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California Small Businesses Paid in Scrip

Tuesday, July 7th, 2009

World's 8th Largest Economy Can't Pay Its Bills

Just when you thought it was hard enough with lack of access to bank loans, some small businesses in California that contract with the state are being paid for their services in IOUs instead of liquid funds. Owing to a $26.3 billion budget deficit, and the apparent inability of lawmakers to agree to spending cuts or tax hikes, the state does not have sufficient cash to cover all of its payments. I have spoken with small business owners in California that contract to provide goods and services to the state and cash flow pressures in the summer months are nothing new. The California Legislature has rarely met its own June 30 budget deadline, with the result that the state is often in arrears in making scheduled payments to contractors over the summer months. However, this is the first time since 1992 that California has printed IOUs against certain of its obligations. State Controller John Chiang has stated that he will issue $3.3 billion in IOUs along with $11 billion in regular cash payments. Remember, California is the world’s eighth largest economy.

California’s cash flow problems may be disproportionately shouldered by small businesses. When California last issued IOUs for payments, state employees litigated their claims that receiving their paychecks in scrip constituted a violation of the Fair Labor Standards Act. A federal judge agreed, and the workers received their cash payments plus extra vacation time. So state employees will not receive IOUs for their paychecks this time. And, because the federal government is paying certain of California’s social service obligations to the elderly and disabled, they will not be affected by the lack of cash. Governor Schwarzenegger reached out to financial institutions to urge them to accept the IOUs, called individual registered warrants, which will be redeemable by October at a 3.75% interest rate. Wells Fargo, Bank of America and Chase Bank have announced that they will accept the IOUs from existing customers through July 10. It is not clear what will happen after July 10 or what other institutions will do.

In Prepare for the Worst, Plan for the Best: Disaster Preparedness and Recovery for Small Businesses (Wiley, second edition, paperback, 2009), I presented a framework for which the California liquidity crisis would qualify as a third-party service failure. Small businesses that depend on clients, such as California, to make timely payments to fund their own obligations are at risk for failure to diversify their client base, just as you would with a vendor or service provider. I am sympathetic to the start-ups in that state, as the market there is brutal.

Tags:California, IOUs
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FDIC May Extend Coverage of Some Deposits

Monday, July 6th, 2009

Follow This News

According to American Banker, the Federal Deposit Insurance Corp. may extend its blanket coverage for noninterest deposits, currently scheduled to expire at year end. Business customers often keep checking account balances that exceed FDIC coverage limits on insured deposits in order to meet payroll and other large obligations. The FDIC provided this guarantee in the fourth quarter of 2008 as the financial crisis deteriorated. The FDIC is said to be concerned that if it fails to provide assurances that it intends to extend the program, business customers might begin to withdraw funds and split accounts across a number of insured banks, creating some unnecessary uncertainty in the banking and business systems. Small businesses that have accounts exceeding FDIC coverage requirements should watch the FDIC website for developments in this matter to ensure that their deposits remain within coverage limits.

Tags:Deposit Insurance, FDIC
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Recovery and Reinvestment Tax Benefits

Sunday, July 5th, 2009

Something for Everyone

While the emergency loan program legislated into effect by the stimulus bill may have limited benefits for small business owners, there are other provisions to encourage capital investment that are worth considering. The American Recovery and Reinvestment Act provides certain incentives, for a very brief time frame, for small businesses considering capital investment:

Faster recovery of certain investments in business property. If your small business invests in new property or equipment in 2009, there are two means to increase deductions related to those capital expenditures:

Increased limit on Section 179 expense. You may expense, rather than depreciate, the cost of machinery, equipment, vehicles and other tangible property placed in service in 2009, up to a maximum deduction of $250,000. The cost of property in excess of $250,000 may be depreciated over its life. In 2010, the Section 179 cap will drop from $250,000 to $133,000 (indexed for inflation). After 2010, the cap returns to the prior limit of $25,000. The Section 179 deduction cannot exceed taxable income, but it may be carried over to future years. However, it phases out for capital expenditures above $800,000 and limits the tax break to smaller businesses.

Bonus depreciation allowed in 2009. You may deduct up to 50% of the cost of “qualified property” (defined as almost any capital expenditure other than buildings) purchased and placed in service in 2009. You may take the benefit of both the Section 179 expense and the bonus depreciation. However, the basis for depreciating the property must first be reduced by the Section 179 expense.

Extended net operating loss (NOL) carry-back period. Typically, a net operating loss may be carried back two years and forward twenty years to offset taxable income. For NOLs created after Dec. 31, 2007, the Recovery and Reinvestment Act provides a five-year carry-back period. So if your business paid taxes in the prior five years, the NOL may be carried back to the fifth prior year and each succeeding year to offset income and refund taxes. This benefit is available provided that your business gross income did not average more than $15 million in the three years leading up to the NOL. To claim the refund, eligible businesses must file Form 1139 by Sept. 15. Eligible individuals must file by Oct. 15 using Form 1045.
Shortened period for taxing S corporation built-in gains. Corporations which elect S corporation status are not taxed at the corporate level. Instead, the income, deductions and credits are reported by the owners. If a C corporation elects S corporation status, any gain inherent in property owned by the corporation at the time of the election and sold within 10 years of the election will be taxed at the maximum corporate rate (currently 35%). The Recovery and Reinvestment reduces the 10-year period to seven years in 2009 and 2010. This will benefit corporations that became S corporations (or acquired property from a C corporation) between 1999 and 2003. How Congress thinks a backward-looking adjustment will motivate forward-looking investment is beyond me, but I guess the lobbyists have been busy.
Benefits for small business owners. You may exclude 75% of the gain from qualified small-business stock acquired after Feb. 17 of this year and before Jan. 1, 2011. To qualify, the stock must be held at least five years and acquired at the original issue date. This provision will benefit individuals after Feb. 17, 2014, upon satisfying the five-year holding period. Certain limitations apply to the exclusion, which is normally 50% of the gain. In addition, if you receive more than 50% of your income from a small business, the required 2009 estimated tax payments are lowered. Normally, estimated tax payments must equal or exceed the lesser of 90% of the current year tax or 110% of the prior-year tax obligation. In 2009, taxpayers who qualify only make estimated payments based on the lesser of 90% of the 2008 tax or 90% of the 2009 tax. This provision benefits taxpayers with 2009 income greater than 2008.

One caveat: I am not an accountant, so print out this entry and discuss this information with your accountant to get the advice that is specific to your unique situation.

Tags:Tax Benefits
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Will the Courts Do What Congress Did Not?

Wednesday, July 1st, 2009

There Should Have Been a Better Way

The website for Advanta Corp. identifies the tagline of that company on the upper left hand corner as “Credit cards for small businesses”. In the center of the home page the company announces “Account closures: We deeply regret that all Advanta Business Credit Card accounts are closed, effective May 30, 2009.” Advanta stopped lending against open credit card accounts last month due to funding problems. On May 11, Advanta announced that it would allow its securitization facility to unwind.

Now irate small business cardholders are seeking class-action status in litigation against Advanta filed in Superior Court in Santa Clara, California on June 16. They allege that Advanta “unilaterally, unfairly and illegally” changed the terms of credit card agreements, “increasing their effective interest rates…in an attempt to unfairly accelerate repayment of outstanding balances and to increase immediate revenues”. Consumer complaints against Advanta rose dramatically last year when the company responded to the spike in charge-offs by re-pricing accounts, sometimes by as much as 30 percentage points. The documents filed in court state that last year “Advanta imposed new APRs on plaintiffs’ credit cards…increasing the promised fixed rate to as high as 29.99%….These new terms were not previously disclosed in any form to Advanta’s customers and were not the result of any breach of the contract by the consumer”. The plaintiffs are Advanta cardholders who believe that they and other customers have been harmed by “having to pay interest and finance charges with interest accrued at higher rates than Advanta promised”. The lawsuit is seeking $75,000 per cardholder plus interests and costs.

Given that Advanta has terminated all of its small business accounts, what do the plaintiffs hope to gain, besides compensation which, even if awarded by the court, may not justify the time and effort invested in the process of litigation? According to American Banker, Arthur D. Levy, the attorney for the plaintiff, wrote that “Advanta’s lending moratorium does not affect this case. This is to make customers whole for past illegal rate increases. We are monitoring Advanta’s financial situation and so far….they appear to have sufficient capital to repay their customers in our case.” In effect, they are litigating over past abuses that credit card reform legislation was meant to correct. However, as I wrote in an earlier blog posting, the legislation Congress passed aids individual consumers and is of no benefit to small businesses. In choosing inaction, Congress likely left small business owners to pursue justice in the courts, at expense to all taxpayers.

Tags:Advanta Corp., Credit Card Abuse
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Fed Chairman Bernanke Should Visit Small Businesses in Harlem and the South Bronx

Wednesday, July 1st, 2009

Alexander Doll Company in Harlem

On June 17, Chairman of the Board of Governors of the Federal Reserve Bank System Ben Bernanke addressed the Global Financial Literacy Summit in Washington, D.C. He spoke about the challenges and opportunities facing community development financial institutions (“CDFIs”). Such organizations reach consumers in traditionally underserved markets, helping them to manage credit, buy homes and start small businesses. There are more than 1,000 CDFIs holding about $25 billion in assets and like everyone else, they are affected by the economic downturn. Philanthropic funding to these institutions has declined as foundation endowments and investment earnings have declined in value. At the same time, support for CDFIs from state and local governments and more traditional institutions are also declining. In particular, banks that sought to avail themselves of Low-Income Housing Tax Credits saw the value of those credits decline as tax credits declined in value commensurate with their deposits.

I read Chairman Bernanke’s speech in its entirety and my reaction to his remarks is mixed. On the one hand, I am always glad to see the issue of financial access on the radar screens of regulators. But at the same time, I am troubled by the philosophy implicit in the Chairman’s remarks and in the Obama Administration’s financial regulation white paper. Their view appears to be that banks have to be bribed and cajoled by tax credits or regulatory fiat into doing business in low-income areas. In fact, low-income areas are often vibrant entrepreneurial communities, creating opportunities for themselves after larger corporations have moved employment elsewhere. As long as banks perceive the stick as the inducement to enter these markets, they will not stay for long, when the stick becomes less menacing, as it does in an economic recession. However, when banks see the carrot, the profit opportunity for reaching under-served markets, their commitment will be sincere and longer-lasting.

For a more forward-looking perspective on the purchasing power, due to income density, of under-served urban areas, check out the Initiative for a Competitive Inner City (“ICIC”). When I was in business school, I received an award from the ICIC for a case study I had written on the Alexander Doll Company. The award provided for my participation in ICIC’s annual program for MBA students. The Alexander Doll Company is based in Harlem and manufactures the Madame Alexander line of dolls that I was given as gifts as a little girl. No one who would tour the doll company (and I encourage you to do so!) would see under-served communities as economic basket cases. I think that the future belongs to institutions like CheckSpring Bank in the South Bronx and the Alexander Doll Company that act on opportunities to build their workforces in very motivated communities.

Tags:Alexander Doll Company, CheckSpring Bank, Entrepreneurial Opportunity, Federal Reserve Chairman Ben Bernanke, Initiative for a Competitive Inner City
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What’s Not to Like?

Wednesday, June 17th, 2009

They Turn Very Slowly

100% risk-free to the lender and interest-free to the borrower – what is not to like about America’s Recovery Capital Loans, the new program of the U.S. Small Business Administration? Well, for one thing, it is hard to find a bank that will underwrite the loans. SBA loans are guaranteed by the SBA, but issued by participating banks. I have called most of the institutions on the SBA’s preferred lender list and I have yet to identify one that has decided it will participate in the program. The banks have identified four problems: first, they have to navigate the thicket of SBA rules with little guidance for this new program. That is a lot of work to do for loans capped at $35,000. Second, while the loans are interest-free for the borrowers, the SBA will pay the lenders prime plus 2%, a lower interest rate than the SBA charges for its other loan programs. Third, 100% of the principal is guaranteed and should the default rate continue to rise, a not unlikely prospect given that unemployment is high and rising, bankers don’t want to be blamed for shifting more losses to taxpayers. Finally, there may be relatively few qualified applicants for this program given the criteria established by the SBA and the risk for small businesses to assume more debt in such an uncertain market.

Tags:ARC Loans, SBA loans
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Time Is Not On Your Side

Thursday, June 11th, 2009

Speed Is Of The Essence

In Prepare for the Worst, Plan for the Best: Disaster Preparedness and Recovery for Small Businesses (Wiley, second edition paperback, 2009), I cited a study conducted by the group of certified public accountants concerning the experiences of small businesses in the immediate vicinity of the World Trade Center at the time of the 1993 bombing. They found that of those businesses that could not resume operations within five days, 90% of them were out of business one year later. In other words, small businesses recover quickly or they do not recover at all. You simply cannot recover at a leisurely pace. And cash flow is the life blood of a small business. This lesson appears to have eluded the U.S. Small Business Administration which on June 15 will begin to accept applications for the small business emergency loan program that was authorized by Congress back in February. The adage “Better late than never” simply does not apply to small businesses.

Tags:Bank Loans, Timeliness
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Well, At Least Two Senators Tried

Thursday, June 4th, 2009

The Senate Lost Its Way

Last week, President Obama signed into law the Credit Card Accountability Responsibility and Disclosure Act that will put into effect within 45 days certain protections against credit card abuse that the Federal Reserve had scheduled for implementation in July 2010. The law prohibits retroactive rate increases on outstanding credit card balances for cardholders in good standing; requires at least 45 days’ advance notice to raise rates for new charges; bans double-cycle billing, a practice which allowed for fees to be charged for balances that had already been paid down; and prohibits universal default, a practice that raises credit card charges to customers who are late making payments on unrelated accounts. That is the good news. The bad news is that this new law amends legislation that governs consumer credit, the Truth in Lending Act, so it does not apply to business cards.

Senators Mary Landrieu (D-LA) and Olympia Snowe (R-ME) proposed an amendment to extend the protections of the new legislation to any businesses with 50 or fewer employees. Unfortunately, this measure did not pass the Senate, which instead directed the Federal Reserve Bank to examine credit card use by small businesses. So if you use your personal card to make business purchases and are reimbursed by the company, you will benefit from the new protections. Additionally, business cards based on your personal credit, such as those used for businesses organized as sole proprietorships, should be protected as well. However, I would seek legal guidance on these matters as commingling personal and business credit to avail yourself of the benefits of consumer protections could leave your business exposed in other ways. I suspect that this is what many small businesses will wind up doing anyway in this tough environment. According to a recent survey conducted by the National Small Business Association, 60% of small businesses used a credit card as a financing tool over the past twelve months. And over one million small businesses just learned that as of May 30, 2009, Advanta Corp. has stopped their credit. Even worse, the credit loss may hurt the FICO scores of the affected small businesses. Advanta announced on its website that its small business customers “should be aware that ‘utilization percentage,’ which is a way of describing how much of your available credit you use, may be affected because your available credit will decrease as a result of the closure, and this may affect your credit score.” We have to commend Senators Landrieu and Snowe for trying and express our disappointment to their colleagues who did not support this amendment.

Tags:Credit Card Reform
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The Single Best Policy Option for the U.S. Treasury in Support of Small Businesses

Wednesday, June 3rd, 2009

Better Than Green Shoots

I have written several blog entries on the topic of government policy to unblock the flow of credit to the small business sector. I was motivated to do so by the recent hearing of the U.S. Senate Banking Committee at which small business credit was the topic that absorbed most of the focus of Treasury Secretary Geithner and the Committee members. Clearly their constituents are making known their displeasure with the fact that while small businesses create more than half of all U.S. employment, Wall Street investment banks, whose payrolls were shrinking even prior to the credit crisis, availed themselves of substantial government bailouts, with virtually nothing going to small businesses. Having critiqued the substance of what was discussed at the hearing, I would now like to put forward my own recommendation for a positive policy option.

The U.S. federal government has substantial purchasing power; it is the world’s largest buyer of goods and services. Contracts with the federal government are typically on net thirty day payment terms. Yet the federal government has been stretching out payments to its small business vendors to 140 – 150 days. I have had dealings with this issue as my small business was a bidder for microfinance contracts of the U.S. Agency for International Development. I know that this experience is not unique to me; I travel around the country speaking to small business groups and hear that this is a universal phenomenon. Last June, for example, I spoke at a small business awards luncheon of the Colorado Springs Small Business Development Center. As the Air Force Academy is located in that area, there are many local small businesses that are contractors or sub-contractors to the federal government. Their owners reported to me the same issue of delayed payments, to 140 – 150 days.

This means that small businesses are unwilling creditors, financing interest-free purchases to the federal government for up to five months at a time. If the federal government were to pay its obligations in a timely manner, that could substantially alleviate, but not eliminate, the strain on working capital that many small businesses are experiencing. This would allow small business contractors, in turn, to pay their obligations in a timely manner and would recycle funds in the economy. But wait, you say. We have a credit crisis. The federal government is printing money to monetize its debt. It cannot afford to pay its obligations in time. But it does – selectively. The banks that received TARP aid (Troubled Asset Relief Program) all received their funds within days. Paying small business promptly, as they are contractually obliged to do, for work performed is the best “assistance” that the federal government can provide our sector.

If the U.S. federal government were to pay its small businesses in accordance with the terms and conditions for payment, which are typically net 30 days, we would be playing catch-up with what other governments are doing to support their small business sectors. In Ireland, for example, Fine Gael leaders have proposed a small business rescue package that requires prompt payments to businesses from the government for procurement contracts.

Tags:Small Business Policy, U.S. Treasury
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U.S. Government: Punish the Prudent Small Businesses

Thursday, May 21st, 2009

In his testimony yesterday to the U.S. Senate Banking Committee, Treasury Secretary Timothy Geithner acknowledged that “small businesses account for most of the jobs in this country. That is why are trying to expand these programs for them.” Reflecting the popular anger at the bailouts of the rich and the reckless, Geithner appears to be repeating message points about how the “prudent” who did not become over-extended and behaved responsibly are suffering as a result of the behavior of the less prudent. At the hearing yesterday, he specifically referenced “viable businesses” that were “prudent” and “did not take on too much debt” now need to be helped because their access to capital has been hindered by the choking up of the credit markets.

Except that is not what the federal government has done.

The stimulus bill passed by Congress in February requires the Small Business Administration to create a new “business stabilization” program to back loans of up to $35,000 to small businesses “experiencing immediate financial hardship”. Known as America’s Recovery Capital (ARC) Loan Program, this emergency SBA program restricts the use of the proceeds of the loan. It rewards debtors in an unusual way. Small business owners cannot use new ARC loans to cover payments on existing SBA-guaranteed debt. However, as I posted on this blog on March 23, private loans made for any legitimate business purpose — including credit card debts, bank loans and real estate loans — would be eligible for the program. So if you managed your small business carefully and avoided taking on debt, or you took on less expensive (relative to credit card debt) SBA loans, this program is of no help to you.

This is exactly at odds with what Secretary Geithner said about the administration’s plan to help “viable businesses” that were “prudent”.

Perhaps reflecting their own lack of familiarity with the legislation they had passed, not one senator on the banking committee called him on it.

Tags:SBA loans, Stimulus Bill, U.S. Senate Banking Committee, U.S. Treasury Secretary
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Pertinent Perils