The recent turmoil involving Lehman Brothers, Merrill Lynch, and AIG have cost the economy billions of dollars, led to thousands of layoffs, and conjured up comparisons to the Great Depression. But how will the crisis impact entrepreneurs? The answer might surprise you.
To borrow from John Lennon, we read the financial news today… oh, boy.
This week saw Lehman Brothers file for bankruptcy, Merrill Lynch swallowed up by Bank of America, and a federal bailout of AIG. On Monday, as the startling news became reality, the Dow dropped 504 points -- its biggest fall since the aftermath of the 9/11 terrorist attacks. All of this comes on the heels of federal bailouts of Bear Sterns, Fannie Mae, and Freddie Mac, major slumps in the housing and automotive industries, and a national jobless rate at 6.1 percent, the highest in five years.
So does a slumping economy mean it's time for entrepreneurs to panic? To gauge what impact the crisis on Wall Street will have on Main Street, we assembled a panel of business owners, money managers, and finance gurus to offer their take on the real ramifications. The outlook, it seems, may not be as grim as you think. Sure, for the foreseeable future, money is going to be harder to come by, but, as with every business cycle, the strongest companies will survive. And it never hurts to have cash on hand.
Roughly a third of small businesses are backed by home equity loans. What will the effects of the mortgage crisis be?
Victor Cheng, president of Bookmercial Productions, a San Francisco-based branding and marketing company: If they have a home equity loan already, it won't affect them, but it will be hard to refinance. If they have a home equity line of credit, it will probably be reduced, if it hasn't already.
Clint Greenleaf, chairman and CEO of Austin, Texas-based Greenleaf Book Group: Even after Freddie and Fannie, the mortgage rate is still right around 6 percent, which is pretty good. If you already have the money, you shouldn't be in too much trouble.
Christopher Sobecki, managing director of private equity for Invus Group: It's obviously going to be more difficult and small businesses are going to have to look more broadly for financing. Being able to exercise equity in housing seems to have disappeared.
Eric Janszen, owner of iTulip, a finance and economics website, and the former CEO of Bluesocket and AutoCell, and managing director of Osborn Capital: It's going to affect them badly. Banks have already reduced the traditional means of credit and replaced them with revolving credit. Credit cards are more profitable and home equity loans are no longer economical.
Will there be something of a small-business correction?
Cheng: I think there will be a correction, but the bigger problem many entrepreneurs may have is that their personal finances are co-mingled with the business.
Greenleaf: For me, that's a tough question. I hate to say we're counter-cyclical, but our primary revenue is through book sales. When times are tough, people want to educate themselves and a book isn't a big-ticket item. I've seen a few deals fall apart because of financing, but I don't think it's more than normal. We're overextended as a country and people made a lot of dumb loans, so this is the natural progression.
Sobecki: I don't think a lot has changed in the way we go about finding companies to invest in. We look for long-term businesses with good management and provide capital. Whether the stock market is up or down is irrelevant.
Janszen: The economy is contracting, lending standards are tightening and banks want to increase deposits, so things are tough. The economy is evolving, though, and I see it going away from what I call the FIRE economy [finance, insurance, and real estate] back to an entrepreneurial investment economy where owners make products and invest the profits back into the companies. Good old-fashioned capitalism. Unfortunately, I think it will be a couple of tough years rebuilding the real economy.
Will entrepreneurs have a tougher time raising capital?
Cheng: Banks are under enormous profit pressures, but they still have to make money. They will be more conservative, but it has always been slightly harder for business owners to borrow money. On the order of magnitude of the real estate market, in which maybe 40 out of 100 loans from last year would qualify, business lending will only be off by 10 percent.
Greenleaf: Unless you are the poster child for good credit, you are going to have a hard time.
Sobecki: It's possible, but I think ultimately capital will be there. Private equity and venture capital may impact the way industry values assets, but I think even in this economy, capital will be available to entrepreneurs with solid business plans and the ability to execute them.
Janszen: Yes, banks are freer when times are good.
What are some strategies that can be in put in place to ride out the storm?
Cheng: You need to have cash on hand as a buffer. Business owners should also look to sell off any unproductive assets that are lying around, whether its outdated equipment, excess inventory, cell phones, whatever. Anything that can be turned into cash. That's what basically happened at Lehman -- they couldn't pay the bills and tried to turn it around in 24 hours.
Greenleaf: Cash is king, and access to any cash you have will put you in a better spot. Smart people will look at the opportunities, buying up more assets, and looking to vertically integrate the business.
Sobecki: Recognize the environment we are in and run things prudently. In the next year-to-18 months, it's going to be pretty tough to be a consumer. As part of a group that provides capital, I would tell entrepreneurs to be smart about how much money they need to run their business.
Janszen: The hidden benefit is that if you've been smart about cash management and can quickly reduce the fixed costs, it will be beneficial because your weaker competition will be probably going out of business. The pie will be shrinking, but you can increase your slice.
What are your general feelings about government bailouts?
Cheng: It doesn't work if we bail out everybody, but it also won't work if we bail out nobody. If companies know they will be fine, they will assume too much risk. It's the same reason we don't negotiate with terrorists. On the other hand, sometimes it's necessary. If Fannie and Freddie had gone under, you would have seen changes on your block. The ability to get a home loan would've been chopped in half, which would've been much worse.
Greenleaf: I can't stand it. I think it's a dumb idea. I imagine there are quite a few construction companies in Las Vegas that have gotten into a lot of trouble in this housing market who could use a bailout, but that would never happen. I understand Fannie and Freddie, but why Bear Sterns and not Lehman? I'm not a fan of big government in any way.
Sobecki: I think the government is trying to hold the banks accountable for their bad decisions. If an entrepreneur makes a foolish choice, they pay for it.
Janszen: They have to be separated on a case-by-case basis. Bear Sterns posed significant financial risk because of derivatives and it couldn't be allowed to fail. About $1 trillion of Fannie and Freddie is owned by China, so if we let that fall, besides the political ramifications, it could have sent inflation to 10 percent. A huge portion of Lehman was owned by Asian banks, so that's not our problem. I'm philosophically opposed to bailouts, but pragmatically, what are you going to do? I hate when the federal government gets in the way of innovation, like the $25 billion the auto industry loan is probably going to get. A bailout like that doesn't allow entrepreneurs to compete with GM and Ford on the next generation of efficient vehicles we desperately need.
Even if an entrepreneur hasn't felt the direct pinch of the economic crisis, should they be concerned with the general outlook? Are you optimistic or pessimistic?
Cheng: In my business, we've had record sales this year, so I'm optimistic, but carefully so. As a general rule of thumb, somewhere in the United States, business is good, so follow the money. Clearly, it's not real estate or Wall Street, but people still have to work, eat, and buy stuff.
Greenleaf: I'm worriedly optimistic. I think in the long run it will be a good thing to clear out all the crap in the credit markets, even if a lot more companies are sick than I initially thought there were. I think you'll see the Inc. type of companies that are lean, intelligent and don't need a government bailout coming through it fine. Even in this economy, we're having our best year ever.
Sobecki: In the short term, it will be a struggle. There will be a lack of liquidity, and capital won't be allocated as much, but ultimately it will strengthen the lending process. In the long term, our economy will be just fine.
Janszen: To me, it depends on the industry. For instance, the value of the dollar has been so low. It's been great for businesses that export. If you own a restaurant, though, food costs are going up and a down economy means fewer customers. Some industries will have it much tougher, so all you can do is be smarter than the competition.
Any other thoughts on the current woes?
Cheng: Look close at what's doing well locally, be nimble, and adapt quickly. We adjusted moving away from projects with smaller companies and focusing our "Bookmercials" on bigger market leaders. Oh, and make sure to put your arms around your current customers and show them some love.
Greenleaf: I'm an AIG shareholder and they insure our company, so that has me a little worried. I didn't see that one coming. Seems like an insurance company with all that steady income would be a lot more solid.
Sobecki: It's not time for a major panic. Businesses just need to keep on doing what they do, tightening where they can and trying to be as efficient as possible.
Janszen: My number one recommendation is too not assume things will get better in a hurry.