Small and medium-sized enterprises (SMEs), firms with fewer than 500 employees, are the backbone of U.S. economy. They make up 99 percent of all firms, employ over 50 percent of private sector employees, and generate 65 percent of net new private sector jobs. SMEs account for over half of U.S. non-farm GDP, and represent 98 percent of all U.S. exporters and 34 percent of U.S. export revenue.
To grow and globalize, SMEs need access to credit and cash flow. Credit conditions for U.S. SMEs deteriorated in the wake of the financial crisis, and are expected to continue depressed as Basel III capital adequacy requirements come into effect in 2015. Early-stage companies seeking equity finance have also faced challenges, as venture capital is increasingly focused on later-stage companies and available only to a handful of firms. Small business exporters have been doubly challenged, as entering and operating in international markets implies costs that far exceed those of firms targeting and shipping within their domestic markets alone.
What is the state of SME finance in the United States today, five years after the financial crisis? This TradeUp white paper provides answers. Overall, financing for SMEs appears to be recovering from the immediate post-recession years. However, the more traditional sources of SME capital – banks for loans and VCs for early-stage funding – are focusing on larger and less nascent companies. A number of instances and new delivery methods are taking their place, from online micro- and small business lenders to supply chains finance programs, angel investors, and crowdfunding platforms. Our summary highlights are as follows:
- Bank lending to SMEs has improved, but has yet to return to pre-crisis levels. In June 2013, the loan balances for commercial and industrial (C&I) loans of $1 million or less stood at $288.7 billion, $47 billion below June 2008.
- Federal government sources have played a complementary and to an extent countercyclical role during the past few years in SME lending. In FY 2013, SBA supported $29.6 billion in lending to small businesses, about the levels of the prior two years. The Export-Import Bank supported export credit insurances and export working capital for SMEs at $5.2 billion in 2013, somewhat below 2011-12 authorizations. ExIm also fell somewhat short of its mandate to dedicate at least 20% of its portfolio for support for small business.
- The burgeoning market of online lenders has yet to be analyzed fully, but the success of several platforms indicates a new, strong, and relatively affordable source for financing particularly for small firms that lack access to sufficient bank credit.
- Expansion- and late-stage investments together accounted for $13.4 billion of VC investments through Q1-Q3 of 2013. Seed- and early-stage investments attracted 46 percent less investments during the same time period amounting to a total of $7.2 billion. The Software industry continues to garner the most VC dollars in the United States, while Silicon Valley continues to dominate the US VC investments by geography, leading the pack with 42 percent investments in 2013. Internationally, Israel and United States remain the hotbeds of innovation with the highest VC spending as a percent of GDP among the OECD countries in 2012.
- Angel investment is recovering and has become a strong complement to VC financing. In the first two quarters of 2013, angels invested a total of $9.7 billion, an increase of 5.2 percent over the first half of 2012 and 5 percent increase form 2007.
- Global crowdfunding volume nearly doubled in 2012 to $2.7 billion, of which over one-half, or $1.6 billion, was in North America. Crowdfunding is expected to exceed $5 billion in 2013.
As the U.S. economy recovers, 2014 is becoming a big year for alternative lenders and investors on the online and crowdfunding spaces, and see their expansion also to mobile platforms. However, bank financing to SMEs is expected to continue subdued as Basel III capital adequacy requirements come into effect in 2015. Because banks will have to hold additional cash in reserve to meet the terms of Basel III, they will have less money to lend compared to pre-crisis levels, which is expected to have a disproportionately negative effect on SME financing opportunities. This however will open up opportunities for new business models to accommodate the recovering financing demands by American SMEs and SME exporters. We at TradeUp are building just such a model.