Hard Times on Main Street

By Alexander L. Taylor III

Small businesses everywhere are staggering from sky-high interest rates

It was a protest that both spoke of frustration and a sense of enveloping helplessness. Silver-haired Chicago Businessman William H. Hoyerman, 55, walked outside the red brick entrance of his truck-body plant, General Body Co., and lowered the American flag to half-mast. He then sent letters to his suppliers and customers, exhorting them to do the same. Said he: "Let us fly our flags at half-mast in mourning for the millions of employees and businesses like ourselves, who are being hurt by high interest rates."

Small businesses, which are roughly denned as those firms with fewer than 500 employees, are the very backbone of the U.S. economy, accounting for more than 56% of all jobs in the American labor force. Yet all across the U.S. managers and owners of small businesses are reeling as the towering cost of money pushes one firm after another to the edge of bankruptcy and, all too frequently, right down into the abyss of forced liquidation. During the first week of October alone, 468 U.S. companies, ranging in size from neighborhood dry cleaners to sprawling regional lumber mills, closed their doors for good, a rate that is more than double the number of a year ago and a cruel reminder to Ronald Reagan that for millions of self-employed small businessmen, supply-side economics is coming to mean pain and suffering aplenty.

Interest rates have replaced inflation as the No. 1 double-digit nightmare of businessmen everywhere, and the sheer unpredictability of the future cost of money has all but paralyzed decision making in firms both large and small. Last week short-term interest rates moved a notch downward, as several of the nation's largest banks dropped their prime rate to 18%. But long-term rates for corporate bonds and other such investments actually showed signs of inching upward a touch.

Meanwhile, Economist Henry Kaufman of the New York investment banking firm of Salomon Brothers, whose pessimistic yearlong predictions of ever higher rates have proved unnervingly accurate, delivered yet another gloomy forecast. He warned a group of corporate financial officers in New York that Government borrowing will propel the cost of money to new and higher peaks in the next six months or so. Said he: "A noose is now tightening around the credit markets."

With the cost of money high, business conditions have begun to deteriorate, and hardest hit are the smaller firms. Unlike large corporations, which can pass on mounting overhead expenses by raising prices or turn to friendly banks for loans at a discount from the prime rate whenever they need a few million in cash, smaller firms have no such opportunities. Even in the best of times, many of them exist on a shoestring of high debts, thin profits and volatile markets.

When the economy turns sour, small businesses are the first to feel it. Customers delay payments for months on end, while suppliers turn around and demand cash on delivery. At the same time lenders, such as local and regional commercial banks and finance companies, demand rates of two, three, and five points above the prime, and sometimes just turn off the money spigot altogether.

The current interest-rate squeeze first made itself felt nearly two years ago among auto dealers and homebuilders.

Now, it is rippling through the rest of the economy, causing failures from garment wholesalers to furniture dealers, from small manufacturers to Main Street retailers. Some casualties:

-- In June of 1980, Lessie McMiller took a $44,000 second mortgage on his Oakland, Calif., home to buy the La Rue restaurant in Emeryville, Calif., and go into business for himself. Yet no sooner did he open his doors than the Bay Area restaurant business began to dry up. For a while, Me Miller's suppliers delayed payments on his monthly food and laundry bills, but then they began demanding cash on delivery. As his debts grew--eventually to more than $4,000 per month in payments--McMiller tried to borrow his way out of trouble, but no bank would lend. Last August he filed to restructure his debt under the Federal Bankruptcy Act. He has laid off six of his ten employees and leased his restaurant.

-- Tasco Inc., a Shell Rock, Iowa, builder of hog barns, grew rapidly during the 1970s and saw its employment rolls swell to 200.

Last year the cost of carrying Tasco's debt load escalated as the company frantically borrowed money from one lender in order to pay off another. At the same time Tasco's hard-pressed farmer customers, equally strapped for cash, began to postpone building plans and cancel orders for hog sheds. With debts of $8.5 million and assets of only $1.2 million, the company filed for bankruptcy last spring and is now in receivership.

-- Stephen C. Kent, 38, the father of two, opened a hardware and building-supply store in Atkins, Ark., 2 1/2 years ago with a $50,000 loan, at 10%, from the Small Business Administration. When sales turned down this year, Kent could not stretch his finances any further. By last week he was literally out on the street. Said he glumly the day before an auctioneer gaveled off pieces of his business to the highest bidder: "It was almost impossible to make my payments; I just couldn't see any future in it."

The companies that wind up in bankruptcy court are only the most visible victims of the nation's small-business blues.

Often unnoticed are the ripple effects that come when businesses go under: the failure of the small sawmill that shakes the economy of a rural community; the entrepreneur who amasses only red ink in return for risking his capital and decides to play it smart next time and stick his cash in a high-yielding money-market fund; the worthy new enterprise that cannot afford to borrow and expand and therefore loses market share and stagnates, perhaps eventually being driven out of business altogether by some tough and well-heeled foreign competitor from, say, Japan. Says Purdue University Economist William Dunkelberg, a small-business expert: "For every firm that goes bankrupt, there are another 15 to 20 firms that pay off their debts and just close their doors."

"The small businessman is acting like he's in an airplane threatening to crash," says Mike McKevitt, director of the National Federation of Independent Business, which has 502,000 members. "He's throwing stuff out the windows to lighten up--trimming back inventories, prolonging payments, laying off workers--anything to keep going a while longer."

Though he empathizes with the plight of new businesses that get knocked flat before they can stand upright on their own, McKevitt is much more concerned about the growing number of existing businesses that are beginning to succumb. Says he:

"Everywhere I go it is the same question:

'How much longer am I going to have to hold out?' When you see the collapse of businesses that are ten, 20 and 30 years old, that is when you start to worry."

Ironically, some financing gimmicks designed to help small businessmen are backfiring. Frank Romano, owner of a Massachusetts advertising firm, borrowed $1 million in 1979 at a 10% rate designed to float up or down in tandem with movements in the prime rate. Now the rate on Romano's loan stands at 22%. The increased interest cost of $220,000 in annual loan charges is a key reason why Romano has now laid off fully one-half his staff of 100. Romano blames the Federal Reserve for his high interest rate miseries, and is lobbying the Massachusetts congressional delegation in Washington to get a small businessman and a farmer appointed to the Fed's board of governors.

Other suffering small businessmen say that commercial banks themselves are much to blame. Complains Jan Pitman Vanderpool, owner of a cash-strapped California management-consulting firm:

"Banks are fair-weather friends. They'll hold an umbrella over your head when the sun shines. But when you need money, the bank either isn't there or the debt service is so high that you end up working for free."

More and more small businessmen are now being forced to look for money from unconventional sources, and this has given rise to small-business money brokers.

One such firm is Octagon Financial of Marietta, Ga., which arranges credit lines for small-business clients through finance companies and then charges as much as 4% of the total loan as a commission.

Many small businessmen say they are just managing to hang on until interest rates come down, but they may have a long wait. Thomas J. Holt of West port, Conn., who publishes a prescient, twice-monthly investment newsletter, Holt Investment Advisory, contends that interest rates will remain high even as the economy itself slows. Reason: companies will have to borrow more than ever in order to compensate for reduced cash flow and fewer sales, as well as to keep rolling over their already accumulated debt. If retail sales drop suddenly, and inventories build up even more rapidly, credit will be further strained.

The small businessman seems caught in a dilemma not of his own making. While inflation was roaring at a double-digit rate, he was pinched in the vise of high prices and high labor costs. Now that inflation shows some signs of abating, he is being punished instead by high lending costs.

Eventually, he will have no choice but to adapt. Adjustment to changing conditions is in fact what being in business for one's self is all about, and the small businessman has demonstrated time and again that he is up to the challenge. On this occasion, however, the cost of adaptation is proving extraordinary.

--By Alexander L. Taylor III.

Reported by J. Madeleine Nash/ Chicago and Sara White/ Boston, with other U.S. bureaus

With reporting by J. MADELEINE NASH, Sara White

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