CREDIT AND EQUITY SUPPORT AS COMPONENTS
OF SELF-EMPLOYMENT DEVELOPMENT PROGRAMS
Matthew C. Sonfield, Hofstra University
Robert J. Barbato, Rochester Institute of Technology
This paper focuses on the specific concept of enabling displaced workers to become self-employed through the use of assistance programs which combine entrepreneurial training and development with credit or equity support. Previous research is reviewed, existing American and European programs are surveyed, and an especially effective program in Washington State is analyzed in detail. From this analysis a set of assistance factors which appear to correlate with entrepreneurial success is presented.
Previous research by the authors has focused on workers displaced from their jobs due to plant layoffs or closings and the concept of training these persons to become entrepreneurs.(1) It was recognized that entrepreneurial propensity is often a factor of personality traits. After administering the Miner Sentence Completion Scale - Form T to several groups of displaced workers who had participated in ten week entrepreneurial workshops it was concluded that these displaced workers tend to have lower than average entrepreneurial propensity. Thus, any efforts to enable them to become self-employed should recognize that some self- employment is more entrepreneurial than others, and that these displaced workers will have a better chance for self-employment success in non-entrepreneurial small business ventures, including one-person businesses operated from one's own home. One of the conclusions resulting from this study was a suggestion that short-term grants or loans be given to these displaced workers to start basic small businesses that would provide income. These small grants or loans, it was argued, would be in lieu of money spent on traditional entrepreneurial programs. At the time, this alternative seemed rather far-fetched, but subsequent research by two of the authors indicates that some programs of this nature do exist and may indeed be a viable alternative to the more traditional approaches to assisting displaced workers. This paper will analyze this concept, survey some existing programs including one that appears to be especially effective, and develop conclusions and recommendations with regard to the effectiveness of both this type of alternative and to traditional entrepreneurial development programs.
Self-Employment and MicroEnterprises
The promotion of self employment is a basic but minor component of economic development and social policy in most developed countries and in many less-developed nations. In conjunction with a wide variety of public assistance and "welfare" programs, self-employment is recognized as one means of bringing a person into the mainstream of society as a productive and contributing individual. A sizable portion of the American population (6.7%) is self-employed, and this percentage is higher for lower-income persons than for those with higher incomes.l. Furthermore, the number of self-employed persons in the U.S. has grown considerably in the past two 3 decades (up 45% since 1970).(3) Also, the significance of tiny "micro-enterprises" or very small businesses (often home based one person operations), which have often been characterized as insignificant in terms of their economic impact, are now being recognized for their to micro" rather than "macro" effects. Although such businesses have little positive impact on the local economy and rarely create new jobs, they do provide one person with employment and self - sufficiency at a minimal cost to society. And they sometimes mark the start of a path to more significant entrepreneurial activity in the future activity that does impact the economy and create jobs for others.(4) Self-employment programs exist throughout the United States and in many other nations. They are aimed at a variety of target groups, including existing micro-entrepreneurs, the unemployed, welfare recipients, and poor women. Although public and private funds dedicated to such programs are still relatively minimal in comparison to more traditional income maintenance and welfare programs, the attraction of such programs to those who control social policy is that they help people to help themselves, and that they have the potential to eventually benefit not only the individual recipient but the larger community as well. Of course, not all disadvantaged persons are appropriate recipients of such programs. A 1988 study conducted in Maine provides some indicative data.(5) In a random survey of ten percent of the state's welfare recipients (with a 25% response rate), 60 percent said they were interested in running a small business, could name one or more business ideas, and had a realistic understanding of the difficulties of starting one's own business. Eighty-five percent of these respondents cited lack of money as the major reason keeping them from becoming self-employed, while 45% cited their limited business knowledge and experience (most cited more than one reason). Clearly, these data indicate that a sizable portion of our disadvantaged population may be benefitted by self employment programs. Our focus, however, is specifically the displaced worker, a phenomenon which has become a significant problem in our society.(6) Such an individual has by definition work experience and should be more likely to be both interested and to benefit from such a program. Thus the study of such programs is even more meaningful in the context of this current research.
Credit and Equity Support
As discussed previously, most existing programs aimed at assisting displaced and unemployed workers to become entrepreneurs or small business owners through training, workshops, etc. have two major weaknesses. First, the typical displaced worker has a low entrepreneurial propensity and would probably perform better as an employee in a hierarchical environment. Second, it is the lack of capital that most frequently keeps a person from becoming self-employed. Therefore, the addition of credit and/or equity support to existing training activities would increase the effectiveness of most self-employment development programs. That lack of capital is so frequently a barrier to self employment is especially frustrating because the amount of money needed to start a small business is generally quite minimal. Microenterprises and small businesses can be defined in capital requirements of from $500 to $100,000. U.S. census data show that half of all small business owners started their firms with less than $5000.(7) Some self-employment programs in this country do include capital support components in their total assistance packages, although most do not.(8) These programs usually have loan funds from which credit is supplied to qualified program participants. The purpose is to provide credit to new small business owners or entrepreneurs who would be considered too risky by the traditional credit sources, such as banks and other lending institutions. Of course, the goal is to enable these business owners to eventually become satisfactory in the eyes of potential lenders. Loans in these programs are relatively small, and often provided in steps- a series of increasing short-term amounts, dependent upon the repayment of the previous step. In order to spread the programs' funds available for credit purposes as far as possible, these funds are also used for purposes other than direct loans, such as for loan guarantees which will convince traditional lending institutions to provide the actual loan. Some existing self-employment programs have set up peer group lending programs, where small business owners established with the assistance of direct loans from the program are then encouraged or required to provide credit to other program participants. These programs substitute peer pressure for collateral and foster group support for entrepreneurial effort. The biggest problem that these programs face is, not surprisingly, a lack of funding for themselves. Loans of this nature are inherently very risky, and few of these lending programs are self sufficient. Even though most programs provide credit rather than equity assistance and thus receive their funds back in time as loan repayments, there is always a percentage of loans that is not repaid, and additional funding of the programs is periodically required. Yet equity assistance is preferable to credit assistance. Small start-up businesses generally have weak or poor cash flow situations for a period of time, often for more than a year. The difficulties and pressures facing a new business owner are always very formidable, and an obligatory and totally structured loan repayment schedule can often be a fatal factor. Thus, although obviously more difficult to fund, a self-employment development program which includes equity support rather than credit support is more likely to create a greater number of successful new start-up businesses. The issue of program funding then becomes a critical one. A number of European countries have met this challenge by instituting "transfer payment diversion" programs.(9) These programs all in some manner allow the government to pay out unemployment benefits in single lump sums to qualified displaced workers who wish to start their own businesses. The first of these programs, France's Chomeurs Cr‚ateurs, was instituted in 1979, and Britain's Enterprise Allowance Scheme followed in 1983. Over 700,000 persons have participated in these two programs to date, and some seventeen other countries have instituted similar programs since. Working within the existing unemployment benefits programs, these equity support programs generally require the prospective small business owner to develop a business plan and in other ways show that he or she has a real chance for success in the proposed venture. In most programs, the entire amount of unemployment benefits that would normally be paid out over the maximum allowable period of time is paid out in one lump sum, specifically for use to start a new business. In some countries the displaced worker receives the money as soon as the business plan has been approved, while in other countries the business must be started (with personal funds or borrowing) before the government transfers the entitled funds. Most programs also provide management assistance, training, workshops, etc. in conjunction with the equity support. Most of the businesses resulting from these programs are home-based microenterprises, but about ten percent turn into real growth businesses. One set of data indicates that for every one hundred businesses started, about 130 new jobs have been created. As more of these programs reach a maturity stage, hopefully these data will become more concrete. However, it is important to recognize that all of these transfer payment diversion programs overcome the funding issues raised earlier in this paper by simply diverting funds already available and to which the recipients are already entitled. Thus, there is less political or practical opposition to these programs.
The Washington State Program
While most equity support programs involving transfer payment diversion are found outside the United States, one program recently initiated in the state of Washington is worthy of an in-depth analysis (10). Modeled after the European programs, Washington's version is being run on a limited one-year trial basis. One thousand laid off workers are receiving a lump sum payment of their unemployment benefits, averaging $4,100. As in Europe, the program is for only a small percentage of all unemployed people. In selected trial cities, all newly unemployed persons are advised of this new program. About five percent of those notified indicate any interest and perhaps three percent actually complete initial applications for the program. Candidates are then required to take a four day, 20-hour series of business classes, perform market research, and then develop a detailed business plan (including financials) that is acceptable to a counselor. Since these people are already receiving their weekly unemployment benefits during this period, there is pressure upon them to complete this portion of the program quickly so as to leave as much of their total benefits available for the lump sum payment. Upon final qualification, the displaced worker receives the full payment and is assisted in the business start-up and subsequent operations by a personal business counselor from the program. As of mid-August 1990, 477 people had enrolled in the program and 178 businesses have actually been started. Only three of these businesses have employees other than the proprietor.
Our analysis of these various self-employment development programs, and a subsequent series of personal interviews with directors of both the Washington State and other programs, have led us to develop a number of conclusions regarding those factors that are likely to lead to the success of these equity support programs, and to the success of other types of self-employment development programs as well.(11)
- The "open admissions" policies of most of the European programs indicate that there is more small business ownership potential in a wider range of the population than previously thought.
- Early intervention is very important. The program must quickly recruit, screen, and select participants as soon as possible after their being laid off.
- It is important to focus the initial part of the program on confidence building. Many people in these programs are middle aged and are scared of the prospect of starting out on their own, usually for the first time.
- It is preferable to steer the clients toward business proposals which make use of skills which they already possess, often based on the jobs from which they were laid off.
- All unemployed people should be made aware of these programs. Since only a very small percentage reach the actual assistance programs, the greater the initial applicant pool the better the quality and chances for success of the final client group.
- For transfer payment diversion programs, since the amount of the lump sum payment is limited by the traditional stream of unemployment benefits, it is important to run the program quickly, leaving the lump sum payment as large as possible. Since the total lump sum tends to be small (Washington average = $4,100) relative to the startup needs of even a microenterprise, every extra dollar can make a difference toward the chances of success.
- Support groups are of value. In Seattle an Entrepreneurs Club of program participants has been established, holds monthly meetings, has published a membership directory, and provides a network for these budding business people.
- Success rates in these programs seem to be higher for those participants who are older, male and married, who have had more recent and higher levels of work experience, and who have more of their own funds to invest in the new business venture. Yet success is also attained by persons who do not meet these profiles.
- Recent federal legislation requiring most larger companies to provide advance notice of plant closings should allow self-employment programs to intervene and assist even before a person is actually laid off.
- The most successful programs provide a continuum of self - employment development and support services. They start with a speedy but rigorous client selection process and follow up with a full range of flexible, client-responsive, and business-oriented assistance. These programs continue to serve the clients after they start their businesses.
Although previous research has shown that displaced workers tend to have below average entrepreneurial propensity, self-employment is still a viable option for these persons. Self-employment development programs can be effective and successful in this context if we recognize that micro-enterprise ownership rather than entrepreneurship or growth business ownership is a more appropriate goal and path for displaced workers who can not find new employment. While self-employment development programs that do not include credit or equity support can assist people in initiating small business ownership, those which do include such support have a greater chance of succeeding. Furthermore, equity support is preferably to credit support, and the transfer payment diversion model can overcome the funding problems inherent in other equity support models. Analysis of a wide variety of self-employment development programs leads to a series of conclusions regarding program success factors, and these have been presented above. Clearly the concept of self employment development should be pursued in the context of displaced workers, and greater emphasis should be placed on the inclusion of credit and equity support components in such programs.
- Sonfield, Matthew C. , Robert J. Barbato and Jeffrey S. Bracker, "Worker Dislocation and Potential Entrepreneurship," Journal of Business and Entrepreneurship, forthcoming.
- Friedman, Robert, "On the Economic Significance of Self- Employment," in Gaining Momentum. Expanding Opportunities (Don Mills, Ontario: Self-Employment Development Initiatives, 1989), pp. 2-5.
- Feit, Rona, "Supporting and Servicing Programs- Questions of Capacity and Demand, to in Gaining Momentum. Expanding Opportunities. (Don Mills, Ontario: Self-Employment Development Initiatives, 1989), pp. 8-14.
- The Self-Employment Strategy: Building The New Economy (Don Mills, Ontario: Self-Employment Development Initiatives, 1989), pp. 5-8. Also: Sonfield, Matthew C., "Macro and Micro Impacts of Black-Owned Franchise Units," Proceedings of the 1990 Annual Eastern Conference of the Small Business Institute Directors Association, Scranton, PA, September 1990.
- Feit, op. cit.
- Herz, Diane, "Worker Displacement in a Period of Rapid Job Expansion: 1983-87," Monthly Labor Review, May 1990, pp. 21-33.
- The Self-Employment Strategy, pp. 12.
- Reit, Rona, "The U.S. Experience," in Gaining Momentum Expanding Opportunities. (Don Mills, Ontario: Self-Employment Development Initiatives, 1989), pp.35-40.
- Brooks, Chris, "Lessons From Europe," in Gaining Momentum. Expanding Opportunities. (Don Mills, Ontario: Self-Employment Development Initiatives, 1989), pp. 16-20.
- Kilborn, Peter, "Novel Program for the Jobless Aims to Create Entrepreneurs," The New York Times, May 16, 1990, p. Al.
- Telephone interviews with Cathy Countryman, Washington State Director of Research Projects; Clare Phillips, Washington State Department of Trade and Economic Development; and Peter Nares, Ontario Social Development Council.
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