Small businesses are dead capital

Often, when I’m reading a Forbes article and I think to myself, “This is a darned fine article,” I look at the byline to find it is another good article by Daniel Fisher.

That happened recently while reading, How the Government is Helping Hedge Funds Make Billions off IPOs.  This paragraph caused me to glance at the byline:

Hedge fund managers can thank Congress and the SEC for the opportunity [to buy early stakes in companies before they go public]. Some call it “regulatory arbitrage”: well-meaning but inherently flawed laws such as Sarbanes-Oxley that were designed to protect small investors from the next Enron have imposed such heavy costs on public companies that many private ones are delaying their initial public offerings. Venture capitalists, employees and early investors who want to sell out have little choice but to sell their shares to lightly regulated funds, which can buy stock in the next IPO at a steep discount to what retail investors ultimately will pay.

Innovation has a lot of headwinds these days. Most of it caused by (to borrow Fisher’s words) ‘well-meaning but inherently flawed’ ideas.

But I find the well-meaning and inherently flawed ideas around investing in small businesses especially annoying.

In this country you can easily sign up for an online brokerage account and buy and sell slivers of ownership in thousands of publicly traded companies on the various stock exchanges for as little as $4 per trade, with some assurance that the presence of the Securities and Exchange Commission has lowered your chances of being defrauded.

You can just as easily make personal loans to people who need cash now using Prosper.com.

You can donate money to loan to small businesses and create jobs (and make money). Well, at least you get a bracelet with that one.  Or you can lend money to entrepreneurs all over the world. You can also donate to individuals who need help funding the creative projects like a large tortoise that looks like a trading post.

But, if you want to invest with entrepreneurs here at home, it’s not so easy. You need to know somebody who wants to start a business. Or know someone who knows someone. Or you need to know a venture capitalist. Start-up investing is an opaque network of angel investors and venture capitalists.

This, folks will tell you, is for our own protection because there will be too many con men out to get you to invest in their bogus company.

But, I’d rather make it easier for everyone to invest in start-ups and let the market develop solutions to help people from being defrauded. The SEC currently makes trading equity in unregistered companies very difficult. This basically makes small businesses dead capital.

Prosper.com and Kiva.org use simple approaches to limit your risk.  First, you lend in small amounts to individual borrowers — for example, $25 — and you can diversify across many borrowers. So, if you lend to one deadbeat who doesn’t repay you, you’re not out your life savings.

Second, these sites act as an SEC and rating agency of sorts by qualifying borrowers and setting appropriate interest rates based on credit risk. Kiva.org works with organizations that administer the loans with the entrepreneurs with full disclosure on that organization’s track record.

We could use the Prosper/Kiva/Kickstarter models bring start-up and small business capital alive. A similar service could act as registration agent of sorts and market maker to connect investors and business owners and allow users to invest as little as $5 directly with entrepreneurs.

Why not? I’d rather invest directly in an entrepreneur with a chance, even if it is ever so slight, of getting a return on that investment than donate it with the assurance that I won’t.

Too much education?

The local newspaper recently published a letter to its editor from a teenager complaining about her homework load.  Four hours of homework along with extracurricular activities and volunteer requirements is stressing her out and doesn’t leave her time to have a job, so she wrote.

Most of the online comments to her letter were of the “life’s tough kid” type.

But, I happen to agree with this whiner.

In this post, I suggested one reason the average age at which folks made significant contributions to their respective fields had increased over the last 100 years is because we’ve occupied more of their time with expanded education requirements.

Maybe a broad education, high extracurricular involvement and volunteerism is good.  But, there may be costs too.  I can think of couple costs.

One cost is innovation.  We train the initiative and self-direction out of folks by laying out the steps for them.  As Seth Godin pointed out (see this blog post), our education model churns out “predictable, testable and mediocre factory workers,” rather than folks inclined to discover the next Google or Facebook.

Another cost is maturity and experience.  We insulate and delay students from the harsh realities of the real world — like having to make a tough choice between work or playing sports, spending on a budget, coping with failures and setbacks and figuring out how to  produce something others value.

I read that companies say that college hasn’t prepared students for the work force.  Maybe.  Or maybe the students have been kept so busy with the curriculum and extracurricular activities that they haven’t accumulated as much work experience as previous generations had by the same age.

I wonder how many folks get their first significant job after they graduate from college.  Or, more importantly, how many years of (any) work experience the typical new college grad has now compared to 30 years ago.  How many folks are learning key work lessons — like the importance of a well-groomed appearance, showing up on time and meeting deadlines — at 25 years of age instead of 15?

Where do jobs come from? II

Here’s a nice follow-up to this post on jobs via Marginal Revolution.

The chart on Mother Jones blog shows a declining trend in the number of new jobs from startups since the late 90s.

It seems there are a few possible explanations.

Maybe startups are creating fewer jobs in the U.S. because they are hiring overseas.

Perhaps there are just fewer startups.  Maybe fewer startups are a demographic artifact.  It seems like baby boomers may have been around peak startup age in the 90s.

Or, maybe this evidence supports Nothhaft’s contention that government regulation is suppressing startup activity.  Regulation certainly doesn’t seem to help startup activity.  Perhaps regulation is good, but as always, there are trade-offs.  Startup activity and fewer jobs may be one of those trade-offs.

Megan McArdle is “Very Sorry”

In this blog post about Small Business and Income Tax, Megan McArdle explains that ‘we’ [presumably meaning the government] need to raise taxes:

So I end up thinking that it [tax increases] will effect small business, that I’m very sorry about that, but that we need to go ahead and raise the taxes anyway.  I feel the same about taxes on the middle class.

…we need money to cover promises we shouldn’t have made decades ago.  The current structure of our federal budget isn’t sustainable, which means we’ll all have to learn to get by on a little less–including small business owners, and the people they employ.

Two questions for Megan:

  1. What if raising taxes on small business and the middle class reduces the net present value of the value of the money needed to “cover promises we [again with the we?] shouldn’t have made decades ago”?
  2. Have you considered lowering government spending?

Earlier in the blog post, Megan expresses doubt that small business is the job growth engine Republicans claim it to be:

…Republicans… have been…exaggerating the extent to which the average small business creates jobs (job growth is mostly concentrated in a handful of fast-growing ones that don’t stay small).

While it’s not entirely clear why Megan included that remark, the only reason I can think to include it is that she thinks this concentration, if it exists, matters.

Is she reasoning that not all small businesses matter that much for job growth, just those that are growing fast?

If so, I disagree.  It’s hard to predict which small businesses will not “stay small.”  Read The Black Swan.  We wouldn’t do ourselves any favors by hampering small businesses.  We should be happy with as many small business experiments as we can get.  Only a small percentage will grow big.  Reduce the number of small business experiments and you may reduce the number of those that grow big.

Even without the “grow big” argument, I see no reason to hamper small business.  Small businesses employ significant numbers of people and they make our lives better through the products and services they offer us.

It is a bit frustrating when I see someone like Megan, who admitted on an EconTalk podcast about her struggles to manage her personal finances (i.e. make tough choices), who wants to force tough choices on others because she thinks its the right thing to do.

It’s even more frustrating when someone like her makes such suggestions without considering that she might not have thought it through well enough and thought through other options, like cutting government spending.

UPDATE: At least in this post, Megan thinks that small businesses that don’t grow large have value.