Printed in Investor’s Business Daily
Small Firms: Stacking The Odds In A Crisis
Friday November 7, 2008
Gary M. Stern
It pays to be a big guy.
When losses at American International Group (NYSE:AIG – News) hit the billions, the federal government bailed it out to save the economy. When subprime mortgages tanked at Washington Mutual, regulators arranged its sale to JPMorgan Chase (NYSE:JPM – News) to protect the financial system.
But when small businesses falter — despite contributing over 70% of GNP — they’re on their own.
“There’s no safety net for small businesses,” said Steve Bloom, an Atlanta-based counselor at SCORE, a nonprofit association that partners with the Small Business Administration. “The SBA is not in the business of making loans to small businesses; it only offers financial guarantees to participating lenders,” he said.
This means that typical small-firm owners have to rely on themselves and not governmental agencies. The good news is that they can not only survive, they can thrive by acting on their own.
One ways to do that is to generate enough capital to invest in growth, or network to find investors willing to lend the money.
But before taking action, it’s always best to know where you stand. The first thing to do is “analyze why you’re in trouble, why you’re losing customers or why customers aren’t paying you fast enough,” explained Ed Hess, co-author of “So, You Want to Start a Business? 8 Steps to Take Before Making the Leap.” Entrepreneurs must cut costs, generate cash flow, and if the system self-corrects, tap community banks for loans, he added.
Beware Ripple Effect
When access to capital from banks is cut off to most small businesses, there’s a ripple effect. Small players can’t expand or hire more employees so unemployment rises. Orders to suppliers are cut back, reducing the revenue of other businesses. When small firms can’t grow, the impact is felt in loss of jobs, revenue stagnation and supplier retrenchment.
Without access to capital, small businesses are at risk. Retail businesses without a seasonal line of credit that do much of their business between Halloween and New Year’s face hardship, says Dennis Ceru, an adjunct professor of entrepreneurship and business strategy at Babson College. Desperate for cash, some small-business owners are forced to borrow against their homes, take out expensive loans, or offer suppliers a small percentage of profits to pay faster.
This credit crunch worsens the money squeeze for many small firms. Most small businesses already have a tough time getting loans from banks, which want to see three years of rising profits, something many businesses can’t provide. “Banks are collateralized lenders only,” Bloom said.
A Baker’s Example
To survive, Dan Leader, owner of Bread Alone, a Boiceville, N.Y., wholesale and retail bakery with three outlets, raised bread prices three times and added a fuel surcharge for deliveries. In fact, he raised his prices to offset the $140,000 jump in his cost of flour in 2008.
But Leader also focused on expanding business without requiring additional capital. He spends one or two days weekly making cold calls to new customers who have multiple locations that can yield $100,000 of annual business. He made presentations about new products to major customers like Fairway’s, Whole Foods (NasdaqGS:WFMI – News) and Zabar’s, which led to a surge in orders.
Diversification is key to Bread Alone’s keeping its $7 million in annual revenue intact. One-third of its business comes from retail stores. Another third comes from wholesale orders, while the remaining third comes from mail order and Internet sales.
In case he needs to open another retail outlet, Leader maintains a strong relationship with a local bank, which loaned him $100,000 several years ago. The money was repaid. “For a small business, a close relationship with a local banker is key,” Leader said.
If a small business has some capital to invest, it can prosper during these hard times. In times of tight credit, SCORE counselors advise that owners with capital on hand turn to buying used trucks or used office equipment, for example, rather than buying new. “With foreclosures and bankruptcies, you can get things for 30 cents on the dollar via eBay and Craigslist,” Bloom said.
To obtain capital in tough times, savvy small businesses are advised to intensify networking. Join trade associations, chambers of commerce and rotary groups to tap private investors, Bloom said. Angel investors are more likely to invest in the hot tech firm, not the local hardware store, restaurant or uniform supplier.
Most small businesses fail when “they haven’t planned for the proverbial rainy days and haven’t established an emergency fund,” Ceru said. He advises that owners put aside three to six months in operating cash and salary to withstand a downturn. “Businesses have to plan for eventualities that can happen outside of their control, like a luncheonette (that finds itself) near Wall Street after 9/11,” he added.
Hess urges entrepreneurs to draft a detailed emergency plan to stay afloat. Included in the plan would be detailing which employees are critical, which 10% of employees can be cut, how severance pay will be handled, and ways to cut personal living expenses and increase cash flow.
Some businesses are taking smart steps to stay alive. One business sends out invoices that day, instead of after 30 days, and gives discounts to customers that pay within a week.
Businesses that thrive during a credit crisis and downturn “understand how to best manage their cash, minimize expenditures, and utilize their resources effectively. They lease rather than buy and hire part-time rather than full-time employees,” Ceru said. Small firms, knowing that they can’t rely on the federal government or banks in a jam, depend on their own resources to succeed.
“In tough times, entrepreneurs must adopt a survival mentality, do everything you can to focus on getting cash in, delay paying expenses and keep the essence of your business alive to survive and play another day,” Hess said.