Access to Capital in Rural America Supporting Business Startup ...

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Access to Capital in Rural America Supporting Business Startup, Growth and Job Creation in the Wake of the Great Recession Interim Briefing for USDA April 2012 Project Team: Deborah Markley (RUPRI Center for Rural Entrepreneurship), Erik R. Pages (EntreWorks Consulting), Patricia Scruggs (Scruggs & Associates), Kathleen Miller (RUPRI/University of Missouri) INTRODUCTION Over the past 20 years, the capital market environment in the U.S. has evolved significantly. In the past, a business startup seeking capital had two primary options – to bootstrap using personal resources, including those of family and friends, or to approach a local commercial bank. Now, the ecosystem for business capital contains a wide range of new players – community development financial institutions providing both debt and equity, microlending programs for the smallest businesses, venture capital funds particularly for firms in targeted sectors, public financing programs such as USDA’s intermediary relending program and the New Markets Tax Credit program, formal and informal angel investor groups, and new innovations including crowd financing. While this range of players, operating in both urban and rural markets, means more options for business startup and growth, understanding the supply side of the capital market becomes a more challenging task. In the wake of the Great Recession, getting a handle on capital access for business startup and growth is even more challenging. There is a widely held perception that businesses – particularly small businesses – face unprecedented capital access challenges. For example, a recent study of small business capital access in northern Michigan found that lack of capital was a problem for small businesses, particularly young firms, and that inadequate capital was keeping firms from growing and adding employees.1 This project seeks to dig deeper into these issues of small business capital access, particularly as they affect firms operating in rural regions. If national economic recovery is dependent, in large part, on strong and growing small businesses that are hiring new workers and making capital investments, then understanding the precise nature of the capital access challenges they face is critical to effective policy development. The first phase of this project assesses what current economic research and statistics suggest about the capital market ecosystem for businesses in the U.S. with particular attention to rural businesses J.D. Snyder, et al. Understanding Small Business Needs and Capital Access Barriers in Northern Lower Michigan, Center for Community and Economic Development, University Outreach and Engagement, Michigan State University, March 31, 2011. 1

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and entrepreneurs. The review focuses on two distinct parts of the capital market system – the supply side including both debt and equity capital, and the demand side including the quality of both the entrepreneurs and the ventures they create. While an extensive research literature exists, few of these analyses provide specific assessments of rural capital markets. In fact, data are often reported in ways that make a focus on rural geographies problematic. National level data are not often analyzed to identify or explain any fundamental differences that may exist in rural vs. urban landscapes. In addition to our data analysis and research reviews, the next phase of work related to the cooperative agreement between RUPRI and USDA will focus more deeply on targeted issues and exemplary programs and policies to better understand both challenges and innovations in rural capital access. This research will provide case studies, innovative practices, and other reports from the field as a means to paint a more complete picture of how rural businesses raise funds to start, expand, and prosper.

SUMMARY OBSERVATIONS FROM CURRENT RESEARCH2 This summary focuses on three important questions:   

What do we know about the rural entrepreneurs who make up the demand side of the capital market in rural America? What do we know about the supply of and access to debt capital in rural America? What do we know about the supply of and access to equity capital in rural America?

THE DEMAND SIDE – RURAL ENTREPRENEURS Rural entrepreneurs present several unique characteristics that should affect public policies toward rural capital access, economic development, and entrepreneurial support.      

Rural startups are prevalent and do not look much different from startups located in other parts of the U.S. Most firms – both urban and rural – start small and stay small. But, more rural firms remain locked in this stage as self-employment ventures or microenterprises. Rural firms are more persistent. They tend to have better survival rates than other firms. But, survival does not equal prosperity. These persistent firms tend to grow slower, create fewer jobs, and generate less spin-off benefits than their urban counterparts. Slower growth rates seem to result from a mix of natural competitive disadvantages, such as smaller home markets, and more restricted access to business growth services, including equity capital and sophisticated coaching/mentoring/consulting. Rural firms that do achieve fast growth tend to lose any distinctive characteristics. While they are based in a rural region, their operations and growth patterns are similar to other fast-growing ventures.

While it is tempting to suggest that any capital access challenges post-Great Recession are related to supply side constraints alone, research suggests that is not the case. In the October 2011 Federal A more detailed review of current literature has been developed by this research team and is available at http://www.energizingentrepreneurs.org/site/index.php?option=com_content&view=article&id=105&Itemi d=34. This page also includes a link to electronically available background research cited in the literature review and will contain more detailed maps as they become available. 2

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Reserve Senior Loan Officer Survey, reports of weaker demand for commercial and industrial loans outnumbered reports of stronger demand, a reversal of recent quarters.3 Chow and Dunkelberg consider the performance of the small business sector in the current vs. past recoveries and conclude that small business optimism is at levels below those associated with other recoveries and business owner expectations about future business conditions are less optimistic.4 Together these trends suggest a lower demand for capital as small businesses climb out of the Great Recession. From the perspective of this study of rural capital access, rural-urban differences in firm startup, growth and persistence, and innovation characteristics are important for their implications related to the demand for capital. We explore two key questions. Do rural businesses use capital differently than their urban counterparts? How do business advisory services factor into the rural demand for capital? Rural Businesses and the Use of Capital Data from the 2010 survey of small businesses conducted by the National Federation of Independent Businesses (NFIB) suggest that rural businesses had a more positive experience accessing credit than urban businesses (Table 1).5 Table 1. Business Experience Gaining Access to Credit in the Last 12 Months Urban Respondents Rural Respondents Total Number (percent) Number (percent) Respondents Number (percent) All of the credit wanted 168 (44.2) 63 (54.8) 231 (46.7) Most of the credit wanted 62 (16.3) 26 (22.6) 88 (17.8) Some of the credit wanted 78 (20.5) 14 (12.2) 92 (18.6) None of the credit wanted 54 (14.2) 10 (8.7) 64 (12.9) No answer 18 (4.7) 2 (1.7) 20 (4.0) Total 380 115 495 Source: RUPRI Analysis of NFIB 2010 Small Business Capital Access Survey For those businesses, both rural and urban, who were successful in gaining access to credit, there are strong similarities in the way that rural and urban firms utilize the capital (Table 2). Rural businesses were more likely to apply credit to the purchase of real estate/structures and the replacement of aging plant, equipment and vehicles than their urban counterparts, perhaps due in part to the sectors represented by these rural businesses.

3 The October 2011 Senior Loan Officer Opinion Survey on Bank Lending Practices, The Federal Reserve Board, November 2011. 4 Michael J. Chow and William C. Dunkelberg, “The Small Business Sector in Recent Recoveries,” Presentation to the Small Business and Entrepreneurship during an Economic Recovery Conference, Federal Reserve Board, November 2011. 5 Survey conducted with a stratified random sample of businesses with between one and 250 employees drawn from Dun & Bradstreet files.

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Table 2. Business Use of Credit Received in the Last 12 Months Urban Respondents Rural Respondents Number (percent) Number (percent) Cash flow and/or daily 214 (59.1) 53 (46.9) operations Real estate and/or structures 78 (21.6) 35 (31.0) Replacement of old plant, 121 (33.4) 45 (39.8) equipment, and/or vehicles Investment in additional 139 (38.4) 43 (38.1) plant, equipment, and/or vehicles Repayment of debt 84 (23.2) 24 (21.2) Reserve or cushion 123 (34.0) 34 (30.1) Inventory 123 (34.0) 33 (29.2) Source: RUPRI Analysis of NFIB 2010 Small Business Capital Access Survey

Total Respondents Number (percent) 267 (56.2) 113 (23.8) 166 (35.0) 182 (38.3)

108 (22.7) 157 (33.1) 156 (32.8)

When it comes to the ability to raise equity capital, some important rural-urban differences do emerge. Rural small businesses are more likely to utilize bank loans than their urban counterparts, and are also less likely to attract outside equity investments. As noted later in this update, these patterns may not be the result of differences in the quality of demand for capital. Instead, they may result from rural equity capital gaps and a correspondingly more robust rural marketplace in debt capital availability from banks, farm lending institutions, and various government-backed finance programs. Rural Businesses and Advisory Services Access to advisory services – business support services – along with capital may play an important role in determining how well rural entrepreneurs can start, grow and maintain their businesses. Leading programs across the country are pairing advisory services with debt and equity funding.6 Some of these are provided by traditionally-structured equity funds, while an increasing number are provided by regional or state organizations – often referred to as Venture Development Organizations – that serve as intermediaries connecting entrepreneurs and businesses with essential expertise and resources. There is growing evidence that the provision of advisory services prior to capital infusion helps entrepreneurs both launch and grow their companies. A recent Ford Foundation survey of rural firms that received advisory services prior to obtaining capital found that over 95% of companies reported operational changes that led to a direct impact on their business within six months. These impacts included expansion into new markets that resulted in increased revenues and product placement, changes in business operation models that resulted in increased revenues, and increased financial controls leading to cost containment and productivity improvements. Other impacts of these services included an enhanced network of advisors and peer businesses, and

6 Jumpstart, Tech Columbus, i2E, Oregon Entrepreneurs Network, Innovation Works, Pacific Community Ventures, and Tech 2020 are examples of award winning programs that combine advisory services with promotion or management of equity capital. To see a preliminary map and guide to these organizations, visit the U.S. Economic Development Administration-backed Regional Innovation Acceleration Network website at www.regionalinnovation.org.

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enhanced awareness of other business providers that leads to a more robust regional network of assistance.7

THE SUPPLY SIDE – DEBT CAPITAL Rural businesses tap investment capital from a diverse and growing set of players. New financial tools seem to arise on a daily basis, with new resources such as crowdfunding or business accelerators gaining much media attention. Nonetheless, most businesses still use traditional sources of capital. Debt capital remains the primary source of funding for businesses in the U.S., particularly those operating in non-high tech sectors and in more rural areas. Key findings suggest that:      

While the landscape has changed in terms of suppliers of debt capital, commercial banks remain the key institutional players in most markets, particularly in rural America. The need for business loans and the opportunity to tap banking markets varies over the life of a firm, with evidence that startup firms rely primarily on their own savings with some able to access bank capital. Aggregate small business lending by banking institutions declined by 6.2% from 2009 to 2010, marking a continuation of a downward trend since 2008. The cause of this decline in lending is complicated, a combination of supply restrictions resulting from caution on the part of banks, increased regulatory scrutiny, and reduced demand as business owners remain concerned about economic and business growth. For many rural and urban businesses, the most pressing concerns relate to economic recovery and identifying new business opportunities. Capital access challenges are not cited as top-priority challenges, according to a NFIB survey. Non-bank sources of funding (e.g., Community Development Financial Institutions, public sector programs, crowdfunding) are filling gaps in capital markets across the country, but research on the impacts on rural markets is lacking.

Regardless of the exact causes, the steady decline in small business lending is worrisome. What is driving the decline in lending to smaller businesses? A 2011 U.S. Small Business Administration report pointed to a mix of factors at work: “Small business owners are reluctant to acquire more debt, lenders are cautious about extending more debt, and regulators are carefully watching the performance of all outstanding debt.”8 Similarly, a recent Federal Reserve Bank assessment finds that the decline cannot be explained by any single element but rather by the interaction of five factors:9     

Tightened credit standards on the part of banks Weak demand on the part of businesses Poor health on the part of banks (e.g., 829 of 7800 institutions on the FDIC’s list of problem banking institutions) Limitations associated with SBA lending related to both the temporary nature of stimulus expansion and the lack of resources to support technical assistance and business support Credit gap for some businesses that are not bank or SBA qualified

7 Scruggs, Patricia and Wayne Embree, The Role of Equity Capital in Rural Economies, A report prepared for the Ford Foundation, April 2010. 8 U.S. Small Business Administration, Small Business Lending in the U.S. 2009-2010, p. 3. 9 Julie Stackhouse, “Understanding the Small Business “Credit Crunch”: Perspective from a Federal Regulator,” Bridges, Federal Reserve Bank of St. Louis, Fall 2010.

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In effect, these factors have created something of “perfect storm” in small business capital markets. Banks are weaker, firms are weaker, and the economy is weaker. These factors lead to both reduced supplies of available capital and weaker demand for these funds. The issue of declining demand can also be observed in recent data from the NFIB survey of small businesses.10 For both rural and urban businesses, access to credit is not the most important challenge. When asked to identify their most important finance challenge, the responses show it to be less about the money than it is about the economy (Table 3). Almost 54% of respondents, both rural and urban, indicated that their most important finance challenges were slow/poor sales and unpredictability of business conditions. Only 11% of businesses, 5% in rural and 13% in urban, indicated that the inability to obtain credit was the most important challenge. Table 3. Most Important Finance Problem Facing Business Today (2010) Most important Urban Respondents Rural Respondents Total Respondents finance problem Number (percent) Number (percent) Number (percent) Inability to obtain 82 (12.8) 11 (5.1) 93 (10.9) credit Slow/poor sales 166 (26.0) 59 (27.6) 225 (26.4) Real estate values 16 (2.5) 12 (5.6) 28 (3.3) Cost and/or terms of 23 (3.6) 4 (1.9) 27 (3.2) credit Unpredictability of 178 (27.9) 55 (25.7) 233 (27.3) business conditions No finance problems 87 (13.6) 37 (17.3) 124 (14.5) Cash flow 9 (1.4) 4 (1.9) 13 (1.5) Receivables 13 (2.0) 7 (3.3) 20 (2.3) Something else 41 (6.4) 9 (4.2) 50 (5.9) No answer 5 (0.8) 2 (0.9) 7 (0.8) Total 639 (100) 214 (100) 853 (100) Source: RUPRI Analysis of NFIB 2010 Small Business Capital Access Survey Importance of Bank Capital for Small Businesses While demand for small business loans has been weaker, it has not disappeared. Thus, it is important to understand how those businesses actively seeking bank loans are faring. The NFIB 2010 survey (see Table 1) found that nearly 65% of firms were able to access all or most of the capital they needed. However, the results suggest some important differences for rural and urban businesses. About 24% of respondents sought a new line of credit in the 12 months before the survey (Table 4). The percent of businesses obtaining a new line with both satisfactory limits and terms was 59% for rural businesses, compared to 40% for urban businesses. For the one-third of respondents who sought to renew an existing line of credit, nearly 72% of rural businesses extended their line with satisfactory limits and terms, compared to only 57% of urban businesses who were similarly successful. While 70% of rural businesses who attempted to obtain a business loan were successful in obtaining the amount and terms sought, only 43% of urban businesses were successful.

William J. Dennis, Jr. Financing Small Business: Small Business and Credit Access, NFIB Research Foundation, January 2011.

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What explains these differing patterns for rural firms? It is not clear from the survey data whether the quality of the business application was significantly different across rural and urban businesses. However, the data do suggest that the presence of local capital pools in rural regions may be important. In the NFIB survey, 71% of rural businesses identified their primary financial institution as a local bank, compared to only 49% of urban respondents. It is possible that relationship banking continues to play a positive role in helping rural businesses access capital. However, further research is needed to explore the tradeoffs involved in relying more heavily on local financial institutions vs. a broader range of capital providers. Table 4. Outcome of Most Recent Attempts to Obtain a New Line of Credit Urban Respondents Rural Respondents Number (percent) Number (percent) Obtained the new line with a 61 (39.6) 27 (58.7) satisfactory limit AND terms Obtained the new line, but 20 (13.0) 6 (13.0) with an unsatisfactory limit OR terms Didn’t take the new line 22 (14.3) 3 (6.5) because the limit or terms were UNACCEPTABLE Were not able to obtain the 43 (27.9) 8 (17.4) new line No answer 8 (5.2) 2 (4.4) Total 154 46 Source: RUPRI Analysis of NFIB 2010 Small Business Capital Access Survey

Total Respondents Number (percent) 88 (44.0) 26 (13.0)

25 (12.5)

51 (25.5) 10 (5.0) 200

Analysis of Bank Lending Data To get a better understanding of bank lending across the country, we looked at data from the Federal Financial Institutions Examination Council (FFIEC). These data are obtained from banking institutions as part of their compliance with the Community Reinvestment Act. Table 5 presents summary data on bank lending for 2005 and 2010. Not surprisingly, these data show a decline in lending, both in terms of dollar volume and number of loans made, pre- to post-recession. The numbers also depict a fairly consistent rural-urban breakdown between 2005 and 2010. Lending in non-core counties did shift over this time frame. Overall lending volume in noncore areas (as percent of total lending) actually grew slightly, but the number of loans declined rapidly. The data suggest a trend of fewer loans to larger firms and may indicate future capital access challenges for new firms or microbusinesses in these areas.

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Table 5. Summary Data for FFIEC Lending, 2005 and 2010 Total FFIEC Loan $ (M) Total FFIEC Loan $ (M)/% to Metropolitan Counties Total FFIEC Loan $ (M)/% to Micropolitan Counties Total FFIEC Loan $ (M)/% to Noncore Counties Total FFIEC Loans (#) Total FFIEC Loan (#)/% to Metropolitan Counties Total FFIEC Loan (#)/% to Micropolitan Counties Total FFIEC Loan (#)/% to Noncore Counties FFIEC $/Loan in Metropolitan Counties FFIEC $/Loan in Micropolitan Counties FFIEC $/Loan in Noncore Counties

2005 $266,027 $233,168/87.6% $21,996/8.3% $10,865/4.1% 7,881,500 6,757,081/85.7% 706,797/10.5% 714,622/10.6% $34,507 $31,121 $15,204

2010 $83,598 $72,102/86.2% $7,450/8.9% $4,043/4.8% 4,197,610 3,677,513/87.6% 330,149/9.0% 189,948/5.2% $19,606 $22,566 $21,285

Figure 1 provides an initial view of the distribution of bank lending across the country, using data from FFIEC. What the data show is an uneven distribution of capital across the country. We calculated each county’s four-year average loan per establishment value for 2005-2008 and compared that average to national values. Counties were then coded as:      

5 = counties with 250% or more of the four-year national average loan per establishment amount and at least two years of funding 4 = counties with 150-249% of the four-year national average loan per establishment amount and at least two years of funding 3 = counties with 75-149% of the four-year national average loan per establishment amount and at least two years of funding 2 = counties with large one-time funding of at least 200% of the four-year national average loan per establishment amount and no other years of funding (one hit wonders) 1 = counties with 10-74% of the four-year national average loan per establishment amount and at least two years of funding 0 = counties with no funding or less than 10% of the four-year national average loan per establishment amount

These data suggest that several regions may have less robust opportunities to access bank loans. Considering bank lending, most of the counties with more limited access to capital appear to be in the central and upper Great Plains, Central Appalachia, and parts of the Southwest. “Capital Deserts”? We coined the term “capital deserts” as a way to describe the more limited access to capital in certain regions of the country. The concept is parallel to that of a food desert, defined as a Census tract where a substantial number of low income people have limited access to a grocery store or supermarket. However, just as the Food Environmental Atlas developed by USDA’s Economic Research Service seeks a more nuanced understanding of a community’s ability to access healthy food and its success in doing so, we need a deeper understanding of these apparent “capital deserts.” Having a better grasp of the characteristics of the demand side will provide greater insight into capital access challenges – quality of deal flow, presence of alternative lending institutions, etc. This work should be viewed as an initial attempt to provide a spatial overview of rural capital access; more research to clarify the “capital desert” concept is needed.

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Figure 1. Distribution of Bank Lending, 2005-2008

Access to Public Sources of Business Capital A number of Federal programs provide support for business lending including:   

SBA’s 7a loan guarantees, including the Small and Rural Lender Advantage program, and 504 loan program USDA’s business lending programs including intermediary relending program, rural business enterprise grants, business & industry loan guarantees Revolving loan funds (RLFs) established with USDA, Economic Development Administration, SBA, and/or HUD Community Development Block Grant funds

While there is reasonable data on SBA and USDA programs to get a sense of where the loan and grant capital is flowing, understanding public business loan funds is more challenging since (1) the money often flows through local units of government, regional development organizations and/or non-profit entities and (2) the money, by definition, revolves and at some point becomes

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disconnected from its initial public funding source. A 2011 report on public sector business loan funds offered some sense of the scale of support provided by these funds:11    

Funding from HUD-backed third-party loans amounted to $2.2 billion in the 1990s, according to a 2002 study 578 EDA-backed RLFs managed a capital base of more than $852 million as of March 2009 137 of the 260 SBA 504 Certified Development Companies invested $30 billion in more than 66,000 small businesses (2009 national survey by National Association of Development Companies) 400 USDA intermediary re-lenders made over $700 million in loans to rural businesses (according to July 2010 Congressional testimony)

What these data do not tell us is how this lending is distributed across rural America. To provide this insight, we examined how public sources of capital were distributed across metropolitan, micropolitan, and noncore counties using four measures:  





Distribution of activity – The percent of counties reporting financing activity in any given year. Relative share of activity – The distribution of dollars by metropolitan, micropolitan and noncore counties, and the overall proportion of those dollars as compared to the percent of firms in each type of region. For example, if metropolitan regions are home to 84% of all small firms, then their share of public sources of financing would be described as disproportionately large if it was greater than 84%. Coverage of activity – The percentage of firms that reside within counties reporting financing activity. This measure provides insight into accessibility. For example, if 50% of counties report financing activity and those counties represent 85% of all firms, then the coverage is better than if they represented only 40% of firms. Concentration of activity – The proportion of dollars going to the top 2% of counties and the percent of total firms represented by these counties. For example, if the top 2% of counties account for 20% of dollars, then one would expect those counties to represent 20% of small businesses if the distribution was proportionate.

Distribution of SBA 504 Financing Programs. On average, about 40% of all U.S. counties report SBA 504 financing in any given year. Metropolitan areas are much more likely to have 504 financing activity – approximately 65% of metropolitan counties – as compared to less than 20% of noncore counties. In terms of proportionality, metropolitan regions account for almost 90% of dollars but 84.1% of total firms; noncore regions received just over 3% of 504 dollars, yet accounted for 6% of all small businesses in the U.S. The coverage achieved by 504 financing also shows metropolitan – noncore differences. In 2008, the 67% of metropolitan counties with 504 activity represented 93% of all small businesses (establishments with less than 500 employees) in metropolitan counties; the 19.7% of noncore counties with 504 activity covered only 40% of all small businesses in rural regions. These data suggest that more than half of all small businesses in noncore counties operate in areas with limited access to SBA 504 lending. SBA 504 funding is also concentrated in relatively few counties. In any given year, over 45% of 504 funds are distributed in only 2% of counties. In 2008, these counties were home to only 30% of the Public Sector Business Loan Funds: Views and Recommendations from Practitioners, Forum Findings and Recommendations prepared by National Association of Development Organizations Research Foundation and Development District Association of Appalachia, 2011.

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country’s small businesses, indicating that 504 lending activity is highly concentrated. Data on SBA 504 lending patterns are summarized in Table 6. One caveat related to the 504 data is that lending is not broken out by firm size. Using the SBA definition of small business (one with less than 500 employees) does not provide the detailed breakdown by firm size that might allow consideration of the interaction between lending and firm size. Table 6. Summary Data for SBA 504 Lending, 2008 – 2011 2008 2009 Total ($ M) $5,206.00 $3,812.00 Distribution of $ to Metropolitan Counties (note: 84.1% of U.S. firms are metro based) 87.38% 89.92% Distribution of $ to Micropolitan Counties (note: 9.8% of U.S. firms are micro based) 8.47% 6.79% Distribution of $ to Noncore Counties (note: 6.1% of U.S. firms are noncore based) 4.04% 3.29% % of funding going to top 2% of counties 45.9% 45.03% Total # of Counties with 504 financing 1,365 1,148 % of all U.S. Counties 43.37% 36.48% % of Metropolitan Counties with 504 $ 67.09% 62.09% % of Micropolitan Counties with 504 $ 52.33% 38.66% % of Noncore Counties with 504 $ 19.65% 14.64%

2010 $4,388.80

2011 $4,809.90

89.90%

90.00%

7.07%

7.11%

3.00%

2.89%

46.07%

46.23%

1,250

1,177

39.72%

37.40%

65.55%

62.73%

44.48%

40.84%

16.41%

15.08%

Using data for SBA 504 loans, we looked at the geographic distribution of business capital over the 2005 to 2008 period. The map in Figure 2 is color coded to show the distribution of SBA 504 lending over the 2005-2008 period, using the same coding described for Figure 1. There are clear regional disparities in lending, with counties in the central U.S., upper Great Plains and parts of the Northwest, the Delta and deep south regions, and the Appalachian highlands showing more limited access to capital than the upper Midwest (IL, MI, MN, WI), west coast, central Rockies, southwest and northeast regions.

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Figure 2. Distribution of SBA 504 Lending, 2005-2008

Distribution of SBA 7a Financing Programs. In any given year, approximately 75% of U.S. counties report 7a activity – over 90% of metropolitan counties and 55% of noncore counties. Compared to SBA 504 and USDA programs, the dollar distribution of 7a financing across regions more accurately aligns with the distribution of small businesses. In other words, metropolitan regions receive approximately the same percentage of 7a dollars (86%) as their share of all small businesses (84.1%). The coverage of 7a activity is also broader than 504 lending. Active metropolitan counties (those with 7a financing activity) account for over 99% percent of small businesses in metropolitan settings, and noncore counties accounted for 75% of small businesses operating in more rural areas. While more firms tap into 7a programs, overall lending activity still remains highly concentrated in a few regions. The top 2% of counties account for 40% of 7a dollars. In 2008, these counties were home to 33% of all small businesses, indicating a slightly higher proportion of 7a activity in these counties than would be expected. In the noncore areas, however, the top 2% of counties accounted for 20% of 7a financing, yet covered only 6% of noncore small businesses. These data suggest greater concentration of 7a lending activity in noncore regions than in metropolitan counties (Table 7).

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Table 7. Summary Data for SBA 7a Loan Guarantees, 2008 – 2011 2008 2009 2010 Total ($ M) $8,995.00 $7,212.00 $9,985.00 Distribution of $ to Metropolitan Counties (note: 84.1% of firms are metro based) 88.00% 85.00% 85.05% Distribution of $ to Micropolitan Counties (note: 9.8% of firms are micro-based) 7.17% 9.28% 8.12% Distribution of $ to Noncore Counties (note: 6.1% of firms are noncore based) 4.82% 5.73% 6.14% % of funding going to top 2% of counties 42.70% 37.15% 39.08% Total Counties w/ 7a $ 2442 2299 2366 % of Counties 77.60% 73.05% 75.18% % of Metropolitan Counties with 7a $ 91.55% 89.45% 90.55% % of Micropolitan Counties with 7a $ 88.66% 84.16% 85.32% % of Noncore Counties with 7a $ 62.69% 54.16% 57.62%

2011 $15,231.00

86.65%

8.09%

5.26% 41.07% 2349 74.64% 90.64% 87.21% 55.33%

There also appear to be fewer areas with very limited capital access associated with SBA 7a financing. Figure 3 demonstrates much more universal coverage of the U.S. for the 7a program than, for example, SBA’s 504 lending program. One interesting research question would be to consider to what extent differences in the program management models lead to differing lending patterns. SBA 504 loans are made through a national network of 260 Certified Development Corporations while 7a loans are made through a network of qualified financial institutions that includes some of the largest banking institutions in the country.

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Figure 3. Distribution of SBA 7a Loan Guarantees, 2005-2008

Distribution of USDA Business Financing. Compared to SBA 504 and 7a programs, USDA-backed lending is much smaller in terms of dollar activity (about three times smaller than 504 funding and about six times smaller than 7a funding). Consistent with Congressional intent, the programs are also concentrated in micropolitan and noncore counties. Micropolitan regions account for 30% of funding activity while representing 9.8% of all firms, and noncore areas account for 20% of funding while representing only 6% of firms in the U.S. (Table 8). Given the size of the program, it is not unexpected that the total number of active counties ranges between 16% and 37% in a given year, yet the distribution across metropolitan, micropolitan and noncore counties is relatively stable. The coverage of USDA financing also reflects the low percent of active counties. In 2008, the 24.8% of noncore counties reporting activity covered 32.5% of all establishments in noncore areas, leaving a large portion of rural businesses without regular access to USDA business financing programs. USDA business financing is also very highly concentrated in only a few counties. In 2008, the top 2% of counties accounted for 43% of all USDA dollars, yet these counties were home to only 4% of all firms. The USDA funding is also highly concentrated by state, where each year just seven or eight states account for more than 50% of all USDA financing to businesses in rural or noncore counties. While the ranking of states changes slightly from year to year, they are primarily located in the Midwest and Great Plains regions (Table 9).

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Table 8. Summary Data for USDA Business Financing Programs, 2008 – 2011 2008 2009 2010 2011 Total ($ M) $1,580.00 $1,449.00 $3,204.50 $1,016.00 Distribution of $ to Metropolitan Counties (note: 84.1% of firms are metro based) 43.48% 50.03% 49.46% 48.65% Distribution of $ to Micropolitan Counties (note: 9.8% of firms are micro based) 30.51% 29.95% 29.19% 31.69% Distribution of $ to Noncore Counties (note: 6.1% of firms are noncore based) 26.01% 20.01% 21.34% 19.65% Total Counties with 7a $ 931 887 1165 514 % of Counties 29.58% 28.19% 37.02% 16.33% % of Metropolitan Counties with USDA $ 30.55% 28.73% 41.36% 18.27% % of Micropolitan Counties with USDA $ 37.50% 35.61% 46.22% 22.38% % of Noncore Counties with USDA $ 24.80% 23.99% 28.84% 11.70% Table 9. USDA Business Financing – Top States, 2009 and 2010 State 2010 USDA Financing to State noncore counties Iowa $48.99 million Iowa Wisconsin $55.0 million Alaska Nebraska $51.23 million Wisconsin Georgia $48.91 million Minnesota Kansas $39.85 million Idaho Louisiana $37.1 million Colorado Missouri $36.46 million Texas Oklahoma $26.3 million Total $343.84 million Total Percent of total 50.1% Percent of total

2009 USDA Financing to noncore counties $54.63 million $20.98 million $20.83 million $15.92 million $11.42 million $11.39 million $11.14 million $146.31 million 50.5%

Figure 3 shows that similar to the SBA data there are regional disparities in USDA business financing. Almost every region of the country has sub-regions where there is limited access to USDA financing.

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Figure 3. Distribution of USDA Business Lending, 2005-2009

Community Development Financial Institutions. Community development banks and other financial institutions are those that are guided by both social and financial goals. They generally serve low and moderate income markets and those that are not served well by more traditional banking institutions, including rural areas. These institutions are supported in their work by the U.S. Department of Treasury’s Community Development Financial Institutions (CDFI) fund, created in 1995 to help support the work of CDFIs. From 2009 to 2011, the number of CDFI banks grew by 35% – with 84 institutions operating today.12 While the sector is growing, CDFI banks still represent a miniscule part of the market, accounting for less than 1% of total FDIC deposits in 2011. CDFI banks are also highly concentrated in major urban areas. At present, twenty two states have no CDFI banks and large parts of the country have no local CDFI presence. Figure 4 provides a snapshot of the geographic distribution of qualified low-income community investments using data supplied by the Department of Treasury’s Community Development Financial Institutions Fund. To get an initial view of the distribution of community investments flowing through CDFIs, we considered two measures. One is the percent of community investments Robin Newberger and Susan Longworth, “Recently certified CDFI banks and the CDFI banking sector,” Profitwise News and Views, Federal Reserve Bank of Chicago, December 2011. 12

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going to a state compared to the state’s eight-year average (2003-2010) contribution to Gross Domestic Product (GDP). This measure gives us one way of considering the distribution of community financial investments compared to each state’s relative economic contribution. The other measure is the eight-year average percent of community financial investments (CFIs) going to metropolitan investments as compared to the percent of metropolitan population in each state. The color coding of states in Figure 4 shows the following: 

 

High proportion states have a higher percentage of community financial investments than their contribution to national GDP. These states may also exhibit an urban bias (higher percent of funds flowing to metropolitan areas than the percent of population in metropolitan areas), a rural bias (higher percent of funds flowing to rural areas than the percent of population in rural areas), or no bias. Low proportion states have a lower percentage of community financial investments than their contribution to national GDP. These states may also exhibit an urban, rural, or no bias. No disproportion states have community financial investments in line with their percent contribution to national GDP. They may also show an urban, rural or no bias.

Figure 4. Distribution of Community Financial Investments, 2003-2010

This initial assessment suggests that there are many parts of the country with disproportionately low levels of investment relative to at least one measure of economic activity. This observation is definitely in line with the concentration of CDFI infrastructure across the country. A more detailed assessment of community financial investments requires a more detailed look at the geographic Access to Capital in Rural America – Interim Briefing for USDA – April 2012

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distribution of investments by county. The CDFI dataset is limited in its county geocoding and more analysis is needed to present a county-level picture of CDFI investment.

THE SUPPLY SIDE – EQUITY CAPITAL Until recently, equity capital investments, especially institutional venture capital, were almost exclusively concentrated in major metropolitan areas. In more recent years, numerous new rural equity sources have emerged. This is a promising trend, as much research suggests that equitybacked firms have greater economic impact than comparable non-equity backed firms.13 Key findings from the literature include:        

Businesses in rural and less intensive venture capital (VC) markets perform on par with investments in VC-intensive markets, indicating there is no geographic bias for performance. The presence of angel investors along with organized structures for investors to pool resources and expertise has been shown to accelerate the amount of equity capital invested into a region. Corporate or strategic investors are increasingly important players in equity capital and may complement angel and venture funds. The link between advisory services and capital access is strong. Businesses and funds, especially those focused on seed and early stage investments, perform better when there are advisory services attached. Even though fund size has increased over time, smaller funds outperform larger funds. However, there is evidence that small and large funds both have a place in a region’s equity market. Seasoned fund managers and local sources of capital are critical elements for increasing capital to targeted regions. Resident capital is often viewed by outside investors as an indicator that the companies within a particular state have “something worth looking at.” There is no indication that equity investments move out of rural or less VC-intensive states at rates faster than other regions. There are, however, business characteristics that contribute to and can enhance the “stickiness” of an investment. Equity capital is relatively mobile and is increasingly crossing state lines.

The relative concentration of equity investment in metropolitan regions has been fueled by a general perception that the best investments are those in technology-heavy metropolitan areas. Based on these trends, one might assume that the deals in these areas perform significantly better than deals in other parts of the country. However, there is a growing body of research that indicates that a venture-backed business in a state like Oklahoma performs just as well as one from the Silicon Valley. Recent research tracked over 19,000 venture-backed deals and examined these deals based on the VC intensity of the state – VC-heavy states like California or Massachusetts and VC-lite states like Kansas, Oklahoma, or Kentucky. The analysis showed that there were slight differences in the inputs (e.g., amount of funding), yet no statistical difference in terms of outcomes (e.g., return on investment, jobs created, type of exit). In other words, high performing equitybacked investments are found in all parts of the country; smaller, more rural regions can have ventures that perform on par with those in California or Massachusetts.14

13Global

Insight, “Venture Impact: the Economic Importance of Venture Capital-Backed Companies to the U.S. Economy,” National Venture Capital Association, 2009. 14 Analysis published in “The Role of Equity Capital in Rural Communities” a report to the Ford Foundation.

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Specific findings from this analysis include (Table 10):    

The average investment in a VC-lite state was just over $6 million, compared to California or Massachusetts, which averaged $12 million per deal. There were slightly more investments from individual investors in VC-lite states than other states (perhaps indicating the importance of angels in these regions.) The return on investment in terms of multipliers and the type of exit (ratio of IPOs, acquisitions or failure) showed no statistical difference across regions. VC-lite states created the same number of jobs per deal as VC-heavy states, even though the average amount of financing received was half the amount.

Table 10: Summary of Venture Capital Performance by State Groupings CA/MA TX/CO/WA VA/MD/NY/NJ/PA/DC Total Equity $ $187.46 B $49.6 B $61.7B Average $12.9 M $10.2 M $8.0 M Investment $ IPO Exit Raise $38.4 M $38 M $42.0 M (median) Exit Type: 2.6 2.9 2.9 Acquisition to IPO ratio Percent out of 37/30 37 37 business (%) Mean # of 25 25 23 employees Source: Analysis conducted by Dr. Rob Wiltbank, Willamette University

All others $69B $6.6 M

$33.9 M 2.7

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Analysis of Venture Capital in More “Rural” States. To better understand equity funding in more rural states, we examined data for the 22 states with population density and/or percent of population living in metropolitan regions less than the U.S. average.15 Together these 22 states (Table 11) represent 17.5% of the nation’s gross domestic product, yet only 5.7% of the 2010 venture capital invested, 8.2% of all venture-backed deals, and 3.3% of all venture capital under management. While statistically these states are more rural than others, it is important to note that all of these states contain metropolitan areas. It is not possible with the equity capital data available to determine whether investments are made primarily (or even exclusively) in the metropolitan centers or whether they are spread across metropolitan, micropolitan and noncore areas. With the caveat above in mind, the analysis of these states clearly shows that states with lower populations and densities can be high performing in terms of equity. Here, Colorado, Minnesota, Oregon and Utah receive almost 80% of the venture capital funds invested in the 22 more rural states. States like Vermont, New Mexico and Kansas perform fairly well in terms of venture capital investment per gross state product or total number of business establishments. An important research question is what distinguishes more rural states that are attracting venture capital from those that are not. Understanding the capital networks in these states and their connections to demand side services may provide valuable insights that could help lower performing states participate more fully in venture capital markets. Due to the geographic isolation and large percent of federal land ownership, Alaska was excluded from the states analyzed. 15

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When we compare a state’s ability to attract venture capital and fund more than just a handful of deals, several characteristics appear: 







Geography does not seem to be a primary factor in venture capital performance. Each region of the country, except the south/southeast, had at least one top performing state; the top three performing states (Colorado, Minnesota and Utah) were quite distant from the two major centers of venture capital resources – California and Massachusetts/New York. Having capital under management in the state does not necessarily result in capital being invested in the state. In other words, some of the states with the lowest amount of venture capital investment in local businesses were also some of the states with the largest average amount of venture capital under management (e.g. Alabama, Kentucky, Maine, and Missouri). Workforce and R&D characteristics seem to be strongly correlated with venture capital investments. States that have an educated workforce, along with management, professional and scientific talent, attract significantly more venture capital. Patent activity, the percent of high tech jobs, and use of technology in agriculture also strongly correlate with investment capital. Venture capital is mobile. These 22 states attracted capital from across the country. However, Table 12 shows that lower performing states, on average, are more reliant on smaller regional capital networks whereas the top performing states have a more robust national network.

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Table 11. Analysis of Venture Capital in More Rural States 8 Year Average Venture Capital $ under mgt. ($M) $3,362.63 $883.00 $2,109.63 $63.88 $37.75 $70.13 $4.75 $54.13 $934.13 $27.88 $175.50

8 Year Average Venture Capital $ Invested ($M) $567.70 $160.74 $324.06 $152.14 $17.90 $42.63 $32.68 $16.99 $57.18 $30.34 $5.05

Average Venture Capital Invested $M/Gross State Product $B 2.19 1.38 1.21 0.91 0.68 0.56 0.26 0.31 0.23 0.34 0.09

8 Year Average Number of Venture Deals 85.75 31.75 45.25 29.75 5.50 13.25 16.63 4.38 14.75 2.13 3.88

Number of Venture Deals per 10,000 establishments 6.76 5.46 3.81 3.35 2.94 3.65 2.79 1.17 1.24 0.51 1.15

Average State Ranking on Key Economic Factors 8 16 12 17 17 25 22 23 31 28 30

Overall Venture Capital Ranking (based on Avg. VC $/GSP $) 1 2 3 4 5 6 7 8 9 10 11

Colorado Utah Minnesota Oregon Vermont New Mexico Kansas Idaho Missouri Nebraska Maine North Dakota $4.88 $3.88 0.12 1.38 0.77 31 Iowa $56.13 $32.54 0.22 3.63 0.57 33 West Virginia $13.13 $9.68 0.15 3.38 1.12 41 Alabama $260.50 $23.53 0.14 6.38 0.83 37 Kentucky $145.13 $27.18 0.17 7.38 1.06 42 Montana $0.00 $7.61 0.20 1.00 0.32 31 Oklahoma $88.75 $19.79 0.12 5.00 0.69 37 Wyoming $74.00 $2.86 0.07 1.13 0.64 37 South Dakota $95.88 $1.29 0.03 1.38 0.64 40 Mississippi $22.00 $2.65 0.03 2.00 0.43 47 Arkansas $9.50 $1.25 0.01 1.63 0.32 44 Source: Calculations derived from 2011 National Venture Capital Association Yearbook Notes:  VC under management: The total amount of venture capital managed by funds resident in a given state, including previous deals that have not exited, current year’s investments and uncommitted cash.  VC investment: The amount of new venture capital invested in a specific year, including initial and follow-on investment. Average investment/Gross State Product is used to create a relative comparison of VC investment to a state’s economy.  VC deals: The number of investments made in business enterprises; may include multiple investments in a single business entity. Deals/10,000 establishments is used to make relative comparisons among states.  Key economic factors: Venture capital is attracted to areas with high levels of innovation. These include the education level of the workforce, the management, technical and scientific talent, the patent activity, the percent of high tech jobs, and the technology level of the agricultural sector.

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Table 12. Capital Networks of More “Rural” States vs. Top Performing States % Total % % Capital Sources Capital Capital from of from from CA Nearby 2010 VC Capital Sources Capital In-state and MA States

% Capital from other States, Foreign or Unknown Sources

Average for 22 Rural States

38%

5

10%

19%

33%

Average for Top Performing States 15 10% 38% 4% 47% Source: Calculations derived from 2010 National Venture Capital Association Yearbook Making the Most of Capital Networks: A Comparison of Two States. Examining patterns of capital under management can provide insights into the capital networks that may be at play in a state. Maine is a good example of a state with significant capital under management, yet little annual investment in Maine businesses. Since 2003, the state has had an average of $175 million under management in any given year, yet the actual amount of capital invested in Maine companies over the same time period is only $5 million per year, or 3% of the total under management. By comparison, Oregon has had less than $65 million under management per year since 2003, yet attracts on average $152 million per year in new investments or 230% of the total under management. 16 What might account for the differences in these two states? One possibility is the capital network in each state – the infrastructure to manage and attract investment capital and to develop the deal flow in which venture capital can be invested. Taking a deeper look at both states, Oregon has a robust capital network that systematically works to connect supply and demand. The state has a long-standing and award-winning entrepreneurial development organization (privately funded) with chapters across the state that mentors new companies to make them venture ready, then holds angel and venture capital forums to connect companies to investors inside and outside the state. There are multiple angel groups, many more than ten years old. There is an active set of industry associations that work collaboratively through the Oregon Innovation Council to address capital and other growth issues. And finally, the state has invested in Oregon-based equity funds through the Oregon Growth Account as well as outside venture funds through a fund-of-fund model requiring funds from outside the state to have a presence in Oregon to search for deals. These venture funds are also tied into the state network of business groups, angels, and corporate equity funds like Intel Capital. Maine, on the other hand, has a less developed set of resources that directly tie entrepreneurs to capital. The state’s angel network is less mature, and the entrepreneurial assistance programs are more educational institution-based, with hands-on mentoring from experienced CEOs only recently added. State funding for equity investments has gone to very early stage ideas and is not as well connected to the advisory services that help entrepreneurs be “venture-ready.” While there is an active and well-known CDFI and venture fund using New Market Tax Credits, this fund is not well connected to other entrepreneurial or state supported activities. While many pieces of a capital network exist in Maine, there does not appear to be the same level of cohesion within the network as in Oregon.

16

Calculations based on data from the National Venture Capital Association 2010 and 2011 Yearbooks.

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A FRAMEWORK FOR GUIDING NEXT STEPS Our review of the current literature and analysis of secondary data have raised a number of research questions and identified some issues worthy of deeper exploration. These include the following: 

 

 





More research is needed to better understand the geographic disparities in the distribution of bank and public sector financing across the U.S. We need to further test the concept of “capital deserts” and the contribution of supply and demand factors toward creating these deficits. How well a region is able to absorb capital is likely to depend at least in part on the quality of the surrounding ecosystem, the quality of the entrepreneurs and other factors that interact to determine how well communities are positioned to take advantage of and optimize business capital in their region, and attract new sources of capital to the region. More analysis of the relationship between firm size/age and capital access, particularly in terms of SBA lending programs, is needed. Additional analysis of CDFI data by geography is needed to gain a better understanding of rural vs. urban differences in investment patterns. More research is needed to understand why some relatively rural states seem to attract equity capital while others do not. What accounts for these differences? Does the presence of angel investors, both formal and informal, have anything to do with these trends? There is evidence that rural venture capital deals offer similar returns and have similar job creation impacts as urban deals. Are there intermediaries in the states attracting or keeping venture capital that are better able to make the case for such rural investments? Is there stronger institutional capacity in these places? On the demand side, more research is needed to explore the capital access experience in some diverse rural regions and markets – how do these experiences differ? Building on the evidence from the NFIB study, what is the capital access experience of businesses in micropolitan or noncore regions? Do relationships with local sources of business financing matter in terms of capital access? What impact does the business support infrastructure have on capital access? Where are businesses finding the support needed to effectively access capital – what are their value networks for gaining access to both capital and the advisory services they need to support business startup, growth and job creation?

While these issues are worthy of further research, what is equally important from the perspective of USDA is a framework for guiding how we move forward in gaining deeper insights into rural capital access. Through this initial assessment, we have identified a clear need to understand the leverage points that will make the greatest difference in access to capital in rural America and to the economic outcomes that result from the effective deployment of that capital. In a time of scarce resources, it becomes even more critical to identify interventions that offer the greatest return on investment in terms of improved economic outcomes for rural places. We propose looking at leverage points on three levels:  

Policy Levers – What are the changes or enhancements to policies that would strengthen the distribution and coverage of capital programs? Program Levers – What are the lessons learned from high performing regions that could be applied to help develop or enhance programs in underserved capital regions?

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Infrastructure Levers – What are the most critical elements of the capital market ecosystem or “infrastructure” of a region that can enhance the outcomes of federal capital programs, in particular?

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