Why the small business jobs bill won't create that many jobs.

How to start and grow companies.
Sept. 22 2010 9:57 AM

Small Change

Why the small business jobs bill won't create that many jobs.

Man with a briefcase. Click image to expand.
Small startups often don't go to banks for their seed money.

It's rare for small business to drive headlines, but the Small Business Jobs Act, passed by Congress last week, has brought the sometimes yawn-inducing and often misunderstood sector to the front pages.

Heavy on lending and tax provisions, the legislation has been touted as a means to spur job growth. But the bill is actually a Cash for Clunkers-like Band-Aid for the intertwined scourges of chronic joblessness and stymied growth. While the aid package will help many small businesses, it won't create many jobs because it will benefit more established firms, rather than the young ones that do the bulk of hiring.

As denizens of the little-guy economy already know, capital is the No. 1 concern for startups and small businesses. Raising money is difficult. Business owners can't get loans from the bailed-out, dollar-hoarding banks. And while the $30 billion allocated for Small Business Administration loans is laudable, the loans will be doled out carefully in order to comply with requirements that a lot of small businesses won't come close to meeting.

Like small businesses, banks still are in a holding pattern. Wary of regulatory changes and the cash bottleneck, managers won't make loans to people who are struggling, especially small businesses that don't have enough collateral to secure a loan. "The government can induce the banks to lend money, but it can't make them lend money they don't want to lend," said Robert Litan, vice president of research and policy at the Kauffman Foundation.

Even if small firms have, say, inventory or a healthy mortgage with which to secure funds, a loan is a loan is a loan. It needs to be paid back, sometimes within a couple of years (although the terms can be extended). If a small business or startup with little or no profits has no cash or ability to generate revenue in the first year or two, how will it pay the loan back and simultaneously grow the business?

There are small businesses with cash or the ability to generate it, but these often aren't the ones that hire. Recent Kauffman Foundation studies suggest that without startups, there would be no net job growth, and that these firms retain 80 percent of their initial employment up to their fifth year in existence. Startups drive job growth, but often, these high-impact firms rely not on debt-based lending like SBA loans, but rather angel-, VC-, or equity-based funding because lenders generally perceive them as too risky. Google's first outside funder, for example, was not a bank, but Sun Microsystems co-founder Andy Bechtolsheim.

In many cases, a startup won't be able to get a loan, even though the SBA is guaranteeing 90 percent of it. As a result, the SBA loans will help more mature small businesses that often don't recruit. "There's a disconnect between the rhetoric, which is that small businesses create jobs, and the reality that a small fraction of small businesses create jobs," said Josh Lerner, professor of investment banking at Harvard University and author of Boulevard of Broken Dreams: Why the Public Efforts to Boost Entrepreneurship Have Failed—and What To Do About It.

The Small Business Investment Company Program, a federal program founded in 1958 to help start-ups, suffers from the same misstep as the SBA loans. A public-private partnership, the SBIC matches private funds, but these federal investments are structured as debt that has to be paid back. As a result, like bank lending, the program favors not high-risk entities that are more likely to create jobs, but more mature companies that can satisfy reporting requirements and pay off debt. "The goal of the program is to address market failures and fund high-risk companies, but the mechanism actually cuts against doing these kinds of high-risk investments," said Lerner.

Like the bill's lending aspects, the short-term tax provisions are a boon to more mature firms either in a holding pattern or contemplating layoffs. The capital gains exclusion—which eliminates all taxes on profits from assets sold for more than the purchase price—benefits firms with abundant capital. Companies with less than $50 million in gross receipts that can carry tax credits back five years, of course, are firms that actually have existed for at least five years. So do the business equipment and real property write-offs. "There's a serious economic chicken-and-egg thing going on here. The companies that need a tax deduction are the ones that can't use it because they aren't profitable," said Scott Hodge, president of the Tax Foundation, a nonpartisan tax policy think tank in Washington.

The jobs bill would be more effective if it tweaked the federal assistance already in place to help high-growth, job-creating companies. The Small Business Innovation Research Program, which distributes about $12.5 billion in funding annually, often rewards companies that never commercialize. While there are plenty of SBIR success stories, the agency has also battled fraud. But many SBIR recipients simply subsist on government grants, rather than use the awards as a bridge to private equity funding.

As the president said earlier this month, it took years for these economic problems to develop and it will take a lot of time to solve them. But it's hard to imagine that an administration known for its academic sensibility has not considered the flaws in this makeshift solution that many thinkers and problem-solvers have identified. In the meantime, the few-jobs jobs bill will have to do.

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