Why Startups Surged During the Recession

High unemployment has led to a record level of new businesses. If they survive, it's great news.

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Here's the good news: Americans aren't lazy.

With more than 15 million Americans unemployed, many for six months or longer, it's easy to stereotype the jobless as dropouts who have lost hope and motivation. But a new study of entrepreneurship suggests that the unemployed are quite industrious, helping spur the pace of new-business startups to a record level in 2009.

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The annual index of entrepreneurial activity published by the nonprofit Kauffman Foundation shows that the pace of new-business creation last year was the highest since the index began 14 years ago. It's not clear why there would be so many startups in the midst of a brutal recession, but it stands to reason that many new business owners these days are "necessity entrepreneurs"—people laid off from conventional jobs, with few other opportunities. "Either these people can't find jobs, or they're incredibly motivated to start businesses," says Bob Litan, vice president for research and policy at Kauffman. "I suspect it's a combination of both."

Entrepreneurial activity often rises when traditional jobs disappear, but the past two years have been notoriously tough on small businesses. So it's too early to declare that a new army of entrepreneurs will save the American economy. Consumers have curtailed spending, for one thing, hitting businesses from dry cleaners and nail salons to Silicon Valley tech startups. But the biggest problem has been the credit crunch. Banks essentially stopped lending during the 2008 financial crisis, and while big companies can now get loans, many small businesses—often financed with personal loans or credit cards—still can't. White House economic advisor Larry Summers said a few weeks ago that "there's a Great Recession everywhere. There's a quiet depression in small business."

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But entrepreneurs may know something that Summers doesn't. The Kauffman data, based on Census surveys, shows that entrepreneurs created about 558,000 new businesses each month in 2009, a sharp rise from historical averages. Put another way, about 340 people out of every 100,000 started a business each month in 2009, compared with a rate of 320 people in 2008 and 270 people in 2000. Those new businesses aren't necessarily the next Google, but to qualify, individuals must consider the business their main job and work at it at least 15 hours per week. So selling tomatoes from the summer garden probably doesn't qualify.

One factor luring do-it-yourselfers may be the relative ease of starting a business these days. Servers and computers are cheaper than ever. The Web allows business owners to reach customers and promote their companies without expensive marketing campaigns or even a sales staff. With unemployment high, it's cheaper to hire help. And rents have been tumbling, making commercial space more affordable.

The Kauffman data suggests that many newbie entrepreneurs are in fact refugees from hard-hit areas of the economy. Between 2006 and 2009, for instance, there was a spike in new businesses in the construction industry, which came at the same time the housing bubble burst and employment related to housing collapsed. So it's likely that many tradespeople laid off by contractors opened their own one-man shops. In terms of age, the 35-to-44 and 55-to-64 age groups showed the biggest surge in entrepreneurial activity in 2009, which might reflect laid-off or bought-out workers starting consulting or contracting gigs.

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Ray Nowak of Holland, Mich. fled the troubled auto industry in 2008, taking a buyout from Johnson Controls at the age of 52—with no idea what to do next. After a few months of research, he decided to start a Fast-Teks franchise, offering onsite computer support to families and businesses. The learning curve was steep, as he plunged into accounting, marketing, advertising, and a bunch of other things he never learned in his engineering work for Johnson Controls. Cash flow came in below projections for a few months, as he spent more than expected on advertising. But after a year, Nowak is turning a profit and thinking of expanding. "It seemed like a time to take a risk and do something different," he says. "It's not too often you get a buyout and a chance to discover what you can do."

If the bulk of new entrepreneurs are all-in like Nowak, it could signal a major boost for the economy down the road. Small businesses account for about 65 percent of the jobs in America, and with big companies more likely to invest in new technology before they hire new workers, Mom and Pop could do more to juice a recovery than Wal-Mart or ExxonMobil. Still, the failure rate for new businesses is about 50 percent, and if many of the recent startups are simply filling a void until corporate hiring picks up, the surge in entrepreneurship could be fleeting. At least there will be a lot more people who know what it's like to be the boss, even if they end up working for somebody else.