Small Businesses and Their Impact on the Economy
Small businesses are companies that employ fewer than 500 employees (manufacturing) or 100 employees (wholesale trade). The federal government has specific definitions for small businesses in all other industries.
The Small Business Administration defines small businesses as follows:
- Manufacturing and mining industries - 500 employees.
- Wholesale trade - 100 employees.
- Retail and service - $6 million.
- Construction - $28.5 million.
- Trade contractors - $12 million.
- Agricultural - $0.75 million.
The chart below illustrates how many companies employ 1–99 people, 100–999, and 1000+.
- Small businesses are those that keep within a specified low-volume range of revenues, assets, and employees.
- The SBA’s classification of small businesses varies according to industry.
- Small businesses fuel economic growth by increasing job opportunities and raising employment rates.
- The U.S. government often favors small businesses with incentives, tax cuts, grants, and good access to funding to help keep them competitive.
How Small Businesses Affect the U.S. Economy
Small businesses are critical to U.S. economic growth. They contribute 65% of all new jobs. Without small businesses, the economy won't grow.
The Congressional Research Service found that the best job creators were firms with 20-499 employees. They are more likely than smaller firms to remain in business after five years. At least half of all new start-ups fail before that milestone.
The vast majority of companies in the United States are very small businesses. In fact, 96% have 50 or fewer employees. That's 5.8 million out of 6 million total companies. Yet, they employ just about 34 million workers.
Programs to Help Small Businesses
The federal government recognizes the important role of small businesses. It targets programs for small business owners in most major legislation. Here are some examples.
The Tax Cuts and Jobs Act of 2017 helped small businesses that are pass-through businesses. These include sole proprietorships, partnerships, limited liability companies, and S corporations. They also include real estate companies, hedge funds, and private equity funds.
The Act offers them a 20% standard deduction on qualified income. This deduction ends after 2025. The deductions phase out for service professionals once their income reaches $157,500 for singles and $315,000 for joint filers.
The Bush tax cuts, originally passed in 2001 and 2003, were extended in 2010. They were extended again in 2012 for those making less than $250,000 a year.
Some argue they should also be extended for those making more because many of them are small business owners. In fact, only 3% of small businesses make that much, but that 3% employs 25% of the workforce.
A compromise that was never passed would have extended the Bush tax cuts for these small businesses only. As many as 70% of the wealthy don't own small businesses. If the tax cuts expired for them, it could have reduced the deficit by $700 billion over the next 10 years.
In the last decade, the cost of providing health care insurance has skyrocketed for small businesses. The average premiums rose from $5,700 in 1999 to $12,700 in 2009. As a result, only 59% of small businesses offered health insurance benefits. That's down from 65% in 1999.
The Affordable Care Act requires small businesses with 50 employees or more to provide health insurance or they pay a fine. The penalty is $2,000 per employee for all but the first 30 employees. Despite what you might hear, this requirement doesn't hurt most small businesses. That's because more than 96% of such companies already do provide insurance.
Businesses with fewer than 100 employees can use the state-run exchanges to shop for the most cost-effective plan. Businesses with fewer than 50 employees don't have to pay a fine if their workers get tax credits through the exchange.
Companies with 25 employees or less may qualify for a 50% tax credit. One criterion is that the average annual salary of their employees must be $50,000 or less. Businesses that offer health insurance as a benefit to early retirees 55-64 can get federal financial assistance.
In 2009, the Economic Stimulus Act provided tax credits and funds for small businesses. The TARP program gave $95 billion to community banks for small business loans. In 2010, the federal government gave them another $30 billion that was added to the FY 2011 budget.
The Small Business Administration offers many different types of loan guarantees. The smallest is micro-lending, which are loans less than $50,000. A larger business should apply to the 7a program for loans up to $2 million.
Microloans are from $1,000 to $50,000 loans with a wide range of terms. They're designed for start-ups, so they don't require a demonstrated history of profitability.
The Small Business Administration's Microloan program works through local non-profits. It funds start-up, expansion, and child-care centers. Accion is a website that connects small businesses with lenders from around the world. Kiva allows lenders to contribute just a portion of the borrowers' loan. It is a non-profit designed to help entrepreneurs in under-served parts of the world, but U.S. small businesses can and do apply. Kiva.Zip provides interest-free loans if you're business providing a social good, such as organic food, an urban mushroom farm, or gluten-free vegan granola.
Boot-strap loans are the most common source of funds because loan applications are difficult and time-consuming. Most businesses that are just starting out use their own funds, loans from friends and family, or credit card debt. The advantage is that you can get any of these loans pretty quickly. The disadvantage is that loans from friends and family are emotionally risky.
Other Forms of Small Business Funding
- Crowdsourcing is when a group of people provides funds for a business via a website. You must get them excited about your company's purpose.
- Angel investors are wealthy individuals who provide their own funds. In return, they expect part-ownership and a percentage of future profits. They are looking for a high rate of return. So, they tolerate high risk.
- Venture capitalists are companies who use investors' funds instead of their own. They want a share of future profits and a controlling share of ownership. They offer more money than angel investors but tolerate less risk.
- Private equity is when a group of investors buys a controlling share of a company. They usually have a five to 10-year time horizon. They look for a $2.50 return for every dollar invested.
- Small business grants don't require repayment. But your business must serve a particular purpose as outlined by the government. The application process is detailed and may require too much time.
- Supply-chain financing is like a pay-day loan for businesses. Suppliers use the invoice for a shipment as collateral to get a low-interest loan from a bank. Banks know that they will get paid due to the credit-worthiness of the business receiving the goods. This helps small suppliers get better financing terms. Even banks that are reluctant to lend to each other are willing to lend against approved purchase orders and invoices with companies that have a good shipping record.
- Another source of funds is becoming more efficient in your operations. This frees up cash to invest in your company's growth. For example, reduce foreign exchange and interest rate risk.
Small Business Grants
Grants are usually only available for specific types of businesses or activities that the government wants to encourage. There are 20 categories on the Grants.gov website alone. These range from agriculture to transportation. They are funded by various federal agencies. For example, the Department of Agriculture provides grants for businesses that provide broadband into rural areas.
States provide grants to specific businesses that further their economic plans. These include child care centers, innovative technology or alternative energy. Although they are awarded by state and local governments, the funding is from the national level.
If your business has a social welfare goal, you'll have better luck finding a local grant. The Community Development Block Grant Program gives cities federal funds that they can allocate for their social improvement goals. They're more likely to fund non-profits, but if your business meets their goals, it's worth a try. They support affordable housing, services to low-income families, and job creation. Contact your local municipal government to find out more.
How to Invest in Small Businesses
Once a small business starts to do well, it often needs more capital to grow. Many companies decide to access the stock market for that capital. They undertake the arduous process to issue an initial public offering. These stock offerings are only available to large investors. They are very risky because you cannot sell the stock during an initial window of time. If the stock plummets, you must helplessly watch your investment shrink.
It's much easier and safer to invest in small-cap stocks. The advantage is that offer the possibility for healthy growth. Small cap stocks are defined as companies with a market capitalization of less than $2 billion.
Congressional Research Service. "Small Business Administration and Job Creation," Page 5, Table 3. Net Employment Change from Small Establishments, 2010-2018. Accessed June 4, 2020.
Congressional Research Service. “Small Business Administration and Job Creation,” Accessed Feb. 3, 2020.
CMS.gov. “The Center for Consumer Information & Insurance Oversight,” Accessed Feb. 3, 2020.
Tax Policy Center. “Treasury Left the Door Open to the 20-Percent Deduction for Pass-Through Businesses,” Accessed Feb. 3, 2020.
The Wall Street Journal. “What the Republican Tax Plan Means for Business,” Accessed Feb. 3, 2020.
The Wall Street Journal. “The Answers to Your Best Tax Questions,” Accessed Feb. 3, 2020.
CMS.gov. “Shining a Light on Health Insurance Rate Increases,” Accessed Feb. 3, 2020.
U.S. Small Business Administration. "Loans," Accessed Jan. 31, 2020.
Accion. "Homepage," Accessed Feb. 3, 2020.
Kiva. "Homepage," Accessed Feb. 3, 2020.
Kiva. “Fund Your Dream, Change Your Life,” Accessed Feb. 3, 2020.
Crowd Sourcing Week. “What is Crowdsourcing?” Accessed Feb. 3, 2020.
Entrepreneur. “Angel Investor,” Accessed Feb. 3, 2020.
U.S. Rural Development, U.S. Department of Agriculture. “Community Connect Grants,” Accessed Feb. 3, 2020.
Hud Exchange. “CDBG: Community Development Block Grant Programs,” Accessed Feb. 3, 2020.
Washington State Department of Commerce. “Community Development Block Grants (CDBG),” Accessed Feb. 3, 2020.