Business Failures and Formations

Patrick Labbe, CFA

You are probably aware of the business failures resulting from pandemic-related restrictions and reduced consumer spending.  Researchers at George Washington University report that the country lost more businesses during the first three months of the crisis than it does in a normal year.  A simple drive around your neighborhood probably confirms the impact.  Keep in mind though that closures are only part of the picture, and the data on business formation, however, is decidedly and surprisingly good.

According to government figures, Americans are starting new businesses at the fastest rate in more than a decade.  Through the end of September, applications for employer identification numbers that are needed to start a business were 3.2 million compared to 2.7 million at the same point last year. This rise prompted John Haltiwanger, a University of Maryland economist who studies business formation, to declare, “This pandemic is actually inducing a surge in employer business startups that takes us back to the days before the decline in the Great Recession.”  It is not clear why so many Americans believe this is a good time to start a business, especially since many surviving businesses are reporting significant revenue declines.  Perhaps some recently-unemployed individuals may be opting to strike out on their own out of a sense of necessity, but certainly others are savvy entrepreneurs who sense attractive opportunities.  It also helps that the personal balance sheets of many Americans are in good shape due to a combination of very high savings rates this year and recent government stimulus payments.  This financial strength makes would-be entrepreneurs more attractive to lenders.  And given the availability of very low borrowing rates, some risk-takers appear to have decided that the time is right.

Historically, the failure rate of new businesses has been high, and many of these new ventures will not pan out.  And given current economic conditions, the rate of attrition among startups may be even higher than normal.  But many notable companies were started in periods of economic upheaval.  Hyatt opened its first hotel and Burger King opened its first restaurant during the 1957 recession, which saw GDP decline by 3.7%.  The 1973-75 oil embargo and ensuing recession saw the birth of Microsoft.  More recently, short-term rental firm Airbnb, and ride-sharing companies Uber and Lyft were formed amidst the Great Recession.  I have little doubt that the origins of some future world-changing companies will be traced to the opportunities created by today’s economic disruption.

Given the important role played by new businesses in employment, innovation, and problem solving, the data on business formation is good news for all Americans.  It will take time to fill the void left by so many business closures, but we should all be pleased that American entrepreneurship, so critical to our economic past and future, appears intact.