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Despite the lip service paid to the importance of small businesses, efforts to ease their credit woes have come up short.
Alix Stuart, CFO Magazine
December 1, 2009
Late last year, Michael Doherty, founder and president of Boston-area IT service provider Mikrodots Inc., went in search of a loan. He approached several local banks, hoping to borrow as much as $200,000 in order to step up marketing and hire more people. In business (and profitable) for nearly 15 years, Doherty thought he had a good chance of obtaining a Small Business Administration–backed facility, despite the economic climate. The community banks he approached, however, told him that he needed more collateral, and that being cash-flow positive was not enough. "They said they wanted not one but two ways to repay the loan [in the event of a default]," says Doherty. The backing of the SBA didn't count.
In February, Congress put several measures in the American Recovery and Reinvestment Act that should have helped Doherty, including increasing some SBA guarantees to 90% of principal (up from an 85% maximum) and waiving loan fees for 2009. The stimulus act also created the SBA's new America's Recovery Capital (ARC) loan program, which floats small businesses up to $35,000 in expenses over six months, interest-free. "I will do whatever it takes to help the small business that can't pay its workers," President Obama said in a speech to Congress shortly after signing the bill.
Unfortunately for Doherty, banks haven't taken a similar pledge. He has investigated the new ARC loan — specifically designed to help struggling companies make debt and interest payments — with two local banks but has concluded that "it's a myth." Among the many reasons he believes banks were reluctant: the risk and administrative hassles associated with the small amount made it a nonstarter for them.
Meanwhile, Doherty lost a $15,000 line of credit and a corporate credit card, and the rate on an existing card rose from 9% to a whopping 30%. He has had to lay off three employees, his growth plans are on hold, and he still needs money. "It's truly not a lack of work, it's a lack of working capital," he says.
Doherty is emblematic of a growing number of small-business owners who say the federal efforts to aid them have missed their target. "Two or three years ago, I was helping entrepreneurs realize their dreams. Now, more often than not, I'm talking them down off the ledge," says Walter Manninen, former CFO of publishing company CXO Media and a senior counselor at a Boston-area Small Business Development Center who has advised Doherty.
The number of small-business bankruptcies is up 50% for the first three quarters of the year, says credit-reporting firm Equifax, with 9,361 closing their doors in September alone. According to a recent survey of 150 business owners commissioned by consulting firm Angrisani Turnarounds, 65% are concerned or very concerned that their business will fail within the next two years.
So there is little optimism about the newest round of proposals designed to help small businesses, including President Obama's October push to increase SBA loan amounts and to lower the cost of capital to smaller banks, elements of which were passed by the House of Representatives in the Small Business Financing and Investing Act. "The government can put a whole bunch of changes out there, and they're good ones, but if the private sector doesn't buy into them, they don't mean anything," says Steve Bloom, past chair of the Atlanta chapter of Service Corps of Retired Executives. Bloom says he's seen plenty of good businesses turned down for funding.
Lacking Credit, or Customers?
Clearly, federal efforts are not leading to more borrowing by small businesses. The SBA's primary programs, the 7(a) and 504, yielded 35% fewer bank loans between September 2008 and September 2009 than the same period a year before. Since ARC loans became available in June, just $116 million of the $255 million allocated had been loaned out as of the end of October (the program can run as late as September 30, 2010).
Meanwhile, small-business owners speculate that government efforts at banking reform may be exacerbating problems associated with other forms of finance. In particular, credit-card issuers are rushing to raise rates and apply them to existing balances ahead of new federal restrictions slated to take hold in February 2010. In response, Sen. Christopher Dodd (D–Conn.) has proposed an emergency ban on applying the new rates to existing balances.
Some argue that the contraction in small-business credit is actually due to a lack of demand. Most entrepreneurs self-finance as much as possible, say experts, and seek a loan only as a last resort or for an extraordinary growth project. Now that new hiring and many capital expenditures are on hold, debt is the last thing small businesses want.
In fact, only 10% of the 827 small-business owners surveyed by the National Federation of Independent Business (NFIB) in September said they couldn't get the financing they wanted, and only 4% named financing as their top concern. "The primary problem facing small-business owners right now in terms of job creation is not access to credit, but a lack of sales, customers, and confidence," says William Dunkelberg, chief economist for the NFIB and also chairman of regional lender Liberty Bell Bank. "You could give them more money, but for what?"
But plenty of small-business owners and advisers say the problem is that banks are sitting on the funds they've received from federal programs in order to boost their balance sheets. "More than half of our customers would be able to accelerate growth plans and add jobs with access to additional capital, but they're absolutely handcuffed right now," says Jamie Pennington, co-founder of Flexible Executives, a temporary-staffing firm.
Banks counter that an increase in SBA guarantees doesn't increase the funds they have available for SBA lending. Ted Morgan, senior vice president at BNB Bank, says "it's still the banks' money" getting loaned out, and that SBA loans still mean a loss for banks if a borrower defaults, even with the government backing. While the increased guarantee level helps a lot, he says, the SBA is simultaneously tightening its standards for what qualifies as a reimbursable loan loss, meaning many banks are increasingly wary of being left holding the bag.
All told, Morgan says, the government's efforts in the stimulus package had a huge impact on lenders, and the 35% drop in SBA loan volume "was a heck of a lot better than it would have been otherwise."
That drop in volume can also be attributed to a drop in the number of lenders. CIT Group, once the top SBA originator, cut its loans by 86% (in dollar volume) between September 2008 and September 2009, as the firm teetered and then fell into bankruptcy. "For every CIT, you have to come up with 25 community-bank lenders," says Charles "Tee" Rowe, CEO of the Association of Small Business Development Centers.
Small banks are inherently at a disadvantage to larger lenders, says Paul Merski, senior vice president and chief economist for the Independent Community Bankers of America, since they generally have to get pre-approved by the SBA, a process that can take months thanks to backlogs. "The [federal] programs are set up to work; it's really just an execution issue [at the SBA]," he says. Reining in "overzealous" bank regulators and continuing to bolster the secondary market for SBA loans (one component of last February's stimulus bill) will also help entice more lenders, Eastern Bank CEO Richard Menzies told a House committee in October.
Calling on Angels
If current government actions aren't working, what would? The NFIB, for one, advocates a business-payroll tax holiday, broad-based tax breaks, tax holidays for consumers, or all three. Bloom suggests having the SBA become a direct lender for a limited span of time, say, 12 to 18 months. (The agency already does this for individuals and businesses affected by national disasters.) Pennington and others say more stimulus money and more pressure from banking regulators is what's needed. "Dedicating only one half of one percent of the total stimulus package toward small businesses, which have created two-thirds of the nation's jobs in the past 15 years, is just ridiculous," she says of the $5 billion total set aside so far.
In the interim, many small-business owners are tapping resources outside the banking sector, namely, private investors. The landscape there is only slightly less bleak. Angel investors, usually the first source of outside equity for small businesses, shelled out 27% fewer dollars in the first half of 2009 compared with the same period in 2008, according to the Center for Venture Research at the University of New Hampshire. The one bright spot? The number of deals increased 6%.
Venture capitalists were even more tightfisted. In the first three quarters of 2009, 463 firms received their first infusions of venture capital, down 50% from 2008, and the dollar volume of such deals dropped 58%, year over year, according to the MoneyTree Report by PricewaterhouseCoopers and the National Venture Capital Association. The third quarter, in particular, showed the lowest dollar volume for such financings in the nearly 15-year history of the survey.
Perhaps the best hope for companies eager to tap federal resources is to take another route: become a government contractor. Federal agencies are required to give a certain percentage of work (the SBA's recently declared goal is 23%) to small and minority-owned businesses, says small-business counselor Manninen. He is crafting such a plan with Doherty, who quips, "That's my government bailout."
Alix Stuart is a senior writer at CFO.