Small business weathers the credit crunch

Large retailers are suffering, but these entrepreneurs believe they can weather a slowing economy.

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Wood Expressions, a Los Angeles business that sells $3 million worth of high-end backgammon sets, dominos, and checkerboards a year, has seen its fair share of recessions over the past 30 years. Owner Ron Reyes says he's heard about the threat of a potential economic downturn, but he's not particularly worried about the upcoming holiday season. "Personally, I don't think it's going to directly affect us," he says. "In fact, I think we're going to do better this Christmas than last year."

While the flood of doomsday headlines amid the subprime mortgage crisis and credit crunch says otherwise, many financial experts around the country share Reyes' sanguine outlook for small business. Harry Davis, the economist for the North Carolina Bankers Association, foresees financial growth for his state, while Keitaro Matsuda, a senior economist for the Union Bank of California, says that the risk of recession is limited in California, where many jobs crop up in healthcare and technology. "Out here in Montana, we're not affected by what's going on," says Linda Kindrick, the executive director of the Montana Community Finance Corporation. "It's not getting any harder for small businesses to get loans."

While corporations such as Target (Charts, Fortune 500) and Office Depot (Charts, Fortune 500) are posting weaker sales and Wall Street firms are executing lay-offs, all is still relatively calm on Main Street: According to the latest employment report by Automatic Data Processing, a provider of payroll services, businesses with staffs of less than 50 added 63,000 employees in October - the biggest expansion over the last fourth months.

Still, the rate of growth is slower than in recent years. A recent survey conducted by the National Federation of Independent Business says that the net increase of hiring in October was 3%, compared to 5% in 2006 and 14% in 2005. William Dunkelberg, the NFIB's chief economist, blames the hiring cuts on paranoia - optimism amongst the study's small business owners fell 1.1 points in October, according to his report.

As lenders place tighter constraints on loans, how many small businesses are actually being squeezed out? According to the NFIB survey, 36% of owners report experiencing regular borrowing activity, while only 7% say that getting loans is harder; both figures closely resemble the data from October of last year.

Wells Fargo's SBA Lending program gave $613 million in loans to small businesses this year - up from $578 million in 2006 - and projects more growth in 2008. "We're getting as many requests for loans as before," says senior vice president Tom Burke, "and we're not seeing a drop off in the amount we're giving."

Dunkelberg agrees: "It's certainly not a 'credit crunch' by any standard. We're not seeing any trouble amongst small businesses - there's no actual bad news, just prognostications of bad news."

But prophecies alone can generate a response: Just as fear of higher fuel bills keeps customers away from stores, the threat of a recession is breeding pessimism amongst entrepreneurs.

A November survey conducted by the Discover Small Business Watch says that more owners are losing faith in both the economy and their own companies' prospects. The survey's findings, however, also support Dunkelberg's claims of a disjoint between attitudes and actual activity: 38% of owners are experiencing difficulty paying bills due to recent cash flow issues, down from 46% in September.

While established businesses such as Wood Expressions will likely escape the credit crunch with few dents, newcomers could face greater peril. According to an April survey by the National Small Business Association, 44% of small business owners finance their companies with credit cards, while 29% rely on bank loans. Thirty percent of owners responding to Discover's survey in August said they use home equity loans - more and more difficult to obtain - for funding. Their dependence on credit, paired with the raising of standards for loans, could brew trouble for budding entrepreneurs.

Fred Mishkin, a Federal Reserve Board governor, insists that "the supply of credit to small business remains healthy," but some say it's getting harder for startups to access that cache. "It's never been easy for small businesses to get credit, but it's even more difficult now," says John Arensmeyer, CEO of the Small Business Majority, a Calif.-based advocacy group for entrepreneurs. "The level for acceptable credit scores has gone up, while the value of collateral, such as home equity, has gone down." Entrepreneurs will also struggle to fund businesses with non-institutional loans, he says. "It's a domino effect - it trickles across the board, so friends and family can't afford to give money either."

There's still one group, however, that can afford to lend - venture capitalists. Kylie Sachs, a partner at Ascend Venture Group in New York City, says that VC's have money, and they're still looking for good ideas. "We're interested in the long term effects," she says. "Investors will shy away from anything dependent on the housing sector or financial services, but other industries could grow."

In a recent survey of 862 real estate, mortgage, and financial workers by PartnerUp, a professional social network, 70% of respondents claimed to be in the process of, or seriously considering, starting a business. Nearly half of them were interested in entering the technology sector, a field that could weather a credit crisis. Scott Kimmel, an attorney, hasn't had to take out loans for his startup. Biometrics Technologies sells software that enables physicians to process insurance claims using fingerprints and other physical scans. "Financially, the space I'm in is a good market," he says. "What I do requires low overhead - I haven't had to seek any credit from banks."

Whether or not technology flies and real estate continues to sink, the real winners are the companies executing damage control. "If I was an entrepreneur right now," says Sachs, "I'd develop something that would help consumers manage their debt."

One such company is Freedom Financial Network, a San Mateo, Calif.-based financial consulting firm that manages more than $500 million in consumer debt. The business, which launched in 2002, will surpass $40 million in revenues this year and expects to double that figure in 2008. "Over the last few months, we couldn't hire fast enough," says CEO Brad Stroh. "The credit bubble is bursting - it's a volatile situation, and we're in the middle of it."

While Stroh's company is thriving, he says he "didn't go into business expecting the mortgage meltdown and the credit crunch." The entrepreneur conceived of Freedom Financial Network while working for a venture capital firm, where he witnessed the volume of debt that businesses built up. "I wanted to address the problem, and I wanted to do right by the consumer," he says.

"When I decided to start up, my partner and I bootstrapped the business." Stroh pauses, then laughs. "We financed it with our credit cards." To top of page

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