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ENTREPRENEURSHIP AND PUBLIC POLICY: BEYOND SOLVING THE CREDIT CRUNCH
Richard P. Taub, University of Chicago
Connie Marie Gaglio, University of Victoria
It is a widely held belief that lack of credit is one of the major constraints on the supply of entrepreneurship. This exploratory study suggests that lack of credit may not always be a serious hinderance. Specifically, perceptions about the role of credit versus other problems encountered during startup seem to vary according to the amount of money needed to capitalize the opportunity. However, regardless of the size of initial investment required, all business owners surveyed indicated that lack of credit seriously constrained their ability to grow their businesses. The implications of these findings for future research and public policy programs are discussed.
Entrepreneurship and self-employment are generally considered central to economic development and revitalization, particularly in underdeveloped countries or economically stagnant regions in the United States (Birch, 1981; Brock & Evans, 1989). As companies increasingly downsize to become more competitive in the world economy, the growth of new businesses becomes an important avenue towards full employment. Policy makers, therefore, have searched for ways to encourage new business and small business growth.
It is a widely held belief that lack of credit is an important constraint in the development of entrepreneurship. Consequently, many public policy programs sponsored by the state and federal governments focus on making credit available to small and growing businesses in settings and circumstances that banks or other lenders are likely to avoid.
In the United States, the Small Business Administration (SBA) is the most influential program; the SBA has lent more than $72.5 billion since 1953. The program has its share of hits and misses but home runs like the $4 billion Nike Corporation, which owes its existence to several SBA loans, seem to validate the approach. Spurred on by the hope of such success, the federal government has expanded the number of credit programs such as the Community Reinvestment Act, or more recently, the Community Development Financial Institutions Act. The number of state programs have proliferated since the 1970s and a number of private programs (e.g., Rural America Fund and The Bank Community Development Corporation) have been established to extend credit to small business owners.
One such private sector credit extension program was developed by the Southern Development Bancorporation (SDB). SDB was created in 1988 with the goal of bringing economic development to Southern Arkansas, a predominantly poor, rural area of about 20,000 miles in size and with a population of approximately half a million people. The fundamental premise of the corporation is that the region was starved for credit, and that by making credit available, as well as some technical assistance, local businesses would grow, thereby generating wealth in the area. The emphasis on local business, rather than branches of national or international corporations, was important. Seven towns in Southern Arkansas were targeted for economic expansion via aggressive credit extension.
In its first five years, Southern Development Bancorporation has lent or invested about $45 million, $23 million of which could be classified as development loans, to approximately 679 small business owners. However, SDB anticipated an even greater pent-up demand than it has seen to date.
This study is part of a larger ongoing study which evaluates the economic revitalization of the southern Arkansas region. The evaluation study includes surveys of business people and community residents as well as measures of business establishment rates, unemployment rates, failure rates, etc., for each of the targeted towns.
The results reported here are based on three surveys conducted during 1990-1994. A random sample survey of 1,235 households in the seven towns identified 112 small business owners. These owners were then interviewed about their startup history and growth plans. Questions included type of business; amount of startup capital needed; sources (s) of startup capital; awareness of programs designed to provide startup capital; perceived problems encountered at startup; perceived problems encountered during growth; etc. Fifty-nine small business owners provided complete responses to both surveys. The third survey was conducted among a random sample of the 679 clients participating in SDB's credit programs; to date, 46 interviews have been completed. The purpose of this survey is to gain a better understanding of the search for startup capital; questions included a detailed history of the search process; loan history; and financing alternatives considered.
Since this is both an exploratory and baseline study, descriptive statistics are employed to uncover the behavior patterns underlying small business owners' search for capital.
Preliminary data analysis of the first two surveys provided several surprises. First, people reportedly needed very little money in order to launch their ventures. The frequency distribution of startup costs indicated that nearly half (49%) of the respondents needed less than $,6000 to launch their businesses; fifteen percent required more than $6,000 but less than $25,000; seventeen percent needed between $25,001 to $50,000; eight percent needed $50,001 to $100,000 and ten percent required more than $100,000. The majority of respondents (64%) in this survey indicated they needed less than $25,000 start their businesses. Those owners who reported higher startup costs (i.e., $100,000 or more) were usually buying existing businesses not launching new ventures.
The surprising cluster towards the low end of the distribution of startup costs raised the question of whether these respondents should be treated as a single homogenous group or whether small business owner perceptions and behaviors might vary according to the amount of capital needed for startup. While the sample size is too small to provide a statistically reliable answer to the question, it was decided to classify small business owners according to their startup costs and to consider the resulting data a source for hypothesis generation and speculation.
The second surprise was relative lack of fund raising. Table 1 indicates that among those with low startup costs (i.e., under $25,000) the majority (63%) relied solely on their personal savings. As startup costs increased, family and friends were recruited and finally traditional lenders such as banks or credit unions were used as a last resort. Mention of SBA assistance or association with any of Southern Development Bancorporation programs were rare, a fact corroborated by the lower than anticipated number of clients SDB serves. One might argue that reliance on personal savings is not surprising given the small amount of money involved but one could also argue that it is surprising that people would be willing to risk their financial security (which can be marginal among many residents in Southern Arkansas, the poorest part of the state) when in fact alternative sources of financing were readily available and designed specifically to encourage small business startups and expansion.
It was interesting that these business owners chose to risk personal savings or family relations rather than draw upon the grants and loans specifically designed to assist small business startups. Subsequent in-depth interviews revealed that in many cases, new entrepreneurs deliberately avoid these credit programs and other mainstream banking relationships. These entrepreneurs gave a variety of reasons for avoiding formal credit. Often, they are not confident their businesses will succeed, and consequently do not want to put themselves at risk with what they describe as a cold-hearted lender (as compared to a family member or friend) or jeopardize credit ratings. Some are not reporting total income to the IRS and/or are paying employees cash under the table and do not want this exposed. Still others expect they will be turned down, even by liberal programs, and do not want to be subjected to embarrassment or rejection.
Perhaps the most surprising of all was the fact that the majority of small business owners indicated that money was not a major concern during startup. The data in Table 2 indicates that for owners whose startup costs were under $100,000, finding customers, the general business climate of Southern Arkansas, and lack of knowledge were the biggest perceived problems.
Concerns about the general business climate in Southern Arkansas reflect the interaction of several issues. First of all, it is not the most densely populated part of the state, so the sheer number of people may not be sufficient to sustain even the best product or service. Secondly, Southern Arkansas is comparatively poor; most jobs pay low wages so the net pool of discretionary income is small. Business people recognize that profit margins must be very slim in order to generate sales, the worst case scenario for new ventures. Finally, feelings and perceptions about the sluggish national economy also found their way into attitudes about the local economy.
The relatively small consumer base may be one reason why new owners experienced trouble getting customers during the early stages of business. Most local business people were thinking in terms of local customers rather than in terms of a geographically dispersed larger market. However, it's also possible that the problems these owners encountered in building their customer base reflect the common entrepreneurial tendency to seriously underestimate the need for professional marketing and its associated costs both in terms of time and money (Hills, 1985) and to fall for the "better mousetrap" fallacy (Timmons, 1994). Novice entrepreneurs frequently calculate only the costs involved in opening for business rather than the costs involved in opening and running a business until there is a positive, reliable cash flow.
The data suggest that the small business owners in this sample may exhibit these tendencies. First, according to their reports, they rely on word of mouth and networking to generate market demand (see Table 3). These techniques are persuasive and inexpensive but they also take a very long time before they contribute to cash flow. Those owners who did use more professional marketing techniques such as advertising tended to rely on the publisher's advice and expertise rather than on marketing professionals. Again, this choice costs less but may not necessarily be most effective. Secondly, the reportedly low startup costs may reflect underestimation of the need for aggressive marketing.
Since the lack of customers is a leading cause of early failure (Bruno, Leidecker & Harder, 1987; Hills, l981; Hogarty, 1993), policy makers and scholars need to explore and address the reasons why small business owners encounter these problems. Perhaps small business owners are stubborn and refuse to do the feasibility assessments that would uncover the product or service idea's fatal flaw. It is also likely that many small business owners do not know how to conduct such assessments or know how to apply the variety of marketing techniques available to generate market demand. If lack of awareness is a major barrier, then public policy makers should give more attention to technical assistance programs. Perhaps there is a problem with the delivery of such assistance programs in that small business owners believe professionals cannot understand the special needs of smaller-scaled marketing. These speculations indicate a need for more research about the small business owners' attitudes and behaviors regarding marketing principles and practices.
The in-depth interviews suggested that the offer of technical assistance is greeted with some suspicion by potential clients. Part of the suspicion arises from the fact that many small business owners are very concrete thinkers who have little patience with abstract thought and general principles (Taub & Taub, 1989). Since the problems in each industry are slightly different, many of these business people feel that general theory applied to their businesses somehow misses the point. Usually, small business owners want advice that feels specific to their industry or situation, even if it is for something as standardized as bookkeeping. They want advice from people who appreciate the minute details and flow of their specific businesses. More often than not, small business owners are right in their misapprehensions. While it may be possible to create effective standardized accounting and order-taking systems, it is doubtful that a generic advertising program or package can really work except in the hands of a sophisticated marketer who can customize by careful consideration of the target market, reach, impact, and other key variables.
Getting customers may be the most serious problem encountered during startup but it also remains a major concern as the business grows (see Table 4). However, more small business owners in this sample perceive money to be the biggest problem they have post-launch. The in-depth interviews revealed that, for some, the lack of cash was the result of poor planning and failing to take into account the time needed before sales converted into cash. However, for many of these small business owners, the lack of cash arose from unanticipated success.
Most traditional lenders believe growth should be financed from cash flow and tend to balk at practices like asset-based lending. However, this type of innovative credit frequently enables small business owners to increase sales volume and profitability. Our surveys have uncovered several examples of the positive impact of asset-based lending. In two cases, loans to buy raw materials (which makes traditional lenders uncomfortable for obvious reasons concerning collateral) enabled these companies to grow their sales by 25% in one year. In another case, a business owner found he could not bid on a production contract until he augmented his labor force by 25%. The loan enabled him to pay workers before the company received payment. This tactic transformed the business from that of a local company with a few nearby clients to a major national player. Despite these success stories, asset-based lending is not easy to obtain even though it is generally acknowledged that startup businesses in their growth phase do not always meet traditional lending criteria.
The experience gained from following business development in Southern Arkansas indicate that all small business owners need help in order to successfully launch their ventures. However, it does not necessarily follow that all small business owners only need financial help. It is important to realize that small business owners are not an homogenous group. Some start small because they intend to remain small; their goal is to be self-employed. Such people may not need financial assistance; they do need marketing and legal assistance as well as sound training in accounting and other management practices in order to sustain themselves. Practical and cost effective programs need to be developed to address their needs because self-employed people represent an important segment in economic revitalization.
Another segment is represented by those individuals who start small and actually intended to stay small until an opportunity crashed into their places of business. These people have the insight and desire to capitalize on the opportunity yet lack the expertise and financial resources to do so. They need a full compliment of technical and financial assistance in order to succeed. Still other small business owners may want to start small, perhaps as a pilot test, but envision rapid growth. These owners are willing to risk their personal savings on outright failure but oddly enough, encounter their greatest risks when the business forecast is positive. They need financial assistance during that middling phase when it appears the business will be successful but is too young to have a sound, credit-worthy track record. Delaying growth for the sake of building a track record may in fact destroy the venture's competitive advantage. Asset-based lending programs like the US Small Business Administration's "Green Line" seem particularly suited to the financial needs of these kinds of rapid-growth new ventures but the recent changes in compliance procedures significantly reduce the appeal of the program for new entrepreneurs. This group needs the aggressive lending programs as originally conceived by public policy makers. Yet they seem to be reluctant to draw upon this resource. We need to know more about why this is so.
The data suggest the need for technical assistance in both the beginning and established stages of young ventures may be stronger than expected. This may be especially true in economically underdeveloped areas that do not have the advantage of relying on other companies and industries to develop a vibrant customer base. However, more research is needed to understand the nature of these assistance needs and why potential clients do not avail themselves of existing programs. The design of user-effective programs and service delivery is especially important as regional development budgets shrink.
Public policy programs designed to facilitate economic development through new venture creation must acknowledge the diversity of entrepreneurial goals and recognize that credit by itself may not be that serious a constraint for all small business owners. What does seem to be true is that in early phases of companies, technical assistance is at least as important as finance. This is true particularly in the areas of marketing and management. After a company has been operating for a while, finance grows in relative importance. Nonetheless, the importance of providing technical assistance does not go away. The challenge for public policy is to figure out how to make that technical assistance cost effective and attractive to entrepreneurs who frequently are reluctant to turn to outsiders for advice.
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Hills, G.E. (1985). Market analysis in the business plan: Venture capitalists' perceptions. Journal of Small Business Management, 23(1), 38-46.
Hills, G.E. (1981). Evaluating new ventures: A concept testing methodology. Journal of Small Business Management, 19(4), 29-41.
Hogarty, D.B. (1993). Beating the odds: Avoid these mistakes at all costs! Management Review, 82(2), 16-21.
Taub, R.P. & Taub, D.L. (1989). Entrepreneurship in India's small scale industries.
Riverdale, MD: Riverdale.
Timmons, J.A. (1994). New venture creation. Burr Ridge, IL: Irwin.
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