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SEC Report Reflects “Banner Year” in Small Business Capital Raising, Though Challenges Remain

  • Report from Securities and Exchange Commission analyzes the state of small business capital access after the start of the COVID-19 pandemic
  • Early-stage companies often grapple with finding adequate knowledge and networks, and barely over one-third apply for financing
  • Women and minorities becomes more prominent among entrepreneurs, but inequities persist

Summary by Dirk Langeveld

Small businesses have experienced a “banner year” in capital raising, according to an annual report from the Securities and Exchange Commission’s Office of the Advocate for Small Business Capital Formation. However, the report also highlights persistent inequities and other challenges.

The report looks at trends affecting small and emerging companies, mature and later stage small companies, small public companies, small companies owned by women and minorities, small rural companies, and the effect of natural disasters on small businesses. The report covers a period from July 1, 2020 to June 30, 2021 and uses information from SEC public filings as well as third party figures.

“The past year has been a banner year for capital raising in the aggregate; however, that headline only tells part of the story,” said Martha Legg Miller, director of the SEC’s Office of the Advocate for Small Business Capital Formation. “For every headline on a successful founder’s seed round or IPO, there are countless entrepreneurs who are struggling. Our report examines the challenges of navigating the inside baseball world of capital raising, bridging founders’ personal networks to sophisticated investors, building first-time funds in the middle of the country, or determining which exit path to pursue, and our team proposes solutions to each of these issues.”

While several reports have highlighted new business growth as people pursue entrepreneurial ambitions out of necessity or due to a desire to change careers, the SEC report found that entrepreneurship dipped in 2020 in both the total entrepreneurial activity rate and established business ownership rate. However, a record 1 million “high propensity businesses,” or those likely to hire employees, were established in the first half of 2021.

Startup capital

Early-stage entrepreneurs face numerous handicaps compared to later stage ones, according to the report. Half of them experience challenges with information, knowledge and education; this was twice the rate of established entrepreneurs, and the SEC found a similar share of early-stage entrepreneurs facing challenges with networks and connections. Just 17 percent used bank loans or venture capital to launch a business, and running dry on cash and an inability to raise new capital was the main reason that early-stage ventures fail.

When seeking an external source of funding, 89 percent of small business startups use a loan or line of credit. This was well above the next most common external sources of funding: credit cards (21 percent) and trade credit (8 percent).

While online lenders and fintech have grown more popular among entrepreneurs, with 11 percent of startups using them for a source of funding, banks remained the predominant source of financing. Eighty-three percent of entrepreneurs used a large or small bank to acquire funding, followed by 23 percent using a financial services company and 12 percent using a credit union.

However, just 37 percent of early-stage entrepreneurs sought financing and only 14 percent of of overall early-stage entrepreneurs received all of the funding they sought. Six percent received most of their desired funding, 8 percent received some, and 9 percent received none.

Sixty-three percent of early-stage entrepreneurs did not apply for credit. One-third of early-stage entrepreneurs overall opted not to do so because they already had sufficient funding. Sixteen percent did not do so because of an aversion to debt, 8 percent were discouraged, and 6 percent decided against it for other reasons.

Among those discouraged, 44 percent said they didn’t think they would qualify for financing because of insufficient cash flow. Forty-one percent said they did not have sufficient collateral, while 36 percent said they had too much debt.

Angel investors were playing a greater role in supporting early-stage companies, with 334,680 active angels funding 64,480 enterprises with an aggregate total of $25.3 billion. The number of active angels was up 3.5 percent from 2019, while the number of enterprises funded grew by 1.5 percent and the funding amount increased by 6 percent. However, just 6 percent of early-stage entrepreneurs received equity investment capital.

It was a record year for crowdfunding overall, with 1,151 offerings – a year-over-year increase of 61 percent. These efforts had a 64 percent success rate, and 40 percent of company founders seeking crowdfunding were women or minorities. The campaigns raised a total of $232.9 million, up 86 percent from the year before.

Women and minorities

Forty-one percent of new entrepreneurs in 2020 were women. One in four women entrepreneurs were the sole source of income for their household, and three-quarters said they contributed at least half of their household income.

The report highlighted the disproportionate impact of child care responsibilities on women entrepreneurs. While just 11 percent of women business founders reported that they were responsible for seven hours or more of child care before the pandemic, the share shot up to 56 percent during the pandemic. The report found that the share of men business founders with this amount of child care responsibility was 0 percent before the pandemic and only rose to 11 percent during the pandemic.

Despite the added responsibilities, women-owned businesses reported no additional negative impact on their revenues when compared to men-owned businesses.

Inequity has persisted in angel deals, though it has improved for women in recent years. One-third of women entrepreneurs sought angel funds in 2020, up from 27.6 percent in 2019. Women had an investment yield rate of 28.1 percent in 2020, up from 21.4 percent. However, just 2.3 percent of venture dollars went to women-owned businesses in 2020, while 10.8 percent want to co-founding teams with both women and men.

The report says capital access remains a major challenge for minority entrepreneurs. Black and Hispanic founders start with 1.5 to 2.75 times less liquid wealth than White ones, are less likely to rely on personal or family savings, and have fewer networking connections to banks, venture capital, or informal capital. The denial rate for loans, lines of credit, or cash advances was 49 percent for Black borrowers, 39 percent for Hispanic borrowers, 30 percent for Asian borrowers, and 22 percent for White borrowers.

Despite these challenges, minorities have grown as a share of overall entrepreneurs in recent decades. Hispanic entrepreneurs account for 21.7 percent of businesses in 2021, more than twice the share of 10 percent in 1996. Black-owned businesses account for 13.1 percent of all businesses, up from 8.4 percent in 1996.

Minorities represented just 5.3 percent of firms seeking angel capital in 2020, down from 9.3 percent in 2019. However, their investment yield rate has increased from 22 percent to 33 percent.

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