Small Business Credit Survey

The COVID-19 pandemic has exposed acute and deep-rooted connections between physical and economic health. Many of the same places hit hardest by the pandemic are reeling concurrently from the health crisis, business closures, and job losses. These communities are disproportionately communities of color. This brief examines reasons why Black firms have been almost twice as likely to shutter as small firms overall.

Overall, we find:

• Volumes of COVID-19 cases coincide with Black-owned business locations: two-thirds of counties with high levels of Black business activity pre-COVID-19 are in the top 50 COVID-affected areas. Data from counties nationwide show Black-owned firms are more likely to be located in COVID-19 hot spots, whereas white-owned firms are less likely to be in the most heavily affected areas.
• The Paycheck Protection Program, the federal government’s signature relief program for small businesses, has left significant coverage gaps: these loans reached only 20% of eligible firms in states with the highest densities of Black-owned firms, and in counties with the densest Black-owned business activity, coverage rates were typically lower than 20%.
• Weaker cash positions, weaker bank relationships, and preexisting funding gaps left Black firms with little cushion entering the crisis: even the healthiest Black firms were financially disadvantaged at the onset of COVID-19.

With each day that passes, the far-reaching economic implications of the COVID-19 pandemic become increasingly apparent. Of particular concern are the effects the pandemic is having and will continue to have on small businesses as they endure the direct impacts of social distancing directives, including temporary closures and modified operations. With declining revenues, many small firms have had to lay off employees. Governments have begun offering small business loans with attractive interest rates and repayment terms in order to help smooth cash flow and retain employees.¹ While we do not have real-time data on the quickly changing small business conditions, the 2019 Small Business Credit Survey sheds light on how firms are likely to remain afloat during this uncertain time.

Overall, we find:

• Even in late 2019, a period characterized by positive economic growth and low unemployment, small businesses exhibited varying degrees of financial health. Smaller firms, younger firms, and firms helmed by black or Latino owners were more likely to be classified as "at risk" or "distressed."
• Only one in five healthy firms (and even fewer less-healthy firms) had sufficient cash reserves to continue normal operations if they experienced a two-month revenue loss. A majority of small businesses would be likely to reduce their workforce and operations, or delay payments. Many firms would rely on personal funds or debt to bridge the gap.

The publication of this report comes at a particularly challenging time for our nation's small business sector. Small businesses across the country are grappling with the profound impact of the COVID-19 pandemic on their operations and on their owners' and employees' livelihoods. As policymakers and service providers begin to enact programs to help firms weather the economic challenges, insights about the financial position of small businesses can provide a useful perspective on how best to target funds and services. The Federal Reserve Banks' Small Business Credit Survey (SBCS), fielded in Q3 and Q4 of 2019, offers baseline data on the financing and credit positions of small firms before the onset of the crisis. The survey findings provide insights into firms' preparedness to withstand the shock, their existing debt levels, and the actions they may take in response to an unexpected loss of revenues.

Understanding that the potential effects of COVID-19 are substantial and will vary by type of business, accompanying this report is a separate analysis that explores small business resiliency. This supplemental brief, Can Small Firms Weather the Economic Effects of COVID-19?, is published concurrently with this report. A subsequent report will provide results from nonemployer firms.

The results of the survey raise several important considerations in the current environment: most firms are ill prepared for a sustained period of revenue loss; firms' reliance on personal funds could mean severe repercussions for those individuals and households in the event of failure; and many small businesses do not rely on traditional banks for credit, and, therefore, any program designed to support them should take that into consideration.

The importance of small businesses to our nation's economy cannot be overstated. Small employer firms, those with 1–499 employees, account for 47.5% of the private-sector workforce¹ and are vital to the fabric of local communities. The SBCS delivers timely information on small business financing needs, decisions, and outcomes to policymakers, lenders, and service providers. The 2019 survey yielded 5,514 responses from small employer firms with 1–499 full- or part-time employees (hereafter "firms"), in the 50 states and the District of Columbia.²

Overall, the survey finds

Firm performance was relatively strong prior to the pandemic.

• Small business respondents reported a strong end to 2019. A majority of small businesses (56%) reported that their firms had experienced revenue growth, and more than one-third added employees to their payrolls.
• The shares of firms reporting revenue growth, profitability, and employment growth were all virtually unchanged from 2018.

Profit margins were tightening for many.

• Input costs increased for 76% of firms over the prior year. Profit margins fell for 40% of firms. Of firms that reported higher input costs, 61% raised the prices that they charge.

Firms have common cash flow challenges, and many rely on personal funds.

• In the prior 12 months, 66% of employer firms faced financial challenges; the most common challenge was paying operating expenses (43%).
• If faced with a two-month revenue loss, 86% of firms would need to take some action to supplement funding or cut expenses.
• The most common action (47% of firms) would be to use the owner's personal funds.
• Another 17% of firms would have to close.
• Among firms that applied for financing in the prior 12 months, 46% would plan to take out additional debt.
• Owners' personal finances remain deeply intertwined with the finances of their businesses, with 88% of firms relying on an owner's personal credit score to secure financing. Additionally, 56% have used funds from their personal savings, friends, or family within the last five years to support their business.

Debt holdings are common and typically small dollar, and nearly half of recent credit applicants have experienced funding gaps.

• Forty percent of firms hold outstanding debt in amounts up to $100,000. A majority of firms used personal guarantees as collateral to secure this debt.
• Demand for new financing has been steady, with 43% of firms applying for new credit in 2019, in line with the 43% that applied in 2018, and 40% in 2017.
• Large and small banks remain small firms' top choices when applying for credit, followed closely by online lenders; having a relationship with a lender drives many firms to apply to banks, but the chances of being funded and speed of credit decisions are top reasons firms apply to an online lender.
• Fifty-one percent of applicants received the full amount of financing sought. Of the firms that did not receive the full amount, 20% indicated that the firm chose to decline some or all of the approved financing—most often because the interest rate was too high.

Though banks are the most broad-reaching lending channel, many small businesses do not use bank funding.

• Less than half (44%) of small firms have obtained funds from a bank in the last five years. The most common source of funding for firms overall was personal savings or funds from friends or family.
• Among firms that have obtained external financing—outside of family or friend networks—banks were the most common channel (44% of firms), followed by online lenders (22% of firms) and credit unions (6% of firms).
• The use of bank financing varies significantly by race and ethnicity of owner, firm revenue size, and credit risk, with highest reported bank funding found among firms with >$1M in annual revenues (57%), firms with low credit risk (55%), and firms with non-Hispanic white ownership (46%). By contrast, firms with Non-Hispanic black ownership are half as likely to have obtained bank funds (23%), and rates are similarly low among microbusinesses (that is, $100,000 or less in revenues)—24%—and those with Latino ownership (34%).