Fintech, Small Business & the American Dream Read online

  Karen G. Mills

  Fintech, Small Business & the American Dream

  How Technology Is Transforming Lending and Shaping a New Era of Small Business Opportunity

  Karen G. MillsHarvard Business School, Harvard University, Boston, MA, USA

  ISBN 978-3-030-03619-5e-ISBN 978-3-030-03620-1

  https://doi.org/10.1007/978-3-030-03620-1

  Library of Congress Control Number: 2018962465

  © The Editor(s) (if applicable) and The Author(s), under exclusive licence to Springer Nature Switzerland AG 2018

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  “The financial crisis destroyed the traditional small business lending system and left these companies with severely impaired abilities to raise capital and grow. In this book, Karen Mills brings her government and her private sector expertise to bear describing how technology may reinvent the ways small businesses operate and raise capital going forward. Economists, policymakers, and anyone interested in the future of small business will benefit from her insights on how the future of fintech and the small business economy will be inextricably linked.”

  —Austan D. Goolsbee, Professor of Economics at University of Chicago Booth School of Business and Former Chairman of the Council of Economic Advisers

  “Small businesses have been the path to economic independence for millions of Americans. Mills shows how fintech can extend that opportunity to even more.”

  —Deval Patrick, Managing Director, Bain Capital Double Impact and former Governor of Massachusetts

  “Few people have done more over the last decade to help small business owners than Karen Mills. Now, in Fintech, Small Business & the American Dream , Mills describes a brave new world for small businesses where technology has made capital more readily available and fintech firms use data to break down old barriers. She provides a refreshingly optimistic look at how innovation can bring about Small Business Utopia where the entire financial life of a small business is transformed in a positive way by new technology. But this is not pie in the sky thinking, Mills lays out a detailed plan as to how we can reach this new promised land.”

  —Peter Renton, Founder of Lend Academy and Chairman of LendIt Fintech

  “This book should be required reading for all policymakers with an interest in entrepreneurship, small business development and economic growth.”

  —Keith Morgan, CEO, British Business Bank

  “As we have documented with data from over a million enterprises, small businesses have low cash buffers and bumpy cash flows. Mills’ outstanding book assesses the cost of these stresses to small businesses and creates a new vision for technology-driven solutions of the future.”

  —Diana Farrell, President and CEO of JPMorgan Chase Institute

  “Small businesses are often referred to as the ‘backbone of the economy’ and they need capital to grow and succeed. Mills understands small businesses through her work at the SBA and gives us real insights into how technology will affect, as well as benefit their future.”

  —Mike Cherry, National Chairman of the U.K. Federation of Small Businesses

  To Barry, William, Henry, and George

  Preface

  It was a cold day in Arkadelphia and we were shivering out in the muddy grounds of the sawmill. As part of my new role in Washington , I had gotten up at 4 AM, taken two planes to land in Little Rock, and driven two hours south to visit Richie and his wife Angela at their business, Shields Wood Products. I was not in a good mood. Then Angela, who was also the business’s bookkeeper, turned to me and said the words that changed my whole perspective on the day and probably led to the writing of this book. “You know,” she said, “you saved our business.”

  I heard these words dozens of times over the next year as we worked to get capital flowing to small businesses who were suffering because credit markets had frozen during the Great Recession of 2008. Banks that had become overextended stopped lending , making loans guaranteed by the U.S. Small Business Administration (SBA) a lifeline for many. As the head of the SBA , I was the member of President Obama’s Cabinet who was responsible for all of America’s entrepreneurs and small business owners. It was a terrific job. But it sometimes required pounding the table to ensure the voice of small business did not get lost under the mass of other priorities.

  I knew how important small business was to the economy . My Grandpa Jack had come to America from Russia at the turn of the last century with nothing. Starting with two machines in the back of a shoe shop in Boston, he built a textile business that not only provided for his family and extended family, but grew to employ hundreds of people. When I worked for him in the mill during my college years, he would tell me not to go to work for a big company. “Our family,” he would say, “doesn’t work for other businesses. We build our own.”

  Grandpa Jack’s story was the story of the American Dream. Our country is one of the few places in the world where it is possible to lift oneself and one’s family to a new set of opportunities and a new life by starting and growing a small business. This path to opportunity, however, is threatened. Access to capital for small businesses has been under pressure, not only during the recession, but for decades prior, due to consolidations in community banks and the difficulty banks have in making profits with small loans , particularly those given to the smallest businesses.

  Beginning around 2010, however, fintech entrepreneurs have come on the scene. Using data and technology, they have brought a new experience to small business borrowers, massively improving a process that has essentially not changed since the time when Grandpa Jack sought a loan . Through their early success and some subsequent stumbles, these innovators are transforming the small business lending market. Large global banks and small community banks have woken up to the fact that small businesses are looking for a more responsive, more innovative set of products and services focused on their unique needs. Platforms like Amazon , Square , and PayPal are demonstrating the power of data to overcome the information opacity that has long made small businesses difficult to understand.

  This book explores the current and potential future states of small business lending . It asks, “What do small businesses want? Who will be the
winners and losers? And how should regulators respond?” But most of all, this is a book about the role of small business, its importance to the economy , and the prospects that technology brings to overcome some of the fundamental barriers to a better small business lending market. It seeks to define a new state—Small Business Utopia —a world of innovative solutions that will help small businesses get the capital and financial insights they need to grow and succeed.

  At the center of this book is a basic premise that small businesses matter. They matter for economic growth, they are fundamental to our communities, and they are critical to the future of the American Dream. This has been my experience as a venture capitalist and a small business owner, and during my time in government. And it is confirmed by the stories of Richie and Angela, Grandpa Jack, and the owners and employees of so many of America’s 30 million small businesses.

  In October 2009, I was standing with President Obama in a warehouse in Landover , Maryland, filled with small business owners. The President finished his speech, looked into the faces of these entrepreneurs who were suffering in the aftermath of the financial crisis, and said: I know that times are tough, and I can only imagine what many of you are going through, in terms of keeping things going in the midst of a very tough economic climate. But I guarantee you this: This administration is going to stand behind small businesses . You are our highest priority because we are confident that when you are succeeding, America succeeds. 1

  Small businesses are better off today in terms of access to capital than they were in the midst of the financial crisis, but obstacles remain. The rise of technology may serve to help small businesses overcome these challenges, forging transformative new products and services and a renewed pathway to the American Dream. In this period of change, we must ensure that innovations flourish in ways that enhance the prospects and prosperity of small businesses. Because, when small businesses succeed, America succeeds.

  Karen G. Mills

  Boston, MA, USA

  Acknowledgments

  A book is a long effort and is built from the input of many wise and generous colleagues. I thank Louis Caditz-Peck, Ronnie Chatterji, Diana Farrell, Bill Kerr, Barbara Lipman, Brayden McCarthy, Ramana Nanda, Richard Nieman, Robin Prager, Peter Renton, Scott Stern, and Jonathan Swain for taking the time to read drafts and give comments and edits that significantly improved the book. I am particularly grateful to Bill Kerr for his input and for the example of his book, The Gift of Global Talent , from which we took much guidance. No one contributed more to this book than Aaron Mukerjee, Justin Schardin, and Annie Dang, who researched, wrote, and edited with me for months, providing stories, drafts, and good judgment throughout. Many thanks to Jacey Taft for her efforts on obtaining the permissions for the stories and graphics, and for her daily support. Brayden McCarthy had the original idea to write about the gap in small business lending, after working at the SBA and in the White House, and was my coauthor on two Harvard Business School white papers that form the basis for Part I of the book.

  This book had its origins in the time I spent in Washington running the SBA during the financial crisis. I want to thank the team at the SBA for their inspiration and dedication, particularly those in the field offices who spend every day getting capital into the hands of small business owners. The impact we made would never have been possible without the vision and hard work of the SBA leadership team, especially Jonathan Swain, Chief of Staff, who continues to work with me on these issues. Those that have worked in Washington know that nothing gets done without support from the White House and Congress. To this day, I am grateful to President Barack Obama and to Larry Summers, Gene Sperling, Valerie Jarrett, and Pete Rouse for their commitment to small businesses and to me. Senators Mary Landrieu and Olympia Snowe set an example of bipartisan leadership by working together to pass critical legislation that is still helping small business owners.

  At Harvard Business School, the encouragement given by Dean Nitin Nohria, Jan Rivkin, and my colleagues in the Entrepreneurial Management unit was a critical factor in the decision to write this book, and the Division of Research and Faculty Development provided significant and much appreciated support. I thank Tula Weis, Ruth Noble, and the team at Palgrave Macmillan for the opportunity and for all their help. Glenn Kaplan and Rebecca Uberti provided design and wise counsel on the book cover.

  The inspiration for this book comes from watching my family, particularly my parents Ellen and Melvin Gordon, and my grandparents, go to work each day in offices just off the factory floor and build businesses. I am grateful to them, and especially to Barry and our boys, William, Henry, and George, for their support and encouragement in this book and in all endeavors.

  Contents

  1 The Story of Small Business Lending

  Part I The Problem

  2 Small Businesses Are Important to the Economy

  3 Small Businesses and Their Banks:​ The Impact of the Great Recession

  4 Structural Obstacles Slow Small Business Lending

  5 What Small Businesses Want

  Part II The New World of Fintech Innovation

  6 The Fintech Innovation Cycle

  7 The Early Days of Fintech Lending

  8 Technology Changes the Game:​ Small Business Utopia

  9 A Playbook for Banks

  Part III The Role of Regulation

  10 Regulatory Obstacles:​ Confusion, Omission, and Overlap

  11 The Regulatory System of the Future

  Conclusion

  12 The Future of Fintech and the American Dream

  Notes

  Index

  Footnotes

  1 President Barack Obama , “Remarks at Metropolitan Archives, LLC” (speech, Landover , Maryland, October 21, 2009), Government Publishing Office, https://​www.​govinfo.​gov/​content/​pkg/​PPP-2009-book2/​pdf/​PPP-2009-book2-doc-pg1555.​pdf .

  © The Author(s) 2018

  Karen G. MillsFintech, Small Business & the American Dreamhttps://doi.org/10.1007/978-3-030-03620-1_1

  1. The Story of Small Business Lending

  Karen G. Mills1

  (1)Harvard Business School, Harvard University, Boston, MA, USA

  Karen G. Mills

  Email: [email protected]

  Half of the people who work in America own or work for a small business. They account for half of this country’s jobs. There are more than 30 million small businesses in the United States today, underpinning our economy and the fabric of our society. These businesses operate in every corner of every state, and exist in every industry, from retail shops to oil and gas exploration. The story of the small business owner is often one of the community-minded citizen who supports the local Little League or the immigrant entrepreneur who builds a life of opportunity.

  All of these small businesses are different, but they face a common challenge: it is often difficult for them to get access to the capital they need to operate and succeed. Until recently, lending to small businesses hadn’t changed much over the past century. A small business owner would compile a stack of paperwork, go to their local banker, and often wait weeks for a response. If the answer was “no,” they would go down the street to the next bank and try again.

  While this might sound like a frustrating process, there are many who say that it is not a serious problem. They argue that many of the small businesses that have trouble accessing capital should not actually get it because they are not creditworthy, and that most small businesses don’t want to grow, so have no need for external financing. They also argue that today’s banks are fully meeting the needs of the creditworthy borrowers in the marketplace. These statements have some truth to them. Not every business who wants a loan should get one and many businesses don’t want to grow. The lending environment is also much improved from the dark days of the Great Recession. However, these views are blind to market failures in small business lending, which have only worsened over recent decades.

  Small business lending is har
d. In this book, we will meet small business owners—from Miami to Manhattan to Maine—who are struggling to get the right loan in the right amount at the right cost. We will meet lenders—from New England to Texas to Silicon Valley—who are trying to figure out which small businesses are creditworthy and how to lend to them profitably. These are not just isolated anecdotes, but rather, they represent the experiences of small business borrowers and lenders in a market filled with frictions . Using the best available research and data, we will show a picture of the gaps in access to capital for creditworthy small businesses, and the barriers that have made many traditional lenders less willing or able to meet their needs. And we will track how innovations in fintech have begun to address some of these problems.

  Transforming Small Business Lending

  Many industries, from music to telecommunications, have been transformed by technology, but small business banking has been slow to evolve. That is changing. Financial technology, or “fintech,” is a broad category that includes innovation across the banking, insurance, and financial services sectors, as well as new activities in areas like cryptocurrencies and blockchain . This book uses a narrower fintech lens, focusing on the way technology will affect lending—specifically, small business lending.

  Lending does not happen in isolation. Other fintech innovations , particularly in payments, will have a related impact as they evolve. But, for the purposes of this narrative, the innovations in lending, and in data and intelligence related to lending, provide a rich environment to explore the ways in which technology will bring changes to the market. The cycle of fintech innovation in small business lending is not yet complete, but it has ushered in promising changes.