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No More IOUs

Friday, October 30, 2009
NASE Members Focus On Controlling Debt
By Jan Norman

When NASE Member Heather Angel Chandler started her business, Innovative Multimedia Group in San Antonio, Texas, she put $15,000 on credit cards to buy high-definition video equipment.

That was in 2007. Chandler paid off the debt and now only buys equipment she can pay for with cash.

“I’m not debt averse, but I’m definitely more fiscally conservative now,” says the veteran television news reporter who owns the video production and graphic design company.
NASE Member Heather Angel Chandler
There are times when borrowing is necessary, or even advantageous, for a micro-business. Debt can help a business owner buy a competitor to gain market share. Debt can also help bridge the gap between delivering products or services and getting paid. And debt can even fund equipment that gives a business a competitive edge, as it did in Chandler’s case.

But anyone who doesn’t understand Chandler’s change of attitude toward debt hasn’t been running a micro-business for the past two years.

The New World Of Credit
As the subprime mortgage market collapsed, financial tremors slowly rippled out to the rest of the economy.

Financial institutions started tightening their lending standards toward the end of 2007, and the U.S. economy slowed until virtually every sector was affected by “one of the worst credit crunches in recent history,” as the Federal Reserve Bank of San Francisco stated.

Since last year, business owners and individuals have found loans and credit cards hard to get. And the interest rates on their existing credit cards have gone up significantly. Between July and October 2008, the Federal Reserve Senior Loan Officer Open Survey on Lending Practices showed a record level of credit tightening. For small firms, 71.1 percent of large banks and 8.3 percent of small banks tightened their lending standards.

Small businesses have been especially hard hit by the credit squeeze because they have fewer capital resources than big companies. For example:
  • Advanta, which once specialized in small-business credit cards, completely closed that sector of its business with little notice in June.
  • Hundreds of banks, including JPMorgan Chase and Wachovia (since purchased by Wells Fargo), reduced or terminated lines of credit for even profitable, long-time business customers who never missed a payment.
  • CIT Group Inc., a major lender to small businesses, hit serious financial trouble in July and teetered on the edge of bankruptcy.
“The world of small-business financing is different now, and some things are changing permanently,” says Jim Anderson, a finance specialist with the Orange County, Calif., chapter of SCORE, which provides free counseling to small businesses.

Financial Attitude Adjustment

Micro-business owners must change their attitude about their finances—especially about how much debt they can handle—if they want to survive, Anderson says.

Many micro-business owners go to Anderson for help when trying to get a loan. Part of working through that process involves setting up complete financial record keeping, which includes owners doing monthly cash flow projections for two years out.

Anderson recommends that in this economy, micro-business owners study their financials weekly and make adjustments to catch problems early.

For example, declining revenues may signal a need to cut costs, delay planned spending or even lay off workers. Also, micro-business owners must be aggressive about collecting accounts receivable. Collecting accounts on time means owners won’t have to delay paying their own bills—and their balance sheets will keep looking good.

For businesses that get paid in installments over time, experts now recommend that those owners require a larger payment before starting work or delivering goods. Instead of accepting 25 percent or 50 percent of the contract price upfront, ask for 75 percent.

Such diligence is vital, Anderson says.

“If businesses get too much debt, they are not going to make it. Clients come to me to help them get a loan and I say, ‘If you don’t increase sales, you won’t get any help.’ There are not sympathy loans there now.”

The reason is simple. Banks themselves are in trouble.

The Federal Deposit Insurance Corporation has closed more than 50 banks nationwide this year.
And there are more problems, says Jim Davis, president of Southland Economic Development Corp., which facilitates small-business real estate and is based in Santa Ana, Calif.

Even as the Treasury Department urges banks to lend more, federal regulators are insisting that banks increase their reserves to cover potentially bad loans on their books. “They can’t do both,” Davis says about the bank squeeze.

The U.S. Small Business Administration (SBA), which guarantees small-business loans, weighed in on the financial crunch, too.

In a formal statement, the SBA said: “The financial crisis has created a variety of conditions that impact small businesses, including a lack of liquidity in the banking system, a reluctance of many lenders to extend new loans, tightened credit standards, weaker finances at small businesses and uncertainty about taking on new debt on the part of many entrepreneurs.”

The Upside Of Debt
However, micro-business owners should understand that debt itself isn’t bad.

“Debt is a very necessary, critical component of any business,” says Southern California bankruptcy attorney Jim Bastian.

“Keep in mind, debt isn’t just a loan. It’s equipment leases, credit cards, even payroll. If you take on any financial obligation that is due and owing, that’s debt. Taking on debt is appropriate when you have good sales and good accounts receivable, but you may not get your payment for 60 to 90 days and you need cash to run your operations.”

Video producer Chandler agrees that her initial indebtedness helped establish her company.

“I needed high-definition equipment to give me an edge over competitors who didn’t have that equipment,” she says. “I’m at the level I am now because I did have the high-def equipment.”

NASE Member Adam Edelman “studiously avoided debt” when he started Refined Technology Solutions. He launched the technology marketing company in 2002 in Baltimore, Md. But as circumstances provided growth opportunities, he did get a line of credit.

“I knew what I was doing,” he explains. “It was part of an overall strategy with an endgame in mind. The line of credit allowed me to invest in software that has helped grow my business.”
NASE Member Adam Edelman
His advice for micro-business owners is to write a plan before borrowing. Detail what the money will be used for and how it will be repaid.

Financial institutions typically require such a plan before approving a business loan, but it’s a useful exercise for the owner’s benefit, too.

Business owners shouldn’t be too quick to take on debt even when they begin to see the economy inching upward.

Bastian tells his business clients that economic recovery will be slow and urges them to expect to keep their belts tightened for at least another year regardless of some scattered signs the economy is improving.

The Downside Of Debt
“It’s not taboo [to borrow] if you’re using it for growth, but it is if you’re using it to keep up with the Joneses,” Edelman says about debt.

Bankruptcy attorney Bastian agrees.

“Bad debt is when you borrow money to fill cash flow shortfalls that are not backed up by assets or increasing sales. Attempting to borrow your way out of financial problems exacerbates them.”

The past year has been especially difficult for businesses with that bad debt, Bastian says. Starting three or four years ago, many owners got comfortable borrowing money because interest rates were cheap and the economy was strong.

They borrowed for acquisitions, staff expansion, equipment upgrades and marketing initiatives because they assumed their businesses and the economy would continue to grow, Bastian explains. And banks went along because they made the same assumptions about the good times continuing.

“When the credit crunch hit, lines of credit started being called, and companies weren’t prepared to pay that debt,” he says. “For every bankruptcy, I’m working on 10 cases to keep them out of bankruptcy court. Creditors and trade vendors are being more flexible now, but my clients have to make tough choices. They don’t want to make cuts because they’ve invested so much personally in their businesses. I tell them, ‘You didn’t make a mistake; no one saw this coming. Get over it and make the tough choices.’”

Edelman experienced the credit tightening firsthand when his bank reduced his business line of credit.

“I had been planning to increase it, but I had to suck it up and got through it. Owing too much debt really limits your independence. The old saw is, ‘make more than you spend.’”

Working Through The Credit Squeeze
Micro-business owners can take steps to ease the credit crunch and manage their debt. Edelman suggests that owners work with their lenders and credit card companies.

“The interest rate on my credit card went up to 13 percent,” says Edelman. “I called the company and told them I was a good customer and deserved an 8-percent rate. They dropped it to 7.6 percent. You have to ask. You have to make your case.”

SCORE counselor Anderson says he typically starts working with his clients on cutting expenses to the bone as well.

“Don’t cut the muscle, but keep costs as low as possible because no one is going to loan money to a struggling business.

“Almost all banks say they are still making loans, but only if you come in with a solid plan, none of this back-of-the-envelope stuff. We’ve had some clients turned down for loans that we thought looked pretty good.

“But sometimes, the only way I can figure that they can get out of a deep hole is to get their marketing machine going,” Anderson says of business owners. “They’re angling for loans, and I say, ‘if you don’t increase sales, you won’t get any help.’

“I have clients who have cut everything they can. The only way out is to build sales.”

Jan Norman is a freelance writer who is living debt-free until the economy improves. Visit her blog at http://ocregister.com/jan.


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