The financial crisis in 2008 hit small businesses hard – in fact, harder than large firms. Many small businesses went under or were forced to lay off employees, slash spending, halt expansion plans and find new ways to survive until the financial crisis subsided. A decade has passed since the crisis began. How have small businesses weathered the storm?
What the Financial Crisis Did to Small Business
The small business landscape certainly changed during the crisis, and in the decade that followed.
The number of businesses created annually in the decade before the financial crisis averaged 670,000 a year, reaching a high of more than 715,000 in 2006. The startup numbers fell dramatically during the crisis, reaching a low in 2010 of 560,000. While new small businesses are being born now, the rate of business creation has not yet returned to pre-crisis levels.
The financial crisis forced many small companies to go out of business. Between December 2008 and December 2010, about 1.8 million small businesses went under. Small business “deaths” today are down dramatically from financial crisis numbers, with fewer than 400,000 closures in 2014 (the latest year for statistics).
Small businesses have traditionally been referred to as the country’s “job creators.” However, during the financial crisis, layoffs at small businesses were dramatic. In two years (from December 2007 through December 2009), about 8.7 million jobs were lost. According to the Federal Reserve, workers in industries that relied on high external financing, such as certain manufacturers, were more likely to become unemployed during the financial crisis.
During the recession, small businesses didn’t create jobs; they lost jobs (declining 60% from pre-recession levels). Fortunately, there has been solid recovery on this front. Small businesses are back to creating about 62% of all new jobs. And small business owners report that finding qualified employees today is their number-one problem.
The Effect on Commercial Lending
Before the financial crisis, the number of commercial loans to small businesses – the traditional borrowing option – continued to grow at double-digit rates. This came to a virtual standstill during the financial crisis. In fact, loans by large banks to small businesses from 2008 to 2011 were practically nonexistent, while loans by small banks were down dramatically. The total amount of commercial loans to small businesses between the second quarter of 2008 and the second quarter of 2010 declined by $40 billion.
Average Percentage Change in Dollar Amount of Small Business Loans by Large and Small Banks, 1995-2015
The economy started to recover in 2011 and 2012, but there was not a concurrent recovery in bank lending to small businesses. According to the U.S. Small Business Administration, “The amount of small business loan originations plummeted by more than half during the crisis and has seen only a very limited recovery post-crisis, leaving small business loan originations down 40 percent from pre-crisis levels.”
One of the key obstacles to small businesses obtaining commercial financing post-financial crisis was creditworthiness. In most situations, loans to small businesses must be personally guaranteed by owners. During the financial crisis, owners’ personal finances were stretched to the max, with the result that many experienced declines in their personal FICO scores. This has meant that even though the business may have recovered, the ability to obtain commercial loans supported by owners’ personal guarantees has not been so easy to come by. When owners could obtain such loans, the interest rates have been higher than for owners with good FICO scores.
Fortunately, 10 years later things seemed to have recovered nicely when it comes to small business borrowing. Today, SBA loan programs have been expanded, with over $16 million in 7(a) loans (the SBA’s primary loan option) made in 2018. (For more on SBA lending, see Expanding Your Small Business with an SBA Loan.) And small businesses are having loan applications approved at impressive rates. According to the Biz2Credit Small Business Lending Index, which began to track lending in January 2014, small banks granted 49.7% of the funding requests they received in July 2018 (the highest figure for small banks since December 2014).
The Rise of Alternative Lending
Before the financial crisis, the term “alternative lending” generally was limited to factoring (a financing arrangement where a factor essentially buys a business’s invoices at a discount). However, to meet the needs of small businesses lacking access to traditional financing during the financial crisis, some companies started to offer new financing options.
For example, merchant cash advances (MCAs) are similar to factoring but are based on a company’s credit card transactions. The effective cost of this method of financing is very high, but during the crisis may have been the only option for certain companies. Equipment financing, while not new, became more popular during the financial crisis. It was a way for vendors to sell their wares to small businesses on payment terms at a time when companies couldn’t find other ways to pay for needed machinery or other items. And credit unions began to ramp up their small business lending to the extent permitted by law (from 1998 until 2017 they were only allowed to lend up to 12.25% of their assets to small businesses). These alternative lending options continue to be used by small businesses today, with the current loan approval rates among alternative lenders currently at 56.5% and at credit unions 40.3%.
This online method of raising small amounts from large numbers of people has flourished post-crisis. Crowdfunding can be in the form of gifts (e.g., Indiegogo, Kickstarter), loans (e.g., LendingClub) or equity (explained next). In 2012, President Barack Obama signed the Jumpstart Our Business Startups (JOBS) Act to enable small businesses to raise equity without registering through the SEC. This equity crowdfunding option took some years to get into gear because of the need for SEC regulations, but it’s now up and running. (See Understand the SEC Rules on Equity Crowdfunding.) There are a number of equity crowdfunding portals that can be used to raise up to set limits (e.g., Fundable, AngelList, EquityNet, Wefunder).
In the decade since the financial crisis, the way business is done has changed, with technology gaining prominence. Small businesses are now attuned to online financing options, with 21% seeking online lenders in 2016 and 24% in 2017.
The best effect of the financial crisis on small businesses would be that they learned important lessons about watching their debt, keeping tight reins on spending and maintaining access to capital. In addition, new sources of financial assistance undreamed of during that crisis are currently available, and even newer ones could be introduced. At present the economy appears to be solid and thoughts of another recession are not high on the list. Who knows what lies ahead?