Does working at a start-up pay off?

The role of newly founded firms, so-called start-ups, in structural change and job creation is a highly disputed topic both in scientific and political debates (Shane, 2009). There exists a broad empirical literature focusing on the quantity of jobs created and destroyed in new firms, across regions and at the aggregate level, mostly finding positive net effects of start-ups (see, e.g., Haltiwanger et al., 2013 for the USA, Fritsch & Weyh, 2006 for Germany, Criscuolo et al., 2014 for 18 countries, and the review by Block et al., 2018). In contrast, relatively few studies have analyzed the quality of these jobs from the viewpoint of the individual worker. Some of these studies suggest that job quality in start-ups may be questionable, but evidence so far is too scarce to make any definite statements (see the reviews by Block et al., 2018 and Nyström, 2021). For workers—be they employed or unemployed—it is largely an open question whether joining a newly founded rather than an incumbent firm is advisable or not. Hence, the primary objective of this paper is to analyze empirically whether working at a start-up is beneficial in the short and long run for individual workers. Are there temporary or persistent advantages and disadvantages in terms of remuneration and (un)employment prospects from entering a start-up rather than an incumbent firm?

Although the quality of jobs is a multi-dimensional concept that also includes work content and non-monetary benefits (Block et al., 2018), the employment and earnings prospects individuals face in start-ups surely play a major role. Workers entering a start-up rather than an incumbent firm may receive higher wages as a compensation for the higher failure risk of start-ups, but they also could initially face lower wages due to the financial constraints of their young employer operating at an inefficient scale (Brixy et al., 2007). In the latter case, working at a start-up could pay off in the long run if new firms survive and become more profitable (Nyström, 2021). Wages in start-ups might even rise more steeply than in incumbent firms if flat hierarchies in expanding young firms mean that the initial workers are first in line to reach better-paid positions quickly (Fackler et al., 2019). Similarly, the greater variation in performed tasks and the expanded responsibility individuals typically experience in (small) start-ups may accelerate their career progression and earnings growth when moving to other, more mature firms. On the downside, the diverse and often idiosyncratic activities employees perform in start-ups may limit earnings growth and impede workers from moving to incumbent, better-paying firms (Sorenson et al., 2021). Furthermore, wage profiles could be steeper in incumbent firms if these are more likely to offer backloaded compensation schemes to their employees—a strategy that will be less credible for risky new firms (Schmieder, 2013).

Regarding (un)employment prospects, workers in newly founded firms face a high risk of involuntary job loss due to their employer’s closure (Fackler et al., 2013; Fairlie et al., 2019; Haltiwanger et al., 2013). Hence, entering a start-up might be associated with a higher risk of unemployment and worse future labor market opportunities due to displacement and stigma effects (Sorenson et al., 2021). As start-ups are particularly vulnerable to economic downturns, displaced employees of start-ups may experience more serious problems in finding a new job during a recession (Sorenson et al., 2021), and the resulting spells of unemployment may have negative, long-lasting effects on employment and earnings trajectories. Employees joining start-ups can thus be expected to record less days in employment and more days of benefit receipt (and consequently lower annual incomes). These brief considerations suggest that it is initially not clear whether entering a start-up as opposed to an incumbent firm will pay off for workers in the short and the long run.

In addressing this open question, previous research has primarily compared average wages in start-ups and incumbents or focused on differences in workers’ entry wages at the point of being hired. The empirical evidence so far is ambiguous (see the reviews by Block et al., 2018 and Nyström, 2021). While some papers show that wages are significantly lower in start-ups than in incumbent firms, ceteris paribus (e.g., Fackler et al., 2019; Nyström & Elvung, 2014), others find a positive wage differential, in particular for very successful start-ups (e.g., Ouimet & Zarutskie, 2014; Schmieder, 2013). Brixy et al. (2007) identify a negative wage differential that becomes smaller over time, but they only have data at the level of establishments and not of workers. According to Burton et al. (2018), the typical start-up, which is both young and small, pays less than the average incumbent firm but the largest start-ups even pay a wage premium. Babina et al. (2019) report a pay penalty at young firms that turns into a small pay premium after controlling for various dimensions of worker and firm heterogeneity. Finally, Kim (2018) finds that MIT graduates at venture capital–backed start-ups (but not at other start-ups) earn about 10% higher entry wages than their counterparts at incumbent firms, which mainly reflects worker ability and selection.

Very few papers have been able to follow workers and their wages over time.¹ The paper most closely related to our research is the study by Sorenson et al. (2021) with Danish registry data. Like us, the authors use a matched employer-employee database and follow (full-time) employees ten years after changing employers. They show that individuals who join young firms (i.e., less than four years old) earn substantially less than matched employees of large, mature firms over the subsequent ten years, and these earnings disparities are not found to diminish over time. Analyzing linked employer-employee data from Britain, Adrjan (2018) finds that young firms pay slightly higher wages to new hires, but subsequent wage growth is steeper at mature firms. He demonstrates that this finding holds both within continuing employment relationships and for individuals who change jobs, but he is not able to further analyze workers’ (un)employment trajectories. A certain limitation of both studies is that they focus only on remuneration as the sole indicator for labor market success. In her recent review article, Nyström (2021, p. 928) concludes that “there is a clear scarcity of research regarding the long-term wage trajectories of employees in entrepreneurial firms.” In addition, there is a lack of studies that look at the long-term (un)employment trajectories of individuals.²

Our paper contributes to this small literature and goes beyond previous studies in various ways. First, when asking whether it pays off to enter a start-up rather than an incumbent establishment, we not solely focus on wages but also consider other indicators of labor market success such as days in employment and unemployment benefit receipt. This is important because workers suffer from job loss and unemployment not only in terms of earnings losses but also in terms of non-monetary outcomes such as psychological costs or negative effects on children and families (see, e.g., the survey by Brand, 2015). Second, using a large, representative linked employer-employee data set for Germany, we follow individuals joining a start-up over ten years and analyze whether there are differences in wages and (un)employment compared to similar individuals who have entered incumbent firms. To ensure comparability of the two groups of workers, we apply entropy balancing (Hainmueller, 2012). We then examine whether the remaining differences are only temporary or long-lasting and whether they vary for different groups of workers. Third, we further add to the literature by investigating various potential explanations for the observed short- and long-term differences, such as joining successful vs. failing start-ups or pursuing different subsequent employment paths (like staying or leaving the establishment).

The upshot of our empirical analysis is that there are large and long-lasting drawbacks from entering a start-up rather than an incumbent establishment. Workers joining start-ups experience significantly lower income and daily wages, which is in line with recent studies on wage developments by Adrjan (2018) for Great Britain and Sorenson et al. (2021) for Denmark. In addition, we present first evidence that workers entering a newly founded firm record less days in employment and more days of benefit receipt than their counterparts joining incumbent firms. These disadvantages are persistent and hold for all groups of workers and types of start-ups analyzed.

The remainder of the paper is organized as follows: Section 2 explains our data and provides descriptive evidence on the composition of workers entering either a new or an incumbent firm. The methods and results of our econometric analyses are presented and discussed in Section 3. Section 4 concludes.

To analyze the different labor market prospects of workers entering either a start-up or an incumbent firm, we use an extensive linked employer-employee data set for Germany based on social security notifications, which is provided by the Institute for Employment Research (IAB). Our data set combines worker-level information from the Integrated Employment Biographies (IEB) and establishment-level information from the Establishment History Panel (BHP).

Detailed data on labor market participants is collected in the IEB, which provides daily information on employment relationships for all workers subject to social security notifications, as well as periods of benefit receipt, registered job search, and participation in active labor market programs from 1975 to 2014 for Western Germany.³ Since 1992, Eastern Germany is included in the data as well, and from 1999 onwards, information on marginally employed workers is collected, too. Additionally, the IEB contains individual characteristics such as age, gender, education, and nationality.⁴

Yearly information on all German establishments with at least one worker subject to social security contributions is contained in the BHP, including size, sector, location, and workforce composition as of June 30 of a given year.⁵ Crucial for our analysis of newly founded establishments, the BHP also contains information on worker flows (Hethey-Maier & Schmieder, 2013). In order to distinguish whether a new establishment identifier in the data refers to a truly new entry or is caused by mergers, acquisitions, or other changes of the identification number, worker flows are used to identify which fraction of a new establishment’s initial workforce has previously been employed together in another establishment. We restrict our analysis to newly founded establishments defined by Hethey-Maier and Schmieder (2013) as “new (small)” or “new (med & big)”, implying that the establishment either employs not more than three workers in its first year of business, or, if larger, less than 30% of its initial workforce have worked together under a common establishment identifier in the previous year.

Moreover, it must be noted that establishments in the BHP are defined as local production units, which do not necessarily correspond to firms as legal entities. Since we intend to focus our analysis on the foundation of new, independent firms instead of branch openings of multi-plant firms, we exclude establishments with more than 20 employees in their first year of business. We evaluate the success of this procedure in reducing the number of branch openings by using information from the IAB Establishment Panel, a yearly survey of approximately 16,000 German establishments.⁶ Since the Establishment Panel includes information on single- and multi-plant firms, we can link this information with those establishments from the BHP that we classify as start-ups as described above and that meet further sample restrictions described below. It can be shown that circa 94% of the establishments we define as start-ups are independent new firms, while only 6% are branch openings of existing entities.

The sample of start-ups that is used for our analyses consists of a 10% random draw of all establishments newly founded in the years 2000 to 2004, only focusing on establishments in their very first year of business. We then link information from the IEB on all newly hired workers in the respective year, i.e., workers that have not been working with the same employer in the previous year. Since workers’ employment biographies are available until 2014, this allows us to follow each cohort of workers (and firms) over ten subsequent years. Note that we do not restrict our analysis to a balanced panel but allow for attrition, e.g., due to exit from the labor force. The control group of incumbent establishments is constructed by drawing a 5% sample of all establishments existing during that period. Here, for each cohort of workers, we keep only those who join establishments that are five years or older.⁷ In both groups, we exclude establishments in agriculture, energy and mining, and in the public sector. We further exclude workers younger than 18 and older than 50 at the time of being hired, as well as apprentices.

Table 1 gives a short overview over the establishments in our final sample. To summarize the composition of workers entering new and incumbent establishments, respectively, we present selected individual characteristics at the point of entry in Table 2. We see that the two groups differ significantly in almost all variables presented. Workers entering new establishments are more often women and they are on average older than the control group. They are more often medium-qualified, while a higher share of workers entering incumbent establishments is either low-qualified, i.e., having no degree at all, or high-qualified, i.e., graduated from university. Moreover, workers taking up a job in a start-up are less often of German nationality, have less frequently performed a job-to-job transition⁸ and are less often hired in a part-time job. In terms of years of working experience, we find no significant differences, while workers entering new establishments have previously spent more time in benefit receipt.⁹ Moreover, individuals entering start-ups have had more previous employers, which points towards more stable employment biographies in the control group. All these differences in the sample composition might affect the labor market success of the two groups of workers. Our goal in the following empirical analysis is to study workers’ employment trajectories in the long run and to investigate whether various indicators of labor market success differ between workers entering either a start-up or an incumbent, thereby conditioning a broad range of individual and firm characteristics.

Although the role of start-ups as employers is often discussed politically and many scholars have analyzed the quantity of jobs created by newly founded firms, the implications of joining a start-up for the individual worker have not been analyzed in depth so far. Therefore, we explore the advantages and disadvantages of entering start-ups instead of incumbent firms, both in terms of remuneration and employment prospects, and investigate whether differences in labor market performance are long-lasting over a worker’s subsequent career path. We apply entropy balancing to make both groups of entrants comparable and follow individuals in start-ups and incumbent firms over ten years. Our results imply that workers joining a start-up experience significantly lower income and daily wages, as well as less days in employment and more days of benefit receipt, than similar workers joining an incumbent. These severe drawbacks are persistent over the subsequent ten years after entering the respective establishment and they hold for all groups of workers and types of start-ups analyzed.

Concerning earnings differences between workers entering start-ups and those joining incumbents, the negative differential in entry wages found is in accordance with findings by Nyström and Elvung (2014) for Sweden and Fackler et al. (2019) for Germany but somewhat questions the positive or insignificant wage differentials found in some other studies (e.g. Ouimet & Zarutskie, 2014 and Kim, 2018). Regarding the development of earnings differences over time, our findings are in line with other current research on by Adrjan (2018) for Great Britain and Sorenson et al. (2021) for Denmark, as both studies find long-run pecuniary disadvantages from entering a newly founded firm.³¹ We go beyond existing research by showing that persistent drawbacks from joining a start-up can also be found in terms of (un)employment prospects. We also provide insights concerning the role of the higher failure risk and the lower employment stability in start-ups as potential explanations for the observed differences in labor market performance (see also Schnabel et al., 2011). Analyzing workers who remain employed with their initial employer and workers who enter successful vis-à-vis failing start-ups, we still find substantial drawbacks compared to similar workers entering incumbents. When focusing on workers who use start-up employment as a stepping stone to positions in other establishments, we find that even this strategy does not render workers joining newly founded firms as successful as those entering incumbents.

While our main insights imply long-lasting negative consequences from working at a start-up, some limitations of our analysis must be taken into account when interpreting our results. First and foremost, the various indicators of labor market success investigated in this study do not represent all dimensions of job quality. In particular, our data do not allow us to draw any conclusions concerning job satisfaction. Hence, it is possible that workers in start-ups experience especially high levels of job satisfaction due to, e.g., flatter hierarchies or more autonomy and responsibility (Sauermann, 2018). Focusing on remuneration, one must bear in mind that our data do not include information on non-standard means of financial compensation, such as fringe benefits or firm shares. We argue that this shortcoming should not affect our insights, since fringe benefits do not play an important role in the German labor market due to the scope of social security provision by the state (Schmieder, 2013), and employee share ownership is not very common in Germany and rarely found in small establishments (Bellmann & Möller, 2016). Moreover, the risky nature of start-ups makes it unlikely that firm shares are regarded as an adequate form of compensation by employees. Another limitation could be that our data do not contain self-employed individuals. We thus cannot observe if some workers who were initially employed at start-ups become entrepreneurs themselves, another potential career path that we are not able to analyze. A final, small caveat when interpreting our results is that we do not observe workers’ complete employment biographies after entering the respective establishment. However, we claim that the time span of ten years is long enough to observe whether a convergence process sets in and therefore suffices to make meaningful statements on the long-run effects of entering a start-up.

Since all our insights point towards significant disadvantages from entering a start-up, the question arises why workers decide to join newly founded firms at all. One reason might be that individuals are just not well informed about the negative consequences of working for a start-up. Although the high likelihood of failure among new firms is a stylized fact that is often discussed both politically and scientifically (e.g., Fackler et al., 2013; Fairlie et al., 2019; Geroski, 1995; Haltiwanger et al., 2013), workers might not be aware of the disadvantages arising even if their employers do not fail. A second potential explanation for workers’ decision to enter a new firm could be the different types of work environment. As already mentioned, employment in start-ups is often associated with flat hierarchies, a broader set of tasks assigned to a job, and more responsibility for the individual worker. These factors might compensate workers with strong preferences for such non-monetary job attributes for foregone earnings and worse employment prospects.³² Finally, it must be noted that newly founded firms often offer opportunities for workers who face disadvantages at the labor market due to, e.g., their age, foreign nationality, or previous unemployment experience (Coad et al., 2017; Fackler et al., 2019; Nyström, 2012). Put differently, for some groups of workers, the superior alternative of joining an incumbent may simply not be available. From this perspective, working at a start-up can still offer an opportunity for disadvantaged workers who would otherwise be unemployed, especially if they enter start-ups that prosper and survive or if they intend to use the start-up as a stepping stone for (better) positions in other establishments.

In conclusion, since our insights indicate that jobs created by start-ups do not provide workers with the same opportunities for long-run career advancement as those created by incumbents, the role of new firms as job creators should be interpreted cautiously (see also Sorenson et al., 2021). Even though the strong political attention and financial support which start-ups receive in many countries is probably not motivated by the expectation that they create stable high-wage employment, the worker-level perspective taken in our analyses provides some additional support for the skepticism toward start-up subsidization expressed by some authors (e.g., Santarelli & Vivarelli, 2007; Shane, 2009).