“The Mass Extinction Event for startups is under way,” a partner for a well-known venture capital firm warned in a recent article in the Wall Street Journal. Capital from venture investors and bank loans is “scarce and expensive” and “venture-backed startups are running out of money and facing hard choices”.
The numbers support this: venture capital funding in the first quarter of 2023 was only at 40% of the levels seen in the fourth quarter of 2021. But mass extinction?
Maybe for people starting up tech businesses based on a shaky premise and dubious cashflow projections that venture capital firms let fly because money was so cheap and the competition to find the next Uber or Facebook took priority over common sense. Venture capital funding may be in the doldrums right now, but the industry will ultimately recover and is already making investments in the new generation of AI startups that are popping up everywhere.
Meanwhile, in the real world that is the rest of the country where people aren’t creating AI solutions and instead are opening up restaurants, real estate firms and healthcare services companies, entrepreneurism seems to be doing just fine.
The US Census Bureau tracks those applying for an employer identification number (EIN) from the Internal Revenue Service – an excellent way to determine the number of new businesses because a startup needs an EIN to file tax returns, apply for loans and form an organization. What do these numbers show? They show that there have been a lot of people starting up businesses over the past few years and that those levels remain high.
The total number of startups from January 2019 through May 2023 was 20.5m. But I like to focus on what the Census Bureau calls a “high-propensity business” (HPB), which is likely to hire people, because to me – and no offense to all the freelancers, independent contractors and side-giggers out there – that’s a real business. The number of HPB startups during that period was 6.9m. Not only that but there were 1.3m HBPs started in 2019, 1.5m in 2020, 1.8m in 2021 and 1.7m in 2022 – and so far through May of 2023 there were 721,000 HPBs started, which annualized is on a track to reach 1.7m.
There’s no denying that capital is more expensive. The average bank prime rate nationally is about 8.25%, which means that even existing small businesses are paying anywhere from that to 11% on new financing, a rate much higher than just a year or two ago. But that doesn’t seem to be hurting startups. Lending rates to small businesses from traditional banks, while down from a year ago, appear to be holding steady, according to the financing firm Biz2Credit.
And most startups don’t get their financing from traditional banks. Data from the alternative lending platform Lendio shows that 54% of entrepreneurs started their business with personal funds, of which there is plenty, thanks to the high historical levels of household wealth. According to Lendio, the average loan amount for a small business owner is $47,000, which is not a giant number. For people starting a business, there’s plenty of capital available. And while it may be a little more expensive, it’s certainly not as dear as giving away half your company to a venture capitalist.
“In 2021 and 2022, the US saw more small business funding applications than ever before,” said Mark Cottle, Lendio’s executive vice-president.
So is there a “mass extinction” for startups under way? Not a chance. There are too many people working from home that want to be their own boss. There’s still plenty of capital available. Despite the woes of Silicon Valley tech companies, Americans are starting businesses in record numbers. Just look at the numbers.