Working for an entrepreneur: heaven or hell?

Before any hiring decision can be made,² a matching process must occur; both the employee and employer must feel that the outcome is satisfactory for both pecuniary and nonpecuniary returns associated with the employment. A hiring decision by the employer as well as the decision to accept a job offer includes the problem of asymmetric information between the employer and the employee. The employer does not have full information about the skills and abilities of the employee, and the employee does not know the skills and abilities of the entrepreneur and the prevalent working conditions at his or her future workplace. In disentangling this matching process including asymmetric information, we need to consider the perspectives of both the employer and the employee.

Given the difficulties of attracting employees to entrepreneurial firms, it is often assumed that individuals who are willing to take the risk of accepting employment with an entrepreneurial firm lack other alternatives or are, in some way, marginalized in the labor market; for example, they may be unemployed or have difficulties holding a steady job (Bhide 2000). Lately, individual-level employer-employee-matched datasets covering large populations have become available in several countries. This makes it possible to study the individual characteristics associated with employment in entrepreneurial firms in a more detailed and systematic way. Nyström (2011) uses employer-employee-matched data from Sweden and finds that the share of recently graduated employees, immigrants, and people entering the labor market is higher in entrepreneurial firms. Hence, entrepreneurial firms might play a more important role for individuals with a weaker position in the labor market. Additionally, using employer-employee-matched data from Sweden but focusing on people who change jobs, Nyström and Zhetibaeva Elvung (2015) support the hypothesis that the selection of individuals into entrepreneurial firms is not random. Immigrants and individuals who make an involuntary job change (defined as induced by a firm closure) are more likely to become employed in entrepreneurial firms, while individuals with secondary or tertiary education are less likely to be employed by an entrepreneurial firm (Nyström and Zhetibaeva Elvung 2015). Using Danish employer-employee-matched data, Coad et al. (2017) find that people who are hired by entrepreneurial ventures are more likely to be less educated, previously unemployed, or employed with a lower income before they are hired by a solo entrepreneur. Ouimet and Zarutskie (2014) provide evidence that entrepreneurial firms disproportionately hire young employees. Hence, in conclusion, there is convincing evidence that the selection of employees into entrepreneurial firms in the labor market is not random; these firms have a tendency to employ those whose individual characteristics are often associated with a weaker position in the labor market.

What are the motivations for joining an entrepreneurial venture? This is a research area that clearly requires further exploration. As previously mentioned, entrepreneurs may be interested in recruiting entrepreneurial-minded employees. Moser et al. (2017) explore which dimensions of new-venture entrepreneurial-minded individuals find attractive. Following De Jong et al. (2015), they measure entrepreneurial-minded employees by their innovativeness as well as their proactive and risk-taking behavior. Their empirical findings show that for entrepreneurial-minded employees measured by innovativeness, ideological attributes (e.g., the strategic vision of the new venture) and founder legitimacy are important for firm attractiveness. Transactional attributes (such as remuneration) are less important. However, the authors found no relationship between the other two measurements of entrepreneurial behavior (proactive and risk-taking behavior) and employer attractiveness.

An important aspect to consider when accepting a job in an entrepreneurial firm is the firm’s chances of survival. It is well known from empirical research that the survival rate of new firms is low. According to the facts presented in a review of the literature, Geroski (1995) concludes that approximately 60% of firms exit within 5 years and nearly 80% exit within 10 years. According to the OECD (2017), nearly one half of newly created firms do not survive their first 3 years, and survival rates are, on average, lower among employer firms than nonemployer firms. Hence, there is a great risk that an employee of an entrepreneurial firm will be searching for new employment after a very short time. Based on German data, Schnabel et al. (2011) conclude that established firms offer higher job stability than entrepreneurial firms. What type of contracts do entrepreneurial firms offer? De Matos and Parent (2016) find that entrepreneurial firms in Portugal, to a greater extent, offer fixed-term contracts and less job security.

The previous section discussed the recruitment and matching problems associated with employment in new firms. The perceived mismatch may be on both the employer and employee sides. If the consequence of these matching problems has lower quality in matching, we can expect labor turnover to be higher in new firms compared to incumbent firms. Additionally, it can be hypothesized that the skill mismatch of employees in entrepreneurial ventures contributes to those ventures’ lower survival rates. Hence, in future research, it would be interesting to study whether employee turnover is higher in entrepreneurial firms than in established firms; it would also be interesting to examine employee turnover in firms that do survive, i.e., whether the termination of the work contract originates from a mismatch and to what extent skill mismatches influence the performance of entrepreneurial ventures.

In a well-cited paper, Shane (2009) argues that jobs created by entrepreneurial firms are worse than jobs in incumbent companies in terms of, for example, pay and fringe benefits. Shane (2009) refers to a review paper by Wagner (1997), who reviews empirical studies of job quality and firm size and does not specifically focus on firm age. In fact, it has primarily been the firm size-wage relationship and not the firm age-wage relationship that has been the focus of most of the early research studies in this field. In his literature review, Wagner (1997) concludes that in small firms, wages are lower, fringe benefits are lower, job security is lower, and opportunities for skill enhancement are worse than in large firms. The hypothesis that smaller firms pay lower wages is confirmed by Troske (1999), Bayard and Troske (1999), and Waddoups (2007). In these studies, the link between firm size and wages is studied empirically, controlling for a number of individual characteristics (for example, age, educational attainment, and tenure), firm characteristics (for example, industry and occupation), and labor market conditions (for example, industry and region). However, the observable characteristics do not fully account for the wage premium paid by larger firms (see, e.g., Brown and Medoff 1989; Troske 1999; Millimet 2005).

What are the potential explanations for why large employers pay higher wages? According to Troske (1999), large employers hire better workers because both large employers and their employees are more likely to invest in firm-specific human capital. Furthermore, Gerlach and Hübler (1998) find that larger firms attract more qualified workers. Hence, the composition of employment regarding the quality of workers differs across large and small firms. Individuals with greater abilities and skills tend to disproportionally select employment in larger and, on average, older firms; this selection contributes to explaining wage differentials between large and small firms.

Contributing to this discussion, Brown and Medoff (1989) note that because younger firms tend to be smaller, it is relevant to ask whether small firms are also entrepreneurial firms and to what extent the wage premium of larger firms is, in fact, a relationship between firm age and wages. Hence, investigating the firm age-wage relationship, a frequently cited study by Brixy et al. (2007) found a wage penalty of 8% for employment in entrepreneurial firms. Brown and Medoff (2003) find that the relationship between firm age and wages is not monotonic because wages fall and then rise with years in business. Heyman (2007) uses a matched employer-employee dataset from Sweden. The results indicate that the inclusion of firm age does not affect the impact of firm size on wages. In summary, a firm’s age does not fully account for wage differentials across individuals and firms.

As we have seen in the previous section, the selection of employees to entrepreneurial firms is not random, and this finding should have implications for wage levels. Several recent studies have tried to address this nonrandom selection of employees into entrepreneurial firms. Focusing on labor market entrants, Nyström and Zhetibaeva Elvung (2014) study whether there is a wage penalty for employment in entrepreneurial firms. Using employer-employee-matched data from Sweden and propensity score matching to address that selection of employees into entrepreneurial firms is not random, they find that a wage penalty for employment in entrepreneurial firms does exist and the penalty is, on average, 2.9%. Using Danish data, Burton et al. (2018) find, contrary to previous research, that after controlling for individual characteristics, younger firms pay more. A recent paper by Adrjan (2018) using an employer-employee-matched dataset from Great Britain also finds that young firms pay a small (1–2%) wage premium to new hires. For the group of employees at venture-capital-backed startups, Kim (2018) found that these employees earn 10% higher wages than their counterparts in established firms, but that this wage gap disappears if individual fixed effects are considered.

It should be emphasized that there is substantial heterogeneity among entrepreneurial firms regarding the wages they pay. Some entrepreneurial firms that survive and become highly productive firms pay higher wages compared to similar employment by firms that subsequently have low productivity or do not survive (Adrjan 2018). Looking more closely at employees who change jobs, Nyström and Zhetibaeva Elvung (2015) find that individuals who change to a job in an entrepreneurial firm are more likely to lower their wages; 40% of employees who change to a job in an entrepreneurial firm lower their wages, while the corresponding figure for those who change to a job in an incumbent firm is 31%. Furthermore, Dorner et al. (2017) study academic spin-offs and find that these firms, in general, do not pay any wage premium, but a spin-off that commercializes new scientific results or methods pays a wage premium for their employees with a university background. In conclusion, these more recent studies on the wage gap between incumbent and entrepreneurial firms show that addressing individual heterogeneity and selection into entrepreneurial firms seems to generate lower wage penalties or even wage premiums. In fact, also supported by the recent literature review by Block et al. (2018), the previous conventional wisdom that entrepreneurial firms pay less must be reconsidered. A plausible explanation for these new findings is that the more recent empirical work has used detailed matched employer-employee data and has been able to control for selection and heterogeneity across individuals and firms to a larger extent.

What about the long-term wage development of employees working in entrepreneurial firms? If an employee expects an entrepreneurial firm to provide a career path and/or less financial constraints as the firm matures, the employee may tolerate a lower wage during the first years and hopefully enjoy a steeper earnings trajectory later. There is very little research to date on this matter. Two exceptions are very recent papers by Adrjan (2018) and Sorenson et al. (2018). Using matched employer-employee data from Great Britain, Adrjan (2018) investigates the life cycle earnings of employees in young firms and finds that subsequent wage growth is better at mature firms. This finding is valid for individuals who remain in their jobs and when they change jobs. Using Danish registry data, Sorenson et al. (2019) find that employees who join small (i.e., among the first 50 employees) and entrepreneurial firms (i.e., less than 4 years old) on average earn 25% less over the subsequent 10-year period compared to employees in large firms that had been operating more than 4 years. However, approximately half of the wage differential stemmed from the sorting of younger and less-qualified employees into employment in entrepreneurial firms. Nevertheless, a wage penalty of approximately 10–15% remained over the subsequent decade and there was no evidence of earnings disparities improving over time; rather, earnings disparities between incumbent and entrepreneurial firms grew over time. According to Sorenson et al. (2019), these patterns emerge from two factors: liability of newness, suggesting that since entrepreneurial firms have a higher probability of exit, this creates spells of unemployment that are costly for their former employees, and path dependence in career moves, which suggests that once an employee joins an entrepreneurial firm, he or she moves to other entrepreneurial firms that also pay less.

As mentioned above, most previous empirical research that may be relevant to the discussion of the working conditions in entrepreneurial firms is primarily based on small businesses or is focused on the entrepreneurs themselves. Regarding entrepreneurs, empirical research shows that male entrepreneurs work longer hours on average, and in particular, the entrepreneurs who are employers work longer hours. On the other hand, entrepreneurs tend to benefit from higher job satisfaction (see the literature review in Parker (2009)). It is also interesting to note that recent empirical evidence matching prescription records with entrepreneurial data shows that entrepreneurship is associated with increased stress for both entrepreneurs and their spouses. However, entrepreneurs are less likely to use antidepressants (Dahl et al. 2010).

For small firms, rather than explicitly focusing on entrepreneurial firms, there is a somewhat inconclusive empirical finding based on UK and U.S. studies in which Atkinson and Storey (1994) argue that there is weak evidence of higher job satisfaction of employees in small firms, while Rowden (2002) refers to studies in the USA showing that employees in small businesses report higher job satisfaction. What are the working conditions that influence job satisfaction in small firms? Davis (2004) discusses some advantages and disadvantages related to job satisfaction based on previous research. A disadvantage is that when organizational problems occur in small firms, they are less likely to be approached scientifically and in a timely manner. However, working for a small firm comes with frequent interpersonal contact with other employees, customers, and managers and often involves a high degree of complexity and challenge, which may be rewarding if an employee prefers these types of job characteristics. Finally, according to Parker (2004), employees in small firms receive lower levels of training, work longer hours, and face a greater risk of major injury at work.

However, to the best of my knowledge, it is not known whether these poor working conditions for entrepreneurs or employees in small firms pertain to workers in entrepreneurial firms. The lack of knowledge regarding these issues related to the quality of the jobs created by entrepreneurs is further illustrated by the absence of such studies in the recent literature review by Block et al. (2018), which does not include any studies of stress or work hours.³ What could be expected in terms of working conditions? If work tasks are not clearly defined in entrepreneurial firms, it is reasonable to expect that work hours would be longer for the employees of those firms (given that the employee are on a contract that allows paid or unpaid overtime). Financial constraints and a potential lack of priority for employee training in the initial stages are plausible reasons we should expect in lower levels of training in entrepreneurial firms. However, it should be noted that the need for training may be less prevalent in entrepreneurial firms since knowledge and skills necessary for performing the work tasks are unlikely to become obsolete in the short term (such as the lifetime of an entrepreneurial firm). Regarding stress, it is possible that the employees are also affected by the insecurity that many firms face in their initial stages; however, perhaps the challenging tasks result in greater job satisfaction. These are important and interesting questions for future research to explore.

In the entrepreneurship literature, it has been suggested that employees of small firms are more likely to become entrepreneurs themselves (Hyytinen and Maliranta 2008). This proposal is known as the “small firm effect.” What explains this small firm effect? Elfenbein et al. (2010) argue that employment in small firms has several features similar to those of being an entrepreneur. Hence, individuals who like working conditions that offer independence and less bureaucracy tend to select employment in small firms. Furthermore, employees who are less risk-averse select employment in small firms. In addition, the lower wages of small firms imply that employees are more likely to transition to entrepreneurship to increase their income. Finally, employment in small firms helps employees develop knowledge and skills relevant to entrepreneurship because they are required to perform many different tasks within the small firm. This entrepreneurial learning may stimulate an individual to become an entrepreneur. Similar arguments are also valid for employees in new firms, i.e., arguments related to the nonrandom selection, learning, and opportunity identification that occur after an employee works for an entrepreneurial firm. However, related to the discussion of self-selection of individuals with a preference for entrepreneurial work values into entrepreneurial firms, it can be argued that if there is a good fit between entrepreneurial work values and characteristics, these individuals may receive sufficient job satisfaction in this dimension at their current job and do not need to become entrepreneurs themselves. Based on this argument, it can be argued that the “new firm effect” should primarily be driven by the learning effect and result in opportunity-based entrepreneurship. The selection effect would then be valid to explain the situation in which a higher share of employees begins their own venture after their previous employer closes. To what extent the new firm effect empirically exists is less investigated (compared to the small firm effect) in the literature; exceptions are Wagner (2004), Sørensen (2007), and Zhetibaeva Elvung (2016a).

Based on German microdata, Wagner (2004) finds that work experience in both small and young firms increases the probability that an employee will subsequently become an entrepreneur. Using employee-employer data covering the whole Danish population, Sørensen (2007) shows that employees in less bureaucratic firms, as measured by size and age, have a higher probability of becoming entrepreneurs. Sørensen (2007) argues that this effect is not due to these firms attracting a more entrepreneurial type of individual, but rather that the work environment itself creates entrepreneurs, hence supporting the learning effect. Another interesting finding is that the probability of becoming an entrepreneur increases if the employee joined the employer during the formative years of the business (i.e., when it was less than 3 years old). Using Swedish individual-level matched employee-employer data, Zhetibaeva Elvung (2016a) finds that employees of entrepreneurial firms are more likely to transition to entrepreneurship, which supports the new firm effect. In particular, individuals with the lowest and highest levels of ability are more likely to enter entrepreneurship. Interestingly, in a recent meta-analysis of the literature on individual and firm characteristics related to entrepreneurial spawning, Garrett et al. (2017) do not find support for the small firm effect, while the hypothesis that firm age is negatively related to entrepreneurial spawning is supported.

Under which circumstances do former employees decide to become entrepreneurs? Here, the spin-out literature may offer some guidance. For instance, employees who experience frustration with parental inertia or perceive the existence of underexploited opportunities are more likely to transfer to spin-outs (Agarwal et al. 2004; Klepper and Thompson 2010). However, it should be noted that this literature does not explicitly discuss the extent to which the age of the parent firm influences the probability of becoming an entrepreneur. Another reason why employees at new ventures may become entrepreneurs is that they have gained entrepreneurial knowledge and inspiration from their former coworkers. Nanda and Sorensen (2010) find that individuals are more likely to become entrepreneurs if their former coworkers have previously been entrepreneurs. Furthermore, Nanda and Sorensen (2010) find that peer influences are substitutes for other sources of entrepreneurial influence because the effects of peer influences on entrepreneurship are strongest for individuals with less exposure to entrepreneurship in other aspects of their lives.

Sorgner and Fritsch (2018) study the extent to which an occupation-specific environment influences the choice to become an entrepreneur. Based on German microlevel data, they find that future entrepreneurs opt for different types of occupations when they enter the labor market as paid employees. In addition, when future entrepreneurs enter the labor market, they are more likely to choose occupations that require a relatively high variety of skills. Furthermore, Sorgner and Fritsch (2018) find that people working in occupations characterized by relatively high unemployment risks, high earnings risks, and high self-employment rates have a high probability of moving into self-employment. Sørensen and Sharkey (2014) study how organizational opportunity structures influence the transition to entrepreneurship, i.e., how the shape of the hierarchy in an organization affects the decision to become an entrepreneur. Based on Danish microlevel data, they find that employees who work in organizations with lower wage ceilings and greater internal wage inequality are more likely to transition to entrepreneurship.

In transitioning to entrepreneurship from the public sector, Özcan and Reichstein (2009) argue for both context and tenure effects. The context effect assumes that employees who are dissatisfied with the intrinsic job characteristics and bureaucracy in the public sector are more likely to leave employment in the public sector in favor of an entrepreneurial career. The tenure effect implies that if an employee stays for some time with an organization, the organization shapes the individual’s ability to pursue entrepreneurial activities. Individuals adopt and develop attitudes consistent with the organization’s expectations and role. Applying this framework to employees working for an entrepreneurial firm implies that these employees over time would adapt to the entrepreneurial organizational culture and hence may increase their probability of becoming entrepreneurs. The available literature discussed in this section partly addresses the reasons and motives for former employees to become entrepreneurs. However, an avenue for further research would be to attempt to further disentangle the interplay between selection and learning mechanisms behind the new firm effect, in particular in a context that considers if the ventures created are opportunity- or necessity-based.

This section has addressed a transition to entrepreneurship after an employee has worked for an entrepreneur. Less is known about alternative career paths for former employees of entrepreneurial firms. In the labor market, part-time jobs, temporary contracts, and low-wage jobs are discussed as potential “stepping stones” toward “better” jobs in terms of wages or permanence (Sicherman and Galor 1990). Given that entrepreneurial firms hire individuals who have weaker positions in the labor market, can employment in a new firm act as a stepping stone toward permanent employment? According to Zhetibaeva Elvung (2016b), this may be the case for individuals with nonemployment status prior to their employment in new firms. Additionally, the stepping stone effect is more pronounced for younger individuals.

When a former employee launches a venture, does the prior experience of working for an entrepreneur have implications for the performance of the venture that he or she creates? Again, the spin-out literature provides us some insights. Previous research on spin-outs argues that a parent of high quality in terms of, for example, larger stocks of capabilities spawns more and better spin-offs than a low-quality parent (e.g., Agarwal et al. 2004; Klepper and Sleeper 2005). However, the role of the parent in relation to the performance of the spin-out is challenged by Hunt and Lerner (2012), who find spin-off performance to be more heterogeneous; they find that founder-specific experience rather than parental lineage is the primary driver of spin-off performance heterogeneity. Again, it should be noted that these papers do not distinguish between experience working at an entrepreneurial firm or an experienced firm; instead, their empirical analysis may include the number of years of working experience and the diversity of occupational experience. On this topic, Åstebro and Yong (2016) find that entrepreneurs with experience working in many different occupations within the same industry have the best chance of being successful as entrepreneurs. Hence, there is more research to be done focusing on whether employees’ entrepreneurial learning at entrepreneurial firms has implications for the performance of their subsequent start-ups.

What about the performance in career paths other than entrepreneurship for previous employees of entrepreneurial firms? Unfortunately, questions related to the future career paths of employees in entrepreneurial firm remain relatively unexplored. For individuals who decide to exit entrepreneurship, it has recently been shown that there are positive rewards from entrepreneurship in subsequent paid employment (Luzzi and Sasson 2016; Lougui and Broström 2018). The positive reward for entrepreneurship experience is shown, in particular, for entrepreneurs hired in highly innovative sectors (Luzzi and Sasson 2016) and jobs requiring general and managerial skills rather than industry-specific expertise (Lougui and Broström 2018). In this literature, it is argued that entrepreneurs are multiskilled “jacks-of-all-trades” (Lazear 2004) either by selection or by acquiring these skills through learning during their entrepreneurial experience. As discussed above, similar arguments can be proposed to individuals who decide to accept employment at an entrepreneurial firm. Interesting research questions to explore would be to study the earnings of former employees in subsequent employment using a methodology similar to that of Luzzi and Sasson (2016). In addition, it would be interesting to explore if former employees of entrepreneurial firms, for instance, take on managerial or innovative positions in other firms to a greater extent. What do their career paths look like if they decide to remain in the entrepreneurial venture (assuming that the firm survives)?