While startups and small business are often (rightly) hailed as the engines that power growth in the American economy, when it comes time to secure funds — the situation gets tricky. Stated simply, ten years out of the financial crisis and small business lending remains a chronically sluggish and difficult to work in environment.
According to a report by the country's 12 regional Federal Reserve banks, over half of all startups report difficulty in securing loans and 81 percent report having had to dip into their personal funds to cover gaps in their corporate cash flow. Startups, as defined by the new report, are firms that are less than two years old and employing less than 500 workers.
“Given the importance of startups for the economy, the question of startup capital is of central importance,” according to the 2016 Small Business Credit Survey Report on Startup Firms. “While funding is the lifeblood of every company, capital is especially critical for startups. To reach scale, startups need to be able to secure expansion capital.”
And this is a position that is gaining increasing traction in some segments in Washington.
“It is very difficult to have access to capital and get loans when you really have no collateral against that except your own cash flow,” Linda McMahon, head of the Small Business Administration, told the Senate Committee on Small Business & Entrepreneurship in January. “I know that there are a lot of startups that face those kinds of issues in getting capital.”
The problem, at base is newness — and that startups tend be associated with much higher credit risk (given the staggering numbers of new businesses that fail within their first five years). A shame, since startups also tend to have the most intensive cash-on-demand needs and tend to have the least access. The study notes that 69 percent of startups have applied for some type of financing and received less than they requested, while 28 percent were able to borrow nothing at all. Only 31 percent of borrowers reported being able to obtain the full amount they tried to get underwritten.
“[Access to credit] is especially critical to these young firms who need funds to weather initial costs and grow,” Claire Kramer Mills, an assistant vice president at the Federal Reserve Bank of New York, said in a statement. “Despite startups' strong demand for financing, their problems are more acute than other firms, with most facing shortfalls and many discouraged from even applying.”
And even startups with relatively strong credit find it hard to get loans, particularly when stacked up against their more mature peers, with 53 percent having difficulty getting their hands on funds as opposed to 41 percent of more established businesses.
Online lenders, notably, have managed to change the topography of this landscape with their faster underwriting platforms and alternative methods of rendering and ranking credit worthiness. Despite the fact that SMB consumers still show a preference for traditional banks’ lending, online lenders tend to offer at least partial approval for applicants (with low risk profiles) 76 percent of the time. Higher risk profiles, as one might expect, don't do quite as well — they manage to secure borrowed funds about 45 percent of the time.
“With traditional providers, you see a noticeable difference in their ability to make timely decisions,” Kramer Mills noted. “Online providers are rated much better on that dimension. Where online lenders score poorly is with higher interest rates. There's a lack of understanding among startups of exactly what the effective interest rates are and what the total borrowing costs are.”
And banks are taking notice.
JPMorgan Chase & Co. has announced that as of this week it is expanding its partnership with OnDeck Capital to provide small-business loans using that firm's application, scoring and approval platform to speed up the process. That partnership is on the table for four years, and the product — Chase Business Quick Capital — will offer startups loans up to $200,000 for a term of up to two years. In some cases, the money can be paid out on the same day.
“We set out to simplify the conventional originations processes, which can take weeks to months — time that many small businesses don't have,” Julie Kimmerling, the head of Business Quick, said in a statement.