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A Major Obstacle Facing New Entrepreneurs: Student Debt

By Keith Morelli

Pinshuo Wang

TAMPA (October 31, 2018) -- Entrepreneurial-minded students focused on starting their own businesses upon graduation – after their ideas have been refined and methods perfected – may find something out there they had not fully considered; something that could will doom them to failure.

Student debt.

A recently published paper titled "The Cost of Higher Education: Can Student Loans Hinder Entrepreneurship?" co-authored by Pinshuo Wang, an assistant professor of finance in the Muma College of Business, takes a long, hard look at how that debt, which grads carry into the real world, affects their hopes and dreams.

The research conducted with the collaboration of Karthik Krishnan, associate professor of finance in the D’Amore-McKim School of Business at Northeastern University, is forthcoming in Management Science but was recently published online.

“Student debt is the second largest consumer debt, right after mortgage,” Wang said. “What distinguishes student debt from other debts is its non-dischargability through personal bankruptcy procedures and the fact that you take on these loans when you are quite young, in many cases not understanding the potential life impacts of these debts.

“Student debt not only impacts individuals taking loans, but also has larger spillover effects on the economy, as our study suggests,” she said. “Given the broad scope of financial and life outcomes that student loans can affect, including career choices, the choice to save for retirement, participating in the stock market and buying a house, I felt that the real world impact of research in this space can be significant.

“In a nutshell,” said Wang, who joined the Muma College of Business faculty this fall, “we find systematic causal evidence of student loans having a negative impact on entrepreneurship. Our evidence indicates that student debt inhibits entrepreneurship by exacerbating the effect of negative business outcomes on the individual.”

So, while graduates embarking on a path of entrepreneurship are thinking of start-up, payroll and distribution costs that come with running a business, most likely don’t figure in the cost of paying off that student debt, which can be substantial.

Though most would figure that hefty student loans could impact plans to open up new businesses upon graduation, this study puts hard and fast numbers to those conclusions.

The research says student loans topped $1 trillion in 2011, with most held by federal and state governments, where policy makers are in a quandary over this. On one hand, they want those debts to be paid, while on the other, they want entrepreneurs to thrive, the paper says, “given that entrepreneurship has been a strong and reliable engine of economic growth and employment.

“For instance,” the paper says, “a recent study released by the Kauffman Foundation reports that companies that are less than one year old with one to four employees have created, on average, more than a million jobs per year over the past three decades.”

Though there have been some efforts by the government to reduce or even erase some student debt, there seems to be little research done into the effect that debt has on entrepreneurship.

“We find that student debt is negatively related to the propensity to start a firm," the paper says, "particularly larger and more successful ventures,” the paper says.

Wang said she and Krishnan expected to find a significant relationship between debt and entrepreneurship, “but the economic magnitudes of our findings are larger than what even we expected.

“We find that an increase in student debt from zero to $10,000 reduces entrepreneurship likelihood by 1.4 percentage points … and going from zero to $10,000 in student loans is associated with a 42 percent decline in business income, conditional on starting up a firm.”

How can a budding entrepreneur escape the debt trap?

“There are various things one can do to reduce the restrictive effect of student loans,” Wang said. “Staying current on interest payments ensures that the principal balance does not increase. Refinancing student debt, if one can find cheaper options, is a possibility. However, one downside of this is that you lose the forbearance options provided by federal loans.

“Another option to consider is the income-driven repayment plan, in which the monthly student debt payment is based on income,” she said. “This reduces the risk of starting a business with student debt.”