It is not just the banks that are too big to fail. Smaller US businesses that make components for large manufacturing companies were devastated by the reduction in orders during the economic downturn. When we think of supply chain risks, we typically think of our vulnerability to a single supplier that produces a component critical to the creation and delivery of our products. We rarely consider what happens when the customer fails. The Financial Times has an excellent article describing how the recession taught smaller businesses to diversify their customer bases. A Deloitte consultant quoted in the article offers good advice about the risk of having “too many eggs in the same basket.”

Time to Rethink Housing Assets

Declining home values are choking a major source of small business capital. Sadly, the consequences are most severe in the Gulf Coast states that are dealing with the longer-term consequences of the oil spill. According to Lending Tree, three of the top ten states with underwater mortgages are Florida (47.8% of mortgages in the state are underwater, meaning negative equity for the homeowner), Louisiana and Mississippi, each with 23.8% of mortgages underwater. Nationwide, small business owners frequently tapped home equity lines of credit to finance their businesses. Barlow Research’s quarterly small business survey reports that one-quarter of respondents used their homes as collateral for their businesses or for personal loans in which the proceeds were used to finance the businesses. With housing prices having fallen by one-quarter from their peak in March 2006, the home ATM machine has dried up. At the same time, banks have tightened loan underwriting criteria to deal with their nonperforming real estate loans, leaving small business owners with few financing options.  Add to that pain the fact that more than 99.6% of all companies operating in the real estate and construction industries (according to the U.S. Small Business Administration) are small businesses, which took an extra hit from declining home prices. Small wonder that many Americans feel tethered to their homes. We must de-couple small business finance from housing finance and develop better lending options to resume growth in the small business sector.

The home foreclosure that halted other foreclosures nationwide, that of Mrs. Nicolle Bradbury of Maine, is the subject of a compelling article in the New York Times. Mrs. Bradbury’s mortgage lender, General Motors Acceptance Corporation, is now making its third attempt to foreclose on the home. Mrs. Bradbury would today be homeless but for the determined work of a pro bono attorney who deposed an employee of GMAC Mortgage. It was through this deposition that we learned that contrary to his sworn statements, the employee had no knowledge of Mrs. Bradbury’s case as he was preparing 400 foreclosures each day. Thus, the term “robo-signer” entered our lexicon.

The judge who heard the foreclosure case censured GMAC for its failure to comply with the directive of a Florida court four years ago for its unacceptable use of robo-signers. GMAC’s lawyers asked the court to place the incriminating deposition of its employee under court seal and to delete the transcript of the deposition from any online posting. The brazen nature of that request speaks volumes about the abuse of corporate power. The New York Times, to its credit, posted the deposition online if you wish to download it, click here.

We still don’t have clarity on whether these practices were common to commercial mortgage as well as residential ones. If your small business owns a mortgage and you are in arrears on your payments, you should consult legal counsel immediately.

Global Entrepreneurship

A report from the World Bank’s Development Research Group finds that new business creation fell dramatically in the wealthiest countries as the global banking crisis of 2008 – 09 deepened. But business creation in low-income countries remained constant. The inhibition in the wealthier countries appears to be the result of a widespread lack of business confidence and frozen credit markets. For lower-income countries, where the credit markets are generally not accessible to entrepreneurs to begin with, the banking crisis did not have the same impact. Leora F. Klapper and Inessa Love, the World Bank senior economists who authored the report, emphasize that the recent crisis notwithstanding, the financial markets offer more benefits than risks to new business creation. They write

Entrepreneurship is essential for the continued dynamism of the modern market economy and a robust entry rate of new businesses can foster competition and economic growth…Entrepreneurial activity can also contribute to employment generation. For instance, in the United States and Canada, young firms have been shown to be an important source of net job creation, relative to incumbent firms.

The World Bank’s “Doing Business” series, unrelated to this report on new business creation, tracks metrics such as ease of incorporating a new business, access to finance, tax policy and other variables that influence entrepreneurial activity. True to the adage that “what is measured is managed”, countries take active steps to improve their rankings in this report, with reform measures to streamline the process of business start-ups. As small business owners, we need to get our elected officials in Washington to read this report and act upon its recommendations.

Not Always King

Businesses in the Gulf Coast states that cannot document their earned income are at a disadvantage in filing claims for losses arising from the oil spill. But for all business owners, there are other costs of running a cash business that may not be obvious until it comes time to think about the exit strategy. The value of a business is typically derived as a multiple of earnings, so any cash or phantom income reduces the perceived value of the business to the buyer. Indeed, the lack of good financial records is consistently identified as one of the top three reasons why businesses are not saleable or sell for far less than the owners believe the businesses to be worth.

I recently heard Andrew Bryan Burnett, managing director of the Cathedral Consulting Group, deliver a presentation “Running Your Business With the Exit Strategy in Mind”. He holds an MBA from Wharton and hosts his own radio show, “My Father’s Business”. Based on his experience in advising business owners, he identified six obstacles to maximizing value on the sale of the business:

• Tax structure
• Poor financial statements or lack of records
• Complicated structures involving too many people
• Minority interest without a buy-sell agreement
• Inability to identify potential buyers
• Asset structure that impairs the sale of the business

The value of the business is the future cash flow to the buyer which value must be identifiable and transferable. A major source of contention on disaster relief post-Katrina was the lack of transferable property deeds in New Orleans as some properties passed from one generation to the next in the family without an update of public records. A disaster is the worst time to put your records in order. Do it now – it will reduce your stress levels later.

Poor Marks for Banks

When the lead headline on the front page of the Financial Times announces the crisis in small business capital access, the problem can no longer be ignored. Under the headline “Small business lose out” follows an article summarizing the data presented in the “Terms of Business Lending” survey released this week by the Federal Reserve Bank. The survey collects quarterly data from 348 U.S.-chartered commercial banks and 50 U.S. branches of foreign banks. The survey found that interest rates on small commercial and industrial loans were 3.5% higher than the federal funds rate (the rate at which banks borrow to on-lend to customers), the highest spread since the Fed began the survey nearly 25 years ago. It seems that every policy initiative to motivate large banks to unblock the flow of credit to the small business sector, including the Troubled Asset Relief Program, has failed.

Perhaps this is why the Obama administration’s legislation to create a $30 billion small business lending fund has just cleared the Senate with negligible opposition. To accelerate the bill’s passage, Senate Majority Leader Harry Reid blocked any effort to tack amendments onto the bill, limiting the Congressional debate to the matter at hand. The fund would offer reduced capital costs to community banks commensurate with their growth in small business lending – a carrot that was missing in TARP. Other restrictive elements of TARP, such as preferred warrants, are not part of this legislation, which should speed its passage. But if banks continue to believe that small businesses are poor risks in this recession, the carrots might not have the desired effect.

Just Listen to Us

Policymakers continue to be frustrated by their inability to unblock the flow of credit to the small business sector. The President has put forward a $30 billion legislative package to offer incentives to community banks to lend to small businesses. While the measure has passed the House and is on its way to a Senate vote, there are doubts as to the efficacy of the proposed measures to stimulate lending. One critic expressing such doubts is Harvard Law Professor Elizabeth Warren who was appointed by Congress to oversee the $700 billion Troubled Asset Relief Program. In an interview with Bloomberg Businessweek, she stated, “policymakers are flying blind”, owing to a dearth of data on small business lending. While the original intent was that TARP recipients would on-lend some of their capital infusion from Washington to the small business sector, they have clearly failed to do that. The largest TARP recipients, those with assets in excess of $100 billion, reported 10% declines in small business lending from June 2008 to June 2009. (One bank has even offered rate reductions on its loans to small businesses that hire new employees.) But Warren is uncertain if the decline is the consequence of the banks’ reluctance to lend or the reluctance of credit-worthy small businesses to borrow. To remedy the data gap, the Federal Reserve Bank of Atlanta recently began a quarterly survey of small business lending in its region, in the hope that better data might craft better policies.

If we were not experiencing double digit unemployment even as viable small businesses that wish to hire are choked for credit, this would be funny. But what the monetary economists of the Fed and their academic advisors needs to do is to actually talk to a few small business owners. I am very active in entrepreneurial groups and the message I hear everywhere is the same. Those of us who own businesses that are credible candidates for loans are reluctant to borrow for fear of rising taxes, higher costs due to healthcare reform and other areas of uncertainty arising from government policies. Businesses generally prefer stable environments when taking on longer-term liabilities, such as loans. We are not close to having clarity on some very important tax and economic policies (yes, we know taxes will rise, but by how much?) that would enable us to see through the fog to determine how much debt we could prudently take on. This is the message that Washington needs to hear.

On July 17, the Internal Revenue Service will hold a “Gulf Coast Special Assistance Day” in four states: Alabama (Mobile), Florida (Panama City and Pensacola), Louisiana (New Orleans, Houma and Baton Rouge) and Mississippi (Gulfport). The intent is to address questions related to tax liabilities arising from compensation for losses incurred in connection with the Gulf Coast Oil spill. “This is a very difficult time for many people affected by the oil spill in the Gulf of Mexico. As residents of the region cope with the evolving situation, I want to assure them that the IRS will be doing everything it can to provide tax help to those who need it,” IRS Commissioner Doug Shulman said. “We encourage anyone who has an issue with the IRS to contact us and explain their hardship, and we will work with them to find a solution. We’ll do everything we can under current law to help taxpayers.” The IRS has published guidance on its website to explain that BP payments for lost income are taxable as the payments replace wages or business income that would otherwise be taxed. Reimbursement for property loss is generally not taxable. The IRS is setting up a toll-free telephone hotline to answer taxpayers’ questions in these matters. Gulf Coast residents should also be certain to ask about the deductibility of uninsured or unreimbursed losses.

Reading the Fine Print

In May of last year, President Obama signed into law the CARD Act, which restricts some of the more abusive practices of credit card accounts, such as retroactive rate increases on outstanding balances. Unfortunately, despite the heroic efforts of Senators Landrieu and Snowe, the protections are limited to individual consumers and do not extend to small businesses. The bank lobby argued against extending protections to small businesses, claiming that such action may limit the availability of capital for revolving loans on credit card accounts and may result in higher interest rate charges. Of course, small businesses are already experiencing lack of access to credit and high charges, so if you accept the banks’ argument at face value, there was nothing to lose by extending the CARD Act to include small businesses.

As a concession of sorts, the Senate, in quashing the attempt to include small businesses in the CARD legislation, directed the Federal Reserve Bank to conduct a study of credit card use by small businesses. The Fed has just released the study, smallbusinesscredit click to download it. The Fed’s report does confirm the positions taken by small business advocacy groups as to the extensive use of credit cards by small business owners for working capital needs. It also highlights the benefits of improved disclosure requirements. However, it stops short of offering specific recommendations to protect small business credit card accounts from deceptive practices by the issuing banks. The good news is that the Small Business Credit Card Act of 2009 (H.R. 3457) is working its way through Congress. Add your voice to the fifteen national business and consumer organizations that have endorsed this legislation. Write to your senator and congressman and urge his support of this legislation at a critical time when small businesses need transparent terms on their credit card accounts.

File Your Appeal on Time

Many communities close their fiscal years in June or July, which means that business owners need to keep an eye on pending deadlines to appeal commercial property tax assessments. The states, desperate for revenues to meet their own budget shortfalls, did not take into consideration the full impact of the recession on property valuations. The result is that many businesses are burdened with inflated tax assessments. Business owners simply cannot afford to overpay their tax obligations, particularly in this difficult economy. Accounting firm Grant Thornton LLP recommends that commercial property owners who suspect that their assessment may be overvalued should retain the services of a certified, independent appraiser, experienced in commercial valuations. According to Terry Conley, a partner at Grant Thornton, “an independent appraisal is the biggest influencer for an appeal. A business owner can get a truncated appraisal that that allows them to compare their business to similar properties in the area, which is usually enough for an appeal. When more proof of overvaluation is necessary, we conduct an in-depth assessment that considers everything from infrastructure to landscaping to entryways.” Business owners also need to establish where to file their property tax appeals, as commercial properties are often considered by separate agencies than those that treat residential properties. Appeals can be challenging, but those who undertake them have a high rate of success. Of course, if you own your own home, you should consider your residential property valuation as well. Every dollar of tax relief is a dollar you should fight to obtain.