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Management in Practice

What Do Small Businesses Need?

Tech startups get the most attention, but it’s other kinds of small businesses that are creating most new jobs. Sean Greene ’90, an investor who previously served in the U.S. Small Business Administration, talked with Yale Insights about how better government policies and access to capital can help small businesses grow.

Small businesses, defined by the U.S. Small Business Administration (SBA) as companies with fewer than 500 employees, account for 99% of all U.S. firms and employ 57 million people—48% of all private-sector jobs. Within the universe of small businesses, there is a huge amount of variation—they take in everything from technology startups to family-owned manufacturers to mom-and-pop restaurants and dry cleaners.

Tech firms with the potential for a huge payoff get plenty of attention, from the media and from investors. But other kinds of small businesses have the potential for growth too, and could benefit from more access to capital. When they do well, it’s good for all of us; small businesses created 63% of net new jobs between 1992 and 2013.

To understand what enables small businesses to thrive, Yale Insights talked with Sean Greene ’90. Greene, the managing director at the private equity firm Siguler Guff, served as the associate administrator for investment and special advisor for innovation at the SBA from 2009 to 2013. He was also the founder and CEO of the online travel startup, which he eventually sold to Orbitz.

Q: What is small business’s most important role in the economy?

It’s very easy—job creation. Countless studies from different academics over time show that the bulk of net new job creation comes from small businesses. Large corporations obviously employ lots of people, but over time they net lose jobs. In aggregate, there is no question: the economy adds jobs through small businesses.

But not all small businesses are alike. There are on the order of 26 million small businesses, depending on how you count. Twenty million are sole proprietorships. Of the six million small businesses that employ others, I divide them into three buckets. One is the mom-and-pop small business—the dry cleaner or restaurant. Those are inherently local businesses. Mom-and-pops employ a lot of people, but they’re not the net new job creators.

On the other extreme are companies like Facebook, venture capital-funded startups that just take off. The Facebooks of the world get all of the attention, but at the end of the day, they don’t necessarily employ that many people, either. They do drive critically important innovation. And while they don’t have that many direct employees, they enable employment at companies that have relationships with them.

But it’s the third bucket that is the real driver of net new jobs. People don’t talk as much about this group. These are companies with high-growth ambitions and potential, but they aren’t the overnight success. Many are family-owned businesses. They might have $50 million in revenue and 100 employees. This is the group that creates new jobs across all sectors: manufacturing, business services, retail, consumer goods. While the tech startup is justifiably an iconic image of the American entrepreneur, small business, and particularly its role in job creation, is much broader than that.

Q: Is there a downside to the tech sector getting so much attention?

I’ve been an entrepreneur in that sector, and I have no problem with the amount of attention that tech gets. We could give more attention to the other buckets because small business, as a whole, still doesn’t get as much attention as it deserves.

Venture capital is doing well making sure the next social mobile app is funded. Ensuring there’s capital available for a broader set of smaller companies, that’s a bigger policy challenge.

Q: How much of an issue is access to capital for small businesses?

While it ebbs and flows over time, capital continues to be a massive challenge for many small businesses. Some would argue the market is reasonably efficient and making it difficult to get capital helps ensure that the most fit companies get it. There’s a powerful argument saying that’s the essence of the capitalist system.

On the other hand, I think you can point to many places where there are fundamental inefficiencies in the market. Let me give an example. Whether it’s private equity or the venture world, a firm raises money from private investors. Generally, they’re institutional investors that don’t want to write small checks into a small fund. When they’re looking to deploy millions of dollars, they really only can do that by writing large checks.

Once a fund takes large checks, they don’t want to write small checks. So there’s an institutional bias to size across financial markets. As investors and funds get larger and larger, the transaction cost of serving a smaller company get higher and higher.

The exact same bias is being replicated in small-business lending. In the banking space we’re seeing two fundamental trends that are working against small businesses. First is massive consolidation. Over the last 20 years, the number of banks that do commercial lending has basically been cut in half. And again, as the banks get larger and larger, the economics of doing small transactions become less worthwhile.

The second trend is regulatory changes, including Basel III and Dodd-Frank, that have changed the risk profile of banks. The new rules make it less economical to do small-business lending. As a result, it’s harder and harder to get small-business loans from banks.

I have confidence that over time, where there are meaningful opportunities, the market will correct. We’re seeing private credit funds starting to step in. However, anybody who tells you that as things stand today, the system is perfectly efficient and everybody who should get capital does isn’t being realistic.

Q: How important do you think crowdfunding could be as a source of capital?

I was very involved in the Jobs Act, which helps small businesses in a range of scenarios including facilitating crowdfunding. My view is that crowdfunding is consistent with the “let a thousand flowers bloom” approach to innovation and entrepreneurship.

For the next Facebook, I don’t know if it’s that critical; there are already angel networks. I think crowdfunding can be important for a mom-and-pop or businesses that have modest growth aspirations. For those categories, it could make entry easier. It could be critically important.

The venture business is all about hitting home runs; that’s an explicit part of the model. You’re swinging for the fences to get the next Facebook, and you know that a lot of your investments will fail. The mom-and-pops or the family-owned businesses—for the most part, they’re not home run businesses. They’re singles and doubles. Crowdfunding can support businesses that venture folks are not really looking at and some of them will end up taking off in a meteoric way.

Q: Having been an entrepreneur and an administrator for the U.S. Small Business Administration, you’re now an investor. What’s your focus?

My current firm invests in small businesses. Unlike venture, which tends to be massively consolidated in a few places, we invest truly across the United States. The typical firm we’re looking at is a family-owned business that has been around for more than 30 years and is seeking institutional capital for the first time. They might have anywhere between $5 million and $100 million of revenue. There are hundreds of thousands of companies like that in the country.

They do naturally tend to occur in certain places. We’ve done a lot of manufacturing deals in the Midwest. We’ve done a lot of food service deals in and around Chicago. Part of the opportunity is because capital tends to concentrate in hubs, too, even though there are high-quality companies are all over the place.

Investing, whether it’s venture or private equity, tends to be a lot more local than people realize. Venture capitalists like to invest in portfolio companies that they can drive to, rather than having to fly. That’s part of what created Silicon Valley. Being willing to look outside of the established finance centers is saying, let’s fish where other people are not.

Q: How much do geography and hubs of expertise matter?

I traveled around the country with the SBA, and everybody wanted to know how to be more like Silicon Valley. Places that aren’t Silicon Valley shouldn’t be trying to be the next Silicon Valley. They should be asking, how do we tap into the unique expertise of our particular region?

Look at Nashville, Tennessee. You think of Nashville as country music and sure, there are plenty of opportunities there, but the infrastructure that they have around healthcare finance and healthcare services is incredible. Focusing entrepreneurial activity around healthcare in Nashville is fantastic. It’s the same with consumer-products businesses in and around Cincinnati. That’s more interesting and compelling than trying to be another Silicon Valley.

That said, it takes decades for hubs to emerge. From a policy side, there are ways to accelerate things. But it has to be built bottom-up with the energy of the individuals involved. Fundamentally, I believe the entrepreneurs themselves are the primary driver. This isn’t about a plan from the federal or the state government to create a hub from scratch. It’s entrepreneurs drawing on a region’s natural strengths.

Q: When you talked with small business owners as a representative of the federal government, what did they want?

It’s hard to speak about all small business in the aggregate. But in general entrepreneurs are trying to move forward on an idea. If they want anything from government, it’s help reducing the barriers that are slowing them down.

I joined the SBA in 2009, post-financial crisis. I thought of small businesses as our customers. And what should every business do? Listen to its customers. So, we hosted forums around the country asking about their biggest concerns. The range of replies was phenomenal. Even more impressive, they didn’t just present a problem; very often, they also offered a concrete idea on how to fix it.

One entrepreneur said, “I don’t need a loan. The federal government is already one of my biggest customers. Can you just pay me faster?”

People have been talking about changing federal procurement for years, and there are tremendous opportunities there, but it would be difficult. And it would take a long time. Big corporations like to sit on their cash and extend their small business vendors. The federal government doesn’t need to do that. So what was stopping us from paying faster? It hadn’t been made a priority. The president issued an executive order telling all agencies to pay their small business customers in 15 days. It wasn’t a story the media cared about, but to a small business owner where cash flow is king, it was incredibly important. With the stroke of a pen, we had a better way to do things, and it benefits the people in states across the country.

Another example: a venture capitalist told us, “I have an entrepreneur who wants to come to America, create a company here, create jobs here. I’m willing to invest, but that entrepreneur can’t get a visa.” Everybody can agree that that makes no sense, so what do you do about it? Again, passing immigration reform on Capitol Hill is complicated and contentious, so we looked at existing visa programs.

There’s a category for people of exceptional talent. It has been used to help artists and musicians come to the U.S., but the allocated visas weren’t being fully utilized. We were able to change the language on the existing program to include entrepreneurs who have lined up potential investors. That’s not going to fundamentally change the system, but, in the interim, it reduced an obstacle. There are dozens and dozens of examples like that.

Q: How do you scale those successes?

Working in the federal government, doing any one thing was 10 times harder than it should have been as common sense would dictate. That being said, when you implement something, you have opportunity to have impact at a massive scale, and that’s really powerful. Todd Park, the CTO for the U.S., used an idea from physics—force equals mass times acceleration. Government already has the mass. So he sees a focus on the acceleration piece as the way to have impact.

The concept of speed and acceleration is the norm in the entrepreneurial sector. So dealing with the government can be frustrating for entrepreneurs. I was frustrated at many moments. But even within the private sector, I’ve seen large corporations that act a lot like the federal government. Part of my passion about small business entrepreneurship is this notion of acceleration. What fueled me as an entrepreneur was passion about change as a means to build and create and grow. I loved being entrepreneurial in the federal government. Your initial reaction is “That’s an oxymoron. That can’t happen.” But it can, and it’s tremendously satisfying when you’re able to deliver.

Interview conducted and edited by Ted O’Callahan