In-Depth

The Crunch for Cash

Solutions providers and their customers with established credit histories suddenly can't get financing. Is help on the way?

• By Anne Stuart
• April 01, 2010

While the crisis that nearly brought the nation's largest banks to the brink now appears to have stabilized, lending to small and midsize businesses (SMBs) remains at a standstill. Economists say the prosperity of SMBs is critical to an overall economic recovery in order to spur growth in capital spending and create much-needed jobs.

But this credit crisis is putting a chokehold on solutions providers and their customers alike. Customers, even those with good credit and cash flow, can't borrow to fund much-needed IT upgrades -- often to finance growth in their own businesses. Meanwhile, once-thriving solutions providers -- also with healthy credit ratings and balance sheets -- are struggling to obtain loans to float projects and capital they procure for customers.

Why is this happening? Blame a perfect storm of factors, all driven by the economic meltdown. Last November, two leading SMB lenders filed for bankruptcy within days of each other. First, New York-based CIT Group Inc., a 101-year-old commercial lender, filed a Chapter 11 petition in U.S. Bankruptcy Court. About a week later, Advanta Corp., a major SMB credit-card lender based in Spring House, Pa., filed its own Chapter 11 petition.

From there, the two lenders' stories took decidedly different turns. CIT Group emerged from bankruptcy a little more than a month later, after a judge approved a restructuring plan that cut about $11 billion in debt from its books. At press time, CIT Group was vowing to rebuild its SMB lending business, beginning with committing $500 million to small business loans within the next year. At the same time, Advanta -- which had stopped giving new loans months before filing its bankruptcy petition -- was liquidating its assets. (A subsidiary, Advanta Bank Corp. of Draper, Utah, wasn't included in the bankruptcy filing.)

Meanwhile, while actual lending is down, demand for funding is up. In January, 43 percent of about 850 SMB owners surveyed said they will need to raise money to keep their businesses afloat this year, according to research conducted by Rasmussen LLC for the Discover Small Business Watch, a monthly report on U.S. small businesses. That's up from 32 percent a year earlier.

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A Catch-22
But even before the news about the two big lenders surfaced, SMBs were finding it increasingly tough to obtain credit, according to a Gallup Inc. survey for the National Federation of Independent Businesses (NFIB), a Washington, D.C.-based industry group. The poll, conducted in late 2009 and released in February 2010, indicates that 55 percent of the 751 SMB owners it surveyed had tried to borrow money at some point last year. Of those, only 40 percent received all the credit they needed -- while 23 percent received none of the credit requested.

"The current level of borrowing success is significantly lower than in the mid-2000s, when up to 90 percent had their most recent credit request approved," Denny Dennis, a senior fellow at the NFIB Research Foundation, wrote in the "Small Business Credit in a Deep Recession" report, released in February.

In addition, he said, lending conditions "have deteriorated. Not only have banks changed the terms and conditions on loans and lines of credit, but poor sales and real estate values have damaged balance sheets, making it difficult to qualify for loans."

Specifically, the NFIB report found that:

• Financial institutions changed the terms or conditions of their lines of credit last year, according to 29 percent of the small businesses surveyed. The most frequent change: increased interest rates.
• The best "predictors of success" for obtaining credit included higher credit scores, fewer second mortgages held and being customers of banks with less than $100 billion in assets.
• SMBs typically weren't borrowing to hire new employees, buy new equipment or invest in new products: "Overwhelmingly, the most common planned purpose of credit rejected was to fill cash flow needs," Dennis wrote in the report.
• The stagnant or declining real-estate market "is a major reason why small businesses have not yet begun to recover, why larger businesses have been able to recover more quickly than small businesses, and why this recession is different, at least for small business owners, from recent ones," according to the NFIB report. Another NFIB report, its most recent quarterly "Small Business Economic Trends Data" survey, noted that regular borrowers -- those who access capital markets at least once during each quarter -- "continue to report difficulties in arranging credit at the highest frequency since 1983." (For links to both NFIB reports, see "Resources.")

Plastic, Please
The lending crunch has generated another disturbing trend: Seeing nowhere else to turn, a growing number of SMBs have resorted to using corporate or personal credit cards to keep their companies afloat, according to the National Small Business Association (NBSA), another Washington, D.C.-based trade group. The NSBA reports that nearly 60 percent of the 288 SMB owners it surveyed in mid-2009 admitted using credit cards to cover business expenses, up from 49 percent in late 2008. Some respondents reported carrying credit-card balances exceeding $100,000.

In addition to the often-hefty interest rates, the credit-card route can lead straight to serious problems for holders who eventually do apply for bank loans. That's because large credit-card balances and late payments can ding the all-important credit scores that financial institutions consider in deciding whether to make loans and in setting interest rates. (For that reason, credit-card reform is among the NSBA's top legislative priorities for this year -- just behind providing SMBs with better access to capital.)

Not surprisingly, the struggle to obtain credit hasn't done much for SMB optimism: "Small-business owners entered 2010 the same way they left 2009 -- depressed," the NFIB quarterly report noted. Only 1 percent of those surveyed for that report, released in early February, expected conditions to improve within the following six months.

Good News at Last
SMBs have historically bounced back from recessions more quickly than larger enterprises. Yet this time they're not leading the recovery, which administration officials call a key reason that the economy remains stagnant. That's because SMBs can't borrow, so they can't build or update their facilities. They can't replace equipment. They can't hire new people. They can't invest in new opportunities. And many are struggling just to market and sell their existing products and services to customers who simply aren't spending as freely as they once did.

Yet despite all this bad news, there are some highly hopeful signs for SMB credit and growth. In December, President Obama announced a package of proposals for accelerating job growth in 2010 and beyond. Topping the list was a series of initiatives designed to help "small businesses expand investment, hire workers and access credit."

Among other things, the administration recommended:

• Eliminating, for one year, the capital gains tax for small businesses in 2010.
• Extending, through this year, a provision of the American Recovery and Reinvestment Act of 2009 that allows SMBs to immediately expense up to $250,000 of qualified investment.
• Extending a Recovery Act provision that speeds up the depreciation rate for capital expenditures, which the administration said would "put more than $20 billion in the hands of businesses in 2010, while enabling Treasury to recoup much of the funding as business[es] regain their strength."
• Eliminating fees and increasing guarantees for small businesses that borrow through major U.S. Small Business Administration (SBA) programs this year.
• Offering tax breaks to SMBs that hire employees in 2010.

Obama, who mentioned "small business" repeatedly in his first State of the Union address on Jan. 27, unveiled more details about his administration's efforts to aid SMBs during the following days.

On Jan. 29, Obama spelled out details of the SMB tax-cut proposal. The plan calls for giving businesses a $5,000 tax credit for each "net new employee" hired in 2010 and exempting the employer from paying Social Security taxes for that worker for the rest of the year. Provisions in the proposal are aimed at ensuring that companies taking advantage of these incentives can't reduce the hours of existing employees or give them contractor status.

In addition, tax credits would be retroactive to the beginning of 2010, and companies could claim them each quarter, rather than wait until the end of the year to see the benefits. Even brand-new businesses would be eligible to get in on the action: start-ups would be eligible for half the tax credit. The plan would also cover Social Security payroll taxes for employee raises that exceed the inflation rate. More than 1 million SMBs would be eligible to participate in the program, according to administration estimates.

Speaking in Nashua, N.H., in early February, Obama announced the credit piece of the puzzle. He unveiled a proposal to create a Small Business Lending Fund that would provide $30 billion to community banks. Those banks -- up to 8,000 of them, according to the White House -- would, in turn, provide loans to many of the nation's 6 million SMBs. The money would come from federal Troubled Asset Relief Program (TARP) funds that have been repaid by bailed-out Wall Street financial institutions.

The Obama administration has also floated proposals to increase the reach of the U.S. SBA's loan-backing programs. (The SBA doesn't actually provide credit; it simply guarantees a portion of a commercial lender's loan, which can help SMBs who couldn't otherwise offer enough collateral to obtain the amount of funding they want.)

One initiative would temporarily increase the cap for SBA Express loans from $350,000 to $1 million. That's an attractive provision because those fast-tracked loans can be structured as revolving lines of credit, providing recipients with more flexibility over how and when they draw on the funds. Obama also proposed permanently increasing loan caps for several other SBA loan programs. The proposals were making their way through Congress at press time.

The Partner Picture
All of this is reverberating among IT solutions providers. Arlin Sorensen, founder of the fast-growing HTG Peer Group partner network, reports hearing from many partners who are going through their own travails.

"The frantic calls usually involve a very large sale that exceeds the minimal credit capacity that most partners often have available," Sorensen, CEO of Heartland Technology Solutions, a Harlan, Iowa-based Gold Certified Partner, wrote in a recent post to his Peer Power blog. "The good news is that end customers seem to be spending money again. The bad news is that many partners have done nothing to prepare for the increased demand and credit needs" -- and, as a result, they're struggling to take advantage of those business opportunities.

Sorensen urges partners to try to obtain credit before they need it -- a process that he warns will almost certainly be more difficult and labor-intensive than they've experienced in the past. "Prepare to provide a lot more documentation," including proof of profitability over time, he advises. And be prepared to consider creative structuring to make deals happen.

For its part, the HTG network has arranged for Ingram Micro Inc., a Santa Ana, Calif.-based technology distributor, to "accelerate credit-line reviews" for partners who follow the guidelines outlined in Sorensen's blog post (see "Resources" for a link to those details).

It's too early to determine whether any of the latest initiatives will provide the much-needed relief in the current lending freeze. But if any of the proposed measures helps break the chains currently binding commercial credit, that could go a long way toward helping Microsoft partners and other SMBs once again become what the Obama administration has called "the engine that drives the American economy."