Running the Numbers

Based on statistics drawn from the most recent Kauffman Firm Survey, which followed nearly 5,000 U.S. start-up ventures from 2004 to 2008, the odds of starting a business that lasts at least four years, generates revenues greater than $25,000, and goes on to hire at least one employee by its fourth year are about one in eight. To put these numbers in context, the average acceptance rate at an Ivy League college in 2009 was just under 16 percent.

Generally speaking, as a nation, we encourage young folks (and not-so-young folks) to start their own businesses, but we rarely tell them how to prepare to become successful business owners—often implying or even declaring outright that you don’t need a college education to thrive as an entrepreneur: “Look at Bill Gates; he was a college dropout!” But of those who hold up Bill Gates as an example, how many fill in the blanks? After all, Bill Gates dropped out of Harvard College, not MetroTech Community College. (He was also born rich.)

While Harvard was less selective in the 1970s than it is in the present era, it still was no cakewalk to get into—but it was much easier to get into and graduate from Harvard than to build the company that would become Microsoft. In fact, it’s fair to say that it’s probably vastly easier to get into Harvard than to build a business that will employ 20,000 people, 2,000 people, 200 people—or even 20 people, which happens to be the number of employees that the average “employer-firm” has on its payroll. In 2009, Harvard accepted only 7 percent of applicants into the Class of 2012. But fewer than 3 percent of all firms employ twenty or more people. (If any of these statistics surprise you, you now know why I wrote this book!)

Employer-firms, as the SBA calls them, are the one-fifth of all businesses that have a payroll—those that employ salaried or hourly workers. Of that one-fifth of firms with employees, almost 11 percent employ twenty or more people.

In many respects, building a business is like entering a triathlon. Both pursuits seem very ambitious from the perspective of less adventurous souls—but they’re not nearly as impressive as growing that business or actually finishing that race. It’s fairly easy to sign up for a triathlon; the challenge, of course, is doing it—let alone being competitive in it!

Now, the likelihood of ascending to Bill Gates’s stature in business and the likelihood of being accepted by and graduating from Harvard are two very different things. It’s like comparing apples to oranges, or, as is the case with Gates, windows to doors. But whatever metaphor is most appropriate here, you get the point: starting a business that lasts and grows—let alone one that earns a consistent profit—is ridiculously hard.

If you’ve ever been asked to speak to a class of high schoolers, you probably know that you don’t encourage students to apply to Harvard without knowing their scholastic aptitude. To do so would be reckless at best, and cruel at worst. Yet every day people tell folks to start a business based on little more than hearing someone’s “great idea.” Would you tell a senior in high school who has mediocre grades, no extracurriculars, and skipped taking the SAT to apply to Harvard just because she really, really wanted to go there?

When we encourage young people to go to college, it is because we know that doing so opens up more professional and other career opportunities and the likelihood of securing better-paying jobs. That’s been the traditional thinking, anyway—certainly before the Great Recession. We also know that there are thousands of schools to choose from that can help students receive a good education, stimulate their intellectual development, expand their skills and life experiences, and improve their chances of joining the workforce after graduation. Few people claim that setting your sights on an elite, highly selective college is the only way to obtain an excellent education and good prospects of economic uplift. Yet when we tell people that they should go into business for themselves, particularly starting a company that will eventually require employees, we are essentially saying “Go to Harvard” to people whose scholastic track record may not be that competitive.

Figure 3
Elite Subgroups of Total U.S. Firm Population

Why do we do it? Because we don’t know any better. But I suspect when you’re done reading this book, you’ll resist the urge to tell someone who likes eating cake to open up his own bakery.

The good news is that in the United States, starting a business is pretty darn easy. All you have to do is figure out what you want to do, come up with a catchy name, print out a bunch of business cards on your printer, and get a business license at city hall, and you’re technically in business. And if you report even the pittance you may have made in the previous tax year, the IRS will label your activity—whether it’s babysitting or getting paid to speak at an event—as a business enterprise that must file a Schedule C, the tax form that documents the nonemployee income and expenses of sole proprietorships, entities totaling over 21 million in 2007. Of course, this means that of the millions of firms that the IRS—and as a consequence, the U.S. Census Bureau—recognizes as businesses, only a fraction actually consider themselves “in business,” which explains in part why their enterprises’ annual earnings represent on average less than 10 percent of the revenues of their counterparts with payrolls.

But what if you want to start the next Netflix or Cold Stone Creamery? What if you want to start a business that will grow to hundreds (or thousands) of employees in a nice office building—the kind of business that will net you enough take-home pay to retire to a life of leisure?

People planning to start new businesses often imagine that their businesses will grow big enough to employ hundreds of workers simply because most of us work at those kinds of large companies. Firms with over 2,500 employees account for 64 percent of the American workforce, even though they make up less than 1 percent of all U.S. firms.

Let’s sum up. Three out of four businesses have no employees. Nine out of ten employer-firms have fewer than twenty employees. So just getting to the point where you have done well enough to hire a few people is a nontrivial feat—only about 2 in 100 companies make it to that point. Hiring employees is not usually a business owner’s first concern, however. Their first concern is usually staying in business one way or another.

No one wants to run a business that just barely makes ends meet, whether or not it has employees. Entrepreneurs start businesses to make a profit—even tree-hugging, Birkenstock-wearing entrepreneurs. And just as a highly relevant point of reference, the average business without employees brings in just over $45,000 a year. (Given how many hours that business owner’s probably working to make this amount, his hourly wage would make a low-paying, semiskilled job look pretty appealing!) Of course, staying in business is a reasonable concern and a necessary goal. But there’s a big difference between surviving in business and thriving in business. It’s the difference between wanting not to die and choosing to live well.

For some entrepreneurs, though, the dream is not to just “make it,” but to “make it big,” which for many entrepreneurial aspirants means building a highly scalable business. This higher threshold therefore requires that the dreamer’s business not only generate recurring profits, but generate enough operating cash flow for the business owner to retain the funds (personally) to buy that vacation villa in the Caribbean, that Italian sports car, and an exclusive country club membership.

Remember: according to the Kauffman Firm Survey, only about 13 out of every 100 newly minted business owners surveyed survived four years, made over $25,000 in annual revenues, and hired employees. Surely, these milestones are nothing to sneeze at, but they are far from what is necessary to buy that Ferrari or oceanfront property in Antigua.

According to the Kauffman Foundation’s Anatomy of an Entrepreneur study, the average entrepreneur is a White, middle-aged, well-educated man with a wife and kids and considerable experience in the industry in which he established his new venture. Does this sound like you? Odds are it doesn’t.

So what does this average entrepreneur have to do with you? Nothing—unless you want to know how close to average you are in terms of the probability you will establish a viable business. After all, if the example presented in the previous paragraph represents conventional business success (on a fairly modest scale), it’s a fair question to pose whether you are more or less likely to achieve this success than “the average guy.”

How do we arrive at averages, anyway? Simply put, in order to find an average (or what in statistics is called the mean), we add the sum of the total numbers and divide by the amount of those numbers we’ve added up. So let’s assign the value zero to represent an average person’s chances of being among the 12 out of every 100 new business owners who go on to modest success. Of course, some people are going to be in a better-than-average position to achieve success; we can represent their chances by assigning them values above zero. Others may be ill equipped to survive, and we can represent their chances with values below zero.

Figure 4
What Are the Diminishing Odds of Building a Business That Lasts?

For example, we could rate two entrepreneurs at −2 and two at +2. The average—or the mean—for these four enterprising souls would equal zero. So, too, would four individuals rated −50 and +50, −75 and +75. But, as shown in Figure 4, just as likely would be four people rated −79, +92, +8, and −21. In this scenario, which number best represents you? If you’re modest, you might surmise you’re at +8, if par is zero. But how would you know for sure? Could you really be −21? Or even worse, that dismal −79?

But the statistics tell a more sobering story, which means that some large percentage of new entrepreneurs are not just overly optimistic, they’re absolutely clueless, and thus inordinately ill-prepared for their journey. They literally don’t have a clue because few people in the average entrepreneur’s sphere are in a position to alert them to the unseen forces that shape entrepreneurial opportunity—in particular, those things that will significantly boost their chances of achieving even modest success in business.

Not breaking out the champagne, are you? For good reason. Running a viable business that lasts is not for the faint of heart or the easily dissuaded. Running one that generates serious wealth for its owner is highly unlikely when you give the aforementioned statistics some serious thought. Granted, you have a better chance of succeeding in business than of winning the Powerball jackpot, but playing the lottery is much less work (and a lot less taxing on your bank account, your credit card balances, your personal relationships, and your stomach lining).