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Crossing the Employer Threshold: Determinants of Firms Hiring Their First Employee

Full Report

Research Summary

December 2013                  No. 418

Crossing the Employer Threshold:
Determinants of Firms Hiring Their First Employee


By Robert W. Fairlie, Santa Cruz, California 95060. 39 pages.
Under contract number SBAHQ-12-M-0184.

Purpose

Job creation is paramount to America’s full economic
recovery. How can job creation be encouraged? Since
small businesses have historically created a disproportionately
large share of new jobs, this research
analyzes the factors that lead new businesses without
employees to hire their first employee. This is a significant
aspect of small business job creation. Given
that about three in four small businesses do not have
employees, these non-employer businesses present an
important source of potential new jobs.

To date, there has been little research on the factors
leading a non-employer to hire its first employee.
This study uses two unique datasets to examine
several aspects of this decision. First, what owner
characteristics are associated with a business’s decision
to hire its first employee in the first several
years of operation? Second, what business conditions
are associated with the decision (for instance, assets,
sales, or intellectual property)? Finally, does entrepreneurship
training increase the likelihood that a
non-employer will hire its first employee?

Background

One of the major thresholds that small businesses
encounter as they grow is whether to hire employees.
The step from non-employer to employer entails registration
and legal requirements, workers’ compensation,
unemployment insurance, and the ongoing burden
of making payroll. But perhaps the most important
consideration for an owner is whether current
and projected revenues are enough to cover the extra
expenses of having employees. Current uncertainty
in the economy may complicate this decision.

The lack of relevant data has limited the analysis
of this question. However, a report from the U.S.
Census Bureau’s Center for Economic Studies, indicates
around 1 percent of non-employers become
employers each year.1 Figuring out which of the 20
million-plus non-employers are likely to cross the
threshold would allow policymakers to better target
business assistance.

This research builds upon previous research
funded by the Office of Advocacy which found
that financing and owners’ human capital (such as
education or multiple owners) led to the growth of
startups.2 While the labor market is improving, having
more non-employers become employers would
certainly speed up these positive trends.3

Overall Findings

According to the study, over the seven-year period
from 2004 to 2011, 59 percent of non-employers
in the survey group hired their first employee, 13
percent did not hire anyone, and 28 percent ceased
operations (Figure 1).

Those that hired their first employee were more
likely to do so in the first three years after startup:
38.1 percent hired their first employee by one year
after startup and 54 percent by three years after
startup.

Non-employer startups owned by African-
Americans and non-Hispanic whites had similar rates
of hiring their first employee; Asian and Hispanic
owners had higher rates (Figure 2). Related to these
racial and ethnic patterns, immigrant owners had
higher rates of hiring their first employee by the first
two follow-up years than native-born owners, but
their hiring rates were similar by the seventh year.
Female-owned startups were roughly 10 percentage
points less likely to hire their first employee by the
first, second, and seventh years after startup.

Industry differences are important in determining
which non-employer startups are likely to hire
employees. Non-employer startups in wholesale
trade have the highest rate of hiring employees,
followed by the transportation, manufacturing and
professional industries. In these industries, hiring
employees may be important for capturing returns-
to-scale for growth of businesses.

Two of the business characteristics that correlated
with an increased likelihood of hiring a first employee
were the availability of assets and incorporation.
In addition, owning intellectual property (such as
patents, copyrights and trademarks) was associated
with a 7 percentage point increase in the annual
probability of hiring the first employee. These tangible
and intangible assets give a company leverage
needed to acquire capital and grow the business.

Non-employers who received entrepreneurial
training were more likely to add a first employee
than those who did not. Of those who received training,
21.5 percent hired an employee within five years
compared with 17.3 percent of those who did not
receive training. While the study shows that entrepreneurship
training had a large and positive effect
on hiring the first employee, the results are not statistically
significant because of the small sample size.
Although this rules out making definitive conclusions,
the consistency of positive estimates across all
specifications and time periods at least suggests this
positive effect.

Policy Implications

Policymakers have enacted legislation to support
small businesses in recent years. The Small Business
Jobs Act of 2010 and the Jumpstart Our Business
Startups of 2012 both focus on increasing financing
for small businesses, which is an important component
of small businesses’ ability to create jobs.

The report’s conclusions indicate three policy
directions. Policymakers interested in increasing
employment should:

• Concentrate efforts on helping firms start as
corporations

• Focus on younger non-employers, and

• Encourage reinvesting earnings into the company
to purchase assets.

The results of providing entrepreneurial training
were inconclusive in this report because of the limited
sample size, but a positive direction was visible
in the raw results.

Scope and Methodology

Annual data from the Kauffman Firm Survey (KFS)
was used to determine the characteristics of non-
employers hiring their first employee. The survey
tracked the growth pattern and characteristics of
about 5,000 firms born in 2004 until their closure
or 2011, when the KFS was discontinued. The
author applied his econometric model to the KFS’s
approximately 2,500 non-employer data points. Non-
employers in the KFS tended to be larger (such as
having higher sales) than the average non-employer
reported in Census data. Therefore, KFS would tend
to overstate the share of non-employers becoming
employers.

The author also examined firms with no employees
that applied for the entrepreneurship training program,
Growing America through Entrepreneurship
(GATE), a pilot training program administered from
2003 to 2005 in several cities. Strong interest among
potential participants necessitated a lottery be held
among the applicants. Lottery losers were an excellent
control group for proper comparisons. About
five years after GATE efforts began, the outcomes of
firms that did and did not receive training were compared.
The possibility that firms could have received
training outside of the GATE program was accounted
for in the study methodology, however, it prevents
these results from serving as a specific measure of
the GATE program’s effectiveness.

This report was peer reviewed consistent with
Advocacy’s data quality guidelines. More information
on this process can be obtained by contacting the
director of economic research at advocacy@sba.gov
or (202) 205-6533.

Additional Information


This report is available on the Office of Advocacy’s
website at www.sba.gov/advocacy/7540. To receive
email notices of new Advocacy research, news
releases, regulatory communications, publications,
and the latest issue of The Small Business Advocate
newsletter, visit www.sba.gov/updates and subscribe
to the Small Business Regulation & Research


1. Measuring the Dynamics of Young and Small Businesses:
Integrating the Employer and Non-employer
Universes, by Steven J. Davis et al. U.S. Census Bureau
Center for Economic Studies discussion paper no. 06-04,
February 2006. www.census.gov/ces.

2. Utilizing the Kauffman Firm Survey to Predict Growth
in Venture Size and Scope among Small Firm Startups:
2004 Startups Tracked through 2008, by Timothy Bates,
Alicia Robb, and Simon Parker, www.sba.gov/sites/default/
files/files/rs405tot.pdf.

3. Small Business Quarterly Employment Bulletin, Third
Quarter 2013, www.sba.gov/advocacy/10871.


This document is a summary of the report identified above, developed under contract for the Small Business Administration, Office
of Advocacy. As stated in the report, the final conclusions of the full report do not necessarily reflect the views of the Office of
Advocacy. This summary may contain additional information, analysis, and policy recommendations from the Office of Advocacy.

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