Is becoming an entrepreneur financially worthwhile? While many people start businesses because of the nonfinancial benefits that being your own boss provides, a lot of others, before taking the plunge, want to know whether entrepreneurs tend to make money. So what does the research say?
In a nutshell, starting a business pays, but only if you're an above-average entrepreneur.
Small Business Owners Make a Lot of Money
The average small-business-owning household makes a lot of money. According to Federal Reserve Survey of Consumer Finance data analyzed by Montana State University's George Haynes, the average small-business-owning family made $185,350 in 2007, much more than the $64,207 earned by non-business-owning households. So at first glance, starting a business appears to pay.
The Typical Entrepreneur Earns Less Than the Typical Employee
However, in an article that will be published in the forthcoming Handbook of Entrepreneurial Finance, Thomas Astebro of HEC Paris explains that the typical entrepreneur doesn't do so well. Astebro reviewed all of the academic studies on entrepreneurs' earnings and found that in almost all of the studies conducted in the U.S. and the United Kingdom over the past 30 years, typical earnings are lower for entrepreneurs than for people who work for others. In addition, he found that the gap between the earnings of the typical entrepreneur and the typical employee has increased since the 1950s and that the typical entrepreneur earns less than the typical worker in all industrialized countries except Germany.
Reconciling the Numbers
How can the typical entrepreneur make less money than the typical employee, but the average small-business-owning household make more? The answer is the greater variation in entrepreneurs' incomes. Almost all of the studies reviewed by Astebro show that people who work for themselves have more varied incomes than those who work for others. Moreover, at the top end of the income scale, some entrepreneurs earn much more than people who work for others. For instance, a study by Bart Hamilton showed, among the top 25% of earners, entrepreneurs make more money than those who work for others (despite showing that the typical entrepreneur makes only about two-thirds of what the typical employee makes).
George Haynes' analysis also shows that the income of small-business-owning households is highly skewed, more so than for non-business-owning households. According to his report, the typical small business made only $86,383 in 2007 even though the average small-business-owning household made more than $185,000. (The Fed data also show that small business incomes have been getting more skewed since the late 1990s.)
In fact, the data Haynes looked at show that the revenues from the typical small business aren't large enough to support much higher levels of income. Haynes reports that nearly half of all businesses owned by U.S. households generate less than $50,000 in annual gross sales and almost 60% produce less than $100,000.
So what's the lesson here? If you're from Garrison Keillor's fictional town of Lake Wobegon, Minn., where "all of the children are above average," it pays to become an entrepreneur. Above-average entrepreneurs tend to earn more money than they would have made working for others.
For the rest of you, the implication is that becoming an entrepreneur is a (relatively) high-risk, high-reward activity. The typical person starting a business will be worse off financially than if he or she hadn't done it. But the successful entrepreneurs will be much better off.