Federal Reserve Banks Report On Small Businesses Nonemployer Firms

Financial Services Law

In a pair of new reports, the 12 Federal Reserve Banks provided data on the financing needs, decisions and outcomes of (i) small businesses (fewer than 500 employees) and (ii) nonemployer firms.

Small-employer firms experienced revenue growth in 2018, according to findings, and while credit demand held steady, applications to online lenders continued to trend upward. As for nonemployer firms, the report highlighted the challenges facing minority-owned sole proprietorships in obtaining financial services.

What happened

Together, the 12 Federal Reserve Banks collaborate on the Small Business Credit Survey (SBCS), an effort to provide an in-depth look at the performance, debt holdings and credit experiences of small businesses. The report data was based on survey responses given during the latter half of 2018 from 6,614 small employers (firms with 1–499 full- or part-time employees) in all 50 states and Washington, D.C.

Small-business respondents reported a “strong end” to 2018, with 57 percent experiencing revenue growth and more than one-third adding employees to their payrolls. Both the percentage of small businesses with growing revenues and the percentage of those with increasing employment represented increases from the 2017 survey, although the percentage of firms operating at a profit stayed the same.

Credit demand by small businesses held steady last year, according to the report, with 43 percent of firms seeking external funds, an increase over the 40 percent seeking new financing in 2017. Roughly half of the applicants told the Federal Reserve Banks they received the full amount of funding they sought, in line with the numbers from 2017.

Overall, 48 percent of small businesses reported that their funding needs were satisfied, while 23 percent had shortfalls and another 29 percent said they had unmet funding needs. Shortfalls were “particularly pronounced” among firms with weak credit, unprofitable firms, younger firms and firms in urban areas, with gaps “most acute” for small businesses seeking funding in the range of $100,000 to $250,000.

On the financing front, applications to online lenders continued to move upward. In 2018, 32 percent of firms sought funding from online lenders, an increase from 24 percent in 2017 and 19 percent in 2016. Interestingly, the report documented that the growth continued despite accompanying lower satisfaction with online lenders as compared with satisfaction levels with large and small banks.

Of those firms applying to online lenders, medium- and high-credit-risk applicants were more likely to apply to an online lender than to a small bank or credit union, and as likely to apply to a large bank. According to the report, approximately 20 percent of medium- and high-credit-risk applicants sought financing from other sources, such as private investors, government entities or auto/equipment dealers.

Looking ahead, a majority of the respondents predicted continued revenue growth (72 percent reported optimism for 2019), although a smaller percentage (just 38 percent) expect to add jobs.

In a separate document, the SBCS also shared information on nonemployer firms, defined as establishments without employees on payroll. Such firms are “a dynamic and growing part of the U.S. economy,” the Federal Reserve Banks said, rising from about 15 million in 1997 to more than 25 million in 2017. While they make up just three percent of business receipts, the number of nonemployer firms represents 81 percent of all small businesses.

Similarly, based on late-2018 survey responses (5,841 from all 50 states and D.C.), the nonemployer firm report discovered that “despite being a key income source for their owners, these firms face acute profitability and financing challenges.”

Nonemployer firms are an important source of income for their owners, with 63 percent serving as the primary source of income for the owner; roughly 20 percent of the firms were started because the owner lacked other employment options, according to the report. However, despite the reliance of their owners on the firm for income, a majority of nonemployer firms are either unprofitable or just breaking even.

Importantly, nonemployer firms seeking capital face “significant obstacles,” the Federal Reserve Banks said, and more than half experienced financial shortfalls in the prior year. While 58 percent reported they were low credit risk, about half reported prior debt outstanding (balances of $25,000 or less made up of 59 percent, while 87 percent had balances of $100,000 or less). Nonemployer firms with prior debt were more likely to report funding shortfalls than were firms without prior debt.

According to the report, 32 percent of nonemployer firms with debt have unsecured debt, while 42 percent have debt secured by a personal guarantee and 25 percent reported that they used personal assets as their collateral.

The Federal Reserve Banks also revealed discrepancies based on race with regard to funding. While 62 percent of nonemployer firms reported financial challenges in the prior 12 months, that number jumped to 76 percent of Hispanic-owned firms and 70 percent of African-American-owned firms. Similarly, 39 percent of all firms had their funding needs met, but only 25 percent of Hispanic-owned firms and just 17 percent of African-American-owned firms could say the same.

For those firms that did not apply for financing, 36 percent reported they were debt averse or discouraged from applying; African-American- and Hispanic-owned nonemployer firms were more likely to report they were discouraged or debt averse.

“A majority of these firms struggle with making a profit, facing both rising costs and limits in passing on those costs to consumers,” Claire Kramer Mills, assistant vice president at the New York Fed, said in a press release. “The data also underscore financing challenges for nonwhite business owners, echoing similar findings for employer firms.”

To read the report on small employers, click here.

To read the report on nonemployer firms, click here.

Why it matters

While the overall message of the Federal Reserve reports on small employers and nonemployer firms were positive—documenting increasing revenues and additional employees for small businesses—they also highlighted challenges for nonemployer firms, particularly for minority-owned firms seeking funding. In addition to providing insights into the business performance of both types of companies, the reports indicate financial institutions have significant opportunities to satisfy unmet demands for funding needs.