Even during an existential crisis, small businesses will do everything possible to avoid going into debt. According to the latest Small Business Credit Survey (SBCS), conducted and published by 12 Federal Reserve banks, the most common actions taken by small businesses in response to financial challenges from fall 2020 to fall 2021 were:
- Obtaining funds that do not have to be repaid: 71%
- Use of personal funds: 61%
- Use of cash reserves: 56%
- Obtaining funds that must be repaid: 52%
In any given year, of course, according to the SBCS, less than half of small businesses seek external financing. The past two years have forced most small businesses to seek outside help from financial institutions, including through the Paycheck Protection Program (PPP). For most borrowers, a PPP loan ended up being a grant. A few days ago, 89% of the total value of PPP loans had been forgiven.
As the survey results above show, small business owners have sought forgivable P3 funds as well as grants from public and private sources. Then, before applying for credit, they used everything they had in the bank, including their personal accounts. In the 2016 SBCS survey, 71% of small businesses reported having outstanding debt. In 2021, 74% did.
We hear about small business resilience all the time – part of crisis resilience means going to great lengths to support your business without jeopardizing its long-term viability. Many small businesses have obviously been able to survive the pandemic without going into debt. (The situation is slightly different for many of those who received economic disaster loans.)
The experience of COVID-19, for both small business borrowers and lenders, raises several questions about the future of small business financing. Some may have used an online lender or another alternative. Some might even have used a bank for the first time. Many have turned to the Small Business Administration (SBA) for the first time.
Will funding gaps close or widen?
It is well known that the Covid-19 pandemic has had a disproportionate negative impact on people of color. Prior to Omicron’s push over the winter, SBCS data indicates that companies owned by people of color “were more likely to be in fair or poor financial condition.” Three-quarters (76%) of black-owned businesses, for example, describe themselves as such, compared to 55% of white-owned businesses.
The uneven racial and ethnic impact of the pandemic has added to the racial gaps in small business and startup funding that have persisted for many years. Black and Hispanic business owners have historically been more inclined to seek smaller amounts of credit. This type of funding gap only gets wider over time as companies grow and mature.
This graph is from a recent report by the Bipartisan Policy Center, in collaboration with Goldman Sachs 10,000 small business voices. The report examines these disparities and how public policies could help close them. Tracking small business financing gaps should be a top priority for policymakers in the months ahead.
Will more small businesses seek SBA loan guarantees?
Excluding PPP and EIDL, more small businesses turned to SBA loan guarantees in 2021 than in previous years. Many small businesses previously ignored or refused to use SBA loan support programs. SBA programs such as its 7(a) Loan Guarantee are generally designed to help small businesses that cannot find “credit elsewhere.”
From 2016 to 2019, according to the SBCS, less than a quarter of small businesses surveyed applied for credit through the SBA. In 2020 and 2021, this share was over 40%. The secret of 7(a) is revealed. Again, this excludes PPP and EIDL.
High utilization is evident in the SBA data. The number of 7(a) loans in FY21 increased 22.5% from FY20, returning to nearly the same volume as FY19. The amount of funding provided by through 7(a) loan guarantees increased significantly from $22.7 billion in FY20 to $36 billion in FY21. Last year’s amount was the largest ever provided under the 7(a) program (not inflation-adjusted). According to the SBA, in the first five months of FY22, 7(a) loans are already in progress before 2021.
A major question facing the SBA and its lenders is to what extent the past two years — and the increased awareness among small businesses of the agency and its support — represent a new trajectory or pandemic aberration.
Where are the financing innovations headed?
The BPC report cited above also highlights research findings that the inclusion of online lenders in PPPs helped reduce the disparities that characterized the first phase of the program. Prior to 2020, online and alternative lenders could not participate directly in government-backed loan programs.
Beyond government guarantee programs, of course, the market for small business financing had exploded in the decade before Covid. The rapid growth of lending options in the market has been a major factor in this. According to the SBCS, while application rates from online lenders (excluding pandemic-related assistance) fell in 2020, they rebounded in 2021. In contrast, there was a decline from 2020 to 2021 from small businesses applying for credit from small banks.
Online lenders are now a major part of the small business lending landscape. The tradeoffs for small businesses to different types of lenders are clear in the SBCS data. They face difficult application processes and long waits for credit decisions at banks, especially large ones. And they face high interest rates and sometimes unfavorable repayment terms from online lenders (and finance companies).
Beyond market lenders, there is constant innovation in capital structures and growth in areas such as revenue-based financing. As small businesses seek to recover and grow, and new business creation explodes, policymakers will need to make adjustments to accommodate innovation, even as they seek to close long-standing gaps .