Our recent report and technical appendix examines the state of business incentives for entrepreneurial firms. Funded by the Ewing Marion Kauffman Foundation, we analyze financial, fiscal, and services (such as incubators) incentives to determine if and how they are assisting small business entrepreneurs and innovation or technology entrepreneurs, including micro enterprises, inclusive/social enterprises, and second-stage/growth firms. The research highlights several insights for policy savvy economic developers, policy makers, and program administrators seeking to design and offer incentives to stimulate their entrepreneurship ecosystem and regional economic growth.
Last week, we outlined the types of state and local incentives offered and the implementation issues that affect their ability to achieve economic development policy objectives. Beyond understanding how policies can be designed more robustly, we found that few programs across the states provide good data on the effect these different types of business incentives had on entrepreneurial firms or on regional economic growth. This week, we call out six specific outcomes and provide recommendations on business incentive program design to better align programs with policy objectives.
Outcome 1: Small business lending programs can be effective but are often too small.
Most stand-alone state and local small business loan programs are too small to have a substantial community- or firm-level impact. The programs themselves may fill a gap in credit access, but they are still a minuscule segment of the small business credit universe.
Recommendation: Good management practices, technical expertise, sustained outreach, and effective compliance procedures are necessary to ensure a chance for success. This holds true even though these small business lending programs manage a small number of transactions per year and could enable growth in these programs. The use of COVID-19 relief and recovery funding for small businesses provides ample opportunity to improve and understand these programs better. We will be examining these efforts in our 2021 update of this work.
Outcome 2: Grants can have positive impacts on the firm and its community but are often limited.
Grants appear to have positive firm-level effects, including employment and sales growth, that should yield community-level benefits, as well. The scale and scope of most grant programs, however, suggest that community-level outcomes would not be widely felt.
Recommendation: COVID-19 relief and recovery grant funding provides ample opportunity to see if scale and scope could improve firm and community impacts. We will be examining these efforts in our 2021 update of this work.
Outcome 3: Private equity investment is popular, risky, and successes are not necessarily anchored to the investing area.
Research tends to highlight the risks associated with public funds for private equity investment, but this strategy remains popular. Even successful private equity investors generate few breakout successes and tolerate many company failures. State and local governments face an even greater challenge in achieving success because their goals are for firms receiving investments to create a substantial number of new jobs and remain in the state over the long term.
Recommendation: Experienced managers and good management practices play an especially important role in equity programs. Improved data collection is essential to assess if benefits accrue in the state and local areas making the investment.
Outcome 4: Angel investor tax credits seem beneficial, but uncertainties come from program design and data issues.
Angel investor tax credits appear to have a positive but limited impact on the firm and community. Research in this area, however, is not definitive. Program design can allow the tax credits to disproportionately or unintentionally go to company insiders who may have made the investment even without the tax credit. Community-level benefits are often not be widely felt except in the unusual case of a breakout company success.
Recommendation: Good program design and management practices and improved data collection would improve our understanding as to whether the benefits accrue at the firm and community levels.
Outcome 5: Tax incentives are not the best method of helping entrepreneurial firms.
At best, tax incentives, including R&D tax credits, have indirect positive effects; at worst, they have negative impacts on entrepreneurial firms. Transaction costs can diminish the value of refundable or transferrable tax credits and end up diverting intended resources away from the entrepreneurial firm.
Recommendation: More research is needed to determine if large companies crowd out smaller firms, possibly decreasing growth rate of startups and scaleup firms.
Outcome 6: Services to entrepreneurial firms appear to generate positive firm-level outcomes, but it is not clear which types of services are most valuable. Service offerings must be sufficiently staffed and funded to be effective.
Recommendation: The suite of services offered to entrepreneurial firms are diverse, and service-specific analysis is needed to determine the level and diversity of services that different types of entrepreneurs and startups find helpful. This could allow the services to be targeted to the firm’s type of innovation, the phase of ideation and development, and other firm characteristics and track firm outcomes.
For a detailed look at the business incentives research and the findings, see the technical appendix. Next week we will call out policy and data deficits that hinder evaluation efforts and offer ways that policy makers can improve entrepreneurial incentive programs.