Just prior to the COVID-19 pandemic, the Small Business Index from MetLife and the U.S. Chamber of Commerce reached an all-time high. The sentiments of American business owners and entrepreneurs matched the national economy, which was enjoying robust growth, rising wages, and low unemployment.
The pandemic crisis dealt a harsh blow to small and young companies, forcing thousands to close and threatening the survival of hundreds of thousands more. As crises are wont to do, COVID-19 exposed underlying fractures in the small business landscape. Despite the heady pre-pandemic days, the crisis forced us to confront large disparities in financing and discouraging trends that had existed for many years.
- While business creation among people of color has been higher than among whites for many years, business exit in the first three years has consistently been higher for Black- and Hispanic-owned businesses.
- Over half (58%) of Black-owned small businesses were classified as “at risk or distressed” before the pandemic compared to 27% of white-owned firms.
- Going into the crisis, Black- and Hispanic-owned small businesses had no more than two weeks’ worth of cash buffer.
Emergency relief programs, such as the Paycheck Protection Program (PPP), were broadly effective in helping small firms maintain employment and survive the worst phases of the pandemic. Yet its structure, which was based on the Small Business Administration’s 7(a) loan guarantee program, reflected demographic differences in how small businesses access credit.
The Biggest Gaps
This past spring, the Bipartisan Policy Center asked several experts about the financing landscape for small businesses. The question was broad: what is the one action the federal government should take to expand access to capital? The responses:
- “Capital is simply not flowing to Black and Brown entrepreneurs … the public and private sectors are not united around basic priorities of how to finance small businesses, or a fundamental understanding of how barriers to access compound.” — Lauren Paul, director of partnership and policy, Common Future
- “Our small business economy really is a story of two different economies. One economy is the economy of minority entrepreneurs. In that case we see historically that minority-owned businesses are half as likely to get the credit that they need as their white business counterparts.” — Tom Sullivan, vice president of small business policy, U.S. Chamber of Commerce
- “We need to expand the eligibility of federal dollars for capital deployment. … Policy should be expanded to have more capital providers eligible for dollars from the federal government that also can be levered in the community.” — Melissa Bradley, founder and managing partner, 1863 Ventures
- “The smaller microloans tend to be used by underserved markets, minority-owned businesses, and sole proprietors.” — Ryan Metcalf, head of public policy and regulatory affairs, Funding Circle
- “The number one impediment for low-income communities and people of color is the credit score.” — Nancy Santiago Negron, community impact lead, Ureeka
Two themes emerge from these comments. First, demographic financing gaps are the largest challenge to American entrepreneurial dynamism. Second, fresh thinking around public policy is needed to close them.
SBA Programs and Financing Disparities
There are longstanding public efforts to close these gaps. One of them is the 7(a) program itself, which was created to address perceived failures in the market for small business credit and is intended to assist those firms failing to find “credit elsewhere.”
Yet over the last decade, credit provision in the 7(a) program has gradually drifted toward larger loans. Consider that in 2016, compared to 2012, the number of 7(a) loans approved (after cancellations and modifications) was 33% higher but the average loan size was just 9% bigger. More loans guaranteed without a large increase in average size meant expanded access to credit. In fiscal year 2020, however, the number of approved 7(a) loans was 37% lower than in 2016—but the average loan size was 29% larger. The average loan size has grown every year since 2015.
Why does this matter? Because Black- and Hispanic-owned small businesses are more likely to seek smaller amounts of financing. According to the Small Business Credit Survey from the Federal Reserve Banks:
- One-quarter of Black- and Hispanic-owned firms, when they apply for external financing, seek less than $25,000. That compares to 15% and 9%, respectively, for white and Asian-owned firms.
- Over half, 54% and 58%, respectively, of white and Asian-owned small businesses, when they apply for external financing, seek more than $100,000. That compares to 37% and 33%, respectively, for Black- and Hispanic-owned firms.
SBA loan guarantees are intended to help address gaps in the market, but if they are steadily getting larger, they’re likely missing many small businesses who need credit the most.
Public Policy to Expand Access to Capital
Support for small business has historically been robustly bipartisan in Washington. The current Congress, polarization on most issues notwithstanding, is no exception. A new report from BPC and Goldman Sachs 10,000 Small Businesses Voices includes a list of relevant bills from the 117th Congress. While some might seem to propose just small changes to existing programs, others demonstrate a willingness to engage in bold and creative action.
Small business access to capital is a complex issue, intertwined with other issues of opportunity, equity, and regulation. To make headway against existing challenges and help support small business vibrancy and entrepreneurial growth, advocates and champions need to outline a detailed roadmap for policymakers. This column will have more to come on this over the next several weeks.