How to identify and support fast-growing firms that can take off, create jobs, and yield significant value in a short period of time is one of our biggest dilemmas in nurturing private sector development in emerging markets.
The Sustainable Development Goals (#8) include the need for decent jobs as an important developmental priority, and small and medium size enterprises (SMEs) are expected to create most jobs required to absorb the growing global workforce.
But many young firms will fail; by some accounts more than half of new firms won’t make it to their second birthday.
However, despite the high rate of firm failure, research from the US and evidence from India, Morocco, Lebanon, Canada and Europe shows that it’s largely young firms that create the bulk of net new jobs (net jobs are jobs created minus jobs lost) and lasting employment opportunities.
In addition, even when a firm survives beyond the first two years of operation, there are no assurances it will become a fast-growing firm -- a gazelle.
Although estimates vary widely, the share of gazelles -- fast-growing firms that generate a lot of value-added and jobs -- is thought to be only between 4% to 6% of all SMEs, and, possibly, even less in many emerging countries.
All this makes creating favorable conditions for entrepreneurship a priority.
Easing business entry -- the time and cost involved in establishing a new enterprise -- is extremely important. As the annual Doing Business report shows, many countries have made a lot of progress on this indicator over the past decade.
But business exit is an equally critical piece of the puzzle.
Having easy exit procedures is important to encourage more entrepreneurs to enter the market , attempt to establish a business, and, hopefully, become a gazelle – or fail fast in the process.
Laws that trap businesses in years of lengthy court proceedings or send a borrower to jail for bankruptcy aren’t conducive for an entrepreneur, a financial institution, or for taking a risk on a new venture, where the known attrition rate is exceptionally high.
An effective system for insolvency and business exit must be able quickly to distinguish between those firms that can be saved and those that must exit fast.
Then the exiting firms must be able to have their assets – and, crucially, their entrepreneurs – returned to productive use, as soon as possible.
However, in far too many countries, this is where the dynamic forces of the market meet the immovable object that is the legal system.
Simple issues like fast enforcement of contracts, quick access to courts and private sector actors (lawyers, receivers, trustees, etc.), which are taken for granted as functioning well in some countries, become an insurmountable stumbling block in far too many others.
American entrepreneurs frequently talk about “failing fast and often” as the secret to their ultimate success as a businessperson. In Silicon Valley, arguably the global center of entrepreneurialism, the notion that ‘failing is succeeding’ has become so ingrained that entrepreneurs, who may have gone through one or even two business bankruptcies, wear failure as a badge of honor. A recent Newsweek article likened this to frogs laying 20,000 eggs to eventually just yield a handful that will grow to adulthood.
A system which encourages easy entry and easy exit for businesses is likely to encourage more entrepreneurs to enter the market and try their luck in building a business.
While failures and job churn will still happen, more firms going through the creative destruction process will produce a larger number of gazelles.
Quickly returning individual failed entrepreneurs to productive use requires a pro-active approach in giving them a “fresh start,” in addition to decriminalizing business failure.
Also, business exit solutions have to be able to deal with individual bankruptcy.
Many SMEs, particularly in Africa, are essentially one-person ventures, and distinguishing between an entrepreneur’s business debts and personal debts can be arbitrary.
Increasingly, fintech and other technological advances are developing screening methodologies that can test and pre-determine enterprise success. Big data and psychometric testing are two such examples.
Big data, including social data, is now being used to unlock access to financial services to financially-excluded individuals and businesses. On psychometric tests, more research is needed to establish its true merits and ability to determine entrepreneurial aptitude.
Financial institutions and others are interested in opportunities, and risks, that big data and psychometric tests hold to support entrepreneurs, but these approaches are still in their infancy.
In the meantime, we see huge merits in creating and supporting the entrepreneurial culture the tested, old-fashioned way -- by lowering barriers to business entry and exit.
Securing a large pool of fast-growing companies will help address some of the growth and employment challenges many developing countries face.
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