Starting a business informally is beneficial for growth, research finds

Starting a business informally almost always benefits its development in the early stages, new research from NEOMA Business School reveals.

According to the NEOMA researchers, Ana Colovic (Full Professor of Strategy and Entrepreneurship), Bisrat Misganaw (Assistant Professor of Strategy and Entrepreneurship), and Dawit Assefa (Research Engineer), starting a business without reporting it to the authorities can be a key ingredient for success in some countries.

“The informal economy is typified by activities that are not formally registered with the relevant government agencies. Up to 50 percent of businesses in developing countries operate in the shadows, compared to 15 percent in member states of the Organization for Economic Co-operation and Development (OECD),” says Professor Bisrat Misganaw.

Studying the performance of 49,520 companies from 116 countries, the authors’ findings show that an informal beginning is usually beneficial for the development of start-ups, but firms would lose this benefit if they stay informal for more than a few years. The findings also show that this window is shorter in countries with better institutional quality.

“Pro-informal business scientists champion the idea that registering with the authorities in the start-up phase stunts growth. Informal start-ups can redirect money usually earmarked for authorities in taxes, registration fees, etc., to expand the company. They also rely more on their leaders’ networks than on public services to obtain resources and gain legitimacy,” says Professor Ana Colovic.

After the first years (about 7.52 years, according to authors’ findings), these advantages start to dry up due to the increased costs needed to keep the company afloat, limited access to external resources, and a personal network that burns out after a finite period of time, the researchers find.

The researchers believe informal companies should be encouraged to become legal by swelling the associated advantages, for example by cutting the costs of registering the company. They can then contribute fully to the local and national economy.

This research was published in the International Journal of Entrepreneurial Behaviour & Research.