“Entrepreneurship is not always about chasing profits or dreams. Sometimes it’s about survival. 1 in 4 entrepreneurs in Europe and 1 in 6 in the USA didn’t leap – they were pushed into entrepreneurship. For them, entrepreneurship was a way to escape unemployment or a very bad job. It was necessity – not opportunity – that birthed these entrepreneurs.” (M. Svetek for Evidnce-Based Entrepreneurship)

It’s not uncommon for policymakers to encourage individuals, particularly those who are unemployed or have low employment prospects, to become entrepreneurs. After all, entrepreneurship is often touted as a panacea for economic development and an instant fix for unemployment. However, it’s important to understand the substantial differences between different types of entrepreneurial activity before encouraging people to become entrepreneurs.

Entrepreneurship scholars distinguish between two types of entrepreneurial activity based on the motivation to engage in entrepreneurship: opportunity-driven and necessity-driven entrepreneurship. Opportunity-driven entrepreneurs are motivated by the potential for profit, growth, or the achievement of personal aspirations. In contrast, necessity-driven entrepreneurs are motivated by difficult financial circumstances and are often unemployed before turning to entrepreneurship. The disparity between the outcomes of necessity-driven and opportunity-driven entrepreneurs begins precisely with the opportunities they pursue. Because opportunity entrepreneurs are not pushed into entrepreneurship, they typically engage in it only after identifying a good business opportunity. As opportunity entrepreneurs have more resources to burn at the beginning, they are also more likely to enter industries with higher barriers to entry; these industries are generally more profitable. On the other hand, necessity-driven entrepreneurs often find themselves in a rat race within highly competitive, low-profitability industries, which, unsurprisingly, have the highest business failure rates.

One reason necessity entrepreneurs tend to underperform compared to opportunity entrepreneurs—particularly in terms of profitability and failure rates—is their tendency to self-select into less favorable industries. But evidence also suggests that ventures led by necessity entrepreneurs are often worse managed than those led by opportunity entrepreneurs. Necessity entrepreneurs are generally more risk-averse and less ambitious. They typically aim to create employment only for themselves; after all, they mostly turned to entrepreneurship due to a lack of other job opportunities.

However, one might argue, that even if necessity-driven entrepreneurship yields little or no economic advantages to those who undertake it, it could still be worthwhile pursuit if it creates some social or psychological benefits to the founders. But the fact is that when ventures are struggling, entrepreneurs are struggling. By some calculations, an average self-employed individual earns 35% less than their employed counterparts over a 20-year period. While it is well-documented that being an entrepreneur can bring a sense of meaning and satisfaction, necessity entrepreneurs are no more satisfied with their lives than employees. The primary reason for this appears to be the significant financial stress they experience.

Although we as a society like to romanticize small businesses, the reality is that most entrepreneurial ventures aren’t the powerhouses of innovation and job creation. Instead, it’s a narrow 4% of companies, known as “gazelles”, that create an astonishing 75% of all new jobs. These high-performing enterprises not only generate employment but also deliver 2-3 times the value per employee and push other industry players to become more efficient or to offer better products and services. These enterprises are not born out of necessity nor are they typical opportunity-driven ventures; rather, they represent the top performers among opportunity-driven enterprises. In fact, the average new venture does little for the economy aside from providing its founder with employment. And a healthy economy is characterized by a lot of good employment opportunities, to the extent that entrepreneurship seems unattractive to all but the most entrepreneurial individuals.

It is important to challenge the simplistic view that all entrepreneurship is inherently beneficial. By pushing individuals towards entrepreneurship, we risk unintentionally fueling a surge in necessity entrepreneurship, which could exacerbate social inequality and place greater strain and personal responsibility on the most vulnerable in the labour market. A more effective public policy would focus on supporting entrepreneurship that creates high-quality jobs, including opportunities for those on the margins of the labour market.

Note: This article is based on a podcast episode entitled “Is encouraging people to become entrepreneurs harmful?” from the Evidence-Based Entrepreneurship.