It pains me to see the Obama administration failing so badly to comprehend the fundamental problem facing the economy. I fear the economic consequences and the likely political disenfranchisement it is likely to cause. I was an early Obama adopter, volunteered and gave money, and now feel like a fleeced sucker at a card sharp’s table.
There has been plenty of mainstream and blogosphere comment on the error of Obama’s ways – the retention of the Wall Street cabal, the bailouts of the rich by the middle class, the enabling of Wall Street corruption, and so on. No need to recite the history here.
The issue, it seems, is that the administration, and perhaps Obama himself, have fallen spellbound to the shiny gyrating watch of Wall Street, the Fed and the “big money” progenitors. They have failed to connect the dots, learn the lessons, and take the medicine.
Here it is in a nutshell. Small business, and by that I mean very small business, is the engine that drives the US economy. Big business is the leech that sucks its lifeblood. Yet the government sponsored programs, and the regulatory swords of its various agencies, tilt the playing field in the exact opposite direction. Small business creates jobs, big business outsources jobs. Small business pays taxes, big business is paid by taxes.
Here are the government’s own facts. The U. S. Department of Labor reports that 64% of all net new jobs from 1993 to 2008 from firms of less than 500 employees. US Census data indicates that 2/3 of job creation comes from new business that started within past five years.
The Small Business Administration takes it a step further. The SBA says 20% of all employment in this country operate with less than 20 employees. These are very small businesses. 40% of all employment is provided by businesses that employee 100 or less.
Yet we make it nearly impossible for small business entrepreneurs to get financed. The traditional sources:
1. Personal Assets, including credit cards. (But these have been eroded including access to credit cards.)
2. Home Equity. (Also eroded by loss of equity, failure of banks, credit freeze in secondary markets.)
3. Friends and family. (Equally limited and fearful.)
4. Accredited investors and angel investors. Issue here is that people already invested are being asked to keep existing investments afloat, so less new money.
5. Reinvestment of cash flow. But decreased business leads to decreased cash flow.
6. Venture Capital. Private equity firms typically look for positive cash flow businesses in their niche, but they are also worried about redemptions from their investors.
7. Banks. Credit lending standards have been tightened. Banks lend money to people that don’t need it and right now nearly every small business needs it. Problem also is that business that have roll over type arrangements. 36% tightened and only 2% loosened in the past 6 months. SBA lending is picking up.
Incredibly, the SBA doesn’t collect information on actual small business loans but instead looks at the Bank Senior Loan officer survey. The SBA estimates that 90% of all business financing comes in some sort of bank financing.
Yet banks don’t “finance” small business. They finance the entrepreneurs setting them up, largely based on FICO scores and, to a lesser extent, collateral. The SBA loan programs provide no direct loans. They provide partial government guarantees for commercial loans made by banks. To be eligible, a credit test requires that the lending bank certify they would not make the loan, at least on the same terms, without the guaranty.
Even with these guarantees, banks have simply found more profitable ways to make use of their available capital and 78% of surveyed loan officers recently cite said reduced risk tolerance. In short, the “trickle down” method of funding banks who, in turn, loan money to local enterprises had hit a structural impasse.
This leaves enterprising entrepreneurs with non-traditional credit like credit cards, and home equity lines. 34% of small businesses rely on credit cards for 25% or more of their financing. Of those that used credit cards, 41% reported reduced credit lines and 79% report worsened terms on the credit cards. Again, credit cards are simply a profit source for the banks and not a method of funding businesses.
The net effect is that small business is typically relegated to the owner’s credit resources. When those run dry, regardless of the stage of the business plan, the business must operate from cash flow. Ironically, the faster the growth, the more rapidly the cash flow is absorbed, creating the “gazelle” effect.
The conventional wisdom “yes, but” financiers like venture funds and angel investors are largely imaginary. A “mini-summit” by the law firm Jones, Day essentially concluded that these models were broken as well. A study by the University of New Hampshire showed only 5,000 venture fund financings for the estimated 2.1 Million startups each year. And even that figure is misleading, since many of the venture financings were “down round” for existing clientele and not infusions to fresh clientele.
Further, the venture model presumes that the invested capital will be “refreshed” every 5 to 7 years with the entire hold lastly no longer than 10 years. This is premised on very liquid markets available when the venture capital firm seeks its exit, but that isn’t happening.
Angels have a larger number, estimated at 46,000 transactions, but “angels” are so diffuse and ill defined that a significant portion of these transactions are likely relatives, partners and others not available to the small business community at large.
There is essentially no governmental response to this situation at all, except to the extent that it worsens the problems. Start up costs for small business absorb a vastly greater percentage of available resources.
One possible remedy might be equity capital for small business, but this is an area where the regulators, and their shadowy brethren alphabet soup private companies like FINRA and DTC effectively provide the nail in the coffin, along with the coffin, gravesite and single bullet for you to shoot yourself.
