Show Me the Data: Serial Entrepreneurs and Toddler Firms

January 8, 2018

This post is the latest installment in the Show Me the Data blog series. See a former post here.

Private sector firms are the engine of economic growth in most countries and an important driver of labor demand. This is especially true in developing countries. The problem facing donor agencies, host governments, and impact investors is: how can we target the firms that are most likely to increase employment because of our interventions?

Many of us, including USAID, have targeted small and medium-sized enterprises (SMEs). However, recent evidence about firm size and likelihood of growth seems conflicting. McKenzie & Paffhausen observe that “small” firms are as likely to die as one-person firms, whereas Aga et al. found that SMEs have higher net employment growth rates than large firms.

As usual, the devil is in the detailed definitions of firm size. What McKenzie & Paffhausen call “small” firms, most USAID colleagues and partners would call microenterprises or household enterprises — those with fewer than 10 employees. It may not be surprising then, that these firms of 1-10 employees are all equally likely to die, with about 8.3 percent dying per year in the first five years. McKenzie & Paffhausen review developing country evidence that firms with 50-100 employees are more likely to survive than microenterprises. This may be the threshold size — medium, if you will — where firms have “made it” and are more likely to survive. Most studies also suggest that firm age is at least as important a predictor of SME growth and survival as size. Aga et al. review evidence that younger firms (five years or less — “toddler” firms, if you will) have higher net job growth rates than older firms.

This raises a related question: if a USAID beneficiary firm closes, does this necessarily reflect a final failure of the entrepreneur and our program? What can we reasonably expect in our programs, given that microenterprise death is so common? Where do successful entrepreneurs come from, anyway? In the U.S., many entrepreneurs are actually serial ones, being well-known for their later, more successful endeavors. Endeavor Insight’s mapping of the New York City technology sector found that top-performing entrepreneurs are more likely to start new companies, encourage their employees to do the same, and serve as mentors and angel investors. If we target our programs well, it should actually be quite likely that a good portion of beneficiary firms may fail, or the founder — especially a young founder under the age of 35 — may exit the firm and use their knowledge to start new firms with new opportunities. 

This has important implications for USAID programming, suggesting that we should target “toddler” firms of 10-50 employees and perhaps see them through to about 50-100 employees to ensure survival. We might provide the most expensive interventions for the younger but larger firms, phasing out our role over time. It’s sometimes not feasible or meaningful to set strict limits on program eligibility, when we cannot verify many of these numbers. We should also think twice about focusing direct support in sectors with only older firms and instead consider removing barriers to competition that keep out new entrants.

Finally, we need to shift our program designs away from a "one entrepreneur, one firm" mentality, especially for younger entrepreneurs. For long-term, systemic impact, we need to facilitate entrepreneur-investor networks as well as provide direct support to entrepreneurs and track what our partner entrepreneurs are up to for at least a few years after the intervention. Chances are, they’re starting something better than their last enterprise.