Shrinking in a Bad Economy: America's Entrepreneur Class

Imagine a small airstrip where single-seat planes head down the runway, get 100 feet into the air and crash back to Earth, joining a heap of wreckage that grows by the day.

You'd think this might discourage people deciding to become a pilot.

That's a snapshot of what the recent recession did to many small businesses in America, where beneath the wreckage of failed companies lies a collection of would-be entrepreneurs. Economic funk, poor sales, tight credit, competition from new entrepreneurs abroad—all either choked existing businesses or caused aspiring entrepreneurs to hunker down and not take the leap.

Which leads to the question: Will the damage done by the weak economy have a long-lasting effect, discouraging the next generation of entrepreneurs?

U.S. job growth depends on small businesses, which generate about two thirds of net new jobs, according to the U.S. Small Business Administration. Start-ups fuel job growth disproportionately since by definition they are starting and growing, adding employees, says the Kauffman Foundation, which researches and advocates for entrepreneurship.

Though there was start-up activity during and after the recession, driven partly by unemployed individuals putting out a shingle, Bureau of Labor Statistics data show the total number of "births" of new businesses declined sharply from previous years. What's more, the number of people employed by new businesses that are less than a year old—a common definition of a start-up—also declined. That trend started a decade ago.

In a recent report on entrepreneurship, the BLS said the number of new businesses less than a year old that existed in the year ending March 2010 "was lower than any other year" since its research began in 1994. The downdraft started with the recession.

"More people who were self-employed failed and left self-employment than people who entered," says Scott Shane, an economics professor at Case Western Reserve University who wrote a study on entrepreneurship and the recession for the Cleveland Fed. "The net effect is negative, not positive, largely because downturns hurt those in business and those thinking of entering business."

Of course, there are plenty of hopeful stories to tell. In 2009, Audrey Todd opened Food for Good Thought, a bakery in Columbus, Ohio, after getting an SBA-backed bank loan and later some funding from state agencies. The bakery employs 11 people, including individuals with autism. And Othniel Denis used his savings this April to launch Excellent Ones Consulting, a part-time venture based in Brooklyn, N.Y., that helps companies automate administrative tasks.

And then there's the Web-based, fast-growth, stratosphere of the start-up firmament, where entrepreneurship is red hot. Silicon Valley and tech hubs throughout the U.S. are filled with these enterprises.

"You have a real dichotomy between the technology and Web-based economy versus the meat and potatoes economy," says Steven Kaplan, who teaches entrepreneurship at the University of Chicago Booth School of Business. Students at the school have lately gotten record funding from venture-capital and angel-financing groups for their tech projects. "I had two students this year, they had offers from private equity firms, and they turned down those jobs to go to work for start ups," he says. "I haven't seen that since the end of the 1990s."

But it is in the realm of meat a