I often criticize others for attributing 100% of any bad trend to their personal pet peeve. To some extent I am guilty of that in my last post, where I blamed declining business formation on increasingly complex regulation and licensing. I think there are good reasons for doing so -- I have spent the last 6 months passing up on business growth opportunities because I was too consumed with catching up on regulatory compliance minutia, particularly in California. And I have watched as many of my smaller competitors who have fewer resources to dedicate to such compliance issues have left the business, telling me they could no longer keep up with all the requirements.
But there is seldom just one single cause for any trend in a complex, chaotic system (e.g. climate, but economics as well). One other reason business formation may have dropped is the crash of the housing market and specifically in the equity many have in their homes.
Home equity has historically been an important source of capital for small business formation. My first large investment in my company was funded with a loan that was secured by the equity in my home. What outsiders may not realize about small business banking nowadays is that it is nothing like how banking is taught in high school civics. In that model, the small business person goes to her local banker and presents a business plan, which the banker may fund if they think it is a good risk.
In the real world, trying to get such an unsecured loan from a bank as a small business will at best result in laughter. My company is no longer what many would call "small" -- we will do millions in revenue this year. But there is no way in the world that my banker of over 10 years will lend to my business unsecured -- they will demand some asset they can put a lien on. So we can get financing of equipment purchases (as a capital lease on the equipment) and on factored receivables and inventory. But without any of that stuff, a new business that just needs cash for startup cash flow is out of luck -- unless the owner has a personal asset, typically a house, on which the banker can place a lien.
So, without home equity, one of the two top sources of capital for small business formation disappears (the other top source is loans from friends and family, which one might also expect to dry up in a tough economy).
Postscript: Banks will make cash flow loans if guaranteed by the SBA. This is another whole can of worms, which I will not discuss today. SBA loans are expensive and difficult to get, and the SBA has a tendency to turn the money spigot on and off at random times. I have often wondered if the SBA helped to kill cash flow lending by banks. First, why make risky small unsecured loans when you can get a government guarantee? And second, with more formulaic lending criteria, SBA lending eliminated the need for loan officers who were good at evaluating business risks. I can say from personal experience that the folks who can intelligently discuss a business plan and its risks are all gone from banks now (at least in the small business market).