Table of Contents

Executive Summary

As an addition to its Target Population Analysis and to further assist the New Jersey Community Loan Fund’s (FUND) goal of economic development lending, Project Community investigated the lending environment and business climate at the local level. The emphasis, although not exclusively, was on small businesses. As background, researchers examined the existing literature on small business and community lending. Additionally, a fifteen minute telephone survey was administered to 25 small businesses in Paterson, New Jersey’s fifth largest city. This report presents the results of those two avenues of research.

Three questions were developed to guide the research. The questions attempted to investigate the performance of lending to small and micro-sized businesses; the value added to a community by such loans; and the need for small business loans provided by community development financial institutions (CDFIs).

Questions addressing the performance, as well as the value added, of community development lending are addressed with information collected through a search of the existing literature. It was found that loans by CDFIs perform quite well: several studies reported loan loss rates of less than 1%. This rate is very comparable to the loss rate reported by traditional banks. However, it was more difficult to reach a conclusion on the topic of value added to a community. Researchers sought studies assessing either the business activity generated by community lending or the jobs created by such lending. No studies regarding the first indicator were found; in contrast, several studies of the latter indicator were located. These studies suggested that to date community development lending has created a significant number of jobs. Thus, from the literature, it appears that this type of lending may produce some value-added effects for the community.

Researchers addressed the current need for small business lending through the survey instrument. In addition to providing general statistics about their business, survey respondents were asked to identify their business’ lending histories, as well as the strengths of, weaknesses of, and support services available in, Paterson’s business climate.

There are several interesting findings: First, formal lending institutions may not be providing adequate loan opportunities to start-up small businesses. This tentative conclusion is based on the result that existing businesses received many more loans than did start-ups. These loans were also for a greater amount. Second, financial institutions may not be adequately marketing existing loan products. Many business owners who had not sought out a loan did not even know such products existed. Finally, every business surveyed made use of at least one support service, and most relied on more than one. There was still a need for additional supports. When asked to identify services that would be helpful, respondents offered many suggestions, such as flexible and affordable loans and more security (police). Many businesses however are ambivalent about using support services, if they become available.

Purpose

The New Jersey Community Loan Fund is considering diversifying its lending portfolio to target loans for business development and expansion to aid job growth for low income people. Project Community sought to support the FUND’s efforts by conducting some exploratory research which would yield results from the local level on the lending experiences and the general climate for businesses. The research focused mostly on small businesses. Therefore, in order to narrow the research, specific questions were formulated:

1. How have small and micro-sized business loans performed?
2. What is the value added to a community by such lending (measured by jobs created, business generated)?
3. Can we determine the need for small business lending by community development financial institutions?

Methodology

With limited time and resources to carry out the survey, researchers decided to administer a qualitative telephone questionnaire to a sample of businesses in Paterson. Researchers chose Paterson as the location for several reasons. The city was one of the sites the FUND was planning to focus other aspects of its research, e.g., capital markets audit. Paterson is New Jersey’s fifth largest city and would provide a good example of the issues and problems facing smaller-scale businesses in New Jersey's cities. In addition, students at the Bloustein School of Planning and Public Policy had recently completed a redevelopment plan for downtown Paterson; information in their report helped to inform this research. A random sample of Paterson businesses was selected from the August 1994 issue of PhoneDisc, a telephone yellow pages directory on CD-ROM. From the more than 2,500 businesses listed in Paterson, 250 were randomly chosen as representative of the New Jersey's businesses.

The survey is an exploratory approach to the research and has several limitations. The scope of the survey is narrow and does not include other sectors which may be able to confirm or contrasts the results obtained, e.g., interviewing bank lending officers. The size of the sample is small. Paterson may not be typical of business settings in the state. There is a definite urban bias. Another limitation is the source used --yellow pages of business telephone numbers. Using the phone listings excluded businesses that either do not have phones, or are not advertising in the yellow pages. The findings obtained from this study are therefore only a preliminary description of the situation. Despite these limitations, the findings into the lending and operating experiences of the businesses surveyed should provide valuable qualitative information and an important first step upon which to build further research.

The initial sample of 250 businesses was immediately reduced by 42 due to incomplete addresses in the PhoneDisc telephone listing. The remaining 208 businesses were sent a letter describing Project Community and asking for their participation in a short telephone survey (see Appendix ##). Out of a total of 208 letters mailed, 36 were returned: 19 because the business had moved leaving no forwarding address (the assumption was made that these firms were no longer in existence); and an additional 17 because of insufficient address. Again, due to time constraints, these 17 were not remailed. That left a total of 172 businesses whom, we assume, received the letter.

During the week following the mailing, respondents were called by student representatives from Project Community and asked if they received the letter. If not, they were apprised of Project Community's work with the Fund, and then asked if they would participate in a ten to fifteen minute interview. In total, 168 businesses were called, and 25 participated in the interview. Based on these numbers, our response rate was 15%. However, from the 168 businesses that we tried to contact, approximately 10% were out of service.

The questionnaire is divided into two parts. Section I is comprised of questions with discrete, codable answers. Some of the questions are ‘yes/no’; others required respondents to provide specific information, such as "number of employees" or "years in business". Results were entered onto a spreadsheet, from which a qualitative analysis was performed. Section II is comprised of three open-ended questions. Results in this section were compared and analyzed.

Discussion

The survey was designed to develop an overview of a typical small business climate in New Jersey: general characteristics, lending needs, and borrowing practices of various establishments. The survey extracted many provocative responses; following is a summary of the results.

Section I: Business and Lending Profiles

• The twenty-five completed surveys included six retail establishments, ten services providers, three wholesalers, and six manufacturing establishments.
• Of the respondents, nineteen were owners, five were managers, and one was an employee.
• Nineteen of the establishments employed less than 5 people (full-time or part-time); four establishments employed between 6 and 10 people; the remaining two employed between 11 and 25 persons.
• Ten establishments were between 5 and 10 years old; eleven were more than 10 years old; three were between 1 and 4 years old; one was less than a year old.
• Twelve respondents were employed in the same or a related business before holding his or her current position; eight were either previously unemployed or worked in an unrelated field. The question was not applicable in the five remaining cases.
• In total, 17 businesses rented their property, while only eight owned it. Of the six retail establishments, four rented their property and two owned it; for wholesalers, two rented and one owned; manufacturing establishments were as likely to own as they were to rent (three owned; three rented); service providers were much more likely to rent than to own -- eight rented and only two owned. Three of the manufacturing businesses owned their property, while only one of the six retailers owned it.
• Of the business owners who had been in business for less than ten years, only one of ten owned their property. In contrast, of the owners who had been in businesses ten years or more, half owned their property and half rented it. Of the eight business owners who also owned their property, seven had been in business ten or more years; of the seventeen who rented, ten had been in business less than ten years.
• All businesses reported use of at least one support service: twenty-two retained an accountant or used an accounting service; fourteen used a legal service; one used a payroll service; one used a real estate agent.
• Fifteen establishments reported that the owner's income was the sole source of support for his or her family. Nine business owners had working spouses. One owner reported income from a second job.

• Of the twenty-five businesses, nine received some form of loan to start their business. Four businesses started with loans from family members or friends; two received a bank loan; two from a combination of family loans and personal savings; one purchased the business from the original owner on installment. For sixteen businesses, start up money came exclusively from personal savings.
• Eleven businesses received fourteen loans after start-up (two businesses received two loans and one business received three). Five of the fourteen post-start-up loans were from a bank; six were from friends or family members; one was from the Small Business Administration (SBA); and one was from a leasing company. Four of the businesses received both a start-up loan and at least one post-start-up loan.
• Of the nine start-up loans from both formal and informal sources, four were for between $10,000 and $20,000; one was for under $10,000; and the remaining four were for an unknown amount.
• Of the fourteen post-start-up loans, eight were for between $10,000 and $20,000; two were for between $50,000 and $100,000; two were for more than $100,000; one was for between $20,000 and $50,000; and the last was for less than $10,000.
• Six businesses borrowed money for cash flow reasons. Three businesses borrowed money for jobless expansion; one borrowed money for expansion creating additional jobs. One business used a credit line; another borrowed money to repair fire damage.
• Of the fourteen businesses that never took out a post-start-up loan, only two ever considered one. One expressed interest in using a loan for cash flow reasons; the other considered a loan to purchase new equipment. Of these two businesses, one had borrowed money for start-up.

Due to the qualitative nature of this study, our conclusions must be confined to general observations. Nonetheless, our findings reveal several intriguing patterns. First, it is interesting to note that business start-up was financed primarily from personal savings or informal loans. Sixteen business were started from personal savings and family loans accounted for all or part of six others. In contrast only 2 received a bank loan to start their business. None of the twelve businesses which were younger than ten years old received a start-up loan from any formal lending institution. This suggests a combination of conditions that may have existed. Formal lending institutions may not be providing adequate loan opportunities for start-up small businesses. Lending institutions may not be adequately marketing their existing products targeted to potential start-ups. Finally, entrepreneurs may not need or want these loans.

In contrast to the results for start-up loans, seven of the fourteen post-start-up loans originated from formal lending establishments -- five from banks, one from the SBA, and one from a leasing company. Additionally, these loans tended to be larger loans. None of the start-up bank loans were for more than $10,000; while all but one of the post start-up loans exceeded that amount. Four of the post start-up loans were for over $50,000. The majority of loans (57%) were between ($10,000 - $20,000.) This intimates that lending institutions may be willing to finance older, more established firms with a track record, rather than taking a risk on firms in their nascent stage.

Taken together, these findings suggest that conventional banks may not offer the loan products which small business start-ups might find helpful. This qualified conclusion stems from two of the above findings: the dearth of start-up loans in our sample businesses when compared to the amount of post-start-up loans, and the smaller size of these start-up loans that were given.

Another interesting finding was that every business used some form of outside service, be it accounting (twenty-two businesses), legal assistance (fourteen business), payroll services (one business), or real estate agents (one business). Many used more than one of these services; most listed accounting as the most important service when they were required to rank them. Nonetheless, there was still a need for additional support services in the area. When asked to identify services that would be helpful, respondents offered many suggestions, such as flexible and affordable loans and more security.

A surprising finding was that only fifteen of the business owners listed the business’s income as the only source of support for his or her family. Furthermore, it made virtually no difference whether the business was mature (over 10 years old) or relatively new (under 10 years): Of the fourteen businesses over ten years old, nine provided the owner his or her family’s sole source of income, while five owners had other jobs or a working spouse. Similarly, of the eleven younger businesses, six provided the sole source of financial support for its owner’s family, while five owners had other jobs or a working spouse.

Section II: Analysis of General Business Climate

In general, most respondents pointed to several positives that make Paterson a good place for small business. There was a common theme thread through most of the responses: respondents identified five specific factors of the Paterson small business environment which stand out as positives. They are:

• Good location (seven responses);
• Solid customer base/market (seven responses);
• Low cost of land (seven responses);
• Security (six responses); and
• Good labor pool (five responses).

Responses referring to security, low cost of land, and a good labor pool are self-explanatory and were fairly easy to aggregate. However, when respondents mentioned favorable location as an attribute, they were often referring to the relative ease of access to major roads. Also, positive responses about the business’ customer base were assigned to the solid customer base/market category.

Next Steps

As stated, this study served as an exploration into the lending environment and business climate at the local level. The study’s limitations and findings however provide ample areas for the FUND to do additional research. Several important questions should be pursued.

• Did business owners seek bank loans for start-up? Do entrepreneurs need or want such loans?
• Did most business owners rely for start-up on personal savings and informal loans because of prohibitive factors such as financing costs or lack of credit worthiness?
• How much, if any, were credit cards used to finance start-ups?
• Do banks possess the types of loan products that small businesses may need, especially for start-up operations, and, if so, how are they marketed?
• It would also be useful to sample former owners of firms which went out of business to determine if limited access to lending was a factor in the failure of the businessess.

APPENDICES

Appendix A: Bibliography

Appendix B: List of Interview Questions

1. What type of business is this?
2. What is your position in this firm?
3. How long have you worked in this capacity?
4. What did you do before?
5. How long has the firm been in business?
6. Do you own the property on which the business sits?
7. How many people do you employ?
8. How did you get the money to start your business?
9. If you borrowed money, how much?
10. Have you borrowed any money for the business since start-up?
    
          If yes...
          A. What was the reason for the loan?
          B. How much did you borrow?
          C. What was the lending source?
    
          If no...
          A. Have you ever considered applying for a loan since start-up?
          B. For what were you considering using the loan?
    
    
11. Do you use any support or professional services of any kind in you business?
12. Is the business the only source of support for your family?

1. If you could, please list, if there are any, the positive of Paterson's business climate.
2. If you could, please list, if there are any, the negatives of Paterson's business climate.
3. If you could, please list, if there are any, the support services available for small businesses in Paterson.
4. If you could, please list, if there are any, support services that are not currently offered which you feel would be helpful to small businesses in Paterson.

Appendix C: Copy of Letter Sent to Sample Business