Smart Money by Palmer Andrew

Author:Palmer, Andrew
Language: eng
Format: epub
Publisher: Basic Books
Published: 2015-02-06T05:00:00+00:00

6. Equity and the License to Dream

Visit the offices of a start-up, and there’ll usually be something self-consciously wacky to see. Someone might be playing table tennis in a desultory, “Look-at-us-being-noncorporate” way. There’ll be a hammock. The plants will tweet when they need water. The real mavericks of the start-up world would get everyone to wear suits and work in cubicles.

If the start-up environment sounds formulaic, the job that entrepreneurs do is anything but. The great technological breakthroughs often happen at new firms. And they make an outsized contribution to job growth. New firms are much more likely to fail than older ones: 50–70 percent of business start-ups fail. But those that do survive grow more rapidly than their mature counterparts. The OECD’s biennial Science, Technology, and Industry Scoreboard shows that across all the countries it looks at, young small firms (as opposed to established small firms) are disproportionately important to job creation. Young firms with fewer than fifty employees represent only 11 percent of employment but account for more than a third of total job creation in nonfinancial businesses. The figures are yet more striking for even younger businesses. Start-ups account for only 3 percent of total employment in the United States but almost 20 percent of gross job creation.1

If you care about employment, in other words, you should care about how to nurture new companies. Finance is fundamental to this challenge. Channeling capital to unproven ventures is by its nature a tougher proposition than funding established businesses. The risks are higher, and the information available to investors is scarcer. These same problems also exist when it comes to funding young people—whether young graduates with entrepreneurial ambitions or students who simply need money to fund themselves through college. The answers that finance has come up with to this problem of funding youth vary for businesses and people. But they have not worked as well as they might.

Let’s start with companies. In the ten years before the 2007–2008 crisis, two great, distorting financial events solved the problem of getting money to really young businesses. The first was the dot-com boom, when a wild enthusiasm for online start-ups saw huge amounts of equity flowing to businesses that made no commercial sense at all. Finding money was easier if you were a start-up than if you were a long-standing business with real assets.

The second great distortion was the housing boom of the mid-2000s, which enabled entrepreneurs in many countries to turn their biggest assets—their houses—into cash. Lenders were prepared to use property as security when they extended credit, in the expectation that prices would keep on rising. By marrying data on home ownership and data on house-price shocks, researchers have shown that French entrepreneurs who own their own houses are able to expand their businesses faster if their house values appreciate more quickly. Another study, looking at precrisis America, found that areas with rising house prices experienced significantly bigger increases in both small-business creation and in the number of people working for firms with fewer than ten employees, compared with areas that did not see house-price growth.

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