The great news for small businesses in today’s economy is that the options for small business financing are many. Bootstrapping a business with personal money, using credit cards, and asking friends and family for help are still common ways to start a new venture (75% of entrepreneurs rely on personal finances as their primary source of funding). But, there are a lot more options today for finding capital to pursue your dreams of running and growing a business. As the private sector adapts to the needs of the marketplace, regulators and legislators are watching to ensure that the best interests of small businesses are protected. Consider these small business financing trends and how they are evolving as you determine the best way to access capital to realize your company’s potential.
Traditional Loans
While conventional small business lending is still at only 84% of pre-recession levels, bigger banks that can provide low interest rates have shown a renewed interest in small business lending. Currently, big banks (those with $10 billion or more in assets) are approving funding for entrepreneurs at a rate above 23%, according to a BIZ2Credit survey, a rate that is 6% better than last year. With this competition from the big banks, smaller institutions are seeing their lending rates a little bit lower, but are still doing well. For example, small banks approved 48.8% of loans for entrepreneurs and credit unions approved about 42% of loan applications, according to BIZ2Credit. The Federal Reserve’s 2015 survey of small businesses with employees shows better results. The survey revealed that small banks are approving at least some of the amount requested for 76% of small employer applicants, compared to big banks’ approval rate of 58%.
While encouraging, these percentages don’t demonstrate that traditional loans are easy to get. That’s why the Small Business Administration (SBA) provides loan guarantees for small businesses who would otherwise not qualify for a bank loan (See blog post: What is the SBA and Can It Help Your Small Business?). While the SBA process requires some extra work, it’s an option that offers small businesses capital to meet a variety of business goals. The most popular SBA loan program, the 7(a) loan guarantee program, hit its cap last July, and Congress quickly acted to increase the authorization from $18.75 billion to $23.5 billion to keep the program running. The 7(a) loan volume in FY 2015 was about 22% higher than in FY 2014. In anticipation of continued high demand, the cap for FY 2016 is set at $26.5 billion.
Online Alternative Lending
In the wake of the financial crisis when traditional lending slowed, the online alternative lending industry cropped up and has been growing steadily. With loan approval rates reaching 70 percent and quick turnaround on applications, alternative lending may be a good option for small companies that need fast cash. These lenders utilize big data and less traditional measures of a company’s worth, including things like vendor payments, credit card use and even social media activity, to approve loans. The risk these lenders take on businesses that can’t access bank financing has a price. Interest rates range from 5% to 40%, and with fees the cost can be much higher.
Still, if small businesses understand and can stomach the terms of the loan, they may be able to access capital in a way that makes sense for their business through alternative lending platforms. Estimates of the the industry’s growth potential varies, but most see a steep incline. Business Insider predicts small business loan origination by alternative lenders will reach $52 billion by 2020 (up from $5 billion in 2015), the Department of Treasury estimates loan origination by online lenders could reach $90 billion by 2020, and Morgan Stanley thinks loan volume of “marketplace lenders” will be closer to $120 billion by the end of the decade.
Some hiccups in the industry of late have some more pessimistic about its future, and surely the industry will continue to evolve. Rapid growth has attracted the attention of policymakers. A study by the Treasury Department has resulted in recommendations for more transparency in online lending products, as well as the creation of an interagency task force to look at what regulations apply to the industry. United States Senators have asked the Government Accountability Office (GAO) to examine alternative lenders’ practices. This scrutiny could very well result in more regulation down the road.
Credit Sources Applied To By Revenue Size Of Firm
| All | >$10M | $1M-$10M | $100K-$1M | Micro (<$100K) | |
| Small Bank | 52% | 53% | 59% | 52% | 44% |
| Large Bank | 42% | 58% | 45% | 39% | 41% |
| Online Lender | 20% | 6% | 11% | 22% | 30% |
| Credit Union | 9% | 1% | 4% | 9% | 14% |
Source: Federal Reserve 2015 Small Business Credit Survey: Report on Employer Firms
Angel Investors
Angel investors still provide a significant amount of capital to start-up or early-stage companies to the tune of $24.6 billion last year, an annual increase of almost 2%, and close to the market high in 2007. The size of investment by angels ranges from about $50,000 to $2 million, with the average investment size close to $350,000. Angels currently supply about 90% of equity funding for start-ups. There are proposals in Congress to increase this activity. For example, the House just passed a bill in July that would increase the number of individuals who can participate in an investment company fund from 100 to 250 and still be exempt from Securities and Exchange Commission registration.
Venture Capital
Compared to angel investment, venture capital (VC) generally flows to companies at later stages of development and the investments are larger in size. Often the financing involves the goal of a public offering. In 2015, VC investments reached an all-time high. Some $58.5 billion was invested by venture capital funds, which is the second highest annual total in 20 years. More than 3,700 companies received VC funds in 2015, and competition is stiff. According to the National Venture Capital Association, for every 100 business plans that come to a venture capital firm for funding, only 10 or so get a serious look, and only one ends up being funded. Policymakers are interested in keeping VC strong and available for U.S. companies. A hearing before the Senate Committee on Small Business and Entrepreneurship on July14th, sought policy recommendations to bolster the capital provided to small businesses by venture capitalists and angel investors.
Equity-Based Crowdfunding
Crowdfunding has “democratized” access to capital by allowing more people of lesser means the opportunity to finance projects and businesses they deem worthy, usually in exchange for some kind of non-monetary reward. This method of raising capital uses internet platforms to engage the public and has shown great promise. Massolutions reports that reward or donation crowdfunding raised $5.5 billion in 2015. Growth may be bolstered by the newest iteration of equity-based crowdfunding. This option, which just became available in May, allows companies to raise capital from non-accredited (less wealthy) investors in exchange for equity. While it’s not going gangbusters yet, the final rules governing the concept allow companies to raise up to $1 million in a 12-month period. The requirements for issuers of securities through crowdfunding are significant in the interest of protecting presumably less-savvy investors. To ensure that equity-based crowdfunding is a workable, attractive option for small businesses, Congress is already seeking to tweak the rules.
Let’s hope policymakers can facilitate the technology, innovation, and economic growth that will enable small businesses to get the financing they need to grow and create jobs
Contact us if you have comments or questions about financing your small business.