Viewpoint May 14, 2010, 1:15PM EST

The Term 'Small Business' Is Baloney

The government's definition—a firm with fewer than 500 employees—is too broad. To create relevant policy, we need to focus on narrower size categories

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The term "small business" is virtually meaningless.

At least it is if you use a commonly accepted definition: a firm with a maximum of 499 employees. The Small Business Administration's Office of Advocacy uses that size-based definition and the FAQ on its Web site categorizes 99.9 percent of all U.S. businesses as "small businesses." But the differences between types of businesses with fewer than 500 employees are so great, it's almost impossible to talk about what's common among them. That's a bigger problem for policymakers and those impacted by their policies than you might think.

Policymakers Are Talking About All Kinds of Small Businesses at Once

To illustrate the range of small businesses out there, consider these two examples. The first is a sole proprietorship that generates less than $50,000 per year in revenue and is run on a part-time basis by an individual with a full-time regular job. He started it with money from his own savings. The second is a corporation with 490 employees run by a team of experienced entrepreneurs that generates $25 million in annual sales and is funded by an equity investment from a venture capital firm. Both are small businesses. When journalists, academics, policymakers, and politicians talk about small businesses, the vast differences are often ignored, because they neglect to explain what type or types to which they're referring.

Size Matters

It's pretty obvious that corporations differ from sole proprietorships. It's also clear that businesses run on a full-time basis vary from those managed part time. And it should go without saying that self-financed companies aren't the same as those that receive outside equity. Same for high-revenue companies differing from low-sales ones. Perhaps less talked about is the fact that the business owners' problems, contributions, and aspirations vary a great deal depending on their number of employees.

This point became very clear during the recent debate on the health-care bill. The Kaiser Family Foundation's 2009 report on health care found that 87 percent of companies with 25 to 49 employees made health insurance available to their personnel in 2009, compared with only 46 percent of companies with 3 to 9 employees. The inability to offer employee health insurance isn't a small business problem so much as it is a very small business problem.

Similarly, the provision of retirement plans to employees varies greatly by the number of employees in small businesses. As I mentioned in an earlier column, one government study showed that only 29 percent of businesses with fewer than 25 workers offer a retirement plan to employees, while another study showed that the odds that the owners of businesses with fewer than 10 employees have a 401(k) plan for themselves is much lower than that of owners of larger small businesses. Not surprisingly, a recent Guardian Life Small Business Research Institute study that surveyed 1,100 owners of small companies in 13 different industry sectors in May 2009 shows that retirement planning increases in importance to owners as small companies become larger.

The business challenges that small business owners focus on varies with the number of employees in the company. The Guardian Life study showed that employees become a more important focus of small business owners' attention as companies become larger. The report shows that the perceived value of employees, the top management team, and outside advisers like lawyers and accountants goes up with the size of the firm. Moreover, strategies for finding employees become more important to the company owners.

Large Small Businesses Are the Most Economically Important

Small businesses don't all make an equal contribution to economic activity. Larger small companies account for most of the contribution to wealth and job creation. U.S.