Why Small Businesses See a Gloomy Future

If small businesses are the backbone of the U.S. economy—as politicians routinely claim—then we're in worse shape than a lot of people realize.

Most economists, including Federal Reserve Chairman Ben Bernanke, believe the recession is technically over and the economy is growing again. But the news apparently hasn't trickled down to the people who run delicatessens, plumbing outfits, and Web start-ups. A recent survey by the nonprofit Kauffman Foundation found that 68 percent of entrepreneurs do not believe the economy is beginning to recover, and 61 percent think the economy's on the wrong track. Only 13 percent believe a recovery is underway.

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Entrepreneurs are usually optimists inclined to believe things will work out, which is why they're willing to try something as laborious as starting their own business. But the recession has put them in a foul mood. A startling 94 percent said the recession will last at least another year. Only 3 percent believe the pain will end within six months. And 66 percent believe the United States is facing a long period of high unemployment.

Entrepreneurs aren't economists, but it's possible that their street-level view of the economy actually meshes with the predictions of analysts crunching numbers and running computer models. Bernanke, for instance, has tempered his own optimism by saying that "it is still going to feel like a very weak economy for some time." The Congressional Budget Office predicts that the unemployment rate will be 10.2 percent in 2010—which would be worse than this year—and an unpleasant 9.1 percent in 2011. So maybe the entrepreneurs in the survey spend their spare time reading Federal Reserve and CBO reports.

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Still, the entrepreneur blues are a big worry because small businesses often pick up the slack when big businesses slash their payrolls, as they've done over the past 18 months. Recessions tend to create "accidental entrepreneurs" who start a business because they get laid off and have no choice. Others may take a buyout from their firm to avoid the ax later on and use part of the cash to fund a start-up. Ray Nowak was a design manager for auto-supplier Johnson Controls who accepted a buyout offer in October 2008, figuring he'd rather pocket the cash voluntarily than be forced to accept a much worse deal later on. Four months later, he opened a Fast-teks franchise in Holland, Mich., offering onsite computer support to businesses and individuals. He has three employees, expects his business to become profitable soon, and is already thinking of expanding. "It's not too often you get a buyout and a new chance to discover what you can do," he says.

A Kauffman Foundation study published in June found that a disproportionately large number of successful businesses tend to get started during tough economic times. More than half of the Fortune 500 companies were founded during a recession or bear market, for instance, even though such economic contractions occurred only about one third of the time. The formation of new firms dipped during the recessions that began in 1991 and 2001 but returned to prior levels or exceeded them within a year or two.

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Layoffs in the 2008-2009 recession have been steeper than during most other downturns of the past century, and there are plenty of anecdotal reports of bankers, software engineers, lawyers, and retail employees who got laid off and started their own businesses. But there are no reliable data yet on whether there's been an overall surge of start-ups, and it's too early to tell how many of those that did get started became profitable.

Meanwhile, there's at least one powerful discouraging factor: scarce credit. Some entrepreneurs use their savings or borrow from friends and family to set up shop, but sooner or later most businesses require loans to grow and expand. And with the financial sector still in rough shape, loans are hard to come by.

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Aggressive government intervention in the economy probably prevented an even worse financial meltdown, but entrepreneurs, typically free-marketeers, are turned off by the bank bailouts and the $787 billion stimulus package. Still, 58 percent of the respondents in the Kauffman survey said the government should do more to encourage entrepreneurship, and many would like the government to cut their taxes and fix the healthcare system while they're at it. Wouldn't we all.