The Problem of Defining Entrepreneurship

Policy makers face a dilemma over how to define entrepreneurship.

They can either adopt a volume-based definition or they can adopt an impact-based definition. The rub is that their choice influences the types of entrepreneurship policies they develop.

The volume-based approach tends to define any person who has started or owns his or her own business as an entrepreneur. By contrast, the impact-based approach says that a person is an entrepreneur only if they are starting a business that meets some sort of threshold, such as hiring employees or receiving external investment.

The two definitions point to an important dichotomy about entrepreneurship: Either a lot of people are entrepreneurs, but the economic impact of the typical entrepreneur is quite limited or the economic impact of the typical entrepreneur is substantial, but there aren’t very many entrepreneurs. The world policymakers want to have – one composed of a large number of entrepreneurs who have substantial economic impact – doesn’t exist.

To give you a sense of how many entrepreneurs there are if we adopt a volume-based definition, let me provide some numbers.

According to the Census Bureau, in 2007 (the latest year for which data are available), there were 28.7 million businesses in the United States. Take out the small number (less than 20,000) of large, public companies, and you end up with a pretty substantial number of companies that have an “entrepreneur” running them.

In fact, data from a variety of sources show that more than 12 per cent of US households own businesses and more than 8 per cent of adult-age Americans are in the process of starting a business in any given year.

Unfortunately, when everyone who starts or owns a business is considered an “entrepreneur,” the performance of the typical entrepreneur isn’t very good. Three-quarters of all entrepreneurs have no employees, according to Census Bureau estimates. The majority of new businesses created every year are gone within five years. And the median income of a single small business owning household was $82,000 in 2007, according to the Federal Reserve’s Survey of Consumer Finances.

As you might expect, the typical “entrepreneur” has much greater economic impact if we adopt an impact-based definition.

For instance, if we limited the term “entrepreneur” to people who start companies that receive external equity, then a much higher percentage grows their businesses, hires employees, has substantial sales and so on than if we used the volume-based definition.

But if we use the narrower definition of an entrepreneur, few Americans meet the criteria. For example, in 2008, only 3,200 of the 29.6 million businesses in the United States received venture capital financing. And Census data indicates that only 1.3 per cent of businesses less than 6 years old has received an external equity investment.

While neither definition alone is problematic, policymakers want to have their cake and eat it too. So they pick the best of both definitions and say that we have a lot of typically successful entrepreneurs with substantive economic impact.

Their cherry picking is understandable. Policymakers want to view the typical entrepreneur as successful and they want a lot of people to be typical entrepreneurs. If few people are entrepreneurs, or most entrepreneurs are unsuccessful, then it’s politically difficult to justify supporting entrepreneurship.

However, unless policymakers come to grips with dichotomy between definitions of entrepreneurship, they will have trouble formulating effective entrepreneurship policy.

To see why, consider employment regulations. If we use a volume-based definition, employment regulations mean little to the typical US entrepreneur because three quarters of US businesses are non-employer firms. However, if we use an impact-based definition, they matter a lot.

Companies backed by venture-capitalists at one time or another account for 10 per cent of US employment, and those once backed by informal investors employ a bunch more.

Similarly, if we use an impact-based definition, improving small business finance means increasing access to sources of equity capital, like venture capitalists and business angels, because high growth start-ups often need to access external equity. But if we use a volume-based definition, improving small business finance means facilitating credit because borrowing is the way that most start-ups get money not provided by the founder.

Failure to see the dichotomy between the volume-based and impact-based definitions of entrepreneurship keeps policy makers from focusing on the right entrepreneurship policies because it keeps them searching for something that doesn’t exist – a large number of high impact entrepreneurs.

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