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Wednesday, June 27, 2018

High growth firms as the Holy Grail or fool’s gold?

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In 2006 Finfacts reported that Xsil, an Irish firm producing innovative laser micro-machining systems to the semiconductor industry, had won the top prize in that year's Deloitte Technology Fast 50 awards. The company had achieved an impressive aggregate growth in revenue of 17,333% in the previous 5 years. Three years later Peter Conlon, the co-founder, told The Irish Times that Xsil Ltd had no assets to speak of except stock, which had been valued at “a couple of hundred thousand dollars, but we’d be lucky to get a cent on the dollar for it” — note that the superlative performance was based on revenue, not profitability.

High growth firms (HGF) have been getting a lot of attention from policymakers in recent times as these firms create a disproportionate number of jobs while most surviving employer startups don’t add any net jobs. Finfacts reported on HGFs in 2016:

High-growth firms transient; not typically in high-tech sector

Earlier this year the Brookings Institution published an analysis of Inc. magazine’s 500|5000 listing of the top 5,000 private companies in the US using the Organisation for Economic Cooperation and Development’s (OECD) definition of “high-growth”— at least 10 employees at the start of the period; annualised revenue growth of 20% or more each year during a three-year period, or 72.8% over the entire 3 years.

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Ian Hathaway reported that 3 information technology industries — IT Services, Software, and Computer Hardware — accounted for 21% of HGFs while the other predominantly high-tech industry —Health (which includes biotechnology and medical technology) — accounted for another 8%.

According to Hathaway, the US information technology sector accounted for 2.8% of employment in 1980 and 2.7% in 2015. There are higher estimates but direct employment typically is in low single digits.

In the European Union Eurostat defines “high growth” as 10% expansion in revenues compared with the OECD’s 20% and the statistics office says that 15% of HGFs are in the Information and Communication sector.

A survey by the Kauffman Foundation of 479 companies from the 500|5000 database in 2013 showed that only about 6.5% of them had raised venture capital. The entrepreneurship think-tank also studied the performance of firms on the list 5 to 8 years later and found that two-thirds had either failed, shrunk or had been acquired by another firm.

According to Inc. magazine:

Most companies on the Inc. 5000 are not startups. In fact, 80% of companies (18,863) were at least 7 years old when they first made the list. The median revenue of companies on first appearance was under US$6.9m… When it comes to headlines, startups with spectacular growth get the glory. But a lesson from Inc. 5000 companies is that business success is a marathon, not a sprint…only 3 companies ― Total Quality Logistics, G&A Partners and Skoda Minotti ― appeared on Inc. lists 13 times (including multiple appearances on the Inc. 500). Many sustained growth companies occupy the bottom 40% of the list, year after year without much glory. For many of these companies, the law of large numbers comes into play: Their base revenue is high, so percentage sales growth is not as high.”

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I wrote on Finfacts in 2015 on scaleups in the UK; London School of Economics slides:

Less than 4% of UK startups have 10 or more employees 10 years after their creation according to a report on scaling-up companies that was commissioned by the British government. However, the fastest growing 6% of businesses between 2002 and 2008 created half the new UK jobs in that period, according to data from Nesta, an innovation think-tank.

British researchers have examined data on 239,649 employer firms that were born in 1998 and just about 10% survived in the 15-year period to 2013. 212,427 of the firms (90%) were born with less than 5 jobs and these very small firms had a similar proportion among the survivors. The researchers say that two-thirds of the born very small remain very small but amongst the 9,266 which grew, and had 5 jobs or more by age 15, there is an even smaller group, just 1,248 firms, which have grown quite spectacularly: taken together they account for 40% of all jobs added between birth and age 15 by all survivors.

What if a business support agency had as an objective the early identification of those 1248 firms? Choosing a member of this small group from the 1998 firms born with less than 5 jobs requires considerable luck: the chance at birth is 1,248 out of 212,427 – about 0.5%.

Eurostat data show that Ireland in 2015 had the highest rate of HGFs (based on the 10% growth level; see chart above) among firms in the EU-28 with 10 or more employees. However, the Irish data likely reflects the significant foreign multinational sector. Ireland had a very low startup rate for employer firms in 2015:

Ireland has very low employer firm startup rate- the UK is 4 times bigger

HGFs are very important but the Holy Grail of how to sustain high growth has yet to be found. There are not sufficient data on firms currently available’ to track in particular firm profitability. Longitudinal studies could help in Ireland for example in tracking firms that succeed and fail despite State support. However, the answer to the question in the title in respect of Ireland, in particular, is to get a boost in Irish-owned employer firm startups as that would increase the likelihood of HGFs being created.

The Irish government focuses on support of high tech startups but anyone with international potential is typically acquired by a foreign-owned firm before there is a scaleup in Ireland — venture capital investors of course insist on a sale when a big name international firm comes calling. See here

It’s more than 20 years since there was a significant high tech scaleup in Ireland.