Small Business

Why small businesses don't want a loan

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Fed Chair Janet Yellen revealed to Congress this week that demand is not "very high" for small business loans, adding that some of this may be due to uncertainties caused by the financial crisis and the fact that home values have fallen so much.

Yellen's comments come at an interesting time in the world of small business, where, by several indicators, there is still a fair amount of optimism.

For example, the Wells Fargo and Gallup Small Business Survey for January was also at a seven-year high, and a separate report from Dun & Bradstreet Credibility Corp. and Pepperdine University, the quarterly Private Capital Access (PCA) index, also showed an increase in optimism, with small business owners expecting better financial performance, hiring projections and wages. But the latter index showed loan demand down 12 percent from when the index began in the second quarter of 2012, and 52 percent of business owners said they would not seek financing in the next six months.

How can optimism be higher if loan demand is low? It's largely because of how bad things got for small businesses during the financial crisis, and that today's conditions, while not as robust as they had been, look pretty good to small business owners. What's more, some owners are increasingly looking to financing alternatives, outside of traditional bank loans.

National Federation of Independent Businesses' Chief Economist Bill Dunkelberg said his group finds more than half of small business owners say flat out they are not interested in obtaining a loan.

"Optimism isn't really up and running," Dunkelberg said. "We've gotten so used to bad numbers that today's numbers look good. Small businesses haven't had a good enough reason to go out and borrow money and invest heavily yet."

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Historically low interest rates haven't been a driver for smaller companies either. Dunkelberg said it's less about the rate and more about the necessity.

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"Low interest rates are nice, but you have to still invest that money—the prospects that drive loan demand aren't tied to interest rates," he said.

And more business owners are able to operate with their current cash flows. This may be, in part, what is driving optimism higher, said Jeff Stibel, CEO of Dun & Bradstreet Credibility Corp.

Other small business owners are turning to alternative lenders—this has given rise to the success of companies like Prosper and Lending Club. The size of the nonbank financial system is estimated to be at $3.2 trillion in the U.S., according to the Bank for International Settlements, and will continue to grow especially for smaller businesses, according to Stibel.

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"Alternative lending is a big deal and it's becoming an even bigger deal for the smallest businesses with revenues under $5 million. The latest PCA Index found that 3.4 percent of businesses with $5 million or less in revenue attempted to raise financing via an online marketplace lender in Q1 2015, compared to 2 percent of larger businesses with $5 million to $100 million in revenue," Stibel said in an email message. "We can expect that share to grow as more small businesses become more aware of these financing sources."

At some point though, demand for loans, no matter the source, will have to increase, as more business owners are planning to invest and expand, according to Dunkelberg.

"We've seen plans for capital outlays going up, so they will have to see more borrowing to finance that," he said. "If consumption picks up, will we spend more money and have to borrow more money to finance the business?"