They may be young and small, but collectively they are a force to be reckoned with in the overall economy.

They are startups, and they account for one-third of all small businesses and a large portion of innovation and productivity, according to the Report on Startup Firms, the second in a series of reports based on the 2016 Small Business Credit Survey. Conducted by the Federal Reserve Bank of New York and released last week, the report defines startups as small businesses that were five years or younger in 2016 and had full- or part-time employees.

Based on outside research, the report says startups account for nearly all net new job creation and nearly 20 percent of gross job creation, meaning they create jobs without eliminating them at a rate much higher than established firms.

“Startups are the primary drivers of U.S. job growth and their success is essential to a healthy economy,” Claire Kramer Mills, assistant vice president and community affairs officer with the New York Fed, said.

Western Connecticut boasts a healthy startup environment as evidenced by the number of new companies in a variety of industries launched in the last five years. According to the Connecticut Data Collaborative, there have been 4,333 business formations in Danbury from 2012 to 2016.

High hopes

Nelson Merchan, a business adviser at the Danbury office of the Connecticut Small Business Development Center, has worked with several local entrepreneurs who have launched businesses in recent years. He said optimism is high among the startup owners he has met.

“It is energizing to talk to people starting a business or in the first few months of starting one,” he said. “It is a time for dreams to come true. You need that energy to start a business no matter your age, gender or background.”

The optimism expressed in Danbury correlates with the findings of the national report, which found that 61 percent of companies started within the last two years and 54 percent of those started three to five years ago expect to add jobs. Only 29 percent of firms older than five years expect to add jobs.

Justin Krul, who last weekend opened his New Milford antiques store in a new location, said he is confident his business and revenues will grow, but is not yet in a position to add new employees.

“I think the economy will remain steady and grow over the next few years,” said Krul, owner of Just In Antiques. “I could see (adding employees) maybe happening in the next few years.”

Many pitfalls

Andrea Gartner, who opened the restaurant Pour Me in downtown Danbury this spring, has already hired about 20 people. She expects to hire more people, but many of the hires will be replacing staff who leave following the summer. New restaurants typically require owners to hire several employees prior to opening.

While the excitement level and potential rewards are high with starting a business, the challenges and risks are also high. The Report on Startup Firms points out that one-third of new businesses fail within the first two years and half of them fail within five years.

“Starting a business is the easier part; making it profitable is where the challenge is,” Merchan said.

Merchan said there are quick paths to failure when it comes to starting a business.

“Not doing business validation, a lack of an aggressive and well-thought sales and marketing strategy, and the lack of capital can bring new businesses to failure faster than expected,” he said.

Access to capital has long been one of the most critical challenges faced by new business owners. The challenge for startup companies is they cannot prove to banks they are a good risk because they do not yet have a history of profitability.

“Although financing is important for all companies, it’s especially critical to these young firms who need funds to weather initial costs and grow,” Kramer Mills with the New York Fed said. “Despite startups’ strong demand for financing, their problems are more acute than other firms, with most facing shortfalls and many discouraged from even applying.”

Funding options

The Report on Startup Firms states that 52 percent of new firms applied for financing in 2016, compared to 42 percent of older firms. The amount of money sought by new firms, however, is typically lower. A strong majority (63 percent) of startups that applied for financing were looking for $100,000 or less.

Yet the money woes continue for many startups, according to the survey. Nearly 60 percent of new firms reported difficulty accessing funds, compared with 39 percent of older firms. Also, 69 percent of new firms said they experienced a financial shortfall and obtained less money than sought.

“Startup firms with medium and high credit risk cannot take planning lightly,” Merchan said. “In today’s business environment, it is more challenging for a pre-venture or startup to access additional capital easily.”

Then there is the self-funding option. Liz Ceppos, a Danbury resident who along with her husband founded Cross Culture Kombucha earlier this year, said they took a measured approach and invested their own money to launch the company.

“We wanted to test the product in the market and see consumer reaction before making much larger investments,” she said. “I know some of the things we want to do in the future will require financing. We are preparing ourselves for that.”

When self-funding is not an option and a bank loan is unlikely, many startup owners have turned to non-traditional types of funding such as grants and crowd-funding.

“In a few cases, where access to capital through a bank is not an option, we help our clients apply for matching grants and or loans from the state of Connecticut,” Merchan said. “The fundamentals of the business and the ability to repay the loan are still of great importance when evaluating the application.”

cbosak@hearstmediact.com; 203-731-3338