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Sources of Financing

Major categories of financing available to small businesses include internal sources, such as owners' savings, business retained earnings and depreciation; informal external sources, such as friends and business associates; financial intermediaries, such as banks and finance companies; and public markets, where standardized financial instruments are sold.

More than two-thirds of all new firms begin with less than $10,000 in total capital according to Census Bureau and Federal Reserve surveys. In fact, almost half of new firms begin with less than $5,000, usually provided by the owner, family members and friends. Overall, small firms rely more on equity capital and short-term debt, and less on external-debt capital and long-term debt, than larger firms. Most small firms use external financing only occasionally. Under 50 per-cent of small firms borrow once or more during a year. However, small firms experiencing rapid growth or those with high volumes of receivables require frequent use of external financing.

A recent national survey of small firm financing (co-funded by the SBA and the Federal Reserve) for firms with one to 499 employees revealed the following financing patterns:

Of all small firms, 26 percent had lines of credit, 9 percent had financial leases, 6 percent had mortgage loans, 14 percent had equipment loans, and 24 percent had motor-vehicle loans in 1993.
Of larger firms with 100 to 499 employees, 60 percent had lines of credit, 30 percent had financial leases, 19 percent had mortgage loans, 29 percent had equipment loans, and 26 percent had motor-vehicle loans in 1993.

Banks are the dominant suppliers of these types of financing; 37 per-cent of small firms obtained some financing from commercial banks. Other major suppliers include finance companies, leasing companies and other non-financial institutions. The cost of borrowed funds is higher for small firms - interest rates on bank loans average two or three percentage points over the prime rate, and fixed-rate loans are usually more expensive than floating-rate loans. For the smallest firms, those mom-and-pop operations with or without hired employees, owner capital is the most important source of financing. Other sources of financing include trade credit, personal loans from financial institutions, and loans from friends and relatives.