Print version (178 KB PDF)

Financial Services Used by Small Businesses: Evidence from the 2003 Survey of Small Business Finances

Traci L. Mach and John D. Wolken, of the Board's Division of Research and Statistics, prepared this article. Courtney M. Carter, John A. Holmes, and Lieu N. Hazelwood provided research assistance.

Small businesses--nonfarm entities with fewer than 500 employees--are an integral part of the U.S. economy. They account for about half of private-sector output, employ more than half of private-sector workers, and have generated 60 percent to 80 percent of net new jobs annually over the past decade.¹ Given the significant role of small businesses in the national economy, understanding trends in the types and sources of financing they use is important for economic research and policymaking, especially because small businesses typically finance their operations quite differently than large corporations do. For example, a small business often relies on the personal resources and credit history of the firm's owners to access credit.

Newly available data from the Federal Reserve Board's 2003 Survey of Small Business Finances (SSBF) provide detailed information on the use of credit and other financial services by these firms. The SSBF is the most comprehensive source of information available on the characteristics of small businesses and their owners; no other survey provides the breadth and detail of information for a nationally representative sample of such firms. Moreover, policymakers and researchers can compare the newest SSBF data with results from the previous surveys, which cover 1987, 1993, and 1998. Most of the changes reported in this article are for the period between the 1998 and 2003 surveys.²

The latest survey gathered data from 4,240 firms selected to be representative of small businesses operating in the United States at the end of 2003.³ As in previous surveys, the data show that most businesses were very small and were located in urban areas. Also as in previous surveys, the percentage of firms involved in the provision of business and professional services increased somewhat, whereas the percentages of firms engaged in manufacturing and in retail and wholesale trade declined. Among firms that were corporations, those organized under subchapter S of the U.S. Internal Revenue Code (S corporations) continued to grow as a proportion of all small businesses relative to those organized under subchapter C (C corporations).⁴

The financial affairs of small business in 2003 were conducted in a financial marketplace whose elements--including regulations, technology, and organizational structures--have changed markedly since the Federal Reserve Board's first small business survey. For example, state and federal restrictions on interstate branching and banking have been relaxed, certain financial institutions are now permitted to offer a wider range of financial services, lenders employ complex credit-scoring models to evaluate would-be borrowers, and mergers and acquisitions have produced a financial industry with fewer but larger organizations.

In this changing financial marketplace, small businesses have been diversifying their providers of financial services. Nondepository institutions have become increasingly important sources of financial services to small businesses; more than half reported using nondepository sources in 2003, compared with about 40 percent in 1998. Among these sources, finance companies and leasing companies were important suppliers of credit and financial management services, especially for the largest small businesses, and brokerage firms were important suppliers of brokerage and trust and pension services. Nonetheless, commercial banks continued to be, by a wide margin, the supplier most commonly used by small businesses for checking and savings accounts, for loans other than leases and vehicle loans, and for financial management services other than brokerage and trust and pension services. They were the second most commonly reported provider of vehicle loans and trust and pension services.

The types of credit used by small businesses have also been changing. The percentage of firms that had outstanding vehicle loans and credit lines increased between the 1998 and 2003 surveys; the use of capital leases declined somewhat; and the use of equipment loans, mortgages, and other loans remained about the same. The use of personal credit cards for business purposes remained roughly constant, whereas the use of business credit cards increased substantially.

This article focuses on some of the major results from the 2003 SSBF for broad subgroups of small businesses.⁵ Understanding and explaining many of the findings may require a more-detailed and in-depth analysis than is possible in this article. To facilitate additional research, a micro-level data set for public use will be released shortly after the publication of this article.⁶ These data will permit a rigorous analysis that takes into account characteristics of the businesses, their owners, and local banking markets. Researchers will be able to study many aspects of small business finance, including, for example, how the proximity of financial institutions affects the mix of financial products the firm uses, which characteristics of firms and owners affect the ability of small businesses to obtain credit, and how lending patterns vary with these characteristics.

Return to contents

Economic and Financial Services Environment

In 1998 the economy was in its seventh year of sustained economic expansion. The annual unemployment rate had fallen to 4.5 percent; the consumer price index rose 1.6 percent, gross domestic product grew 4.4 percent, and productivity in the nonfarm business sector increased 2.7 percent.

In 2003 the economic climate for small businesses was quite different than in 1998. A recession in 2001 was followed by a sluggish recovery. By the end of 2003, the pace of economic activity was picking up, although many small businesses were likely still feeling some effects from the subpar performance in the preceding few years. Many small businesses had failed, and those that had weathered the period were probably facing declining revenues. Health-care costs had increased sharply, venture capital opportunities had declined, and banks had instituted new fees and raised existing fees and balance requirements. At the same time, interest rates in 2003 were lower than they had been in decades; these low rates made relatively low cost new loans available and provided opportunities for substantial savings from refinancing.

These differences in the overall economy between the two most recent surveys are reflected in the problems reported by firms (table 1). In 2003, poor sales topped the list, particularly among the smallest firms. In 1998, firms reported that their most important problems were competition from other firms and the quality of labor. The quality of labor remained a commonly reported concern in 2003, especially among firms with ten or more employees. The 2003 survey also recorded a marked increase in the percentage of firms reporting the cost and availability of insurance as their most important problem.Skip table

Return to contents

Characteristics of Small Businesses

Like its predecessors, the 2003 SSBF collected a wide variety of information about firms and owners, including the firm's size, primary industry, and organizational structure and the owners' race, ethnicity, sex, and extent of participation in the firm (table 2).Skip table

The composition of small businesses has remained largely unchanged between the 1998 and 2003 surveys. The large majority continued to be very small and owner-managed. More than 80 percent of firms employed fewer than ten workers, and less than 3 percent employed fifty or more.⁷ More than 70 percent of firms had annual sales of less than $500,000, and more than 80 percent had assets of less than $500,000. Finally, more than 85 percent conducted business out of a single location, and the vast majority of owners (94 percent) managed day-to-day activities themselves.

In 2003, 47 percent of all small businesses were corporations (31 percent were S corporations and 16 percent were C corporations), 45 percent were proprietorships, and the remaining 9 percent were partnerships. The proportion of S corporations relative to C corporations has grown since 1993, when they accounted for 20 percent and 30 percent, respectively, of all small businesses. A portion of this shift may be attributable to the Small Business Job Protection Act of 1996, which liberalized the rules for subchapter S qualification.⁸

Service industries (both business and professional services) accounted for the largest fraction--46 percent--of small businesses' primary activities, and 18 percent of all firms were primarily in retail trade. This distribution is similar to that in 1998; between the two surveys, small increases were observed in business and professional services and small decreases in manufacturing and retail and wholesale trade.

The geographic distribution of the firms corresponded closely to the distribution of the population: 35 percent in the South, 24 percent in the West, 21 percent in the Midwest, and 20 percent in the Northeast.⁹ About 79 percent of firms had their headquarters or main office in an urban area, and the remaining 21 percent were in rural areas. The vast majority of the firms (95 percent) conducted business primarily within the United States, and the remaining 5 percent operated internationally.

Number and Ownership Shares of Small Business Owners

Information on the owners of the firm was collected differently for the 2003 survey than it had been previously. In the past, characteristics of owners were collected only for the owner with the largest share, and respondents were asked whether a majority of firm owners were Hispanic, nonwhite, or female. The 2003 survey followed the lead taken by the U.S. Census Bureau in its Survey of Business Owners and collected demographic information on up to three owners.¹⁰ Respondents were asked to report first on the individual with the largest ownership share (referred to in this article as the first owner); if that individual did not have a controlling interest in the company (an ownership share of at least 51 percent), information was also collected on up to two additional owners.

This new method confirmed the implicit assumption under which previous information was collected about firm owners: Small businesses are very closely held. The average firm had only three owners, and the owner with the largest share held an 81.5 percent interest in the firm (table 3). The largest differences in ownership dispersion of the firms can be seen across organizational type and firm size. Among partnerships, the average firm had 2.9 owners, and the partner with the largest share controlled 52.3 percent of the firm. Compared with partnerships, C corporations had more owners (10.2 on average), but the largest owner held a larger share of the firm (73.0 percent). S corporations had 2 owners on average, with the largest shareholder controlling 76.6 percent of the firm.Skip table

The average number of owners increased with the number of employees: The smallest firms (0-1 employees) had an average of 1.2 owners; intermediate-sized firms (5-19 employees and 20-49 employees) had 2.4 and 8.7 owners respectively; and the largest firms (100-499 employees) had 13 owners. The ownership share of the first owner decreased as the number of owners increased, from 94.6 percent among the smallest firms to 62.9 percent among the largest.

Race, Ethnicity, and Sex of Small Business Owners

The race, ethnicity, and sex of the ownership of a small business in the survey were defined by the weighted sum of the characteristics of the firms' owners.¹¹ Unlike in previous years, owners were allowed to identify themselves as being of more than one race, and therefore firms could be classified as being of more than one race. For firms in which less than 100 percent of the ownership was reported, characteristics were scaled up by a factor that made the reported ownership equal 100 percent. If the characteristic was 51 percent or more, the firm was determined to be of that group.¹²

In 2003, 13.1 percent of firms were owned by nonwhite or Hispanic individuals (table 2); the share is statistically lower than that recorded by the 1998 survey (14.6 percent). The shares for nonwhite groups alone did not change by a statistically significant amount: The share for blacks and the share for Asians each held at roughly 4 percent;¹³ the share for American Indians and Alaska Natives held at roughly 1 percent. However, the share of Hispanic-owned firms fell a statistically significant amount, from 5.6 percent to 4.2 percent (refer to appendix B for a discussion of changes in the estimated rates of nonwhite and Hispanic ownership).

The largest change in ownership composition in 2003 was among firms owned equally by males and females. The proportion of such firms rose sharply, from 3.7 percent in 1998 to 12.8 percent in 2003, although part of this increase may stem from changes in how the question was asked.¹⁴ This increase is reflected in the decline in the percentage of firms that were owned by males, from 72.0 percent to 64.8 percent; the percentage of firms owned by females also declined between the two surveys, but much less--from 24.3 percent to 22.4 percent.

Firms owned by females, nonwhites, or Hispanics differed in several ways from firms owned by males, whites, or non-Hispanics (table A.1). As seen in previous surveys, the female-owned firms tended to be younger and smaller in terms of employment, sales, and assets than those owned by males. They were also more likely to organize as proprietorships and less likely to organize as S corporations than male-owned firms. Female-owned firms were more likely to be engaged in professional and business services than male-owned firms and less likely to be engaged in construction, mining, and manufacturing.

Relative to white, non-Hispanic firms, nonwhite or Hispanic firms were younger and smaller in employment, sales, and assets and were more often organized as proprietorships. Similarly, nonwhite or Hispanic firms were also more likely to be engaged in business services and less likely to be engaged in construction and mining and insurance and real estate businesses.

Computer Use within the Firm

Use of a computer within a firm is one indicator of the extent of the firm's adoption of technological advances. In the 1998 survey, which was the first SSBF to ask firms about their use of computers, 76.2 percent reported using them (table 4). By 2003, the proportion had increased to 85.9 percent. Among the firms using computers, the proportion that used them for online banking rose between the two surveys from 15.0 percent to 46.8 percent; likewise, the proportion that used computers to apply for credit or loans also rose substantially, from 5.3 percent to 12.9 percent.Skip table

With the rise in prevalence of computer use came a rise in incidence and a narrowing in the variation of incidence across firm age and size. For example although the incidence of use still varied with the number of employees, the range in 2003--80 percent to 100 percent--was higher and narrower than that in 1998--63 percent to 97 percent. And although incidence of use varies inversely with firm age, the range of incidence by age also rose and narrowed between the two surveys.

Nonstandard Work Arrangements

The use of nonstandard work arrangements has been on the rise since at least the mid-1990s. For example, estimates from the February 1995 Current Population Survey indicate that 12.1 million workers (or 9.8 percent of the total) were independent contractors, on-call workers, temporary agency workers, or workers provided through contract firms.¹⁵ By 2005, estimates indicate that 14.8 million workers, or 10.7 percent of total employment, fell into one of these groups.¹⁶

For the 2003 survey, the SSBF asked respondents for the first time about the use of nonstandard work arrangements. After a series of questions on the use of standard employees (both paid and unpaid), respondents were asked whether, during a typical pay period, they used any paid day laborers, temporary agency employees, workers from an employee-leasing firm, or contractors. About half of the firms reported using at least one of these arrangements.

The use of nonstandard work arrangements varied substantially by firm size. In general, the larger the firm, the more likely it was to have employed at least one worker in each of the nonstandard arrangements (table 5). Across all firm sizes, contractors and consultants were the most common types of nonstandard workers reported, a result consistent with statistics calculated from the employee side (refer to text notes 15 and 16). About 30 percent of the smallest firms used contractors and consultants, and about 59 percent of the very largest firms did so. Among firms using any nonstandard workers, the number generally increased with firm size.Skip table

The use of nonstandard work arrangements varied substantially by firm industry. At the extremes, nearly 70 percent of firms involved in construction and mining reported some type of nonstandard arrangement, whereas only 31 percent of retail trade firms reported doing so. Across all industries, contractors and consultants again were the most common types of nonstandard workers reported; by industry, the proportion of firms that used contractors and consultants ranged from 25 percent in retail trade to 62 percent in construction and mining.

Return to contents

Types of Financial Services Used by Small Businesses

Firms were asked which of fourteen financial services they used at up to twenty institutions.¹⁷ The financial services can be grouped into three broad categories: (1) liquid asset accounts, which are checking and savings-type accounts, (2) credit lines, loans, and capital leases, which are lines of credit, mortgages used for business purposes, motor vehicle loans, equipment loans, capital leases, and miscellaneous or "other" loans, and (3) financial management services, which are transaction services, credit card and debit card processing services, cash management services, credit-related services, brokerage services, and trust and pension services. Loans from owners, credit cards, and trade credit are discussed separately and are not included in the tabulations for "any financial service" because no information was collected about the providers of these services.

Nearly all small businesses (about 96 percent) used at least one financial service in 2003, a finding essentially the same as in 1998 (table 6.A). In general, use increased with firm size, and nearly all firms with at least five employees, or with sales of at least $250,000, or with assets of at least $50,000 used some financial service. About 11 percent of firms with one worker used no financial service in 2003.¹⁸Skip table