Background
Small businesses are a foundational element of the American economy. There are 30.7 million small businesses in the U.S., and they employ 47 percent of all workers. Small businesses generate economic growth and help create wealth in local economies. They are also key to helping to create wealth for owners. Business ownership is the second-largest wealth generator behind homeownership, helping close racial and gender-based wealth gaps in low- and moderate-income communities.
Access to capital is essential to starting, sustaining, and growing a small business. Yet small-business owners—particularly those from communities of color and women—face barriers to accessing capital through traditional financial institutions. For example, a study by Federal Reserve Banks found that 46 percent of white-owned businesses received credit from a bank, compared with just 23 percent of Black-owned companies and 32 percent of Hispanic-owned companies. Access to small-business lending is also important for older adults. Four out of five small-business owners are age 45 and older.
Lack of existing banking relationships, low credit scores, absence of extensive financial documentation, and high interest rates are among the reasons entrepreneurs of color have difficulties securing commercial loans from banks. With less access to affordable, traditional small-business loan products, women and people from communities of color disproportionately turn to other ways to finance their small businesses. They are more likely to rely on nontraditional financing options. This includes financial technology (fintech) products, merchant cash advances (which provide small-business owners with up-front cash in exchange for a percentage of future sales), crowdfunding, “bootstrapping” (self-funding by using one’s own financial resources or by leaning on family and friends for capital), and online lending.
In addition, federal or state consumer lending laws do not apply to small-business loans. Small-business loans, therefore, often lack transparency, making it difficult for borrowers to compare products and offers. Some loans also have predatory features. For example, some small-business loans include confessions of judgment, which allow lenders to bypass court and seize a borrower’s assets without notice or opportunity for the borrower to defend themselves.
SMALL-BUSINESS LENDING: Policy
SMALL-BUSINESS LENDING: Policy
Access to responsible credit options
Policymakers should expand access to affordable small-business government-guaranteed loans, including those from the Small Business Administration. Policymakers should research the benefits and risks of securitization of government-guaranteed loans and, if appropriate, expand investor pools to increase available funding for small-business loans.
Government programs should provide access to capital for small-business owners who are more likely to face difficulty securing funding. This includes older women, people from communities of color, people living in rural areas, and people who own microbusinesses (that have just a few employees). For example, programs could assist borrowers with securing a down payment, improve the credit risk profile of a business to obtain better loan terms, or lower collateral requirements.
Policymakers should require small-business loans to be offered equitably and with fair and transparent terms. Loans and alternative financing products, such as merchant cash advances, should be subject to consumer protection laws prohibiting unfair, deceptive, or abusive acts or practices. This should be the case regardless of the type of financial institution making the loan. This includes prohibiting confessions of judgment clauses in small-business loan contracts, which require the borrower to accept an automatic judgment against themselves without notice or a hearing.
Policymakers should provide oversight and enforcement over financial technology (fintech) products and services targeting small-business owners. At the same time, they should support innovative, consumer-friendly solutions that expand access to capital and promote the growth of small businesses.
Small-business financing providers should be required to provide loan-level data to regulators, including age and other demographic data. Regulators should make data public while protecting the privacy of individual applicants.
Policymakers should expand and improve the effectiveness of the Community Reinvestment Act to better support underserved small-business owners, including women and people of color.