Distant Thunder
August 20th, 2019

It’s a glorious summer day at the beach.  The economy is roaring along; interest rates are continuing to decline with all the benefits that come with lower interest rates; the president just postponed tariffs until after Christmas on certain items without which the world as we know it would end – such things as laptops and iPhones.  The sun is shining brightly.  But anyone who has been at the beach in the summer probably remembers seeing way off in the distance these beautiful high clouds beginning to appear.  Then you hear something that’s so far away that you can’t tell what it is, and you finally realize that it is thunder.  It’s still a long way off but it’s there, and the clouds are beginning to get larger and creep closer.

We’re beginning to see in those clouds more and more signs of a looming recession sometime in the next year or two.  In my opinion the word recession is like crying fire in a crowded theater.  But it sells ads.  Recession usually indicates big problems.  I think the economy is still healthy enough over a wide spectrum that while a slowdown is coming it doesn’t have to be a disaster.  But disasters sell ads.  One of the things worrying people to most is a US-China trade war.  Many companies are holding off on investment decisions on things like plants and equipment until the situation becomes clearer.  The US services sector declined in July to its lowest level in three years.  Last week the Conference Board said its index of consumer sentiment fell to its lowest level in nearly two years, and it is the consumer that has been driving the economy.  And then there is the inverted yield curve (next week).

So what does this say to small business?  Only that it may be time to look at all the pieces and parts of your business and make sure that everything is tight and you’re on top of your numbers.  When things are rolling like they have been there is sometimes a tendency to get a little complacent.  So a little tightening up may be warranted.  Maybe you have everything completely under control, but you want to keep an eye on the clouds.  You don’t want to get caught without an umbrella.

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With interest rates continuing to fall, if you have existing business debt it may be worth looking to see whether it might be eligible to refinance with an SBA loan in order to lower your monthly payments.  SBA loans were created with longer amortizations than banks were normally comfortable with in order to enhance business cash flows because of the lower monthly payments associated with longer amortizations.  Another key benefit is that interest rates allowable under the SBA loan program are capped.  So the interest rate on any SBA 7(a) loan (by far the largest SBA loan program) over $50,000 cannot exceed 2 ¾% over prime.  Since interest rates have been dropping you may have debt that was obtained earlier when rates were higher.  So even though they may not have been thought to be that high at the time, with rates where they are now and expected to go still lower you may still be able to lower your monthly payments. 

To refinance existing debt there are certain conditions that have to be met.  One of the prime requirements is that a new loan must provide the borrower with a “substantial benefit” demonstrated by the payment amount being at least 10% lower than the existing loan.  Some of the other important requirements are:

·       A demand or balloon maturity feature in the existing note or the current maturity is not appropriate to the original purpose

·       The existing debt being refinanced is on a revolving line or a credit card

·       Interest rate exceeds SBA’s maximum

·       Loan is over-collateralized

·       Line of credit lender is unwilling to renew

There are other considerations but these are some of the most important.  If you think that you might be able to benefit from an SBA refinance go talk to your banker or an SBA lender and find out.  It could be well worth the effort.

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Is nothing sacred anymore?  In a lab at Columbia University in New York graduate engineers are developing ways to laser print pizzas and cook them with laser beams.  The whole idea behind this desecration of the noble pizza is to be able to create a pizza that can improve nutrition.  The 3D printer has an array of cartridges in which ingredients can be loaded.  So for example the printer can lay down the dough, then another cartridge lays down the tomato and another lays down the cheese.  Then it is put into a specially-developed oven and baked with laser beams.  Makes for more even baking they say.

So the thinking goes that you could customize the material in the cartridge, say maybe the cheese, with certain additives or medicines that might be used in a hospital setting for example where people may have certain nutritional deficiencies.  Why not?  Meatless burgers are here to stay with all the societal benefits attendant.  Why not 3D pizzas?  New technologies already here and being regularly developed  and are creating opportunities currently undreamed of for startups to create whole new businesses developing products for the betterment of mankind or just consumers’ lives.  Such as pizzas.  Digitized food to help people stay healthy.  Bon appetit.

Yuk.

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Raising venture capital for a founder is an exercise in seeing how high the founder’s tolerance for rejection is.  But if success is achieved, survival is assured and the horizons are unlimited.  Maybe grow the company and sell it for a big number.  Maybe even go public.  Maybe even build to a large successful company that is a leader in the industry.  But in the meantime, there is a business to manage, and managing a growing company is a lot more complicated than raising a round of venture capital.  Managing goes on “forever” as long as you own the company.

In the earliest stages the founder has to manage him/her and maybe one or two employees.  Not that hard.  But then success and growth start to happen.  More people, with all the attendant problems they bring are being added to the payroll.  There are hiring and firing decisions to be made, maybe some government regulations (like having to pay taxes, hence having correct records, hence paying attention to the company financials).  You may need new space, with all the time required to find the right space to grow into.  And finally the small matter of always having to make sure that there is enough cash on hand, not to mention constantly focusing on increasing sales and revenue.

When you become a manager you may look back on raising venture capital as a walk in the park.  Now you have to learn to manage, whatever that takes and whatever that is.  Success won’t come without it.

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In Hamlet Act 1, scene 3, 75-77 Polonius provides this counseling to his son Laertes.  So we know that Polonius didn’t own a small business in today’s banking environment.  It’s fairly certain that the Fed is going to lower interest rates soon by at least a quarter of a point, on top of the already historically low interest rates that we have today.  One factor affecting the Fed’s decision is that China’s second quarter economic growth decelerated to the slowest growth in 27.  And since China is a major buyer of US goods a weak economy in China can slow growth in some sectors of the US economy.   

In March I wrote a post about no more interest rate hikes.  I never thought that instead rates would be coming back down.  So I will say again that if the Fed does go ahead and make the cut there will be plenty of time to look at your company and its future to see whether a loan of some kind would help your company grow and increase its profitability.  One way lower interest rates would help if nothing else would be that if you have credit card debt that has been used for your business you might be able to pay it off and increase your cash flow because of the substantially lower payments on a bank loan.  Taking on debt is obviously risky and not always wise.  But if it would help you grow and profit it might be worth serious consideration.

I wonder what Polonius would say today.

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Approximately 10,000 Baby Boomers are retiring each day.  A lot of these Boomers own businesses and a lot of them would like to see these businesses, which are their legacies, continue.  Starting a business from scratch may be a dream so that you can look back and say that you built your own successful business.  But as exciting as that idea may sound it is hard – really hard, and a very high percentage (some say up to 50%) fail in the first year.  That’s lousy odds when you consider that you are usually risking everything and therefore you could lose everything if you don’t make it.

Or, you could buy an existing business – one that is long past the high-risk startup stage.  Perhaps most important, it has a salary in place for the owner.  Otherwise, why would you buy it?  It already has customers although this could be a little dicey if you aren’t careful.  Often, and this of course does not apply to all businesses, business drops off for a period of time for a new owner because the customers were comfortable with dealing with the old owner and aren’t sure whether you can live up to the service, quality, whatever provided by the previous owner.  It should be incumbent as a new owner to try to make sure existing customers are aware of the transition and that you will continue to provide the same level (or better) of service that they had become accustomed to.  And one more thing.  Commercial financing to acquire an existing business, and especially SBA financing, is much more likely to be available than to a startup.

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It’s sooooooooooo easy.  The small business owner needs cash – fast, maybe for a new opportunity; maybe a new piece of equipment; maybe a fast infusion of inventory to meet an unexpected demand.  Even if the business owner has a relationship with a bank, fast isn’t going to happen.  First of all the loan may be too small, but if not, it still has to be underwritten to some degree and then approved by someone.  By the time it goes through that process the need may have gone.  But with an online cash flow lender, a usually simple application online and an approval within a few hours or maybe a day and the money is sent to your account.  Slam bam thank you ma’am.

Some cash flow lenders, based on the average amount that a business keeps in its checking account will make a loan – sometimes large, as soon as they get from you your bank statements for a certain period.  One or two other things may be checked but that can be done in minutes by the lender while waiting for the bank statements.  Once that is completed, the loan is made.  Fast.  To repay the loan the lender might take a small amount out of the checking account every day or several times a week.  No big deal; so small you’ll hardly miss it. Doesn’t hurt a bit.  But by the time the loan is paid off you could have had an APR in the range of 45%-plus with some lenders.  It is an unregulated industry.

These lenders lend hundreds of millions of dollars a year because there is a demand for it.  They are filling a need that banks won’t.  So if the small business owner needs cash fast they have to understand that it may cost them – big time.  But the cost of not getting the cash could be worse.  So the moral of the story is go in with your eyes open and read the fine print.

More on alternative lenders coming.

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Economics 101
June 18th, 2019

A few of you may have had to take Economics 101 in college.  A few of you might have even been able to stay awake for the whole class.  When the good times are rolling it doesn’t seem to be a real big deal to catch a couple of winks.  Don’t’ worry, the good times are still going to be rolling when you wake up.  Supply and demand – Economics 101 at its most basic.  There is lots of demand because we have money in our pockets, and lots of supply to fill that demand.  Business is good.  The fat lady hasn’t even gotten to the theater to sing yet.

The stock market just keeps going up, setting new records.  Jobs are plentiful, so much in some cases that there aren’t enough people to fill them putting a damper on opportunities to continue to grow.  In terms of unfulfilled demand, just look at the long-haul trucking industry.  I have seen figures as high as 50,000 jobs going begging in that industry alone.  Wages are continuing to be forced up to attract new drivers.  But the shortages still exist.  House prices, the major source of most people’s personal wealth are high.  Consumer sentiment is high.  The Small Business Optimism Index continues to set new records.

And just to keep the party going a little longer, interest rates are probably not going to keep going up as it appeared just a few months ago but instead may be dropping slightly, offering a longer window for small businesses to borrow at very favorable rates if funds are needed to grow their businesses or purchase big ticket items such as real estate.

“We have six exits from our aircraft….  In case of a sudden decrease in cabin pressure oxygen masks will drop down from the overhead bin.  Place the mask….”  It may be time to at least pull out the seat card in front of you to familiarize yourself with how to get out of this plane that just keeps flying higher and higher.

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PayPal; Amazon (Why not?  They’re already selling you wheat germ.); On Deck; Kabbage;  Square Capital.  In 2018 these five online lenders originated over $11 billion in loans, almost all to small businesses.  In another segment of the small business lending space lives peer-to-peer lending.  Online lenders such as Lending Club and Prosper have been operating in this space for several years.  Another one of the major players – Funding Circle, reports that they have originated $9.5 billion in loans.  Again, a high percentage to small businesses.

Most banks, especially smaller banks, can’t compete in this market because traditional banks still have to use conventional underwriting methods to underwrite almost any loan request including very small loans such as the sizes that any small business owners often need.  It becomes cost prohibitive for a bank to go through the same process for loans that are often higher risk and don’t make the bank much money.  Adding one zero to a loan request (say $500,000 versus $50,000) for example takes almost the same process as a small loan request.  So why make small loans?  Small business owners needing working capital or inventory financing for example don’t have time to wait for a loan committee to make a decision.

The mega banks are getting there.  But unless smaller banks can figure it out they are going to continue to lose small business customers.

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Maybe even a lot more depending on which bike.  Tariffs again.  One specific example illustrating last week’s post, “Higher Prices at the Store” is the bicycle industry.  For example, a Richmond, Virginia company founded in 2014 makes lightweight bikes for children.  It has generally been selling 400 to 500 small two-wheelers a year.  It designs the bikes and they are made in China.  The company paid a 10% tariff on its last shipment, and if new tariffs are imposed on certain consumer goods the cost to the company could even go higher forcing it to pass along most or all of it to their customers.  What that would do for their sales is hard to predict, but a good guess would be that their selling prices would have to go up with potentially negative effect on sales and earnings..

China dominates the American bike business.  90% of bikes with small wheels come from China.  Many other bike accessories such as coaster brakes (80%) and signaling equipment (approximately 70%) come from China as well.  Almost 100% of imported rubber tire tubes come from Taiwan Vietnam or China.

So there is your next bicycle, and that is just one specific industry.  Other things such as furniture and clothing could be dramatically affected.  How many small businesses that have Chinese-made components have started thinking about a strategy to deal with higher tariffs?  Looking even longer term, how might lower sales and earnings affect the ability to borrow money for expansion, inventory financing, working capital and other needs?  We may be looking at a ticking time bomb. 

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