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The Term 'Small Business' Is Baloney

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. Census data show that businesses with no employees (the smallest small businesses) account for a whopping three-quarters of all companies in this country but generate only 4 percent of sales.

Similar differences can be seen in job creation. In an earlier blog post, I summarized Bureau of Labor Statistics data which showed that from 1992 to 2008, firms with 9 or fewer workers made up 79 percent of companies but created only 15 percent of the jobs. And those with 10 to 49 employees accounted for 17 percent of companies but created 20 percent of the jobs. However, those with 50 to 499 employees made up only 4 percent of firms but created 30 percent of the jobs.


If we are going to forge meaningful domestic economic policy, we need to break small businesses into different size categories. Based on what the data show, I would propose defining businesses as non-employer businesses, microbusinesses (1 to 9 employees), small businesses (10 to 24 employees), medium-sized businesses (25 to 99 employees), and large small businesses (100 to 499 employees).

We need only look at one of the most talked-about topics today—access to credit—to see the value of disaggregating small businesses. Because companies of different sizes obtain their financing from different sources, we can't talk accurately about the problems or the solutions if we lump small businesses together in one group.

Is drying up of lines of credit a big part of the problem small businesses face today? According to data from the National Federation of Independent Business, that's more likely to be the case for businesses with 1 to 9 employees, since 52 percent of businesses that size which sought to renew or extend a line of credit last year failed to get credit on satisfactory terms. That's in contrast to only 29 percent of businesses with more than 20 employees.

What about difficulty getting credit from a commercial bank? Data from the Federal Reserve Survey of Small Business Finances indicate this is more likely to be an issue for businesses with 100 to 499 employees, 86 percent of which had such loans before the financial crisis, than for non-employer businesses, only 21 percent of which did at that time.

Not all of the small businesses in each of these categories will have common needs or face the same problems, but, on average, small businesses in these different size categories are much more similar than all small businesses are to each other.

Of course, dividing small businesses into different categories will reveal that non-employers and microbusinesses, which are by far the majority of all small businesses, contribute less to economic activity than the much smaller group of large small businesses. Our political leaders might not like that pattern. The confusion generated using the umbrella of "small business" to discuss the wide range of issues facing 99.9 percent of U.S. companies might suit their goals much better.

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

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