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Large, Diverse, and Growing: The Market for Small Business Financing

Small businesses, at any stage and any age, need money. A new restaurant or food truck needs money to lease a location or vehicle, purchase equipment, and perhaps hire staff. A growing software startup needs money to pay developers and a sales team. A small business in operation for two decades needs financing for a renovation or investment in new machinery or to sustain itself through a rough patch or seasonal ebb.

To meet these varying needs, small businesses secure financing in several ways—most often in exchange for a share of ownership (equity) or through debt. In their early months and years, small businesses frequently rely on various personal or familial sources for initial capital. This could be from a savings account, an early withdrawal from a retirement account, or contribution from a parent or other family member. While equity financing is not a fit for most small businesses, many others opt not to seek new credit each year, the primary reasons being that they have sufficient financing and do not want to take on debt.1

Nonetheless, credit has always been an essential financing tool for small businesses as they start, grow, and operate. Among a cohort of new firms in the early 2000s, for example, 79% used some form of credit. Over one-third (36%) relied on “outsider debt” supplied through financial institutions.2 Twenty years ago, among those young small businesses, bank loans and credit cards were the primary sources of external credit. Since then, the “small business lending landscape has … transformed.”3 The credit options available to small businesses have exploded.

Increasing variety and choice in the small business credit market has led to enormous lending volume. The total estimated value of the small business lending market, according to the Consumer Financial Protection Bureau (CFPB) is $1.4 trillion.4 The true size is likely larger, as many small businesses—especially younger ones—use personal loans, personal credit cards, and home equity lines of credit. Here, we take a summary look at three key sources of small business credit: depository institutions, finance companies, and online lenders. Subsequent briefs will explore these credit sources in more detail.

Lending from Depository Institutions to Small Businesses

Among depository institutions, such as banks and credit unions, the outstanding value of small business loans rose (in unadjusted terms) from $173 billion in 1995 to $368 billion in 2019, just before the COVID-19 pandemic. (See Figure 1.) 5 If commercial real estate loans are included, the value of small business loans rises by another $300 billion. These figures refer to the outstanding value of small business loans, not the value of new loan or line of credit originations each year.

Figure 1. Source: Federal Deposit Insurance Corporation. Chart shows small business loans, defined as C&I loans for less than $1 million.

Asset-Based Lending from Depository Institutions to Small Businesses

Finance companies, also known as “asset-based” lenders, are non-depository entities that specialize in credit for small businesses. There are different types of finance companies—those owned by banks, those that are “captive” or attached to large companies such as equipment manufacturers, and those that are independent. Their role in small business financing has grown markedly over the last 20 years. By one measure, the outstanding value of small business credit from finance companies matches that from depository institutions, at nearly $400 billion.6

Credit Provided to Small Businesses from Online Lenders

The newest entrants to small business financing—growing particularly over the last 10 to 15 years—are online lenders. By the CFPB’s estimate, online lenders (or fintechs) held about $25 billion in outstanding credit to small businesses in 2019.7 Online lenders operate according to a number of different business models, from serving as marketplaces to partnering with banks or lending directly to small businesses.

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Footnotes

1Federal Reserve Banks, Small Business Credit Survey, various years, available at: https://www.fedsmallbusiness.org/survey.

2Alicia M. Robb and David T. Robinson, “The Capital Structure Decisions of New Firms,” Kauffman Firm Survey, Kauffman Foundation, November 2008, available at: https://www.kauffman.org/entrepreneurship/reports/kauffman-firm-survey-series/the-capital-structure-decisions-of-new-firms/

3Bureau of Consumer Financial Protection, “Small Business Lending Data Collection under the Equal Credit Opportunity Act (Regulation B),” Proposed Rule, 86 FR 56356, September 2021, available at: https://www.federalregister.gov/documents/2021/10/08/2021-19274/small-business-lending-data-collection-under-the-equal-credit-opportunity-act-regulation-b</em/.

4Consumer Financial Protection Bureau, “Key dimensions of the small business lending landscape,” May 2017, available at: https://www.consumerfinance.gov/data-research/research-reports/key-dimensions-small-business-lending-landscape/

5These numbers refer only to commercial and industrial (C&I) loans under $1 million, the standard definition for small business loans by depository institutions used by the Federal Deposit Insurance Corporation (FDIC) and Small Business Administration.

6Federal Reserve Board of Governors.

7Supra note 3.

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