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DECEMBER 7, 2000

FINANCE

Starting to Feel the Squeeze
As the economy slows, small-business owners have one eye on increasingly cautious consumers -- and the other on their debt load

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It's the debt, stupid. As talk spreads of an economic slowdown that even Fed Chairman Alan Greenspan says could worsen next year, small-business owners are becoming increasingly worried about how deep they have gone into hock -- and how much they must pay to borrow money. Typically, small companies have less wiggle room than larger ones because they have less of everything: capital, product diversity, customers. Less of everything, that is, except high-interest debt.

This financial vulnerability starts to show whenever the good times take a breather. As corporate defaults and household-debt levels rise, banks tighten their lending standards, forcing more small-business owners to rely on equity lines of credit with an average interest rate well in excess of 10%. William C. Dunkelberg, chief economist for the National Federation of Small Business, says it's hard to calculate changes in small-business debt because a lot of small companies get working capital by using credit-card financing, or by borrowing against personal assets. One thing of which he is certain: Based on his surveys, borrowing activity and loan rates have both been increasing of late.

PLASTIC BURDEN. Whatever the precise number, many small companies "can't compete in the next phase of this business cycle because of credit," says Robert D. Manning, senior research fellow at the University of Houston Law Center and author of Credit Card Nation, to be published this month. "Their No. 1 source of credit is credit cards. Their No. 2 source is home-equity loans."

This increase in costs is often accompanied by revenue stagnation: As consumers pulled back a bit this fall, for instance, small companies watched sales moderate in such bellwether industries as automobiles and housing. So they are ratcheting down their spending -- and those that can are paying off debt.

In past downturns, for example, Donna Myers, owner of DHM Group, a marketing- communications firm in Holmdel, N.J., has seen clients cut back on advertising. "I think we're headed for a slowdown...you have to tighten your belt, get into a better cash position," says Myers, who is also president of the N.J. Women Business Owners Assn. "Debt is the first thing most small-business owners start to think about."

It's also the first thing their creditors consider. Kathy Fink's family business -- Harvey Fink Properties in Farmington Hills, Mich. -- just finished building two small neighborhood shopping centers and is about to start work on another. The company's lenders have grown more cautious, asking for more preleasing before construction and higher equity-to-loan ratios. "The economy is first and foremost in our minds," she says.

LOSING TRACTION. Her company's shopping centers primarily house small tenants -- dry cleaners, shoe-repair shops, drugstores, and the like. "As their business goes, your business goes," Fink notes. "We have to be prepared to accept rent late, accept it in twice-monthly payments -- be a lot more flexible, because, if the economy is soft, there's not going to be another tenant in line to take their place."

In Michigan, where the auto industry is an integral part of both the economy and the local psyche, the recent idling of several Chrysler plants has been sobering. "With the DaimlerChrysler merger of equals turning out to be not so equal, everybody has a real quiet 'Let's-wait-and-see-what-happens-after-the first-of-the-year' outlook," Fink says. "You don't expand. You don't buy a bigger house. You just wait and see."

Although the state economy is more diverse than it was 10 years ago, slower automobile sales are "a cloud on our horizon," adds Michael Rogers, vice president of Michigan's Small Business Assn. All the same, he notes the state's strength in health care, education, agriculture, and tourism. "It's unlikely all those would turn down at the same time," he says.

However things shake out, small-business owners nationwide have grown more pessimistic. Capital spending and inventory building by their customers has slowed, and many companies are finding that credit is tighter and more expensive, according to the latest monthly surveys of members of the National Federation of Independent Business. It's the consumer who will determine whether this slowdown slides into a recession, says Dunkelberg. Because of the stock market's decline, the $500 billion in reported capital gains last tax season will not recur, he says. "This will take a bite out of income and consumption."

NOT-SO-MERRY CHRISTMAS? Apparently, it already has. During the first full week of the holiday shopping season -- Nov. 27 through Dec. 3 -- sales at the nation's malls were down 6.9%, vs. the same period last year, according to the International Council of Shopping Centers. Overall, consumer spending in October was flat, and it could fall in the fourth quarter. Asked what they would do if they got $5,000 for Christmas, 80% of consumers surveyed said they would either save it or pay down debt, according to a survey by the Consumer Federation of America. Only 15% said they would spend the money.

"I think you're going to see a so-so Christmas," says Irwin Cohen, global managing director of consumer business practice at acountants Deloitte & Touche. The firm's annual holiday survey indicated that festive-season spending will be flat. "I feel a little less bullish today than when we did this survey back in October," Cohen says.

At the same time, hardly anyone is outright pessimistic. "People are starting to talk about a recession, but I don't see that in the near future," says National Retail Federation Chief Economist Rosalind Well, who notes that economic growth is expected to decline from about 5% this year to 2% to 3% in 2001. "It's not that bad," she adds. "It's just that relative to where we were, it's slow."

That's how auto dealers see it, too, says Mark Morrissey, spokesman for the National Automobile Dealers Assn. "We're coming down, but we're hardly coming down to what would be a hardship," he says. Despite a 3.5% drop in sales during November, the industry is forecasting 17.5 million auto sales for this year, which would be a record, and 16.5 million for 2001.

WEALTH OF WORRIES. This year's auto-sales growth came from rapidly expanding household wealth fueled by gains in the stock market and full employment. The smaller numbers projected for next year reflect, at least in part, the weaker stock market. As Morrissey acknowledges: "People aren't so sure about their stock portfolio now." The Nasdaq composite index is down some 30% for the year, the Dow Jones industrial average is down more than 5%, and the Standard & Poor's 500-stock index more than 6%.

Should the mood persist, of course, those sell-offs could affect consumer spending. Some of realtor Jay Goober's clients are among the people Fed Chairman Greenspan was referring to this week when he said the plunge in stock prices could cause consumers to cut back. People who were counting on their stock portfolios for downpayments, or as a cushion, "are discovering it isn't there," notes Goober, of Innovative Moves in Boston. "Every month, you're seeing a new revision of your expectations," he adds.

Although the real estate business is still good, would-be buyers are dropping out of deals, and property is staying on the market about 20% longer than it was a few months ago, he says.

Lower interest rates, which Greenspan is hinting may come after the next Fed meeting, on Dec. 19, would help many small businesses weather the immediate future. Auto dealers, for example, could make up some of their lost sales in 2001 by paying less to finance the cars sitting on their lots. As rates have gone up and sales have slowed, "they've had to watch their inventory very tightly," says Morrissey of the dealers association.

SPRING CRUNCH? Lower interest rates, however, might be too little too late for many heavily indebted companies, says author Manning, who expects a recession by spring. "These small businessess are going to be squeezed first and hardest." His advice? "I would pay off as many debts as I could."

It's too soon to tell whether the slowdown will turn into a recession. But it's clear that caution is starting to be the byword for business owners and consumers alike. Last year at this time, many were worried about the potential economic fallout from the much exaggerated Y2K problem. This year, they're worried about fallout from what might become known as the Nasdaq 2K problem.