Barbara’s Blog

The U.S. Small Business Administration (SBA) releases quarterly statistics on business churn. What is this and why should you care about it? Business churn is defined as changes in the number of births and deaths of firms in this country. When business births (startups) increase and business deaths decline, the resulting rise in the number as business churn is good. “Business churn is needed to keep the economy from stagnating,” says the SBA.

Business births are vital for employment creation. The government says that small firms (20-499 employees) were responsible for three-quarters of job creation from the end of the economic downturn (from 2009 on). However, now (since 2011) even smaller firms (1-19 employees) are creating jobs.

Business bankruptcies—one of the ways in which businesses die—are on the decline for firms of all sizes. In the last quarter of 2011, there were 11,149 bankruptcies. In the first quarter of this year, there were only 10,998, showing that business deaths are on the decline.

Clearly, things are moving in the right direction. However, we are nowhere near pre-recession numbers in business creation. The number of unincorporated businesses created in 2011 is markedly below the number in previous years: 10,586,000 in 2006, 10,413,000 in 2007, 10,080,000 in 2008, 9,831,000 in 2009, 9,681,000 in 2010, and only 9,449,000 in 2011. It’s too early to pop the cork and celebrate the return of a strong economy, despite the statistical rise in business churn.

Word on the street (from small business owners I know) is that they are largely still just hanging on. They aren’t expanding. They aren’t hiring. They aren’t buying new equipment (other than what is absolutely necessary). There are “for rent” signs everywhere, with store fronts and office space showing significant vacancies. My personal view on business churn is not as rosy as the SBA’s, but I sure hope things change real soon!

The President has proclaimed November as “National Entrepreneurship Month.”  Now is the time to cheer for ourselves, existing entrepreneurs, and help others achieve their dreams of entrepreneurship.

SBA activities

In celebration, the Small Business Administration is pushing three programs:

• Student start-up plan to help graduates manage their student loan debt so they can start businesses. This income-based repayment plan for federal student loan debt can limit repayments to 15% of discretionary income.
• Young entrepreneurs series is a live program held at various locations around the country. The program educates young people about entrepreneurship; connects them to each other and other successful business owners; and supports them by providing better access to tools, resources and information on how to start, grow, and manage a business.
• Apps for entrepreneurs contest will award prizes of $20,000 for apps created to help small businesses and entrepreneurs navigate the federal government more effectively. Entry deadline: November 20.

Kauffman Foundation activities

There are a number of events highlighting global entrepreneurship week, which starts on November 14. In the three short years since the Kauffman Foundation helped to get Global Entrepreneurship Week started, it has expanded to more than 100 countries—empowering nearly 20 million people through 95,000 activities.

Find a list of what is happening globally here.

On February 14, 2011, President Obama released his $3.73 trillion budget proposal for FY 2012. How does small business make out in expenditures, tax changes, and other proposals in the budget?

Here are some good and bad aspects of the proposal.

Cuts in the SBA

Bad. The government agency that is exclusively for small business—the U.S. Small Business Administration—would see a 45% cut in its budget. More specifically, funding for Small Business Development Centers (SBDCs) would be reduced.

Good. Funding would be continued for SBA loan guarantee programs as well as for SBA disaster loans.

Taxes

Bad. According to AP, the proposal suggests $730 billion in new taxes on businesses and wealthy individuals over the next decade. Which businesses are we talking about and who are “wealthy individuals?” For the most part, many small business owners fall into this category (more than $200,000 of income if single or $250,000 if a joint filer).

• Income tax rates after 2012 would rise to a high of 39.6% (up from the current 35%); there would be a second, lower bracket of 36% (up from 33%);

• Capital gains would be taxed at 20% for high-income individuals;

• Expansion of 1099 reporting for services of $600 or more by corporations instead of just services by contractors (the horrendous 1099 reporting for both goods and services would, however, be repealed);

• The federal estate tax rate would be raised after 2012 to 45% (up from the current 35%), while at the same time the exemption for each person would drop to $3.5 million (from the current $5 million);

• The unemployment insurance surtax would be made permanent at 0.8% (it is currently scheduled to decline to 0.6% after June 30, 2011);

• The “last in, first out,” or LIFO, method of inventory accounting would be repealed. Even businesses that do not use this method would be impacted through higher energy costs because this accounting method is favored by energy companies.

The proposal does not aim to cut the corporate tax rate, a factor that has made U.S. corporations less competitive worldwide. The President did suggest that it be reduced, but only if the cut was revenue neutral.

Good.  The proposal includes suggestions to:

• Expand and make permanent the research credit;

• Make the 100% exclusion for gain from investments in certain C corporations permanent;

• Create tax incentives for hiring and buying equipment for businesses in 20 new economic growth zones;

Bottom line

The President’s budget proposal is the first salvo in a battle over the budget. It’s my hope that Congress and the President can work together to craft a budget that reduces the deficit without putting the cost on the backs of small businesses.

On January 31, 2011, President Obama announced the “Startup America” initiative designed to help entrepreneurs start and grow businesses and hire workers. The initiative includes:

• An SBA commitment for early-stage seed financing of $2 billion over the next five years, to be matched by private sector investments.

• Some government-led mentorship programs.

• Private-sector commitments, including Startup America Partnership headed by AOL’s founder, Steve Case.

• Tax incentives and relief, including making the 100% exclusion for gain on the sale of certain small business stock permanent (it’s only set to run for stock acquired through the end of 2011).

What’s Good?
The best part of the initiative is recognition of the important role of entrepreneurship to the country.  A Kauffman Foundation Study last summer showed that most job creation comes from startup businesses—new companies add an average of 3 million jobs in their first year, while older companies lose 1 million jobs annually. So, any White House action to spur business creation is welcome.

The second aspect of the program that is encouraging is the emphasis on the private sector to help startups; it doesn’t take any tax dollars to work. This help will come from investments, mentoring, and other assistance from large corporations, including Intel, IBM, HP, and Facebook.

What’s Bad?
The initiative does not eliminate the government’s toxic role in hindering startup and growth. The government needs to look at the following stumbling blocks that it creates:

• Regulatory burden. While President Obama has issued an executive order directing reduction in the burden, the regulations from Washington just keep coming and coming.

• Tax burden. Every penny that a small business owner sends to Washington is one less penny to be invested in business growth. Most small business owners pay tax on their share of profits on their personal returns (only C corporations are separate taxpayers). While favorable tax rates have been maintained for another two years, they could rise after 2012. A permanent, low top tax rate would help small businesses. The President’s new initiative has a couple of tax incentives, but none that would help the vast majority of small businesses.

• Health care premiums. Obamacare was sold with the idea that it would bring down costs; just the opposite has happened so far. What’s needed is action that will reduce premiums. This could include, for example, tort reform and other measures to reduce health care costs.

The Startup America initiative is a step in the right direction. Let’s hope it goes farther than just the end of the block.

Everyone knows George Santayana’s words: “Those who cannot remember the past are condemned to repeat it,” yet few in government seem to heed them.

The SBA Office of Advocacy just released a working paper  entitled “The Role of Small Business in Economic Development of the United States: From the End of the Korean War (1953) to the Present.” Some of the information in the paper and the lessons drawn from them should be required reading for members of Congress and others.

Initiatives to help small business
The importance of small business and initiatives to spur growth were first recognized by the Eisenhower administration with enactment of the Small Business Act in 1953 (which created the Small Business Administration) and the Rural Development Program in 1955.

A famous quote preceding enactment of these small business programs was  “If America will save the small businessmen, the small businessmen will save America.”   The SBA became the first peacetime agency with (as the report says) “a mandate to ‘encourage’ and ‘develop’ small business growth, and to aid minorities and other disadvantaged people in securing loans and learning management techniques.”

Excerpts from the Small Business Act:

“The essence of the American economic system of private enterprise is free competition.”

“Only through full and free competition can free markets, free entry into business, and opportunities for the expression and personal growth initiative and individual judgment be assured.”

“The preservation and expansion of such competition is basic not only to economic well-being but to the security of this Nation.”

Government action
Despite the creation of the SBA and words recognizing the importance of small business, most government resources and attention continued to be focused on large companies. With the enactment of the Small Business Economic Policy Act of 1979, at last there was an avowed national policy to implement and coordinate efforts to expand small business. However, words did not translate into serious action. Only recently has there been a mandate that a certain percentage of government contracts be allocated to small businesses and, what is not said in the report, that this mandate is too often skirted by large corporations masquerading as small businesses.

Some conclusions of the report
Until the 1970s, “America lost a tremendous amount of manpower and economic strength because the economic value of the small business community was not acknowledged and the value of a well trained diversified population was not recognized.” Today, there are about 29 million small businesses that generate about 75% of net job creation.

In 2005 following Hurricane Katrina, it was clear that “policy makers did not understand the pivotal role small businesses play in the local and regional economy…[I]t took a national disaster…to understand why small businesses must participate as full economic partners at all levels of government.”

Certain tax incentives and other federal programs are at least trying to address small business needs. The greater help would come from some fundamental changes in how government operates:  lower taxes, less regulation, and less intrusion into business operations.

Today, millions of people are becoming accidental entrepreneurs—they never thought they’d be starting businesses, but prolonged unemployment and new business opportunities have changed their direction.  Before starting businesses, they should be aware of some misconceptions so they don’t become statistics.

The SBA says  that 7 out of 10 firms don’t make it past 2 years, and only about half survive for 5 years. The economy continues to be tough and only those who are realistic have a chance at success.

Myth #1: You have freedom to control your own schedule.

Reality: Small business owners work longer hours than employees. Don’t believe the infomercial claims that you only need to work a few hours a week to see thousands of dollars roll in. Most business owners I know work much more than 35 hours a week, the typical schedule for an employee. Working 60 hours each week, or nearly double that for employees, is common.

Not only is it difficult to control hours, but it’s also challenging to manage scheduling. An owner who wants to attend his child’s school play may have more difficulty shifting appointments than an employee who has personal days. Owners often are “on” 24/7.

Holidays for many small business owners, especially those in start-ups, become infrequent or nonexistent, in contrast to employees with two to four weeks or more of paid time off. Family sacrifices are required by many small business owners in order to succeed.

Myth #2: Anyone can start a business; there’s no barrier to entry.

Reality: While the U.S. has one of the greatest rates of entrepreneurship (4.3% according to the GEM Consortium) among more developed countries, this does not mean that there is no barrier to entry. It is true that education, family background, sex, and race are not overt barriers, but being well educated and having family connections still goes a long way toward ensuring success. It helps, for example, in raising the capital needed to get started.

Myth #3: You have security because you can’t be fired.

Reality: There is more certainty in owning a business than working for someone else. Despite the bad economy and high unemployment (currently 9.5%), about 90% or so of the workforce employed. This can be viewed as security. In contrast, there is no security as an owner of a small business. You can be successful one day and closing your doors the next. Your security is dependent on: customers, vendors, bankers, and the government, to name just a few stakeholders in your venture.

Final thought
Despite the reality, there’s nothing better than owning your own business. The potential upside is limitless—for financial and personal rewards.

As part of the Department of Defense Appropriations Act, 2010, which was signed into law on December 19, the Small Business Administration received $4.5 billion in additional funding through February 28, 2010. This funding enables the SBA to raise its guarantee to 90% on loans made by commercial lenders to small business owners and to waive fees on two popular loan programs—7a and 504 loans.

Sounds like this was a good holiday gift to small business? It’s not bad, especially for about 1,000 businesses already on a waiting list for loans, but let’s take another look at this gift horse. 

Many small businesses today are no longer in the market for loans; they could have used them when the economy started to go south. Now, they don’t have the customers or revenue to support the growth that the loans would otherwise have been used for. Some of the businesses that do want loans now may no longer qualify (or at least qualify at affordable interest rates) if the business’s and owner’s credit ratings were severely damaged in the recession.

Looking ahead, even companies positioned to benefit from the loans may want to rethink the entire concept of borrowing. If the recession taught us anything, it’s that having cash, not debt, is the way to survive and prosper. Debt means incurring monthly interest costs and requires regular cash outlays to service the debt. When inflation takes off, it means higher interest rates and a steeper cost of borrowing.

Better ways to finance business projects may be:

• Vendor financing to acquire inventory, machinery, and other items needed by your business—this borrowing is limited, short term, and usually available on attractive terms.
• Retained earnings to self-finance any projects—this is a no-cost financing option.

In this tough economy, many small businesses are struggling to survive. The SBA’s Office of Advocacy has released an updated fact sheet shedding light on survival. The data present a picture that is more optimistic than might be expected.

About 627,000 new businesses started up in 2008, despite the declining economy. This was fewer than the number of start-ups in 2007 (664,100), but it still means that people with good business ideas are finding the capital and the means to start up companies.

About 595,000 businesses closed their doors in 2008; this is only slightly higher than in 2007 (571,300) and fewer than in 2006 (599,333). The turnover rate is about 10%, but it’s three times higher for companies with no payroll versus companies with employees.

According to the latest data, about 70% of companies survive for at least two years, and about 51% for five years. The survival rates are higher than those reported last year, when only 67% lasted two years, 44% at least four years, and 31% for at least seven years. The survival rates are similar across states and major industries.

If you’re in a cash crunch because of debt servicing, there may be relief available. The SBA has announced a new American Capital Recovery (ARC) program under which small businesses can borrow up to $35,000 interest free. Loan proceeds can be received over a six-month period; repayment of principal is deferred for 12 months after the last disbursement of the proceeds and can be extended up to five years.

This temporary lending program is designed to help ease the commercial credit crunch (made worse by Advanta’s elimination of small business credit cards starting June 10).  ARC loans are limited to small businesses with outstanding loans (credit cards, notes payable to vendors, capital leases, and certain other types of borrowing) and that are experiencing immediate financial hardship (declining sales, difficulty in paying expenses, etc.).

The program is not for start-ups (you must be in business for a minimum of two years) and loans will not be given to small businesses that are already seriously delinquent in outstanding loan payments.

The ARC program is set to start on June 15. Loans are made by commercial lenders (not directly by the SBA); they are 100% guaranteed by the SBA. The program will continue until September 30, 2010, or when funds run out, whichever is first.

With small business lending at a virtual standstill, the Administration is trying to jumpstart the credit markets by taking certain actions announced on March 16.  Actions include: 

• Purchasing up to $15 billion in securities so lenders will have more funds available for new loans,
• Raising temporarily the SBA loan guarantee under the 7(a) loan program to 90% (up from the usual 85% for loans up to $150,000 and 75% for larger loans),
• Eliminating SBA loan fees (including rebating fees paid on loans approved on or after February 17th), and,
• Requiring the 21 largest commercial banks to report each month on their small business lending activities.

These measures are welcome moves in a tough economy and will surely prime the pump of the lending activities. But it’s important to recognize that they only benefit small businesses seeking capital.

What about other small businesses that do not need financing? What measures will help the entire small business community?

Many small business owners, especially those “larger” small businesses that create jobs, are concerned about other issues that could seriously impact them, including tax increases and additional costs for health coverage.