Is small business the future?
Both of the major presidential candidates are on the stump extolling the virtues of small business. And it’s true that small businesses create the majority of new jobs in our economy. But actually, it’s young businesses that create jobs. Small businesses that have been small for the past 5 years tend to create jobs at the same rate as big businesses.
it’s also true that, over time, small-cap companies outperform large-cap companies. They have better sales growth, better ROE, and better stock market returns. Part of this is due to their higher volatility—small businesses are just riskier. They have less capital and their managers have less experience. But part of this is due to the fact that it’s easier, just as a matter of math, for small businesses to grow.
So when I hear politicians say they want to favor small businesses, I think they’re missing the point. To borrow from General George S. Patton, no small business ever succeeded by staying small; it succeeds by growing to become big. There are already too many set-asides and special perks in the tax code. Another special provision for small businesses just makes for more paperwork.
And it increases taxes on the margin. Because as they grow, at some point those small companies will no longer qualify for those special provisions—they have to be phased out. And that phase-out effectively raises the marginal tax rate on companies who are growing. So something designed as a support becomes a disincentive to grow.
It’s no great shame to be small. Of course, it’s no great honor, either.
Douglas R. Tengdin, CFA
Chief Investment Officer
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