Prediction #2: There Will Be Small Business Banks
The narrative of this book begins with the fact that small businesses are important, but often get less attention than they deserve. In lending, small business products and services are sometimes treated as the poor cousins of larger consumer lending divisions. In the future, this will not be the case. The future winners in small business lending will be the players, new or old, that focus on understanding and serving the unique needs and operations of small businesses. With low-cost digital banks able to serve a national footprint, specialized banks providing best in class services will become a new competitive factor.
These small business banks of the future will provide an integrated gateway to loans, lines of credit, payments platforms, business intelligence, and numerous other products and services. They will create easy to use digital experiences that cater to the time-strapped small business owner and automate functions that used to require paperwork or a physical trip to the branch. Yet, they will not abandon personal relationships. Whether it is by telephone, online, or in person, the successful players will find ways to feed the insatiable need of small business owners for personal advice and counsel. The solutions could be as traditional as the Chase BizMobileTM bus (Chapter 8) or as new as the peer advisory groups on Alignable’s small business network.
As online banks take hold, there will be small business banks with vertical specializations. By focusing on specific industries, these banks will improve their expertise in underwriting and their ability to deliver more customized services and advice. For example, imagine new financial services entities ready to support restaurants, electricians, or dentists, and building custom financial dashboards and loan products adapted to that small business segment. As the best solutions emerge, word of mouth, facilitated by online small business communities, will send customers flocking to the provider.
In the longer term, digitization in small business credit will put pressure on borrowing rates and profit margins. As options are increasingly transparent and comparable, business owners will be able to more easily find their way to products that meet their needs. As demonstrated by some consumer sectors such as insurance and mortgages, this trend will commoditize products and services as customers demand comparable features and simple interactions. Banks and other financial services providers will need to have at least a base level of competitive loan products and be conduits to other specialized options if they want to maintain their role as the primary source of capital to small businesses in the future.
Prediction #3: Regulation Will Fail to Keep Up
While it would be ideal for policymakers to be proactive, history shows that human nature is more often prone to reaction. Congress in particular is a reactive body, if only because voters reward elected officials for responding to problems, rather than preventing them from happening. U.S. financial regulatory agencies have the advantage of greater independence from Congress and the executive branch, including independent funding in some cases. This gives them greater latitude to be proactive, and sometimes they are. But fixing the fragmented structure of U.S. financial regulation, with its overlapping and duplicative jurisdictions, will require well-coordinated, forward-thinking policy and true bipartisan commitment.
Therefore, we expect that regulation will struggle to keep up, to the detriment of the market, allowing bad actors to prey on unsuspecting small businesses and fueling a confusing and costly regulatory environment. Unintended consequences in a world of increased data usage, such as privacy issues and disparate impact, will also result if policymaking does not become more proactive.
Fintech, Small Business & the American Dream
The view of this book is largely optimistic. Additional data and efforts to innovate in small business lending markets are generally good trends, which we predict will have a positive impact on small business outcomes. The entry of fintech entrepreneurs has awakened the competitive instincts of banks and traditional lenders, who have realized that they don’t want to cede the small business market to the new disruptors. Large technology companies have also demonstrated that they view small business lending as an important place to play. This heightened competition is good for small businesses, who too often have been an afterthought for lenders, in the shadow of consumers and large businesses.
Of course, the full picture of the future is not entirely rosy. The U.S. regulatory system in its present state is ill-equipped to protect small business owners, and political realities seem likely to prevent simplification of the current morass of rules. Nonetheless, we could be on the brink of one of the most positive transformations in small business lending in at least a century. As new entrepreneurs enter, and older players innovate, the attention will be on understanding what small businesses want and delivering new options that will make it easier for small businesses to succeed.
There is a long debate within economics about the degree to which finance causes economic growth, as opposed to just following economic activity. In a seminal 1997 article, Ross Levine outlined several key functions performed by the financial sector that drive economic growth, including allocating capital.9 Levine saw the development of financial markets as a critical influence on growth, and not as an inconsequential or passive “side show.” Thus, innovations that reduce frictions in critical functions like lending and make financial markets work better are a positive force that should drive more prosperity. From the evidence we see today, fintech may be just such a force for small business lending and the small businesses that depend on America’s financial markets for their growth and success.
* * *
Ten years ago, Ron Siegel decided to start a bakery, and wondered what he would call his new business. “It was difficult and scary to break out of my daily work routine to pursue a dream that had an unknown outcome,” Ron said. “The name ‘When Pigs Fly’ means ‘I doubt it’s possible’ and that’s why it was the perfect name for my bakery.”10 Today, Ron tells his story on the packages of millions of loaves of his bread. And following in the footsteps of Dumuzi-gamil, our bread distributor from Mesopotamia, “When Pigs Fly” sells its bread all over New England from its operating plant in York, Maine.
The American spirit of entrepreneurship has been a defining element since the founding of our nation. Today, innovators have brought new ideas and technology to the small business lending market and, as we have described in this book, a consequential transformation has begun. The outlook for small businesses is getting brighter, as these changes create more opportunities for people like Ron to do what often seems impossible—open and operate a small business and successfully pursue the American Dream.
Notes
Chapter 1
1. Interview with Frank Rotman of QED Investors, April 13, 2018.
2. The Dodd-Frank Wall Street Reform and Consumer Protection Act was the U.S. Congress’ main legislative action that changed regulations after the financial crisis of 2008.
Chapter 2
1. Lydia Saad, “Military, Small Business, Police Still Stir Most Confidence,” Gallup , June 28, 2018, https://news.gallup.com/poll/236243/military-small-business-police-stir-confidence.aspx .
2. https://www.youtube.com/watch?v=00wQYmvfhn4 .
3. Paul M. Romer, “Implementing a National Technology Strategy with Self-Organizing Industry Investment Boards,” Brookings Papers on Economic Activity: Microeconomics , no. 2 (1993): 345, https://www.brookings.edu/wp-content/uploads/1993/01/1993b_bpeamicro_romer.pdf .
4. Robert Atkinson and Howard Wial, “Boosting Productivity, Innovation, and Growth through a National Innovation Foundation,” Brookings Institution and Information Technology and Innovation Foundation , April 2008, https://www.brookings.edu/wp-content/uploads/2016/06/NIF-Report.pdf .
5. J.A. Schumpeter, The Theory of Economic Development (Cambridge, MA: Cambridge University Press, 1934).
6. Erik Hurst a
nd Benjamin Wild Pugsley, “What Do Small Businesses Do?,” Brookings Papers on Economic Activity, 2011 , no. 2 (2011), https://www.brookings.edu/wp-content/uploads/2011/09/2011b_bpea_hurst.pdf .
7. J. John Wu and Robert D. Atkinson, “How Technology-Based Startups Support U.S. Economic Growth,” Information Technology and Innovation Foundation , November 2017, https://itif.org/publications/2017/11/28/how-technology-based-start-ups-support-us-economic-growth .
8. “Consumers Now More Willing to Go Out of Their Way to Support Small Businesses,” UPS Store , May 12, 2014, https://www.theupsstore.com/about/pressroom/consumers-support-small-businesses .
9. “American Express Teams Up with Shaquille O’Neal and Friends to Drive Card Members to Shop Small and Earn Big Rewards,” American Express , November 10, 2016, https://about.americanexpress.com/press-release/american-express-teams-shaquille-oneal-and-friends-drive-card-members-shop-small-and .
10. “MIT Work of the Future: Perspectives from Business and Economics,” Video (Cambridge, MA: MIT Technology Review, 2018), https://www.technologyreview.com/video/611340/mit-work-of-the-future-perspectives-from-business-and-economics/ . Note: Solow observes that the share of national income going to wages and salaries has fallen from 75 percent to 62 percent over the past few decades, perhaps requiring that we change our paradigm when it comes to jobs being the main way the economy drives income distribution.
11. “United States Small Business Profile, 2018,” U.S. Small Business Administration Office of Advocacy , 2018, https://www.sba.gov/sites/default/files/advocacy/2018-Small-Business-Profiles-US.pdf .
12. “Frequently Asked Questions about Small Business,” U.S. Small Business Administration Office of Advocacy , August 2018, https://www.sba.gov/sites/default/files/advocacy/Frequently-Asked-Questions-Small-Business-2018.pdf .
13. “Business Employment Dynamics—Table E. Quarterly Net Change by Firm Size Class, Seasonally Adjusted,” Bureau of Labor Statistics , last modified July 25, 2018, https://www.bls.gov/bdm/bdmfirmsize.htm .
14. David Madland, “Growth and the Middle Class,” Democracy Journal , no. 20 (Spring 2011), https://democracyjournal.org/magazine/20/growth-and-the-middle-class/ .
15. William Easterly, “The Middle Class Consensus and Economic Development,” Journal of Economic Growth 6, no. 4 (July 2001): 317–335, https://williameasterly.files.wordpress.com/2010/08/34_easterly_middleclassconsensus_prp.pdf .
16. Ben Hubbard and Kate Kelly, “Saudi Arabia’s Grand Plan to Move Beyond Oil: Big Goals, Bigger Hurdles,” New York Times , October 25, 2017, https://www.nytimes.com/2017/10/25/world/middleeast/saudi-arabias-grand-plan-to-move-beyond-oil-big-goals-bigger-hurdles.html .
17. Daron Acemoglu, Ufuk Akcigit, Harun Alp, Nicholas Bloom, and William Kerr, “Innovation, Reallocation and Growth,” Becker Friedman Institute for Research in Economics Working Paper , no. 21, December 1, 2017, https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3079898 .
18. Edward L. Glaeser, Sari Pekkala Kerr, and William R. Kerr, “Entrepreneurship and Urban Growth: An Empirical Assessment with Historical Mines,” Review of Economics and Statistics 97, no. 2, May 2015, https://www.mitpressjournals.org/doi/abs/10.1162/REST_a_00456?journalCode=rest .
19. Anthony Breitzman and Diana Hicks, “An Analysis of Small Business Patents by Industry and Firm Size,” SBA Advocacy , no. 335 (2008): 6, https://rdw.rowan.edu/cgi/viewcontent.cgi?referer=https://www.google.com/&httpsredir=1&article=1011&context=csm_facpub .
20. Mirjam Van Praag and Peter H. Versloot, “What is the Value of Entrepreneurship? A Review of Recent Research,” Small Business Economics , no. 29 (2007): 351–382, https://link.springer.com/content/pdf/10.1007%2Fs11187-007-9074-x.pdf .
21. William R. Kerr, Ramana Nanda, and Matthew Rhodes-Kropf, “Entrepreneurship as Experimentation,” Journal of Economic Perspectives 28, no. 3 (Summer 2014): 25–48, https://pubs.aeaweb.org/doi/pdfplus/10.1257/jep.28.3.25 .
22. Elizabeth Brown and Austin Nichols, “Self-Employment, Family-Business Ownership, and Economic Mobility,” Urban Institute , May 2014, https://www.urban.org/sites/default/files/publication/33841/413134-self-employment-family-business-ownership-and-economic-mobility.pdf .
23. Ben R. Craig, William E. Jackson, and James B. Thomson, “Small Firm Finance, Credit Rationing, and the Impact of SBA-Guaranteed Lending on Local Economic Growth,” Journal of Small Business Management 45, no. 1 (2007): 116–132, https://papers.ssrn.com/sol3/papers.cfm?abstract_id=984724 .
24. William R. Kerr, The Gift of Global Talent: How Migration Shapes Business, Economy & Society (Palo Alto, CA: Stanford University Press, 2018).
25. “The 2017 Kauffman Index of Startup Activity: National Trends,” Kauffman Foundation , May 2017, https://www.kauffman.org/kauffman-index/reporting/startup-activity .
26. Adam Bluestein, “The Most Entrepreneurial Group in America Wasn’t Born in America,” Inc ., February 2015, https://www.inc.com/magazine/201502/adam-bluestein/the-most-entrepreneurial-group-in-america-wasnt-born-in-america.html .
27. “United States Small Business Profile, 2018,” U.S. Small Business Administration Office of Advocacy , 2018, https://www.sba.gov/sites/default/files/advocacy/2018-Small-Business-Profiles-US.pdf .
28. Note: In 2016, 15.4 million people were reported as self-employed. Some of them operated firms that had employees. However, given that there were only 5.9 million employer firms in 2016, most of the self-employed were likely also non-employer firms. As an estimate, 12 million or approximately half of the 24 million non-employer firms were full-time jobs for their owners, while the others were side businesses. Data for “Nonemployer businesses” is taken from the Nonemployer Statistics at the U.S. Census Bureau ( https://www.census.gov/programs-surveys/nonemployer-statistics/data/tables.All.html ); Data for Unincorporated Nonemployer Businesses is taken from the Bureau of Labor Statistics table on Self-employed workers, unincorporated (not seasonally adjusted), ( https://www.bls.gov/webapps/legacy/cpsatab9.htm ).
29. Note: Aggregate firm data is taken from the Census Bureau’s Statistics of U.S. Businesses (SUSB) data tables: https://www.census.gov/programs-surveys/susb.html . Subcategories are derived from the supply chain categorization of the economy developed in Mercedes Delgado and Karen G. Mills, “A New Categorization of the U.S. Economy: The Role of Supply Chain Industries in Innovation and Economic Performance,” MIT Sloan Research Paper, no. 5241-16, December 11, 2018, http://dx.doi.org/10.2139/ssrn.3050296 . The supplier category includes only supply chain traded firms. For the purpose of this figure, supply chain local firms are included in the Main Street category.
30. Lawrence F. Katz and Alan B. Krueger, “The Rise and Nature of Alternative Work Arrangements in the United States, 1995–2015,” National Bureau of Economic Research , September 2016, http://www.nber.org/papers/w22667 .
31. Ian Hathaway and Mark Muro, “Tracking the Gig Economy: New Numbers,” Brookings , October 2016, https://www.brookings.edu/research/tracking-the-gig-economy-new-numbers/ .
32.Note: For example, from 2016 to 2017, the number of non-employer businesses grew by 482,000, while the number of self-employed grew by 179,000.
33. Mercedes Delgado and Karen Mills, “A New Categorization of the U.S. Economy: The Role of Supply Chain Industries in Innovation and Economic Performance,” MIT Sloan Research Paper , no. 5241–16, December 11, 2018, http://dx.doi.org/10.2139/ssrn.305
0296 . Note: This paper estimates a new industry categorization that separates supply chain (SC) industries (i.e. those that sell primarily to businesses or government) from business-to-consumer (B2C) industries (i.e. those that sell primarily to consumers). To our knowledge, this is the first systematic quantification of the supply chain economy. The supply chain includes both manufacturers, and importantly, service providers. It is a large and distinct sector with higher wages and a higher degree of innovative capacity than B2C industries. See also: Mercedes Delgado and Karen Mills, “Policy Briefing: The Supply Chain Economy: A New Framework for Understanding Innovation and Services,” October 2017, https://innovation.mit.edu/assets/MITii_Lab_Supply-Chain-Economy_FINAL.pdf .
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