Justin Gage is an analyst at Cornerstone Venture Partners and previously a data science major at NYU’s business school. You can follow him on Twitter here.
Conventional wisdom states that we live in a golden era of startups. The rise of accelerator and incubator programs like Y Combinator, a robust VC ecosystem with more capital than it can deploy, and the dramatic decrease in infrastructure costs (via the public cloud) help make starting a new company today much easier than it once was.
Technology is becoming more mainstream and normalized, as once small and darling tech startups have grown to represent the modern economic world, with the likes of Facebook, Google, Amazon, and Apple dominating the headlines.
On the other side of the spectrum, exiting a startup, the process that runs the virtuous and necessary startup funding cycle, has never been more achievable. Companies across the spectrum, like GE and Walmart, are snapping up tech startups to bolster their digital presences, an activity that was usually relegated to the tech giants themselves. Leaving aside some fluctuations over the past few quarters, tech M&A value is near the highest it’s ever been. The IPO market hasn’t been stellar, but recent months have seen some major tech companies go public. An overflowing pen of unicorns also means that we might be in for some exciting new tech IPOs in the near future, although that floodgate hasn’t opened quite yet.
So you can get funded and advised, set up infrastructure for little cost, raise capital when you need it, and bring liquidity to those investors; all the factors driving new startup formation seem to be in place.
In my conversations with VCs, this topic comes up all the time. They’re floored with how many quality, fundable companies there are today. In the words of successful entrepreneur Will King, “it has never been easier to start a great business.”
If it’s easier than ever to start a company, you might expect the number of new tech startups founded per year to be pretty high. Surprisingly, the data tells us a different story.
What If Startup Activity is Actually Far Lower Than (Almost) Ever?
The Kauffman Foundation, a nonprofit focused on advancing education and fostering entrepreneurship, publishes a yearly report called the “Kauffman Index” that measures various facets of startup activity. The graph of startup density, or the number of startups per 1,000 firms, doesn’t look like the hockey stick that we might expect to see:
Barring a slight pickup over the past decade or so, there are two important observations to note here. First, startup density has been decreasing since the Kauffman Foundation started measuring it in 1977. And second, the financial crisis (or more accurately, the time period immediately before it) kicked off the most significant downturn in entrepreneurial activity since the chart starts.
And despite incremental progress since 2010, we’re nowhere near pre-2008 startup activity levels. Other Kauffman Index measures show some slightly more promising figures, but not what we might expect given the “golden age” narrative that seems so prevalent.
Tech vs. The Rest
In all fairness, these Kauffman Index measures relate to all kinds of startups (such as bakeries and auto parts manufacturers). The growth factors that we’re talking about, like accelerators and cheap cloud computing, largely focus on tech startups.
But here, too, the data shows lower activity than expected. The Kauffman Foundation also published a separate report in 2013 about high-tech businesses; the attached graph, where the blue line represents the number of high-tech startups founded in a given year, shows a similar decline since 2008.
(ICT stands for Information and Computer Technology, a more concentrated group of high-tech startups.)
Instead of spurring record numbers of new tech startups, our “golden age” hasn’t really helped company formation much at all. It turns out that the real golden age for startup formation was actually the 90’s and the Dotcom era. And that’s despite the high, fixed cost of infrastructure and less mature funding environments.
Another surprising and emerging trend is the founder age gap. Moving back to the original Kauffman Index, there’s a notable divergence between younger and older founders. Companies are increasingly being started by older people.
Why might that be the case? In the words of Fareed Zakaria, who wrote recently on this topic: “Young people today dress like Silicon Valley entrepreneurs, consume technology voraciously and talk about disruptive innovation. But they want to work at Goldman Sachs, McKinsey and Google.”
Why Aren’t We Founding More Companies?
So what’s going on? Why haven’t the amazing resources that today’s startups enjoy led to increased tech startup formation? I’ll suggest a few possibilities, and then I will return to the importance of what the data tells us.
Kids Like Good Jobs
One reason why more people might not be founding companies is opportunity – especially for young people exiting school. Simply put, there are far more attractive alternatives to startups than there used to be.
Tech giants like Facebook and Google, who pride themselves on how they treat their employees, are hot destinations for graduating software engineers and other relevant majors. These companies simply didn’t exist at their current scale (or at all, in Facebook’s case) during the dot com era.
And it’s not just software companies that are embracing younger workers and creating a more welcoming workplace. Traditional juggernauts like GE have created impressive digital hubs, and banks like J.P. Morgan have begun allowing employees to wear jeans to work. And finally, even leaving large corporations aside, there are lots of mid-to-larger companies like Github and Airbnb that offer dynamic and exciting work environments. In short, people may be dis-incentivized to start new companies when their alternate employment options are so attractive.
Another potential reason is the double edged sword of a robust funding environment. Companies that might have died in previous cycles can stay alive and in business longer.
With less VC funding available 20 years ago, your company, to stay alive, needed to do one of the following:
- Raise money from a limited cadre of investors.
- Make enough money to support yourself.
- Go public or be acquired.
There’s a lot more VC money around nowadays at all different stages ($40 billion raised in 2016), and that gives companies more runway and flexibility to push off profitability or exit. Founders and employees who might otherwise be starting new companies can stick around right where they are.
These two possibilities – better employment opportunities and potentially lower company turnover – may help explain why today’s “golden age” of startups hasn’t actually resulted in more startups.
But the conclusion stands: we might not be forming companies at the rate that we think. It’s my personal belief that within reason, more startups are good for the economy and entrepreneurship should be encouraged. I hope that these statistics and this article can spur some dialogue on how we can parlay today’s ease of starting a company into tangible growth.
Illustration: Li-Anne Dias