Report Card On The States

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Ask any small businessman which state has the best business climate, and you can bet he'll give his home state as the answer. At a different time, ask the same businessman which state has the worst business climate, and you can bet he'll give you his home state as the answer.

To bring some objectivity to the process of analyzing the business climate in each of the 50 states, INC. researched over 50 factors in six areas of doing business: tax burdens, labor, capital resources, official commitment to small business, energy costs, and quality of life. We have ranked the top 10 states in each of the six areas: The rankings and an explanation of the factors involved in each ranking begin on page 92.

In addition, INC. decided to give each state a report card based on the combination of five of the individual rankings (excluding quality of life, which is so subjective). We've assigned each state a letter grade, from A through F, and published each report card in the table on pages 96 and 97.The results (10 A's, 18 B's, 11 C's, 6 D's, and 5 F's) are often surprising. You wouldn't think, for instance, of North Dakota and Idaho as states rating an A for small business climate. Both follow much the same formula for getting that grade: very high rates of small business activity (number of small companies per 1,000 population), excellent labor conditions, and light tax burdens. Both states share the same failings: weak official commitment to small business on state programs and limited capital available to home-state businesses. Idaho, in particular, gets good grades for its lower energy costs.

Minnesota has a fairly heavy tax burden, but gets an A for its efforts to attract high-technology companies. The state is one of the top five in its official sensitivity to the needs of small business, and offers a large pool of capital to its entrepreneurs. Colorado gets an A from its above-average labor climate, its light tax burden, and a positive ranking in the cost of energy.

Both Arizona and California get an A because of their governments' respective commitments to helping out small business. Beyond that similarity, the two states diverge: Arizona has a light tax burden, low energy costs, and a good labor situation, although it doesn't offer entrepreneurs much in the way of capital resources. California, on the other hand, has the second largest pool of venture capital, but is seriously weakened by high taxes and high labor costs.

While no state in the Northeast earned an A, four southern states came out tops: Texas, Mississippi, Alabama, and North Carolina. If any state could be pegged as Number 1 overall as a place to run a small company, Texas would be the one. (We wanted to avoid ranking the states' overall climates because the decision about where to do business is so complex that it grossly oversimplifies the problem to say that one state is the best place for all small businesses.) Texas made the top 10 in labor, taxes, and capital resources: more top rankings than any other state. Though Alabama is hurt by its labor climate, the state shows exceptional performance in capital resources. Mississippi is helped out by its capital resources, primarily distributed through Industrial Revenue Bonds. And North Carolina gets particularly good grades for its labor pool and a low tax burden.

The second tier of states, those that got a B, include most of the industrial states in the country. New York and Massachusetts, for example, have enormous pools of capital for small business people, but also suffer from high taxes and energy costs. Arkansas, on the other hand, offers the fifth-best tax structure and reasonable energy costs, but has little capital. And Maine has an above-average small business activity rate, inexpensive labor, and insignificant cooling costs, but its economy is one of the most depressed in the country.

Pennsylvania and Illinois both got C grades, surprisingly. Those Philadelphia banks help their state get a top-10 ranking in capital resources, but the state is hurt by high taxes, high energy costs, a poor labor picture, and an abysmal rate of small business activity. Illinois, on the other hand, has a surprisingly strong commitment to small business through government programs and a fair amount of capital, but is hurt by its labor and energy costs.

Iowa and Maryland are surprising states to get a D on small business climate. While Maryland has an awakening interest in small companies, particularly high-technology firms, it ranks in the bottom 10 for its tax burden and its energy costs. And Iowa scores well in its tax structure and its government support of small business, but is hurt by a tight labor supply and a shortage of venture capital.

The five states that earned a failing grade are, perhaps, most interesting of all 50. Hawaii is a great place to visit, but it's a tough place to run a business. It has the lowest energy costs in the country, but it's number 49 in taxes, number 48 in labor, and gets poor marks for capital resources and official support for small business. West Virginia's government is sensitive to small business, but the state ranks in the bottom five for labor, taxes, and capital resources, and has the lowest rate of small business activity in the country.

Delaware ranks in the bottom five in taxes and energy costs, and Missouri makes the top 10 for its taxes, but ranks in the bottom 20 in labor, energy costs, and capital resources. And, unless you run a gambling business, Nevada may be one of the hardest states to do business in: The state ranks in the bottom 20 in every category.

Missouri, in particular, demonstrates the difficulties in grading states on their relative business climates. INC. didn't consider transportation costs in its analysis, and that factor is one of Missouri's advantages. Its location in the hub of the country's transportation system is an extremely important factor for companies with heavy shipping requirements.

In order to compute rankings in six areas of doing business and to assign a grade to each of the 50 states, INC. programmed a computer to weigh and compare more than 50 factors, based on data from numerous sources. We weighted these factors to reflect their importance to small businesses in general. For example, the availability of venture capital is far more important to smaller enterprises than giant corporations, so INC. placed more emphasis on that factor in ranking the states for capital resources. Likewise, we de-emphasized the importance of unions in the work force, because they affect smaller businesses less relative to large ones.

In addition, INC. generalized the computer model to make sure that the results of our analysis would be meaningful to a wide range of small companies. Energy costs, though, were analyzed for a high-technology, light-manufacturing company. Therefore the energy rankings would be somewhat different if the costs had been calculated from the point of view of a retail or service business, and considerably different for a heavy industrial manufacturing business.

Generalizing factors for whole states was also a problem. Tax burdens, for instance, are not necessarily uniform throughout the whole state. Maryland and Michigan both have very high tax burdens, but some aggressive areas within both states offer substantial property-tax exemptions. And California presents a significant problem in analyzing energy costs, because the whole state spans East Coast latitudes ranging from Connecticut in the north to South Carolina in the south. The degree days required for both heating and cooling cover wide ranges between the northern and southern latitudes. In addition, California, Florida, and New York are difficult states for calculating statewide labor climates: In each, the unemployment rates are higher in the southern, urban areas than in the northern, rural areas.

Perhaps the most difficult obstacles to creating an objective and meaningful critique of the states' small business climates is the highly subjective nature of the decision about where to locate a business. Among people who study this sort of decision, the current thinking is that most start-up businesses are located where their founders live. If the entrepreneur does have the luxury of deciding where to locate, the decision is most often based on factors that affect his business directly: proximity to markets in the case of regional, distribution companies, for example. Or the decision is based purely on the owner's lifestyle.

But a state's business climate does become particularly important in the case of companies that, having reached the expansion stage, want to find a good location for a new plant or branch office. And, from the state government's point of view, the true measure of managing the business climate well comes from the performance of those small companies already in the state. Without successful small companies, no state can look for real growth.