Entrepreneurs statistically fail more often than not, but new research has suggested the financial risk is not as great as previously thought, as failed entrepreneurs can return to the salaried workforce and recover their earnings quickly.
"Even if the business fails, entrepreneurs don't suffer as much"
While prior research has maintained that entrepreneurs bear more risk than salaried workers, Gustavo Manso of the Haas Finance Group at UC Berkeley's Haas School of Business found that entrepreneurs receive comparable lifetime earnings when they return to a salaried position and, therefore, are exposed to less risk.
It was also suggested that those who remained entrepreneurs earned substantially more than their less adventurous counterparts over time.
"Research on entrepreneurs earning less and bearing more risk raises the question of why people choose to become entrepreneurs," he said. "Prevailing explanations for this puzzle are based on non-standard beliefs or preferences. For example, entrepreneurs may enjoy non-pecuniary benefits, have a preference for skewness, or be overconfident.
"Non-standard beliefs or preferences may not be necessary to justify the decision to become entrepreneur. Studies showing that entrepreneurship does not pay rely on cross-sectional data to compute estimates of mean and standard deviation of entrepreneurial earnings. I showed that such estimates do not reflect the risk and return that individuals face when they decide to become entrepreneurs as they fail to account for the option value of experimenting with new ideas.
"Using longitudinal data, I found patterns that are consistent with entrepreneurship as experimentation:entrepreneurship spells are short, the probability of abandoning entrepreneurship is higher after bad performance, and failed entrepreneurs are not punished when they return to the salaried workforce.
"Would-be entrepreneurs may think they have a huge chance of failure and will be sacrificing earnings for the rest of their lives, but it's not true," explained Manso. "Even if the business fails, entrepreneurs don't suffer as much since they are able to quickly transition to the salaried workforce."
Ahead of the findings, Manso followed the careers of entrepreneurs over three decades, including founders of startups and small business owners – both successful and unsuccessful.
He used the National Longitudinal Survey of Youth to model entrepreneurship's return on investment, or ROI, and gained access to data on 12,686 men and women who ranged between the ages of 14 to 22.
The participants were interviewed annually through 1994 – and were continually interviewed every other year. The Longitudinal Survey also provided Manso with the participants' demographics, education, careers, and labor market traits.
The survey revealed that 52 per cent of entrepreneurial endeavours lasted less than two years. Understandably, entrepreneurs who earned less while self-employed tended to abandon the solo route more often than those who earned more as entrepreneurs.
Over a lifetime, however, entrepreneurs not only earned ten per cent more but also did so with less risk. "The study suggested that becoming an entrepreneur is a rational decision and failing isn't as bad as one would think," said Manso. "It doesn't hurt your lifetime prospects."