The State of Small Business: A Report of the President, 1998 To the Congress of the United States: I am pleased to present my sixth annual report on the state of small business. In 1997, the year covered by this report, 23.7 million business tax returns were filed and a record 885,416 new small employers opened their doors. Industries dominated by small firms created jobs at a rate almost 60 percent faster than those dominated by large businesses. Consumer confidence hit a 28-year high-an important trend for small businesses, which depend on consumer purchases of goods and services for more than two-thirds of their jobs. What makes the American economy work? One of the essential elements is small business-a dynamic agent for change in the innovative process. Small businesses are the door to economic self-sufficiency and market power for countless individuals who start with little more than a dream. And they create jobs for the entire spectrum of American workers-the old, the young, men and women, minorities of all ethnic backgrounds, those at the top of the economic ladder and those struggling to find work. America's Innovators A great strength of small business is its role in renewing the American economy. New and small firms play a key role in the experimentation and innovation that leads to technological change and economic growth. They are continual sources of new ideas that might otherwise remain untapped-and their experimental efforts are an essential part of the organic and ever-changing American economy. In the research and development stages, before any product is developed or marketed, small high-technology businesses can find themselves in dire need of capital. At this stage, the Government can provide an important bridge by simply directing some of its already planned research to small business sources. Small business' share of Federal research and development has been increasing steadily in recent years, thanks in part to programs like the Small Business Innovation Research (SBIR) Program. The SBIR program, which encourages small businesses to help meet our Nation's need for groundbreaking research, has resulted in more than $7.7 billion in research awards going to small firms over the first 15 years of the program. Getting Startup Money to Small Business America's small business owners and potential entrepreneurs often have the ideas, the energy, and the willingness to work hard, but face an almost insurmountable challenge in finding the capital they need when it can make a difference-in the early stages. Financing can be especially costly or more difficult for small firms to find. Banks are important sources for small firms, but the banking market has been changing rapidly, and small firms are watching to see how the trends in mergers and acquisitions will affect their access to capital. Through studies based on new information available through new Community Reinvestment Act requirements, my Administration has been monitoring these trends carefully. I am proud that we have been able to bring new investment to areas that are especially in need of capital through our empowerment zones and enterprise communities. We've also begun a new markets initiative-a public/private partnership to provide tax credits, investment capital and credit, and technical assistance to stimulate business formation and job creation in inner city areas. Relieving Tax and Regulatory Burdens Taxation and regulation, applied equally to large and small entities, can be more burdensome to small businesses, which have fewer resources to meet the same overhead costs of their larger counterparts. I'm pleased that we've been able to reduce the burdens on small firms, first of all by eliminating the budget deficit that has burdened us all. And today more than 90 percent of small businesses can take advantage of tax reductions through the increased small business expensing limit and capital gains tax relief targeted to small firms. Through the implementation of the Small Business Regulatory Enforcement Fairness Act, my Administration has made progress in fine-tuning new rules or exempting small businesses from the most burdensome regulations. The law also provides for regulatory compliance assistance and legal remedies when agencies fail to address small business concerns in the regulatory process. The Government as Consumer One of the most direct ways for the Government to move capital to small firms is through its purchases of goods and services. And the level of procurement from small, minority-owned, and women-owned businesses is rising. In fiscal year 1997, small businesses won $63.7 billion in contract awards from the Federal Government, up from the previous year. In December 1997, we increased from 20 to 23 percent the percentage of goods and services that Federal agencies must purchase from small firms, so we expect future reports to reflect more Federal dollars purchasing goods from small firms. Small Business: Tapping the Power of Individuals Small firms represent opportunity for many who have traditionally had little access to economic power-including minorities, immigrants, and women. The numbers of women and minorities in business have been rising as never before. In 1997, an estimated 8 million women and 3.2 million minorities owned small, noncorporate businesses. Of the self-employed, more than one-third were women; African American, Hispanic, and Asian American minorities each owned between 5 and 6 percent of noncorporate businesses. We've heard it before and it's still true-small businesses are dynamic job creators. In 1997, industries dominated by small firms created almost two-thirds of the new jobs. The people who work in America's small businesses represent the full spectrum of the American populace. In 1997, the small business workforce consisted of 45.5 percent women, 13.1 percent Hispanics, 9.7 percent African Americans, and 4.5 percent Asian Americans, Pacific Islanders, American Indians or Aleut Eskimos. Small businesses hire both older and younger workers in disproportionate numbers, and they put to work more employees who have been on public assistance. I am pleased that small businesses are taking a leadership role in moving workers off welfare and on to productive and more satisfying lives in the workforce. Our welfare to work initiative is working: through the nonprofit Welfare to Work partnership, thousands of businesses of all sizes have hired many thousands of former welfare recipients. But small businesses were already doing that, and I am confident they will continue to be a force for change, providing opportunities for Americans, whatever their circumstances, into the new millennium. William J. Clinton THE WHITE HOUSE ----------------------------------------------------------------------------- Executive Summary Nineteen ninety-seven was an excellent year for the economy and for small business. The economy gained almost 3 million payroll jobs and real gross domestic product increased by 3.9 percent. The unemployment rate fell from 5.4 percent in 1996 to 4.9 percent in 1997. Consumer prices remained stable, while corporate profits and employment compensation both increased. A record 885,416 new small firms with employees opened their doors in 1997 and new incorporations hit a record high for the third straight year. More than 23.6 million business tax returns were filed. Business bankruptcies remained low for the fourth consecutive year. Corporate profits increased in 1997 for the seventh year in a row. Employment compensation and proprietorship earnings also increased significantly. Small-business-dominated industries added jobs to the economy at a rate almost 60 percent faster than large-business-dominated industries. However, more than one-third of the job increase was in sectors dominated by neither small nor large firms. Of particular note, 1997 saw a revival in manufacturing employment-more than 229,000 new jobs in all industries. Consumer confidence in December 1997 reached 134.5, the highest reading in 28 years and a harbinger of continued good economic news for 1998. The Consumer Confidence Index is important to small firms: more than two-thirds of small firm jobs come from consumer purchases of goods or services. New Data for Analysis of Small Business Job Creation Small businesses created three-fourths of the net new jobs from 1990 to 1995. Overall, employment in establishments owned by small firms grew 10.5 percent over the period, compared with 3.7 percent employment growth in establishments owned by firms with more than 500 employees. How does it happen, then, that while small firms had much higher job growth rates than large firms, their share of overall employment actually fell slightly, from 53.7 percent in 1990 to 52.5 percent in 1995? To understand this paradox is to understand why static data cannot be used to measure dynamic change. The static data usually used to portray small and large businesses' relative shares of employment are based on snapshots at two points in time. These data do not give a clue to the immense dynamic activity behind the scenes-activity that turns high-growth small firms into large firms. With the Business Information Tracking Series (BITS) file, a new longitudinal database covering all U.S. establishments with employees, it is now feasible to study the underlying dynamics of business births, deaths, expansions, and contractions. The BITS allows the tracking of establishments over time, including shifts in the firm size classes of growing small businesses or downsizing large businesses. It provides a picture, for example, of how a small computer firm can expand so quickly it becomes a giant within the period of observation. The database also allows businesses to be tracked in more detail, including their locations and industries. Over the 1990-1995 period, establishments in the smaller firm size classes grew fastest in services, agricultural services, and transportation, communications, and public utilities. Why Small Firms Are Important A quiet evolution has revolutionized the American economy in its transition from the industrial age to the information age. The purpose here is to document the role of small- and medium-sized enterprises in the new American evolution by asking a fundamental question, "Are small firms important?" The response to this question requires an understanding of change in the economy as a dynamic process. Viewed through an evolutionary lens, small firms make two indispensable contributions to the American economy: • First, they are an integral part of the renewal process that pervades and defines market economies. New and small firms play a crucial role in experimentation and innovation that leads to technological change and productivity growth. In short, small firms are about change and competition because they change market structure. The U.S. economy is a dynamic organic entity always in the process of becoming, rather than an established one that has arrived. • Second, small firms are the essential mechanism by which millions enter the economic and social mainstream of American society. Small businesses enable millions, including women, minorities, and immigrants, to access the American Dream. A great source of American strength has always been the dream of economic growth, equal opportunity, upward mobility. In this evolutionary process, community plays the crucial and indispensable role of providing the "social glue" and networking opportunities that bind small firms together in both high tech and "Main Street" activities. The American economy is a democratic system, as well as an economic system, that invites change and participation. The crucial barometer for economic and social well-being is the continued high level of creation of new and small firms in all sectors of the economy by all segments of society. Characteristics of Small Business Owners and Employees Small firms represent business ownership opportunities for women, minorities, the young and the elderly, as well as the population in their prime working years. Ownership opens doors for women and minorities to move into the economy less encumbered by traditional barriers to economic achievement. Small firms are also more likely than large businesses to hire individuals that are on the margin of the labor force. By giving entry-level positions to the young and individuals on public assistance, for example, they help create the skills needed to move the society and economy forward. To understand these small business contributions, it is useful to look at the characteristics of small business owners, their businesses, and the small business labor force. In 1997, according to Current Population Survey data, 11.5 million Americans had some self-employment earnings. A total of 7.2 million men; 4.3 million women; 500,000 Asians, Pacific Islanders, American Indians, and Aleut Eskimos; almost 700,000 blacks; 10.3 million whites; and almost 700,000 Hispanics were self-employed. Women- and minority-owned businesses are rising in importance in our nation's economy. They are represented in every type of industry and in every form of business. Based on data from the Census Bureau's Survey of Women-Owned Businesses and Survey of Minority-Owned Business Enterprises, the U.S. Small Business Administration's Office of Advocacy estimates that in 1997 there were almost 8 million women-owned businesses (8.5 million with C corporations) and 3.2 million minority-owned businesses. Their numbers have been increasing steadily, and more rapidly, than those in the economy as a whole. Small businesses also employ thousands of individuals of all races, genders, and ages. In 1997, the small business work force consisted of 54.5 percent males, 45.5 percent females. It represented diverse ethnic and racial groups: 4.5 percent Asians, Pacific Islanders, American Indians, and Aleut Eskimos; 9.7 percent blacks; 85.8 percent whites; and 13.1 percent Hispanics. Small businesses hire a larger proportion of younger and older workers, part-time employees, employees with lower educational attainment, and individuals that receive public assistance than large businesses. Small Business Financing The U.S. financial markets continued to perform well in 1997, despite some uncertainty stemming from the Asian financial crisis. Overall borrowing showed stronger growth than expected, increasing by 5.0 percent, compared with 3.6 percent in 1996. Large increases in the demand for credit from the business and state and local government sectors were only slightly offset by decreases in demand from households and the federal government. The business sector was the biggest borrower, increasing net borrowing from $196 billion in 1996 to a record $311 billion in 1997. The large growth in business demand reflected strong expansion in capital spending, especially in outlays for computers and other types of equipment. U.S. banks had another excellent year in 1997, with high profitability and growth in assets. A total of 7.9 million small business loans of less than $1 million were outstanding from 9,293 reporting banks as of June 1997. The number of the smallest business loans-those under $100,000-increased very significantly, by 27 percent, in 1997. The percentage increase in the dollar amount was far less, an indication that more of the larger loans in this category may have been cleared from the books and more very small loans extended. Total assets continued to be concentrated in the largest banks, partly because of the overall growth of banking assets over time and partly because of increased merger and acquisition activity. While the number of loans made through the SBA's loan guaranty programs declined in 1997, the dollar amount increased significantly, from $7.7 billion to $9.5 billion. The large increase was made possible by reduced subsidy rates, which enabled more SBA-guaranteed lending at the same total subsidy level authorized by the Congress. Equity markets continued to be favorable for small businesses in 1997. The initial public offering market stepped back from the boom of the previous year, but the average offering size increased slightly for small IPOs, from $19 million to $20.4 million in 1997. Fundraising by venture capital funds prospered, and disbursements by small business investment companies increased significantly-by 25 percent. Recent analysis of the National Survey of Small Business Finances (NSSBF) indicates that in 1993 small businesses accounted for about 25 percent of credit market debt in the United States. According to the NSSBF data, some 5 million small firms in the Dun & Bradstreet small business population had $668 billion outstanding in six traditional types of financing. Lines of credit were the most significant for small firms, accounting for 42 percent, or $280 billion. Nearly three-quarters of women-owned firms had access to some type of credit in 1993. Women-owned firms were more likely than firms overall to use personal credit cards and loans from the owners themselves. Relatively fewer minority-owned firms-two-thirds-used some type of credit in 1993. Only 13.9 percent of minority-owned firms said they used owner loans, but more than one-third used personal credit cards and more than one-quarter used business credit cards. Procurement from Small Firms The federal government spends about $200 billion a year on the procurement of goods and services. Small firms annually receive more than 20 percent of all prime contract dollars and another 10-14 percent of the federal procurement pie in subcontracts. Large firms receive more than 60 percent of all federal procurement dollars. Federal contract markets are changing at an unparalleled pace. Two laws, the Federal Acquisition Streamlining Act (FASA), enacted in 1994, and the Federal Acquisition Reform Act (FARA) or Clinger-Cohen Act, enacted in 1996, have had an unprecedented impact on the federal procurement process. Additional reforms were enacted in December 1997 in the HUBZone and contract bundling legislation. The 1994 and 1996 laws were designed to make the government operate more like a commercial buyer and make it easier and more appealing for businesses to participate in government markets. Many of the implemented changes are benefiting small firms, although some longstanding small business protections have been weakened or eliminated in the process. In FY 1997, small businesses won $63.7 billion in federal contract awards, including $41.2 billion in direct contract awards from the federal government and an additional $22.5 billion in subcontracts from prime contractors working directly for the federal government. The $63.7 billion total represents 32.6 percent of the $195.3 billion in contract actions awarded by the federal government in FY 1997, a slight decrease from the previous year's 34 percent small business share. Prime contract dollars awarded to small businesses increased very slightly, from $41.1 billion in FY 1996 to $41.3 billion in FY 1997. The overall share decreased by more than 1 percent because a smaller share of subcontract dollars were awarded to small firms. The percentage of prime contracts awarded in FY 1997 to small minority-and women-owned businesses remained at levels consistent with FY 1996. In FY 1997, minority-owned firms were awarded $11.1 billion in prime contracts or 5.7 percent of total federal contract dollars. Women-owned firms were awarded $3.6 billion in prime contracts or 1.8 percent of federal buys for the same period.