Small businesses devastated by the credit crunch

Yesterday, I received a call from a good friend of mine who is president of a chamber of commerce.  Also on the call was a successful, small business owner who I have never met.  (Let’s name him Chris for convenience.)  They called to inform me of yet another horror story that involved American Express, but this story was a little different because I normally hear about consumer credit horror stories, not business horror stories.

In a nutshell, Chris, whose company is doing well and was offered the American Express Black Card at one point, had his credit line reduced tremendously.  Unfortunately, there was no warning.  He found out while on a business trip in Germany when his card was declined.    I listened to his story, told him what I know about the changing industry, and gave him some advice.

Recently, an article appeared in The Wall Street Journal detailing similar stories.  The credit crunch is hitting small businesses the hardest, causing the rate of business bankruptcy filings to outpace consumer bankruptcy filings over the past 12 to 15 months. 

The main problem caused by credit line reductions and account cancellations is not having access to working capital, especially if cash flow is low or negative.  Many business owners use credit cards to buy inventory.  Without access to capital, they have no choice but to lay off workers or look for cash in other ways.  If that doesn’t work, bankruptcy is the last option.  Furthermore, because of the slow economy, Days Sales Outstanding (DSO) is prolonged, and consequently business owners may not be able to pay back on time debt used to buy products.

The Wall Street Journal article also mentioned a study done by Fair Isaac Corp. and Robert Morris Associates.  This study, conducted in 1995, indicated that the best predictor of repayment of a business debt was a business owner’s personal credit score.  Subsequently, credit card debt extended to small business owners soared. However, I doubt the study predicted that when in dire straits, small business owners are more likely to file bankruptcy for their business than in their personal lives. 

In conclusion, the government rescue plan for businesses may be too late in many cases.  Thousands of small businesses, the engine of the economy, have no lifeline.   But it gets worse: for every business that goes under, it takes with it employees and dependent families that undoubtedly will suffer.  As for Chris and his business, he says he has adjusted the terms for his vendors, giving them less time to pay.  Furthermore, he has started to use other credit cards to tread water.  He is hopeful that he will not have to lay off some of his employees.  

[ Read The Wall Street Journal Article. ]

Comments

[Dr Robert Lahm]

I was the one who briefed Jane Kim on the background regarding the surge in "small business credit cards" and the history (Fair Isaac/RMA). As you know, I published a "Credit Cards and Small Business Usage Report" on my ChangeInTerms.com site. The report was originally a 3 page backgrounder that I wrote for her (and since I had the momentum, I decided to go a little further and issue my own e-report/publication).

Although I did get a tiny mention in the WSJ article, I have conducted research (while I have been an entrepreneurship professor-academic) on entrepreneurial bootstrapping and credit cards for several years.

I'm not complaining about the tiny mention, because I was pleased that Jane evidently interviewed entrepreneurs (highlighting the "human interest" angle). Nevertheless, the report (which includes links to my research and bibliographic referenced) provides the details.

[Been There]

Yup...Am Ex decided to get rid of their entire line of Business Lines of Credit last Fall. Left my business hanging with no funds to purchase new inventory, as we relied on that line. Luckily, we were able to arrange new financing with a bank but it was VERY scary due to the tight credit climate. How many small businesses were put in dire straights by what American Express--now a horrible, anti-business and anti-consumer company--did to its customers? I am still appalled that American Express was given bailout money since they were a MAJOR problem in the credit tightening last Fall, and the TARP funds didn't change their tactics. They are a disgrace.

[DW]

Yup. Been there. Doin' this now. Amex screwed me and I cried for two days and then had to figure out how to pay all the bills. They took away my 30 day float and it was scary - we are still recovering.

I employ 5 people with benefits and I am cutting out my own salary to keep everyone employed. Amex sucks. Ken made 40+ million last year, folks.