US Small Businesses Utilize Community Borrowing Amid Difficulties Accessing Banks

In the face of challenges accessing traditional bank loans, US small businesses have turned to their communities for financial support.

In the face of challenges accessing traditional bank loans, US small businesses have turned to their communities for financial support. Thanks to innovative fundraising platforms, small businesses and startups across the United States now have the opportunity to sell bonds to local customers and individuals, effectively raising capital without impacting their equity structure. This alternative method of mobilizing funds has gained popularity as bank lending rates continue to rise and lending conditions become more stringent.

By leveraging little-known fundraising tools, small businesses can sell bonds to hundreds of investors, including corporate clients and local residents, with minimum investment thresholds as low as US$10. This novel approach has become possible due to a regulatory change that permits small businesses to attract capital from nonaccredited investors, as defined by the Securities and Exchange Commission (SEC). This offers an opportunity for investors with modest incomes or assets to support struggling local businesses, particularly those affected by the ongoing Covid-19 pandemic, while also earning a financial return on their investment.

Until recently, small businesses were limited in their ability to raise capital from investors who did not meet the accreditation criteria set by the SEC, namely individuals with an annual salary of less than $200,000 or investable assets under $1 million. However, the passage of the US Employment Act of 2012 introduced a pathway for small businesses to raise capital from unaccredited investors through registered platforms. These platforms are required to be registered with the SEC and must also be members of the US Financial Conduct Authority.

The approval process for this regulatory change took four years, primarily focused on enabling fundraising through the sale of shares, presenting retail investors with opportunities to generate substantial profits by investing in high-growth businesses. Subsequently, it became apparent that this new crowdfunding mechanism could also be utilized for debt issuance, which often serves as a more suitable means of raising funds for smaller-scale endeavors. For instance, a restaurant business might seek to cover costs associated with relocating to a larger space or upgrading kitchen equipment. By issuing bonds instead of equity, businesses can obtain funds without relinquishing control of their company to shareholders.

As an alternative to conventional bank loans, debt funding platforms such as Mainvest, Honeycomb Credit, SMBX, and WeFunder have gained regulatory approval over the course of three years. These crowdfunding platforms can establish their own minimum investment requirements for each debt issue. Bonds enable certain small businesses to overcome obstacles encountered when seeking loans from banks and other financial institutions, particularly during times of economic uncertainty or when interest rates are high. A recent study by the Federal Reserve revealed that nearly half of banks have tightened lending standards for small businesses in recent months.

Scott Rogalski, associate director of strategic initiatives at the Northern California Center for Small Business Development, notes that acquiring a bank loan can be particularly challenging for business owners lacking financial statements, a strong credit history, or collateral. In such cases, the possibility of securing a loan from a traditional financial institution becomes increasingly fragile. Consequently, the largest bond issuance platforms exercise selectivity in business underwriting, rejecting over 90% of applicants out of concern that investors may withdraw their support if businesses fail to fulfill their debt obligations.

Despite the inherent risk involved, many investors find the prospect of supporting locally significant businesses highly compelling. By assisting these small enterprises, investors contribute to the growth and prosperity of their communities. Additionally, this symbiotic relationship may allow investors to potentially reap desirable returns.

The rise of community borrowing among US small businesses offers an alternative solution to conventional bank loans. By leveraging fundraising platforms and selling bonds, small businesses can access capital from nonaccredited investors, fostering economic stability and growth. This approach represents a lifeline for businesses struggling to secure loans from traditional financial institutions due to stringent lending conditions. As lending rates continue to rise and economic uncertainty persists, this innovative mechanism serves as a viable avenue for small businesses to obtain the necessary funds to thrive, while providing investors with an opportunity to support local enterprises and gain returns on their investment.