Policy Innovation Blog

I love Luke Johnson - but not his Start-up Act

Stian Westlake - 09.09.2011

Anyone with a pulse and an interest in innovative business should read Luke Johnson’s FT column. You can rely on it for a challenging, entrepreneurial take on the economy.

And the title of Luke's recent column was a gem: "Only a bold Start-Up Act can help us". NESTA has often argued that government policy should be geared to the needs of high-growth, innovative businesses. And with the economy in a prolonged funk, a law that can encourage more Luke Johnsons would hit the spot right now.

But I'm disappointed to say the article didn't live up to my expectations. In fact, I'd argue that Luke's Start-Up Act is misdirected and will end up spraying large amounts of taxpayer's money at people who look very little like Luke. Let me explain.

The piece starts well, arguing that we need policies to encourage the private sector to harness Britain's natural innovation, and invest in jobs and growth. Three cheers for that.

Then the article makes the innocuous-sounding comment "research shows that start-ups are the source of most innovation, job creation and growth", and uses this as the justification for a huge and generous tax break for all new businesses - no corporation tax, business rates, or National Insurance for the first three years of the life of any business, and exemption from regulation and an increase in funding. Expensive policies, to be sure, but if start-ups are so important, then perhaps they're justified.

But here's the problem: the research isn't all it's cracked up to be. Sure, it sounds plausible that start-ups make or break the economy - after all, we can all think of innovative, dynamic start-ups that have changed the way we live our lives. Unfortunately, it's not so simple. There are two important reasons.

Firstly, not all start-ups are created equal. The vast majority of new businesses aren't innovative companies with the potential to disrupt markets and grow fast. On the contrary, they're small, family or lifestyle businesses that are overwhelmingly likely to stay that way, if they survive at all. Indeed, a layperson probably wouldn't even use the word "start-up", with all its connotations of high technology and VC funding, to describe them. Silicon Valley veteran Steve Blank summed it up well in his recent article on the six types of start-up, most of which will never be the next Facebook. For chapter and verse, try Scott Shane's The Illusions of Entrepreneurship, based on the Kauffman Foundation's comprehensive entrepreneur survey. A few start-ups are a major source of innovation, but they're wildly outnumbered by small, lifestyle businesses with limited growth ambitions. These are worthy undertakings. But they won't change the world.

Secondly, the claims that start-ups generate the bulk of job growth and economic growth are just wrong. The idea that start-ups generate the majority of new employment in particular is a misperception that's arisen because of a misunderstanding of (detailed and careful) work done by the Kauffman Foundation. (Geeky explanation - feel free to skip: Kauffman's research observed that the number of net jobs created by new US businesses was close to 100% of the total net jobs generated in the US economy. The problem is that, because net job creation is made up of jobs created minus jobs lost, lots of different groups of companies can be responsible for "most" net job creation. Even in an economy where most jobs aren't created by start-ups, it's quite likely that new businesses, which by definition don't lose jobs in the year they're created, will generate around 100% of net new jobs. Imagine a simple economy with a bank, a factory and a start-up; the start-up hires two people, the bank lays off 100, and the factory hires 100. Net-net, the economy creates two jobs. The start-up can honestly claim to have created "100% of net new jobs", even though the factory hired 50 times more people.)

Why does all this research geekery matter? It matters because it shows the tax breaks in Luke's Start-Up Act are poorly targeted. Providing tax holidays for every lifestyle business and new freelancer will soak up enormous amount of taxpayers' money. Indeed, since corporation tax is chargeable on profits, the most ambitious start-ups, which endure years of losses as they invest in innovation, may not even benefit from some of these breaks.

There is one very important part of Luke's Start-Up Act that I like a lot: that's his recommendation that we make funding for start-ups easier to come by. NESTA believes passionately that Venture Capital and Angel funding are very effective ways to back not just any old start-up, but those with a good chance of innovating, growing, and disrupting the status quo. Getting banks to provide more growth capital, as Luke also suggests, is something close to our hearts too.

And there's one other area where Luke and I definitely see eye-to-eye: Britain needs to get moving on this issue now.