- According to a study in the Quarterly Journal of Economics, a business's legal status is what separates entrepreneurs from other business owners.
- Entrepreneurs tend to be incorporated, while small business owners are not.
- Incorporated business owners reported an increase of $6,600 in median annual earnings compared to their previous salaries when they became entrepreneurs, according to study findings.
Just because you run your own business doesn't mean you are an entrepreneur.
A study published in the Quarterly Journal of Economics revealed a key difference of being self-employed and an entrepreneur. The researchers found that a business's legal status – whether it is incorporated or unincorporated – is what separates entrepreneurs from other business owners.
Defining entrepreneurs and small business owners
To understand the differences between entrepreneurs and small business owners, it's important to first know what the terms themselves mean. According to the Oxford Dictionary, an entrepreneur is "a person who organizes and operates a business or businesses, taking on greater than normal financial risks to do so." A business owner is defined as "an individual or entity who owns a business entity in an attempt to profit from the successful operation of the company."
Entrepreneurs may be more willing to take big risks, whereas business owners may be focused on the profitability of their business, yet profit isn't mentioned in the definition for entrepreneur.
Different strengths and personality types
The study found that incorporated business owners tend to launch ventures that are entrepreneurial and require high-level cognitive skills, while unincorporated business owners typically lead companies that demand more manual talents.
The researchers cited examples of the types of businesses an entrepreneur or incorporated business owner might establish. For instance, an entrepreneur might found a digital advertising agency or a mobile app startup. On the flip side, an unincorporated business owner might be a plumber, contractor or cleaning person who founds their own company. [See related story: Entrepreneurship Defined: What It Means to Be an Entrepreneur]
"To the extent that one associates entrepreneurship with analytical reasoning, creativity, and complex interpersonal communications rather than with eye, hand, and foot coordination, the data suggest that, on average, the incorporated self-employed engage in entrepreneurial activities while the unincorporated do not," wrote the study's authors.
Ross Levine, one of the study's authors and a professor at the University of California at Berkeley, said people often think of entrepreneurs as someone who creates something novel, nonroutine, risky and cognitively challenging.
"We found that people who open such businesses tend to open incorporated businesses," Levine said in a statement. "In contrast, when people open businesses that perform fairly routine activities, the founders tend to have less formal education and open unincorporated businesses."
The differences between incorporated and unincorporated
The study found that an incorporated status provides business owners with some added legal protections, which often provides them a little more freedom to delve into larger and riskier investments compared to their unincorporated counterparts.
The legal status distinction appears to reflect how many business owners already think of themselves.
"We found that over time incorporated business owners are more likely to describe themselves as 'entrepreneurs' than unincorporated business owners," Levine said.
Benefits of incorporation
Incorporated businesses are able to separate their personal finances from the business. This means that if there's a liability issue, only the business's assets are at risk. In an unincorporated business, there is no legal distinction between personal and company finances and assets.
In addition to limited liability, incorporation allows for more financial flexibility. This flexibility extends to splitting the income among shareholders and when and how funds are withdrawn from the business.
According to Free Advice Legal, incorporated businesses are often viewed as more stable and professional by investors and customers alike. For a new business struggling to raise capital, this can be an important benefit.
Disadvantages of incorporation
There are added expenses to incorporation. First, the process of incorporation has associated fees. Many entrepreneurs hire an attorney to help with legal paperwork and ensure that the process goes smoothly, which also adds expense.
Keeping up with regulations and maintaining proper financial and management records requires more time, because the requirements are more stringent for incorporated businesses. A lawyer and/or accountant may be needed to comply with federal and state, as well as tax, regulations.
Differences between entrepreneurs and other small business owners
The study's authors found several differences between incorporated and unincorporated business owners after reviewing data from the results of the Current Population Survey from between 1995 and 2012 and the National Longitudinal Survey of Youth, which surveyed more than 12,000 people annually between 1979 and 1994 and biennially since then.
The research found that before starting their own company, incorporated entrepreneurs:
1. Exhibited greater self-esteem
2. Wanted to be more in charge of their own futures
3. Were usually involved in jobs that primarily rely on intellect
4. Were more likely than salaried workers to come from high-earning families with two well-educated parents
In addition, before launching their own ventures, entrepreneurs scored high on learning aptitude tests and engaged in more illicit, risky activities such as cutting classes, vandalism, shoplifting, gambling, assault, and using alcohol and marijuana.
"It is a particular mixture of traits that seems to matter for both becoming an entrepreneur and succeeding as an entrepreneur," the study's authors wrote. "It is the high-ability person who tends to 'break the rules' as a youth who is especially likely to become a successful entrepreneur."
On the other side of the equation, unincorporated business owners tend to have responsibilities that require more manual skills and were previously employed in similar work.
In addition, the researchers discovered that incorporated entrepreneurs are more likely to have many employees while unincorporated business owners have few or no employees.
There is also a difference in financial earnings relative to each group of business owners. The study reported that incorporated business owners gained $6,600 in median annual earnings relative to their previous salaries when they became entrepreneurs. Unincorporated business owners had median annual earnings increases of $716.
The study was co-authored by Yona Rubinstein, a professor at the London School of Economics and Political Science.