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Tight Credit Puts the Squeeze on Small Business

by Michael A. Robinson

The credit crunch defining the financial meltdown threatens to derail small business activity in the United States. Many small firms rely on credit for everyday operations because they lack the liquidity to fund their business activities. As entrepreneurs find it increasingly difficult to obtain necessary seed money, potential startups may remain stillborn.

Many economists predict the credit crunch will lead to higher unemployment; overall, small companies create many more jobs than do big corporations. But faced with the current financial crisis, small businesses are expected to cut back on jobs or close their doors completely.

This credit crunch, economists say, is substantially bigger and more complex than the last major financial crisis: the savings and loan (S&L) bailout of 1989 and the recession that followed a year later. The price tags also were much smaller, maybe as much as $200 billion to cover the cost of about 1,000 failed S&Ls, historians estimate. By contrast, what many think of as the Wall Street bailout will cost a minimum of $700 billion, a figure that does not include shoring up Fannie Mae and Freddie Mac with combined assets of more than $2 trillion.

Small businesses are coping with the crisis by cutting back on marketing and advertising, delaying new hires, keeping inventories low and reducing health coverage for employees.

Mike McFarland is happily out of step with many of his colleagues in the nation’s small business community. While the credit crunch is wreaking havoc on small companies throughout the United States, McFarland’s Acree Technologies Incorporated, is sailing ahead, thanks to several ongoing federal contracts.

Based in the Bay Area suburb of Concord, California, Acree provides research and development for specialty coatings that protect critical metal parts such as engine impellors from damage such as high-pressure exposure to sand and dust. This expertise has landed Acree several federal contracts that encompass all branches of the Defense Department as well as the Defense Advanced Research Projects Agency and the Department of Energy.

Less than five years ago, McFarland and a friend founded Acree in McFarland’s garage after each ponied up $20,000 in savings and incorporated the company by dividing equity shares in the enterprise.

Six months later, the firm moved 25 minutes northeast to Concord and signed a lease on 2,000 square feet of space. With the company having grown to six employees and $1.3 million in annual revenues, McFarland, a former carpenter who is the firm’s chief executive officer, again relocated the company to a space with 6,000 square feet, yielding more room for anticipated expansion.

“A lot of people are being hit by the credit crunch,” McFarland says. “Right now, I see no impact on us because most of our contracts are either phase one-type contracts or phase two. Phase ones tend to be six to nine months, and phase twos tend to be two-year contracts. Our funding right now basically is fairly stable.”

For his part, McFarland hopes to reduce his reliance on federal money by obtaining more commercial contracts as a hedge against budget cuts, tax increases or a combination of the two.

Economic observers note that small business was one of the bright spots in the economy going into fall 2008. The ADP National Employment Report stated that employment nationally had declined by 98,000 people, but companies with fewer than 500 employees increased their employment by a net 137,000 positions.

A member survey by the National Small Business Association, a Washington, D.C., trade group, finds the proportion of small business owners with access to bank loans fell to a 14-year low. Forty-four percent of respondents reported using credit cards as a primary source of financing.

“I don’t think people really appreciate what frozen credit markets mean to small business,” says Robert Fowler, president and chief executive officer of the Small Business Association of Michigan in Lansing. “There are a lot of small businesses that run on credit every day. Lots of companies use short-term credit because they may have accounts receivables but have current bills or payroll to make.”

Karen Schnatterly, a management expert and business professor at the University of Missouri-Columbia, says the liquidity crisis and consequent downturn may have an especially dramatic impact on would-be entrepreneurs exiting the corporate world and looking to start their own firms.

Many entrepreneurs will take out second mortgages on their homes to capitalize their companies, Schnatterly observes. But with falling home prices and tight credit, many will not have this typical access to funds.

Schnatterly’s advice is very simple. "Don’t panic,” she says. “Trying to drill down to a silver lining, I think there is a chance to reexamine your business model: how do you make money and are you doing it as efficiently as you can. And the answer to that is usually not as efficiently as possible.”

 

Read an expanded version of this article in the January 2009 issue of SIGNAL Magazine, in the mail to AFCEA members and subscribers January 2, 2009. For more information about purchasing this issue, joining AFCEA or subscribing to SIGNAL, contact AFCEA Member Services.