Those Small Business Blues

Sales drop faster than interest rates, and Mom and Pop face hard times

Borrowed money is the plasma of U.S. business. It provides the energy to build factories, finance inventories and meet payrolls. But across the nation, businesses large and small have watched their borrowing costs zoom as the Federal Reserve slowly tightens credit in an attempt to restrain inflation. While this credit pinch affects every business, it is especially serious for small business. And what is serious for small business is serious for the economy as a whole.

There are about 11 million companies in the U.S. classified as small. Of these, 3.4 million do $5 million or less in business each year and employ fewer than 100 workers. Nonetheless, bantam businesses contribute a surprising 43% to the gross national product. Between 1969 and 1976, according to David Birch, urban studies professor at M.I.T., two-thirds of the economy's new jobs came from firms with 20 or fewer employees. At least half of the nation's private work force is in some way dependent on small business. General Motors, for example, has 55,000 small suppliers. "This is not just a Mom and Pop syndrome, but a lot of retailers, wholesalers and small manufacturers," says James ("Mike") McKevitt, a former Congressman who has become a powerful Washington lobbyist for the National Federation of Independent Business.

Whether bright-eyed entrepreneurs or crafty corporate tycoons, businessmen continue being hit by the plethora of bad economic news. The prime rate has eased off its nosebleed height of 20% and last week declined to 19% at some banks. Despite other signs of a downturn, including the Dow Jones industrial average's two-year low of 759.13 last week before it rebounded more than 30 points the following day, inflation continues to roar ahead. In March the Consumer Price Index rose another 1.4%, which would be a compounded annual rate of 18.2%. This dampens all hope for any substantial drop in interest rates soon.

Yet small business firms are most severely affected by the high cost of money. They are chronically short of capital and heavily dependent on borrowed funds to meet payrolls and to keep shelves stocked. Orders from recession-wary customers are tapering off, but interest rates are not coming down as fast as sales. And the cost of carrying these ever growing inventories is soaring. James Edelen, an entrepreneur who started his own welding supply company in 1976, now wonders why he ever opened shop. Says he: "In this business you've got to sell in order to buy supplies. If I had known how hard that was four years ago, I probably would have been better off working for someone else."

NIPSCO, Edelen's Waukegan, Ill., firm, employs six people and last year grossed $550,000 selling welding equipment and industrial clamps to customers like International Harvester and Caterpillar Tractor. This was to be the year that it would hire another salesman, but instead the money will be used to finance huge unsold inventory. Currently Edelen is paying 25% bank charges on a $125,000 debt. "It costs me one good employee to pay those loans," he says.

Though the Federal Reserve has asked banks to keep funds available for small business lending, commercial banks are less willing to finance these riskier endeavors. Any money available is expensive: the prime rate for small business is usually two or three points above the rate for big business. Last year Idaho Businessman Nick Sterling, owner of Sterling Battery in Boise, negotiated a Small Business Administration guaranteed loan for $250,000 to build a warehouse. It was pegged to the prime, then 12%. But Sterling now pays 21%. His interest payments alone are running at $2,500 a month.

When credit evaporates, small businessmen face bankruptcies and layoffs. According to a Dun & Bradstreet report, such business bankruptcies so far this year number 3.106, up 25% from twelve months ago.

Though many small businessmen manage to avoid bankruptcy, they complain that interest costs are eating into profit margins and forcing the cancellation of growth plans. Says Cimena Cummings, president of TLC, Inc., a Chicago manufacturer of disposable hospital gowns: "Today you can't afford to borrow to expand." New projects have now been indefinitely postponed. Says James Phelps, executive vice president of the First Security Bank of Idaho: "We are seeing very limited borrowing. Some of the SBA guaranteed loan applications are coming through for debt consolidation and working capital. None are for expansion."

High interest rates are also causing small businessmen another headache: customers are turning into slow payers. Increasingly, large companies are taking as long as three months to settle bills normally due in 30 days. Some are short of funds, but other cash-management-conscious firms may be keeping the money they owe suppliers a few days longer in short-term money market securities like Treasury bills that may pay 12% interest. Says Jeffrey Sands, an accountant with Peat, Marwick, Mitchell & Co. in New York: "The small business ends up being the banker for the large company."

Jay Goldberg, president of Software Design Associates, a Manhattan data processing services company with revenues of $11.5 million last year, has experienced this dour dilemma. The delay in bill payment for his computer software products has grown from 60 to 75 days. "And our customers are all blue chip," he complains. In order to protect his own cash flow, Goldberg admits that he too has started paying his bills more slowly. "We used to be a prompt 30-day payer, now we're not," he says.

To withstand what they see as the coming crunch, many small businessmen are trying to stay out of the banks, living on their retained earnings--and on their memories. Says Richard Jackson, president of Atlanta's First Georgia Bank: "The 1974-75 recession was not that many years ago, and we haven't forgotten it." New York Restaurateur Michael O'Neal, who with his actor-brother Patrick owns a chain of Manhattan saloons, saw his profits melt away during the last recession after heeding President Gerald Ford's plea to "Whip Inflation Now" by keeping his prices down. O'Neal vowed that he was never going to get caught again not raising prices. He passes along supplier increases as fast as he can and even chalks a number of entrees on a blackboard so that the tab can be raised daily if necessary.

Other businessmen are seeking inventive ways to keep cash flowing. Software Design's Goldberg says that his company recently offered a large insurance company a 5% discount if it paid its contract fee all at once. The firm accepted the deal, and now Goldberg plans to offer it to his other customers. Some small manufacturers are finding new markets abroad to help overcome the recessionary woes in the U.S. Baker Electric of Denver has set up a special subsidiary to sell electronic testing equipment to customers in Japan and India. Ortho-Kinetics of Waukesha, Wis., a $3.5 million maker of appliances for the handicapped, is now trying to sell in Europe.

Actually many small businesses are in better shape for the 1980 recession than they were for the one in 1974-75. The venture capital market, traditionally the provider of seed money to entrepreneurs, almost vanished six years ago but today is flush. Apollo Computer, Inc., which at present is run out of the Winchester, Mass., basement of its president, John Poduska, had little trouble raising $1.7 million this past year to build its $20,000 data processors. Over the next three years Poduska expects to corral a total of $6 million in investment funds. Stanley Pratt, publisher of Venture Capital, estimates that these investments, which go mostly to already existing companies or high technology firms, have grown from $400 million in 1977 to close to $1 billion last year. The increase is due in large part to the lowering of the maximum capital gains tax from 49% to 28% in 1978.

Washington has taken a number of other steps to assist budding entrepreneurs. The tax code was also revised to permit lower rates on the first $100,000 of corporate earnings. The Securities & Exchange Commission has simplified its cumbersome disclosure rules for small firms that want to put out public stock offerings.

Starting one's own business has always been part of the well-worn American dream, but the existence of healthy small businesses does more than just fulfill a fantasy. A study published in 1977 by the National Science Foundation shows that innovation is perhaps the most important factor in U.S. economic growth, and that between 1953 and 1973, four times more major innovations came from companies with fewer than 1,000 employees than from medium-size firms. If inflation and the high cost of money discourage entrepreneurs from risking their money in small businesses, the U.S. could wind up as a nation of aging corporate behemoths with neither the incentive nor the ability to create new products. -

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