A recent report by the U.S. Small Business Administration’s Office of Advocacy provides detailed data about the state of small business funding. The data illustrates some of the challenges and opportunities for small business owners in 2018.In Small Business Funding By The Numbers: What Every Entrepreneur Should Know, we take a closer look at the report and its implications for entrepreneurs.
The Scope of Small Business in the United States
The report indicates that 99 percent of all businesses in the United States are small businesses, with 29.6 million such companies. Those companies employ 59.6 million people or 47.8 percent of all U.S. workers.
Small businesses comprise 97 percent of all U.S. exporters and contributed 1.4 million net new jobs for the year (2014) the assessment was completed.
A closer look at the most recently studied time period, the second quarter of 2015, shows a net gain in new businesses and jobs, but the margin is thin. In that period, there were 234,000 new small businesses with 213,000 companies exiting the economy. (A company is considered exited when it goes from at least one employee to none and remains closed for at least a year.)
Those new companies generated 839,000 jobs that quarter while the closed companies resulted in the loss of 735,000 jobs.
Small businesses cover a range of sectors, with the top five being:
- Health care and social assistance (8.56 million employees)
- Accommodations and food service (7.71 million)
- Retail trade (5.44 million)
- Manufacturing (5.11 million)
- Professional, scientific, and technical services (4.98 million)
Small Business Funding Basics
Small businesses are an essential component of borrowing for business, according to the SBA. In 2015, small business loans totaled about $600 billion, with the National Small Business Association noting that nearly three quarters, or 73 percent, of all small businesses used financing in the past 12 months.
Access to capital is essential for small businesses. The SBA reports the top four reasons that businesses opt for financing as:
- Start-up costs to begin a new business
- Purchasing inventory
- Business expansion
- Strengthening the company’s overall financial position
Companies typically resort to two types of financing: debt (typically provided by bank loans) and equity (provided by venture capital or angel investing). The type of financing businesses seek depends largely on the need and size of the investment.
There are, of course, other options for small business owners, including using personal savings, crowdfunding, online lending, loans from family and friends, personal and business credit cards, and the use of 401(k) and IRA savings.
New Businesses Lack Access, Use of Funding
According to the SBA, a quarter of all new businesses do not rely on any source of financing and heavily rely on their own funds to start the business, with more than half relying on their own savings. The agency lists the top sources for funding new businesses as:
- Personal savings (57 percent)
- No startup capital (25 percent)
- Personal credit cards (8 percent)
- Bank loans (8 percent)
- Other personal assets (6 percent)
- Home equity (3 percent)
- Business credit cards (2 percent)
One common question among those considering starting their own business is how much funding is necessary. Capital needs for small businesses obviously vary widely given the type of business, scope, need for employees, and other start-up costs.
Firms with employees tend to need more start-up funds than nonemployer firms. According to the SBA, the amounts needed reported by firms (not including companies that did not use start-up funds) were:
- Less than $5,000 (22.5 percent (employee firms) and 39.5 percent (nonemployee firms)
- $5,000 to $24,999 (14.2 percent and 7.1 percent)
- $25,000 to $99,999 (11.5 percent and 2.8 percent)
- $100,000 to $999,999 (7.3 percent and 1.8 percent)
The good news is that the vast majority of companies start their companies with small amounts of capital. The downside is that nearly two-thirds, 63 percent, of small businesses carry some amount of debt.
Newer companies tend to carry less debt than more established companies. And three-quarters of companies with 50 or more employees carry debt while among those with fewer than 10 employees, only 60 percent carry debt.
Interest rates, especially those sponsored by SBA programs, vary based on the size and duration of the loan. More alternative lending products, including those with much shorter payback timeframes, generally have higher interest rates.
Commercial and industrial bank loans have been below 5 percent since 2009. Credit cards typically have much higher interest rates.
The U.S. Census Bureau reports that just one percent of businesses wanting to expand were unable to secure needed funding. However, that data is disputed by other research. The Kauffman Foundation, in contrast, indicates that 20 percent of businesses responding to their survey were denied access to funding.
Even those that secure funding often do not get what they need. The Federal Reserve reports that while 82 percent of small businesses received approval for financing, just half of those companies received the full amount requested.
The belief that they will be turned down often discourages small business owners from seeking financing, according to the Federal Reserve. Women- and minority-owned businesses are disproportionately more apt to be in this group of discouraged businesses.
This data is contrasted by the default rate among small businesses. Small business default rates are at an all-time low, according to the SBA, of less than 2 percent compared to a peak rate of 6 percent in 2009.
Of course, that year was in the midst of the Great Recession. Small businesses have generally rebounded in the years since, but have not returned to pre-recession levels.
Expansion Sources of Funding
For businesses looking to secure funding to help expand operations, the outlook is similar, with personal savings the main source. Here is the breakdown of funding sources for business expansion:
- Personal savings (22 percent)
- Business profits or assets (6 percent)
- Personal credit cards (5 percent)
- Bank loans (5 percent)
- Other personal assets (2 percent)
- Home equity (2 percent)
The Small Business Administration offers special programs for and studies data about women-, minority-, and veteran-owned businesses. Here's a closer look at the differences among these segments of business ownership.
Women are more likely to start a business without using any financing than their male counterparts (34.3 percent versus 21.9 percent versus 11.2 percent for equally male- and female-owned companies).
Women are slightly less likely to use personal savings than men (51.3 percent versus 59.0 percent) and much less likely (more than half) to use bank financing (3.6 percent versus 8.5 percent). The SBA analysis surmises that this gap in traditional lending may place women collectively at a disadvantage, given that having established banking relationships can help small business owners with future financing needs.
While 8.1 percent of non-minority-owned businesses rely on bank loans, the rates are much lower by minority groups: Asian, 7.0 percent; Hispanic, 3.6 percent, and African American, 3.2 percent. As is the case with women, this may put minority business owners at a disadvantage as they seek options for business growth.
Hispanic (27.6 percent) and African American (29.2 percent) business owners are more apt not to use financing to start a business than Asian (18.8 percent) and non-minority (25.0 percent) owners. All groups heavily rely on personal savings, with 54.8 percent to 61.7 percent of those owners dipping into their own resources.
Veteran-owned business owners have rates of financing resources similar to the overall small business owner cohort. As an example, 4.3 percent of veterans use bank loans to expand their businesses compared to 4.5 percent of all small business owners. Veterans used personal credit cards for business expansion at the rate of 4.5 percent compared to 5 percent overall.
Options for Small Businesses
There are, of course, options other than traditional funding for small businesses. Venture capital and angel investing are good sources of funding but are often limited to certain sectors and criteria. In return for those investments, companies will surrender equity shares and, in some cases, take on management influence from those investors.
Another option is to leverage existing retirement savings, without the risk of tax implications or early withdrawal penalties.
At Benetrends, we’ve pioneered the approach that uses existing 401(k) or IRA funds to provide fast access to funds that can be used for start-up costs or business expansion efforts. Under the Benetrends plan, business leaders establish their new companies as C corporations and establish new retirement plans with the newly established company.
After the new retirement plan is established, existing funds can be withdrawn from previous 401(k) or IRA accounts and transferred to the new company’s plan. Owners can then purchase shares of the new company that draw on the newly established funds to launch or grow.
Benetrends offers guidance and assistance with the mechanics of using this strategy for small business funding as we have for 35 years for thousands of fellow business owners. We also support small businesses with other services, from retirement plan management to insurance.
To learn more about how Benetrends can help launch or grow your business, download Innovative Funding Strategies For Entrepreneurs.