Capital access: behind America’s small business problem
By Luke LaHaie, Co-Founder and Co-CEO of Newity
The salvation for American small business is rooted in capital access
Small businesses are America’s lifeblood, comprising 44% of national GDP, creating 62% of new jobs, and representing 99.9% of all U.S. businesses. Despite the government’s recent efforts to support entrepreneurs, small businesses are failing to keep up with major corporations amid the current economic landscape.
Afflicted by limited and unaffordable financing, nearly all small businesses are undercapitalized. This is not a new issue. Established in 1953 to protect the interests of small businesses and encourage competition in the private market, the Small Business Administration (“SBA”) was the government’s solution to an emerging problem: small businesses needed specialized support to access capital resources that were otherwise readily available to big business. Although the SBA allocates funds for small business lending, it is not a direct lender and cannot bear the weight of small business capital inefficiencies alone. While the SBA leaves banks, credit unions, and other financial institutions with clear directives to provide small business loans, there is no practical method for the SBA nor its lenders to underwrite, process, and service these loans at scale.
The 2020 Paycheck Protection Program (“PPP”) catalyzed a novel era of issuances for the SBA, utilizing new channels to disburse $798 billion to small businesses throughout the U.S. This program, though enacted for emergency use, revealed the depth and breadth of the small business market not previously evidenced in traditional SBA lending programs, like 7(a) loans. In 2021, the SBA approved less than 200 7(a) loans under $25k, excluding SBA Express. By comparison, the SBA approved 3.2 million PPP loans for similarly sized businesses in 2020 alone.
Although PPP demonstrated small businesses’ appetite for capital, it has not yet become economically practical for banks and credit unions to originate these small business loans, and so, they don’t. Today, 29% of businesses fail due to lack of funding. Banks with the most fiscal and human capital only support a sliver of the market with small business loan approval rates of 14.3%. Until banks provide time, staff, and capital to implement programs to economize the issuance of smaller business loans, entrepreneurs bear the consequences of our misaligned financial system.
With no affordable alternatives, small business owners are forced to avoid loans all together, despite being a key component for corporate growth, or settle for high-priced loans that are often easier to obtain. Credit cards and merchant cash advance approval rates near 84%, but the cost of these financing mechanisms require small business owners to allocate a portion of their loan proceeds to cover the interest portion of their monthly payments. Utilizing debt to pay for the debt needed to grow a business is significantly less efficient at 20%+ interest rates compared to the single digit interest rates typical for large corporate loans.
As entrepreneurs resort to high interest loans amidst the lack of efficient alternatives, over 70% of small businesses become entrenched in debt. For the businesses that grow and mature, obtaining lower cost loans becomes increasingly difficult due to their poor credit scores, which are cited for 36% of loan denials. Subsequently, small business owners often become trapped in a vicious cycle of high-interest rate loan reliance due to their inability to obtain a lower-cost alternative.
The ongoing national labor shortage, estimated at over 11.3 million vacancies, has exacerbated the harm caused by small businesses’ inability to obtain low-cost financing. With limited capital to deploy, small businesses cannot compete with higher salaries offered by larger corporations, severely hindering their recruitment efforts. Beyond annual compensation, small businesses cannot provide the ancillary benefits landmarked by corporate culture. Small businesses cannot afford stocked break rooms, childcare, and transportation. With inflation reaching 9.1%, small businesses are also now recruiting from a continuously shrinking talent pool that can afford to ignore added benefits like free meals and snacks.
Retaining talent is equally difficult for small businesses. Over 61% of employees would change jobs to have health insurance. This would be less troublesome for small businesses if the average cost for insurance per employee had not increased over 9.6% for small businesses in 2021. For employees who decide to leave small companies for larger ones, the cost for a business to replace an employee can range from 50% to 200% of the employee’s annual salary. When a small business reinitiates their hiring search, they may also fall victim to the flight to safety, uncovered by a Harvard Business School 2020 study. Following the COVID-19 pandemic, researchers found experienced job seekers sought larger, established companies over their venture counterparts.
Technology would seem an obvious solution for small business staffing issues, but implementation of new technologies is neither easy nor cheap. The importance of technological investments is repeatedly made clear in annual corporate growth objectives, evidenced by JP Morgan Chase’s $12 billion technology spend. To keep pace with the advancements of larger competitors, experts recommend small businesses spend 6.9% of their total revenue on technology. In reality, small businesses are investing closer to 2.6%, leaving them further behind their competitors as the world becomes increasingly digitized. While large companies implement artificial intelligence to make their systems smarter and employees more efficient, small businesses are struggling to deploy basic tech equipment. 36% of small businesses are solely focused on infrastructure, implementing the use of laptops, desktops, servers, phones, and storage. Without the funds to integrate simple technology, the gap will continue to widen between small businesses and their corporate counterparts.
The Bottom Line
America is indebted to the ingenuity and tenacity of its countless entrepreneurs. The Small Business Administration’s continuous efforts to place capital in the hands of small business owners ought to be celebrated, but the SBA still needs the help of financial institutions to achieve its mission. Enabling equitable access to capital is the only way to ensure equal opportunity across the nation to maintain the hope and promise of the American Dream.
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