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The Market is Excited, But Challenges Still Loom For Small Businesses
The market rally has been disconnected from the fact that the economy may soon return to normal and small businesses are facing a challenging environment. First, we must put market rallies in historical perspective and we must interpret market rallies. The market rally has caused quite a stir, being one of the strongest market rallies in history. However the 50% growth from March to July 2009 should be compared to other historical benchmarks. According to Barron’s Market Week (August 3, 2009), the S&P ended July 1997 at 954 and the S&P ended July 2009 at 987. The return over a 12 year period was only 3% (total return, annual return approx. no. Basis). Additionally, the July 2009 S&P level is well below the October 2007 all-time high of nearly 1,580 (down 37% according to Yahoo! Finance). The current market bullishness indicates that times are beginning to settle for large and publicly traded companies. Maybe not an improvement, but less bad news is better news in the current environment. However, small businesses face more challenging times.
Financial lending institutions must keep money flowing from Wall Street to Main Street. The credit market is thawing and large companies can once again qualify for loans. Qualifying for a loan can help big companies calm their cash flow nerves. However, small businesses face increased scrutiny when applying for and renewing loans. Despite high credit scores and collateral, a large portion of small business owners are not getting accepted or renewed for loans. If loans are not renewed, small businesses cannot raise equity and take advantage of their local market conditions. Then the loan is not renewed, the small business is forced to repay. Many small businesses and small business owners do not have the assets to repay the loan. A lack of cash flow to repay debt (if available) can cause financial difficulties for a small business by accelerating liquidity, working capital needs and cash burn rates. All this makes it more difficult to qualify for a loan from other lenders. These barriers put more pressure on small businesses (even in recovery). Additional small businesses will be subject to stricter lending standards that improve the economy for larger firms while potentially increasing the number of small business failures. It is important for small business owners to understand this situation because they can (immediately) begin to review their operations and focus on their finances to take steps to strengthen their overall position before requesting a loan or applying for a loan renewal. Financial institutions.
Second, financial lending institutions are currently trying to find new lending standards. The new standards are tougher than small business owners want. Small businesses enjoy ninja time (no income no job or assets – no problem). Small businesses now feel that they are suffering during renewals because they have to provide accurate financial information and they understand that renewals are no longer guaranteed. Small business “hassles” include increased time and high financing costs, including hiring a certified public accountant (CPA) to issue financial statements and attend loan exercise meetings. However, financial lending institutions have faced high loan defaults and are currently finding that the personal guarantees they have signed by small business owners are semi-worthless. The small business owner protected himself by transferring all assets to his spouse who did not sign the personal guarantee. This leaves the bank with bad loans and worthless personal guarantees. Banks may require both spouses to sign a personal guarantee for greater protection in the future. A troubling sign is that many small businesses and owners are not well capitalized (meaning they don’t have a lot of assets, but they have debts and a good lifestyle). Large companies have built up assets over time and made major cuts and reductions in labor costs, so small companies have minimal assets and minimal liquidity and have not reduced costs and workforces as quickly or dramatically as larger businesses.
Wall Street and the US government are lending and bailing out Wall Street companies, but Wall Street and the US government are not lending or bailing out Main Street companies. Large companies have begun to receive financing from financial institutions and receive money from the US government; Small business lenders like CIT don’t get much attention from Uncle Sam. CIT is an important lending institution for small businesses (The CIT Threat by Donna Childs). Of all financial institutions, small business lenders and regional banks seem to be suffering the most at the moment. These institutions will have to raise their lending standards to lend to small businesses in the future. In order to qualify for loans from Main Street firms in the future, small businesses will need to make major adjustments to their business models that include building assets and strengthening the financial position of the business and owner (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 Chef, said that “what matters is the contour of the recovery” (the best five-month run since 1938 by Coppin Tan and Andrew Barry) which means the economy still has a long way to go to recover. The markets may have “improved” by 50% between March and July 2009, however the business climate has not improved or improved much. Economic recovery and growth continue to be under pressure over the next several years with unemployment hovering around 10% and rising, the US savings rate rising over the past 12 months, corporate America de-leveraging and the US government heavily involved in private markets. .
Unemployment at 10% and rising as well as a rise in the US savings rate put pressure on consumer spending due to uncertainty about future employment and income. Consumer spending at the local level directly affects small business performance. Cutbacks in consumer spending put pressure on small businesses to survive. 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 expected to be created by 2011, however the economy has lost 6.5 million jobs since December 2007. Consumer spending from uncertain employment could put a financial strain on local small businesses over the next several years. As corporate America continues to de-leverage itself, it repays debt instead of buying and growing its workforce. Reduced purchases affect small businesses, and reduced purchases affect small business revenues. US government involvement in large corporations should be more troubling than news reports suggest. Our pride in having a market-based economy and democracy has turned America socialist without much opposition. Yes, we are socialists as government owned private enterprises. Taxpayers complain that the government can’t do at least something decent or efficient. Now we are using more taxpayer resources for Wall Street companies and Main Street companies will not have a significant impact on the future of Main Street. Mr. Gross says it costs the US government $92,000 in government spending or $145,000 in government tax breaks to create one job. The average job in the US pays 1/3 to ½ less than this amount. The jobs created will affect large businesses first, with the hope that they will trickle down to small businesses. At least Main Street would be proud of it (even if forced into bankruptcy). Small businesses need to be aware of this environment and understand that there are many challenges to recovery in the years ahead.
Finally, small businesses face many challenges in the years ahead. Immediate action is required to develop their business model and strengthen their financial position. Business owners should expect to sacrifice more and potentially increase equity (reduce their ownership) to survive the rest of the recession and try to survive through the recovery. Small businesses must remain vigilant during a potential economic recovery to continue operating.
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