Crossing the Employer Threshold: Determinants of Firms Hiring Their First Employee
Robert W. Fairlie, December 2013
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?
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
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.