Tight Credit Puts The Squeeze on Small Business
The main pump for the economy is not being primed.
The credit crunch that has defined the financial meltdown threatens to derail small business activity in the
Many economists predict the credit crunch will lead to higher unemployment because, overall, small companies create many more jobs than do big corporations. But faced with rising health care costs, increasing costs of production, a cutback in demand because of the soft economy, lack of consumer confidence and precipitous decline in bank lending, many are expected to cut back on jobs or close their doors completely.
At press time, most economists were forecasting a severe recession in the
The U.S. Small Business Administration reports that companies with 500 or fewer workers pay nearly 45 percent of the
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. Back then, most of the carnage occurred at thrifts, financial institutions originally chartered to make home mortgages but that became involved in risky, high-yield loans. Commercial banks generally did well then as did big stock brokerage houses.
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. In an unprecedented move, the
With the great S&L debacle, family homes lost value in some key states such as
Small businesses are coping with the crisis by tightening their belts. They are 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
Based in the Bay Area suburb of
Armed with a doctorate degree in physics from the
Six months later, the firm moved 25 minutes northeast to
If McFarland is worried that he expanded into a declining market brought on by the meltdown on Wall Street and the evaporation of loans to businesses and individuals, he certainly does not sound like it.
“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,” he continues. “These contracts are in place, and we just got two more that go for nine months each. The nice thing about the government is that even if they are broke, they still print money and give it to you somehow. When you sign a contract with the government, as far as I know, you are pretty much guaranteed to get paid.”
For his part, McFarland hopes to reduce his reliance on federal funding by obtaining more commercial contracts as a hedge against budget cuts, tax increases or a combination of the two. “I can see where maybe a year from now there will be less funding for the type of work we do,” he says. “That will probably start to dry up a little bit. It’s probably going to become more competitive, more companies going after fewer dollars.”
Actually, economic observers note, 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.
However, that trend changed dramatically in the fourth quarter with a surge of layoffs at small companies, which left this segment with a net decline of several thousand jobs. The exact figure was not available at press time.
The National Small Business Association, a
The organization said a member survey found the proportion of small business owners with access to bank loans fell to a 14-year low, with 368 banks dropping out of programs fostered by the Small Business Administration. Forty-four percent of respondents reported using credit cards as a primary source of financing, and terms were growing worse.
“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
“Lots of companies use short-term credit because they may have accounts receivables but have current bills or payroll to make. We have talked with a couple of our member companies who are talking about not making payroll. When you don’t make payroll, you are in big trouble. I don’t think the full impact of this situation has been appreciated yet.”
Fowler predicts small businesses will drastically reduce or even eliminate health care coverage for their employees. He says they also will try to improve cash flow by billing clients early and paying invoices later than usual.
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. In previous recessions or economic slowdowns, managers who were laid off or offered early retirement or corporate buyouts would decide to start their own companies, fueling the next round of job growth.
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. Taking cash advances on credit cards also will become more difficult, especially for those who do not have nearly perfect credit scores.
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 re-examine 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.
“And if you do manage to survive this period, it means you will be better positioned for rapid growth once we do get a recovery—and we will get a recovery. It’s just not imminent.”