The decline in New Startups: Cause for Concern or False Alarm?

A time lag in the data covering newly founded start-up companies in Israel presents us with a grim picture of the current growth rate. However, when we correct for that lag, we learn that despite a mild decrease in the number of new start-ups annually, the actual trend is far less drastic than it first appears.

Concern over a decline in the number of new start-ups founded each year is not new to the Israeli economic landscape. It reflects the fear that the celebrated ‘Start-Up Nation’ could slowly be losing its entrepreneurial edge. For example, SNC’s figures as they stood in mid-2018 showed a steady decline in the number of new start-ups since 2014. However, when we look at the updated figures for the same period, we see that the growth rate is quite stable up until 2016, and begins to decline only from 2017 onwards.

What causes this disparity in the data?

SNC’s Finder and similar databases are constantly collecting open-source data and proprietary information from both start-up companies and investors. But, as we know, start-ups tend to be small, private companies that often choose to maintain a low profile throughout the early stages of their development to protect themselves from competitors – commonly referred to as “stealth mode.” For this reason, it is not uncommon for the very existence of a new start-up to remain a total secret to the outside world during the first several years after its founding. This inevitably creates a significant time lag between the available data at the time the company is founded and the more complete data sets compiled in subsequent years.

How significant is this difference?

Based on the average of the time lags observed in previous years, it appears that the true number of new start-ups founded in any given year is approximately 2.5 times greater than is reported at the time. For example, the current data show that 340 new start-ups were founded in the year 2020; therefore, the actual number is most likely well over 800.

(For an explanation for our time lag correction methodology please see the Methodology Annex).

Should these figures alarm us?

The short answer is no. While we do in fact observe a certain decline in the growth rate even after we apply the time lag correction, the phenomenon is considerably more gradual than it appears when looking at the unadjusted data. Although the trend is indeed somewhat worrisome, the adjusted data indicate that we are by no means on the brink of a catastrophe, as illustrated in the graph below. Since 2016, the growth rate of new Israeli start-ups has been declining at a compound annual rate of 7.8%. Viewed on its own, this may feel like a precipitous decrease, but it presents a stark and optimistic contrast to the 25% decline that the original data implied.

What is causing the decrease in the number of new start-ups?

It is difficult to determine the exact causes of this decline in entrepreneurship. Some researchers suggest that the differing perception of risk and fear of failure in distinct populations may affect entrepreneurial propensity among varying demographics. According to them, the generation from which new entrepreneurs generally emerge is losing its appetite for risk-taking and becoming leerier of failure. The result of this perception shift is an increasing desire to avoid risk.

Another potential factor is the growing trend of business consolidation and the subsequent attractiveness of employment at large, well-established companies. As the terms of employment offered by these large companies become more and more generous, the alternative cost of entrepreneurship endeavors increases accordingly. Therefore, the motivation to engage in such ventures is severely impacted, both for the founders and their potential employees¹.

Of course, governmental regulation and the ready availability of funding are central factors as well. However, accurately assessing whether regulatory conditions have changed dramatically in the past several years poses a considerable challenge. As regards access to investors, data show that VC funding in the Israeli ecosystem and other prominent economic landscapes has risen noticeably in recent years, while the number of seed rounds has dropped. This issue opens the door to some highly debatable topics that I will address and attempt to clarify in a future post series.

More to come

The Israeli start-up ecosystem is still growing, as evidenced by the number of new start-ups formed each year, which remains slightly higher than that of annual closures. However, while the adjusted figures may present a brighter picture of the founding of new companies in comparison to the original raw data, when we apply the same methodology to the closure rate of start-ups, we notice a trend of similarly inflated values.

This will be the topic of the next blog in this series, that is scheduled to be published next week.

Methodology Annex

Our time lag correction methodology calculates a 3-year average gap (in percentage terms) between each year and  every consecutive year. For example, to calculate the lag correction for 2020 we take the average addition (in percentage) made after 1 year for 2019, 2018 and 2017, called the “t+1 addition”, and add it to the figures for 2020. Then we add the average addition made after 2 years, the “t+2 addition”, and so on. For instance, we already know the actual t+1 addition for the year 2019, so we add only the t+2 and subsequent additions; accordingly, the addition to 2018 is made from the “t+3 addition” and onward.

The chart below details the time lag correction additions for each year based on our methodology:

¹ For further reading see:

Zhang, T., Acs, Z. Age and entrepreneurship: nuances from entrepreneur types and generation effects. Small Bus Econ 51, 773–809 (2018)

Ensari, M . “A STUDY ON THE DIFFERENCES OF ENTREPRENEURSHIP POTENTIAL AMONG

GENERATIONS”. Research Journal of Business and Management 4 (2017): 52-62

Stangler, Dane, The Coming Entrepreneurship Boom (June 1, 2009). Available at SSRN: https://ssrn.com/abstract=1456428 or http://dx.doi.org/10.2139/ssrn.1456428

https://www.nytimes.com/2017/09/20/business/economy/startup-business.html