Taking the Leap: The Determinants of Entrepreneurs Hiring Their First Employee

• Date: 01 February 2017
• Published date: 01 February 2017
• DOI: http://doi.org/10.1111/jems.12176
• Author: Javier Miranda,Robert W. Fairlie

Taking the Leap: The Determinants of Entrepreneurs

Hiring Their First Employee

ROBERT W. FAIRLIE

Department of Economics

Engineering 2 Bldg.

University of California

Santa Cruz, CA 95064

rfairlie@ucsc.edu

JAVIER MIRANDA

Center for Economic Studies

U.S. Census Bureau

4600 Silver Hill Road, 5K137 Washington, DC 20233

javier.miranda@census.gov

Job creation is one of the most important aspects of entrepreneurship, but we know relatively little

about the hiring patterns and decisions of start-ups. Longitudinal data from the Integrated Lon-

gitudinal Business Database (iLBD), Kauffman Firm Survey (KFS), and the Growing America

through Entrepreneurship (GATE) experiment are used to provide some of the first evidence in

the literature on the determinants of taking the leap from a nonemployer to employer firm among

start-ups. Several interesting patterns emerge regarding the dynamics of nonemployer start-

ups hiring their first employee. Hiring rates among the universe of nonemployer start-ups are

very low, but increase when the population of nonemployers is focused on more growth-oriented

businesses such as incorporated and employer identification number businesses. If nonemployer

start-ups hire, the bulk of hiring occurs in the first few years of existence. After this point

in time, relatively few nonemployer start-ups hire an employee. Focusing on more growth- and

employment-oriented start-ups in the KFS, we find that Asian-owned and Hispanic-owned start-

ups have higher rates of hiring their first employee than white-owned start-ups. Female-owned

start-ups are roughly 10 percentage points less likely to hire their first employee by the first,

second, and seventh years after start-up. The education level of the owner, however, is not found

to be associated with the probability of hiring an employee. Among business characteristics, we

find evidence that business assets and intellectual property are associated with hiring the first

employee. Using data from the largest random experiment providing entrepreneurship training

in the United States ever conducted, we do not find evidence that entrepreneurship training

increases the likelihood that nonemployers hire their first employee.

1. Introduction

Many policymakers and organizations have called upon entrepreneurs to create new

jobs. For example, President Obama has repeatedly emphasized the importance of

We thank Michael Roach, Nick Papageorge,and seminar participants at Cornell University, Harvard Univer-

sity,the London School of Economics, the University of Bristol, UC Berkeley, University of Arizona, Louisiana

Tech, Tufts University,Northeastern University, and the Kauffman/IZA Conference on Entrepreneurship for

comments and suggestions. We also thank the Small Business Administration for partial funding for the

project. Any opinions and conclusions expressed herein are those of the author(s) and do not necessarily

represent the views of the U.S. Census Bureau. All results have been reviewed to ensure that no confidential

information is disclosed.

C2016 Wiley Periodicals, Inc.

Journal of Economics & Management Strategy, Volume26, Number 1, Spring 2017, 3–34

4Journal of Economics & Management Strategy

start-ups and small businesses in creating jobs, and has signed laws such as the Small

Business Jobs Act of 2010 and the Jumpstart Our Business Start-ups (JOBS) Act of 2012,

which aim to create jobs through promoting small businesses. The focus on the job cre-

ation potential of entrepreneurs also exists in Europe and other countries around the

world (OECD, 2014).

Several previous studies examine the impact of small businesses on employment.

Starting with the seminal study by Birch (1979) showing that small businesses were

the principal driver of job creation in the U.S. economy and recent refinements of this

argument to focus on young and high-impact firms, there has been considerable interest

in what types of firms generate jobs. Recent evidence indicates that young and high-

impact businesses (defined as having high rates of growth in sales and employment)

account for essentially all net jobs in the economy (Tracy, 2011; Haltiwanger et al., 2013).

Often overlooked is that self-employed business owners also create jobs for themselves,

representing more than 10% of total employment in the United States and that many

employer businesses start as nonemployers (Davis et al., 2007).

But, hiring employees represents one of the major thresholdsthat entrepreneurs en-

counter when growing their businesses. The step from nonemployer to employer entails

additional registration and legal requirements; health insurance, workers compensation

and unemployment insurance issues, and the ongoing burden of making payroll. Nav-

igating through filing for an employer identification number (EIN), federal wage and

tax statement (Form W-2), employee eligibility verification (Form I-9), state new hire

reporting program, workers’ compensation insurance program, unemployment insur-

ance tax registration program, and disability insurance in some states may be especially

daunting to small business owners considering hiring their first employee. But, perhaps,

the most important consideration for the owner is whether current and future revenues

are large enough to cover the extra expenses of having employees. Surprisingly, given

its importance, there is very little research on the topic.

This paper examines four main questions related to the decision by entrepreneurs

to hire their first employee that have not been examined in detail in the previous litera-

ture. First, what are the dynamic patterns of hiring employees among start-ups in their

first few years of existence? Second, what are the demographic and human capital char-

acteristics of entrepreneurs that are associated with making the decision to hire theirfirst

employee in the first several years of operation? Are female, minority, and immigrant

owners less likely to cross the employer threshold? Are more educated entrepreneurs

more likely to hire their first employee in the first years of existence? Third, can an

alternative form of human capital, entrepreneurship training, help overcome some of

the barriers to hiring employees? Entrepreneurship training often specifically teaches

self-employed business owners strategies for hiring and managing employees, and pro-

vides training on registering for EINs, tax and insurance compliance, and legal issues,

but does it increase the likelihood of hiring the first employee? Finally, what dynamic

business conditions are associated with hiring the first employee? Is there a sales or

business asset milestone that firms often reach before hiring their first employee? Do

nonemployer firms typically have intellectual property,such as patents, copyrights, and

trademarks, before hiring their first employee?

In addition to the previous research on the impact of small businesses on employ-

ment in the United States, a few recent studies examine the relationship and growth

patterns between nonemployer to employer businesses. Acs et al. (2009), for example,

find that nonemployers have a start-up rate of 35%, which is nearly three times the

start-up rate of employer firms. Using matched data from the Census Bureau, Davis

Taking the Leap 5

et al. (2007) find that a significant number of new employer firms start as nonemployer

firms. The link between nonemployer and employer status and how it is related to

reaching business milestones and owner characteristics, however, has not been previ-

ously examined in detail.

Another strand of research indicates variation in employment rates and average

number of employees by demographic and human capital characteristics of the business

owner. Parker (2009) reviews the literatureand reports evidence of positive effects from

education, age, experience, male, parental self-employment, wealth, and industry.1Three

factors that especially stand out are minority, female ownership, and education. In

the United States, for example, substantial disparities exist between minority versus

nonminority owned firms and female versus male owned firms, for example: 13.3%

of minority-owned firms hire employees compared with 21.6% of nonminority owned

firms, and 11.7% of female-owned business hire employees compared with 23.2% of

male-owned businesses (U.S. Census Bureau, 2013).2The education level of the business

owner is also associated with hiring employees, with 32% of owners with a university

degree hiring employees compared with 28% of owners with a high school degree or

lower level of education hiring employees.3These findings, however, are for all existing

businesses and do not capture the relationship between owner characteristic and the

employment decision when that decision is made. Previous research also does not focus

on start-ups, and hiring patterns may differ substantially for all new businesses than for

the subsample of businesses that survive up to the survey year.

In this paper,we use data from three sources: 1) the U.S. Census Bureau’s Integrated

Longitudinal Business Database (iLBD) that provides panel data on the universe of

nonemployers matched to employers over time, 2) the Kauffman Firm Survey (KFS) that

provides panel data on detailed owner and business characteristics and follows growth-

oriented start-ups over the first several years of existence, and 3) the Growing America

through Entrepreneurship (GATE) experiment that is the largest random experiment

on the effects of entrepreneurship training ever conducted. Using these data, this paper

provides one of the first detailed longitudinal studies of the owner,business, and training

determinants of nonemployers hiring their first employee. The novel results from the

iLBD provide the first evidence in the literature on hiring patterns among the universe

of nonemployer start-ups.4

The limited previous research on the topic appears to be due to data limitations.

Very few datasets provide information on the time at which a business hires its first

employee, owner and business characteristics, and longitudinal information on business

conditions or milestones. Additionally, no previous datasets have information allowing

for a credible method of identifying whether entrepreneurship training helps business

owners hire their first employee.

2. Data

Three datasets, the iLBD, the KFS, and the GATE Project, are used in this study.

All three datasets provide difficult-to-find information on when a nonemployer

1. Also, see Burke et al. (2000, 2002), van Praag and Cramer (2001), Cowling et al. (2004), Henley (2005),

and Fairlie and Robb (2007a).

2. See Fairlie and Robb (2007b, 2008) for a review of the literature on racial and ethnic patterns in business

employment.

3. See van der Sluis et al. (2005) for evidence on the relationship between education and business outcomes.

4. These results from the new and revised iLBD complement earlier results reportedin Davis et al. (2007).

Two major differences in the current study arethat we focus specifically on the population of start-ups and

that we include all industries.