For Start Up Financing, Banks Count Little

When it comes to financing new small businesses in that critical initial phase, bank loans don’t matter much. Home equity loans and credit cards do matter

In truth, banks shouldn’t be lending much to start ups. There is the detail of risk.

The observations come from the Dennis Lockhart, president and chief executive officer of the Federal Reserve Bank of Atlanta.

This financing situation means that the real estate mess of the past few years probably has provided a major contribution to the reduction in new business formations from 870,000 in 2006 to 720,000 in 2010. The number of credit card accounts and the borrowing limits are well below pre-recession levels, Lockhard says.

New businesses on the way to becoming medium and large firms “are the true drivers of job creation” with 40% of new jobs during a given year coming from the fastest growing one percent of businesses. Mom-and-pop firms—by definition small scale—are much less important in job-growth terms.

The businesses that count are the ones that are “scalable,” that grow quickly. Lockhart refers to one study that says 40% of new jobs each year come from the fastest growing one percent of firms and that 75% are younger than five years.

Lockhart’s comments are in the Fourth Quarter 2011 issue of EconSouth. Find it at frbatlanta.org.