Small businesses—whether cafés, mechanics’ shops, or florists—play a crucial role in their communities, shaping local economies and providing residents with a sense of place and vitality. However, while many entrepreneurs share some characteristics, small business owners and their aspirations rarely fit a single mold.
Some entrepreneurs have a novel business idea with the potential for growth, while others are looking to maintain a family operation that has been established for decades. No matter the motivation, owning and operating a small business is hard work characterized by challenges and uncertainty. Not every small business succeeds. Many fail, and most end up somewhere in the middle.
Many small businesses—including microbusinesses—take on debt to meet payroll, stock inventory, and fulfill other day-to-day requirements. How an entrepreneur manages that debt as part of their overall financial management can lead to significant differences in business trajectory.
To better understand these different trajectories, we analyzed 13,527 businesses that received a microloan from a Community Development Financial Institution (CDFI) between 2014 and 2018. Through this analysis, we created clusters of businesses that illustrate the different paths microbusinesses and their owners can follow. We also offer strategies to support these businesses no matter their trajectory.
Microbusinesses Rely on Lending—but Outcomes Differ
Across our sample, most borrowers were the only full-time worker for their business and took on a median loan amount of $11,500. Although this represents a relatively small amount of money borrowed, previous research shows that even a couple thousand dollars can provide the boost a fledgling entrepreneur needs.
For the most part, the borrowers in our analysis ended up better off five years after taking out the loan. The median borrower credit score, mortgage balance, and new business trade balance all increased, while credit card utilization (the ratio of credit card balance to maximum credit limit) decreased. At the same time, the owner delinquency rate (the share of businesses with at least one credit account late on payment more than 30 days) and median credit card balance rose, suggesting that the new debt presented issues for some businesses.
Increasing mortgage and business trade balances suggest that business owners can purchase property and finance larger operations. Decreasing credit card utilization is typically considered beneficial for personal credit, as increased credit limits relative to balances suggests lower risk to lenders. However, increasing credit card balances may indicate that entrepreneurs need to supplement insufficient business credit using personal finances.
Put simply: Some businesses used credit effectively; others encountered challenges managing their debt.
By breaking these overall results into clusters, we identify four common microbusiness trajectories. To determine these clusters, we considered owner and business characteristics like the number of employees, loan amount, credit score, delinquencies, bankruptcies, and indicators of business risk.
In general, this analysis demonstrates that not all microbusinesses manage taking on additional capital the same way, and as a result, not all borrowers need the same kind of support. Below, we illustrate each of these groups and highlight several key lessons for CDFIs, entrepreneurs, philanthropists, and policymakers to tailor supports in a way that can promote a thriving ecosystem of microbusinesses.
Small Businesses Do Not Fit a Single Mold
Although further research is necessary to better understand why businesses follow these different trajectories, our cluster analysis indicates that tailored strategies are needed to reach different groups of businesses.
With the right guardrails in place, lenders can jumpstart a business’s growth trajectory, help struggling owners stay afloat, and spur local economies with just a few thousand dollars.
Here we outline a few strategies for lenders to tailor support for each group of businesses:
- Thriving Microbusinesses. The upward trajectory of Thriving Microbusinesses demonstrates the value of access to capital early in a business’s development. Once these businesses have established that they can manage debt effectively, community lenders can help microloan borrowers graduate to larger loan sizes. This can mean introducing entrepreneurs to a CDFI, bank, or other lender that offers larger business loans such as a Small Business Administration 7(a) loan. Some community lenders have in-house programs to connect owners with business mentors, while others can partner with business mentoring programs.
- Established Microbusinesses. As these owners have more personal resources to fall back on, community lenders can offer or refer businesses to additional assistance such as advising and coaching, including on debt management, to help these businesses sustain their ongoing operations, whether that’s through extended repayment terms, lower interest rates to reflect lower risk, or a connection to specialty services like accountants or insurance brokers. An Established Microbusiness may also have the credit profile and business sophistication to effectively manage a line of credit. This can be a more affordable option than a term loan, provided the business owner pays the line of credit off on a regular basis. Most CDFIs do not offer lines of credit, but if they are working with a lot of Established Microbusinesses, they should try to begin relationships with banks that do.
- Troubled Microbusinesses. With hindsight, these businesses might have had a better chance at success with a grant, not a loan. Grant capital is an underprovided resource that localities and states should consider, though there are challenges of effectively targeting limited resources to businesses that have the most need and opportunity to support their long-term sustainability. When these businesses start to run into trouble, community lenders have some options to restructure loans to attempt to forestall the worst outcomes. Business owners also may need greater education and advisory services before receiving a loan and after the first signs of struggle. This assistance may take the form of business coaching or exit strategies to facilitate a soft landing.
- Emerging Microbusinesses. Even with their early success, Emerging Microbusinesses still need more capital and support to continue their growth. As these businesses scale, community lenders can offer additional technical assistance, small grants, and larger loans.
Ultimately, small businesses in the US will follow a variety of paths. Dynamism and experimentation across the small business landscape contributes to a robust and thriving economy. Entrepreneurs should be celebrated for their attempt to start something new, even those whose businesses struggle or fail. That experience may be what propels them to succeed at their next professional endeavor, whether that’s launching another business or following a new career path. And yet, lenders need the data and the understanding of owner outcomes to recognize different business trajectories.
As policymakers, business advisors, and lenders look for new ways to support entrepreneurs, the field needs innovation, experimentation, testing, and long-term research. Too little is known about which strategies are effective for different types of businesses and owners, and at what stage in a business’s life these strategies are most effective. These efforts can help ensure that every would-be entrepreneur has a chance to pursue their dream.
ABOUT THE DATA
We partnered with five CDFIs— Accion Opportunity Fund, CDC Small Business Finance (now part of Momentus), Community Reinvestment Fund (CRF), DreamSpring, and LiftFund—to combine their administrative borrower loan data with consumer and business credit data from a major national credit bureau to create a business-level longitudinal dataset. For more on the data construction see "Credit Trajectories of Business Owners Who Receive Loans from Community Development Financial Institutions (CDFIs)".
We limit the data to borrowers with at least two years of preloan data and four years of postloan data to create a balanced panel. We refer to these businesses as microbusinesses for ease of communication and define them as having received a microloan (i.e., a business loan of less than $50,000 from one of the five study CDFIs).
Prior to clustering, we normalized the data. To cluster we use the k-means algorithm with 20 initial configurations per cluster and 3 to 5 centers across 35 different combinations of credit attributes. We select the final clusters based on a combination of model performance and relevance to theory.
PROJECT CREDITS
This data analysis was funded by a grant from JPMorganChase. We are grateful to them and to all our funders, who make it possible for Urban to advance its mission. The views expressed are those of the authors and should not be attributed to the Urban Institute, its trustees, or its funders. Funders do not determine research findings or the insights and recommendations of Urban experts or the underlying methodology. Further information on the Urban Institute’s funding principles is available here. Read our terms of service here.
We would like to thank Eric Hangen, Eric Weaver, and Gwyneth Galbraith for reviewing earlier iterations of this tool.
Research Brett Theodos and Noah McDaniel
Design Brittney Spinner
Development Rachel Marconi and Lydia Nguyen
Editing Lauren Lastowka
Illustration Alysheia Shaw-Dansby
Writing Wesley Jenkins
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