Back to Public Sector SupportBy Michael T. Childress and Michal Smith-Mello; Peter Schirmer
From Entrepreneurs and Small Business—Kentucky’s Neglected Natural Resource
pp. 70-76, published 1998
By many aggregate measures, the products of Kentucky entrepreneurship are not of the quantity nor the quality we would hope for. Instead, the state’s performance by a number of traditional measures is anemic at best. As we noted previously, however, the rural character of our state and the resultant dilution of resources blur the portrait of made-in-Kentucky entrepreneurship. Because, among other things, urban populations are more educated, enjoy significantly higher earnings, and form far more businesses, the Commonwealth’s poor overall performance by a number of measures is a reflection of the historic weaknesses of rural economies. Nevertheless, the products of Kentucky’s comparatively weak inputs suggest real promise. Here we examine some traditional outcomes and explore the impact of the rural character of our state on selected measures.
Perhaps the most significant measure of the outcomes of a state’s economy is its ability to produce results in the lives of its citizens. Between 1994 and 1996, median household income in Kentucky rose at the third fastest pace in the nation (7.2 percent), but historic and persistently high rates of poverty dilute the impact of even high rates of growth. Only nine states, including neighboring Tennessee ($30,327) and West Virginia ($25,270), reported lower three-year averages for median household income between 1994 and 1996 than Kentucky ($30,420).(1) As previously noted, the poverty rate declined by less than a percentage point between 1995 and 1996. While this represented a decline from a three-year average of 17.9 percent between 1993 and 1995(2) to 17.0 percent in 1996, the rate was exceeded or matched by only six other states and the District of Columbia, according to the U.S. Bureau of the Census.(3) To close the economic gap between Kentucky and other states, it will be necessary to continue high rates of income growth, a goal that makes entrepreneurial development key to the state’s future.
The numbers of self-employed individuals, nonfarm proprietorships and business establishments also help gauge the entrepreneurial vitality of a state’s economy. Though none of these are synonymous with entrepreneurs and the data exclude farmers, they serve as reasonable indicators of entrepreneurial energy. Self-employed individuals and nonfarm proprietorships, for example, represent what the Kentucky Science and Technology Council terms the entrepreneurial supply market or the seedlings of new enterprises. These are typically very young firms with no business plan or institutional sources of capital. Many self-employed individuals work from their homes, more than 4.1 million nationally.(4) Though they ordinarily serve local markets exclusively and do not offer substantial potential for expansion, growth in their numbers may indicate the entrepreneurial vitality of a state. If the climate is conducive to entrepreneurship, the number of people willing to accept the risks of running their own microenterprise, it would seem, multiplies. As illustrated in Figure 1, the number of self-employed individuals in the United States has been steadily increasing since the late 1960s.
Figure 1: U.S. Self-Employed Workers, 1963-2005
The number of self-employed workers in Kentucky, as illustrated in Figure 2, is estimated to be comparable to those in surrounding states. As shown, Ohio, Virginia and West Virginia have more self-employed workers per 1,000 population, an outcome that suggests mixed interpretations of these data. While Virginia and Ohio have successful entrepreneurial economies, West Virginia’s high population of self-employed workers may be a consequence of limited employment opportunities.
Figure 2: Self-Employed Workers, 1995
Accordingly, an important caveat about self-employed workers should be noted. Carlos Craycraft, a labor market analyst with the Division of Employment Services, observes that it is generally theorized that a robust economy such as today’s attracts more individuals to formal employment opportunities. Conversely, economic downturns force more individuals to generate income through self-employment. The frequently informal or off-the-books nature of self-employment complicates the already difficult task of capturing data about these individuals. Consequently, Craycraft terms estimates of the self-employed in Kentucky as less than reliable. Ironically, according to Craycraft, at a time when self-employment is increasing nationally, the Bureau of Labor Statistics, to which the Division of Employment Services reports, has established no new methodology for collecting data about this important employment sector to replace one that is no longer used. Employment Services estimates that Kentucky’s self-employed population increased 4.6 percent between 1994 and 1996, from 123,679 to 129,405. However, the Small Business Administration estimates the state’s 1996 self-employed population at 113,000.
Total nonfarm proprietors’ income in Kentucky was among the lowest in the southeast region and among surrounding states in both 1994 and 1995, according to the Bureau of Economic Analysis. Only Mississippi and South Carolina in the Southeast and surrounding states West Virginia and Missouri registered lower nonfarm proprietors’ income levels in 1995. However, Kentucky’s rate of growth in nonfarm proprietorship income between 1994 and 1995 (8.6 percent) exceeded the national average (8.0 percent) and was ranked 19th nationally.(5) Again, the state’s relatively low income levels are reflected in proprietorship income, just as they are in virtually every measure of economic well-being in the Commonwealth. So long as incomes are diminished, the proprietors of small businesses and microenterprises can expect their earnings to be adversely affected. In short, dramatically reducing poverty is in everyone’s best interest.
A fairly steady stream of new firms has emerged annually in Kentucky, ranging from a low of 7,406 in 1985 to a high of 9,078 new firms in 1995. Between 1994 and 1995, the number of new firms increased by 12.6 percent, ranking seventh in the nation, according to the SBA’s Office of Advocacy, a growth rate in which the Corporation for Enterprise Development sees strong development potential.(6) According to recent SBA figures, in addition, Kentucky ranks 44th in the number of new firms per 1,000 population. To many, these SBA figures confirm Kentucky’s inability to create, nurture and grow high-performance companies. However, if we rank the number of new firms per 1,000 urban population, Kentucky moves from 44th to 23rd.
While Kentucky ranked 13th nationally in the percent of change in small business bankruptcies between 1994 and 1995, 11 states experienced essentially the same .6 percent rate increase, which was below the national average of .8 percent. Over the course of the 1985-1995 decade, according to SBA, bankruptcies among Kentucky small businesses have essentially been cut in half, from 997 in 1985, to just 473 in 1995. Business failures in Kentucky have seesawed somewhat over the last decade, from 983 in 1985, to a high of 1,234 in 1991, to a low of 322 in 1993. Between 1993 and 1994, they more than doubled but dropped again in 1995 to 663, for a ranking of 34th in the percent change in business failures between 1994 and 1995. Further indication of rising business stability is seen in the number of business terminations in Kentucky, which reached a decade low of 9,307 in 1995, compared with 10,385 in 1985, and a high of 11,276 in 1990.
Those enterprises that accumulate sufficient capacity to make an initial public offering (IPO) of stock in their companies are able to achieve very rapid growth. But IPO data is, at best, an imperfect measure of a state’s entrepreneurial capacity. As Harvard Professor and MACED’s Innovator in Residence Greg Dees observes, a measure of self-selection is involved based on the growth objectives of a firm. The very nature of some businesses precludes the need to go public in order to generate capital to finance growth objectives. Additionally, IPO data by states in which firms are incorporated rather than headquartered, for example, may be primarily a reflection of the tax and regulatory environment of that state, rather than its entrepreneurial capacity. Indeed, only a tiny fraction of some of the fastest growing companies in the nation opts to go public. Most simply never become large enough to issue an IPO while others choose to remain private.
In 1996, Inc. magazine published a progress report on its 1985 class of Inc. 500 firms, an annually compiled list of the fastest growing U.S. firms. Among the 1985 Inc. 500, 48 percent of the firms were still privately held, but only 6 percent had gone public even though these select firms were far more likely to go public than the average U.S. firm.(7) Though only a small percentage of the 1985 Inc. 500 class went public, those firms that did—including Microsoft—enjoyed dramatic growth, growing by $18.9 billion in revenues and creating almost 60,000 new jobs.(8) Clearly, publicly traded growth companies are, as the Louisville Area Chamber of Commerce observes, powerful engines of economic growth. Their presence serves as a measure of a state’s success in creating and supporting successful entrepreneurial ventures. In 1993 and 1994, according to the Securities Data Company, the United States had $70 billion of initial public offerings, as much as in the previous six years combined.
The recent contributions of companies headquartered in Kentucky, however, have been somewhat anemic. Between January 1, 1993, and December 31, 1995, only 6 companies headquartered in Kentucky went public compared with 31 in neighboring Indiana and 54 in Tennessee.(9) However, when examined in light of Kentucky’s "ruralness," a far less damning performance emerges. As shown in Figure 3, a simple comparison of total numbers finds Indiana with five times and Tennessee with nine times more IPOs than Kentucky between 1993 and 1995. However, after controlling for the Commonwealth’s high rural population, the differences narrow considerably. Indiana had 2.3 times and Tennessee has 4.8 times as many IPOs during the given time period. More recently, however, Goetz and Freshwater report for the Kentucky Science and Technology Council that Kentucky ranked 17th in the nation in critically important technology-sector IPOs per million persons during 1996 and 1997. Importantly, only 23 states reported at least one filing for technology IPOs during this time period.(10)
Since 1982, Inc. magazine’s annual Inc. 500 list has provided a compendium of the nation’s fastest growing firms ranked by their rate of growth. Again, this widely used measure of entrepreneurial capacity is less than perfect because significant self-selection is involved. Companies apply for inclusion on this annual "who’s who list" of entrepreneurs, and the information they submit is independently verified by certified public accountants who review tax records and other documents. Further, Inc. looks only at the growth rates of independent, privately held firms that had a minimum base of sales revenue five years prior to the list’s compilation. In 1997, for example, applicant firms were required to have 1992 sales of $200,000.
Firms that seek inclusion on the annual Inc. 500 list may do so to heighten their presence in the marketplace and broaden their customer base or, perhaps more importantly, to attract capital from venture firms or other investors. Some firms, like Tekno in Cave City, which designs and builds automated manufacturing systems, and Louisville-based Tova Industries, which manufactures dehydrated food products, have made multiple appearances on the Inc. 500 list. But many high-growth companies simply never bother to apply for recognition of their high-growth status.
In spite of its limitations, the Inc. 500 list indicates the aggressiveness of the entrepreneurial community in a state. However, the aggregate number of appearances on the Inc. 500 list tells us little. The number of appearances is a reflection of a state’s population and, we find, the level of urbanization of its population. In an analysis of Inc. 500 firms in all 50 states, we found a strong bias toward urban centers. Indeed, there is an almost perfect correlation between a state’s level of urbanization and how many Inc. 500 companies it has (r=D.91).(11)
Kentucky not only has a far smaller population, it is a far more rural state than the larger community of states surrounding it. Only West Virginia has a smaller population and a smaller portion of its population living in metropolitan areas, 40.8 percent versus 48.5 percent in Kentucky. By contrast, neighboring Ohio (11 million; 81.3 percent urban) is among the most populous and most urban states in the nation. In the Southeast, only Florida is more populous and more urban than neighboring Virginia (6.4 million; 74.2 percent urban). The sheer volume of high-growth Virginia firms appearing on this annual list serves to illustrate the magnetic power of urban centers, in this case, the Washington, DC, metropolitan area where a substantial portion of the state’s Inc. 500 firms are based.
Figure 4 compares the Inc. 500 performance of Kentucky firms with that of firms in selected surrounding states in light of metropolitan population. As shown, the wide disparity indicated by totals alone disappears completely when these data are controlled for urban population. Indeed, these data suggest that Kentucky possesses strong entrepreneurial capacity. Consequently, a measure often used to illustrate Kentucky’s entrepreneurial weaknesses reveals a far different picture, one of considerable strength, when examined in light of urban population.
Figure 4: Inc. 500 Firms, Kentucky and Selected Surrounding States, 1982-1995
As in the rest of the nation, Kentucky’s Inc. 500 firms have been concentrated heavily in the state’s urban triangle formed by Northern Kentucky, Louisville, and Lexington. Given the strong urban bias of the Inc. 500, the inclusion of such firms as Tekno in Cave City (1994, 1995 and 1996), Halton Company in Glasgow (1995), which designs and manufactures ventilation hoods for commercial kitchens, and Dippin’ Dots in Paducah (1996, 1997), which manufactures novelty ice cream products, shows entrepreneurial strength in regions generally underrepresented on this annual list. Consequently, Kentucky’s show of entrepreneurial strength in what would ordinarily be regarded as unexpected places, namely rural areas, may suggest enormous potential.
Arguably, the current pace of income growth in Kentucky is attributable to the state’s diverse, small business-dominated economy, which is enjoying increased stability and growth in today’s robust national economy. In order to capture more of the Commonwealth’s development potential, sustain recent rates of income growth and broaden its impact, it will be necessary to enhance the entrepreneurial capacities of individuals and communities. To do so, Kentucky must substantively improve the critical raw material of entrepreneurial development in this state. The preparation that educational institutions at all levels provide for the era of entrepreneurship in which we live, for example, is key to the ability to generate innovation and execute ideas. Moreover, our focus on services that are key to the cultivation and development of entrepreneurs and small businesses must be broadened.
Ultimately, we must fashion a development policy that not only recognizes the vital role that development from within plays in the economic health of our state but also works on a range of fronts to advance it. Through efforts that combine local, regional and state resources, we can liberate more innovative ideas, nurture them into fruition, create jobs in unexpected and unlikely places, and raise income throughout the Commonwealth. These efforts are especially likely to be of benefit to rural communities, for which too many leaders see migration to urban centers as the only solution to economic woes.
Ahead to Trends Influencing Entrepreneurial Development
U
.S. Bureau of the Census, March 1997 Current Population Survey (Washington: U.S. Department of Commerce, 1997). Return to text.U
.S. Bureau of the Census, Poverty in the United States: 1995, Series P60-194 (Washington: U.S. Department of Commerce, 1996). Return to text.U
.S. Bureau of the Census, Annual Demographic Survey, March Supplement (Washington: U.S. Department of Commerce, 1997). Return to text.Bureau
of Labor Statistics, "Work at Home in 1997" (News Release), U.S. Department of Labor, Washington, DC 11 Mar. 1998. Return to text.USSBA
, "Small Business Economic Indicators," online, USSBA Office of Advocacy, Internet, Aug. 1997. Return to text.USSBA
, "Small Business Economic Indicators." Return to text.Martha
E. Mangelsdorf, "The Startling Truth About Growth Companies," Inc. 15 May 1996: 84-91. Return to text.Mangelsdorf
. Return to text.Louisville
Area Chamber of Commerce 7. Return to text.Goetz
and Freshwater. Return to text.We
did not include California in the analysis because it is an egregious outlier. If California is included, however, the correlation (Pearson’s r) is still quite high at 0.85. The number of Inc. 500 companies is the average number of Inc. 500s in the state during 1984, 1989 and 1994. The population number is the average from 1985, 1989 and 1993. The percentage urban is the average from 1980 and 1992. Return to text.