Understanding Rural Business Success

Trying to understand the factors that lead a local start-up company in your community to succeed is never easy. With more than half of all small business ventures never successfully emerging from the survival stage (typically the first five years), it seems like the deck is stacked against them from the start. Yet, from the viewpoint of an economic development practitioner, you want to assist small business owners in your community grow, but clearly you can’t assist them all.

While there is no “secret sauce” that can be identified to easily predict business success, the EDA Center at the University of Minnesota, Crookston wanted to further explore this question. So instead of identifying probable factors that might lead to business success and examining their importance, the EDA Center took an inductive approach and first identified successful rural businesses and then sought to understand what factors they might have in common.

With the help of the Regional Development Commissions across rural Minnesota, we identified close to 70 rural businesses that met our criteria of “success.” First, we wanted businesses that have cleared the survival stage of development and were ready and poised for growth. This meant that we wanted companies that were at least 5 years old, but no older than 15. And second, we wanted to identify companies that were clearly growing in sales and employment. Using these criteria we collected information from 62 successful rural businesses.

Of the 62 companies examined, the average number of years in business was 7. The overwhelming percent (75%) were incorporated or were structured as a limited liability company ( LLC); with only 22 percent reporting being structured as a sole proprietorship. The average annual sales were approximately $1 million, but 12 percent of companies reported sales of $10 million or more. And most importantly, the businesses represented a wide range of industries; from manufacturers to information technology, to construction, to food processors. It was a diverse group of businesses with no specific industry clusters identified. Clearly, if you were trying to identify a specific industry to build your economic development plan around, you would have a difficult time. What was more easily identified were the characteristics of the business owners and founders themselves. Here in many ways the similarities were unmistakable. Below are some of the most salient characteristics:

A Business Pedigree: Two-thirds of our successful business owners reported having other family members/parents who also owned businesses; and half of them reported having previously started a business prior to the one they were currently operating.

Value Experience over Education: More than 80% of these successful business owners had over a decade of experience in their current industry prior to starting their own business. And while they valued education, 52 percent reported having an Associate’s degree or less; and 88 percent reported having no higher education beyond the Bachelor’s degree. Clearly, they valued experience and industry knowledge over formal education.

Be Invested from the Start: More than 90 percent of the business owners reported investing their own capital into the business before their start-up; and more than half indicated that they devoted themselves full-time to the business before even registering it. More than 70 percent reported that they had a formal business plan in place; 75% formed a legal entity and 46 percent even organized a team of employees prior to registering the business. Equally interesting, in a time when it appears that many businesses and business start-ups seek government funds or tax breaks to launch their business, more than two-thirds of these successful owners reported that they never even sought government support in the development of their business.

Look for a Hands-on Owner: It was also equally clear that these successful business owners were not hands-off managers. Rather they were completely invested in the financing, operations and management of their companies. 90 percent reported that the business was either moderately or extremely dependent upon the owners’ technical/operational skills; and 92 percent reported being dependent upon the owners’ managerial skills.

Growth-Oriented and Optimistic: It is also evident that these successful business owners are both growth-oriented and optimistic about the future. Approximately 70% report plans to introduce new products and services in the next 12 months; 48% report plans to increase their number of full-time employees; and two-thirds report plans to purchase additional capital equipment.

And lastly, their while some economic pundits report an atmosphere of economic uncertainty holding back businesses from hiring new employees, these business owners were asked how they would react to a 100 percent increase in their number of employees over the next 5 years? Not surprisingly, 19 percent of owners reported that such rapid employment growth would be looked upon negatively; however, 60 percent reported such a rapid growth scenario as either “positive” or “very positive”.

So what’s the secret sauce to business success? Well I’m not sure if this study sheds enough light to answer that question, but it suggests that it has more to do with the orientation and characteristics of the business owner than the business itself. As some point out, “you don’t put your money on the horse race, you bet on the horse.”

Is Government Too Large?

Few issues have captured the attention of Congress in the past year as much as the national debt; and with the debt now exceeding $14 trillion, who could blame them. In the long run an unsustainable national debt will wreak havoc; not only putting the U.S. in an economically and politically fragile position, but it will draw government resources away from providing important public services to simply servicing this burgeoning debt. At the same time an obsession with the national debt can at times paralyze a government; as we saw when even a simple, noncontroversial appropriation to fund FEMA for routine disaster relief became a battle over debt reduction. With a belief that government has simply grown too large, some are trying to turn every political decision into a referendum on the growth of government.

Here in Minnesota the issue is not exactly debt reduction, as the state is required to have a balanced budget; but in many ways the sentiment is the same. Policymakers are concerned about the growth in state government and last session some even sported penny lapel pins, symbolizing their opposition to spending “one penny more.”

Writing this post near the doorway where we have a growth chart that has tracked the height of our four kids, makes me think about how we actually measure growth. Clearly for many in St. Paul, the simplest way to measure growth in government is by examining the amount of money the government spends. And using that measure, there is no doubt that our state government has significantly grown. For example, in 2000 Minnesota’s annual general fund expenditures was approximately $12 billion and by 2010 it had increased by approximately 40 percent to $17 billion. But is simply looking at expenditures really the best way to measure growth in government? After all, we all know it takes more to build and maintain a mile of road today than it did in the year 2000. So should those added costs be considered growth in government?

Another growth measure tracked by our state is called the overall price of government. This measure views how much our government spends as a percentage of our collective personal incomes. The argument here is that while government expenditures rise, so do our personal wages and incomes. So the real concern should be whether government expenditures grow faster than our personal incomes. Using this measure a different story emerges. According to the Minnesota Department of Management and Budget, in FY 2002 the cost of all state and local governments combined was equal to 15.5 percent. Or put another way, for every dollar of our personal income, 15.5 cents was paid to our state, county, municipal, township and school districts for their services. Comparatively for FY 2012 that amount is now 15.8 cents out of every dollar; far from the 40% growth seen when simply looking at gross expenditures.

Still others suggest that the best measure of growth in any organization is by examining the number of workers it employs. Organizations that continually increase the size of their workforce are clearly growing, right? In fact, a bill submitted this past legislative session was designed to reduce the number of state employees by 15 percent. So I again went to the Minnesota Department of Management and Budget to find out just how large the state’s largest employer actually is. There I learned that at the beginning of the decade in 2001 the State of Minnesota employed 32,608 (full-time equivalent) employees and at the end of the decade in 2010 the employee FTE count was 32,786. This change actually represents less than one percent growth in state employees throughout the decade. Further, it should be recognized that during the decade Minnesota’s population grew from 4,919,479 in 2000 to 5,303,925 in 2010. Looking at it another way, in 2001 Minnesota employed 1 state worker to provide services for every 150.8 Minnesotans and in 2010 one state worker serviced 161.8 Minnesotans. Using this measure, not only has the Minnesota workforce barely grown, but it has increased its efficiency as well.

So how exactly should we measure the growth in government; and is the size Minnesota’s government growing out of control or isn’t it? Well, the simply answer is that you have to use your common sense. For example, it’s important to remember that not only do things cost more today, but a significant percentage of the revenue our government spends gets returned to the private sector through the procurement of contracts to build roads, bridges and buildings. Should these contracts with the private sector employers also be considered growth in government?

After all, politicians, lobbyists and other public officials love to toss numbers and statistics around in an effort to convince you that their interpretation represents the “truth”. But in the end I can’t help remembering the words of my college statistics professor many years ago when he noted, “If you torture the statistics long enough, they will confess to anything!”

Jobs, Jobs, Jobs

I was recently in my car listening to one of those personal finance shows on public radio on a day when the Dow dropped 250 points due to a weaker than expected jobs report. Given that the news about the disappointing jobs report was being replayed every 30 minutes, the show’s host said in jest to the guest being interviewed that he would try to get through the interview without using the word “jobs.” Needless to say … he failed miserably.

Public officials of all political stripes now appear to have a renewed focus on jobs, as they are coming to realize that the term “jobless recovery” is nothing but an oxymoron. You simply cannot have a full economic recovery with 9 percent or more of your workforce sitting idle and unemployed. At the same time many politicians are acting schizophrenic in deciding what they want our government to do. Some point out forcefully that government does not create jobs … the private sector creates jobs. Yet without taking a second breath they are quick to chastise the government for not doing enough to create jobs. Only in politics can such contradictions make sense.

So now that it’s official that jobs will be the central focus of our economic and political debate between now and the 2012 elections, I thought I might offer my take on the matter. Below I have outlined two simple principles that comprise my thoughts on stimulating a full jobs recovery:

Principle # 1 Every Job Counts: Our economy is comprised of jobs in the private, public and nonprofit sectors and they all are important to our economy. A worker in the private sector making $40K per year pays the same income taxes, property taxes and affects consumer spending the same way a government worker earning $40k. And a job layoff in state or local government affects the unemployment rate the same way a layoff in the private sector does. So if your priority is getting the workforce back to work understand that ALL JOBS COUNT. Accordingly, political efforts designed to directly or indirectly reduce the size of the public or nonprofit workforce may yield some other benefits, but it will certainly work counter to and slow down the recovery to full employment. As I noted a few months back it’s like dancing the Cha-Cha, taking two steps forward and one step back.

Principle # 2 The Demand Curve Drives Jobs: For decades state and federal governments have tried gimmick after gimmick to encourage private businesses to create more jobs. These include tax credits and various forms of tax relief, de-regulation, tax increment financing, low-interest loans … the list go on and on. Former Governor Pawlenty was proud to call his JOBZ program “tax increment financing on steroids.” The truth is that most of these schemes have had limited success in creating long-lasting jobs and they create other economic inequities that are more problematic in the end.

Of course the rationale behind these programs is the belief that if a company has a stronger bottom line it is more likely to create a job; but in many ways this is a false premise. Creating a job is not an act of generosity, charity or a quid pro quo for a government tax break. Rather creating a job is a rational business response to changing business conditions. When the demand for your goods and services exceeds your capacity to satisfy your customers’ needs, you expand your workforce or risk losing customers to your competitors. Simply put, you can give the owner of the local car dealership all the tax breaks you want - heck - you can eliminate his taxes all together. But unless more people come through the door seeking to purchase cars or to have more of their cars serviced, there is absolutely no reason for the dealer to create jobs and expand his workforce.

And that is exactly where I believe we are with the U.S. economy today. Many corporations are in fine fiscal health sitting on significant amounts of cash, but the sustained demand that will spur job growth is simply not there. And in an economy where 70 percent of economic activity is associated with consumer spending, increased demand will always be directly tied to the resiliency and strength of the middle class. Unfortunately, many economic indicators suggest that the health of the middle class is not that good. In fact there are many economic indicators that suggest that the middle class has been shrinking for decades as income inequality continues to grow. Average wages have been stagnating or shrinking, and their faith in the stability of home ownership, which has been for many Americans their largest economic asset has been severely tested. So where will this increased demand come from? Not from another tax break!

Recently both President Obama and Governor Dayton have been on parallel tracks, holding forums across communities soliciting ideas on how to grow jobs. So here’s my two cents: stop trying to create another tax credit or other jobs gimmick. Focus on stabilizing and strengthening the American middle class, for they are the true job creators. A strengthened and confident middle class will create a sustained surge in consumer spending and the jobs will take care of themselves.

A Real All-Cuts Budget

After the recent resolution to the $5 billion budget deficit that ended Minnesota’s 21-day government shutdown, many are still upset that an all-cuts (i.e. no new taxes) solution was enacted. But in reality the resolution was far from what I would consider being comprised of all cuts. In fact, less than half was comprised of real cuts to the general fund, with the remainder comprised of more accounting shifts and borrowing from future tobacco revenues at rates that might turn out to make a pawnbroker blush. If there was any truth in political advertising, one could never call this an all-cuts resolution.

The truth be told, I was a strong proponent of an all-cuts resolution if legislators would have actually invested the time to closely examine all government spending; not just appropriations to the general fund. Sounds confusing? Well the truth is that government spends money in lots of ways. That is why every two years the Minnesota Department of Revenue is required present to the legislature a report called the Tax Expenditure Budget. What exactly is the tax expenditure budget? Well the simple answer is that when legislators pass a law to exempt certain products or groups of people from specific taxes that the rest of us have to pay, it is recorded as a tax expenditure. Some may consider it a special tax break. And when government revenues get tight just like those who argue that we can no longer afford certain programs or expenses, it seems reasonable that the same can be said for special tax breaks; i.e. maybe we just can’t afford them anymore.

Worse yet, while the appropriated general fund budget must be debated and approved line-by-line by legislators and signed by the Governor every biennium, once a tax expenditure is approved by the legislature it remains in place until the legislature intentionally modifies or repeals it. In simple terms, these tax expenditures are on “auto-pilot,” and most of them have been in place for decades without any legislative discussion or review.

So early in the 2011 session facing a $5 billion budget deficit, Senate Tax Committee Chair Julianne Ortman declared her intention to conduct a complete review of all of these tax expenditures, as the state just may not be able to afford some of these tax breaks anymore. But unfortunately such a review never happened, as some in leadership positions argue that because the repeal of a special tax break brings in added revenue it is the same as a tax increase; and new revenues were off the table. A good example was Rep. Runbeck’s bill to eliminate former Governor Pawlenty’s JOBZ initiative that provides income, corporate, property and sales tax breaks to selected businesses locating or expanding in selected rural areas. Whether you agree with this bill or not, the reality is that it was introduced on April 18 and then died a peaceful death as it never even received a hearing.

So how big is this hidden tax expenditure budget? Well according to a 2009 report by the Public Strategies Group, there are over 200 of these special tax breaks that add up to a projected $11.9 billion. Now please understand that many of these tax breaks, such as the exemption of groceries and prescription drugs from sales tax are exemptions that we all would never want to repeal; but over 200? Clearly there are others we could agree that may no longer be appropriate or that we no longer can afford; and repealing these special tax breaks would have helped close the budget deficit without the gimmicky budget shifts and borrowing. For example, we all heard that if we repealed the sales tax exemption on clothing it could increase state revenues by approximately $250 million per year. But did you realize that according to the Minnesota Department of Revenue, repealing the exemption on consumer and business services such as legal or accountancy services from sales tax could yield more than $2 billion per year? We actually shut down the government over a figure less than that! How about repealing the sales tax exemption on newspapers and magazines ($65 million); the exemption on telecommunications equipment ($26 million); or the exemption on farm machinery ($36 million)? In fact these tax expenditures that were written into Minnesota law are seldom discussed or reviewed during budget hearings, but are worth billions of dollars and are long overdue for a complete review.

The bottom line is that during times of budget deficit we all recognize that reduced spending is required and painful cuts must be made; but don’t confuse such cuts with real reform. Real reform is about changing the way our state government collects revenue, spends money and conducts its business. Unfortunately, unless the Minnesota economy gets revved up pretty soon, this most recent budget fix is projected to simply push another $2 billion structural deficit into the next biennium. Now is the right time for legislators from both parties to work towards real tax and expenditure reform. Just as we can no longer afford government spending to be placed on auto-pilot, we can no longer afford all these special tax breaks on auto-pilot either.

America Loves Small Business

There’s little doubt that America loves small business. Unlike much of the 20^th century when the nation was fixated on the adventures of large corporations, over the past 20 years it has all been about entrepreneurs, venture capitalists and the proliferation small business. In fact, since the roaring economy of the 1990s and the incredible growth and success of businesses such as Google, Apple, Oracle, Amazon, Starbucks, Cisco and Biogen, politicians and economic pundits alike are quick to speak on behalf of small businesses. For the premise being what is good for small business is good for America.

We have been told that the majority of jobs created in our economy each year are created by small businesses (which is true); and as a result we are told that anything that may put a damper on the growth of small businesses is a “job killer.” Whether it is policies regarding finance, economic development or taxes, you can count on a politician or a trade group representative speaking with confidence about what is best for small businesses. But if you notice, seldom do we hear from the average small business owners themselves. So it was refreshing and informative to see the results of Minnesota-based U.S. Bank Corp’s second annual survey of small businesses.

The survey, which was conducted between April and May of 2011 and released in June 2011, surveyed a national sample representing 1,004 business owners across the 25 states where U.S. Bank Corp. has a presence. But more importantly, they also conducted an over-sample of more than 1,900 small business owners in 11 selected states, including Minnesota. From my view it’s an opportunity to hear from small business owners without the filter of a politician or a pundit getting in the way.

So who exactly are these small business owners and how small is small? Well according to the survey demographics, the average business owner surveyed has been in business for approximately 10 years, with annual revenues of under $500,000 and fewer than 10 employees. Almost half of the respondents were located in suburban communities, with a third in urban cities and 21% located in rural areas. More than half (58%) were male; the median age was around 50 years of age and 87 percent were white.

While there is certainly variation in responses across the states, overall this group of small business owners appears cautiously optimistic. Approximately two-thirds (64%) report the financial health of their business as good to excellent and an equal percentage report revenues either in line or higher than they were last year. And in Minnesota small business owners report being even more optimistic. While 41 percent of all respondents report their state’s economic conditions as weaker than the overall U.S. economy, only 6 percent of Minnesota small business owners view our state’s economy as weaker than the U.S. economy overall.

However, a disappointing 70% of respondents also reported that they do not anticipate increasing their number of employees over the next 12 months. And when asked what is the most significant challenge facing their business, the most common answer (27%) was the economic uncertainty facing the country and their state. Not surprisingly, given the political tug of war that has occurred in Saint Paul since the beginning of our legislative session, a much larger 38 percent of Minnesota’s small business owners reported economic uncertainty as the most significant challenge facing their business today. But what exactly does economic uncertainty mean?

Well accordingly to the results of the U.S. Bank Corp. survey, 16% reported poor sales as their most significant challenge; 12% reported Federal regulations and 9% reported competition in the marketplace as the most significant challenge to their business. Of course, such responses will certainly vary based upon the industry involved. For example, bricks and mortar retailers and travel agencies may see the competitive pressures from Internet commerce as the most challenging; manufacturers may view competition from China as the most challenging; while those in health care, insurance or financial services might view the changing regulatory environment as the most challenging. That’s just the nature of small business. But what about taxes? Haven’t politicians, lobbyists and special interest trade group representatives been telling us for years that taxes choke off small businesses and as a result are “job killers?” Well maybe so … but according to the small business owners themselves, only 8 percent reported taxes as the most significant challenge facing their business.

As I started this post, America loves small business and rightfully so. They are a critical element of our national, state and local economy and as a result, helping small businesses thrive and become the job creators they can be should be a priority. At the same time many politicians, special interest groups and individuals will try to use small businesses as a premise to advance their own political and economic agenda. Don’t be fooled; if you really want to learn more about the needs and concerns of small business owners … go ask them.