Many economic development organizations (EDOs) have embraced the mission to support entrepreneurial firms in their communities. One way they do so is by providing business incentives. Our new report describes the types of state and local business incentives available for entrepreneurial firms and provides guidance on how to improve their effectiveness.
Incentive types and targets
The most common types of state and local incentives for entrepreneurial firms are financial, fiscal, and services. Financial incentives include debt, equity and grant programs, while the fiscal category covers tax incentives. Services include a wide variety of program offerings designed to assist entrepreneurial firms, such as incubators, counseling, and networking.
Incentives for entrepreneurial firms are, for the most part, divided into two target categories: small business entrepreneurs and innovation- or technology-oriented entrepreneurs. New or young firms are rarely the defined target for state and local incentives.
However, state and local governments have recognized that incentives designed either for all small businesses or for only technology-oriented businesses with high growth potential leave out many types of entrepreneurial firms that contribute to community and economic development. In response, governments are increasingly devising new approaches to support growth-oriented and second-stage small businesses, inclusive entrepreneurship and social enterprises, and microenterprises.
Implementation of entrepreneurial firm incentives
Incentive types and targets tell only part of the story. Program implementation practices also shape the impact of entrepreneurial firm incentives. Our analysis found that the following six implementation issues influence incentive effectiveness.
Incentives are only a minor component of the entrepreneurial ecosystem. Incentives and EDOs play niche roles in entrepreneurial ecosystem development, with limited influence over new firm formation. Policymakers should be aware that incentives can be expected to have only a marginal effect on entrepreneurial firms.
Incentive program rules may inadvertently constrain access and limit participation. In trying to determine which incentive programs are intended for new entrepreneurial firms, we looked at incentive eligibility guidelines and applications across many states. We found as a byproduct of our effort that these rules exclude many businesses, and the forms are often so complex that they seem designed to deter participation. Our review also found that many financial programs are used by only handfuls of businesses per year. Narrow program eligibility rules and onerous application requirements – often for small amounts of money – diminish the pool of participants.
Awareness of and access to incentive programs remains a challenge. Economic development programs can suffer from an “if you build it, they will come” mentality. Initiatives may be crafted, funded, and set up within state or local government but lack the resources to promote the programs to intended beneficiaries. The challenge can be especially acute for BIPOC- and women-owned businesses and firms in rural or underserved communities that lack networks within the entrepreneurial ecosystem.
Most incentive programs assist a very small number of companies per year. Many serve fewer than 10 or 20 businesses per year, and even large programs serve a tiny fraction of the entrepreneurial firms in their communities. These programs may fill an important niche, but policymakers should be aware that program size and resources may not be consistent with policy expectations for widespread firm- and place-based outcomes.
A new approach to entrepreneurs in underserved locations and demographic categories is needed. BIPOC and women entrepreneurs as well as entrepreneurs in rural communities and distressed urban locations all remain underserved. This means existing programs are primarily engaging a narrow segment of entrepreneurial firms. It would be appropriate for state and local government, economic development leaders, and community partners to initiate a rethink and reset of incentive and financing programs to identify ways to expand program access to meet the needs of all entrepreneurial firms.
Careful program design and active project management can improve effectiveness. Sound program design should include clear and measurable goals, transparent procedures for disbursing funds, an explanation of the way the incentive is expected to influence the expected outcomes, and a basic analysis to see if costs are in line with expected benefits. Incentive program management should provide consistent and specific guidance to program users, allow for reasonable due diligence on applicants, establish compliance procedures, and provide public reporting for accountability.
Next up: Future articles will summarize research findings on the outcomes of different types of incentives for entrepreneurial firms and describe concepts for improving data and research standards that would enhance our understanding of what works and the best practices for achieving policy objectives.
For more information, please see the full report, Incentives for Entrepreneurial Firms, and the accompanying technical and policy appendices. The research for this report was funded by the Kauffman Foundation.