2016 Small Business Credit Survey Report on Minority-Owned Firms

This report is the third in a series of reports based on the 2016 Small Business Credit Survey (SBCS), a national collaboration of the Community Development Offices of the 12 Federal Reserve Banks. As a key financial regulator and economic policymaker, the Federal Reserve System plays an important role in ensuring fair access to credit and promoting economic growth for the well-being of all Americans. Small businesses are an important component of economic success and strong communities; they are responsible for 48% of private sector employees nationwide,¹ are important drivers of local and regional economic growth,² and are an important source of household wealth.³ A healthy small business environment depends on an array of factors, not least of which is the ability to access funds for starting up, scaling up, or maintaining operations. However, as a growing number of studies document, access to funds—whether debt, equity, or personal resources—can vary across race and ethnicity even when business owners are similar in other respects such as business performance and credit risk.⁴

The SBCS provides new data on minority-owned small business performance, financing needs, decisions, and outcomes. This report shares the descriptive comparison of the SBCS results by different firm ownership types (with emphasis placed on results that are statistically significant).⁵ A subsequent paper will investigate the independent marginal effects of race and ethnicity on credit experience. That paper will include analysis that controls for firm age, size, and other available variables. The 2016 SBCS, which was fielded in Q3 and Q4 2016, yielded 7,916 responses from employer firms with race/ethnicity information in 50 states and the District of Columbia. We primarily report results by four race/ethnicity categories: white, black or African American, Hispanic, and Asian or Pacific Islander.⁶ However, when the respondent sample size by race for a particular survey question is too small, we report results in terms of minority- versus nonminority-owned firms [i.e., we compare the experience of minority-owned businesses to businesses with more than 50% ownership by white individual(s)].⁷ For select key statistics, we also report results for the 4,365 nonemployer respondents who provided race/ethnicity information. The SBCS Report on Minority-Owned Firms, therefore, offers unique insight into important, often underserved, segments of the small business population.

Overall, the results show:

• More white-owned firms are profitable than minority-owned firms. The gap is most pronounced between white- (57%) and black-owned (42%) firms.
• Black-owned firm application rates for new funding are 10 percentage points higher than white-owned firms, but their approval rates are 19 percentage points lower.
• Forty percent of nonapplicant black-owned firms did not apply for financing because they were discouraged (i.e., they did not think they would be approved), compared with 14% of white-owned firms and 21% of Hispanic- and Asian-owned firms.
• Looking at just firms that were approved for at least some financing, when comparing minority- and nonminority-owned firms with good personal and/or business credit scores,⁸ 40% of minority-owned firms received full amount sought compared to 68% of nonminority-owned firms.
• Large banks are the most common type of lender applied to overall, regardless of race. Black- and Hispanic-owned firms are less likely to apply for financing at small banks and more likely to apply at community development financial institutions (CDFIs) and online lenders, relative to white-owned firms.

More detailed results include:

Black-, Asian-, and Hispanic-owned firms tend to be younger and smaller in terms of revenue size and are concentrated across different industries

• Approximately 28% of black-owned firms, 28% of Asian-owned firms, and 25% of Hispanic-owned firms are 0–2 years old, compared with 19% of white-owned firms.
• Black-owned firms are most concentrated in the healthcare and education industry (24%). Asian-owned firms are most concentrated in the professional services and real estate industry (28%). Hispanic-owned firms are most concentrated in the nonmanufacturing goods production and associated services industry, which includes building trades and construction (27%). White-owned firms are more evenly distributed across several industries but most commonly operate in the professional services and real estate industry (19%) and the nonmanufacturing goods production and associated services industry (18%).
• Forty-two percent of black-owned firms, 21% of Asian-owned firms, and 24% of Hispanic-owned firms are smaller than $100k in revenue size, compared with 17% of white-owned firms.

The profitability performance index⁹ of minority-owned firms remains well below that experienced by nonminority-owned firms

• In 2016, 42% of black-owned firms, 51% of Asian-owned firms, and 51% of Hispanic-owned firms reported operating at a profit, compared with 57% of white-owned firms.
• Black-owned firms report significantly higher expectations for revenue growth (86%) and employment growth (65%) than white-owned firms (70% and 43%, respectively).

The credit gap is most pronounced for black-owned firms, which are most likely to rely on personal funds

• Black-owned firms report more credit availability challenges (58% vs. 32%) and difficulty obtaining funds for expansion (62% vs. 31%) than white-owned firms—even among firms with revenues more than $1M (49% vs. 24% and 53% vs. 23%, respectively). A similar gap exists between Hispanic- and Asian-owned firms compared with white-owned firms, but it is less pronounced.
• The use of personal funds is the most common action taken as a result of financial challenges, with 86% of black-owned firms, 77% of Asian-owned firms, 76% of white-owned firms, and 74% of Hispanic-owned firms using this source of financing. This is true even though black business owners tend to have lower personal wealth levels than white business owners.¹⁰
• Cutting staff is also a common action taken as a result of financial challenges. Asian-owned firms cited this action most at 48%.

A greater share of black- and Hispanic-owned firms increased debt in the past 12 months, but these firms still have lower debt levels than white- and Asian-owned firms

• Thirty-six percent of black-owned firms and 33% of Hispanic-owned firms have existing debt less than $100k, compared with 21% of white-owned firms and 14% of Asian-owned firms.
• The share of minority-owned firms with outstanding debt increased from 51% in 2015 to 70% in 2016; in comparison, the share of nonminority-owned firms increased from 63% in 2015 to 71% in 2016.
• A greater share of black- (25%), Hispanic- (26%), and Asian-owned (25%) firms also expect to increase their debt levels in the next 12 months, compared with white-owned firms (16%).
• However, minority-owned firms take on greater risk to obtain debt, with black-, Hispanic-, and Asian-owned firms using future sales as collateral more often than white-owned firms. For example, 18% of Hispanic-owned firms more than 5 years old use future sales as collateral, compared with only 6% of similarly aged white-owned firms.

Black-owned firms apply for credit at a higher rate and tend to submit more applications—but seek lower amounts of financing—than white-owned firms

• Fifty-three percent of black-owned firms and 43% of white-owned firms applied for financing in 2016. Forty-three percent of black-owned firms submitted three or more applications, compared with 31% of white-owned firms.
• Regardless of race, the top reason for applying for financing is to expand business or pursue a new opportunity.
• Thirty-two percent of black business owners and 39% of Hispanic business owners sought more than $100k in financing, compared with 46% of white business owners and 49% of Asian business owners.
• Of black-owned firms that did not apply for financing in the past 12 months, only 22% cited sufficient financing as the primary reason compared to 52% of white-, 37% of Asian-, and 32% of Hispanic-owned firms.
• Of the nonapplicant firms, 35% of black and 30% of Hispanic-owned firms do not use external financing on a regular basis, compared to 21% of Asian- and 21% of white-owned firms.

Black- and Hispanic-owned firms tend to apply for higher-cost products and are more likely to apply to online lenders compared with white-owned firms

• Black- (17%) and Hispanic-owned (19%) firms are at least twice as likely to seek financing via merchant cash advances and factoring (i.e., the sale of accounts receivable) compared with white-owned firms (7%).
• Black-, Hispanic, and Asian-owned firms applied to large banks for financing more than they applied to any other source of financing.
• Small banks remain among the most common sources of financing applied to by white-owned firms (50%). Black-owned firms apply to small banks 39% of time, with online lenders not far behind at 33%.
• Hispanic-owned firms apply to small banks 34% of the time and to online lenders 36% of the time.

Not controlling for all firm characteristics, reported credit outcomes differ by race and credit risk

• Sixty-one percent of black-owned firms were approved for at least some financing on their loan/LOC applications, while the loan/LOC approval rate was 80% for white-owned firms, 73% for Asian-owned firms, and 74% for Hispanic-owned firms.
• Among low-risk¹¹ minority-owned firms that applied for new financing, 75% received at least some of the financing requested, compared with 85% of low-risk nonminority applicants who received at least some of the financing requested.¹²

Reported credit outcomes differ by business location

• At large banks, SBCS data suggest that minority-owned firms located in low- and moderate-income minority zip codes experience higher approval rates than minority-owned firms in other zip codes, supporting previous research findings that attributed this to bank efforts to meet CRA requirements.¹³ Conversely, at small banks, minority-owned firms located in low- and moderate-income minority zip codes experience lower approval rates than minority-owned firms located in other zip codes. The differences in approval rates at small banks across zip codes are not robust at traditional levels of statistical significance, and further research is recommended to more precisely identify these effects.

Focus on Nonemployer Firms

Despite a relatively low percentage of firms operating profitably and experiencing revenue growth, black-owned nonemployer firms and Hispanic-owned nonemployer firms remain optimistic

• Approximately 53% of black-owned nonemployer firms operated at a loss during the past 12 months, compared with about 37% of Hispanic-owned nonemployer firms, 38% of Asian-owned nonemployer firms, and 33% of white-owned nonemployer firms.
• Of black-owned nonemployer firms, 87% are less than $100k in revenue size, and nearly 70% experienced either no change or a decrease in revenue during the past 12 months. Only 69% of white-owned nonemployer firms are less than $100k in revenue size, and approximately 54% experienced either no change or a decrease in revenue during the past 12 months.
• Still, approximately 84% of black-owned nonemployer firms and 76% of Hispanic-owned nonemployer firms expect revenue will increase in the next 12 months, compared with 69% of white-owned nonemployer firms and 67% of Asian-owned nonemployer firms.

Nonemployer firms reported seeking financing at lower rates and experienced lower approval rates than employer firms, with black-owned nonemployer firms and Hispanic-owned nonemployer firms experiencing the most difficulty

• Only 24% of Asian-owned nonemployer firms applied for new financing in the previous 12 months, compared with 26% of white-owned nonemployer firms, 32% of Hispanic-owned nonemployer firms, and 34% of black-owned nonemployer firms.
• White-owned nonemployer firms experienced the highest approval rates (60%) for new financing, while black-owned nonemployer firms experienced the lowest approval rates (43%) for new financing. Even among low-risk applicants, only 56% of black-owned nonemployer firms were approved, compared with 74% of white-owned nonemployer firms.
• Among both minority- and nonminority-owned nonemployer firms, credit score (57% vs. 37%) and insufficient credit history (45% vs. 39%) were the most often cited reasons for denial, followed by business performance (41% vs. 37%) and insufficient collateral (37% vs. 33%).