By Daniel Newman
Early-stage business activity in the United States remained healthy in the first half of 2022 despite surging and persistent inflation. The number of business applications over the first half of this year came in well above pre-pandemic levels, although the pace has slowed from the record-breaking levels seen in 2021. More than 817,000 applications were filed to form new businesses likely to hire employees in the first half of 2022, based on the latest data release of the Census Bureau’s Business Formation Statistics. Likely employer businesses (labeled by Census as “high propensity applications”) are a subset of total business applications capturing those most likely to hire employees if and when a business becomes operational.
Quality new business applications are up nearly one-quarter so far this year relative to before the pandemic
As a result of the historically fast pace, applications were 23 percent higher compared to a pre-pandemic baseline covering the first six months of 2019, but that figure was down by a modest 11 percent relative to the first half of 2021, which ultimately finished with the largest annual increase on record. When including applications from nonemployer businesses, the total number of filings is up by 44 percent from before the pandemic and shows a similarly-sized drop off relative to 2021.
The ongoing surge in new business formation began to take off in the middle of 2020 and continues to to show strength even in the face of inflationary pressures — an added challenge for new firms during a time when their financial positions can be most precarious. Inflation pushes up the prices of vital business inputs like raw materials and the cost of labor, which can lead to tighter profit margins if business owners are unable to raise prices along with costs. Now as the Federal Reserve forges ahead with interest rate increases to address inflation, it can also become more difficult to qualify for and afford loans, further challenging the ability of entrepreneurs to navigate the startup environment. However, this crop of entrepreneurs may be less reliant on borrowing — and therefore less exposed to monetary tightening — than most historical comparison groups, since many launched off of record high asset valuations and substantial pandemic-related fiscal support from the federal government.
Even so, the latest monthly survey from the National Federation of Independent Business (NFIB) indicated inflation was the top concern among 34 percent of small businesses, reaching the highest share in more than four decades. The survey also found that respondents’ expectations on the business environment improving over the next six months reached the lowest level in the survey’s 48-year history — a troubling sign for potential entrepreneurs looking to start a business this year. One aspect weighing on these business owners is likely the uncertainty over how long high levels of inflation will continue to persist and when prices and costs will return to relative stability in the long-run. In addition to inflation, many businesses have had difficulty finding important business inputs given supply shortages in a range of industries, as nearly half of small businesses were experiencing domestic supplier delays earlier this year.
Pandemic frontline industries continue to lead the surge in applications, but their relative dominance is shrinking
The shock of the pandemic appears to have caused significant restructuring of certain industries and a realignment of some relationships between businesses and customers. The new business surge remains broad-based across most industry sectors, as applications for new likely employer businesses through June were up across all but a few major industries relative to the first six months of 2019. Among the ten industries with the greatest number of likely employer applications, those with the largest surges emerged in several areas of the economy most affected by the changing preferences and habits of consumers over the course of the pandemic: transportation and warehousing (+53 percent), accommodation and food services (+52 percent), health care and social assistance (+36 percent), and retail trade (+31 percent).
While this year’s modest slowdown is prevalent across industries, the pace of applications has noticeably cooled in several of those sectors that are leading the new application surge. Among the ten largest industries by applications, likely employer filings have come down the most in the retail trade (-18 percent), food and accommodation services (-16 percent), and transportation and warehousing (-13 percent) sectors. As the economy continues to adjust to a new normal — and in some ways revert back to pre-pandemic norms — these industries that had the greatest incentives to innovate and fill the economic void are entering a new phase that more closely resembles the economic environment of 2019 with less uncertainty than in 2020 and 2021.
Many Southern states are hotspots of business formation
Every state in the country has recorded an increase in likely employer business applications, but similar to the way in which some industries have pulled ahead more than others, so too have some states. While the biggest gains have been in Wyoming (+85 percent) and Delaware (+76 percent) — likely due to issues related to taxation and incorporation laws that lead many businesses to file applications there — a handful of states in the South posted significant increases of at least 50 percent: Mississippi (+76 percent), Alabama (+53 percent), and South Carolina (+52 percent). The South has also seen the largest increase in the number of business establishments, or actively operating business locations, since the pandemic began.
But filings have begun to slow in the first half of this year relative to last, as all but seven states recorded fewer likely employer applications in the first half of 2022. Only New Mexico, Vermont, Wyoming, Alaska, South Dakota, Montana, and Delaware recorded more applications for businesses likely to hire employees by the midpoint of this year relative to last.
The continued surge is a real boost to U.S. entrepreneurship
It has become increasingly clear that the pandemic delivered a much-needed positive shock to the rate at which Americans launch new enterprises. A healthy rate of new business formation signals a competitive and dynamic marketplace with low barriers to entry that allow new firms to enter and compete—raising quality, lowering prices, and spurring further innovation. The lack of strong new business formation in the wake of the Great Recession hindered the country’s economic recovery for years, but the new enterprise environment brought on by the pandemic is shaping up quite differently. The jump in intent to form new businesses in part likely reflects a necessity to adapt in response to job losses during the downturn as well as an opportunity to fill new economic needs amid changing consumer preferences, supply chain issues, and novel circumstances brought on by the pandemic.
Last year, applications to form new businesses—both sole proprietorships and businesses likely to hire and scale—reached unprecedented levels, with likely employer applications totaling around 1.8 million by year’s end—just about 481,000 more than in all of 2019. Even as this year looks to be slightly off the pace of 2021, it seems highly probable that total applications will still surpass that of any year before the pandemic. Yet the ultimate survival rate of young firms is low, even in the best economic circumstances, and most entrepreneurs are now facing one of the most challenging periods of inflation and supply chain disruption in decades. It will be many months before official figures emerge on how many of these expressions of entrepreneurial intent actually turn into new businesses that go on to hire workers, but research finds that there historically has been a high correlation between the number of applications and true business formation.
