Magazine

The Small-Biz Job Machine Sputters


It's the biggest question mark hanging over the economy: If the recovery is so great, why is job growth so sluggish? High productivity, imports from China, and outsourcing of jobs to India may all be part of the answer, but some bankruptcy experts also point to the troubles plaguing small businesses. They usually create most of the new jobs in the initial stages of a rebound. But this time, they're increasingly going belly-up and extinguishing jobs instead. In fact, for the first time since 1990, more businesses with more than one and fewer than 500 employees shut down in 2001 and 2002 than were created, according to the Small Business Administration's most recent data. And there's no sign of improvement yet. "You're not seeing an economic recovery for smaller companies," says Michael Sharkey, president of LaSalle Business Credit LLC in Chicago, which lends to smaller companies.

Life has become a lot rougher for small fry: More than ever, their margin for error is slim, and their clout with banks and suppliers is weak. They're getting hit with fast-rising health-care, material, and energy costs that bigger companies can more easily absorb or raise prices to cover. At the same time, many small companies can no longer fend off bankers and investors who have given up waiting for their cash-strapped operations to turn around and are starting to pull the plug on them. Others are going under after losing big customers that have gone bankrupt. Professor Edward I. Altman at New York University's Leonard N. Stern School of Business expects public companies that owe creditors less than $100 million to account for over half of all corporate bankruptcy filings this year, up from 21% in 1999. He figures the average total debt in bankruptcy filings for public companies with $100 million or more in liabilities will also shrink, after falling from $277 million in 2002 to $110 million last year.

DOUBLE STANDARD. All this is happening just as much economic data seem to show that small businesses are getting more upbeat. More applied for loans in 2003's last quarter than in the previous quarter, according to January's Federal Reserve survey of senior loan officers. And the National Federation of Independent Business Index of small-business optimism hit the fourth-highest quarterly reading in the survey's 30-year history in January.

Still, the specter of bankruptcy looms large for the throngs of companies that compete with Wal-Mart Stores Inc. (WMT) and other discounters. Several companies that filed for Chapter 11 protection in recent months -- including Tower Records, toy retailer FAO (FAOOQ.PK), Factory 2-U Stores (FTUSQ), and One Price Clothing Stores -- had earlier specifically cited cutthroat competition with the discounters as major risks to their businesses in Securities & Exchange Commission filings. Wal-Mart declined to comment. Says Gary M. Kulp, president of the retail division of Boston-based restructuring advisory and investment firm Gordon Brothers Group LLC: "Retailers are now faced with a changing consumer dynamic that is so fast that if a public company misses a beat, it gets slammed."

What makes matters worse is that bankers and investors are less willing to toss a lifeline to a troubled small company. Unlike past recoveries, when even small fry could raise cash quickly by issuing a junk bond, investors aren't interested in issues of less than $150 million because they can't easily be traded. "The smaller issuer trying to raise $25 million has many fewer sources than one trying to raise a larger amount," says Jeffrey Bloomberg, a vice-chairman at Gordon Brothers. "This is one area where size matters: Liquidity is available to the larger weak companies but not to the smaller weak ones."

In the wake of a string of business failures, boards are increasingly leery of giving failing companies more than one shot at recovery if their business models seem flawed. Archibald Candy Corp.'s Fanny Farmer and Fannie May stores were once ubiquitous on downtown corners across the Northeast and Midwest. But when no one came to its rescue, it was forced in January by its board to file for bankruptcy for the second time. The same happened to FAO, which catered to a high-end clientele with its FAO Schwarz and Zany Brainy toy stores, after its board decided in December that it had no choice. Says Carter Pate, vice-chairman for client services at PricewaterhouseCoopers: "When many smaller companies' orders didn't pick up, the model they put forth to the investing public was busted."

Some companies are getting dragged down by their customers. On Jan. 28, Perryville Energy Partners LLC, a unit of electric utility Cleco Corp. (CNL) in Pineville, La., filed for bankruptcy. In July, it had gone into automatic default on a $133 million loan after its main customer, Mirant Corp., filed for bankruptcy. Perryville's loan was good only if its main client stayed afloat.

Soon, more industries and other regions may feel the crunch. Last year, California, New York, and Texas were especially hard hit because of their large concentrations of high-tech, energy-related, and financial-services businesses. PricewaterhouseCoopers expects drugmakers, computer manufacturers, and administrative-support companies to be the next big casualties. Many construction and real estate companies could also hit the wall when interest rates inch up, potentially puncturing the recent refinancing boom.

MOUNTAINS OF JUNK. Even big companies could be in trouble again if bankers and investors suddenly become more risk-averse. On Feb. 4, Standard & Poor's (MHP) warned that a rising share of lower-rated bonds, especially from consumer-products and telecom companies, could result in "renewed default pressure" in the next two years. Today, 23% of all American corporate debt is rated junk, up from 17% just two years ago, according to the team that follows global bond indexes for Merrill Lynch & Co. (MER). Many big corporations could be in dire straits if they are held to the same strict standards as smaller ones.

For now, bigger remains better. "Banks seem to be giving more waivers to larger companies, and bondholders are allowing them to put their problems off," says Christopher Stuttard, editor of BankruptcyData.com. That could be one reason why the total number of public companies filing for bankruptcy may decline by 25%, to about 100 this year, according to PricewaterhouseCoopers estimates.

That's little comfort to businesses like Chicago's Archibald. Faced with a deadly combination of rising operating costs and sluggish sales, the 84-year-old producer of Fannie May and Fanny Farmer candies closed its main factory in January. Now it's shutting the last three of its more than 200 stores -- and letting go of thousands of people who worked there. By Emily Thornton in New York


Hollywood Goes YouTube
LIMITED-TIME OFFER SUBSCRIBE NOW

(enter your email)
(enter up to 5 email addresses, separated by commas)

Max 250 characters

 
blog comments powered by Disqus