New for '97

Tweet

And labor shortages are spreading to the unlikeliest of regions. Both small and big businesses seeking the open-space lifestyle have been moving to the Dakotas, for example, only to find themselves vying for workers.

The overall lack of workers threatens to drive up wages. But unlike in the old days, when entire industries raised prices en masse, most businesses won't be able to pass on increased labor costs through price hikes, because of stiff global competition. The conclusion: higher wages won't drive prices up, but they will drive profit margins down.

To complicate matters further, companies that employ skilled labor will increasingly feel the "Silicon Valley Effect." If employers skimp on incentives in terms of income and work environment, good employees will leave for greener places. To keep valued workers, be prepared to reverse the trend, seen over the past six years, of shrinking benefits in the areas of bonuses, profit sharing, and employee stock ownership plans. Some businesses are already doing so, according to a survey by Arthur Andersen's Enterprise Group and National Small Business United, which found that fast-growing businesses were offering more such benefits, compared with the average company, which continued to trim them in an effort to reduce costs.

Reform Opens Money Tap

Contributing to '97's fiscal betterment is, of all things, tax reform. No, Congress didn't eliminate taxes, but our enlightened solons did reformulate Subchapter S rules in ways that, as appraised by Arthur Andersen Enterprise Group deputy director John Evans, "dramatically" enhance the payoffs of electing Subchapter S status.

Among other provisions, the Small Business Job Protection Act of 1996 encourages outside investment in small private businesses by pension plans, trusts, and other tax-exempt entities. Those capital pools were previously ineligible investors. Now such an entity may constitute a single stockholder among an S corporation's new limit of 75 stockholders. (Before the act, the limit was 35.) For fiscal years beginning after December 31, 1997, the act also provides for employee participation in an S corporation through an ESOP, a strategy also previously forbidden to S corporations. (Concomitantly, C corporations with ESOPs and pension plans already extant will then be able to elect S corporation status.)

As a consequence of those new sources of equity financing, S corporations can seek a capital stream that's never before been available. Whether that stream proves to be a trickle or a torrent for the growth of closely held businesses, time will soon tell, says Evans. "After January 1, we'll see if there's a shift in fund interest. Until now fund investment managers focused on the public stock market. But if the market turns and everyone gets frightened, where else is all that money going to go?"

VCs Seek Less Venture

Even at this late point in the current economic expansion, more venture capital is available than ever. Unfortunately for small-business aspirants, more is less. The nature of venture capital is changing rapidly, notes venture capitalist William Elmore, a general partner of Foundation Capital, a Silicon Valley venture firm. One dynamic emerging from more than six straight years of plenty is the compounding effect of nouveau riche entrepreneurs streaming from prosperous companies and eager to start others. So many millionaires have been created among the employees of start-ups in the past few years (in going public in 1995, Netscape Communications created scores of paper millionaires, down to founder James Clark's own office staff), that there are fewer I-can-do-it-too hopefuls looking for seed capital. They've already got their own.

Not long ago, venture-capital firms called the shots and grabbed huge chunks of every deal. Today, awash in capital, the venture-capital industry rushes to accept a smaller share for a larger contribution with less risk. That's OK by Elmore, who has no problem letting rich, smart second-time-around entrepreneurs do their own early financing. More and more often his firm steps in only after customers are buying the company's product. Even in the later stages of a company's development, he says, "a small business coming to a venture firm saying, 'I'd like a half million dollars' is likely to hear, 'I'm sorry, our minimum investment is $3 million."

While statistics indicate that start-ups can still find venture cash (see " Are Big VC Deals Bad for Start-ups?"), the newly conservative venture-capital firms are achieving dramatically higher success rates in their investments. For instance, in Foundation Capital's last eight deals, six companies already had revenues when the first venture commitment was made. The typical cash-out interval has shrunk from about seven years to fewer than four. "We're building management teams that can execute rapidly and cleanly and reduce risk," Elmore says. "I'd rather have a smaller ownership position in a company that's likely to succeed." Even longtime speculators like Boston's TA Associates have turned ultraconservative; TA now admittedly seeks only situations involving companies that have $25 million in annual revenues.

 PREV  1 | 2 | 3  NEXT