Description
During this detailed data in regard to the credit gap easing the squeeze on the smallest businesses.
P O L I C Y B R I E F
PROGRESSI VE POLI CY I NSTI TUTE | POLI CY BRI EF
1
The Credit Gap: Easing the Squeeze
on the Smallest Businesses
BY BRIAN MARTIN DECEMBER 2011
Smaller businesses
clearly need more
options for getting
credit, and credit unions
could be an ideal
source of credit for
these underserved
entrepreneurs.
Among the many casualties of the 2007-2008 financial meltdown were
small businesses. As the financial system virtually shut down, millions of
small business owners across America found themselves unable to get the
credit they desperately needed to run their businesses, let alone expand. As
a result, thousands of otherwise flourishing firms were forced into
bankruptcy or closure, with thousands of American jobs lost.
While this credit freeze has begun to thaw, one critical group of small
businesses—firms with fewer than 50 workers—are still at risk of being left
behind. These smallest of small businesses provide as much as 30 percent
of all private-sector employment.
1
Yet because of their small size, they are
much less likely to benefit from government small business loan programs,
and they are less likely to win loans from big commercial banks. For this
group, the credit crunch is a serious impediment to their success. Many of
these businesses relied on personal assets, such as home equity, for
financing. But with the crash in home prices, those resources have
evaporated. Instead, many smaller businesses rely almost exclusively on
risky and expensive credit cards to finance their firms, if they can get credit
at all.
Smaller businesses clearly need more options for getting credit, and credit
unions, which already help many small borrowers finance their self-
employment and small business ventures with personal loans, lines of
credit, and limited business loans, could be an ideal source of credit for
these underserved entrepreneurs. However, credit unions are blocked from
offering as much help as they could because of an arbitrary and outdated
cap on the amount of small business lending that credit unions can do.
Bipartisan proposals to increase this limit—such as the ones offered by
Senators Mark Udall and Susan Collins and Reps. Ed Royce and Carolyn
McCarthy—would help credit unions fill the “credit gap” that these smaller
businesses face. It would also be a sensible and cost-effective way to
jumpstart the job creation our country urgently needs.
PROGRESSI VE POLI CY I NSTI TUTE | POLI CY BRI EF 2
“Smaller” businesses: Small size and big impact
While there is no standard definition of a “small business,” the federal
Small Business Administration (SBA) and the Bureau of Labor Statistics
(BLS) generally define small businesses, for statistical purposes, as
companies with fewer than 500 workers. This definition may be useful in
broadly distinguishing small businesses from large corporations, but there
is enormous diversity among the more than five million businesses with
fewer than 500 employees. Certainly, a company of 500 is “small”
compared to a publicly-traded corporation employing thousands, but
equally vast is the difference between a company of 500 and a company of
50, five or one. These smaller businesses—those with 50 workers or less,
including the self-employed—are a unique segment of small businesses and
a critical engine of American job growth and innovation. They are also a
different lending market than larger small businesses.
• Smaller businesses and self-employed are a potent engine of
job growth.
Businesses with fewer than 50 employees account for about 30 percent of
private sector employment. They accounted for 34.6 million jobs in 2006
according to the Census Bureau’s Longitudinal Business Database. As the
chart below shows, businesses with fewer than 50 workers have consistently
provided more jobs than any other category of business by firm size,
including the very biggest companies in America.
Source: Longitudinal Business Database of the Census Bureau’s Center for
Economic Studies.
2
Smaller businesses maintain their overall leading role in job creation
despite facing more difficulties and more market turmoil than the larger
0
5,000,000
10,000,000
15,000,000
20,000,000
25,000,000
30,000,000
35,000,000
40,000,000
1
9
7
7
1
9
7
9
1
9
8
1
1
9
8
3
1
9
8
5
1
9
8
7
1
9
8
9
1
9
9
1
1
9
9
3
1
9
9
5
1
9
9
7
1
9
9
9
2
0
0
1
2
0
0
3
2
0
0
5
2
0
0
7
2
0
0
9
Total Business Employment by Size of
Firm
1977 to 2009
1 to 49 Employees 50 to 499
500 to 9999 10000+
PROGRESSI VE POLI CY I NSTI TUTE | POLI CY BRI EF 3
businesses. In a typical year, 500,000 to 600,000 new smaller businesses
are born. These new firms create between 2.5 million to 3.5 million new
jobs. As the next chart shows, businesses with fewer than 50 employees also
account for 40 to 50 percent of the jobs created by new businesses each
year. They are also the quickest to add jobs in the recoveries following
recessions (see, for example, the spikes in smaller business job growth in
the early 1980s and after 2001).
Source: Longitudinal Business Database of the Census Bureau’s Center for
Economic Studies.
3
• Smaller businesses are a growing group.
Smaller businesses—including the self-employed—are likely to become an
even more important segment of small businesses because of a recent wave
of new micro-entrepreneurs. Two recent developments in particular may be
contributing (and could further contribute) to the surge in smaller
businesses: (1) the increase in self-employment; and (2) the passage of
health care reform.
From 2000 to 2008, the number of self-employed Americans grew by 12
percent. The Bureau of Labor Statistics estimates that there are more than
15 million Americans who are now self-employed, including 9.4 million who
aren’t currently captured in small business data because they are
“unincorporated” (i.e. they haven’t created a separate legal entity for their
small business)
4
and another 1.4 million Americans who work at a wage or
salary job but are self-employed as a second job.
5
Much of the growth in self-employment from 2000 to 2008 has been due to
gains in self-employment among Hispanics and older workers. According to
the SBA, Hispanic self-employment more than doubled between 2000 and
2008, and Hispanics now make up 10.2 percent of self-employed workers.
6
0
1,000,000
2,000,000
3,000,000
4,000,000
1
9
7
7
1
9
7
9
1
9
8
1
1
9
8
3
1
9
8
5
1
9
8
7
1
9
8
9
1
9
9
1
1
9
9
3
1
9
9
5
1
9
9
7
1
9
9
9
2
0
0
1
2
0
0
3
2
0
0
5
2
0
0
7
2
0
0
9
Jobs Created at New Business
Establishments
By Firm Size, 1977 to 2009
1 to 49 Employees 50 to 499
500 to 9999 10000+
PROGRESSI VE POLI CY I NSTI TUTE | POLI CY BRI EF 4
Between 2000 and
2008, the share of self-
employed workers
between the ages of 55
and 64 grew from 16.2
percent to 22.2 percent.
Older self-employed workers are an even larger group. Between 2000 and
2008, the share of self-employed workers between the ages of 55 and 64
grew from 16.2 percent to 22.2 percent.
7
The SBA predicts that trend will
continue as more members of the baby boomer generation work to
supplement their retirements. Self-employment also has increased in
business, professional, and other services as advances in technology have
created opportunities for small business and self-employed contractors.
The passage of health reform could further fuel the trend in self-
employment. Proponents of health reform have argued that one of the
signal achievements of the Affordable Care Act is its potential to largely
eliminate the problem of “job lock”—that is, the phenomenon of workers
staying in a job just for the insurance. When the law goes fully into effect in
2014, every self-employed American and small business owner in America
should have access to more affordable health coverage through the health
insurance “exchanges” that the law creates.
This could potentially free up thousands of Americans to pursue small
business or self-employment opportunities. As notable MIT health
economist Jonathan Gruber argues, “a system that provides universal
access to health insurance coverage … is far more likely to promote
entrepreneurship than one in which would-be innovators remain tied to
corporate cubicles for fear of losing their family’s access to affordable health
care.”
8
In an essay for Washington Monthly, Gruber cites studies finding
that better access to affordable health care could increase the ranks of the
self-employed by 2 percent or more.
9
Sand in the gears: The continuing credit crunch
for smaller businesses
But despite the tremendous potential for job growth and innovation that
smaller businesses and self-employed workers can bring to the American
economy, these smaller firms are facing a major threshold obstacle to their
own growth and success: lack of access to credit.
During the financial crisis, according to the Federal Reserve, banks raised
their requirements for collateral, cash flow, and credit scores to such an
extent that even some small businesses with perfect payment histories were
denied new loans and were required to pay additional cash payments to
keep their existing loans. For example, in May 2009, Advanta, then the fifth
largest small business credit card issuer, stopped all new purchases on its
2.5 million small business credit cards before it was eventually shut down
by regulators and put into federal receivership.
10
As a result of developments such as these, some small businesses that were
current in their payments were forced into bankruptcy or closure when
their credit limits were dropped. The Federal Reserve also found that some
PROGRESSI VE POLI CY I NSTI TUTE | POLI CY BRI EF 5
large banks eliminated all new business loans below $200,000, deciding
they were not worth the trouble of assessing the credit risk.
11
Even without
additional borrowing, businesses faced higher fees and rates because their
debt ratios and credit ratings were negatively affected by cuts in their credit
limits.
12
While things are looking much brighter today, small business lending is still
far from having fully recovered. In a recently released study, the Financial
Services Roundtable reported that financial institutions had loaned $607
billion to small businesses in the first half of 2011.
13
However, this figure is
still 15 percent below the $711 billion in small business loans made in the
first half of 2008.
Moreover, according to the monthly Thomson Reuters/PayNet Small
Business Lending Index (SBLI), the volume of new small business loans is
still only three-fourths of its 2007 peak, despite having risen gradually
through 2010 and 2011.
14
For smaller businesses, the environment is even tougher.
• Smaller businesses face bigger obstacles to getting
commercial credit.
Larger small businesses have an easier time getting credit, which means
that as the small business lending environment improves, these larger firms
will be the ones to benefit the first and the most. Smaller businesses,
however, face bigger hurdles to getting credit that are unlikely to go away
even if the economy improves.
The Federal Reserve’s 2003 Survey of Small Business Finances (SSBF)
found that larger small businesses were more likely than smaller ones to
have credit lines, capital leases, motor vehicle loans, mortgages, and
equipment loans. The larger firms were more likely to apply for new credit
and were more likely to be approved. These credit transactions enable the
larger small businesses to build up what the Federal Reserve called
“relationship financing” with lenders. The lender is able to accumulate
information about a business, its owners, its financial history, and its
outlook that would not be apparent to other lenders or credit raters.
15
Smaller firms, on the other hand, are more difficult for lenders to assess.
Many do not have established credit histories apart from the owners’
personal credit. They may not have accumulated enough assets to serve as
collateral. Many are new or expanding businesses whose future cash flow is
difficult to predict, and they are in a more volatile environment.
There is tremendous “churn” in the smaller business market, even if net job
growth is positive. Around 15 to 20 percent of smaller business jobs turn
PROGRESSI VE POLI CY I NSTI TUTE | POLI CY BRI EF 6
Nearly one in five small
business owners say
they haven’t applied for
needed credit within the
past three years
because they expect to
be turned down.
over each year.
16
In 2006, for example, when net employment at smaller
firms grew by more than 1 million jobs—from 33.5 million to 34.6 million—
this was the result of 7.2 million new jobs created and 6.1 million jobs lost.
17
Three-fourths of businesses with fewer than 50 workers are in the service,
retail, or construction industries—sectors that rise and fall with changes in
demand from consumers and other businesses.
18
This job turnover shows the intensity of competition in many small
business markets. Moreover, smaller businesses also generally need smaller
loans, which means the return for banks may not be worth committing the
time and effort to assess all the uncertainties that come with a younger,
smaller business.
In the Federal Reserve’s 2003 Survey of Small Business Finances, 18
percent of business owners—including 26 percent of owners of firms less
than five years old—said that they had not applied for needed credit within
the past three years because they expected to be turned down.
19
• Smaller businesses are less likely to benefit from federal
small business lending programs.
To the extent that smaller businesses do get small business credit, much of
it is based on credit cards, which are riskier and more expensive for small
business owners.
The Federal Reserve Banks of Philadelphia and St. Louis have both
reported that the majority of smaller loans to businesses are credit cards
and that commercial banks have been shifting small businesses from
traditional loans to credit cards since the mid 1990s.
20
This trend was
accelerated during the economic downturn when banks sharply reduced
conventional loans and featured business credit cards as the alternative.
The Nilson Report, a monthly industry report, listed 38 banks that have
issued $123.5 billion in small business credit cards. The top six banks had a
total of 9.4 million small business credit card accounts, with 13.9 million
cards, and $110.5 billion in credit.
21
JPMorgan Chase by itself accounted for
4.7 million small business credit cards totaling $33 billion in credit.
22
According to quarterly data published by the Federal Deposit Insurance
Corporation (FDIC), the number of “unsecured” small business loans (such
as credit card loans) jumped during 2008 (though it has since declined by
22 percent), at the same time that small business loans secured by
commercial real estate (e.g. a storefront) dropped sharply. The most likely
explanation is that businesses that were cut off from conventional loans
took on credit card debt in 2008 before lenders started tightening the credit
card market as well. As the following chart shows, secured loans made up
just 7 percent of small business loans under $1 million in 2011 (compared to
10 percent in 2007).
PROGRESSI VE POLI CY I NSTI TUTE | POLI CY BRI EF 7
Number of Small Business Loans (under $1 million) as of
June 30 FDIC Report, 2007 to 2011
Loan
Category
6/30/2007 6/30/2008 6/30/2009 6/30/2010 6/30/2011
Secured
Loans
2.46 million 1.84 million 1.80 million 1.73 million 1.50 million
Unsecured
Loans
22.1 million 25.4 million 21.4 million 20.7 million 19.8 million
For smaller businesses, especially those that rely on “microloans” of
$100,000 or less, the share of secured lending is even smaller. For the first
half of 2011, real-estate secured loans accounted for just 2 percent of total
microloan volume.
Nonfarm Business Loans of $1 Million or Less as of
June 30, 2011
23
Business
Loan
Category
# of Loans
!$1million
$ Amount
!$1million
Avg.
Loan
# of Loans
!$100,000
$ Amount
!$100,000
Secured
Loans
1.5 million $324 billion $215,322 469,000 $20 billion
Unsecured
Loans
19.8 million $283 billion $14,277 18.9 million $120 billion
Compared to more traditional loans, credit card lending is more expensive
and risky. In addition to charging higher interest rates and potentially
dropping credit limits without warning, small business credit card issuers
also commonly mingle the credit of businesses with the personal credit of
the owners. This means any change in the businesses’ credit will affect the
owners’ personal credit, and vice versa. The Credit Card Accountability
Responsibility and Disclosure Act (Credit CARD Act), enacted in 2009,
provides some protections for personal credit cards against unreasonable
fee and rate increases among other provisions, but the act specifically
excludes business credit cards from those protections.
• Lack of access to credit means lost opportunities and jobs.
Lack of access to credit hurts smaller businesses in two significant ways: (1)
they may be unable to get the resources to launch a new business or self-
employment venture; or (2) for those self-financed businesses that do
succeed, they may still be unable to get the resources necessary to grow
beyond the capacity of the owner’s personal assets and credit.
Starting a new business is a daunting task, and businesses that are financed
with the owners’ personal assets and personal credit have a relatively short
window in which to succeed. They have to generate a positive cash flow
PROGRESSI VE POLI CY I NSTI TUTE | POLI CY BRI EF 8
Raising the cap on
small business lending
by credit unions could
result in $13 billion in
additional small
business lending in the
first year.
from the business before they run out of personal resources and max out
personal credit. Businesses that require significant equipment purchases,
inventories, or other up-front investments require more personal resources
and are more difficult to launch. Moreover, the intensity of the competition
in the smaller business market makes it vital for small business owners to
have access to small loans so they can adapt, modernize, and expand to
keep pace with their competitors.
Better access to credit would help increase the odds that a small business
can achieve liftoff. In the absence of these opportunities, the nation’s
economy would be denied a potential chance for creating new jobs.
Credit unions: An option for easing the squeeze
on smaller businesses
Creating better access to credit for smaller businesses could help ensure
that we leave no opportunities on the table for getting our economy moving
again.
While there are any number of policy options for expanding credit to
smaller businesses, the easiest and most obvious option is to expand the
lending capability of some of the lenders who are already the most likely to
be working with smaller businesses as their customers—that is, credit
unions.
Sen. Mark Udall (D-Colo.) has proposed a bill to allow credit unions to
increase their business lending to a maximum of 27.5 percent of their total
assets—a proposal that credit unions say could result in $13 billion
additional small business lending in the first year.
24
This proposal would amend the current law, under which credit unions are
prohibited from having more than 12.25 percent of their total assets in
business loans. This limit was put into place in 1998 as part of federal
legislation enacted in response to a Supreme Court ruling that would have
tightened the limitations on membership in credit unions.
25
The current
lending cap was not considered a major provision of the legislation at the
time and is now an arbitrary limit on the ability of credit unions to help
smaller businesses make the leap toward growth.
Raising the cap could substantially benefit smaller business owners and in
turn the economy at large. It would enable credit unions to extend more
credit to their existing members who are small business owners interested
in expansion or who are just starting out a new venture, while the current
low cap may block these opportunities for growth.
Moreover, credit unions are uniquely suited to the needs of smaller
businesses. First, credit unions are already specialists in the smaller loans
PROGRESSI VE POLI CY I NSTI TUTE | POLI CY BRI EF 9
that smaller businesses need. According to credit union data, the average
size of a small business credit union loan is about $200,000.
26
Second, because “relationship financing” is a traditional strength of credit
unions, they will be well-equipped to assess the risks of the smaller
businesses who apply, especially since smaller business owners are almost
certainly customers already. While some argue that the existence of some
sort of a lending cap is necessary to distinguish credit unions’ unique non-
profit status from that of commercial banks, raising the limit to at least the
level proposed by Sen. Udall would in no way compromise credit unions’
mission.
Conclusion
Small businesses employ half of all private sector workers and are
responsible for almost two-thirds of the private sector jobs created in the
past 20 years. They lead the innovation of new technologies, products,
services, and business strategies. Small business markets are dynamic with
new businesses constantly entering, many existing businesses profiting and
growing, others struggling, and some that do not survive.
This fierce competition for survival is what fuels innovation. Better access
to credit can help ensure that good ideas also have a good shot at getting off
the ground.
While there is inherent risk in extending credit to new ventures or to the
expansion of small companies, there is even greater risk to the overall
economy if credit is unavailable to those businesses that create new jobs.
The challenge for lenders and for government regulators and guarantors is
to responsibly manage the risk of small business lending, not to avoid it
altogether.
PROGRESSI VE POLI CY I NSTI TUTE | POLI CY BRI EF 10
Endnotes
1
U.S. Census Bureau, Business Dynamics Statistics,http://www.ces.census.gov/index.php/bds/bds_home.
2
U.S. Census Bureau, Business Dynamics Statistics.
3
U.S. Census Bureau, Business Dynamics Statistics.
4
Bureau of Labor Statistics.
5
Bureau of Labor Statistics.
6
U.S. Small Business Administration, “The Small Business Economy: A
Report to the President,” United States Government Printing Office,
Washington, D.C.: 2010,http://www.sba.gov/sites/default/files/sb_econ2010.pdf
7
http://www.sba.gov/sites/default/files/sb_econ2010.pdf.
8
Jonathan Gruber, “A Shot in the Arm: How Today’s Health Care Reform
Can Create Tomorrow’s Entrepreneurs,” Washington Monthly, May/June
2009,http://www.washingtonmonthly.com/features/2009/0905.gruber.html
9
Gruber.
10
Susan Herbst-Murphy, Getting Down to Business: Commercial Cards in
Business-to-Business Payments, Federal Reserve Bank of Philadelphia,
March 2011,http://www.philadelphiafed.org/payment-cards-
center/publications/discussion-papers/2011/D-2011-Commercial-Cards.pdf.
11
Board of Governors of the Federal Reserve System, “Addressing the
Finance Needs of Small Businesses: Summary of Key Themes from the
Federal Reserve System’s Small Business Meeting Series,” July 21, 2010,http://federalreserve.gov/events/conferences/2010/sbc/downloads/small_business_sum
mary.pdf.
12
Board of Governors of the Federal Reserve System.
13
The Financial Services Roundtable, “How the Financial Services Industry
is Supporting Small Business,” November 2011http://www.fsround.org/fsr/pdfs/white_paper/RoundtableSmallBusinessWhitePaper.p
df.
14
PayNet, Inc. “Thomson Reuters/Small Business Lending Index, October
2011http://www.paynetonline.com/small-business-insights/thomson-reuterspaynet-
small-business-lending-index.
15
The Federal Reserve Board, “Report to the Congress on the Availability of
Credit to Small Businesses,” October 2007.http://www.federalreserve.gov/boarddocs/rptcongress/smallbusinesscredit/default.htm
16
U.S. Census Bureau, Business Dynamics Statisticshttp://www.ces.census.gov/index.php/bds/bds_home.
17
U.S. Census Bureau, Business Dynamics Statistics.
18
U.S. Department of Labor, Bureau of Labor Statistics, “The Employment
Situation: November 2011,”http://www.bls.gov/news.release/pdf/empsit.pdf
19
Federal Reserve Board Report to Congress.
20
James W. Fuchs and Amy Chivetta, “New Quarterly Data Provide Timely
Analysis of Banks’ Lending to Small Businesses – What are the Trends,”
Bridges, Fall 2010, Federal Reserve Bank of St. Louis.
21
The Nilson Report, Issue 951, June 2010http://nilsonreport.com/pdf/freeissue_hd7zrb.pdf.
22
The Nilson Report, Issue 951, June 2010.
23
Federal Deposit Insurance Corporation, “Statistics on Banking, June 30,
2011http://www2.fdic.gov/sdi/sob/.
24
Emily Maltby, “A Push for More Loans: Credit Unions Aim to Raise
Lending Cap, Say Banks Aren’t Doing Enough,” Wall Street Journal,
PROGRESSI VE POLI CY I NSTI TUTE | POLI CY BRI EF 11
August 11, 2011,http://online.wsj.com/article/SB10001424053111904140604576496882610221382.
html.
25
Congressional Budget Office, “Cost Estimate: HR 1151, Credit Union
Membership Access Act,” June 2, 1998,http://www.cbo.gov/doc.cfm?index=550&type=0.
26
John Tozzi, “Credit Unions Seek to Lift Small Business Lending Cap,”
Bloomberg BusinessWeek, March 9, 2011,http://www.businessweek.com/smallbiz/running_small_business/archives/2011/03/cre
dit_unions_seek_lift_small_biz_lending_cap.html.
PROGRESSI VE POLI CY I NSTI TUTE | POLI CY BRI EF 12
About the Author
Brian Martin is an independent policy analyst and researcher with 21 years
of Capitol Hill experience on economic policy, health care, disaster
recovery, and federal budget issues. He served as chief of staff and policy
director to Congressman Gene Taylor (D-Miss.). Brian has a bachelor's
degree in Philosophy from Princeton University and a master's degree in
Political Science with a Public Administration emphasis from the University
of Southern Mississippi.
About the Progressive Policy Institute
The Progressive Policy Institute (PPI) is an independent research
institution that seeks to define and promote a new progressive politics in
the 21st century. Through research and policy analysis, PPI challenges the
status quo and advocates for radical policy solutions.
doc_441432869.pdf
During this detailed data in regard to the credit gap easing the squeeze on the smallest businesses.
P O L I C Y B R I E F
PROGRESSI VE POLI CY I NSTI TUTE | POLI CY BRI EF
1
The Credit Gap: Easing the Squeeze
on the Smallest Businesses
BY BRIAN MARTIN DECEMBER 2011
Smaller businesses
clearly need more
options for getting
credit, and credit unions
could be an ideal
source of credit for
these underserved
entrepreneurs.
Among the many casualties of the 2007-2008 financial meltdown were
small businesses. As the financial system virtually shut down, millions of
small business owners across America found themselves unable to get the
credit they desperately needed to run their businesses, let alone expand. As
a result, thousands of otherwise flourishing firms were forced into
bankruptcy or closure, with thousands of American jobs lost.
While this credit freeze has begun to thaw, one critical group of small
businesses—firms with fewer than 50 workers—are still at risk of being left
behind. These smallest of small businesses provide as much as 30 percent
of all private-sector employment.
1
Yet because of their small size, they are
much less likely to benefit from government small business loan programs,
and they are less likely to win loans from big commercial banks. For this
group, the credit crunch is a serious impediment to their success. Many of
these businesses relied on personal assets, such as home equity, for
financing. But with the crash in home prices, those resources have
evaporated. Instead, many smaller businesses rely almost exclusively on
risky and expensive credit cards to finance their firms, if they can get credit
at all.
Smaller businesses clearly need more options for getting credit, and credit
unions, which already help many small borrowers finance their self-
employment and small business ventures with personal loans, lines of
credit, and limited business loans, could be an ideal source of credit for
these underserved entrepreneurs. However, credit unions are blocked from
offering as much help as they could because of an arbitrary and outdated
cap on the amount of small business lending that credit unions can do.
Bipartisan proposals to increase this limit—such as the ones offered by
Senators Mark Udall and Susan Collins and Reps. Ed Royce and Carolyn
McCarthy—would help credit unions fill the “credit gap” that these smaller
businesses face. It would also be a sensible and cost-effective way to
jumpstart the job creation our country urgently needs.
PROGRESSI VE POLI CY I NSTI TUTE | POLI CY BRI EF 2
“Smaller” businesses: Small size and big impact
While there is no standard definition of a “small business,” the federal
Small Business Administration (SBA) and the Bureau of Labor Statistics
(BLS) generally define small businesses, for statistical purposes, as
companies with fewer than 500 workers. This definition may be useful in
broadly distinguishing small businesses from large corporations, but there
is enormous diversity among the more than five million businesses with
fewer than 500 employees. Certainly, a company of 500 is “small”
compared to a publicly-traded corporation employing thousands, but
equally vast is the difference between a company of 500 and a company of
50, five or one. These smaller businesses—those with 50 workers or less,
including the self-employed—are a unique segment of small businesses and
a critical engine of American job growth and innovation. They are also a
different lending market than larger small businesses.
• Smaller businesses and self-employed are a potent engine of
job growth.
Businesses with fewer than 50 employees account for about 30 percent of
private sector employment. They accounted for 34.6 million jobs in 2006
according to the Census Bureau’s Longitudinal Business Database. As the
chart below shows, businesses with fewer than 50 workers have consistently
provided more jobs than any other category of business by firm size,
including the very biggest companies in America.
Source: Longitudinal Business Database of the Census Bureau’s Center for
Economic Studies.
2
Smaller businesses maintain their overall leading role in job creation
despite facing more difficulties and more market turmoil than the larger
0
5,000,000
10,000,000
15,000,000
20,000,000
25,000,000
30,000,000
35,000,000
40,000,000
1
9
7
7
1
9
7
9
1
9
8
1
1
9
8
3
1
9
8
5
1
9
8
7
1
9
8
9
1
9
9
1
1
9
9
3
1
9
9
5
1
9
9
7
1
9
9
9
2
0
0
1
2
0
0
3
2
0
0
5
2
0
0
7
2
0
0
9
Total Business Employment by Size of
Firm
1977 to 2009
1 to 49 Employees 50 to 499
500 to 9999 10000+
PROGRESSI VE POLI CY I NSTI TUTE | POLI CY BRI EF 3
businesses. In a typical year, 500,000 to 600,000 new smaller businesses
are born. These new firms create between 2.5 million to 3.5 million new
jobs. As the next chart shows, businesses with fewer than 50 employees also
account for 40 to 50 percent of the jobs created by new businesses each
year. They are also the quickest to add jobs in the recoveries following
recessions (see, for example, the spikes in smaller business job growth in
the early 1980s and after 2001).
Source: Longitudinal Business Database of the Census Bureau’s Center for
Economic Studies.
3
• Smaller businesses are a growing group.
Smaller businesses—including the self-employed—are likely to become an
even more important segment of small businesses because of a recent wave
of new micro-entrepreneurs. Two recent developments in particular may be
contributing (and could further contribute) to the surge in smaller
businesses: (1) the increase in self-employment; and (2) the passage of
health care reform.
From 2000 to 2008, the number of self-employed Americans grew by 12
percent. The Bureau of Labor Statistics estimates that there are more than
15 million Americans who are now self-employed, including 9.4 million who
aren’t currently captured in small business data because they are
“unincorporated” (i.e. they haven’t created a separate legal entity for their
small business)
4
and another 1.4 million Americans who work at a wage or
salary job but are self-employed as a second job.
5
Much of the growth in self-employment from 2000 to 2008 has been due to
gains in self-employment among Hispanics and older workers. According to
the SBA, Hispanic self-employment more than doubled between 2000 and
2008, and Hispanics now make up 10.2 percent of self-employed workers.
6
0
1,000,000
2,000,000
3,000,000
4,000,000
1
9
7
7
1
9
7
9
1
9
8
1
1
9
8
3
1
9
8
5
1
9
8
7
1
9
8
9
1
9
9
1
1
9
9
3
1
9
9
5
1
9
9
7
1
9
9
9
2
0
0
1
2
0
0
3
2
0
0
5
2
0
0
7
2
0
0
9
Jobs Created at New Business
Establishments
By Firm Size, 1977 to 2009
1 to 49 Employees 50 to 499
500 to 9999 10000+
PROGRESSI VE POLI CY I NSTI TUTE | POLI CY BRI EF 4
Between 2000 and
2008, the share of self-
employed workers
between the ages of 55
and 64 grew from 16.2
percent to 22.2 percent.
Older self-employed workers are an even larger group. Between 2000 and
2008, the share of self-employed workers between the ages of 55 and 64
grew from 16.2 percent to 22.2 percent.
7
The SBA predicts that trend will
continue as more members of the baby boomer generation work to
supplement their retirements. Self-employment also has increased in
business, professional, and other services as advances in technology have
created opportunities for small business and self-employed contractors.
The passage of health reform could further fuel the trend in self-
employment. Proponents of health reform have argued that one of the
signal achievements of the Affordable Care Act is its potential to largely
eliminate the problem of “job lock”—that is, the phenomenon of workers
staying in a job just for the insurance. When the law goes fully into effect in
2014, every self-employed American and small business owner in America
should have access to more affordable health coverage through the health
insurance “exchanges” that the law creates.
This could potentially free up thousands of Americans to pursue small
business or self-employment opportunities. As notable MIT health
economist Jonathan Gruber argues, “a system that provides universal
access to health insurance coverage … is far more likely to promote
entrepreneurship than one in which would-be innovators remain tied to
corporate cubicles for fear of losing their family’s access to affordable health
care.”
8
In an essay for Washington Monthly, Gruber cites studies finding
that better access to affordable health care could increase the ranks of the
self-employed by 2 percent or more.
9
Sand in the gears: The continuing credit crunch
for smaller businesses
But despite the tremendous potential for job growth and innovation that
smaller businesses and self-employed workers can bring to the American
economy, these smaller firms are facing a major threshold obstacle to their
own growth and success: lack of access to credit.
During the financial crisis, according to the Federal Reserve, banks raised
their requirements for collateral, cash flow, and credit scores to such an
extent that even some small businesses with perfect payment histories were
denied new loans and were required to pay additional cash payments to
keep their existing loans. For example, in May 2009, Advanta, then the fifth
largest small business credit card issuer, stopped all new purchases on its
2.5 million small business credit cards before it was eventually shut down
by regulators and put into federal receivership.
10
As a result of developments such as these, some small businesses that were
current in their payments were forced into bankruptcy or closure when
their credit limits were dropped. The Federal Reserve also found that some
PROGRESSI VE POLI CY I NSTI TUTE | POLI CY BRI EF 5
large banks eliminated all new business loans below $200,000, deciding
they were not worth the trouble of assessing the credit risk.
11
Even without
additional borrowing, businesses faced higher fees and rates because their
debt ratios and credit ratings were negatively affected by cuts in their credit
limits.
12
While things are looking much brighter today, small business lending is still
far from having fully recovered. In a recently released study, the Financial
Services Roundtable reported that financial institutions had loaned $607
billion to small businesses in the first half of 2011.
13
However, this figure is
still 15 percent below the $711 billion in small business loans made in the
first half of 2008.
Moreover, according to the monthly Thomson Reuters/PayNet Small
Business Lending Index (SBLI), the volume of new small business loans is
still only three-fourths of its 2007 peak, despite having risen gradually
through 2010 and 2011.
14
For smaller businesses, the environment is even tougher.
• Smaller businesses face bigger obstacles to getting
commercial credit.
Larger small businesses have an easier time getting credit, which means
that as the small business lending environment improves, these larger firms
will be the ones to benefit the first and the most. Smaller businesses,
however, face bigger hurdles to getting credit that are unlikely to go away
even if the economy improves.
The Federal Reserve’s 2003 Survey of Small Business Finances (SSBF)
found that larger small businesses were more likely than smaller ones to
have credit lines, capital leases, motor vehicle loans, mortgages, and
equipment loans. The larger firms were more likely to apply for new credit
and were more likely to be approved. These credit transactions enable the
larger small businesses to build up what the Federal Reserve called
“relationship financing” with lenders. The lender is able to accumulate
information about a business, its owners, its financial history, and its
outlook that would not be apparent to other lenders or credit raters.
15
Smaller firms, on the other hand, are more difficult for lenders to assess.
Many do not have established credit histories apart from the owners’
personal credit. They may not have accumulated enough assets to serve as
collateral. Many are new or expanding businesses whose future cash flow is
difficult to predict, and they are in a more volatile environment.
There is tremendous “churn” in the smaller business market, even if net job
growth is positive. Around 15 to 20 percent of smaller business jobs turn
PROGRESSI VE POLI CY I NSTI TUTE | POLI CY BRI EF 6
Nearly one in five small
business owners say
they haven’t applied for
needed credit within the
past three years
because they expect to
be turned down.
over each year.
16
In 2006, for example, when net employment at smaller
firms grew by more than 1 million jobs—from 33.5 million to 34.6 million—
this was the result of 7.2 million new jobs created and 6.1 million jobs lost.
17
Three-fourths of businesses with fewer than 50 workers are in the service,
retail, or construction industries—sectors that rise and fall with changes in
demand from consumers and other businesses.
18
This job turnover shows the intensity of competition in many small
business markets. Moreover, smaller businesses also generally need smaller
loans, which means the return for banks may not be worth committing the
time and effort to assess all the uncertainties that come with a younger,
smaller business.
In the Federal Reserve’s 2003 Survey of Small Business Finances, 18
percent of business owners—including 26 percent of owners of firms less
than five years old—said that they had not applied for needed credit within
the past three years because they expected to be turned down.
19
• Smaller businesses are less likely to benefit from federal
small business lending programs.
To the extent that smaller businesses do get small business credit, much of
it is based on credit cards, which are riskier and more expensive for small
business owners.
The Federal Reserve Banks of Philadelphia and St. Louis have both
reported that the majority of smaller loans to businesses are credit cards
and that commercial banks have been shifting small businesses from
traditional loans to credit cards since the mid 1990s.
20
This trend was
accelerated during the economic downturn when banks sharply reduced
conventional loans and featured business credit cards as the alternative.
The Nilson Report, a monthly industry report, listed 38 banks that have
issued $123.5 billion in small business credit cards. The top six banks had a
total of 9.4 million small business credit card accounts, with 13.9 million
cards, and $110.5 billion in credit.
21
JPMorgan Chase by itself accounted for
4.7 million small business credit cards totaling $33 billion in credit.
22
According to quarterly data published by the Federal Deposit Insurance
Corporation (FDIC), the number of “unsecured” small business loans (such
as credit card loans) jumped during 2008 (though it has since declined by
22 percent), at the same time that small business loans secured by
commercial real estate (e.g. a storefront) dropped sharply. The most likely
explanation is that businesses that were cut off from conventional loans
took on credit card debt in 2008 before lenders started tightening the credit
card market as well. As the following chart shows, secured loans made up
just 7 percent of small business loans under $1 million in 2011 (compared to
10 percent in 2007).
PROGRESSI VE POLI CY I NSTI TUTE | POLI CY BRI EF 7
Number of Small Business Loans (under $1 million) as of
June 30 FDIC Report, 2007 to 2011
Loan
Category
6/30/2007 6/30/2008 6/30/2009 6/30/2010 6/30/2011
Secured
Loans
2.46 million 1.84 million 1.80 million 1.73 million 1.50 million
Unsecured
Loans
22.1 million 25.4 million 21.4 million 20.7 million 19.8 million
For smaller businesses, especially those that rely on “microloans” of
$100,000 or less, the share of secured lending is even smaller. For the first
half of 2011, real-estate secured loans accounted for just 2 percent of total
microloan volume.
Nonfarm Business Loans of $1 Million or Less as of
June 30, 2011
23
Business
Loan
Category
# of Loans
!$1million
$ Amount
!$1million
Avg.
Loan
# of Loans
!$100,000
$ Amount
!$100,000
Secured
Loans
1.5 million $324 billion $215,322 469,000 $20 billion
Unsecured
Loans
19.8 million $283 billion $14,277 18.9 million $120 billion
Compared to more traditional loans, credit card lending is more expensive
and risky. In addition to charging higher interest rates and potentially
dropping credit limits without warning, small business credit card issuers
also commonly mingle the credit of businesses with the personal credit of
the owners. This means any change in the businesses’ credit will affect the
owners’ personal credit, and vice versa. The Credit Card Accountability
Responsibility and Disclosure Act (Credit CARD Act), enacted in 2009,
provides some protections for personal credit cards against unreasonable
fee and rate increases among other provisions, but the act specifically
excludes business credit cards from those protections.
• Lack of access to credit means lost opportunities and jobs.
Lack of access to credit hurts smaller businesses in two significant ways: (1)
they may be unable to get the resources to launch a new business or self-
employment venture; or (2) for those self-financed businesses that do
succeed, they may still be unable to get the resources necessary to grow
beyond the capacity of the owner’s personal assets and credit.
Starting a new business is a daunting task, and businesses that are financed
with the owners’ personal assets and personal credit have a relatively short
window in which to succeed. They have to generate a positive cash flow
PROGRESSI VE POLI CY I NSTI TUTE | POLI CY BRI EF 8
Raising the cap on
small business lending
by credit unions could
result in $13 billion in
additional small
business lending in the
first year.
from the business before they run out of personal resources and max out
personal credit. Businesses that require significant equipment purchases,
inventories, or other up-front investments require more personal resources
and are more difficult to launch. Moreover, the intensity of the competition
in the smaller business market makes it vital for small business owners to
have access to small loans so they can adapt, modernize, and expand to
keep pace with their competitors.
Better access to credit would help increase the odds that a small business
can achieve liftoff. In the absence of these opportunities, the nation’s
economy would be denied a potential chance for creating new jobs.
Credit unions: An option for easing the squeeze
on smaller businesses
Creating better access to credit for smaller businesses could help ensure
that we leave no opportunities on the table for getting our economy moving
again.
While there are any number of policy options for expanding credit to
smaller businesses, the easiest and most obvious option is to expand the
lending capability of some of the lenders who are already the most likely to
be working with smaller businesses as their customers—that is, credit
unions.
Sen. Mark Udall (D-Colo.) has proposed a bill to allow credit unions to
increase their business lending to a maximum of 27.5 percent of their total
assets—a proposal that credit unions say could result in $13 billion
additional small business lending in the first year.
24
This proposal would amend the current law, under which credit unions are
prohibited from having more than 12.25 percent of their total assets in
business loans. This limit was put into place in 1998 as part of federal
legislation enacted in response to a Supreme Court ruling that would have
tightened the limitations on membership in credit unions.
25
The current
lending cap was not considered a major provision of the legislation at the
time and is now an arbitrary limit on the ability of credit unions to help
smaller businesses make the leap toward growth.
Raising the cap could substantially benefit smaller business owners and in
turn the economy at large. It would enable credit unions to extend more
credit to their existing members who are small business owners interested
in expansion or who are just starting out a new venture, while the current
low cap may block these opportunities for growth.
Moreover, credit unions are uniquely suited to the needs of smaller
businesses. First, credit unions are already specialists in the smaller loans
PROGRESSI VE POLI CY I NSTI TUTE | POLI CY BRI EF 9
that smaller businesses need. According to credit union data, the average
size of a small business credit union loan is about $200,000.
26
Second, because “relationship financing” is a traditional strength of credit
unions, they will be well-equipped to assess the risks of the smaller
businesses who apply, especially since smaller business owners are almost
certainly customers already. While some argue that the existence of some
sort of a lending cap is necessary to distinguish credit unions’ unique non-
profit status from that of commercial banks, raising the limit to at least the
level proposed by Sen. Udall would in no way compromise credit unions’
mission.
Conclusion
Small businesses employ half of all private sector workers and are
responsible for almost two-thirds of the private sector jobs created in the
past 20 years. They lead the innovation of new technologies, products,
services, and business strategies. Small business markets are dynamic with
new businesses constantly entering, many existing businesses profiting and
growing, others struggling, and some that do not survive.
This fierce competition for survival is what fuels innovation. Better access
to credit can help ensure that good ideas also have a good shot at getting off
the ground.
While there is inherent risk in extending credit to new ventures or to the
expansion of small companies, there is even greater risk to the overall
economy if credit is unavailable to those businesses that create new jobs.
The challenge for lenders and for government regulators and guarantors is
to responsibly manage the risk of small business lending, not to avoid it
altogether.
PROGRESSI VE POLI CY I NSTI TUTE | POLI CY BRI EF 10
Endnotes
1
U.S. Census Bureau, Business Dynamics Statistics,http://www.ces.census.gov/index.php/bds/bds_home.
2
U.S. Census Bureau, Business Dynamics Statistics.
3
U.S. Census Bureau, Business Dynamics Statistics.
4
Bureau of Labor Statistics.
5
Bureau of Labor Statistics.
6
U.S. Small Business Administration, “The Small Business Economy: A
Report to the President,” United States Government Printing Office,
Washington, D.C.: 2010,http://www.sba.gov/sites/default/files/sb_econ2010.pdf
7
http://www.sba.gov/sites/default/files/sb_econ2010.pdf.
8
Jonathan Gruber, “A Shot in the Arm: How Today’s Health Care Reform
Can Create Tomorrow’s Entrepreneurs,” Washington Monthly, May/June
2009,http://www.washingtonmonthly.com/features/2009/0905.gruber.html
9
Gruber.
10
Susan Herbst-Murphy, Getting Down to Business: Commercial Cards in
Business-to-Business Payments, Federal Reserve Bank of Philadelphia,
March 2011,http://www.philadelphiafed.org/payment-cards-
center/publications/discussion-papers/2011/D-2011-Commercial-Cards.pdf.
11
Board of Governors of the Federal Reserve System, “Addressing the
Finance Needs of Small Businesses: Summary of Key Themes from the
Federal Reserve System’s Small Business Meeting Series,” July 21, 2010,http://federalreserve.gov/events/conferences/2010/sbc/downloads/small_business_sum
mary.pdf.
12
Board of Governors of the Federal Reserve System.
13
The Financial Services Roundtable, “How the Financial Services Industry
is Supporting Small Business,” November 2011http://www.fsround.org/fsr/pdfs/white_paper/RoundtableSmallBusinessWhitePaper.p
df.
14
PayNet, Inc. “Thomson Reuters/Small Business Lending Index, October
2011http://www.paynetonline.com/small-business-insights/thomson-reuterspaynet-
small-business-lending-index.
15
The Federal Reserve Board, “Report to the Congress on the Availability of
Credit to Small Businesses,” October 2007.http://www.federalreserve.gov/boarddocs/rptcongress/smallbusinesscredit/default.htm
16
U.S. Census Bureau, Business Dynamics Statisticshttp://www.ces.census.gov/index.php/bds/bds_home.
17
U.S. Census Bureau, Business Dynamics Statistics.
18
U.S. Department of Labor, Bureau of Labor Statistics, “The Employment
Situation: November 2011,”http://www.bls.gov/news.release/pdf/empsit.pdf
19
Federal Reserve Board Report to Congress.
20
James W. Fuchs and Amy Chivetta, “New Quarterly Data Provide Timely
Analysis of Banks’ Lending to Small Businesses – What are the Trends,”
Bridges, Fall 2010, Federal Reserve Bank of St. Louis.
21
The Nilson Report, Issue 951, June 2010http://nilsonreport.com/pdf/freeissue_hd7zrb.pdf.
22
The Nilson Report, Issue 951, June 2010.
23
Federal Deposit Insurance Corporation, “Statistics on Banking, June 30,
2011http://www2.fdic.gov/sdi/sob/.
24
Emily Maltby, “A Push for More Loans: Credit Unions Aim to Raise
Lending Cap, Say Banks Aren’t Doing Enough,” Wall Street Journal,
PROGRESSI VE POLI CY I NSTI TUTE | POLI CY BRI EF 11
August 11, 2011,http://online.wsj.com/article/SB10001424053111904140604576496882610221382.
html.
25
Congressional Budget Office, “Cost Estimate: HR 1151, Credit Union
Membership Access Act,” June 2, 1998,http://www.cbo.gov/doc.cfm?index=550&type=0.
26
John Tozzi, “Credit Unions Seek to Lift Small Business Lending Cap,”
Bloomberg BusinessWeek, March 9, 2011,http://www.businessweek.com/smallbiz/running_small_business/archives/2011/03/cre
dit_unions_seek_lift_small_biz_lending_cap.html.
PROGRESSI VE POLI CY I NSTI TUTE | POLI CY BRI EF 12
About the Author
Brian Martin is an independent policy analyst and researcher with 21 years
of Capitol Hill experience on economic policy, health care, disaster
recovery, and federal budget issues. He served as chief of staff and policy
director to Congressman Gene Taylor (D-Miss.). Brian has a bachelor's
degree in Philosophy from Princeton University and a master's degree in
Political Science with a Public Administration emphasis from the University
of Southern Mississippi.
About the Progressive Policy Institute
The Progressive Policy Institute (PPI) is an independent research
institution that seeks to define and promote a new progressive politics in
the 21st century. Through research and policy analysis, PPI challenges the
status quo and advocates for radical policy solutions.
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