Via Wolf Street

People are massively striking out on their own. But new businesses with planned wages have been getting scarcer since 2007.

By Wolf Richter for WOLF STREET.

Early on in the Pandemic, as 30 million people lost their jobs and gigs, the number of new businesses exploded higher, perhaps fed by stimulus money and the extra $600-a-week in unemployment benefits that allowed people to strike out and go after their dreams, or fed by desperation, or fed by new opportunities that arose and that some people saw and grabbed.

Starting in late May, according to the Census Bureau, weekly business applications began to surge, and in the week ended July 18, at 123,000, were up 91% from the same week last year. They have now tapered off but continue to run at a hot pace. In the week through November 21, which the Census Bureau released on Wednesday, business applications, at 83,740 were still 33% higher than in the same week last year (chart shows the three-month moving average of weekly business applications):

Since the end of May, there have been 2.48 million new business applications, up 52% from the same period last year.

The Census Bureau’s weekly data on “business formations” is not survey-based. It’s based on applications by new business entities for a federal “Employer Identification Number” (EIN), the taxpayer identification number by which the IRS tracks businesses for tax purposes. When I started my Wolf Street media mogul empire, I first set up a corporation, then the corporation applied for an EIN (my bank did that), and a few minutes later, using the new EIN, the bank set up a bank account for the corporation.

The Census excludes from these weekly EIN applications those that are not related to typical business formations, such as EIN applications “for tax liens, estates, trusts, or certain financial filings, applications with no state-county geocodes, applications from certain agricultural, public entities, and applications in certain industries (e.g. private households, civic and social organizations).” What’s left becomes the data for business formations, as depicted in the chart above.

But there are also a large number of exits because it’s tough out there, and the risks are high, and it often doesn’t work out for small businesses. Even in a good year, the net total number of new small businesses minus the exits of existing small businesses is much lower – and falls into the negative during tough times, with exits outnumbering startups, such as during the Financial Crisis.

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Applications by businesses with a “high propensity” of having a payroll.

Based on information in EIN applications, the Census Bureau estimates which of those businesses have a high propensity of having a payroll (“High-Propensity Business Applications” or HBA). These businesses are the hoped-for jobs-creating machines.

In the latest week, there were 28,980 HBAs, still up 23% from the same week last year. At the peak in mid-July, there had been 41,380 applications, up 71% from the same week last year. The spike in application started in the week ended June 13, and over the period since that week, applications have surged 42% year-over-year to 803,720.

But that huge spike over the summer only brought these high-propensity business applications back to where they’d been before the Financial Crisis in 2007, with 12 years of drought in the middle, and they’ve now dropped well below that level again:

Applications by businesses with “planned wages.”

This is a step further. Within the HBAs, the Census Bureau splits out which businesses already have a planned date for paying wages (“Business Applications with Planned Wages” or WBA), meaning they have people and funding in place, and they’re ready to hire and grow.

There were 10,120 applications by these businesses with planned wages in the latest week, up 21% from the same week last year. The surge in these types of businesses started in the week ended June 13. Since then, businesses of this type have filed 275,130 applications, up 33% from the same period last year.

Alas, that magnificent surge in applications was just a minor uptick, compared the number of business applications with planned wage dates before the Financial Crisis. These are the businesses that are deemed to have a good chance of turning into significant employers, and the drought that started in 2008 has effectively never ended:

Applications by businesses with a low propensity to create jobs.

Total business applications minus high-propensity business applications would be the businesses with a low propensity to create employment – businesses that have a good chance of remaining small, with just one employee, or maybe just a few employees. This is the most common type of business in America. And many of them don’t make it. Others allow their owners to do something fulfilling, be in control, draw a decent income, and enjoy the tax benefits that come with it, and they do important things, but beyond feeding their owners, they just don’t create a lot of jobs.

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In the latest week, there have been 54,760 EIN applications by these types of businesses, up 39% from a year ago. The boom in applications took off in the week ended May 23. Over the months since then, there have been 1.68 million EIN applications of this type, up 58% from the same period last year.

Turns out, this type of business application – businesses with a low propensity to create jobs – has been soaring for years, having doubled from 2007 to 2019, and having spiked further since then:

What has happened during the Pandemic in terms of business applications and their projected propensity to create jobs, and what happened in prior years, and how the environment for new businesses has changed since the Financial Crisis, becomes clearer when viewed together – businesses with a low propensity to create jobs (red line), businesses with a high propensity to create jobs (green line), and businesses with planned wages (blue line):

PPP-loan fraud not involved in this surge of EIN applications.

Businesses that applied for the forgivable Payroll Protection Program loans had to submit documentation of wages paid over specified periods. The PPP program ended on August 8. The dates were structured so that it would be impossible to create a business entity after the announcement, pay wages for long enough to qualify for a PPP loan, and then apply for a PPP loan. Applicants had to submit historical wage documentation to the lenders whose job it was to sort through it.

Fintech companies and online lenders also piled into PPP loans, and apparently anything went with some of them. A Bloomberg analysis in October found that these companies were connected to 75% of the PPP fraud cases alleged by the US Justice Department, though they only arranged 15% of the number of total loans.

But the fraud didn’t require an EIN because these lenders didn’t check anything: “In many cases, a simple Google or state records search would have suggested an applicant’s business didn’t exist or was dormant.” Other companies “weren’t in good standing with the secretary of state.” In other words, these types of cases didn’t impact the EIN data here.

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Most of the large banks prioritized their existing customers in order to avoid getting tangled up in fraud allegations. And these existing businesses already had EINs.

In short, there was plenty of shady stuff going on – but it didn’t require applying for an EIN. And with the PPP dates and payroll periods being structured the way they were, applying for an EIN after the announcement of the PPP would not have been helpful in committing PPP fraud. There were easier and more effective ways of doing this. So PPP fraud likely had little impact on the EIN applications.

The good and the not-so-good.

That people strike out on their own and start a business is a great thing and a testimony to the American spirit. That they’re doing it in historic numbers during the Pandemic is even better. That many may be doing it out of desperation is the dark side.

It may be a testimony of how tough the job market has become. Some people may not see any other options. For example, experienced and knowledgeable workers, permanently excluded from jobs by ageism, start their own one-man or one-woman show. And that’s great. If they can make it, they may be the happiest with their worklife they’ve ever been. But for many people, it’s very tough to pull off.

The disconcerting part is the thinning out over the years of business startups with a high propensity to create jobs, or with already planned wages at the time of the EIN application. This flies in the face of all the hoopla about the relatively minuscule number of startups with multi-billion dollar “valuations” that garner all the attention in the media.

Stimulus & extra UI dried up. But 16% of “proprietors’ income” in October was PPP money & Pandemic farm aid. Read…  The State of the American Consumer: Free Pandemic-Money Runs Low

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