Strategies to obtain a working capital line of credit for small business

Conducting the literature review on the research topic involved accessing various journals and seminal books through the Walden University Library website. Databases searched included ABI/INFORM Complete, ProQuest Central, Emerald Management, Business Source Complete, Academic Research Complete, and SAGE Premier. I also conducted searches through Google Scholar and AOSIS Open Journals. Google Scholar queries provided various interdisciplinary results, including conference proceedings, and AOSIS Open Journals searches returned peer-reviewed scholarly articles from a wide range of academic disciplines. A review of business journals and publications returned research specific to small businesses and small business owners. Government websites, including those of the SBA and the Maryland Chamber of Commerce, provided valuable information on small businesses’ credit strategies and programs.

In searching for relevant literature, I gave preference to peer-reviewed articles published between 2016 and 2021 to obtain current information and findings. Ulrich’s Periodicals Directory was a helpful tool to ensure the articles were peer reviewed. Keywords and combinations of keywords used for the search included small business, business lending, small business lending, small business financing, credit strategies, bank loans, sources of financing, working capital line of credit, small business and financial constraints, small business continuity, capital structure, information asymmetry, and the lending process, small businesses and audited financial statements, small business leadership, the theory of discouraged borrowers, and small business and discouraged borrower. The literature review search produced 142 sources, 137 (85%) of which were peer-reviewed articles published between 2016 and 2021. Comment by Natalie Casale: Hi Solomon, changing this date range does not resolve the issue I identified in your previous feedback. First, you did not change your percentage. Next, you do not have any 2021 peer-reviewed resources that you included in your literature review (LR). You will need to do so. This is to ensure your LR is current. Please review the attached document to have a clear understanding of the issue. Thank you!

I compared and contrasted the work of different scholars to obtain varied perspectives on the research phenomenon. The first overarching concept, the likelihood of application for and approval of a working capital line of credit, emerged from discussions of the TDB in the context of small businesses. The discussion topics related to the second concept, small businesses, included small business sustainability, small business challenges, and government roles. The concept of small business financing emerged from literature on funding programs, sources of capital, and credit strategies, with a fourth concept of information symmetry in the lending process.

The purpose of this qualitative multiple case study is to explore strategies that small business owners use to obtain a working capital line of credit for business continuity. The literature review begins with an in-depth exploration of the conceptual framework of the TDB and how researchers have used it in related studies. Other relevant topics discussed are small business financing, credit strategies, information symmetry in the lending process, and audited financial statements.

The TDB emerged in the early 21st century when Levenson and Willard (2000) explored how insufficient credit and credit rationing discouraged small business owners from applying for loans. As Levenson and Willard labeled them, the majority of discouraged applicants were founders of smaller, less-established businesses. Levenson and Willard examined U.S. small business owners who encountered credit rationing in their quest for external financing. They drew data from a national survey of businesses in 1987 and 1988—the first years for which direct data were available specific to business owners’ desire for credit—that indicated only a small percentage (2.14%) of small business owners had applied for and failed to procure financing, with an additional 2.17% obtaining financing after an initial rejection (Levenson & Willard, 2000). Comparatively, the percentage of small business owners discouraged from applying was 4.22% (Levenson & Willard, 2000).

In 2003, another set of researchers, Kon and Storey, expanded on the idea of discouraged credit applicants to create the TDB. Kon and Storey (2003) described discouraged borrowers as business owners who, despite needing financing for their operations, do not apply for loans for fear that the bank will reject their application. Kon and Storey adopted the discouraged borrower approach to assess loan application success in response to the extensive literature on credit rationing, collateral, and asymmetry. Business owners feel discouraged from borrowing based on perceived high application costs combined with screening errors and public policies not conducive to small business lending. The greatest degree of borrower discouragement occurs when a bank has inadequate information on the applicant’s business (i.e., information asymmetry). Therefore, small business owners who have not successfully obtained a working capital line of credit might have felt discouraged from even applying.

Han et al. (2009) explored the TDB specific to the factors leading a borrower to become dispirited. Following an analysis of data on financing for U.S. small businesses, the researchers indicated that small business owners with riskier businesses were often less likely to apply for bank financing. Han et al. also introduced the concept of information asymmetry in that, as bank transparency increased, the owners’ likelihood of applying for financing increased.

Chandler (2010) drew parallels between discouraged borrowers and their relationships with banks. A critical component of the bank–business relationship is information symmetry, something discussed in later studies concerning small business owners’ ability to obtain working capital lines of credit for business sustainability and growth (e.g., Ata et al., 2015; Caporale & Gil-Alana, 2016; Moro et al., 2015; Njeru et al., 2013; Sahin et al., 2011). Information symmetry refers to transparency in the loan application process about small businesses’ credit history, balance sheets, business plans, and intended use of the financing (Yan et al., 2015); therefore, information symmetry affects the degree of trust between the parties.

Tang et al. (2017) narrowed the TDB to look specifically at the trust component between a business owner and a loan manager and its effect on the business owners’ decision to apply for credit. Their findings showed the business owners’ degree of perceived trust with the lending agency strongly influenced their decision to apply for credit (i.e., the lower the trust, the greater the borrower’s discouragement). Despite the connection between trust and increased access to working capital lines of credit, the longevity of the owner–lender relationship had no bearing on borrower discouragement. An inverse relationship also emerged between the small business owner’s degree of experience and the subsequent discouragement in borrowing. Business owners with prior entrepreneurial experience had a greater degree of trust in lending institutions and were more inclined to apply for credit.

Scholars have conducted extensive research on the difficulties small business owners face to obtain credit and ensure continuity (Freel et al., 2012). Less common, however, are studies of the discouraged borrowers who, rather than risk rejection, choose not to apply for credit. A literature review showed discouraged borrowers outnumbered rejected borrowers by 2 to 1 (Kon & Storey, 2003). Also indicated were four characteristics common among discouraged borrowers of business strategy: industry sector, the business owner’s prior experience, and preexisting banking relationships (Freel et al., 2012). Findings showed that entrepreneurial and firm strategy factors are the primary differentiators between discouraged and rejected small business borrowers. (Kon & Storey, 2003). Most likely to be discouraged were owners of smaller or family-owned businesses and those who had previous entrepreneurial experience, offered knowledge-intensive services, or led limited liability partnerships or corporations. Freel et al. (2012) conducted an extensive study of small business owners’ need for bank financing specific to their discouragement from applying. The researchers used information from a large-scale survey of small business organizations that measured the attitudes and opinions of owners, including whether they had applied for a loan, received a loan, or felt discouraged from applying for a loan in the last 2 years. Freel et al.’s findings are directly applicable to the theoretical framework for the proposed research, as the percentage of small business owners with rejected credit applications was half of the rate of discouraged small business owners who had not applied. Comment by Natalie Casale: Solomon, You are not getting the issue. You have here FOUR characteristics. You define the FOUR as follows: industry sector, the business owner’s prior experience, preexisting banking relationships How is this FOUR? Comment by Natalie Casale: You added this resource. Now the information presented in this paragraph is not from one resource? How is this so?

One component of Cole and Sokolyk’s (2016) study on small business owners who need and receive credit was the TDB. The four business groups studied were those without a need for financing, those with a need but who feel discouraged from borrowing, those with a need who apply and are approved, and those with a need who apply and do not receive the funds. Specific to the second category of borrowers, the researchers identified four primary components of discouragement: the smaller size of the business, the business’s profitability, the age of the owner, and any access to additional sources of financing (Cole & Sokolyk, 2016). Their findings showed that between 21% and 55% of business owners who had felt discouraged from applying for credit would have received approval. Similar to Freel et al. (2012), Cole and Sokolyk found the likelihood of discouraged borrowers to have received financing was significantly higher than the likelihood of denial.

Some researchers have focused specifically on small business owners’ characteristics as the chief determinant of borrower discouragement. Singh (2014) studied discouraged borrowers with a focus on gender differences, among other factors. Singh’s general findings showed that business owners in the goods sector had a greater need for external financing than did those in the retail and wholesale sectors. In addition, primarily female-owned businesses had less need for outside funding. Singh also identified a parallel between reduced borrower discouragement and both relationship banking and 50-50 male–female business ownership.

Jude and Adamou (2018) suggested that small business owners’ behaviors had the greatest influence on their decision to apply for bank loans and working capital lines of credit. In addition to control aversion and overconfidence, the researchers found discouragement heavily influenced whether a business owner would apply for bank financing. Bhusal and Wang (2019) attributed borrower discouragement to three determinants: the perceived cost of financing, the small business owner’s history with financing, and the would-be applicant’s fear of facing prejudice.

The TDB (Kon & Storey, 2003) was the most applicable theory to the proposed study, with other concepts only peripherally related. The alternative theories I considered to the TDB were the credit theory of money and the theory of financial management.

Credit Theory of Money

The earliest published credit theory was Innes’s (1914) credit theory of money. Innes’s assertion was that money was the only capital that mattered, which directly applies to small businesses needing a working capital line of credit. Innes identified a subtheory to explain a business owner’s satisfaction with the lending process and subsequent ability to repay the loan; however, the author did not address factors affecting business owners’ success in achieving loans. Because Innes’s credit theory of money pertained only to the lending and repayment of business loans and not the strategies used to obtain the loan, it was not appropriate for this study.

Theory of Financial Management

Ang (1991, 1992) proposed a theory peripherally related to the focus of this study. Applied to small businesses, the theory of financial management centered on business failures due to a lack of financing options (Ang, 1991). Ang (1991) wavered in theoretical focus, first introducing the loosely termed theory of modern corporate finance, which applied to businesses of any size. Ultimately, Ang (1991, 1992) conceded that identifying a single theory specific to small businesses’ capital structure was not possible. Ang (1992) explored the difficulty faced by small business owners in securing funding for continued operation. After asserting that no single theory of finance fully addressed small businesses’ unique needs, Ang (1992) differentiated between large and small businesses, finding the latter’s success aligned closely with the business owner’s reputation and the relationships with lenders. The theory of financial management is related to restricted financing options and organizational failure for businesses of any size. The theory does not apply specifically to small business owners and the strategies used to obtain financing for continued operation, making it also not appropriate for this study.

Analysis of Potential Themes

Small Businesses

Small businesses—defined as companies with fewer than 500 employees (SBA, 2018b)—are essential to the U.S. economy (Klimczak et al., 2017). In 2013, 28 million small businesses accounted for over 99.9% of all businesses in the United States (SBA, 2018b). Small businesses have a positive effect on gross domestic product (Klimczak et al., 2017), driving the economies of both developed and underdeveloped countries (Karadag, 2015).

In the United States, small business leaders struggle to sustain their business longer than 5 years (SBA, 2018a). In 2013, 406,353 start-up businesses appeared, and 400,687 others dissolved, showing a narrow gap between the openings and closings of prior years. Businesses fail for many reasons, including an inability to access and manage finances (Lee, 2016). A lack of access to financing and mismanagement of working capital could result in business failure (Karadag, 2015; Lussier & Corman, 2015).

Small Business Sustainability

Business leaders heading operations of any size must have strategies in place to remain sustainable. Relevant to the focus of this study, one key to sustainability is to develop ways to acquire financing for business growth and development (Eggers & Lin, 2015; Leroy et al., 2015). The relationship between management and business partners is a key component of guaranteeing a favorable business return (Fang et al., 2015). Other means of promoting business continuity include networking (Song, 2015), relationship-building (Fang et al., 2015), cost minimization (Banker et al., 2014), and differentiation (Mathooko & Ogutu, 2015). Building positive relationships with the right individuals and making the correct business decisions could lead to ongoing business sustainability and strategies for leaders to obtain a working capital line of credit and ensure business continuity (Bauman, 2015).

Many small business leaders attribute business failures to external factors, despite internal management capabilities and approaches having much to do with business sustainability (Eggers & Lin, 2015). In a study of existing data on small business owners in the United States and China, Eggers and Lin (2015) identified one sustainability strategy to be exploring avenues to acquire financing for business continuity and growth. Pollack et al. (2015) found that small business owners who assembled a network of stakeholders, such as loan officers at traditional banks, were better prepared for positive sustainability outcomes. The findings of both studies are particularly applicable to the study, which will explore how small business owners acquire working capital lines of credit for business continuity. Small business owners must have strategies in place for their organizations to remain sustainable.

Small Business Credit

Small business owners rely on external credit for sustainability. In 2016, 400 small business owners from 12 cities, including Richmond, Maryland, took part in the Small Business Credit interviews administered by the Federal Reserve Bank (FRB) of New York (2017). More than 50% of small business leaders reported encountering problems securing credit for business expansion. Business leaders’ challenges included paying for operating expenses, debts, and inventory without the aid of a small business line of credit. As such, small business owners need a strategy to obtain a line of credit for working capital to sustain their business.

A past working relationship may be a component of a successful application for financing. In general, small business owners pursued financing through lenders with whom they had a good relationship or from whom they expected to receive approval (Neagu, 2016). The applicants generally looked for loans from banks, credit unions, community development financial institutions, and online lenders (Neagu, 2016), finding the greatest satisfaction with small banks (FRB of New York, 2017).

Means of bank financing are integral to understand as relevant to this study; however, not all small businesses seek financing. Business leaders give many reasons for not seeking funds, including already having enough financing, being debt-averse, and having a low credit score, the latter of which is a strong determinant of obtaining financing (FRB of New York, 2017). About 85% of business leaders relied on the credit score of the owner in securing funding. Leaders of businesses with less than $1 million in annual revenue tend to have lower credit scores. Business leaders who failed to acquire financing gave reasons such as high interest rate, unfavorable repayment plan, long approval wait time, complicated process, and lack of transparency, with the latter the primary concern. Participants also attributed credit denial to weak business performance, insufficient collateral, too much existing debt, and inadequate credit history.

Small Businesses and Government Roles

The government also plays an essential role in lending to small and medium-sized enterprises. Many government officials realize access to financing is essential to small business sustainability (Moscalu, 2015). External funding is necessary for the sustainability and growth of small businesses, contributing significantly to economic development (Neagu, 2016). Financing availability is essential for small businesses’ viability and survival (Lussier & Corman, 2015). Small businesses need access to funds to compete in the international market (Osano & Languitone, 2016). However, banks are less likely to lend to small businesses because of high risk and insufficient collateral (Kamguia Wabo, 2015; Kozarevic et al., 2015).

Government involvement can also mitigate financing constraints. To explore the financing challenges unique to small businesses, Brian and Shingirayi (2014) collected data from one-on-one interviews and questionnaire responses. Their findings showed that small businesses received insufficient funding from financial institutions, which hampered organizational growth. As a result, Brian and Shingirayi recommended creating a government-generated loan guarantee system and a formalized application process for small business owners to obtain funding. In addition, the authors noted the steps small business owners should take to improve their chances of securing funding, including maintaining accurate accounting records and networking with other entrepreneurs. These findings are relevant to the current study because government funding is one way for U.S. small business owners to secure working lines of credit for business continuity.

Strategies in Acquiring a Line of Credit

The strategies small businesses use in acquiring a working capital line of credit is a common topic of recent scholarly inquiry (e.g., Godwin-Opara, 2016; Owusu, 2017; Smith, 2018; Wani, 2018; Wilkinson, 2017). In a multiple case study using resource-based theory as the conceptual framework, Godwin-Opara (2016) interviewed five machine shop owners in Kansas to determine how they sustained business operations for 2 years or more. Among the four themes identified was the need for accessible external financing. Business owners shared the importance of securing bank loans and lines of credit, which some participants noted to be easier processes with better repayment terms.

Closely tied to the current study were studies by Nguyen (2017) and Smith (2018), each exploring strategies small business owners used to secure financing for ongoing business operations. In a highly relevant study, Nguyen interviewed six small business owners in Maryland to determine what strategies they used to overcome the challenges of sustaining business continuity beyond 5 years. Participants shared strategies such as creating long-term business plans, investing in their employees, remaining out of debt, adapting their approach depending on the market, and carefully accounting for expenditures and cash reserves (Nguyen, 2017). In a similar inquiry, Smith used pecking order theory to explore strategies used by small business owners in the southeast United States in securing working capital lines of credit for continued operations. Smith identified six themes regarding successful strategies the participants used from a review of company documents and data analysis from semistructured interviews with six business owners. Instead of bank financing, participants were more likely to have used personal funds, customer revenue streams, bootstrapping, and personal credit (Smith, 2018).

Identifying the strategies used to secure financing could be less important than defining the characteristics of business leaders who succeed in obtaining working capital lines of credit. Themes from a multiple case study by Wani (2018) were more specific to the owners’ traits than their strategic actions. Wani noted the importance of strong entrepreneurial management and financial planning skills in achieving business continuity, identifying the absence of either skill as a challenge to continuity. Other strengths required of business owners to secure funds for continued operation were developing a capital strategy, preparing and adapting to change, and assuming responsibility for creating and maintaining accurate and transparent financial records (Wilkinson, 2017).

Scholars have looked beyond bank financing to uncover other means for small business owners to sustain operations beyond 5 years (e.g., Brooks, 2019). Three small business owners participated in face-to-face, semistructured interviews to discuss strategies they used for business continuity. Data analysis indicated five themes, including sufficient start-up funding, access to private lenders, and business owners’ motivation and awareness.

The least-researched area of corporate financing is small business financing (Kumar & Rao, 2015). Four major gaps related to a company’s inability to obtain sufficient financing are demand, supply, knowledge (i.e., personal characteristics of the owner), and benevolence (i.e., reluctance of the financial institution to lend to small businesses; Kumar & Rao, 2015). Following is a discussion of available funding programs, means of obtaining financing, and factors affecting the decision to extend credit.

Many commerce incentive loans are available to small businesses in Maryland. The 500,000 small businesses in Maryland constitute 97% of total businesses in the state and employ more than 1 million people (SBA, 2018b). In 2014, lending institutions issued over $1 billion in loans to small businesses (SBA, 2018b). According to the SBA (2018b), 4,074 new small businesses started in 2014, and 3,730 businesses exited. The Maryland Small Business Development Financing Authority (Maryland Department of Commerce, n.d.) helps small businesses that do not meet the established loan criteria of financial institutions through a range of funding programs, as shown in Table 1.