New bankruptcy legislation fails to account for hundreds of thousands of entrepreneurs, independent contractors, and self-employed individuals who traditionally have turned to bankruptcy relief as an important safety net in their effort to recover from a failed undertaking, say researchers from Harvard Law School, Cambridge, Mass., and the University of Nevada, Las Vegas. In fact, large numbers of entrepreneurs use the bankruptcy system, despite official government statistics that claim their presence in bankruptcy has declined sharply. A result of the faulty data is a skewed picture of the measurement and strength of the nation's small business economy. The legislation could serve to deter would-be entrepreneurs from embarking on risky new business formation.

According to the research, owners of small businesses annually file an estimated 260,000 to 315,000 bankruptcies. Those numbers are about nine times higher than the government's data, which list about 37,000 cases.

The researchers trace the problem of faulty statistics to efforts in the mid 1980s to simplify the official bankruptcy reporting process and the advent of new computer software that changed the way attorneys complete forms used to compile government information. This technological change has created a systematic bias in which entrepreneurs were reclassified as consumer cases rather than business ones.

In the study, 19.5% of cases labeled as a consumer bankruptcy filing show some evidence of a connection to an underlying business. Moreover, the government's official statistics differ drastically from annual stats compiled by Dun & Bradstreet and the Small Business Administration, both of which show a significant increase in small business failures.

"It is apparent that entrepreneurs continue to use the bankruptcy system in big numbers. The surprising thing is not so much that they are there but why it took so long for someone to notice that the government figures were so divorced from reality," comments Robert M. Lawless, a study co-author and the Gordon & Silver, Ltd., Professor of Law at UNLV. "Each year, the bankruptcy system provides a critical safety net for hundreds of thousands of entrepreneurs. Our findings again suggest that the popular image of the bankruptcy system as full of irresponsible, overspending consumers is myth."

"The data suggest that much of the measurement of the small business economy is simply wrong, and that errors affect every assessment of the strength, number, and role of entrepreneurial businesses in the United States," adds Elizabeth Warren, Leo Gottlieb Professor of Law at Harvard. "Our economic system needs to encourage entrepreneurs to make new investments. Sometimes these investments will fail through no fault of their owners, and when that happens, the owners need to be able to move to other businesses and create new jobs and investment opportunities."