The Disappearance of the American Startup - Entrepreneurship in the U.S.

This year, some of Silicon Valley’s favorite startups from the last decade went public, cementing themselves as established organizations. These include Uber, Slack, Pinterest, Lyft, and Zoom. More still are expected to go public by the end of the year, such as Postmates, WeWork, Bumble, Airbnb, Robinhood, and Peloton. After years of sporadic tech IPOs, 2019 is poised to be a watershed year for unicorns (i.e., billion-dollar companies) hitting the public market.

These companies not only represent the tech industry’s most valuable businesses; they also represent an American Dream (of sorts). Many of us watched as these companies took their first steps, grew into billion-dollar companies, and propelled towards success—granted with a few missteps along the way. Their journey suggests that the startup industry is alive and well when, in reality, that isn’t the case.

The American startup is dying. Twenty years ago, less than 40 percent of businesses were more than ten years old, according to Census data. Today, that number has surpassed more than half. Furthermore, the U.S. was home to 95 percent of global startup and venture-capital activity two decades ago. Today, that number has been cut in half, with most of the decline happening in the last five years.

Why is this happening, and how can we breathe new life into the startup economy?

Why is U.S. Entrepreneurship on the Decline?

A report from the Brookings Institution found that the portion of new companies is declining across all industries and that the share of profits is increasingly consolidated to the top firms in each sector. “If innovations generate an increase in profits, one would expect competition to eventually bring down the profit margin,” the report details. “A set of firms that continuously earns very high profits year after year could imply that competition is not functioning as expected.”

When new companies are not being born and succeeding, old companies can grow faster and consolidate industries resulting in a less resilient economy that is held up by a select few companies, people, and locations. Over the last 30 years, the world’s largest tech giants have made $25 billion worth of acquisitions according to CB Insights. Facebook, Amazon, Microsoft, Google, and Apple have collectively made nearly 750 acquisitions, which have allowed them to maintain their foothold as industry leaders.

The problem is that the U.S. economy thrives on startups. New businesses—and not necessarily small businesses—drive innovation and productivity. They positively influence economic growth and job creation as they introduce new technologies and business models.

It is a natural part of a dynamic economy for businesses to grow, succeed, and fail. This lifecycle creates new jobs and destroys others; allocates resources to new industries; and repurposes labor and capital in new directions to create a more productive and dynamic economy. However, when resources remain cemented in old industries, growth stagnates. While some large firms are engaged in disruption, research, and innovation, they are not the primary change-makers in these departments, as the Brookings Institution notes in its report.

Why Startups Fail: Insufficient Early-Stage Funding

It is a known reality that most startups fail. That is the nature of the game. New businesses are born and either fail or succeed, but in recent years, their lifecycle has been shortened, and most startups fail to even get past the second round of funding. According to CB Insights, less than half of startups manage to raise a second round and every round sees fewer startups moving to through to the next one.

Along those same lines, investment prospector Mattermark tracked startups between 2005 and 2014 and found that the size of their seed investments made by VCs remained stagnant while later-stage rounds nearly doubled. “If you look at when people are getting money, it is way past the startup phase,” explained Karl R. LaPan, former chair of the National Business Incubation Association to Inc. “There is a dearth of capital for idea, pre-seed, and seed startup companies.”

When looking at valuations, it is clear that many companies are overfunded, and recent reports show that “foie gras-ing” startups does not necessarily yield better results. Yet, so many are underfunded, especially at the crucial phase where they might just begin to cross the chasm. VCs and individual investors should look to younger companies with potential and invest not only capital but also time and energy into seeing them succeed, rather than jumping on the bandwagon once a startup is already standing on two feet.

Why Startups Fail: A Lack of Talent

Another reason why startups are few and far between is that it is increasingly difficult to recruit top talent. Twenty years ago, large corporations were hemorrhaging top talent as professionals set out to work for themselves, and thus, the startup culture was born. Today, large companies have incorporated elements of the startup culture into their workplaces, making it a much more enjoyable experience. What’s more, the pioneers of the startup culture—Google and Facebook—are now among the world’s largest employers.

What’s more, the Brookings Institutes notes that entrepreneurship has fallen among highly educated workers. Entrepreneurship is less common than it was 25 years ago as a whole, but that trend is especially visible among those with advanced degrees. In 1992, 4 percent of professionals with an advanced degree were entrepreneurs. By 2017, that rate was cut in half. The Brookings Institution suggests that this could be due to the high demand for educated employees at big companies. Companies like Google, Facebook, and Amazon are recruiting PhD holders en masse and offering much more attractive salaries than those in academia or at a startup.

“The decline in entrepreneurship of highly educated individuals may be of concern given that these individuals are far more likely to engage in patenting, and having some form of intellectual property makes it more likely that a firm will become a high-growth startup,” details the report.

Other factors include new immigration policies that keep talent out, stagnant wages, and student debt. Millennials are starting fewer companies compared to their parents’ generation. In 1996, young people launched 35 percent of startups, and in 2014, that number was reduced to half, according to the Kauffman Foundation.

The Kauffman Foundation noted that Millennials aren’t expected to found startups in big numbers for another five years. Some of this can be attributed to the fact that wages have stayed the same for years and working at an established company provides security in an uncertain time. Along those same lines, younger generations are riddled with student debt making the American startup still just a dream.

How to Support a Resurgence of American Startups

For all that’s been said about the flailing startup economy, there are ways that we work to boost the startup economy.

The first is eliminating subsidies that help out existing businesses. The Brookings report noted that state subsidies to large companies have tripled since 1990. When companies like Amazon get massive tax breaks for opening new offices, it becomes near impossible for startups to compete. Granted, when these corporations move into new communities, they bring job creation at a local level, but it also impedes the startup economy at the local level.

When looking at the startup scene in major tech hubs like Seattle, San Francisco, and New York compared to mid-sized cities like Nashville, Austin, and Portland, there is a distinct difference in being part of a startup. In the former, professionals are more interested in joining a name-brand organization like Microsoft or Google, while in the latter, people are more willing to take a risk as an entrepreneur.

Mid-sized cities across the country are helping to boost their local startup economy in different ways. Boston, Atlanta, Miami, and others have several startup accelerators and incubators in their metropolitan areas. The Twin Cities launched a startup week that provides connection and networking for entrepreneurs and the Arizona Commerce Authority created an angel investment tax credit, which offers startups $2.5 million a year.

Another possible solution could be eliminating student debt for students who found successful startups in their school’s cities, which would allow entrepreneurs the breathing room to take risks and help cities with a high density of students retain talent.

We also need to be diversifying our understanding of what a startup is. Not all startups need to have intricate stacks of technology to be successful. Today, all of the money is going to tech, but startups in other industries have disrupted their sectors. Glossier, Warby Parker, and Casper are just a few examples. The direct-to-consumer market has prospered and will continue to grow.

Along those same lines, the startup economy depends on the next innovation. One of the reasons why there might be fewer startups today is because we haven’t had a major innovation wave to catch. In the 1990s, the internet opened up limitless possibilities—anyone could make a website. Fifteen years later, the iPhone ushered in a new era of smartphones, app stores, and connectivity—anyone could create an app.

We’re still waiting for the next big thing. Artificial intelligence, augmented and virtual reality, and blockchain have all had their shining moments of excitement but have yet to be fully realized as innovations for the masses. Maybe the next big thing is not technology in the strictest sense of the term. Right now, we have five major players dominating the industry who are too big to fail. We need to be looking in new directions for industries and business models to disrupt outside of the tech bubble. That’s where true innovation comes from.