By Shira Hammerslough
Since 2020, the U.S. has seen an unprecedented surge in new business formation, particularly among women and Black, Asian, and Hispanic Americans. Entrepreneurship can be a key path to financial resilience and economic mobility in the United States—but the rewards also come with risks.
New research from Financial Health Network shows that low and moderate income (LMI) entrepreneurs are more financially healthy than their non-entrepreneur peers. However, that advantage may be less accessible than it appears as they also face many financial challenges that threaten their long-term success.
That’s where credit unions can play a critical role—connecting these entrepreneurs with needed capital and resources to help them build their enterprise for sustained success.
Unique Challenges of LMI Entrepreneurs
According to FHN’s research, entrepreneurs have higher credit scores, higher net worth, and are more likely to have multiple income streams in their households than non-entrepreneurs. Even with these financial advantages, LMI entrepreneurs’ financial health was still far behind middle and upper income (MUI) entrepreneurs and MUI non-entrepreneurs alike.
In addition, they face some challenges unique to entrepreneurs—like uneven cash flow. For example, more than half of LMI entrepreneurs (55%) report that their income varies often or occasionally month to month, compared to 34% of LMI non-entrepreneurs and 45% of MUI entrepreneurs.
LMI entrepreneurs also face substantial challenges both in getting started with initial capital and staying afloat as a business. For example, income volatility and lower credit scores can make it difficult to get a loan with traditional underwriting. An entrepreneur in a household with middle-or-upper income and substantial savings might simply shop around a pitch deck to venture capitalists or investors. In contrast, options for obtaining startup capital and staying afloat as a business are much more limited for LMI entrepreneurs.
The Critical Role of Credit Unions with Nontraditional Lending
Credit unions often fill needs for those who don’t fit neatly into the boxes of products and services offered by traditional banks, especially when it comes to credit. In particular, credit unions’ emphasis on member-focused, relationship-driven lending can be more beneficial for these entrepreneurs who have unique challenges and require underwriting that can see beyond a simple credit score or W2 income.
To address this need, credit unions can invest in alternative or expanded underwriting programs that include non-traditional data (such as rent or utility payments, length of membership, or potential of the business to positively impact the local community) in lending decisions.
For example, Alterna Savings Credit Union’s Microfinance program uses character-based evaluations of commitment, experience, and skills of the aspiring entrepreneur to make lending decisions.
A study by JP Morgan Chase showed that founders in the lowest 20% quartile for wealth started their businesses with just $1,000 in their bank accounts. By contrast, those in the highest 20% had an average of $24,000 in their accounts.
This and other research suggests that LMI entrepreneurs typically operate with very limited startup resources and face discrimination in traditional lending. A 2016 study showed that low-wealth founders were less likely to get any external financing, and got lower amounts than high-wealth founders when they did.
Many LMI entrepreneurs must rely on credit cards and informal or family loans to fund their operating expenses. Even though using credit cards is often the easiest way to quickly provide an initial small amount of seed capital, they can potentially harm financial health in the long term. The average APR is more than 20% in today’s environment; nearly triple the average rate from a small business line of credit. There is an opportunity for credit unions to offer greater accessibility — and visibility — for small-dollar loans, micro-loans or lines of credits for LMI entrepreneurs.
Community Support and Resources
Credit unions play a large role in communities through holistic financial relationships, and are well positioned to help businesses grow and be sustainable enterprises in low-income areas. This could include everything from offering business education and coaching, to accounting support and providing information and access to additional sources of funding.
The complexity of LMI entrepreneurs’ finances — where personal and professional monies often mingle — is another opportunity for credit unions to support them with more extensive budgeting tools.
Credit unions are well-poised to serve the complex financial needs of small business owners, like offering a comprehensive platform for cash flow management , tracking loan repayment and providing visibility into the overlap between personal and business accounts all available in one place.
Lastly, given that many LMI entrepreneurs are not W2 workers, their access to benefits such as retirement and health care is more limited. Credit unions can help guide their LMI entrepreneur members to things like the Saver’s Credit and state-run AutoIRAs to help build retirement savings.
Providing access and information to health insurance plans is another way credit unions can support LMI entrepreneurs. For example, Vancity, a credit union in Vancouver, offers health insurance plans to its members who are self-employed or own a small business.
The Boots on the Ground
Successful entrepreneurship can increase income, build household net worth, and lift up households and communities. While business ownership alone cannot close long-standing wealth and opportunity gaps, it can serve as a meaningful tool for upward economic mobility. Credit unions are often already the boots on the ground in local communities—and there are already clear solutions to help support the rise of their local small businesses and entrepreneurs.
As an Associate on the Research team, Shira Hammerslough supports a variety of research projects that advance the Financial Health Network’s mission.