The Entrepreneurial Numbers Game

My first assignment as INC.'s new man in Washington looked to be a snap: get a statistical handle on the much-bally-hood Age of the Entrepreneur. Take its pulse. Gauge its scope. Tell us how big it really is.

For an old hand at Pentagon coverage, this project promised a painless transition to the world of business journalism. And what with all the government bureaus, think tanks, and national organizations crammed into the capital city, each with its own research staff, economists, and computers, here was a first assignment assured of success.

Little did I realize that my journey into the bewildering jungle of economic analysis would suck me deeper and deeper into a kind of statistical quicksand. At each step, I learned a little more. And the more I learned, the less I knew.

The question was simple enough: How many new businesses are formed each year in the United States?The place to start, it seemed clear, was with the number of new incorporations, which had been accelerating briskly for more than a decade. In 1973, corporate commencements were running at an annual rate of some 330,000. Ten years later, they hit 600,000. To many, these numbers are proof of an economic robustness and renewed faith in the American dream.

"For those of us who have been looking at this for a while, the numbers are just breathtaking," said David Birch of Massachusetts Institute of Technology, who is perhaps the nation's most well-known authority on small-business activity. "When we hit 600,000, I said, 'That's it, it's got to plateau.' But it's been continuing at this blistering pace. It's approaching 700,000 now."

The sole source for these numbers on "new incorps" is The Dun & Bradstreet Corp., the country's premier business-research outfit, which sends its reporters each month to all 50 statehouses to count new certificates of incorporation. D&B's numbers are virtually regarded as gospel. As one government economist told me early in my inquiry, they are "the base from which everybody starts."

Thus I was somewhat taken aback when I finally reached D&B's chief economist, Joseph W. Duncan, on the telephone at his office on Park Avenue. "New incorps is a bad number," he was quick to caution. "A lot of people incorporate for future use or for tax or legal purposes and are not really measures of business activity."

Duncan gave the example of a real estate developer who decides to incorporate separately each cul-de-sac in a large housing development, in order to limit legal liability if things should unexpectedly take a turn for the worse. "From an economic point of view, it's one development. But from a new incorporation point of view, it might be 10. I look at that and say it's a fake number."

How much of this kind of activity is factored into the numbers, I wondered. Incorporation could reflect the changing legal status of an existing business -- a partnership or sole proprietorship -- rather than the birth of a new economic entity. Or it could reflect nothing at all -- just a shell corporation established by an individual with an idea or a scheme.

"You find a lot of problems with these sham corporations set up as tax dodges," explained Marc Levinson, a senior editor at Dun's Business Month, in New York City. "Take your typical family corporation. You have a regular salaried job, but you set yourself up as a corporation and channel money through it to yourself because there is some tax advantage for you. It's not really a business, and it has no economic significance apart from tax avoidance. The statistics on corporations are cluttered with companies like that."

Levinson's words were disheartening. I had expected to be on solid ground with the D&B figures, and now things were turning swampy. I could almost feel the quicksand oozing around my ankles.

Looking for help, I called the National Federation of Independent Business (NFIB). A Washington lobbying group with some 500,000 member companies, it seemed a likely repository of bedrock information on business formations.Instead, spokesman Jim Weidman expressed his own doubts about incorporation statistics.

"Given the litigious nature of virtually all business dealings now, if you are incorporated, at least you can limit your liability," Weidman explained, suggesting that many recent incorporations represent not so much a yen for entrepreneurship as a need to hide behind the legal protections of incorporation. "In a corporation, all you stand to lose is your business and your livelihood.If you're not incorporated, you can lose everything."

Weidman seemed to be on to something. A recent survey by the American Medical Association, for example, showed that 54% of all physicians in private practice are now incorporated, compared with 31% a decade ago. B. J. Anderson, an AMA attorney whom I reached by phone in Chicago, explained that the threat of malpractice suits was a major impetus for doctors to incorporate.

The lawyers who bring those malpractice suits are not so dumb, either. Lawyers, too, are apparently incorporating at a brisk pace, individually and in small groups, even within a larger firm that itself is incorporated. Like the doctors, their fear is malpractice litigation. The American Bar Association, however, says it is keeping no figures on the trend.

I felt myself sliding deeper into the morass. Could it be that a big chunk of the fabled entrepreneurial explosion was nothing more than a reshuffling of the old order? Once again, I decided to seek the counsel of David Birch, who suggested looking at the question from a slightly different angle.

Fortune 500 companies, Birch explained, employ 2 million fewer people today than at the start of the decade, even as their sales, in real terms, have increased. Part of that comes from productivity growth. But part is due to subcontracting for work formerly done in-house. To compete internationally, he said, big companies need more flexible labor forces. One way they do that is through subcontractors that they can crank up and down as needed.

These new small corporations are in many cases the beneficiaries of the trend, Birch theorized. "When the large firms increase their employment, as they did in the late 1970s, the rate of start-ups slows down. And when the large ones really have problems, as they did in 1981 and 1982, the growth rate of small businesses accelerates."

The number of new incorporations was looking rather miscast as the seismograph of the entrepreneurial explosion. To be sure, the number exaggerates the dimensions of the phenomenon. But by how much?Surely somewhere in the great statistical maw of Washington, I thought, the numbers are crunched with some precision.

My next stop was only a few blocks from the White House, at the cramped office of Bruce D. Phillips, who directs a database research project for the Small Business Administration. His little room had a professorial disarray about it, with overstuffed file cabinets and untidy stacks of books and journals. I felt confident he would have a handle on the number of new businesses in America.

Not exactly. Phillips said that the SBA, like virtually all government agencies, relies heavily on D&B incorporation statistics, which he admitted were "hazy" at best. "To be sure, it's not 600,000," he opined. "If you ask me how many I think go into business, I'd say two-thirds to three-quarters, based on the number of new tax returns filed every year."

The Internal Revenue Service -- why hadn't I thought of it sooner! What arm of government has a more intimate knowledge of American business than the dreaded taxmen? A quick trip across town yielded a fat little pamphlet full of all manner of tax minutiae called the Statistics of Income Bulletin. The bulletin showed there were 2.9 million corporate returns in 1982, the last year for which figures are available. But I noticed that the totals showed disappointingly small gains year to year -- about 100,000 annually from 1980 to 1982. That was a far cry from the half a million new incorporations logged each year by D&B. Worse still, it was also apparent that not all of the corporate returns represented entrepreneurial success stories. Of a total 2.9 million corporate returns in 1982, just over 1.6 million reported any profits.