more resources should be allocated to helping existing business stay afloat.

By Scott Shane Edited by Dan Bova

Opinions expressed by Entrepreneur contributors are their own.

Why We Should Invest More in Existing Businesses Policy makers have a strange bias. Because small businesses employ a lot of people, our elected officials favor programs that help entrepreneurs start new companies. But they do relatively little to keep small businesses from failing and furloughing their workers, even though existing small companies employ far more people than startups.

First, let me dispense with the false dichotomy that policy makers create to rationalize their focus on startups. Most elected officials associate startups and job creation with small companies and link business closures and job destruction with large companies. However, 99.7 percent of all employers are small businesses. That means virtually all companies being started and shuttered are small.

A decline in the number of startups and an increase in the number of businesses going under are both bad for employment. But keeping businesses in operation has a much bigger effect on employment than helping businesses get started.

Related: Let Small Investors Join Angel Groups (Opinion)

Indeed, new businesses don't employ enough people to make an appreciable difference in employment. Bureau of Labor Statistics (BLS) data indicates that only 2.6 percent of private-sector employment is in establishments less than a year old. Even if we could figure out a way to double the number of businesses being founded--and the economic brain trust in Washington doesn't seem to know how to accomplish that--it still would provide only 2.8 million more jobs. While that might seem like a lot, the BLS reports that 142.1 million Americans were employed in February 2012.

Moreover, we need more startups to generate the same number of jobs that existing companies provide. BLS data shows that the average new establishment has 5.1 workers, while the average business of any age has 15.8.

Because jobs are destroyed when businesses shut down, their survival is obviously crucial to ensuring future employment. But new firms are less likely to survive than existing ones. As I have noted elsewhere, a brand new employer has only a 45 percent chance of being in business five years later, while a five-year-old company has a 64 percent chance. That means for both companies to have the same number of employees in five years, the average new business would need 1.4 times as many workers as the average five-year-old business.

Related: Puzzle for Policy Makers: How to Increase Gender Equality in Entrepreneurship

If new businesses grew faster than existing companies, they might make up for this difference in failure rates. But they don't. Research by Zoltan Acs, university professor at the School of Public Policy at George Mason University, and colleagues shows that the average age of rapidly growing businesses is 25.

If our public-policy goal is employment, we would be better off reallocating some of the resources we devote to helping people start businesses to keeping existing ones going. There are many ways we could do this, but let me give just two examples. Small-business development centers could spend less time teaching would-be entrepreneurs how to write business plans and more time showing existing business owners how to manage their cash flow. The Small Business Administration could remove its bias toward guaranteeing loans to new businesses and offer its guarantees more equitably across small businesses of all ages.

Unfortunately, the belief that new-is-always-better has kept us from adopting the best public policy toward small business.

Related: The Home-Equity Credit Crunch (Opinion)

Scott Shane

Professor at Case Western Reserve University

Scott Shane is the A. Malachi Mixon III professor of entrepreneurial studies at Case Western Reserve University. His books include Illusions of Entrepreneurship: The Costly Myths That Entrepreneurs, Investors, and Policy Makers Live by (Yale University Press, 2008) and Finding Fertile Ground: Identifying Extraordinary Opportunities for New Businesses (Pearson Prentice Hall, 2005).

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