Starting a Business Informally Benefits Early Development, Study Finds

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Starting a business informally can often lead to success in the early stages, according to new research from NEOMA Business School. The study conducted by professors Ana Colovic and Bisrat Misganaw, along with research engineer Dawit Assefa, found that in some countries, not reporting a business to the authorities can be a key ingredient for success. The study examined the performance of 49,520 companies in 116 countries and found that starting informally is usually beneficial for the development of startups. However, if firms remain informal for too long, they lose this advantage. The researchers suggest that informal businesses should be encouraged to become legal by cutting the costs of registering the company, and contribute fully to the local and national economy.

The informal economy refers to activities that are not formally registered with relevant government agencies. The study found that up to 50% of businesses in developing countries operate in the shadows, compared to 15% in member states of the Organization for Economic Co-operation and Development (OECD). Professor Bisrat Misganaw notes that this is a significant difference and highlights the impact of institutional quality on the prevalence of informal businesses.

The researchers found that pro-informal business scientists champion the idea that registering with authorities in the startup phase stunts growth. Informal start-ups can redirect money usually earmarked for authorities in taxes and registration fees, among other things, to expand the company. They also rely more on their leaders’ networks than on public services to obtain resources and gain legitimacy. Professor Ana Colovic says that informal businesses can gain a significant advantage in the early stages by not being subject to the same regulations and fees as formal businesses.

However, the benefits of an informal start to a business decline after a few years, according to the study. After about 7.52 years, the advantages of starting informally start to dry up due to increased costs needed to keep the company afloat, limited access to external resources, and a personal network that burns out after a finite period. The study found that this window is shorter in countries with better institutional quality, suggesting that a better regulatory environment can reduce the time during which informal businesses can thrive.

The researchers suggest that informal companies should be encouraged to become legal by swelling the associated advantages, such as cutting the costs of registering the company. They can then contribute fully to the local and national economy. Encouraging informal businesses to become formal can help ensure that the benefits of an informal start are not lost over time, and that the companies can continue to grow and thrive in a sustainable way.

In conclusion, the study from NEOMA Business School highlights the benefits of starting a business informally, but only in the early stages. The researchers suggest that informal companies should be encouraged to become legal in order to fully contribute to the local and national economy. By cutting the costs of registering a company, these businesses can gain access to formal resources and grow in a sustainable way.