Perhaps even more surprisingly, organic growth firms generate the majority of aggregate revenue, the overwhelming majority of aggregate revenue growth, and even the majority of payroll dollars over these first four years. The right panel of Figure 2 shows that organic growth firms generated 51 percent of aggregate revenue. They make even larger contributions to aggregate revenue growth. Organic growth firms were overwhelmingly the largest contributors to aggregate revenue growth in each of the twenty-five cities we analyzed (Farrell and Wheat, 2019). Moreover, while most organic growth firms were nonemployers, by their fourth year 55 percent of employer firms had grown organically, and these firms generated 52 percent of aggregate payroll dollars (Farrell et al., 2018).
The economic contributions of small businesses through revenue are especially important given the relative stability of employer status. The stability of employer status is important because, as other researchers have observed, the creation of a single job by a large fraction of microbusinesses could have a material impact on net job creation (e.g., JPMC and ICIC, 2016) and a number of recent policy proposals have drawn attention to the possibility of generating inclusive and broad-based economic growth through increased employment in the small business sector. Our data shows that it is decidedly more likely for nonemployer businesses to exit than to add employees to their payroll. In each of their first four years, only 2 percent of nonemployers added employees, while 33 percent exited by their fourth year. Additionally, for the first ten years, the exit rate for nonemployer businesses at each age was more than five times higher than the rate at which nonemployers become employer businesses (Farrell et al., 2018).
After their first year of employment, small businesses actually lose more jobs than they create, principally through firm failure. For every 100 small business jobs, new small businesses created 5.6 new jobs, while existing small businesses lost 3.9 jobs—mostly due to losses from the exit of these small businesses. In many cases, employer small businesses also have to contend with volatile changes in payroll, which can have adverse effects. Most small employer businesses experience unstable payroll and employment volatility including job gains and losses and other spikes and dips in payroll (Farrell and Wheat, 2017b).
Our data uniquely documents the contributions of smaller small businesses for whom the cash-flow lens is more important than the employment lens, and highlights the importance of revenue generation and growth. Nonemployer small businesses make up the majority of the sector and while they are unlikely to transition to employer status, they are nevertheless important when viewed through other lenses of economic growth. Also, while high-growth success stories deserve to be celebrated, they are rare. Most small businesses do not achieve and may not even attempt to achieve this type of success, but they nevertheless produce large shares of small business revenue, especially in their first few years.
Limited Buffers and Irregular Cash Flows
All small businesses, regardless of industry or segment, must manage their cash flows in order to survive and grow. Unless revenues and expenses are perfectly coordinated, small businesses need access to sufficient funds in order to purchase the inputs required to deliver those goods and services. Maintaining cash balances is one approach to address challenges related to the irregularity of cash flows such as these. This potential for mismatched revenues and expenses leads to three key questions:
- Is it common for small businesses revenues, expenses, and financial transactions to occur in irregular patterns that may be difficult to predict?
- Do small businesses carry liquidity consummate with the irregularity of their cash flows?
- Can small businesses weather irregularities in cash flows?
To answer the first question, we first turned to measuring the regularity of small business cash flows from deposit transaction data (See Farrell et al., 2018 for details). Revenues and expenses may be irregular in their dollar amounts and/or their timing. For example, a firm offering a single product might always receive a fixed dollar amount for each sale, but could generate these sales at varying and perhaps unpredictable intervals. Alternatively, a firm providing a weekly service could generate sales on a regular weekly cadence, but with wide variation in dollar amounts. Through this lens, few small businesses have very regular cash-flow patterns, and some have less regular patterns than others (Farrell et al., 2018).
Employer small businesses, while making material contributions to the economy through job creation, may be especially exposed to irregular cash flows. Among small businesses with electronic payroll outflows, 61.8 percent had unstable payroll outflows over a year, driven either by sustained gains or losses in employment, or perhaps less predictably, spikes or dips in employment levels (Farrell and Wheat, 2017).
While many small businesses have irregular cash flows, even more have limited cash liquidity. In principle, a small business might be able to manage irregular cash flows by holding a “cash buffer” that allows it to operate without interruption in the event of a revenue disruption or major expense. We operationalize this idea by calculating the average number of cash buffer days held by small businesses by dividing the average daily cash balance by the average daily cash outflows (Farrell and Wheat, 2016). As shown in Figure 3, 50 percent of small businesses had fewer than fifteen cash buffer days (Farrell et al., 2019b), and only 40 percent had more than three weeks. Small business cash buffers vary substantially across local economies—the median small business in San Francisco, San Jose, and Seattle has eighteen cash buffer days, more than 60 percent higher than the eleven cash buffer days held in reserve by the median business in Atlanta and Orlando.
