Small Business Pain Points
Access to capital is a significant pain point for small businesses, from the burdensome application process to an inability to access credit due to risk factors, size of loan, revenue, or credit factors. Digital platforms and online lenders are emerging to address these needs and support small business growth strategies. COVID-19 has clearly had a prominent impact on small businesses, with access to credit growing as a pain point. However, small businesses have accelerated their use of technology and digital solutions to gain efficiencies, keep their business moving forward, and build their online presence. Detailed insights are found below.
ACCESS TO CAPITAL: SMALL BUSINESS INSIGHTS
Lending Process Complexities a Significant Pain Point Among Small Businesses
- A Federal Reserve study in the US found that small businesses spent an average of 24 hours applying for small business loans, with the process generally found to be cumbersome.
- A 2018 Xero survey of 500 Australian small business owners found that 80% felt that "documentation and other requirements in obtaining a business loan for small businesses are onerous" and 71% would be "interested in applying for business funding if there was an electronic process to facilitate it and create the documentation on their behalf."
- A 2016 Federal Reserve survey of US small business owners found that 42% of borrowers expressed displeasure with the small bank application process, while 26% said the same of the application process at online lenders. 50% of those applying at small banks cited a "long wait for the decision" as the main reason for their frustration.
- Additional factors frustrating the process for borrowers include the amount of paperwork and lack of transparency. 47% of those applying at small banks cited "lack of transparency" as a pain point in the application process, while 49% of those applying with online lenders cited "lack of transparency" as a concern.
- Interestingly, 29% of US small-business owners said they did not apply for an emergency COVID-19 PPP loan due to "too much bureaucracy involved", while 17% said they did not apply because it "would take too long."
- Digitizing the lending process for small businesses was found to save up to 8 hours in the process and $4,000 for the lender, also resulting in a better experience for the borrower. Moody's Analytics found that 56% of lenders felt that manual data collection and data processing were the main factors driving the outdated and inefficient small business loan application process.
- A 2018 American Banker survey found that 80% of small business lenders were interested in digitizing their application process, with 57% claiming they would partner with a digital lending partner to achieve this objective.
- Millennium Bank, a US-based community bank, modernized their lending process by investing in technology to eliminate manual documentation and automate the credit approval process. This allowed them to approve small loans quickly. Their loan volume grew 50% as a result of digitization.
Fintech Gives Rise to Alternative Funding Sources for Small Businesses
- Alternative lenders provide opportunities for small businesses to access funding unavailable via traditional banks and financing institutions. Prior to COVID-19, the global alternative finance industry grew 48% (excluding China), from $60 billion in 2017 to $89 billion in 2018.
- As a source of SME funding, the industry grew from $21 billion in 2017 to $31 billion in 2018. Alternative finance business funding is highest in the US and Canada, followed by the UK and APAC.
- Small businesses are often viewed as higher risk by larger banks, more expensive from a transaction cost standpoint (since loan amounts are generally lower), and often do not have the required collateral to back up their loan. Some banks have even implemented loan thresholds of between $100,000 and $250,000 (and up to $2 million for some larger banks), making it difficult for SMEs to access capital.
- In the US, only 51% of companies who applied for credit even received the full amount of credit they were seeking, despite relatively low funding requests. The average SBA loan in the US is $107,000.
- Fintechs have stepped in to address pain points for small businesses associated with access to funding. Loan requirements are often lower ($50,000 or even lower), loans can often be secured with personal guarantees, and loan decisions are based on a set of criteria beyond the credit score.
- According to a Federal Reserve survey of US small-business owners, 20% have leveraged an online lender, with those who represent a higher credit risk or have lower reported revenue more likely to report using an online lender.
- Fintechs have expanded financing options for small businesses by offering alternative sources of funding to the nearly 50% of small businesses who seek funding. Some examples of Fintech companies operating in the industry include CircleUp, who offers financing based on a combination of credit and equity and Snap Advance, a company providing cash advances to companies based on a projection of future sales.
- Neobanks in the UK, such as Starling and OakNorth, are able to operate efficiently and offer personalized products for small businesses given a modern infrastructure and lack of physical branches.
Demand for Financing Driven By Growth Aspirations
- Access to financing is important at all stages of a small company evolution, from startup to growth, to supporting employment and social inclusion.
- A Federal Reserve small business survey in the United States found that 56% of small business owners applying for external financing did so to "expand business, pursue new opportunity, or acquire business assets." This was followed by "meet operating expenses" (43%) and "refinance or pay down debt" (30%).
- A 2019 Pepperdine/DNB study found that growth aspirations drove small businesses to seek financing, regardless of revenue level. "Planned growth or expansion, including acquisitions (not yet realized)" was cited as the leading reason for applying for financing by 67% of small businesses with revenue less than $5 million and by 54% of small businesses with revenue between $5 million and $100 million.
- Specific factors that support the growth of small businesses include the expansion of real estate operations, equipment purchasing, inventory purchasing, and increased working capital to manage day-to-day operations.
- A 2018 Australian study found that small business owners were likely to use funding for marketing (61%), equipment (46%), additional staff (31%), and new systems and processes to support the business (30%), all activities that support business growth.
Female-Led Small Business Access to Capital May Be More Limited
- A 2019 Bank of America survey of small business owners found that 60% of female small business owners felt they had less access to capital than their male counterparts. 34% felt confident they would have equal access in the distant future (2033).
- A separate Visa survey among female small business owners in the US reported three-quarters of women found access to capital difficult.
- An HSBC survey of 1,200 mostly female entrepreneurs globally also pointed to some bias in the ability to access capital, with 46% of American female small business owners and 54% of UK female small business owners noting they experienced bias in the lending process.
- The International Finance Corporation (IFC) found that just 11% of seed-funded businesses are female-led.
- The World Bank recently launched 2 initiatives to improve access to funding for female-owned businesses. They will partner with UPS to support female-led small businesses in the Middle East and North Africa to help them successfully leverage eCommerce platforms to grow their businesses. Additionally, We-Fi has allocated funds to support women entrepreneurs by launching a ScaleX program, which incentivizes accelerators to fund these small businesses (primarily in developing countries).
- Sérgio Pimenta, IFC Regional Vice President for the Middle East and Africa, says of the ScaleX program, "We are launching the ScaleX program to help women entrepreneurs in emerging markets to access funding at a crucial stage to grow their businesses. This is a win-win for accelerators, investors, and women entrepreneurs.”
COVID-19: SMALL BUSINESS INSIGHTS
COVID-19 Impacting Smaller Businesses Disproportionately
- Companies with fewer than 20 employees (the lower end of the 10-50 employee small business range) are more disproportionately impacted by COVID-19 due to less cash-on-hand and more restricted access to capital.
- An April 2020 analysis by the Federal Reserve Bank of New York, which used profitability, credit risk, and business funding to identify "healthy" firms, found that 35% of US firms with 5-19 employees were considered "healthy" and 36% were considered "stable". Of those with 20-499 employees, 47% were considered "healthy" and 32% "stable." 23% of younger firms (0-5 years) were found to be "healthy" compared to 41% of smaller firms older than 5 years.
- An Economic Policy Research study in Uganda found similar results, with 27.7% of small businesses (10-50 employees) saying continued COVID-19 restrictions would cause them to go out of business within 1-2 months (compared to 58% of micro-businesses and 8.3% of medium-sized businesses).
Small Businesses Accelerating Adoption of Technology Solutions and Increasing Online Presence
- COVID-19 has accelerated the adoption of technology solutions among small businesses, given the requirement of remote working. Several emerging trends include the adoption of software (for tasks such as scheduling, contact management, and billing), moving products and services online, and automating customer service (via tools, such as chatbots).
- Solutions, such as Clever Hub, a workflow automation tool supporting centralized client communication and interaction, and Kajabi, which offers a solution that integrates content, marketing, and products online, are being leveraged by small businesses in the wake of the COVID-19 crisis.
- Open-ended responses in a Florida State survey of 567 US small businesses and non-profits found that one strategy used to meet the COVID-19 challenges to their business was "an increased focus on implementing technology and creating online content in greater frequency than before the pandemic."
- In an April 2020 IDC survey among European small businesses, 22% said they planned to increase their level of IT spending. IDC notes that COVID-19 will accelerate the move of small businesses toward being "data-driven, customer-centric, and highly automated."
- Mark Zuckerberg, Facebook CEO, commented about COVID-19 impact on small business' online presence, "We’re seeing a lot of businesses that never had online presences get online for the first time, and we’re seeing small businesses that had an online presence now make them their primary way of doing business."
Access to Capital is a Growing Concern Among Small Businesses
- A Facebook survey of 86,000 small business leaders in the United States found that 60% are struggling with some aspect of their finances.
- Access to loans and credit guarantees were cited by over one-third of respondents as a "most needed policy to support businesses."
- Drivers of increased need for capital related to keeping day-to-day operations afloat, including "paying workers salaries and wages" (29%) and "paying their bills" (28%). The need for cash and financing to keep their day-to-day business alive was even greater among hospitality businesses, with 44% saying they needed financing to pay their workers and 54% requiring financing to pay bills.
- Half of small businesses reported applying to government sources for additional financing, while 11% said they applied to banks to support their capital needs.
- A Reuters survey in May 2020 corroborated these findings, with "liquidity remaining a key pain point" among small businesses in the US. 52% of small businesses claimed they were cutting operational costs and 59% were applying for loans.
- A May 2020 survey among small and medium businesses in Europe found decreasing expectations associated with external financing options due to COVID-19, with respondents in the Euro area reporting an 11% decline in the perceived likelihood they could secure a bank loan due to the crisis. These businesses were more likely to attribute the difficulty in securing financing to their own deteriorating financial situation.
- Many companies have "stepped up" to provide financial support for small businesses to help alleviate financial issues during COVID-19, including Facebook and Google.
- The World Bank is providing additional funding to small businesses in Europe and Asia to meet the challenges of COVID-19.
Optimism About Future Mixed
- A May 2020 NFIB survey found optimism rebounding among small business owners in the United States, particularly with respect to higher sales and increasing employment. The overall optimism index increased by 3.5 points from the April 2020 survey.
- According to a MetLife study (executed by IPSOS) in May 2020, 50% of small business owners expect their revenue to increase next year, up from 47% in April 2020.
- 57% of small businesses surveyed by Facebook reported they were "very" or "somewhat" optimistic about the future. Facebook CEO, Zuckerberg, attributes the optimism to the resilience of small business owners: "They’re finding new ways to reach their customers online, they’re making adjustments to how and when they do business, and they’re working hard to meet their family obligations at the same time."
- Optimism about the future appears to be mixed, depending on region and industry. 35% of UK small business owners and decision-makers in retail, leisure, and hospitality felt it would be a year until their business fully recovered, while 47% of small businesses in the travel industry said it would be a year until their business recovered.
We leveraged surveys, academic studies, news articles, expert commentary and perspective, and industry research to provide insights surrounding small businesses, in terms of pain points associated with credit and financing access and potential solutions, as well as understanding how small businesses have been impacted by and reacted to COVID-19. While we attempted to define small businesses exclusively as those between 10 and 50 employees, most information referenced small businesses in general, defined small businesses by revenue or provided data in aggregate for micro-businesses, small businesses, and medium businesses (SMEs or MSMEs). We clearly noted when we could break out the data for small businesses with the definition of 10-50 employees. Additionally, many detailed studies were available for the US market. To develop a global perspective, we complemented these learnings with those from other regions and countries.