The Market is Excited, But Challenges Still Loom For Small Businesses

There is a disconnect between the market rally indicating the economy may soon recover and small businesses who continue to face a challenging environment. First, you must keep the market rally in historical perspective and you must interpret the market’s rally. The market rally has caused some excitement due to being one of the strongest market rallies in history. However the 50% rise between March and July 2009 should be compared to other historical benchmarks. According to Barron’s Market Week (August 3, 2009), in July 1997 the S&P ended at 954 and the S&P ended July 2009 at 987. The return during a 12 year period was only 3% (total return, almost no return on an annualized basis). Additionally, the July 2009 S&P level is well below the October 2007 all time high of around 1,580 (over 37% lower according to Yahoo! Finance). The current market rally is indicating that for large and publicly traded companies times are beginning to stabilize. Perhaps not improving, but less bad news is good news in the current environment. Smaller businesses, however, face more challenging times ahead.

The financial lending institutions need to flow monies form Wall Street to Main Street. The credit markets are thawing and larger companies can once again qualify for loans. Qualifying for loans will allow the larger companies to calm their cash flow nerves. However, small businesses are facing increased scrutiny when applying for and renewing loans. Even with a high credit score and a large portion of collateral small business owners are having loans not being accepted or renewed. If the loan is not renewed the small business may not be able to raise equity and to take advantage of their local market conditions. Then loans are not renewed, small business owners are forced into repayment. A lot of small businesses and small business owners do not have the assets to repay the called loans. The cash outflow to repay the loan (if available) can potentially lead to a financial hardship for the small business by crushing liquidity, working capital needs and accelerate the cash burn rate. All of which make it more difficult to qualify for a loan from other lenders. These obstacles place more pressure on small businesses (even in a recovery). In additional small businesses will be forced into tougher lending standards which could potentially increase the number of small business failures at the same time the economy recovers for larger companies. Understanding this situation is important for small business owner because they can (immediately) begin to review their operations and focus attention on their financial position in order to take steps to strengthen their overall position before they request a loan or apply for a loan renewal from a financial institution.

Second, financial lending institutions currently are trying to figure out the new lending standards. The new standards are tougher than small business owners want them to be. Small businesses enjoyed the NINJA times (No Income No Job or Assets – no problem). Now small businesses feel they are being hassled at the time of the renewal since they have to provide accurate financial information and they understand the renewal is no longer guaranteed. The small business’s “hassle” is the increase of time involved and higher financing costs, including hiring a Certified Public Accountant (CPA) to issue financial statements and attend loan workout meetings. Financial lending institutions, however, have been faced with higher loan failures and are currently finding out the personal guarantees they had signed by the small business owners are semi-worthless. The small business owner protected themselves by transferring all of there assets to their spouse who did not sign the personal guarantee. This leaves the bank with a bad loan and a worthless personal guarantee. Banks may have both spouses sign the personal guarantee in the future for more protection. A troubling sign is a lot of small businesses and owners are not well capitalized (i.e. they do not have many assets, but do have debts and a good life style). As larger companies have built assets over time and made drastic cost cuts and lay offs of the work forces smaller companies have minimal assets and minimal liquidity and did not cut costs and work forces as quickly or dramatically as larger businesses.

Wall Street and the U.S. Government are lending to and bailing out Wall Street Companies, but Wall Street and the U.S. Government is not lending to or bailing out Main Street Companies. As larger companies are beginning to receive financing from financial institutions and bail out monies form the U.S. Government; small business lenders, such as CIT, have received little or no attention from Uncle Sam. CIT is one of the more important lending institutions for small businesses (The CIT Threat By Donna Childs). Small business lenders and regions banks seem to be hurting the most out of all of the financial institutions at the moment. In order for these institutions to lend monies to small businesses in the future they will have to increase their lending standards. For Main Street companies to qualify for loans in the future small businesses need to make major adjustments to their business model including building assets and overall strengthening the financial position of the business and owner (just as their larger counterparts have done).

Third, the economy is still in recession and growth will not be the glory days of the past. David Rosenberg, chief economist at Gluskin Sheff, stated “What matters is the contour of the recovery” (The Best Five-Month Run Since 1938 By Kopin Tan and Andrew Bary) meaning that the economy still has a long way to improve. The markets might have “improved” 50% between March and July 2009, however the business environment has not improved or not improved that considerably. Continued pressure on the economic recovery and growth over the next several years includes unemployment around 10% and increasing, the US savings rate has increased over the past 12 months, corporate America continues to de-leverage and the U.S. Government is too involved in private markets.

Unemployment of 10% and rising as well as an increase in the US savings rate places pressure on consumer spending due to uncertainty of future employment and income. Consumer spending at the local level directly affects small business performance. A reduction of consumer spending pressures the survival of small businesses. According to “The Recession is Over Now What We Need Is A New Kind Of Recovery” by Daniel Gross (Newsweek August 3, 2009) 5 million jobs are anticipated to be created by 2011, however the economy has lost 6.5 million jobs since December 2007. Consumer spending due to uncertain employment over the next several years can financially pressure local small businesses. As corporate America continues to de-leverage itself it repays debt instead of making purchases and instead of increasing its workforce. The reduction of purchases does trickle down to small businesses and less procurement can affect small business revenues. The U.S. Government involvement in large corporations should be more troubling than the news reports. Our pride as a market based economy and being a Democracy has been turned into the U.S. being Socialist without any major opposition. Yes, we are Socialists since the government owns private enterprise. As taxpayers complain that the government cannot do anything right or efficient at least. Now we are using more of taxpayer resources for Wall Street companies and not Main Street companies will have significant effect on Main Street’s future. Mr. Gross states it costs the U.S. government $92,000 in government spending or $145,000 in government tax breaks to create one job. The average job in the U.S. pays less 1/3 to ½ than this amount. The jobs created will first affect larger businesses, with hope that it will trickle down to small business. At least Main Street will still have its pride (even if it is forced into bankruptcy). Small businesses must be aware of this environment and understand the recovery has many challenges over the next several years to come.

In conclusion, small businesses have several challenges in the years ahead. Immediate action is necessary to continue to evolve their business model and strengthen their financial position. Business owners should expect to sacrifice more and potentially raise equity (diluting their ownership) in order to survive the rest of the recession and to try to stay alive through the recovery. Small businesses should continue to stay vigilant during the potential economic recovery in order to continue operations.