Small Business Viewpoint

Don’t Bind Investment Incentives to Job Creation


Don’t Bind Investment Incentives to Job Creation

Photograph by Ryan McVay/Getty Images

Our elected officials often design policies to help entrepreneurs because they believe doing so will create jobs. One of their favorite approaches is to give investors incentives such as angel tax credits or capital gains tax exemptions, or by matching grants to finance startups. While it’s obvious that investors want to maximize return on investment—not job creation—policymakers often forget this.

This means that efforts to stimulate job creation through investor incentives work only if the startups generating the highest returns to investors are also those creating the most jobs. That’s not always the case, as illustrated by the case of prototypical successful startup, Facebook.

Facebook Vs. ‘Mission-Essential’ Personnel

Facebook has probably generated the greatest financial returns to investors of any company started in recent years. In its first year of operation, Peter Thiel invested $500,000 in return for 10.2 percent of the company, valuing it at $4.9 million, according to a recent article in Forbes. If the company’s value at its initial public offering reaches the $100 billion some analysts expect, then Facebook will be worth 20,400 times its initial valuation. While I can’t know for sure, I doubt that any other company started around the same time is worth that high a multiple of its early valuation.

Despite generating sky-high financial returns, Facebook doesn’t employ nearly as many workers as other companies started around the same time. Facebook has some 3,200 employees and reported more than $3.7 billion in revenue in 2011, according to its S-1. By contrast, Mission Essential Personnel in Columbus, Ohio, also founded in 2004, employs about 8,200 people, according to its website. This difference shows that if policymakers are striving to spur job creation, using investor incentives to support startups isn’t ideal because investors don’t necessarily pick the startups that create the most jobs.

As a private company, Mission Essential hasn’t released the 2011 numbers necessary to estimate its market value precisely. Estimates based on its 2010 earnings indicate it is worth far less than Facebook. Taking the highest multiple that data provider Biz Stats considers reasonable, Mission Essential is worth $943 million. To match Facebook’s rate of return, Mission Essential Personnel would have to have been initially valued at $46,000, which seems unrealistically low. In short, Facebook was a better startup for investors than Mission Essential, and Mission Essential was a better startup for policymakers.

The Fallacy of a Job-Creation Focus

Consider the policy goal of maximizing job creation. The constellation of policies used to encourage investors to back startups won’t get them to focus on the new businesses that create the most jobs. Because the investors’ goal is to make money, they will favor the Facebooks over the Mission Essentials.

Some elected officials understand this difference and try to push investors by tying incentives to companies’ job creation record. This, too, is unwise. Startups shouldn’t be trying to maximize employment because employment is a cost, not an end in itself. We can always get companies to create more jobs than they need by subsidizing losses sustained from over-hiring. That’s what we do with the U.S. Postal Service and Amtrak. But those subsidies have to come from somewhere and that somewhere is taxpayers’ pockets.

Take aircraft manufacturer Epic Air of Bend, Ore., which was founded the same year as Facebook. The company received more than $1 million in government funding to get started, in part because it promised to create a whopping 4,000 manufacturing jobs, according to a newspaper article. It filed for bankruptcy in 2009.

Companies survive and grow because they do a better job with scarce resources than their competitors do. If we reward people—entrepreneurs or investors—for increasing a business’s cost, they will do that, causing those scarce resources to be misallocated. We could eliminate unemployment overnight by paying entrepreneurs the full cost of every person they hire.

But adding employees won’t make the companies more productive. (After all, those that would be better off by hiring additional people will hire without a government incentive.) To pay for those hires, money will have to be re-allocated away from more productive purposes. Doing that makes us all worse off.

Successful companies are successful, in part, because they don’t create as many jobs as they could if the founders and investors weren’t interested in maximizing profits. Making job creation a public policy goal misallocates resources, shifting them away from the most productive startups. If our elected officials want to get entrepreneurship policy right, they need to make productivity—not job creation—their goal.

Scott_shane
Scott Shane is the A. Malachi Mixon III Professor of Entrepreneurial Studies at Case Western Reserve University.

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