ASCENDING SMALL BIZ RISK

It takes a certain type of personality to jump into ice climbing. In this sport, climbers ascend frozen waterfalls in the dead of winter. Climbers know that the ice is constantly changing, given their weight and the sun's rays. As independent bankers know, small business lending can also be very risky if precautions aren't taken. While the risk in this sector can be high, new research may provide some clues as to what factors are predominate when small businesses fail. Seasoned bankers know that the statistics show more than 30% of new small businesses fail within 2Ys and more than 50% will go out of business within 4Ys. That information isn't new, but the question is whether failure rates are high because of poor budgeting, unrealistic expectations, bad physical locations, or other factors. We strapped on our safety gear and climbed this mountain of research in an effort to get independent bankers some answers. The research was based on information and data taken from thousands of bankruptcy filers. In it, researchers found that one common factor leading to failure was overall size. In general, the smaller the company's size (in particular, companies with less than 10 employees), the more likely they were to file for bankruptcy. Lack of economies of scale and high competition are risk factors that can be too much for many businesses to overcome. Another factor to consider when underwriting is the level of competition the company faces. That is because the data finds those concentrated in retail or service sectors (i.e. highly competitive) with lower profit margins, are more likely to fail. One of the more shocking aspects of the research was that failed business owners were also usually married, had higher education levels and began their companies with a reasonable amount of capital. They also had an average of 10Y of business experience before starting their venture and 36% had even owned a business prior to the one that led to bankruptcy. Intuitively these factors seem to indicate a lower risk profile; the data does not bear that out. It shows that the type of business or target market is more important than the person's business experience. In other words, good economics trump good experience. Another significant factor that led to the demise of many businesses was a high level of credit card debt. As national banks roll out aggressive small business programs designed around credit cards, independent banks may want to take another tack. Bankers should launch programs targeting creditworthy businesses in hopes of lowering their debt service expense and simultaneously improving their chances for survival. Banks should also more closely monitor debt loads for this customer segment. Note that the average small business owner at bankruptcy had over $259k in debts, nearly 5x as much as the average person who filed during the same analysis period. Financing company expenditures periodically with credit cards may be ok for some, but high interest costs can kill a business, so care must also be exercised. In closing, bankers can help their customers by educating them on the value of sticking with a budget, avoiding high cost credit card debt, staying out of highly competitive or low margin business lines, managing tax exposures (cited by 20% of filers), taking time out from the business every so often to limit personal problems from arising (cited by 17% of filers) and ensuring the business has a disaster recovery plan in place (calamities felled 10% of businesses). In so doing, bankers stand a much better chance of making sure their small business clients don't hear the ice begin to crack as they try to ascend toward greatness.