Is government regulation hampering small business’ access to capital? That’s one conclusion you could draw from a study just released by the Pepperdine Private Capital Markets Project.
PPCMP’s Summer 2011 report shows that bank loans are the most desirable source of financing for small businesses, with 48 percent of the 1,221 privately held businesses responding to the survey seeking them as a source of funding. The next most desirable source of funding—friends and family—was far behind at 21 percent. Just 11 percent of businesses were seeking private investors.
But while small businesses are yearning for bank loans, banks aren’t responding in kind. In fact, the majority (60 percent) of loan applications by small businesses are denied. What’s more, 61 percent of banks say that’s because increased regulatory pressures have left them leery of making any loan that regulators could deem risky—even loans banks would normally feel quite comfortable making.
“Privately held business owners favor bank loans among all types of capital because they are typically the cheapest, and banks are generally passive investors,” said Dr. John Paglia, lead researcher of the Pepperdine Private Capital Markets Project and associate professor of finance at Pepperdine University’s Graziadio School of Business and Management. “Banks on the other hand report feeling increased pressure from regulators to avoid making risky loans and because of that they are denying loans that otherwise would have been accepted. The result is that small business owners are left without access to capital.”
In past PPCMP studies, small businesses rejected by banks have typically turned to friends and family. However, in contrast to the Winter/Spring 2010 report, in which 56 percent of businesses turned to friends and family, nearly three-fourths (71 percent) of the business owners responding to the current survey said they did not seek friends and family financing after being denied a bank loan.
Instead, many entrepreneurs turned to credit cards—but once that option was tapped out, 81 percent of respondents who had exhausted their credit card resources still did not seek financing from friends and family.
“Where do small business owners turn for funding?” Paglia asked. “With friends and family becoming seemingly tapped out, small businesses may continue to target bank loans, hoping that regulatory pressure eases.”
Perhaps one place will be private investors. Some 82 percent of survey respondents in the private equity industry believe the demand for business investment will grow over the next 12 months. In what could be more positive news for small businesses, 43 percent predict average investment size will increase, and 47 percent say investors’ appetite for risk will increase. If banks are reluctant to take risks, and entrepreneurs are reluctant to ask their friends and family to take risks, perhaps private investors with a growing appetite for risk will pick up the slack.
Download the full study at the Pepperdine University website.