No Way to Help Small Business
According to the Office of Advocacy of the U.S. Small Business Administration (SBA), 6.1 million small employer firms were operating in the United States in 2008. These businesses are an important part of the economy, making up 99.7 percent of all businesses with employees. They provide jobs for a little more than half of all private-sector employees and consist of 44 percent of U.S. private payroll, the Office of Advocacy explains.
These businesses are facing cash flow problems. Roughly 60 percent of small business owners responding to an September 2009 American Express OPEN Small Business Monitor survey reported concerns with their cash flow. And 51 percent of small business owners answering a January 2010 Discover Small Business Watch survey said they had delayed paying bills because of a temporary cash flow problem. (Both of these surveys are administered to representative samples of the small business owner population.)
Cash flow problems are requiring some small businesses to raise more money. The OPEN survey found that 19 percent of small business owners believed they were having difficulty accessing the capital they needed to operate their businesses. Approximately 43 percent of small business owners answering the Discover survey said they would have to raise money this year to keep their businesses running.
President Obama has proposed a program to use $30 billion of the remaining Troubled Asset Relief Program funds to provide inexpensive capital to smaller banks who could then lend the money to small businesses.
However, bank credit to small businesses remains tight. The January 2010 Federal Reserve Senior Loan Officer Survey showed that the cost, size, maturity, covenants, and collateralization requirements on loans to small businesses have tightened considerably since the beginning of the Great Recession.
The need of many small businesses to raise money, combined with tight credit, has led to several proposals that give small businesses more access to credit. For instance, CNN Money reports that President Obama has proposed a program to use $30 billion from the Troubled Asset Relief Program (TARP) to provide inexpensive capital to smaller banks, which could then lend the money to small businesses. Two House Democrats, Kathy Dahlkemper and Melissa Bean, have proposed enhancing the SBA “Express” loan program by raising the maximum loan size from $350,000 to $1 million and increasing the guarantee portion from 50 percent to 75 percent.
While these programs might help a handful of the larger small-businesses access credit, they will miss the mark for helping the majority of small companies.
First consider the proposed expansion to the SBA “Express” loan program. According to the National Association of Government Guaranteed Lenders, banks made 44,220 SBA 7(A) loans in 2009. That means that less than 1 percent of U.S. small businesses received the types of loans the two congresswomen are proposing to expand. Even a sevenfold increase in the number of businesses receiving these loans would only mean that 5 percent of U.S. small businesses would receive financing.
In fact, borrowing from a bank is not one of the approaches small businesses typically use to deal with cash flow problems.
Moreover, a sevenfold increase in the program would expand the amount of capital provided to small businesses from $9.3 to $65.2 billion, a magnitude that seems implausible. And that’s if the average size of loans don’t go up with the increase in the maximum loan size or guarantee portion.
According to a Federal Reserve Board of Governors’ Report to Congress, the SBA 7(A) program accounts for 90 percent of SBA lending. Thus, SBA loans simply go to too few small businesses to provide much of a solution to the credit problems of small businesses.
How about the proposal to provide smaller banks with TARP funds to lend to small businesses? This, too, is unlikely to provide needed credit to small businesses. One problem is that smaller banks account for too small a share of small business lending. According to research by the SBA Office of Advocacy, institutions of over $10 billion in assets accounted for 67 percent of small business loans (under $1 million) in 2008.
Another problem is that only a small portion of small businesses actually borrow from banks. Only 19 percent of small business owners reported using bank loans when asked in a 2009 Discover Card Small Business Watch survey. This remains almost unchanged from the 21 percent in 2007. A 2009 OPEN survey showed similar results, finding that only 14 percent of small businesses used a bank loan to access the capital needed to run the business.
The proposed government programs will provide capital to only a minority of small business-lending banks and increase limits on programs that only a tiny sliver of businesses use.
In fact, borrowing from a bank is not one of the approaches small business owners typically use to deal with cash flow problems. When asked how they planned to deal with cash flow issues, approximately 32 percent of the small business owners OPEN surveyed in August 2009 answered that they planned to raise personal or private funds, only 3 percent answered that they intended take out a loan. Of the respondents to the Discover survey who said they would need to raise money to survive this year, a bank loan was the first choice of funds for only 20 percent of them.
The tendency not to borrow from banks is particularly acute for small businesses with fewer than five employees, which make up approximately 61 percent of all small employer businesses in the United States—roughly 3,705,000 companies. According to analysis from the Federal Reserve’s most recent Survey of Small Business Finances, only 32.8 percent of small businesses with fewer than five employees had a loan from a commercial bank, and only 24.4 percent of them had a line of credit.
In short, the proposed government programs will provide capital to only a minority of small business-lending banks and increase limits on programs that only a tiny sliver of businesses use. For all small businesses, but particularly for those businesses with fewer than five employees, the programs fail to address the ways that most small businesses raise money.
If we really want to help small businesses access capital, we need to provide them with better access to non-bank sources of financing, particularly trade credit, and make sure that the owners themselves are able to put more capital into their businesses either in the form of loans or as equity.
Scott Shane is the A. Malachi Mixon III Professor of Entrepreneurial Studies at Case Western Reserve University. The author recently released a book from Oxford University Press: Born Entrepreneurs, Born Leaders: How Your Genes Affect Your Work Life.
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