Business Credit for U . S . Subprime Borrowers : How Much Does it Matter for Entrepreneurial Success ?

A lot. Using data on startup loan applicants from a U.S. subprime business lender that employed an automated algorithm in its application review, we implement a regression discontinuity design assessing the causal impact of receiving a loan on entrepreneurial success. Obtaining a relatively small loan has a strong effect on the long-term financial position of startups. Startups receiving funding are dramatically more likely to survive, enjoy higher revenues and create more jobs. Loans are more consequential for survival among subprime entrepreneurs with more education and less managerial experience. JEL codes: G32, L26, M13 We would like to thank Catherine Meyrat, Nelly Rojas-Moreno, and Duangkamol Phuengpanyalert for their guidance about Accion’s institutional details. We are grateful to Manuel Adelino, Nishant Dass, Joan FarreMensa, Thomas Hellmann, David Robinson, and audiences at Berkeley, Instituto de Empresa, NYU Stern, Rutgers, UCLA, Wharton, the ASU Finance Conference, the Napa Conference on Financial Markets, the SFS Finance Cavalcade, the Texas Finance Festival, the UBC Winter Finance Conference, and the UNCDuke Corporate Finance Conference for useful comments. We also thank Rosy Manzanarez, Alejandra Garcia, and Siddharth Subramanian for their research support. Garmaise gratefully acknowledges support from the Harold and Pauline Price Center. Contact information: cesare.fracassi@mccombs.utexas. edu, mark.garmaise@anderson.ucla. edu, shimon.kogan@austin.utexas. edu, gnativid@stern.nyu. edu. New firm creation by non-traditional entrepreneurs has now become a large and dynamic feature of the U.S. small business landscape. Standard studies of entrepreneurs (e.g., Hurst and Lusardi 2004) have traditionally portrayed a group that was almost exclusively white in ethnicity. This has changed, and recent data show that minorities accounted for 22% of U.S. self-employment in 2011, and, further, over the period 2000-2011, minority selfemployment grew by 30%, while overall self-employment grew by only 6%. In other words, minority small business ownership has grown dramatically in the recent period. Many of these minority entrepreneurs may well be classified as subprime or marginal borrowers who are granted only limited access to formal sources of financing. This suggests the possibility that financial constraints are limiting the growth of an important and growing component of the entrepreneurial sector of the economy. In this paper we consider two main empirical questions. First, how effective are relatively small loans (median amount of $11,000) in promoting the success of entrepreneurial firms founded by marginal, often minority, borrowers? Second, which of these constrained entrepreneurs most benefit from receiving financing? On the first issue of the importance of credit, consider a potential loan from a given lender to a low-credit-score entrepreneur starting a small firm. It may be argued that this funding will have a large impact on the firm’s success, as loans typically represent a major source of small business financing (e.g., Bates 1990, Black and Strahan 2002, Robb and Robinson 2012), and early-stage credit may enable entrepreneurial ventures to invest in value-creating opportunities and achieve necessary scale, especially for those without easy access to other sources of financing. On the other hand, there are reasons to suggest that the effect of the loan will be minimal. Specifically, there is evidence that entrepreneurs who Source: Small Business Administration data available at http://www.census. gov/econ/sbo/pums.html and http://www.sba. gov/sites/default/files/us12.pdf. Fairlie (1999) finds that low wealth is a particularly serious problem for minorities considering entrepreneurship, and Calem, Gillen and Wachter (2004) document that subprime lending is especially common in minority neighborhoods.